From the June 14, 2009 Sunday Times (London)
June 14, 2009
by Irwin Stelzer
The airline industry has never generated sustained profits — by some estimates if you add up all the profits and losses since the Wright brothers flew from Kitty Hawk in 1903, the net amount would be written in red ink. This year will be no different. The global industry will lose an estimated $9 billion, after losses of $10.4 billion last year.
The question now is, which carriers will survive the downturn, and with what sort of schedules and service? It’s not an easy question to answer because two forces are at work: the current, temporary cyclical downturn, and a permanent change in travel habits.
Press reports are not much help. One day we learn that the industry has suffered huge losses in every year since 2001, with the exception of 2007, the next that United Airlines is ready to place a $10 billion order for 150 new jetliners. One day British Airways announces that it won’t configure any new planes to offer first-class service, and Qantas scraps first-class service on three of its long-haul routes; the next day Lufthansa and Air France-KLM announce plans to use their new A380 super-jumbos to expand their premium service offerings, even though premium travel (first and business class) is down about 20%.
There is no question that the recession is hitting the airline industry where it hurts – in the premium service category. This is especially true on the transatlantic routes on which BA is so heavily dependent for its profits, and in the Asia-Pacific region. There aren’t many bankers and lawyers jetting back and forth between London and New York (or anywhere, for that matter) to do deals, and those who are find that economy class is more in tune with constrained company budgets and is less likely to attract criticism from politicians who don’t want taxpayers’ bailout funds used to finance luxury travel.
Suddenly, business travellers are being offered price cuts. BA is offering a two-for-one $1,300 per person return ticket to New York (the regular fare is $11,717). Some price-cutters are making up for lost revenues by requiring obese passengers to pay for a second seat, and for bags, extra leg room and just about everything they can unbundle from the basic fare. But if oil prices continue to rise, if interest rates follow, as seems likely given heavy borrowing by governments, and if the fall in premium travel proves more than a cyclical phenomenon, losses will mount rapidly and we might see some American carriers arguing that what’s good for General Motors and Chrysler is good for us, and get access to some free, taxpayer-provided capital – with the unions cut in for a large share of the handout.
The good news, of course, is that during the recession no airline of any consequence has gone out of business. The bad news is that because no airline has gone out of business the industry has substantial excess capacity, especially outside America, a condition that has plagued it for decades. Old airlines never die, they emerge from bankruptcy, or get subsidies from prestige-seeking governments. Throw in the expansion plans of the new state-supported Middle Eastern carriers, and there is little prospect that a lean, mean industry will emerge from the downturn. Well, at least not a lean one. And at least not in America or Britain, where the pilots’ unions are unlikely to follow the lead of their KLM counterpart and allow their underemployed members to volunteer for baggage-handling work to keep summer hiring and costs down.
A former BA chief executive once told me that when he flew between New York and London he would always meet the unions at JFK and at Heathrow. The American unions were tough-minded, but understood that he had to deliver profits if BA was to survive. At the Heathrow end, the unions viewed profits as an unnecessary deduction from their pay cheques. So Willie Walsh, the chief executive, has his work cut out and just might have to weather a round of strikes – or worse, work-to-rule and sick call-ins – if he is to pare his staff down to a size commensurate with what he apparently sees as the grim long-term prospects of BA, which lives and dies with the volume of premium traffic on the transatlantic routes.
United takes a cheerier view of its prospects, witness that order for 150 new planes. It is true that the new aircraft will be more fuel efficient than the planes they replace, and more able to meet the pollution standards that the EU is preparing to impose on all carriers using European air space. True, too, Airbus and Boeing are so desperate for orders that they are likely to offer attractive prices and cheap financing to capture this business.
But it is equally true that the traditional business model, known as hub-and-spoke to describe the system that feeds travellers into a few large cities and flies them out to their final destinations, might prove unable to compete with point-to-point low-fare carriers such as Southwest and their counterparts in other countries.
Moreover, the cost cutting triggered by the recession means that business spending on air travel might never return to the levels of the old days. One chief executive told me his managers have finally learnt to use teleconferencing effectively, enabling him to cut his annual travel budget from $750m to $250m, “and it isn’t ever going to go back up”. So competition for premium business travellers will be intense.
These are the people who put a high value on service. Which is why Lufthansa is sprucing up its lounges and planes, and other airlines are upgrading customers to otherwise empty seats in first class and business class in the hope of building brand loyalty. Whether Walsh’s cost-cutting strategy or Lufthansa’s increased hospitality will win the day on the Atlantic routes remains to be seen.
Perhaps the BA chief might keep in mind Gordon Bethune’s warning, issued when he was serving as chief executive of Continental: take too much cheese off the pizza and you won’t have any customers left.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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