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The airline business doesn’t work ...

The surprise in United Airlines’ likely bankruptcy drama isn’t that it would face such unpleasant options — it’s that it didn’t happen sooner.
Southwest Airlines is fast becoming the low-cost, profit-making industry model to follow. Its strategies are being emulated by airlines around the world.
Southwest Airlines is fast becoming the low-cost, profit-making industry model to follow. Its strategies are being emulated by airlines around the world.
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The surprise in United Airlines’ likely bankruptcy drama isn’t that it faces such unpleasant options — it’s that it didn’t face them sooner. The airline’s business plan, dismissed by the government’s Air Transportation Stabilization Board, is not much worse than any of its competitors. Almost every major U.S. carrier faces the same dire choices.

Even as United struggles to avoid what appears to be an ever more certain bankruptcy filing, it and other full-service carriers around the globe have begun to feel a crisis burgeoning.

It’s not just a sluggish economy or a tepid moment in the business cycle. Executives confront an industry model that, as Air Canada’s CEO Robert Milton said last month, “just doesn’t work anymore.”

Many industry executives place the blame on the Sept. 11 attacks and Americans’ persistent fear of flying afterwards, but analysts suggest the breakdown was well underway before then — in United’s case, stretching back to the partial ownership deal between management and employees struck in 1994.

For United, but also for most other major operators — including US Airways, which is operating under Chapter 11 bankruptcy protection — the competitive pressure to keep prices low and still provide full service has prompted a management dilemma.

“The market is splitting. The low-cost, low-fare group of airlines both here and in Europe … have grown to a point where they have achieved a critical mass,” says Edmund S. Greenslet, who tracks aviation trends for ESG Aviation Services. “The providers are not fly-by-night outfits that are trying to do business on the cheap with a handful of old, obsolete airplanes. They’re quality companies and they’re quality products.”


The low-cost realm has captivated travelers. Southwest Airlines’ strategies have become the stuff of legend, while upstart JetBlue Airways has shown solid profits and growth in its short three years of operation.

The success hinges on capturing revenue per available seat mile (ASM), the profit benchmark for the industry. U.S. low-cost operators have wrangled ASM costs down to six or seven cents, while a major carrier like United pays over 10 cents per seat, per mile.

“Southwest can price a revenue yield of 9 cents and make money, and United will die,” says University of Portland professor Richard Gritta.

The phenomenon is a global one. As European flagship carriers like SwissAir and Belgium’s Sabena went belly-up in recent years, a growing posse of smaller, profit-minded competitors stepped in. At last count, Britain had at least four low-cost airlines, with long-time regional carrier British European converting its fleet and its brand into low-cost flyBE. Dublin-based RyanAir just placed a record order with Boeing for 100 737-800s, with options for 50 more. Germany has at least two newly launched carriers, including Hapag-Lloyd Express, which offers dirt-cheap flights on its fleet of 737s, painted to look like yellow-and-black taxis.

Fares for these European upstarts sound more like bus tickets. Hapag recently offered 13-euro ($13) flights from London to Bonn; British carrier Buzz, owned by KLM, is flying between London and Amsterdam this month for five euros.

The phenomenon is spreading. Malaysia’s Air Asia offers cheap flights out of Kuala Lumpur, whose massive airport was designed as a regional hub. Richard Branson expanded his Virgin brand into Australia with Virgin Blue — which competes with Qantas’ Australian Airlines subsidiary and New Zealand’s Freedom Air. South Africa’s Kulula and Brazil’s Gol offer cheap alternatives on domestic routes.

The trend was spurred by many governments’ decisions to privatize national fleets — forcing airline managers to face the hard reality that they have chosen an industry that is rarely profitable even in good times. Though U.S. airlines were never government-owned, their track records after deregulation has been grim. Of the 14 major carriers from the half-century before 1978, only six remain — and several have faced multiple restructurings.

“What other industry can you think of in the U.S. economy where you’ve had a failure rate of eight out of 14?” asks Gritta.


As their big brothers suffer, these aviation parvenus have largely thrived on a remarkably uniform set of economic principals, many emulating Southwest and the methods honed by the Dallas-based carrier in the years before deregulation when it was limited to a regional slot in the Texas market. As the sector has become more robust, what once seemed like quirky operational decisions have evolved into a new global model for the industry. Keys to the strategy include:

A unified fleet: Operators choose a single aircraft type for operations. Most have emulated Southwest’s model of a 737 fleet, in part because of Boeing’s efforts to increase the 737’s range and cut flight costs. Others, such as JetBlue, use Airbus’ versatile A320; some foreign carriers have turned to even smaller jets, such as the British Aerospace 146, which have quick turnaround times and usually lead to fewer empty seats. The growing popularity of smaller jets by such manufacturers as Bombardier and Embraer is likely to grow as carriers see value in building fleets with smaller, more flexible plane configurations.

Few frills: Details vary, but few low-cost carriers offer more than basic comforts on their flights. Many charge for food and drinks. JetBlue opted to lure customers with seat-back satellite TV, betting that passengers would rather bring their own food and be entertained.

One-class service: Those seeking a cushy seat and high-class victuals may be out of luck, but eliminating the extra equipment and crew needed for business- and first-class service chops away some serious fat. It also saves money at the gate by eliminating separate check-in lines — while soothing the egos of economy travelers who don’t feel as though they’re being treated like last week’s leftovers. Most carriers have also adopted an open seating strategy; it doesn’t help the specialty passenger who needs extra leg room or a window seat, but it rewards conscientious passengers who arrive early and travel often.

Direct routes: The original low-cost strategy hinged on scheduling flights from one point to another, assuming that passengers would book a single flight for their entire journey rather than be shuffled through major carriers’ intricate system of hubs and spokes. Increased congestion and a squeeze on gate space at massive hub airports such as Atlanta’s Hartsfield International and O’Hare in Chicago tear at that system’s seams, especially in bad weather, leading to dire predictions. (“Hub and spoke is dying,” says Gritta.) But even Southwest uses a modified hub system to connect passengers for trans-continental flights, and major carriers are likely to maintain hubs at least to connect passengers to longer domestic and international flights.

Quick turnaround: Full-service carriers have always been hampered by significant waits at the gate while crews hand off duties and caterers reload planes. No full meals means less turnaround, and direct routes mean there’s less time waiting for connecting passengers.

Airport location: Most low-costers skirt major airports and look for a secondary field — Midway Airport in Chicago; Burbank and Long Beach outside Los Angeles; London’s Stansted, Luton and Gatwick airports. JetBlue capitalized on unused gate space and departure times at New York’s John F. Kennedy Airport — allowing it to form its own hub at a major airport on the cheap. Smaller airports are often grateful for the business: Landing and gate fees are dramatically lower; fuel costs are often slashed and many suburban travelers find these smaller airports closer to home.

Direct bookings: No good news for travel agents, but upstarts have largely opted for direct bookings that save them commission fees and leverage the skills of Internet-savvy travelers eager to save a few dollars. AirAsia, for example, placed online kiosks next to check-in stands so passengers can book directly — even at the airport. This trend in particular has gained traction with major carriers, always eager to cut booking costs.


Differences in strategy are profound, but frequent fliers have made stark decisions about value. Full-fare frills may be nice, but it’s a challenge to justify $100 or more on airline food and a more centrally located airport.

“I think that’s going to be critical for these folks to answer, ‘Why is somebody going to pay more money to be on my flight?’” says Tom Cauthen, of Accenture’s global aviation consulting practice.

The groggy economy has also sharpened the focus on value. For business travelers, managers are less willing to approve full fares that often are four times as expensive. Between Southwest’s expansion and the quick growth of JetBlue, U.S. businesses now have low-cost options. Europe’s exploding low-cost market make client visits on the continent almost as cheap as a London taxi ride.

“The business traveler has been the one that has been subsidizing the big airlines for years,” says Greenslet. “Finally, the business traveler has realized that those fares are egregiously large.”


Of all major U.S. carriers, Delta Airlines has been the most willing to ruffle feathers — winning less stringent labor contracts and overhauling its fleet with smaller, more cost-effective jets. Last month, Delta said it would create a low-cost division to compete in the industry’s only growth area.

Delta, too, is aping Southwest with a uniform fleet, direct bookings and plans for an under-$300 price range. But unlike most low-cost competitors, Delta plans to leverage savings from its infrastructure and its 60,000 employees, a sort of Southwest-plus approach.

Even so, analysts’ outlooks are muted. The Atlanta-based airline previously had Delta Express, a low-cost subsidiary that languished.

Greenslet’s firm projects the total market share of the top six carriers, plus Alaska Airlines, to drop to 62 percent by 2010 from 75 percent now; by 2020, it could 45 percent. Delta would be third-largest by then, according to Greenslet — lagging Southwest and JetBlue.

Another model is Air Canada. Last year, its regional airlines were consolidated under a single brand, Jazz; it launched Tango, a low-cost alternative using Air Canada livery jets where customers pay for food and drink; this summer, it launched Zip, a low-cost subsidiary for Western Canada using older jets; and it formed Jetz, an executive charter service catering to high-end business customers. Executives from Delta spent time at Tango this year to get a peek inside the new hybrid.

Results have begun to pay off. Air Canada’s third-quarter profits were C$125 million, a huge improvement over a C$1 billion loss in the same period of 2001.

Savvy though it may be, market segmentation isn’t new, even in the travel industry. Marriott, for example, created a range of hotel offerings to serve every niche from budget stays all the way up to premium.


If any options exist for legacy carriers, they may lie in longer flights, especially international. Open-skies agreements with Europe have helped U.S. carriers edge farther into that market. But even those flights have risk, and remain expensive to operate.

“The more distance you fly, the more you charge for your tickets,” says Darryl Jenkins, director of George Washington University’s Aviation Institute.

The U.S. majors are also likely to crack down on smaller regional routes, many of them perennial money-losers. Smaller cities that want service now find themselves supplicating before the airlines, offering lucrative tax deals and pledges of passenger traffic baselines.

To fill the gap, small regional airlines may step in — but at a premium. Carriers such as Mesa Airlines have carved a healthy niche in regional markets. These small airlines have begun offering potentially popular routes, such as Big Sky’s service between Spokane, Wash. and state capital Olympia, that would never interest majors.

As with all else in today’s airline reality, rural passengers will face the same question as their urban counterparts: How much is it worth to be able to fly?