Commentary: The Airlines: Caught between a Hub and a Hard Place

Most of the big U.S. airlines are getting their wings yanked off. And it's not just because of the aftermath of September 11 or the economic slowdown. In a June meeting with Wall Street analysts, American Airlines CEO Donald J. Carty said: "Everybody knows the industry's current pricing model is badly broken. Many of our customers feel as though they're being cheated. It's clear that something dramatic needs to be done."

One critical problem: the treacherous economics of the carriers' far-flung networks, in which dozens of "spoke" cities are served through a handful of "hub" airports. In good times, hubs enable the airlines to provide frequent service to many cities with short layovers. But the hub-and-spoke networks of United Airlines (UAL ), American Airlines (AMR ), Delta Air Lines (DAL ), and other big carriers are enormously expensive to run--and business travelers seem no longer willing to pay the high ticket prices that make them viable.

Change won't be easy. If hub airlines cut back too much, they will surrender the one advantage--service--they have over discount point-to-point carriers, such as Southwest Airlines Co. (LUV ) Says Peter P. Belobaba, an aeronautics professor at Massachusetts Institute of Technology: "It's very difficult to incrementally dismantle a hub."

The hub airlines' troubles have worrisome implications for other financially stressed, deregulated industries that have high fixed costs, such as telecom and electric utilities. In each industry, serving additional customers is cheap once a network is in place. But price wars are endemic. Airlines, which were deregulated in 1978, have made some money by offering business travelers the high-frequency connections they want, albeit at a high price. But if corporate purchasing departments are balking, it's not a good sign for the other high-fixed-cost industries that have been looking to boost profits.

In many ways, hubs are a great idea. A point-to-point airline could never make money on frequent service between, say, Syracuse and Richmond. But a hub airline can, by routing passengers through Newark or Detroit. It's easy for hub airlines to fill flights out of smaller cities because their planes carry passengers bound for anywhere in the world--not just one destination, as with a point-to-point airline.

But the blanket coverage comes at a price. To minimize layover times, hub airlines schedule lots of flights to arrive and depart within narrow windows of time called "banks." That requires leasing many gates and having lots of ground crew, who are idle between banks. Also, planes and their expensive flight crews spend more time on the ground than point-to-point crews do because they have to wait for connecting flights. Hub airlines' labor costs wouldn't seem so high if they got more hours of useful work out of their employees.

The necessity of charging high fares makes hub carriers vulnerable to attack from both above and below. Some high-paid business travelers are turning to private jets, while the budget-conscious are switching to low-fare airlines, including point-to-point carriers. "What was a competitive advantage in the '90s--hubbing--is becoming a competitive disadvantage," says Bert Winemiller, CEO of Houston-based PROS Revenue Management, which sells fare-setting software to airlines.

Hub-and-spoke systems will never disappear entirely, because only they can provide frequent flights to many cities with short layovers. Even Southwest's chief financial officer, Gary C. Kelly, says: "I would concede that our approach is a niche approach."

But the hub airlines can't continue business as usual. To save money, they are likely to spread their flights out instead of concentrating them in banks, thus lengthening layovers. In the longer run, airlines will merge and close hubs. "There will be less service, and it will be less convenient to travel," predicts Robert Crandall, the ex-chief of American Airlines, who created some of the first hubs. American is already experimenting in Chicago with scheduling flights more evenly, cutting congestion by building in longer layovers.

Corporate America's travel-and-expense accounts have paid for an impressive system of air transportation. As expense accounts shrink, airlines are the first losers. But the ultimate victims will be the traveling public.

By Peter Coy

With Wendy Zellner in Dallas

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