Little Lift from United's Discount Airline

UAL says a low-cost service is key to its rebound. More likely, it'll rile unions, confuse customers, and eat into mainline sales

By Michael Arndt

Two months after taking UAL Corp. (UAL ) into Chapter 11 bankruptcy, Chairman and Chief Executive Glenn Tilton has begun laying out his plan to restructure the airline by mid-2004. The centerpiece: a new low-cost service that would offer bargain fares coast-to-coast and complement UAL's mainline brand, United Airlines.

On paper, the move seems sound. Though details are still being worked out, the new subsidiary, code-named Starfish for now, would look a lot like Southwest Airlines (LUV ), featuring only one type of aircraft, no-frills cabins, and flights to vacation markets such as Orlando and Las Vegas. It would be staffed with lower-paid employees who likely would be reassigned from United's payroll, says Douglas Hacker, UAL's executive vice-president for strategy.

In theory, Starfish should finally blunt Southwest and other cheap-seat carriers that now compete with United on 70% of its routes and are stealing ever-more business. The airline would start next autumn with service from Chicago, Denver, San Francisco, and United's other hubs and could soon account for about a third of United's 1,700 daily flights.


  It would be a radical departure for the world's No. 2 airline, but given UAL's financial straits -- the Elk Grove Township (Ill.) company lost $3.2 billion in 2002, after a $2.1 billion loss in 2001 -- Tilton argues there's no other way. "Every one of us knows that we cannot fix our business as it is currently structured," he told employees in a recorded message before management presented his plan to union chiefs on Feb. 4. "We must establish an alternative to the low-cost carriers that will appeal to the customers in this market segment."

In reality, however, Tilton's transformation may be only another dead-end. Indeed, UAL attempted a discount carrier once before, Shuttle by United, which began in California in 1994. It was folded into the mainline in 2001, after unions pushed labor expenses back up to United's levels, rendering it uneconomical.

And UAL's wasn't the only failure. Every hub-and-spoke carrier that has started a discount subsidiary -- from Continental Airlines' (CAL ) Continental Lite and US Airways' (UAWGQ ) MetroJet to Delta's (DAL ) Delta Express -- has flopped as costs ballooned and single-minded rivals like Southwest or JetBlue Airways (JBLU ) expanded.


  "I'm skeptical an 'airline within an airline' can ever work," says Michael Levine, a Yale University law professor and former airline exec. He predicts that at best UAL would simply trim its losses by creating a second airline, rather than actually make money.

Things aren't likely to be different with United in Chapter 11. United's labor unions, fearing steep wage cuts at Starfish and the loss of more jobs, are vowing a fight to the finish to keep Tilton from launching the low-cost service. Paul Whiteford Jr., chairman of the 8,600-member Air Line Pilots Assn. at United, predicts the plan would lead to a piecemeal sale of United. "There's no recipe out there that says this is a good idea," he says.

Adds Gregory Davidowitch, president of the Association of Flight Attendants at United: "This strategy could not be worse." Granted, the unions may not be able to do much more than complain: At the end of the day, Bankruptcy Court Judge Eugene Wedoff could impose contract terms on labor allowing UAL to proceed.


  Even if Starfish takes off, however, industry consultants and analysts warn that it probably won't get very far. When the new contracts come up for renewal, unions undoubtedly will push to lift pay scales and workplace rules to mainline levels, just as they have done at every other airline that has ever imposed a two-tier wage structure. Once that happens, the new unit no longer will have the edge needed to go head-to-head with low-cost rivals.

Plus, United will incur another cost: surly employees who feel they've been relegated to second-class status, especially if their pay rates were crammed down their throats by the judge.

That's not all. By operating from the same airports with tickets issued by the same company, the twin airlines could easily confuse and rile passengers -- particularly business travelers, who may find themselves stuffed in a one-size-fits-all plane instead of a roomier United jet.


  UAL aims to create a discount airline that would be self-sufficient, but some analysts predict it may be forced to subsidize its bargain prices on Starfish with cash from high-priced tickets on its mainline flights. That's what Delta appears set to do with its new Song discount airline, a 36-plane operation that will launch in April with service between the Northeast and Florida.

United isn't the only network airline getting blown away by discount rivals. As bankruptcy chatter grows louder, American Airlines parent AMR Corp. (AMR ) is telling unions it must slash labor costs by $1.8 billion a year to return to avoid UAL's fate.

The upshot: The more Starfish expands, the more it could eat into mainline sales and the less money UAL would have to funnel into its startup or its own pockets. "This plan is something they could lose the airline over," observes Darryl Jenkins, director of George Washington University's Aviation Institute and an industry consultant. "In all candor, they should forget it."


  Tilton concedes his transformation plan is still evolving. UAL's creditors committee, for instance, hasn't yet been briefed on the restructuring. Once that happens, Hacker says, management will take feedback from all stakeholders and modify the scheme if necessary.

Still, it looks like Tilton's goal of saving UAL might be better served by transforming all of United Airlines into a money-maker, not just a piece of it.

BusinessWeek Chicago Correspondent Arndt always flies discount whenever he travels

Edited by Douglas Harbrecht