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The laws of gravity don't apply

Inefficiency, overcapacity, huge debt...what keeps U.S. carriers up in the air?
/ Source: BusinessWeek Online

With the U.S. airline industry expected to lose at least $8 billion this year, United Airlines and US Airways Group already in bankruptcy, and Delta Air Lines and Northwest Airlines joining them on Sept. 14, you'd think the long-awaited day of reckoning was finally on the horizon.

Don't bet on it. The laws of economics seem to get skewed at higher altitudes. Rather than rising or falling solely on their ability to manage costs or fares, airlines today benefit from a complex web of relationships that seems destined to allow the industry to muddle through for years to come.

Many enablers
That's not to say the airlines haven't identified a key problem: too much capacity, which saps pricing power and boosts debt. Indeed, big carriers like United, American Airlines, and US Airways have collectively shuttered the equivalent of a major airline over the past few years. But they still face a Sisyphean challenge because of the industry's relatively low barriers to entry.

Newcomers such as JetBlue Airways and AirTran Airways add flights almost as quickly as the majors make cuts. And since those airlines usually have lower operating, salary, and pension costs than the shrinking legacy carriers, they're continually bringing price competition to a wider share of the market -- starting the whole vicious cycle over again.

In many other businesses, such a dismal scenario would scare off investors, letting market forces shrink the industry until it reaches a size that yields consistent profits. But not airlines. There are just too many players eager to pitch in cash, despite a flawed business model. For example, General Electric's finance unit has bankrolled reorganizations at Delta, America West, and US Airways. It's no mere coincidence that another GE unit sells highly profitable engines to those same carriers. (MSNBC is a joint venture of Microsoft and NBC, which is a GE company.)

Government trough
Likewise, in return for wage concessions, employees have become major investors in carriers like Northwest, United, and US Airways. That saves the airlines hundreds of millions. Ditto for the pay-to-play deals big carriers force on their smaller commuter partners.

But because workers and partners are often more concerned with keeping their jobs or lucrative feeder contracts than with allocating capital wisely, carriers with poor operating results or dim prospects are allowed to limp along. The feds contribute as well, although unwillingly: Experts say Delta could soon dump $8.4 billion of its pension liabilities on Washington.

Even state and local governments promote the status quo. Chicago, for example, gave now-bankrupt ATA Airlines $25 million in subsidies in 2001 to build an employee training center at Midway Airport. United Airlines bagged $300 million from Indianapolis and the state of Indiana in the 1990s to open a now-shuttered maintenance center there. And smaller cities like Wichita and Tupelo, Miss., routinely offer cash, tax breaks, or terminal subsidies to entice carriers to fly to their locales.

Unfriendly skies ahead?
Since few companies -- airlines or otherwise -- are in the business of turning down free money, capacity from subsidized routes gets added into the system, employees get hired to serve them, benefit and pension liabilities increase, get the picture.

The real winners of this shell game, of course, are consumers, who have seen inflation-adjusted air fares fall 50% since 1978. Indeed, why would fliers (at least those who aren't airline employees or economists) really want a rational market where carriers are able to control capacity and set fares high enough to guarantee healthy profits? The airlines' current lack of pricing power is awful for the carriers and their investors: Shares of major airlines have logged a negative return of 54% since the beginning of 2000, and unsecured bondholders at Northwest may lose 90% of their investment. But the public is flying high -- at least for now.

How can this dysfunctional, profitless business hang in year after year? Because many key constituents have little reason to want it to behave like a disciplined business. That's no way to run a railroad. Then, again, we're talking about airlines.