Life and Death in the Air: Carriers, Manufacturers, Realities
Taken a flight recently ? Noticed that over-crowding and under-servicing continue to be the order of
the day ? That the staff and crews tend to look a little frazzled ? Where it's no big surprise - or shouldn't be. If there's any industry in worse shape than US Auto Manufacturers it's the US Airline Industry. What they do share is some fundamental breakages in strategies, business models and difficulties in facing realities sufficient to change. We've made the comparison before for both industries to the Steel Industry, which is now in the midst of a worldwide revival. And it's not like any of this couldn't have been seen, and probably was, coming. Warren Buffett kids that he's been a member in good standing of AA - Airline Anonymous - for decades. Any time he's tempted to invest he calls them and they talk him out of it. As Warren repeatedly points out the Airlines haven't made their cost-of-capital in decades, even including the days before regulation. Just to put things in perspective here's a little 2+ year industry index chart - notice the ratio between the SPX and XAL - not pretty is it ?
The airlines face some fundamental structural problems which they're still not facing. We think the primary one is the economics of the Hub-n-Spoke route structure. Now we say that, and have been saying it for a while. In fact it's particularly gratifying that in the last few weeks that particularly meme has been picked up by several MSM reporters. Just to give you a mental picture we've put up an abstract graphic of the typical mainstream US carrier route structure. You can, if you like, impose a mental map of the US around the network structure. And it's certainly not all-inclusive but you get the point. What the airlines set out to do was provide coverage and access from any city in the US to any other city and they priced their tickets from end-to-end on the network. Here's the rub - actually here's the two rubs.
First you end up with a lot of excess or under-utilized capacity on many legs of the network but because you price it end-to-end against what you see as the competition you also end up charging just marginal costs on those last branch connections instead of total fully loaded costs. This works as long as the overall network load factors, that is capacity utilization, is high enough and you charge enough to make money on the network as a whole. Second for any given link in the network Total Cost = Fuel + Labor + Aircraft + Overhead. And strangely enough a lot of fuel gets burned in takeoffs, climbouts, taxi and landings. In other words an airline flying a lot of short hops has trouble making money because it's burning fuel prodigiously. Any airline has trouble making money on those legs where the load factors result in fewer passengers at lower prices than the total cost for that leg. Yet finding yourself in that position is almost required by the operating logic of the network.
Here's the final three challenges. 1) In effect the high usage main routes which are the backbone of the system subsidize the rest of the links. 2) The network is vulnerable to cherry-picking by a smaller airline that doesn't build a network but instead comes in with equipment and flight frequencies tailored to the demand on a particular city pair (stop me when the words People Express, Southwest, TransAir or JetBlue occur to you). 3) The industry operates on the romance of its' version of the greater fool theory. There's always some fool that thinks airlines are neat and is willing to put up the capital to start trying to build a new cherry-picker. Who knows what the exact figures are but for the sake of discussion let's say that the Industry is somewhere, despite all the plane retirements, equipment down-sizing, etc. etc., between 10-30% over-capacity.
The fundamental fix - only fly routes where you can make money with the equipment, strategy and business model you've got. Translation - downsize considerably, give up flying all connection and leave it to local/regionals who can implement that strategy, put direct point-to-point connections in yourself where you can and then, and only then, lay a completely re-designed network on top of it. It's no accident that if you look in your seat pocket the route guides for the majors look like our picture and for LUV look like somebody tossed a set if I-Ching sticks on the map.
On the other side of the House are the world's two dominant aircraft manufacturers where the stories, economics, fundamentals and strategies are very different. We won't go into those in detail here as it's another complex story of Darwinian economics. We will say that if the worldwide slowdown continues their orders books will suffer some. But since they're largely selling outside the US anyway and are over-booked, at least BA is, it almost doesn't matter. Airbus though is in terrible trouble having built a vanity aircraft in the AB380 and gotten caught several steps short by BA with it's Dreamliner. Boeing of course is getting hammered thru typical teething problems for a whole new way of doing business. But the B787 is a major innovation on three fronts: 1) Design (major usage of computer-aided design pioneered and proven on the B777), 2) Construction - emphasis on new engines, composities and modular component assemblage which is working but has some teething troubles. And 3) Supply Chain - where they really pulled out all the stops and are having more troubles than ever anticipated. And slowly working their way thru it. Aircraft manufacturing decisions are 30+ year horizon decisions. BA is going to be around a long....long time. As the world economy continues to globalize, as the US carriers rationalize and demand continues strong they're far better positioned than Airbus. We consider them a major buying opportunity eventually.
Airlines
Luggage fee was only the start of airline increases Airlines ratcheted up the pressure on fliers ahead of the holiday weekend, significantly raising ticket prices to offset the runaway cost of fuel. The three biggest carriers each boosted most domestic fares by up to $60 roundtrip, while budget airline AirTran Airways raised its leisure fares by $30 roundtrip.UAL Corp.'s United Airlines led the bigger round of increases late Thursday, lifting roundtrip ticket prices by $10 to $60, depending on how far passengers fly and the competition on the route. Travelers will pay the biggest increase on routes of 750 miles or more — less than the distance from New York to Chicago — that low-cost carriers such as Southwest Airlines Co. do not serve.
- Air Travelers Need to Pack More Money Airlines are passing their financial pain to their passengers in the form of sharply higher airfares and new fees. GRAPHIC on fee structures and changes.
- Airlines Consider Treating Passengers `Like Freight' to Combat Fuel Surge Imagine two scales at the airline ticket counter, one for your bags and one for you. The price of a ticket depends upon the weight of both. That may not be so far-fetched.
American Airlines loses $3.3 million a day red ink in the airline industry is about as novel as weather delays or lost luggage. What has changed for executives like Arpey is that there is not much left to cut. Thanks to bankruptcies or restructuring, airlines like American long ago chopped the low-hanging fruit and added extra fees wherever they could: Pilots make less, planes fly more, and passengers now routinely shell out for once-complimentary items like onboard food and checked luggage. The problem is that no airplane was ever designed to make a profit with jet fuel at these prices, and no carrier has figured out a way to charge enough to make up the difference. Pity the airline CEO. He can't control his biggest costs. He can't really control the prices he charges. Already this year, record fuel prices have forced five carriers to file for bankruptcy. Analysts say more may be on the way - and some believe American is in danger. That's because as the only so-called legacy carrier to have avoided Chapter 11, American has significantly higher labor costs than many of its competitors and operates a largely aging fleet of gas-guzzling aircraft - two problems without easy fixes. The problem? The market allowed fares to go up only 5%. "It's airline Darwinism," says Holly Hegeman, an analyst who runs PlaneBusiness.com. "Those unable to make a profit on their basic business will burn cash until they either figure it out or run out of cash and things to sell off, or oil prices significantly reduce."
AMR's American Air Will Cut `Thousands' of Jobs, Retire Jets as Oil Surges AMR Corp.'s American Airlines, the world's largest carrier, said it will eliminate ``thousands'' of jobs as it drops U.S. routes and retires as many as 85 jets to blunt surging fuel prices and slowing demand. AMR plunged the most since 2003 in New York trading, slicing its market value in half since the start of this year to $1.53 billion. The carrier also added a $15 fee to check one bag, the first in the U.S. with such a charge. Chopping domestic seating by 12 percent ``is the right and necessary thing for American to do with oil at $130,'' said Doug Runte, managing director at RBS Greenwich Capital in Greenwich, Connecticut. The move will help American boost fares, he added. American: Bag fees and layoffs
· LUV is in the Air Reflecting on his time at the helm of Southwest Airlines, with Herb Kelleher, Southwest Airlines founder.
- Herb's Labor of LUV Discussing stepping down as chairman, with Herb Kelleher, Southwest Airlines founder.
Major turbulence ahead for airlines America's aviation system could be at risk of collapsing by the beginning of next year. That warning from aviation experts has prompted some industry leaders to call for re-regulation, something considered almost heresy until now. Others are urging Washington to do more to rein in the oil speculators pushing up fuel costs. But there is agreement among airline officials and analysts that Washington and the two presidential candidates need to recognize the severity of the crisis and take some action now to avert an economically crippling collapse in the near future. "Unless something is done to move toward some kind of fix, we're going to see every one of our major airlines in bankruptcy," says Robert Crandall, former chairman of American Airlines. "If that isn't enough of a crisis to alert everybody, then I don't know what it will take." As a result of the spike upward in oil prices, almost every major airline is now losing millions of dollars each quarter. Unless the price of oil comes down, most are expected to run out of cash by the end of this year or the beginning of next. In a bid to stave off bankruptcy, they're already retrenching. They plan to lay off an estimated 25,000 employees, park hundreds of planes, and cut the number of flights they offer. In addition, a recent study by the Business Travel Coalition, which represents corporate travel managers, estimates that 100 regional and 50 major airports nationwide will lose some of or all their air service by the end of the year.
Flight delays cost $41B in 2007 - study Domestic flight delays cost the industry and passengers $40.7 billion in 2007, according to the Joint Economic Committee from the House and Senate, which released a report Thursday. As part of this overall cost from the delays, passengers lost an estimated $12 billion worth of time that would otherwise have been spent on business and play, said the committee report. These late flights cost airlines $19.1 billion in extra staffing, fuel and maintenance costs - mainly from planes idling at the gate but also from taxiing delays and from circling airports in holding patterns, according to the report. The cost to airlines includes $1.6 billion in fuel costs, as idling planes wasted 740 million gallons of jet fuel, the report said, releasing more than seven million metric tons of carbon dioxide into the air. This was based on the 2007 average wholesale fuel cost of $2.15 per gallon. The committee also said that delays caused $9.6 billion in "spillover costs" to other industries that rely on air traffic, like restaurants, hotels, retailers and public transportation. The calculations from the Air Transport Association, a trade group that represents the airline industry, are significantly different. ATA spokesman David Castelveter said that delays cost the industry $8.1 billion last year, which is less than half of the $19 billion estimate from the Joint Economic Committee. Castelveter said the industry cost is expected to rise to $10 billion this year. He said that he doesn't exactly know how the committee arrived at its calculation, so he doesn't know why the number is different.
How to fix airline industry You get what you pay for. And that means you don't get much anytime you fly these days.In yesterday's Buzz, I criticized companies like American Airlines, which just announced a $15 baggage-check charge, for finding new ways to annoy customers. I sympathize with the plight of the airlines. Even when jet fuel was much cheaper, it was a tough business. Now, it's nearly impossible for airlines to make money. But instead of infuriating passengers with clever new fees for basic services, I suggested that the airline industry should end its decades-long practice of price wars and raise fares dramatically. I figured consumers would be willing to pay higher ticket prices if it helped keep more airlines in business and also led to a better flying experience. Many of you agreed. Here's a sampling of what some readers had to say about the airline industry on our Talkback page. Interestingly, many readers felt that big fare increases were not just long overdue, but would actually be welcomed...especially by airline workers.
In 2010, U.S. airlines are likely to be smaller, maybe smarter Domestic airlines are staring down a double-barreled gun of crushing jet-fuel prices and slowing growth, but analysts predict the industry is bound to recover at some point and could even evolve into something more friendly for investors and travelers alike. The trick for investors is figuring out which U.S. airlines are likely to still be around 18 months from now. So far this year, the global airline industry has been shaken by 24 bankruptcy filings, including several smaller American carriers, while mainstay network airlines remain under siege. "There's going to be just three global airlines and the low cost-carriers are going to become feeders, bringing people into the hubs," predicted Terry Trippler, an airline consultant. The United States also will probably look a lot like it did 25 years ago, when there effectively were two global airlines -- PanAm and TWA -- along with a plethora of regional carriers, he said. Driving the change will be bankruptcies and a sharp reduction in capacity, and the major airlines that are going to survive will have to be smart and bold in cutting their costs. But it's not going to be easy. As a result of bankruptcies after the Sept. 11, 2001, attacks, carriers are already running lean, filling 80% of their seats compared with the historical 60%. That leaves little for airlines to trim beyond cutting low-yield routes and more jobs, but those that do make the sacrifice are going to be stronger for it, perhaps by this time next year. Assuming the so-called legacy carriers slash as much capacity as they're planning, they'll be wiping out about 10 years of domestic growth, the investment bank said. Capacity cuts will help low-cost carriers, which have been able to turn profits on routes that major airlines have flown at a loss. That's because the carriers use a "point-to-point" model that helps them avoid the expenses that major carriers incur to maintain a central hub.
- Airline Consolidation Spotlight on the airline sector, with Jim Corridore, of S&P, and Brent Bowen, of U. of Nebraska's aviation institute
Aircraft Manufacturers
Gathering clouds An aviation giant faces difficulties on several fronts. The past couple of months have been torrid ones for the company that, with Boeing, dominates the market for large civil aircraft. The high price of oil means that many of the firm's shell-shocked airline customers are cutting capacity and reviewing their orders for new planes. Meanwhile, Airbus itself is groaning under the burden of meeting its costs in strong euros while being paid for its aircraft in weak dollars. And a crucial part of its “Power 8” restructuring plan—the disposal of several factories—has been put on hold by the global credit crunch. In the circumstances, confidence at Airbus might be expected to be at a low ebb. But the mood is defiant. Despite the agonies of the airlines, the firm reckons its cushion of orders will allow production to stay at today's levels for several years—even if some customers reduce their commitments. Nor is Airbus panicking over the failure to sell its factories. It admits to being over-ambitious about the selling price, but insists that there are still plenty of potential buyers. But there is outrage within Airbus at its treatment by the AMF.
Oil Surge May Cost Jet Makers Orders (WSJ) As rising oil prices cause even the strongest airlines to struggle, Airbus and Boeing Co. face the possibility that as many as a third of their orders for new jets could be postponed or canceled. Driven largely by demand from airlines outside the U.S., the rival manufacturing giants over the past three years have collected almost 7,000 orders for modern fuel-efficient jets. For now, both jet makers say they are sold out for much of the next three years and are continuing with plans to raise production rates to meet demand. But the landscape is shifting as oil prices rattle the underlying economics of the airline industry. Some airlines, including JetBlue Airways Corp. and Delta Air Lines Inc., are already taking steps to defer deliveries or rid themselves of orders. Others are starting to repeat steps they took after the Sept. 11, 2001, terror attacks, such as permanently parking gas guzzlers and selling newer jets to leasing companies for cash before leasing them back on a monthly basis. The combined value of the orders for Airbus and Boeing planes exceeds $500 billion at list prices, so large-scale cancellations and deferrals could easily amount to tens of billions of dollars and affect suppliers of engines and other parts in addition to the jet makers.