Feb. 18, 2003 — It’s impossible to talk about cutting airline costs without mentioning Bob Crandall, the firebrand former chief of American Airlines. And so, let us revive the olive story. Most notorious among Crandall’s legendary cost-cutting was his idea to remove an olive from each salad served to passengers. A tiny garnish would never be missed, the reasoning went, and savings amounted to at least $40,000 a year.
Oh, for the industry's salad days. With two major U.S. carriers in bankruptcy and an expected $8 billion in losses from last year, it’s safe to say we’re way beyond olives.
Indeed, between June 2001 and 2002, Crandall’s one-time rival United Airlines would have needed to fill 103 percent of available seats to break even — in part a result of waning traffic after Sept. 11, but also a sign the industry’s thin margins and indirect pricing have prompted a sort of economics that even a first-year business student could dismiss as voodoo.
Yet money is being made amid the carnage. Southwest and JetBlue posted modest profits last quarter. Those discount folks have the benefit of winning the expectations game, and have the majors looking to follow their low-fare lead.
While many industry analysts dismiss the notion of an airline like United or Delta starting up a low-fare offshoot — though both are already under way — full-service carriers are emulating their cheaper brethren, or fading into airline history.
“The premium price business that the airlines lived on — and that subsizided a lot of their operations — is gone, it evaporated,” says aviation consultant Edmund Greenslet. “The cost structure for these companies has got to come down.”
Relying on alliances
Bigger has often been better for the airlines, but merger-friendly carriers now find themselves shoehorned between aggressive deregulation policies and the keen eyes of antitrust regulators. The latest response has been to ally rather than merge, to seek a partner who can help cover routes, trim costs and even take on costly booking needs.
The trend started internationally and has come home. A new alliance that allows Delta, Continental and Northwest to sell each others’ tickets and blanket the U.S. with hundreds of new flight options will be worth watching — assuming the Feds don’t scuttle it.
Meantime, global partnerships (Star Alliance, anchored by United, and Oneworld, anchored by American Airlines and British Airways) have proved a booming success. Alliance partners have joined cargo operations, shared hub space and gate leases, unified revenue planning and even gone in on pricing deals for new jets. Oneworld claimed billions in savings last year by leveraging the partnership.
As for passengers, it’s now possible to book tickets around the world almost seamlessly — resulting in a sort of mega-airline that allows you to fly almost seamlessly from Lubbock, Texas, to Bilbao, Spain, or to be checked in for an Air Canada flight by a Lufthansa agent who credits your United frequent-flier plan.
These arrangements have been a salvation for major hubs, which are crucial for linking with partners. A partnership between KLM and Northwest grew the once sleepy Amsterdam-Detroit route by over 50 percent, with most passengers headed for smaller final destinations.
Partners, planes and flexibility
For most airlines, an alliance can provide a vast extension of their routes for essentially no cost. “The proper execution of an alliance is absolutely criticial to getting the benefit, and poor execution can really cost you,” says Gary Chase, airline analyst for Lehman Brothers.
“When it comes right down to it, the airlines are really marketing organizations. Product execution can be very distinct from product marketing.”
Even with quality control, some perks will likely vanish — especially with the new domestic partnerships. Passengers will get more options to more destinations, but service quality will be hard to guarantee.
In such an era of flexibility, a carrier can’t function without being able to grow, shrink and change its fleet. When planes are full and in the air, they can usually at least pay for themselves. When they’re on the ground, they’re money-sucking holes. No matter the original cost, owning an unused airplane is a money loser, which may be why aircraft leasing has become many carriers’ fiscal grail, accounting for at least 20 percent of airline fleets worldwide.
While it may cost more to lease a jet over the short term, it relieves the carriers of one of their worst fears: a hard asset they’ll have to amortize over the next quarter-century, trying to recoup their initial investment and keep depreciation in check as maintenance costs creep up.
With the ability to save $40-$50 million upfront on a new 737, it’s not surprising that leasing has allowed a handful of low-fare carriers to quickly build new fleets without assuming long-term burdens.
“It gives you a tremendous amount of flexibility to manage through up and down markets,” says Bob Genise, president and CEO of Boullioun Aviation Services, which holds $3 billion in aircraft leases for some 70 airlines. “Instead of making a 25-year decision … you can take it on for five years.”
Leasing doesn’t solve every problem, and some low-fare carriers own almost their whole fleet. But for big airlines that need diverse sizes and configurations of planes — even for those like Southwest that run a single type — there’s value in the ability to easily shift to a bigger or smaller plane without emptying your wallet. The only downside, analysts warn, is that leases have become a popular way for some carriers to hide debt off the balance sheet.
Workers and wages
Managers like to invoke the frequent labor tensions in the industry as a cause for their troubles, but employees are just as frustrated with the war of wills.
The frustration level has grown to a point that, for both sides, money appears to have taken a back seat to posturing. Executives feel union demands for each airline to negotiate its own labor deal have resulted in a game of one-upsmanship that spirals up costs. Labor insists it needs that flexibility to address the wide array of working conditions — and fiscal stability — across airlines.
At this point, the only immediate relief will probably be found in court. Unions will likely lose that round as bankruptcy judges force them to tear up contracts and take smaller shares.
Longer term, it’s hard to say how labor will shake out. Mergers and upheaval have left enormous contract discrepancies among the ranks, especially among pilots: Pilots at American, for example, had barely resolved a dispute over lower-paid American Eagle counterparts when they were hit with the TWA merger and a whole new set of salary levels and seniority lists.
Assuming that ailing carriers get themselves back on their feet, unions might demand a return to previous salary levels and deferred payments. But the ill will and finger-pointing has left a management problem that’s as much emotional as fiscal.
“It’s like you’re running a football team and you’re constantly criticizing your quarterback,” says University of Portland airline expert Richard Gritta. “What I would do is go to the workers and admit fault.”
Still, not everyone is miserable. Pilots for low-fare carriers have been happily accepting lower salaries for years, trading off a bigger paycheck for better hours, better routes and an equity share in the company. With more crews flying regional jets and turboprops, and taking less money to do it, the days of the $200,000 salary may be numbered.
Hubs, frequent flyers and pretzels
The venerated U.S. hub-and-spoke system has built-in expenses that are worthwhile when money’s being made and deadly when it’s not. That’s why the current model in vogue is American’s “rolling hub,” which spreads out connections across multiple airports at varied times of day. It means slight delays for passengers, but requires fewer gates to be leased and fewer ground crews working simultaneously.
Flight planners are also increasingly keen to find extra routes that will keep planes in the air as much as possible, even if it means adding just a single flight. JetBlue, for example, opened a New York-Denver route simply by trying to squeeze eight more flight hours per day from one of its jets.
Other venerated low-fare methods are getting new attention from the majors: one-class seating, streamlined frequent-flier programs, simplified fare structures, using air stairs to cut turnaround time. And of course: cutting food costs in a way Bob Crandall never imagined in his olive dreams.
Catering remains a major expense but is near the bottom of customer demands for most short-haul flights. “Even serving pretzels was going to cost us half a million dollars a year,” says Stephen Smith, president of Air Canada’s low-fare subsidiary Zip. “People aren’t putting value in getting pretzels at two o’clock in the afternoon.”
When it came to amenities, Delta’s new offshoot, Song, not only nixed meals in favor of paid snacks but opted to give inflight travelers networked video games and streaming MP3s.
They’re also touting what they call the first “all-digital airline product”: electronic booking and check-in, with a minimum of employees to get passengers onto the plane.
That minimalist take on customer service is gaining traction. Even those within the industry see a grim future for major carriers’ 3,000-strong reservation centers. Online efforts like Orbitz have largely supplanted internal bookings, and with airline commissions all but gone, outside agents don’t feel much loyalty to the majors. Some agents would go even farther, completely relieving the airlines of the business of selling tickets.
“They have lost more money than they’ve made since the beginning of the Wright Brothers,” says Steve Hewins, president of Hewins/Carlson Wagonlit Travel. “What they ought to do is manufacture the product, create the flights ... and leave others to sell it.”
The virtual future?
No fleet, no food, no hubs, no branding — that’s the emerging vision: airline as commodity broker, collecting flight segments and matching customers to seats. As with any good trader, their key to success lies in creating demand. For airlines, it means a crack job of marketing, along with slashing unprofitable routes and stimulating new ones.
Whether they sell their services under one brand or three, via a human or a Web site, the airlines haven’t much time. They’re not only choking on operation costs; their fiscal liabilities have become profound. United and US Airways both have gaps in their pension funds of over $3 billion. American is spending over 10 percent of its revenue on debt service; Continental’s $5 billion in debt is equal to half its total assets.
At that rate, it’s not long before shareholders and employees will demand change. Management at the most troubled majors has already been shaken up, but industry watchdogs question the role of execs like Stephen Wolf, who as chairman of US Airways efforted a merger with his previous employer, United. Bankruptcy for both airlines ensued. Revolving-door hiring and multimillion-dollar salaries would draw scrutiny anyway in this penny-pinching era, but they’re especially heavy weights on airlines diving toward fiscal oblivion.
“It’s like football coaches in the NFL, you fire him, you bring someone else in, you fire him,” Gritta says. “They’re making a fortune while someone else gets screwed.”
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