When I started flying for business in the early 1970s, the company rule was that I wore a suit and tie. Today I dress more casually and so does everyone else, and while the flying public has changed, the airlines are just as cyclically unprofitable as ever.
Today, business in the airline industry is about as hard as it's ever been. Airlines that were posting record profits just a couple of years ago are now in or near bankruptcy. Deregulation, once the save-all of economics, and bad management are catching the blame for the airline problems. But the problems are deeper than that.
When I started flying the airline industry was a regulated industry. The Civil Aeronautics Board (CAB) told airlines whether they could be in business at all, where they could fly and what they would charge. Nobody seemed to like the system very much and everyone, including the CAB, seemed to think that deregulating the airlines would make everything better.
Congress approved the Airline Deregulation Act on October 24, 1978 and President Carter signed it into law. It was supposed to make everything better. There would be increased competition and that would result in lower airfares and more traffic. They were right about all of it except the part about making everything better.
There is a lot more competition. In 1978 there were only 43 carriers to fly large aircraft. Now it's more than double that. In 1978 two thirds of US travelers had a choice of at least two airlines. Today that's 85 percent. And fares have dropped, in real terms, for most travelers.
Most of the growth came in smaller markets as a result of the hub and spoke system that the large airlines put in place after 1978. This system brings passengers from small airports into larger airports where they then have their choice of destinations.
The hub and spoke system works great when air travel demand is high because it turns out to be a very efficient system for reaching multiple markets. It simply wouldn't make economic sense to have individual flights out of Wilmington, North Carolina, where I live, to New York and Los Angeles and Orlando, and Chicago. There won't be enough Wilmington travelers on any given day who want to go to any one of those destinations.
But we can all get on a plane to Charlotte and fill that plane up. Then when we get to Charlotte we can connect to all those other cities and more. Some experts think that the hub and spoke system accounts for 50 percent of today's air travel.
If all those good things happened, why isn't everything better? The answer lies in airline economics and the dynamics of competition. Let's look at some of the economics first.
Airlines are a service business with a highly perishable product. That airline seat on the plane from Atlanta to Frankfurt brings in money only if there's a paying passenger in it when the plane departs.
Airlines are highly capital intensive. Those planes cost a lot, $80 to $150 million, in fact. Airlines need them to have the seats when demand is there. When demand is not there, the airlines still have to pay financing and storage charges, even if the planes aren't flying.
Airlines are highly labor intensive. It takes a lot of people to make an airline work, and most of those people are members of a union. Those unions have negotiated some of the most amazing work rules in the history of business.
United Airlines, for example, employs 427 skilled mechanics at full mechanic's pay to oversee the push-back of planes at 18 airports. Other airlines use lower paid workers for this. United claims that changing this work rule alone could save it $40 million a year.
These three factors make cost control imperative. The major airlines haven't done such a hot job of that. On average, major US passenger airlines need to fill 83.1 percent of their seats in order to break even. That's tough in good times and even tougher in bad times since labor contracts and capital expense don't disappear when times get bad.
Take a look at the three US airlines that have been in the biggest trouble lately. US Airways has to fill 88.4 percent of its seats, American 89.7 percent and United a whopping 90.7 percent. By contrast, Southwest, the most consistently profitable airline, makes money when it fills only 60 percent of its seats.
Here's the way the business cycle seems to work in the airline industry. When times are tight, the airlines negotiate new deals with their unions, strip down their routes and operations to become more efficient and scratch their way back to profitability as the business cycle turns up.
As people, especially business people, start to travel, more of the lower fare airlines like Southwest start to move into profitable routes. They capture market share with their low fares. The major airlines respond, in their time-honored way, by cutting their own fares.
In the meantime the "profit god" returns from the ground and things are looking good. The airlines buy more planes. The unions win back concessions they made during the recession. Costs begin to balloon but no one seems to notice, or want to talk about it, because business is good. When the next downturn hits, the cycle begins again.
Things usually get bad, but this time they got worse. They got worse quickly because of September 11. And they got worse because of the effect of new security regulations.
Air traffic was already declining in early 2001 and costs were still high, just like normal for heading into a downturn. Then September 11, 2001 changed things.
The entire air travel system in the US was shut down for days. Carriers lost money. Since they were already operating close to the edge they looked to the government for help and considered bankruptcy protection. They've negotiated with unions, cut flights, and increased fares.
The government demanded increases in security. The airlines got the bill. The lost business and increased security costs were the most obvious effects of September 11, but what may be more damaging to the airlines over the long term are the Fear Factor and the Hassle Factor that accompany the new security.
The effects of the Fear Factor are obvious. Many families and leisure travelers are reluctant to fly. Instead of flying to a vacation destination, they're driving to something closer to home. The Fear Factor doesn't affect business air travel much, but the Hassle Factor does.
The Hassle Factor comes from having to get to the airport earlier and spend more time standing in lines. It comes from not being able to take some things in cabin baggage and having checked baggage subject to search, and from the possibility that you will be the one standing in a public place while all the folks in line get to watch a security person examine your underwear.
The Hassle Factor means that folks start to think it's easier to do something other than fly. Leisure travelers may decide to drive or forego the Thanksgiving trip to grandma's this year. Business travelers consider virtual meetings. And they'll drive to destinations they used to fly to. Here's an example.
A couple of weeks back I was scheduled to give a speech in Charlotte on a Thursday and conduct a session on the future of business for some CEOs in Charleston, West Virginia on Saturday. Before the Hassle Factor I'd have handled things this way.
I'd have flown from Wilmington to Charlotte for the Thursday speech, stayed the night in Charlotte and then flown on to West Virginia on Friday and home Saturday. I'd have my pick of flights. The fare would be reasonable and I'd save lots of time by flying. With the Hassle Factor, though, things are different.
Today that flight would cost over $900. I bet I'd spend less on a cab from Wilmington to Charleston and back. More important, because of fewer flights and increased airport time, it would take me about the same amount of time to drive as it would to fly.
The net effect of the Hassle Factor and the Fear Factor is that we're simply not making some trips that we used to make and many of us are driving to places where we used to fly. Suddenly the airlines are looking at a very different world that may demand some very different business solutions.
Right now, somewhere out there, an idea or two is taking place and beginning to coalesce into action. Whatever the new solution is, it probably won't be centered on leisure travel. Between the Fear Factor and the declining perception of wealth that's hit middle class families who've watched their retirement plan values vaporize, leisure travel may be much more local for some time to come.
What form will a new solution take? It will have to be a solution that meets the needs of business travelers who are probably more willing than ever to make sure they get good value for their air travel dollar if they can get reasonable comfort and flexibility in the bargain. That might be charters or small jet airlines or something else.
But change is surely coming to the airline industry with the inevitability of weather. And whatever happens, I doubt I'll be wearing a suit when I fly any time soon.
