As low-fare airlines struggle to absorb rising labour costs, the deep cuts made by the major US carriers is making them increasingly competitive
If the quarter, and indeed the half, ended on a gloomy note for the US majors, it has hardly been a bright spell for the low-cost carriers. They face a looming battle to keep down the costs that have defined them but which are bubbling up. At the same time, the traditional carriers are finally beginning to enjoy the benefits of their determined cost-trimming campaigns.
If, or more importantly when, the two sectors approach "convergence", and if and when the low-cost carriers lose their edge on costs, they also lose their edge on pricing. That is the moment the network carriers regain a measure of pricing power and an upward move in fares begins.
Labour pressure
That is doubtless a long way off, but the trends are in motion. Consider Southwest Airlines, the leading discounter, settling a long-simmering standoff with its flight attendants, giving them an average 31% pay increase over the next four years. While Southwest's other costs are low enough to absorb the hit, the big rise is stark evidence that low-cost carriers have begun to feel the labour-cost pressures that have driven their higher-cost competitors. Southwest payroll costs have risen from 35% of total expenses in the first quarter of 2000 to 41% in the first half of 2004, "a steep increase in a brief period", according to Mike Roach of Unisys R2A consultants.
But Southwest has always been the prototype for the low-cost sector and, even if the students follow their teacher carefully, they are bound to experience its stumbles as well as its successes. At AirTran Airways, the Association of Flight Attendants has been pushing for higher pay and picketed the company's Atlanta shareholders meeting in May. For AirTran, CSFB analyst Jim Higgins predicts lower loads and yields ahead "as competition, new aircraft and moving contracted flying in-house weigh on revenue drivers".
America West Airlines, enjoying success in its low-cost carrier incarnation, has had to give its pilots 11% pay increases and in August the Teamsters union won the rights to represent its 3,400 non-union customer service representatives. Elsewhere, JetBlue Airways, the darling of the sector, has been slammed by stiff competition in cross-country markets and warns that it will have to reduce off-peak capacity and increase fares to return to previous levels of transcontinental profitability. That is important since almost half of JetBlue's capacity is in the coast-to-coast market, estimates Lehman Brothers analyst Gary Chase. The carrier's latest quarterly results dropped as yields wavered.
Elsewhere, the low-cost carriers face reminders that the big guys can fight tough. ATA Airlines, formerly American Trans Air, has had to go to its workers for pay cuts as Northwest Airlines moves into its Indianapolis home territory in a big way. Admittedly, ATA has had problems for a long time and has warned it could run out of cash next year. At Frontier, a long-planned West Coast expansion sharply increased costs as revenues sagged. United's low-fare venture is helping to regain traffic from Frontier at Denver. In the June quarter, Frontier's operating margin turned negative.
Mid-life crisis
These are incipient trends. Southwest, now in its mid-30s, is reaching that stage of life when a crisis or two may well be in order. This may mean, as JPMorgan analyst Jamie Baker wonders out loud, that Southwest may be the wrong benchmark for the sector or indeed for the industry. But it also signifies that it was inevitable that this generation of low-cost airlines would eventually become not-as-low-as-we-used-to-be carriers. The rising-cost trend is only part of the story. The rest, according to Baker, sees significant network carrier cost reductions driving the other trend toward convergence. He says that in all areas other than the uncontrollable fuel, the network carriers have rolled back costs to 1999 levels.
Over the last two years, the legacy carriers reduced costs by $12.7 billion, while the low-cost carriers cut little despite their 26% growth, according to an August study for Congress by the Government Accountability Office (GAO). Baker concludes: "Slowly but surely the network airlines are gaining on the low-cost carriers. The network cost disadvantage has fallen from 42% to 33% in just one year and is likely to reach 25% next year. The woes of three major players - Delta, United and US Airways - may push the cost disadvantage down to 20% or 25% next year." Meanwhile, the network yield per seat is rising for the first time since 1997. Baker estimates that this premium has risen from about 7% a year ago to about 10% this year - more in domestic markets.
In effect, the network carriers are striking back. Bolstered by lower labour costs, inherent network breadth and, in some cases, the reincarnating effects of bankruptcy, network airlines just will not die their much-predicted death. Innovation is also on the cards, even if driven by fear rather than hope, but this is not just a simple down-gauging. United is using the change to introduce a new three-class product it calls "ps" service. This includes lie-flat seats in first class, laptop connections at every seat, new menus and more legroom throughout coach. If this is a retreat, it is an elegant one.
None of this is to predict an imminent rebirth of the legacy carriers; in 2003 they depleted cash reserves by $682,000 a day, while the low-cost carriers were accumulating about $2.2 million in cash reserves daily, the GAO estimates. Ron Kuhlmann of Unisys R2A says: "The cultural gap will always be there", no matter how much the legacy carriers reduce costs. For example, he says: "JetBlue is cool because its customers say it is; a legacy carrier cannot just declare itself cool. So, the big unknown is how much more the legacy carriers will be able to bear down on costs even as the low-cost players will face rising costs. The two trend lines may not converge next year but the prospect of seeing some 42% of industry capacity under bankruptcy by next year strongly suggests that they will remain focused wonderfully, whether or not they are about to be hanged."
| US major airline group financial results April-Jun – Second quarter 2004 | ||||||||||
| Group/airline | Revenues | Op result | Operating margin | Net result (b) | Net (a) | Federal | Net (a) | |||
|
| 2004 | change | 2004 | 2004 | 2003 | 2004 | 2003 | 2004 | comp 2003 | 2003 |
| Alaska Air Group | 699 | 14.40% | 18 | 2.50% | 0.70% | 37 | 1 | -2 | 71 | 45 |
| America West | 605 | 5.10% | 21 | 3.40% | 2.80% | 6 | 13 | 6 | 81 | 80 |
| AMR/American | 4,830 | 11.70% | 165 | 3.40% | -4.50% | -25 | -357 | 6 | 358 | -75 |
| Continental Airlines | 2,514 | 13.40% | 73 | 2.90% | 3.40% | 2 | -24 | -17 | 176 | 79 |
| Delta Air Lines | 3,961 | 13.30% | -241 | -6.10% | -5.80% | -312 | -237 | -1,963 | 398 | 184 |
| Northwest Airlines | 2,871 | 18.50% | 52 | 1.80% | -2.10% | -78 | -160 | -182 | 209 | 227 |
| Southwest Airlines | 1,716 | 13.30% | 197 | 11.50% | 9.20% | 113 | 103 | 113 | 271 | 246 |
| UAL/United | 4,041 | 30.00% | 7 | 0.20% | -9.00% | 103 | -476 | -247 | 300 | -623 |
| US Airways | 1,957 | 10.10% | 83 | 4.20% | -1.20% | 34 | -154 | 34 | 214 | 13 |
| TOTAL | 23,194 | 15.70% | 314 | 1.40% | -2.60% | -114 | -1,291 | -2,245 | 2,079 | 176 |
| Selected US independents financial results April-Jun – Second quarter 2004 | ||||||||||
| AirTran | 275 | 17.60% | 31 | 11.30% | 13.10% | 17 | 22 | 17 | 38 | 57 |
| ATA | 391 | 0.70% | -11 | -2.70% | 4.80% | -26 | 4 | -26 | 37 | 41 |
| Frontier | 192 | 35.20% | -7 | -3.80% | 4.30% | -6 | 2 | -7 | 15 | 11 |
| JetBlue | 320 | 30.70% | 45 | 14.10% | 18.60% | 21 | 26 | 21 | 23 | 38 |
| NOTES: Results from preliminary published accounts, compared against the same quarter a year ago. Net result (a)=after effect of special charges/gains. Net result (b)=before major special items. Operating results exclude ESOPs and special charges. | ||||||||||
| US airline scheduled passenger statistics April-Jun – Second quarter 2004 | |||||||||
| Group/airline | Passenger traffic RPK | Capacity | Load factors | Passenger yield | Seat costs | ||||
|
| million | change | change | per cent | change | ¢/RPK | change | ¢/ASK | change |
| Alaska Airlines | 6,603 | 11.60% | 8.20% | 72.80% | 2.2 | 7.87 | 1.20% | 6.61 | 9.60% |
| America West Airlines | 9,517 | 7.50% | 8.30% | 78.30% | -0.6 | 5.98 | -1.70% | 4.8 | -1.00% |
| American Airlines | 53,617 | 10.40% | 8.50% | 75.70% | 1.3 | 7.27 | -0.40% | 5.95 | -6.00% |
| Continental Airlines | 27,078 | 14.70% | 12.40% | 78.10% | 1.6 | 7.08 | -1.60% | 5.77 | -2.30% |
| Delta Air Lines | 47,601 | 18.50% | 16.10% | 76.60% | 1.6 | 7.68 | -4.30% | 6.2 | -6.60% |
| Northwest Airlines | 30,209 | 14.80% | 6.40% | 82.50% | 6 | 7.22 | 4.50% | 6.31 | 4.20% |
| Southwest Airlines | 23,050 | 14.10% | 4.90% | 76.30% | 6.2 | 7.17 | -1.10% | 5.03 | 8.40% |
| United Airlines | 47,831 | 20.20% | 12.80% | 82.00% | 5 | 6.74 | 3.00% | 6.11 | -10.10% |
| US Airways | 17,166 | 8.70% | 4.00% | 78.90% | 3.5 | 8 | -1.80% | 6.95 | -8.40% |
| TOTAL | 262,672 | 10.70% | 10.80% | 78.20% | 0 | 7.23 | -0.80% | 6 | -4.00% |
| US independent airline scheduled passenger statistics April-Jun – Second quarter 2004 | |||||||||
| Air Tran | 3,500 | 21.40% | 17.90% | 75.40% | 2.2 | 7.6 | -3.40% | 5.26 | 1.90% |
| ATA | 6,112 | 0.40% | -1.10% | 71.50% | 1.1 | 6.4 | 0.30% | 4.7 | 22.10% |
| Frontier | 2,517 | 39.00% | 32.00% | 70.70% | 3.6 | 6.71 | -12.20% | 5.03 | -0.50% |
| JetBlue | 6,332 | 40.80% | 42.20% | 84.50% | -0.8 | 4.89 | -7.30% | 3.67 | -3.00% |
| Spirit Airlines | 1,954 | 14.50% | 14.00% | 76.50% | 0.4 | n/a | n/a | 5.08 | 11.50% |
DAVID FIELD WASHINGTON
Source: Airline Business
