Seven Solutions to the Airlines' Woes

Old-style carriers need to radically change the way they do business. Here's how the experts think they should start

By Amy Tsao

These are dark days for the airline industry, particularly for the traditional, so-called legacy carriers: Delta (DAL ), American Airlines (AMR ), US Airways (UAIR ), United, Continental (CAL ), and Northwest (NWAC ). All are well along the way to posting huge losses this year. One, United, is in bankruptcy proceedings, and several more may be headed that way.

Between record fuel costs, an uncertain economy, and a lingering post-September 11 travel slowdown made worse by the SARS disease scare in Asia and Canada, the industry hasn't been able to catch a break.

"This is by far the worst airline downturn ever," says Standard & Poor's airline-credit analyst Phil Baggaley (see BW Online, 8/24/04, "The Downdraft at Delta and US Air"). Baggaley recently downgraded Delta's credit rating, as well as that of US Airways, and he sees a possibly severe shakeout in the year ahead (see BW Online, 8/19/04, "S&P Cuts Delta Air Rating to 'CCC'" and 8/20/04, "S&P Cuts US Airways Ratings").


  Since World War II, airlines have rarely been a high-growth business, with high overhead and huge labor costs. But the old-style carriers have been barely muddling through with the aid of numerous restructurings and lots of government help since September 11. This year -- as the economy strengthened and carriers made changes -- some airlines were expected to turn profits. But this summer's record surge in fuel prices derailed that hope.

Even with the continuing advantage of having the international market to themselves, legacy carriers still must remodel their businesses along the lines of successful domestic discount carriers such as America West Holding's (AWA ) America West Airline and JetBlue Airways (JBLU ), most analysts agree. Even those in relatively strong shape will need to make major changes if they want to thrive.

What must they do? BusinessWeek Online asked several airline experts to list the important changes they would like to see. Here are the seven top recommendations that could go a long way toward curing what ails the big airlines:

1) Reduce labor costs. This is Job No. 1, though it's far easier said than done. In order for the most financially strapped carriers -- Delta, United, and US Airways -- to avoid Chapter 11, managements will have to win significant concessions from their workers in the coming weeks. Lower labor outlays, says Baggaley, would consist of a mix of reduced wages, more flexible work rules, and trimmed benefits. Pension changes might also be needed.

Reducing the actual dollar amount that legacy carriers spend on labor is key, but more flexibility in setting employees' workloads is arguably as important. "There has to be more give and take," says Mike Miller, partner of Velocity Group, an aviation consulting firm in Washington, D.C. Elastic work rules have helped low-cost carrier Southwest (LUV ) remain profitable for decades. "Workers there are paid very well but have very flexible work rules in their contract, so they do more work for the same pay," Baggaley says.

2) Simplify flight operations. Low-cost carriers like Southwest and JetBlue use just a few types of aircraft, a strategy that cuts training and maintenance expenses. It's more complicated for the bigger airlines. They fly internationally, to more remote destinations, and require more varied fleets of both large and small planes. But they can and should work toward streamlining the types of planes they fly.

Another way to simplify operations would be to modify the hub-and-spoke model, which uses designated headquarter airports for transfers. Traditionally, the big airlines have sent many of their flights through hub airports at peak business-travel hours. That way, since carriers typically charge heaps more for business fares, they can get more revenues per flight. But many experts argue that it's time to give up on that model -- especially as low-cost carriers increase service along heavily traveled routes.

Experts like the idea of so-called rolling hub operations, where flights are scheduled throughout the day so that an airline's assets -- from employees to planes to hangars -- can be used more efficiently. In a traditional hub system, planes and workers spend more time waiting for connecting flights to come in at peak operating times. With rolling hubs, travelers may end up waiting a little longer to get a connecting flight, but planes end up in the air for more hours of the day.

"If you spread more evenly, you can use your facilities more efficiently, rather than bunching them up at certain parts of the day," says Baggaley. American Airlines has been lauded for its experiment with a stretched-out schedule at some of its connecting airports. By Amy Tsao 3) Offer more transparent pricing. The legacy carriers have long had an exotic, almost incomprehensible pricing system. However, these days, with the Internet allowing travelers to shop for the cheapest tickets easily, and low-cost airlines offering uncomplicated set prices, traditional carriers have to follow suit or risk losing more and more passengers.

"Airline pricing is one of the issues that legacy carriers have to deal with for people to be loyal to them," says Miller. To the industry's credit, in recent years the gap in pricing between different types of tickets (last-minute business vs. leisure) has closed. And former legacy carrier America West (AWA ) has successfully made the transition to a simplified pricing structure. Any other takers?

4) Get smart on fuel. With oil near $50 a barrel, airlines must be smarter about how they incorporate its price into their costs. "Fuel is killing airlines," says Velocity Group's Miller.

Discount carriers such as Southwest hedge as much as 80% of their jet-fuel costs. Essentially, that means that they lock in prices on future fuel when the price drops. Small wonder Southwest is one of the few success stories in the airline business. "Airlines need to look at how Southwest is doing it and copy that the best they can," says Miller.

Granted, this is no easy task, given that legacy carriers are so low on cash. Still, it's integral to a successful business model. "As a credit analyst, I like to see companies take measures to lower risk, even if it's costly," notes Baggaley in reference to fuel hedging.

5) From bailouts to government partnership. Although the industry was largely deregulated in 1978, plenty of lingering rules and regs have made it "nearly impossible for carriers to be efficient," says Michael Boult, chief operating officer of travel advisory Eclipse Advisers, a subsidiary of American Express (AXP ). Restrictions on foreign ownership and labor laws have kept the industry from innovating, many believe. So instead of lobbying for protective measures like bailouts, airlines need to work with government to tackle longer-term projects like building more runways, running airports more efficiently, and reining in labor costs.

6) Stop chasing market share. Airlines need to be savvier about capacity. At the start of 2004, many planned to add more flights amid signs of an improved economy. When it became clear that demand wasn't as strong as originally forecast, most carriers still wouldn't retrench from their plans for fear of losing out if the market snapped back.

"There have been too many seats added into the market and not enough people to fill them," says Miller. That dynamic makes it harder to raise prices and plays a part in the legacy carriers' inability to make money. Rather than scrambling to add seats in fear of missing out on the party, airlines would do well to take a more cautious approach and focus on efficiency and margins.

7) A new model for premium pricing. Most of the industry's improvement efforts have focused on whittling down costs. However, boosting revenues also needs to be a priority. After all, people are willing to pay more if they believe they're getting more value. This issue is bigger than providing on-board meals and plush seats with more legroom.

The traditional carriers need to do a more effective job of playing up their unique features. They still travel to far more places in both the U.S. and overseas than low-cost rivals, notes Patrick Murphy, a partner at aviation consulting firm Gerchick-Murphy Associates in Washington, D.C. "Legacy carriers still offer certain advantages, especially to the business traveler" including airport lounges and more comfortable seating, Murphy says. Leverage is key.

Certainly, some of these changes may be too little, too late for the carriers with the heaviest debts and least cash. But for the legacy carriers that survive the prolonged downturn, a revolution in how they do business is all but certain.

Tsao is a reporter for BusinessWeek Online in New York

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