Ask the pilot

What's the problem with U.S. airlines? The low-price paradox.


Patrick Smith
February 24, 2006 5:35PM (UTC)

The depth-charging of airline industry wages and benefits, examined in this space a week ago, is of course symptomatic of the ongoing malaise afflicting America's largest carriers -- a sickness that continues to confound many travelers. What exactly is our problem? Throughout Europe, Asia and elsewhere, profits are running high, with passenger satisfaction levels and employee dignity fully intact. Here at home, even with overbooked cabins and payrolls pared to the bone, airlines continue to post substantial losses while service standards are shameful. United and U.S. Airways have, for now, escaped the bankruptcy shackles (the latter after two separate visits to the courts since 2002), though not before Delta and Northwest stumbled into the tar pit of Chapter 11, their fates highly uncertain. Don't look now, but even JetBlue went red by $42.4 million for the fourth quarter of 2005.

To some degree, comparing and contrasting American carriers with those in other regions is a game of peanuts and pretzels. Overseas, the competitive variables are often quite different, taking in everything from government subsidies to marketplace monopolies. It's unfair to say that the templates of success Emirates or Cathay Pacific adhere to are workable schemes for Northwest or United. Indeed, some foreign contenders have been rudely introduced to the kind of warfare their American counterparts know all too well, as Southwest-style low-cost carriers (LCCs) continue to spring up all over, giving at least a few old-timers a literal run for their money. But we're foolish to go searching overseas for answers. The problem isn't between the U.S. airlines and those in other countries, it's between the U.S. airlines themselves.

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As noted in this space a few months ago, you can make pretty quick sense of the situation by having a look at your ticket receipt. Over the past few years, ticket prices have dropped to the lowest levels in the history of commercial aviation. Never before has the world been smaller -- or cheaper.

For that, you can thank those rapacious LCCs -- most notably JetBlue, AirTran and Southwest. These agile youngsters are ultra-streamlined, mostly unencumbered by unionized labor or the need to support ponderous, decades-old infrastructures. Of those just mentioned, only AirTran features more than one aircraft type in its fleet. It costs JetBlue 7.51 pennies to fly one passenger one mile. At Southwest, it's a similar 7.85 cents. This cost per available seat mile, or CASM, tells the story, and it allows the LCCs to sell passage at rock-bottom prices. The average one-way fare at Southwest Airlines is under $100.

At American, United, Continental et al. -- collectively known as "legacy" airlines (that expression has always irked me, but we're stuck with it) -- CASMs for 2005 were somewhere around 10.5 cents. In other words, their expenses per passenger lurk around 30 percent higher than at the LCCs.

To cover those costs, the legacies can raise fares, at which point the LCCs would need to start ordering 747s and A380s to pick up the overflow of defections coming their way. Or, they can match them, absorb the loss, and continue hatcheting their unions for concessions (and continue subsidizing your chance to travel on the cheap).

Operational simplicity and lower wages are obviously a large part of keeping CASMs down. Another important tool is aircraft productivity. At Southwest, planes make half-hour turnarounds in order to remain airborne as much as possible. Compare that to a Delta 767 that flies the red-eye from Atlanta to Santiago, Chile, then sits on the ground for 13 hours until the overnight return. Routes like this are profitable, sure, but fares are high and the effects of such limited use ripple through an airline's entire operational matrix. Aircraft leases can run millions of dollars per month, and downtime is murder.

The wild card is fuel. Subtract the bill for kerosene from CASMs and the gap between the LCCs and legacies gets tighter. Fuel is a more critical factor for the latter because they tend to fly older, thirstier aircraft. Had last year's prices-per-gallon not soared 50 percent above those of 2004 -- reaching double what they were a few years ago -- this would be a different discussion. Continental and American were otherwise destined for the black, and JetBlue's fourth quarter deficit is entirely fuel-related. For each of the biggest carriers, fuel bills in '05 were more than a billion dollars higher than they were in '04. In some cases, for the first time ever, fuel has overtaken labor as the biggest piece of the company cost pie.

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(And to ward off a common question, the answer is no; despite some laboratory tinkering and a couple of token fuel cell designs for small, private-size planes, there are no serious efforts being made to switch commercial aircraft to alternative energies like hydrogen. Progress is moving at about the same speed as that for cars. Which seems baffling, maybe, considering how beholden the airlines are to fuel prices. Aviation seems to be in a perfect place to become a vanguard of new energy technologies, but it's no less entrenched than Detroit. We'll have to wait and see if Mr. Branson can catalyze some progress.)

Fares did increase last year to compensate for spiking fuel tabs, but not enough. What we haven't seen, despite full cabins and the presumed need for all airlines to offset the fuel spike, is the return of pricing power. That's partly because profit-prone players like JetBlue can willingly take a hit for a while without undue duress. They'll make that sacrifice in order to hold fares down. For them, the longer-term effects are mild. For Northwest or Delta, on the other hand, already mired in Chapter 11, they could be devastating.

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So, assuming things stay more or less the same on the oil front (more than a few analysts, with eyes toward Caracas, Venezuela; Baghdad, Iraq; and Tehran, Iran, see little promise in their crystal balls), the carnage won't end until two things happen. First, the legacies must reduce their expenditures to levels at least resembling those at the LCCs. Delta, for instance, believes it can succeed by getting to within 10 percent. Second, we need to have rational, sustainable airfares. To this point, most of the emphasis has been on the first item -- which, as a practical matter, means cutting employee pay and benefits.

One thing we're already seeing is a shift from domestic to international flying, where battling the LCCs isn't (yet) a problem, and premium class yields are traditionally very strong (the pitfalls of my Santiago example, above, notwithstanding). As part of United's reemergence from Chapter 11, it added 35 international routes despite shrinking some 20 percent in overall size. Delta has similarly eyed overseas expansion, with new services either announced or already underway to India, Hungary, Israel and beyond.

Some have proposed the idea of reregulation. If not a return to full-fledged control similar to what existed prior to the Deregulation Act of 1979, perhaps the setting of minimum fares based on mileage could stave off the liquidation of one or more airlines. Price controls might seem decidedly anti-free market, but with the stakes measuring in tens of thousands of workers and tens of billions of dollars, it's worth a debate. Additionally, it would better buttress the industry against utter calamity in the event of another terrorist attack or an economic meltdown.

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That's a serious step, and one I don't foresee. There are simpler, less conceptually radical steps the government can take, starting with a reevaluation of the taxes and surcharges that are levied on fares and fuel. Go back and take another look at your ticket receipt, and behold the numerous fees and taxes. On average, about 16 percent of the price of an airline ticket -- more for international trips -- is composed of surcharges: federal ticket tax; federal segment tax; passenger facility charge; federal security service fee; customs fees; international arrival and departure taxes; cargo waybill tax. Last but certainly not least, a 4.3 cent-per-gallon jet fuel tax is also passed along to consumers.

According to a study by MIT's Shiro Yamanaka and Joakim Karlsson of Daniel Webster College, "The airlines have lost the ability to raise airfares, even to just keep pace with inflation. The average round-trip ticket has dropped 40 percent in real terms since 1993. Meanwhile, average ticket taxes and fees have stayed relatively constant. With the total cost of taxes changing only slightly, the relative share of each ticket that goes to taxes and fees has been steadily increasing."

The revenues from ticket taxes are earmarked for airport infrastructure improvements, Federal Aviation Administration operations, and security. Passengers seldom begrudge shelling out a few more dollars for better security, but in effect the government has outsourced the Transportation Security Administration (TSA), arguably a key component to national security, to the airlines.

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"I do think the current administration has created an ungainly, inefficient, and potentially ineffective aviation security mechanism," says Joakim Karlsson, "and tried to bill the airline industry for much of it, when it is arguably a matter of national security."

The current administration, for all its pro-big-business policies and anti-tax rhetoric, hasn't given struggling airlines much breathing room. The cynic in me says that's no way to repay the industry whose unfortunate fate on Sept. 11 provided the pretext for war and general chicanery that has, in turn, made things even worse.

Elsewhere around the world, governments are known to nurture aerocommerce through tax breaks and subsidies. There's a widely held assumption that this is done excessively and unfairly, but in truth the degrees vary. For example, many E.U. and Asian carriers are up in arms over the massive expansion of Emirates, which they attribute to coddling of the carrier by its owner, the UAE government. However, as revealed in a recent article in Air Transport World, audits by two renowned investment houses concluded otherwise. "We could not find anything in Emirates' accounts which indicated that the business is subsidized directly or indirectly or given undue preference," said one representative. People point out that Emirates pays no corporate income tax, but as the ATW feature notes, it also bears significant social costs by providing housing and education for thousands of expatriate employees. Long and short, while some foreign governments are guilty of over-nourishing their airlines, few handicap them to the extent that we do.

Whichever way things pan out in the United States, the low-cost template is here to stay -- along with all the lower salaries and lower standards of living for those pursuing a career in this weird business. For workers, it's likely that the bad will never be as bad as we've experienced over the past four years, with the concession that the good will never be as good as it was in decades past.

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All of this is being closely monitored by airlines the world over. Americans sometimes fail to grasp the immensity of global civil aviation; just as there are many dozens of mega-carriers besides our country's six or seven household names, the LCC phenomenon is widespread across at least five continents. Budget carriers have sprung up from Mexico to Slovakia, and six of the 10 most successful LCCs, based on a ranking by Air Transport World, are headquartered outside the United States.

In March, a $27 million terminal will open in Kuala Lumpur, Malaysia, dedicated entirely to budget airlines. A similar building is under construction at Singapore's Changi airport. In Kuala Lumpur, the feisty AirAsia has, in the words of Air Transport World, "revolutionized air travel in the region." Barely four years old, AirAsia's network now extends to several countries and dominates the entire Malaysian domestic market, ousting national carrier Malaysia Airlines, the 19th largest airline in the world, from most of its local markets. Part of it, of course, is that in many places LCCs aren't merely stealing passengers away, but creating new markets entirely. In Brazil, where the budget carrier Gol has captured a third of all passengers, 15 percent of its riders have never flown before. Similar numbers are seen across India, where a slew of new upstarts have taken on incumbents Air India and Indian Airlines. For now, most of the legacies in other countries have been thriving in the face of this intense competition, but that could change.

Getting back to CASMs for a moment, here's a game: Calculate your approximate contribution to a carrier's bottom line by dividing the airfare paid, in pennies, by trip mileage. If an airline's CASMs are 9.5 cents, and your coast-to-coast round-trip was $450, you've undercut its break-even point by $25. Actually it's not that simple, as CASM accounts for all of an airline's seats and miles flown, spread evenly, and specific fares are market-driven, not distance-driven. Still, it's fun to compute the impact on your own bottom line, and relish the fact that a super-saver from New York to Singapore or Hong Kong, halfway around the planet, runs about a nickel per mile.

GO-AROUNDS

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Re: Liberty, security, photography

You say that challenging photographers at airports "doesn't quite shatter the foundations of American democracy." I could not disagree with you more. Over three-quarters of my practice as an attorney is criminal law. Police officers have every right to walk up to you and try to engage you in conversation. You also have every right to walk away or politely tell them to pound sand. Every month I bring (and win) motions to suppress evidence because cops got heavy-handed and violated the Fourth Amendment to the United States Constitution. When I read your accounts of Manchester and Providence, I got a hot flash, ready to gird myself for battle. What happened to you was beyond all reason. They violated your civil rights (technically) because they felt they could. One is reminded again of Ben Franklin's old saw that those who are prepared to give up a little liberty for a little security deserve neither.

-- Steven Flowers

Don't fall out of your chair, but Anne Davis from the TSA, as quoted in your article, is misinformed. TSA is not responsible for oversight of airport law enforcement. There have been power struggles as the TSA tries to implement regulations while taking no responsibility, leaving the airports to deal with civil rights infringements, security breaches, and more. Naturally, this has not been popular within the industry. Essentially, on a local level, the TSA's job is still to look through people's socks; the characterization that the agency is responsible for law enforcement and that the "buck stops" with them is not only false but ridiculous. Airports are expected to provide real, sworn peace officers with actual law enforcement powers who can, among other things, arrest and shoot people if need be -- two things the TSA cannot do (at least not yet, but give the Bushies and director Chertoff some time). Meanwhile, many airports do have regulations that pertain to commercial filming and photography, but they have little to do with security. It's generally a legal issue, pertaining to copyright infringement and royalty fees. Protected logos can show up in movies, ads, etc., without permission. Personal photography and videos, on the other hand, are absolutely legal and allowed. The TSA is extremely touchy, however, and will whine whenever they get a chance about people taking pictures.

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-- The letter writer, who wishes to remain anonymous, is the manager of a midsize regional airport in the United States

Last, if not least, a TV recommendation: A cabal of terrorists orchestrate the takeover of multiple jetliners. It's "a scale of hijacking that none of us had seen before." There's panic and horror as terrorists rush the cockpit; the world watches as the drama unfolds over the next several days. Sept. 11? No, it's the infamous and long-forgotten Black September hijackings of 1970, in which five passenger jets were seized over Europe and the Middle East by the Popular Front for Liberation of Palestine (PFLP). This coming Monday, Feb. 27, the PBS series "American Experience" presents "Hijacked," an hourlong documentary on the event. As I recounted once in an old column, Black September was a spectacle of audacity not to be outdone for more than 30 years, and it's high time that somebody else reminds us that the attacks of 2001 were not the be-all, end-all of air crimes. "American Experience" includes some outstanding footage (my favorite is a shot of the commandeered jets parked in the Jordanian desert while a pair of camels lolls in the foreground) and interviews with passengers, crew and even hijackers -- namely that saucy doyenne of '70s-era terrorism, Leila Khalid. The inimitable Ms. Khalid deserves a documentary of her own, and was once the subject of a Teardrop Explodes song.

The show does contain one small technical blooper (they always do), which I'll challenge readers to pick out. The first person to correctly identify the gaffe wins a copy of Ask the Pilot.

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Do you have questions for Salon's aviation expert? Send them to AskThePilot and look for answers in a future column.


Patrick Smith

Patrick Smith is an airline pilot.

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