The US industry as a whole and the legacy sector as a group stand poised to undertake the most meaningful capacity cuts in years, whether or not the retrenchment is voluntary.
After its fourth big airline bankruptcy, following over $34 billion in legacy losses since 2001, the USA may have accepted that its airline industry is sick. But behind this diagnosis of the obvious, Wall Street, Congress and the flying public are as uncertain as airline executives themselves about the prognosis or indeed the next step.
With nearly one-third of the nation’s capacity in the control of bankruptcy judges, the self-administered application of the capacity-trimming scalpel now seems the object of consensus. But with investors holding out open wallets, and with bargain-demanding consumers voting with their dollars for low fares, even this admirable instrument may only be part of the advance.
Without question, the US airline industry has grown immensely in the past 25 years. Between 1984 and 2004, total capacity, measured in kilometres flown by every seat on every flight, swelled nearly 90%, according to the Air Transport Association. By summer 2005, world capacity was at a five-year high and US capacity was peaking as well, with more than 102 million available seats on offer to, from and within the USA and Canada. Almost 82 million of those seats were for domestic flights, according to industry estimates.
Now, with the summer crowds gone, and with Delta and Northwest now in bankruptcy, the North American autumn is a testing time, both of industry fundamentals and of fundamental beliefs. One test is the widely accepted opinion that airlines in bankruptcy use that court-protected status as an artificial prop to support capacity – aircraft, routes, spokes, even hubs – that unconstrained market forces would otherwise squeeze out of the system. Former American Airlines chairman Robert Crandall has long been, and still is, the most passionate and articulate proponent of this theory. He is not alone: a highly regarded blue-ribbon commission of the early 1990s crisis essentially adopted the tenet. Many have accepted it since as a hypothesis worthy of faith.
Such is the certainty in the theory that the question has even reached congress. The leading legislative voice on the airline industry, House Aviation Subcommittee chairman John Mica, says: “Some argue that the industry’s current problem is overcapacity, and that bankruptcies, to the extent they reduce capacity, will solve this problem. While such reductions may offer temporary relief, history shows that the growth of industry capacity has continued unaffected by major liquidations.”
Indeed, his version of history may be right. A federal study by the Government Accountability Office presented after the two most recent bankruptcies concluded that it is only major economic recessions with their dampening of demand for air travel, and the 11 September attacks, that appear to have forced the airline industry to reduce capacity. The capacity curve has moved steadily upwards, growing two-and-a-half times between 1978 and the beginning of 2005, the GAO found.
Over the same period, the US industry suffered 162 bankruptcies, 22 of them in the last five years, according to the study, conducted for Mica and other key congressional committee members. The GAO calculates that even a 22% drop in TWA’s capacity after its first bankruptcy in 1992 could not dent the industry, which was offering 1% more capacity overall by the end of that year.
But is this hypothesis finally coming under question? Never has so much capacity stood to be brought down as it has today. Moreover, the fundamental arithmetic of decisions about capacity cutting is fundamentally different now that a basic integer has changed: fuel is double its cost of a year ago.
The airline industry now would seem to stand at what some business-schooled executives like to call an “inflection point” or a change of tone. It is not a “tipping point” of the design, creation, or choosing of business-school graduates, but has entered the formula as fuel price hikes outpace so many rational moves.
Meaningful capacity cuts
With an industry operating under bankruptcy economics, even when some major players such as American have stayed out and even when the low-cost sector is vibrant, things are changing:
- From October 2004 to October 2005, US domestic flights are down 2% from 2004 with 19,000 fewer flights, and US low-cost flights are actually down 6%, according to industry estimates.
- Delta executives say they plan to cut their domestic schedule by as much as 20% or 25% as it restructures. A significant chunk of that drawback, as much as a 10% decrease in Atlanta alone, is in the Florida markets that are about to become popular winter vacation spots. Simultaneously, Delta’s international flying from Atlanta and New York JFK increases, in what it describes as its largest overseas expansion in its history.
- Northwest said fourth-quarter domestic mainline capacity would be down as much as 10% from last year. International capacity will be down by 5% or slightly less. It expects systemwide mainline capacity in the first quarter of 2006 to be cut by as much as 13% year-over-year. Northwest warned that mainline capacity may be reduced by more than 15%, gradually and over a longer time frame.
- Since September 2004, using its bankruptcy flexibility, United has cut domestic capacity by about 13%, including a dramatic pull down at Baltimore/Washington International, a significant drawback at New York’s Newark Liberty and even a slimming at its Chicago O’Hare hub by 10% or a little less.
Elsewhere, even relatively healthy carriers have drawn back. American jumped into the capacity-control game, cutting 1% of its flights at least through January, mostly from Dallas/Fort Worth and Chicago O’Hare, in response to high fuel prices. American also permanently eliminated service between Chicago and Nagoya, Japan, again due to the high cost of fuel. Fuel costs led its American Eagle regional subsidiary to take more than 550 flights out of its schedule in October alone, with a likely repetition of the exercise this winter.
Motivated by the highest goal of self-interest, namely survival, these pullbacks are carefully and indeed surgically aimed to trim without inflicting more pain than the conscious patient can tolerate. In that sense, they may not be enough. One outspoken observer, consultant Mike Boyd of the Colorado-based Boyd Group, says with some scorn that the cutbacks are far less than meet the ear. Delta cuts at Cincinnati, he says, sound profound: “A 26% cut in capacity sounds like Delta has taken a hacksaw to Cincinnati. What they miss is that most of this capacity has only been in place less than 18 months.”
He concludes that Delta is eliminating “temporary spikes” from its hubs, not eliminating fundamental growth such as the expansion that it shifted to its Atlanta and Cincinnati hubs in early 2005 when it shut its Dallas/Ft Worth hub. But given Delta’s change in focus though to the international scope, even the most cynical may conclude that when enough spokes are trimmed from a hub-based network, the operational core is weakened too.
After all, in one 14-day period in October following Hurricane Katrina, Delta cancelled an undisclosed number of lightly booked flights as part of an “emergency fuel conservation effort”. After the fuel supply stabilised in the south east, Delta resumed its full schedule, but did not declare the emergency procedures off limits.
A more generous view than Boyd’s comes from consultant Dan Kasper of the LEGC Group of Massachusetts. Considering the difficulty of the process, taking out aircraft that lessors may be glad to support and furloughing workers who would rather work, Kasper says that the bankrupts have made significant and, indeed, laudatory cuts in capacity.
Domestic impact
JP Morgan Securities analyst Jamie Baker offers some interesting context. Overall, he expects a 2% domestic capacity decline for next year, including a 6.6% reduction among the eight largest carriers, helped by a shutdown of financially marginal Independence Air. Baker offers a vivid and telling snapshot: “Mainline legacy operators are expected to remove more capacity next year than JetBlue will operate in total.”
Baker’s mention of JetBlue holds out hope, but also a reminder that when legacy carriers pull out, low-cost operators often replant. As Kasper suggests, it is not so simple a calculus. He notes that the revenue side of the formula is a flat constant and does not rise to any degree to cover significantly higher fuel costs. He says: “We have seen some really strong unit-revenue gains, but they’ve been wiped out anyway by fuel costs.”
Nevertheless, this unpleasant reality of high fuel costs rains on new-generation carriers as well. And this year, low-cost, low-fare management has been self-restrained in growth, moving opportunistically, but with some self-pacing. Given the legacy of legacy indiscretion in growth and reluctance to prune, much less trim, this season of capacity cuts may be more than just winter kills, and could offer some hope for the spring season.
DAVID FIELD/WASHINGTON
Source: Airline Business
