Image: Air traffic
The difference between profit and woe in the airline industry is largely a matter of controlling costs in an environment of aggressive competition for the same routes and same passengers.
By Jon Bonné
msnbc.com

If you think the coded jumble on your airline ticket — ITLON KL X/AMS KL SZG M/IT — looks complex, it’s nothing compared to the difficulty in parsing how that bottom figure charged to your credit card is spent. For all the public disclosure required of airlines, their costs remain strikingly opaque.

The current industry blues are largely just the latest refrain of a tune begun after deregulation in 1978, one that’s been sung in some fashion for over two decades. The shift to a minor key is familiar in part because the story is familiar: carriers big and small go head-to-head on major routes, often at a significant cost. Most give up before long, or end up with a money-sucking hole in the sky. Losses are counted. The battle is fought again in a different location.

The first bloodletting actually came in the mid-1980s. Carriers that rushed in after the industry opened — remember People Express or Air Cal? — were bled out by economic realities and relentless pressure from the majors. Even a handful of big carriers, such as Eastern and Piedmont, were eaten up by bigger fish or dissolved in bankruptcy court.

After a quarter-century, an obsession with growth has left airlines with stretch marks, trying to learn a lesson that has plagued the industry since its inception. As one industry textbook warned on the topic of route wars: “In the end, the airlines are simply cutting each other’s throats by duplicating schedules.”

That was written in 1942.

So what's different this time?
The airlines now face a true challenge from lower-cost entrants who have molded a completely different, and profitable, way of doing business — not upstarts, but well established and successful companies.

That difference between profit and woe is largely a matter of controlling costs, both those swallowed by the airline and those passed on to the customer. And so, for those who buy the tickets, it’s worth considering how your fare adds up.

Aircraft
Choosing an airplane isn’t vastly different from shopping for a new car. Aside from a few zeroes tacked on, the same trade-offs and options exist for the aircraft buyer.

Perhaps most important is the decision whether to buy or lease. Firms such as International Lease Finance Corporation, with $27 billion in aircraft — Airbus’ largest customer — give carriers flexibility with their fleets. Should a client not want to keep an airplane, it’s easy enough to market it out to someone else. Overall short-term costs are higher. A carrier may pay $250,000 a month for a 737, but it escapes upfront financing costs for a new $45 million pair of wings.

That’s especially important because, just like the jalopy taking space in your driveway that Junior promises to restore, airplanes are always getting less valuable. You may be able to record that new jet as a $50 million asset on your balance sheet, but depreciation will keep the value sliding and charge up between 4 and 9 percent of total expenses. As fleets age, they’re less and less valuable as assets. This especially hurts such carriers as American, which owns most of its fleet.

It hurts doubly when travel declines and airlines are left with more planes than passengers. Those planes have to be mothballed, and continue to cost money.

“I don’t see how it’s an advantage to park aircraft out in the desert,” says Alex Wilcox of JetBlue, which leases about half its fleet. “They’re going to need the same maintenance 10 years from now.”

Cost to consumers: Negligible, as far as the bottom line. But different planes and configurations offer differing levels of comfort, and the most profitable plane is rarely the one that wins loyal customers. For example, the 737 is notorious even among airline pilots for its cramped cabin — but also remains a favorite among airlines for its cost-effective operations.

Labor
The current situation between airlines and their employees is downright grim. It has extended well beyond the usual tension that marks labor disputes, and has lately descended into bitter recriminations with each side accusing the other of greedily trying to scuttle the industry.

Moreover, unions bristle at the Bush administration’s position on the industry — an odd and not entirely consistent free-market stance. They point to 2001, when the White House forced Northwest’s machinists to stay at work so the skies could remain full — even as the federal Air Transportation Stabilization Board plays the role of stingy loan officer when it comes to keeping airlines liquid.

The pilots union, for example, has renegotiated terms several times and insists they’ve accommodated carriers’ financial stress. By far the best paid of any unionized crew, they still look unforgivingly at executive salaries — and are quick to point out that, despite having an obviously crucial role in the business, they’re still a small chunk of the labor cost.

“The problem isn’t us,” says John Mazor, Air Line Pilots Association spokesman. “We could work free for our airline and they would still be losing money.”

Airline workers don’t work for free, of course: Salaries make up 20 to 30 percent of total revenues for the airlines, with benefits adding another 8 to 15 percent. Not surprisingly, major carriers have the heaviest labor costs — United’s are about half their total expenses. And salary negotiations have become increasingly tense.

Almost every union is bristling under ever more stringent demands from management — made more acute these days by admonishments that cost-cutting may be the only way to escape a complete shutdown.

In June, for example, United was forced to pay its flight attendants $48 million to make up for its pay structures, which lagged behind competitors. Then, this fall, the flight attendants hesitantly took another pay cut as Chapter 11 loomed and talk of job cuts reached a fever pitch. More are expected.

Such ping-pong with wages certainly isn’t unusual for unions, but the airlines have such an unusual role in the economy that those in the boardroom often wonder why government steps into the mess in such an ad hoc manner.

“If the airlines are subject to antitrust,” asks one executive, “why isn’t labor?”

Perhaps more to the point, many wonder why this airline-by-airline negotiation has been allowed to go on so long — and hint that market forces may level out the playing field.

Cost to consumers: Significant. As labor rates are pushed higher, it’s directly reflected in ticket prices — though the industry’s widespread labor woes and creation of lower-wage jobs by smaller operators are leveling off costs. But you might want to think twice about a carrier that seeks out the cheapest pilots it can find.

Taxes
It’s not entirely fair to lump this into the mix because it’s not really unfair to any single airline, but it does hit the consumer’s pocketbook rather heavily. If anything, this is one area where low-fare tickets actually get hit worse: Most airline tariffs are based on fixed costs, such as an airport departure tax, rather than the actual cost of the ticket.

Those costs can be stunning, though, usually ranging from 15 to almost 25 percent of base ticket price. Those extra dollars are sought by the same coalition of federal, state and local governments that maintain they’re the ones who are working hardest to preserve air travel.

Cost to consumers:Significant. But much like hotel taxes, the fees are targeted at those least well positioned to petition against them. And other items — such as the $5 per passenger security fee levied after Sept. 11 — haven’t generated the frustration among fliers some expected.

Routes
As it currently stands, route decisions come not from a simple profit-loss balance, but from trying to assess any given route’s overall value to the airline’s “network.”

“Your decision is not based on how many passengers want to come from that city to your hub but also on passengers who want to travel … down the line,” says aviation economist Clinton Oster at Indiana University. “It makes it a little more complicated to figure it out.”

Even the wacky rules of airline economics are challenged to unravel this bit of legerdemain. Assessing per-seat revenue for a 500-mile flight may be feasible, but unless you revert to simple revenue-minus-cost-equals-profit accounting for every route, it’s almost impossible to compare values of various routes. A 3,000-mile trip from Miami to Seattle might seem a good bet, but it’s hard to do a clear comparison between that and five 600-mile hops between Baltimore and Atlanta unless you revert to profit-loss basics — and make your assessment on the value of the individual routes themselves, not their residual values as hubs. (This, in part, is why so much hype has been focused on the potential profits in the point-to-point airline model.)

As if it wasn’t puzzling enough, many industry pricers admit they often set price points without a clue what the actual per-seat flight cost may be. Instead, the focus is on what customers will pay and what will keep a route competitive — all of it good sense in pleasing consumers, but not so great in keeping out of Chapter 11.

In other cases, choosing routes is a matter of finding the best way to serve them. As an example, Air Canada targeted its route strategies when faced with a revenue crisis. It formed two low-fare offshoots and allowed one, Tango, to parallel its full-service routes with economy flights, while it had the other, Zip, take over routes such as Vancouver-Calgary which it considered a money hole in the full-service market.

“Air Canada basically gets off the route, which is an unprofitable route for them,” says Zip president Stephen Smith. “We basically replaced fin for fin.”

Cost to consumers:Depends where you live. For fliers close to major cities and popular routes, there’s likely to be ever greater savings and a bounty of fare options to choose from. If you’re far from a major airport, you’ll be scrambling to find service to your market — and none of it will be cheap. The Department of Transportation has slowly been cutting away at communities covered by the Essential Air Service program, which subsidizes airline service to small cities. Others still on the list — Oshkosh, Wis., or Utica, N.Y. — may face scrutiny because of their relative proximity to larger airports.

The decisions will leave some travelers feeling shunned, of course, but such is the new reality.

© 2013 msnbc.com Reprints

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