Graham Warwick/CHICAGO
United Airlines is drawing up plans to stay profitable through the next industry downturn, despite being unsure exactly when it will happen. In fact, the carrier seems to regard a recession as necessary if airline stock prices are ever to achieve their full potential again.
As each of the last three industry recessions have been worse than the one before, investors are understandably sceptical about the airlines' ability to cope with the next one. So, while carriers continue to report record profits, the gathering global economic turmoil is causing investors to mark down airline share prices ahead of any recession.
"The industry needs to go through a recession and prove we can cope," says United senior vice-president planning Rono Dutta. "We've managed this upturn so well, the challenge is to manage the next downturn well."
United's stock is trading at a price:earnings ratio of six to seven, compared with a market average of 20, which is a sign of low investor confidence. "We hope to get to 12," says Dutta, "and if we prove we can make money in a recession, we will get there."
UNIQUE CHALLENGES
The world's number two carrier faces some unique challenges in preparing for the expected downturn, as its labour costs are set to increase substantially in 2000 with the scheduled expiration of wage concessions granted by employees in 1994 in return for 55% of the airline.
"Labour costs are going to increase," admits chairman Gerald Greenwald. "We will offset the cost increase in several ways," he says, citing technology improvements, product and service changes, fleet streamlining, reductions in management numbers and the "strong cost focus" already in place. As a result, Greenwald believes, United "...is in a good position to offset increased labour costs."
Cost management is one of United's key strategies for dealing with the next downturn, which could occur as early as next year. "The single biggest issue is how to get ready for and cope with recession," says Dutta. "Every recession has been a traumatic experience for shareholders, employees and passengers," he says. "We have been forced to trash the product, then put it back only to go into recession again."
United believes, therefore, that recession planning is the key not only to staying profitable through the next downturn, but to limiting its impact on passengers. "We must prepare for the recession before it gets here", says Dutta.
"We know a recession is going to happen; we just don't know when," he says. The industry recession, when it happens, will be triggered by a downturn in the US economy, but its severity will be determined by how the airlines react, he believes.
"Industry performance is very sensitive to the economic cycle, but it is more sensitive to the capacity cycle," Dutta says. The last recession was so bad, he says, because airlines were growing capacity at 8-11% a year going into the downturn. This time, growth is at about 4%.
"The whole industry recognises that we can't do anything about the economic cycle, but we can manage the capacity cycle more conservatively," he says. Capacity deployment, therefore, is one of United's strategies to lessen the effects of a downturn.
The carrier plans to use its Boeing 727s as a buffer, retiring some or all of the 75 aircraft remaining if traffic falls so that it can restrain capacity growth while still taking delivery of 69 new aircraft on firm order. United's current plan calls for a steady 3% annual capacity growth to 2003, but the 727s, and older 737s, provide flexibility, he says.
The second defence strategy is route diversification. "The economic cycle is not concurrent is all regions, so we can move capacity around," Dutta says. The airline has already demonstrated this in Asia, he says, by limiting the impact of the region's economic downturn through redeployment of aircraft to other routes.
Dutta also believes that traffic support from the Star Alliance and the growth potential at United's UShubs will limit the effects of a downturn. "Alliance hub-to-hub traffic does not fluctuate as much, and the connecting market acts as a buffer," he says.
MAINTAINING LOYALTY
Maintaining customer loyalty is another defence strategy. Rather than "trash the product" to save money, he says, "...the challenge is to cut costs judiciously." United particularly wants to hold on to its increasing share of high-yield business flyers during the downturn.
The final strategy is to control costs while protecting the product. "How do you cut back in a recession?" asks Dutta: "You have to define the core product and not cut indiscriminately."
United believes that the downturn is coming, and that it will be ready. "We can't run, we can't hide," says Greenwald. "We can only try to run our business well - and we think we are."
Source: Flight International
