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Meltdown 101: Airlines cut capacity to survive

/ Source: The Associated Press

Like most businesses, airlines want to grow. But during these difficult economic times, their survival depends on their ability to shrink, as they try to match how much they fly with the number of travelers willing to pay for a ticket.

Just like Detroit shutting factories rather than building more cars than people want to buy, airlines are reducing the number of available flights to avoid flying empty seats around the sky. That saves them money on fuel and labor costs. Airlines also hope it will tip the supply-and-demand equation back in their favor and allow them to raise fares.

What the industry calls capacity cuts began last year as oil prices spiked. At one point fuel amounted to 40 percent of an airline's costs, said Morningstar equity analyst Basili Alukos, who covers airlines. Cutting flights was one way to reduce that expense.

Last year's fuel prices were the first blow of a one-two punch for airlines. The other has been the recession, which has cut business travel sharply. Airlines rely on business travelers for profits because they generally buy higher-priced last-minute tickets and front-of-the-plane seats.

UBS analyst Kevin Crissey estimates that American Airlines will cut flying by 10.4 percent in August, and that United will fly 6.3 percent fewer seats. The biggest carrier, Delta Air Lines, will reduce capacity by 3.9 percent in August.

Even Southwest Airlines, which has never planned a capacity cut, plans to reduce flying by 6 percent this year.

"After summer I expect most of the major airlines to be more aggressive with capacity cuts, simply because the economics are not working for them right now," said Jim Corridore, an airline analyst at Standard & Poor's.

Here are some questions and answers about capacity cuts.

Q: What is airline capacity, anyway?

A: Capacity is the amount of space available on an airline's flights. Airlines measure it in "available seat miles." That's one seat flown one mile, whether or not someone paid to sit in it. A reduction in seat miles equals less capacity.

Q: How do airlines cut capacity?

A: Two big ways: smaller planes and fewer flights.

Airlines can put smaller planes on a route that used to be served by a bigger jet. Often, this is done by assigning the route to a regional carrier, which can operate anything from propeller-driven planes with a couple of dozen seats to 76-seat regional jets. So maybe the airline keeps just as many flights between two cities, but on a regional jet instead of, say, a 120-seat jet.

Or, they can cut a flight altogether. This has a bigger impact on passengers because a town used to two flights a day might drop to one.

"The airlines have been carefully pruning their own networks to see where they're just not able to make money," Corridore said.

This is tricky in big markets because travelers — especially lucrative business travelers — often shop by flight time. So if one carrier drops its 5 p.m. flight from that city, that traveler may fly on a competitor instead.

Some cities without good prospects for profitable routes are being eliminated from the schedule altogether. Moves like that may or may not leave another carrier serving that city.

"So some cities are seeing much fewer choices, and some cities are seeing very little service whatsoever," Corridore said.

Q: What about international flights?

A: International expansion that looked promising just a couple of years ago is now on hold.

Last week Delta won permission from federal regulators to reduce flights, including Atlanta to Moscow and New York to Kiev, from year-round service to seasonal. Delta needed the waiver so it doesn't lose the permission to fly to those cities, which it won under international agreements.

Delta said in a filing with the Transportation Department that it is reducing capacity "primarily through frequency reductions, changes to seasonal service patterns, and by serving certain international cities through fewer hubs."

Q: Is it working? By flying less, have airlines managed to raise fares or become profitable?

A: Profitable? No. And fares are down this year. But it could have been even worse for the airlines.

The International Air Transport Association expects North American airlines to lose $1 billion this year, but notes that those airlines lost $5.1 billion last year in part because of rising fuel prices. The trade group said capacity cuts are one factor preventing airlines from losing even more this year.

Q: Is there anything that limits how much the airlines can cut?

A: Well, parking planes has its costs, too. Even parked planes require some maintenance, and getting them ready to fly again is expensive.

Also, most airlines owe money on their planes, either for loans or leases. Corridore said that as long as they can generate enough money from the plane to cover at least some of those payments, they're often better off flying the plane — even at a loss — rather than parking it.