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Monday, Jan 16, 2006


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What ails America's airlines?

Pankaj Narayan Pandit

THE "Mega Six" airlines of the United States have been ailing since 2001. In 2005 four of them, Delta, Northwest, and United, filed for bankruptcy under Chapter 11. Another loss-ridden US airline, US Airways, while under Chapter 11, has been taken over by America West.

Filing for bankruptcy under Chapter 11 has been compared to an emergency ward of a hospital, giving companies in the US a reprieve, to reorganise their business, renegotiate with unions on wage cuts, restructure loans, and possibly emerge profitable on a lower cost base.

According to US airline trade sources, since deregulation of the airline industry in 1978, more than 100 US airlines, have filed for bankruptcy under Chapter 11. Few like Continental, emerged profitable while PanAm, TWA, Eastern, have gone extinct in the last century. Reduction of excess airline capacity augurs well for existing airlines.

Such "thinning of herd" is a regular phenomenon in industries such as airline, auto, telecom, where supply often is more than the demand. Bankruptcy unlocks airlines' productive assets to stronger airlines, leading to more a efficient and trimmer industry.

What are the root causes for the precarious financial state of mega airlines in the US? What lessons has it for the emerging airline industry in Asia?

No respite in 2004 for loss-making US majors: The six US majors, called legacy airlines, have been in loss since 2001. Their cumulative losses are $25.5 billion, and estimated losses in 2005 will be $8 billion (see Table showing net results). And the 43 per cent increase in fuel costs dealt a further blow to the travel industry.

As many as eight airlines from North America figure in top 10, worst loss making airlines of 2004.

What are reasons for such huge losses?

Lack of profitable growth opportunities: The domestic air market in the US is far bigger than the international one. Considering that country's huge size, no one airline can control its skies. Each major airlines in the US has a hub in a specific area. The airline derives strengths in that niche area due to concentration of resources, intensity of operations, control of airport slots and departure terminals.

In the last few years, each of the major airline in the US was challenged in their hub by start-up low-cost carriers such as Independence air, Air Tran, Express Jet, Jetblue, Skywest and Southwest. The LCCs wooed customers away from the major players with an efficient, no-frills service at a much lower price. Faced with huge losses, the US majors had to shrink their domestic networks.

Inability to control fixed operating costs: The average unit cost per ASK (Available Seat KM) of US major airlines is 7.7 cents, while the LCCs are 4.5 cents per ASK. Reason for higher costs is the higher proportion of fixed costs that US majors have inherited thanks to their outdated business model.

In a price sensitive market, lower costs give LCCs a considerable advantage in winning over customers.

Further, an aging population in the US means that as the post-War baby boom generation neared retirement, pension fund contributions escalated. The mega airlines' pension-fund liabilities amount to $33 billion (see Table on pension fund debt) due the problem of ageing population. According to insurance industry experts, this is due to a corresponding decline in the productive age group (between 20 to 50 years).

A second reason is the reluctance of Americans to accumulate enough savings during employment for their pension.

Emergence of Asian and European airlines: As Asia-Pacific countries such as China, Japan and Singapore, increased their economic prowess, they also increased travel and trade with the US. The west coast of the US was connected to Asia by highly efficient, profitable and large Asian airlines such as Singapore Airlines, Cathay Pacific.

The East Coast of the US was similarly connected by European airlines such as Lufthansa and British Airways. Using their geographic positions to full their advantage, these airlines charmed penetrated sixth freedom (aviation terminology for the practice of airlines using their geographical position to attract passengers from neighbouring countries to their country hub) air traffic away from US airlines. The world's most profitable airlines are from Asia and Europe (see Table on profitable airlines). Such sixth freedom carriage robs international market share from US airlines.

US airlines missed out on the "Asian growth story": The airlines from the growing tiger economies had no significant population base, or vast domestic air market in their own countries. But thanks to their younger fleet and stronger economies, they have registered robust and consistent growth. These airlines have also backward integrated into the entire profitable aviation supply chain by floating independent companies in business of airline IT, MRO (Maintenance, Repair, Overhaul), cabin catering, ground handling companies. Such airlines have made quick inroads into home territories of high population countries such as the US, and countries in the Indian subcontinent.

High yields on international operations between the US, Europe and Asia, have not been affected by LCCs, as they have been able to penetrate the long haul market. Now EU is urging the US to renegotiate bilateral entitlements. Such a change will entitle airlines of all the 25 EU member countries to mount any number of flights from any point in the EU to any destination of the US. The avalanche of capacities from EU-based airlines may well prove to be the final straw on camel's back for airlines in the US already in precarious financial condition.

Options before US airlines:

  • Lobby with ATSB (Air Transportation Stabilisation Board) for tax cuts on airfares, subsidised loans, financial assistance from US government;

  • Deploy increased capacity on bright spots of US skies, the profitable international routes to Asia such as Singapore, Hong Kong, Europe;

  • Merge with US or foreign airlines by inviting private equity from alliance member airline to bring down debt; reduce deficits in pension schemes by reworking contributions;

    Apart from the above, diversification within the aviation supply chain is crucial for mega airlines. The aviation supply chain that stretches from airports, aircraft manufacturers, airline IT providers, cabin catering firms, is heavily skewed against the airlines.

    Today when most governments wish to liberalise their ASA (Air Service Agreements), airlines have to learn to keep flying efficiently, reducing unnecessary costs, and make money from ancillary business within the aviation value chain. The US mega airlines tottering on verge of bankruptcy shows that it is the most flexible, youthful, and adaptable ones who can survive better in a changing environment.

    (The author is senior associate with Infosys Technology Ltd. The views expressed are personal. He can be reached at Pankaj_Pandit@infosys.com)

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