Can Delta Carry Song's Tune?

The faltering company may remake itself along the lines of its low-cost subsidiary

On the steamy tarmac at gate D33 of Hartsfield-Jackson Atlanta International Airport sits what may be a model for the future of Delta Air Lines Inc. (DAL ): a snazzy white-and-green Boeing 757 operated by its lower-cost subsidiary, Song. Baggage handler Michael J. Moriarty exults that sliding bins on Song's 757s make loading luggage fast and easy, helping him turn around Song flights in 50 minutes. At Delta, hand-loading the heavy bags into holds often pushes turn times to an hour and a half.

Onboard Song, four cheery flight attendants in lime-green Kate Spade outfits work the 199-seat plane, instead of five on Delta's 183-seat 757s. Their job is easier, too. Instead of two or three classes of service, all passengers on Song fly economy. And each one luxuriates in an all-leather seat fitted with a 24-channel TV and two extra inches of legroom. "I wish Delta would do this to all its airplanes," says Steve Hill, a flight attendant on American Airlines Inc., (AMR ) who recently flew Song to New York.

Delta just might. Top management at the third-largest airline is preparing a massive seats-to-skycaps overhaul. CEO Gerald Grinstein, 71, the former chief of Western Airlines, plans to outline Delta's future plans to employees and union reps on July 28, and present that "strategic review" to the board in late August. Grinstein declined to comment on the presentation, but he has already told employees in a series of internal memos that Delta will look radically different within a year. Wrote Grinstein in one such memo on July 1: "A business strategy is being developed that does not rely solely on labor cost-cutting, but includes operational restructuring and innovation we'll need to survive and compete." If he wins deep wage cuts from his pilots, which looks more and more likely, and can toss in a few of the tricks that have helped low-cost carriers thrive, Delta may yet have a fighting chance to save itself.

The situation at Delta is so dire that little short of an extreme makeover can keep it from Chapter 11. On July 19, the carrier reported a $2 billion second-quarter loss, largely the result of $1.65 billion in noncash charges to write off deferred tax credits, and additional pilot pension costs. More than 300 Delta pilots called it quits in June. On an operating basis, Delta lost $312 million, vs. a $383 million loss in the first quarter. At the same time, its 2,090 daily flights have racked up $680 million in higher fuel charges this year. Analysts worry that Delta is depleting its $2 billion in unrestricted cash at a rate that could push it into bankruptcy by year's end. The same day the carrier reported its earnings, ratings agency Standard & Poor's Inc. downgraded Delta's debt to CCC+, or junk-bond status. "This is a last-gasp situation," says Robert J. Gordon, an airline expert and professor of economics at Northwestern University.


Delta probably needs at least $2.1 billion in annual savings to become competitive, say analysts. JetBlue Airways (JBLU ), AirTran Airways (AAI ), and Southwest Airlines (LUV ) fly the same routes that provide Delta over 70% of its domestic revenue, and their costs, on average, are 27% lower. Delta wants about $900 million in pay cuts and reduced medical benefits from its 7,500 pilots, its only unionized employees. It may also try to restructure its pension funds, to which it owes $3.7 billion -- a dicey move that would cut retiree payouts. A further $100 million in savings could come from adding up to eight hours per month to pilots' flying time.

The pilots union says changes in work hours and pay cuts might be O.K. if linked to a complete restructuring. Analysts add that the pilots are also likely to seek equity in Delta and possibly a board seat. While the two sides publicly remain some $200 million apart, they have been quietly swapping proposals for weeks. On July 20, the pilots took a major step toward closing the gap, upping a previous offer of concessions worth about $300 million to as much as $705 million. "Bankruptcy is a bad place," says Richard M. Columbia, a 757 pilot and 25-year Delta veteran. Formal talks are slated to start on Aug. 3.

An additional $1 billion in savings will have to be wrung out of nonlabor costs. Grinstein has said Delta could scale back its Dallas/Forth Worth hub, where it plays second fiddle to American. Delta may also end up paying less for the 348 planes it leases. "It will come as no surprise to aircraft lessors if Delta renegotiates," says Jonathan Rosenthal, a principal at investment bank Saybrook Capital LLC in Santa Monica, Calif., who is advising a group of Delta creditors.

Such moves might be enough to keep Delta in the air over the next year. But to meet the challenge of the low-cost carriers in the long term, Delta must bolster efficiency. "It's essential. They need the productivity," says David F. Ulmer, vice- president for planning at JetBlue. And that's where the new Delta is likely to look most like Song. Launched in April, 2003, Song's costs per available seat mile for its 36 Boeing 757s are about 20% lower than on Delta's 757s. (Overall, Delta had the second-highest costs in the industry last quarter, at 10.32 cents per seat mile, behind only US Airways Inc.) Song's efficiency has been achieved by avoiding expensive hubs, focusing on point-to-point flying with quick turnarounds, simple-fare flights, and the use of larger planes with smaller crews. Flying as many as seven flights daily on routes between Florida and New York, for instance, has made Song competitive with rivals such as JetBlue.

Analysts expect Delta to launch more flights similar to Song's New York-to-Florida runs on busy leisure routes from Florida or out of its small Salt Lake City hub. In fact, it's possible, say analysts, that Song will be folded wholesale into a Delta that appropriates its best practices. "[Song is] instrumental in the whole strategic review," says John Selvaggio, Song's CEO, who is on Delta's restructuring team.

Yet there is no way Delta can become a full-fledged low-cost carrier. On domestic routes with many business travelers, who are more apt to pay full fare, it is likely to stick with multiclass jets. To stay competitive with its low-cost rivals, it has to keep its big Atlanta and Cincinnati hubs. And Delta is loath to tinker with its lucrative international business. While passenger revenue fell 1.3% in North America in the second quarter, it rose 1.4% on transatlantic routes and 42% on flights to Asia.

Remaking Delta will be enormously difficult. Even some company veterans are doubtful that Grinstein can pull it off. "Delta doesn't change very easily," says Geri McManus, a 28-year Delta flight attendant who recently switched to Song. For now, hopes for a pilot pay cut and Grinstein's pledge to make "radical changes" seem to be all that's keeping Delta from singing its swan song.

By Brian Grow in Atlanta

    Before it's here, it's on the Bloomberg Terminal.