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Airline Mismanagement

The major 'dinosaur' airlines have long felt invulnerable, and have proven their ability to kill any competitors that come to threaten their dominance.

But during the last few years, while the dinosaurs have been struggling with billions of dollars in losses, the lower cost new airlines have sprung up, relatively unopposed.

Only now are the dinosaurs turning their attention to these new competitors.  But have they left it too late?  Will the lower cost new airlines actually succeed in displacing the dinosaurs this time?

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The Dinosaurs Fight Back - Futilely?

The world has changed since the glory days of aviation.  But the major airlines - those that remain - have been slow to respond to these changes.

Is it now too late for them to provide modern competitive solutions for today's flying public?



The market dominance of the major traditional airlines is no longer guaranteed.

New low cost competitors not only offer lower fares, but also, in many cases, better service.  And with massively lower operating costs, these new airlines can withstand the price slashing tactics the major airlines have used in the past to bully small airline startups out of business.

The traditional response of major airlines to new startups - to slash prices and increase flights on competitive routes - may, this time, do more harm than good to the dinosaur airlines.


Strengthening business means time to fight back

An interesting thing is happening at present. The dinosaurs, all of which cut back massively on their flights post 9/11, are now awakening from their slumbers, feeling the resurgence of revenues flowing through their veins as business conditions improve and air travel numbers pick up. They are turning their attention to combating the growth of competing lower cost carriers (LCCs) that occurred while the dinosaurs were desperately pre-occupied with simply struggling to survive.

You can't teach an old dinosaur new tricks, and so, in the largest part, their response is the same well worn response that used to work so well. They simply flood any route on which a lower cost carrier has dared to start service with plenty more of their dinosaur flights, and match the LCC's fares.

This was formerly successful, when one dinosaur would be battling only one LCC at a time, and on a small portion of a generally profitable route system. While the new upstart was being bled dry, the dinosaur was suffering only a relative pinprick, on a small part of their system. Eventually, the new carrier would be killed off, and then the dinosaur would cut back flights and return fares to their previous high levels.

Old tactics no longer valid

This tactic may not work this time, because the dinosaurs are finding not just one new upstart carrier, but a whole bunch of them, and covering not just one or two competing routes, but 70% of their entire route system. And, the LCCs aren't underfunded new startups, but are well funded and already established profitable operations. One more point of difference. The LCCs are indeed that - lower cost carriers. The lowest operating cost of the new airlines is enjoyed by JetBlue with a 5.9 a mile cost, compared to the dinosaurs - for example, American Airlines with a cost of 9.5 a mile.

This huge cost differential enables the LCC's to operate routes with low fares and still make a profit, but when the major airlines attempt to match or drive the fares down further, the LCCs remain profitable long past the point where the dinosaurs are hemorrhaging money. A dinosaur has to sell a flight for almost 50% more than a LCC to earn the same level of profit.
How much extra would you pay to fly on, eg, Delta or United, compared to flying on eg JetBlue or AirTran? Few of us would pay even a single penny more, and surely no-one would pay 50% more.

Astonishingly, for the longest time, the dinosaurs pretended to anyone who would listen they could charge 30% or more than the fares offered by LCCs and that the traveling public would gladly pay this extra cost for the benefit of the 'full service' airline with an extensive route network.

Dinosaurs shooting themselves in the foot

This is now being proven incorrect, and the dinosaurs' attempts to squeeze out the new LCCs seem to be harming the dinosaurs more than their competitors. Partially as a result, several market analysts are now lowering their forecasts for the 2004 profit of major airlines, notably Credit Suisse First Boston, who this week revised their earlier projection for AA of a slim profit of $120 million to a loss of $316 million for 2004. UBS revised their estimate down from a $166 million profit to a $190 million loss, also this week.

The lower yields caused by the impact of LCCs and the dinosaur response represented 60% of CSFB's changed projection, the other 40% being due to the steadily increasing cost of jet fuel. The LCCs seem here to stay, and so too do much higher fuel costs.

What can the major airlines do

What can the major airlines do? They have allowed their costs to escalate beyond any sustainable level of good sense, while degrading their product so that it is perceived by passengers as a generic product best selected on price alone. Add into this ugly reality the surprising fact that many times the LCCs actually offer a superior product, at a lower price and with a lower underlying cost, and it is difficult to see how the dinosaurs can survive.

The predicament of the dinosaurs is totally self-made. In this article, after accurately explaining that thrift was never essential to the big airlines, which covered costs by raising ticket prices, new AA CEO Gerard Arpey explains

It wasn't because we were stupid. That kind of thinking just drove us in the 1980's and 1990's.

That kind of thinking (ie 'cost plus') probably existed long before then, and if not stupid, was certainly venal. Such thinking is a hold over from the earlier days of regulated airlines and air fares.

Shame on the dinosaurs for being slow to respond to the new opportunities and challenges offered by deregulation. Their passive non-response not only drove our fares way high, but also now imperil their existence, the livelihoods of present employees and the pensions of former employees.

These criticisms should not exempt the labor forces of the dinosaur carriers, but who deserves the greater share of blame - a pilot for demanding $300,000 a year plus massive benefits to fly planes for less than half normal working hours, or the airlines for acceding to those demands?

The dinosaurs have two things in their favor. Size and time. Their size remains such that they still dominate the aviation marketplace, and have genuine opportunities to use their size (eg international routes, partnerships with other airlines, etc) to translate into true travel benefits for customers and economy of scale savings for themselves.

As for time, part of the LCC advantage is that they typically are recently formed companies, flying nearly new planes, and with relatively junior and still freshly enthusiastic work forces. Their planes will never have the same low cost as they currently offer (especially the ones still under warranty), and as their staff become more senior and - potentially - disillusioned and avaricious - there is a danger that both their operating and labor costs might increase closer to those of the dinosaurs.

The airline industry - an unattractive investment

In a 2002 interview, Warren Buffett famously said, in reply to the question 'Do you still regard USAir as your worst investment?'

I made the comment that if a capitalist had been present at Kittyhawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money.

But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in.

You've got huge fixed costs, you've got strong labor unions and you've got commodity pricing. That is not a great recipe for success.

I have an 800 number now that I call if I get the urge to buy an airline stock. I call at two in the morning and I say: "My name is Warren and I'm an aeroholic." And then they talk me down.

For those of us who have the choice, we might be well advised to do as he says.

We, the traveling public, may finally be the winners

In the past, 'airline competition' has primarily meant a cozy style of 'non-competition' between dinosaur airlines, all offering very similar services on similar airplanes and at similar prices.

Occasionally a startup carrier would appear on some routes, and those major airlines that felt their routes threatened by the startup would slash their fares and add flights in an attempt to squeeze the new startup out of the market.

The general public was usually euphoric about this, seeing airfares halve and flights double.  But this was, sadly, always a short term blip, and as soon as the major carrier had successfully killed off its new competitor, flights would reduce and airfares would increase again.

But now, it seems that many of the low cost carriers have enough diversity of routes, financial strength, and low underlying costs, as to be able to withstand such tactics, meaning that lowered fares - and truly competing airlines - might just possibly be here to stay.

Your best strategy to ensure this is so?  Reward good behavior.  Whenever you have a convenient choice, buy your travel on the new low cost airlines like AirTran, Spirit, JetBlue, America West and Southwest.  Help keep them and their low fares in business.

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Originally published 26 Mar 2004, last update 30 May 2021

You may freely reproduce or distribute this article for noncommercial purposes as long as you give credit to me as original writer.



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