04/24/94
THE SEATTLE TIMES, COPYRIGHT 1994
AIRLINES — HOW LOW CAN THEY GO — STAGGERED BY LOSSES, BUFFETED BY CHANGE, ONE OF THE NATION’S BIGGEST INDUSTRIES IS IN A TAILSPIN
TERRY MCDERMOTT
It’s dirty.
The driver smokes.
He’s new in town, new in the country, in fact, and doesn’t know his way around. He can’t find the freeway – the freeway, the largest man-made structure in the state. After he finally stumbles on it, you get stuck in traffic twice in the 15-mile ride down Interstate 5 to Sea-Tac.
The ride takes 45 minutes, twice what you figured. You run, barely catching your flight.
You board. Buckle up. Somebody brings you a magazine to read. Somebody else brings you juice. Then a meal. Then coffee. Meanwhile, the $40 million machine you’re in is 6 miles above the ground, cruising at nearly the speed of sound. It is flown by three people who among them make $300,000 a year, and its progress is tracked by multimillion-dollar radar systems up and down the Pacific Coast.
Two hours later, the plane lands in Los Angeles. You catch another cab, a genetically flawed twin of the first one. The trip downtown is just as long, the fare even higher.
The two cab rides, total distance of 28 miles, cost $85, plus tip. The plane ride, 965 miles, costs $69, no tip.
What’s wrong with this picture?
How can an airline afford to charge less than a couple of taxis?
It can’t.
It has to.
Why?
Because its competitor does and you, the passenger, are cheap. All you care about is how much the ticket costs. You have the loyalty of a butterfly, the soul of a banker.
The airline industry is in trouble.
Domestic airlines flew 4 billion miles last year. They carried 450 million passengers. Their planes took off more than 20,000 times a day. One industry publication summed up these impressive achievements by headlining its annual review: “Yet another worst year ever . . . more or less.”
U.S. airlines in the past four years have lost in the neighborhood of $12 billion, more money than had been made in the history of aviation.
Since the Wright Brothers.
Those two sets of facts – the huge losses and the huge volume of business – describe both the disaster and the promise of paradise for airline operators.
The losses are breathtaking, but because they are, because all the numbers are so huge, millions of this, a billion of that, very small changes can produce very large results.
Consider:
If on every flight those airlines flew in the last four years, every ticket sold for just $10 more, the airlines would have made money.
Or if every flight had had just two more passengers. Just two more.
About the only thing airline executives – a notoriously querulous bunch – agree on these days is that they are in a very difficult business. They don’t always agree even on what business that is, but they do agree it is difficult.
If you ask them, for example, why anyone should invest money in their industry, their replies are disarming in their candor, almost eerie in their similarity.
One senior executive put it this way:
“If you go back to your basic economic courses and what they say is the basis of a successful industry, the airline industry doesn’t fit the profile.
“Look back. The airline industry, total, has not made any money. If you take a long view, it’s a very marginal business. Which causes someone to say, `Why are you in the business? Why are people investing in it? Why do lenders lend money to airlines?’
“I’m not sure I want to ask that question.”
The woeful condition of the airlines is the result of bad luck, the vagaries of the market, government indifference and airlines’ own self-destructive behavior.
It threatens the vitality of the broader travel and tourism industry, which with 127 million workers and an annual output of $3.5 trillion, is the world’s single largest economic activity, accounting for one-eighth of all consumer spending on the planet.
The economic well-being of the airlines concerns, among many others and more acutely than most, people who make airplanes.
If all airlines lose all their money, even managers as irrational as airline managers appear to be will eventually stop buying airplanes altogether.
The Boeing Co. knows this only too well. Boeing is sending a brand-new airplane, the 777, into a marketplace in chaos.
Few airlines seem to know from month to month what sort of airplanes they want. And there are already too many airplanes.
More than 700 surplus planes are parked in open-air storage in the Mojave and Sonoran deserts and at other locations scattered across the arid Southwest – a ready supply of cheap planes.
Some airlines face more fundamental questions than what to buy, the key ones being: Will this airline still be here next year? Next month? Next week?
Some already have their answers. They’ve gone out of business. Others have gone into bankruptcy, almost always not to emerge.
Since 1978, the beginning of the post-regulation airline industry, 117 airlines have gone bankrupt.
At one point in 1991, one of every three flights in the United States was operated by a bankrupt carrier. Things have improved since, but marginally.
The industry’s condition is so bad, a recent independent analysis of the financial fitness of major U.S. airlines rated all but one of them as candidates for failure. Wall Street rates most of their bonds as junk.
Julius Maldutis, one of the most respected of Wall Street aviation analysts, in a recent speech said that if the airlines were savings and loans, the government would liquidate them.
Gary Kelly, chief financial officer of Southwest Airlines, the industry’s only profitable carrier, characterizes the industry as one of high risk and low return, “which is obviously the wrong combination.”
Can an industry operate like this and survive?
Of course, people in the industry say. How? We don’t have a clue, they say. Then why do you think it will survive? Because it has to.
Whether this is self-evident or self-delusional, it is a widely held view.
“There is for this product virtually an insatiable demand,” said Michael Durham, chief financial officer of American Airlines.
Montie Brewer, a United Airlines executive, said:
“People will always need to travel. That’s a necessity. So in the long run it will all work, out and the industry will find some way to make money. It has to. Otherwise you won’t have a transportation infrastructure and you have to have that. Somehow this will be profitable. The question is when.
“The consensus in the industry now is, not any time soon.”
In addition to the billions of dollars of investor losses and the tens of thousands of employees whose jobs have disappeared, perhaps the most fundamental long-term change resulting from the havoc in the industry has been a severing of trust between the industry and its customers.
Durham said the act of buying an airplane ticket, the prices of which seem to – and sometimes do – vary hourly, has become like buying a used car.
“You don’t like to do it,” he said. “Why? Because you always think you’re getting hosed.
“And you frequently are.”
“There could be no stabilization until sanity replaced daring as the principal ingredient of airline operation,” he wrote.
Stabilization came, in large measure through government regulation. The first airlines grew out of contract airmail carriers. They were awarded routes by the government. Their pay was decided by the government. They were protected from competition by the government.
Among those early mailmen was the son of a wealthy Seattle timber family, Bill Boeing. Boeing bought Pacific Air Transport, a fledgling mail carrier owned by a bus company, shortly after Pacific won U.S. Contract Air Mail Route 8, the Seattle-to-Los Angeles run.
Actual service began in 1926. That year, the first of government-regulated, privately owned airmail service, the average income for an airmail carrier was 49.5 cents a mile. The cost was as high as 80 cents a mile.
This led Boeing, a prospective airplane manufacturer who wanted a market for his products, to begin carrying passengers along with the mail on Route 8. Pacific carried 1,252 passengers between Seattle and Los Angeles the next year and made money.
Boeing’s decision to carry passengers was prompted by a fundamental characteristic of airlines then and now. Once he had contracted to fly the mail up and down the coast, Boeing had committed himself to certain costs – the airplanes, fuel and pilots. Those costs were not going to vary much if he carried five letters or 500. What would vary, since he was paid by the pound, was his income.
He had no control over the amount of mail, but he could add income by carrying other cargo. In this case, the cargo was passengers and he could carry them without increasing his costs much. The plane was going anyway. So was the pilot. So was the fuel.
This relationship between costs and income, the costs being fixed and the income variable, is the chief defining characteristic of the airline business. Because the costs are largely fixed, the additional expense of carrying more of anything is negligible. An airline will almost always make more money on the extra cargo, no matter how little it charges to carry it.
This simple idea has powerful consequences. Out of it grows almost all of contemporary airlines’ huge problems, and their equally huge potential.
The history of the airline business might best be described as the endless search for the extra ticket buyer, the quest for filling just one more seat.
The early passenger routes were built on the mail routes that preceded them. The Post Office divided the country into what amounted to geographical franchises.
By 1931, the major route systems built on those franchises belonged to Transcontinental and Western Airways (TWA) from New York to Los Angeles to San Francisco; Eastern Air Transport, concentrated along the East Coast; American Airways in the South; Northwest Airways across the northern tier; and, after Boeing merged his Pacific Transport into it, United Airlines across the midcontinent and up and down the West Coast.
Those early divisions (done behind closed doors in what opponents of the process called “spoils conferences”) became the base of the national air-transport system for half a century. The franchise airlines or their successors consolidated and built on those systems with remarkably little change.
Stabilization eventually became stagnation. The business grew, but sluggishly. More important, to its critics, air travel remained the domain of the rich and the corporate.
The government, through what eventually evolved into the Civil Aeronautics Board, granted the license, decided where you would fly, who your competitors would be, what you would charge, what they would charge – everything, it sometimes seemed, but what to serve for dessert.
You didn’t have much to say about anything, but up until 1978 if you were an airline, you were going to make money.
Fares were set to accommodate the least-efficient carrier on any route. That is, the airline that spent the most money getting people and planes from A to B would go to the Civil Aeronautics Board and say, “These are my costs. Here’s my proposed fare.”
The CAB would say, “Fly away.”
Every other carrier on the route would be required to charge the same fare, even if they spent less money providing the same service. The CAB was more likely to turn down a request for a fare decrease than for an increase. At one point, several members of Congress actually sued the CAB to stop fares from rising.
There was little incentive to hold down costs. In a perverse way, the fares were not based on costs as much as costs were based on fares. The costs would rise to whatever level the CAB set the fares.
Airplane manufacturers recognized this. They charged for their equipment almost whatever they could get away with.
“The prices Boeing charged had nothing to do with the cost of production,” said Tex Boullion, a former Boeing sales executive. “It had to do with the airline fares.”
Employees prospered, too. According to one recent study, airline workers, building on wage scales established under regulation, are still paid 50 percent more than comparable workers in other industries.
Everybody made money. Everybody was happy, except for the 200 million or so people who couldn’t afford to get on a plane.
One day, the industry was the spoiled child of government; the next, it was an orphan.
One day, its every move was dictated. The next, airlines could fly where they wanted, when they wanted, at whatever price they wanted to charge. The airline supermarket, its supporters called it. The effects were stunning.
New airlines started overnight. Old ones expanded. Business boomed. Competition flourished. Fares fell.
Air travel for the first time became available to all but the poor. And as more and more people flew, more and more people wanted to provide them with flights.
When deregulation occurred in 1978 there were 36 U.S. airlines. Today there are 120.
Airlines came and went – some of them more than once – with such frightening speed that they sometimes seem to have been apparitions. You’ll hear someone today mention a Republic or a People’s Express and realize you had forgotten they ever existed. There were airlines for hippies and for the super rich; for smokers and nonsmokers; commuters and vacationers. There have been airlines with a single plane and airlines with more than 600.
Still they keep coming. Lee Howard, an aviation economist and consultant, said he gets “at least three calls a week from people who want to start airlines.” Some of them actually do.
Five new carriers began in the last four months of last year. Others continue shrinking, or expanding, or collapsing, or reinventing themselves.
This tumult has surpassed even the wildest imaginings of the architects of deregulation; it has in its broadest outlines done exactly what it was intended to do: create competition and thereby opportunity for both consumers and entrepreneurs. But in the not-so-elegant details it has also ravaged companies and local economies, and nearly sunk the industry beneath the burdens of its own ambitions.
Let loose from their CAB cages, a lot of them decided they wanted to fly everywhere. Previously, any single airline had generally flown in more or less straight lines either north and south or east and west. Northwest, United and TWA flew predominantly east and west, each in its own geographic band. Eastern, Western and American flew predominantly north and south, each in its geographic band.
The carriers crisscrossed. If a passenger wanted to travel diagonally – to go from, say, the Northwest to the Southeast – he or she generally had to change not just planes, but airlines.
Competition commenced among the major carriers to develop full-blown national networks, with connections available within one airline at centrally located hub airports. At the same time, some regional carriers wanted to expand their reach and new carriers wanted to acquire some. All of these forces came to bear in the West, which became a strategic battleground for carriers with ambitions.
Boullion, who now owns an aircraft-leasing company, thinks much of the expansion of the 1980s was less a matter of economics than ego.
“I suspect the motivation is deeper than money. Individuals want to be on top. They don’t want anyone to get larger than they are,” he said. “In the old days, they had certain areas they ran. They weren’t trying to clobber the other guys.
“Then they went nuts.”
The basic unit of an airline is a route between two cities, called a city pair. The fundamental decision to fly somewhere is whether the route will be profitable, either in and of itself, or by “flowing” passengers to the airline’s connecting flights, called “beyonds.”
All airlines are constantly ranking city pairs by their revenue potential. There are only about 150 city pairs in the United States large enough to sustain regular nonstop service, said Al Becker, a spokesman of American Airlines.
Brewer, United’s vice president for planning, said the question is one of “pure economics. It’s such a raw supply-and-demand issue it’s frightening. There’s a certain amount of demand to go from A to B, and there’s a certain amount of revenue to be spent going from A to B.
“What we do is look at where there’s an excess of demand and we try to move our excess capacity to those places. We have a certain number of aircraft. You’re going to try to get the best use out of that aircraft. So you scour the globe for excess demand. After deregulation, there was a lot of that going on.”
No area of the country witnessed more change than the West, where deregulation coincided with a period of sustained economic and population growth.
United, Continental and Northwest were already in the market. American, Delta and USAir each hastened its expansion by buying existing Western regional carriers. American took over AirCal, Delta bought Western, and USAir bought Pacific Southwest.
Also joining the fray were a pair of regional carriers – Alaska from the north and Southwest from the southwest – and, eventually, brand-new carriers created out of what, for some of them, became very thin air – America West, Morris, Reno and Markair.
Alaska came in first, landing on cat’s feet, stretching its service a flight at a time south to San Francisco, then to satellite airports in Southern California, doing everything it could to avoid tweaking the noses of the big carriers.
Southwest came later but arrived in force, applying its formula of cheap seats and many flights. It quickly became and remains the No. 1 intrastate carrier in California. This summer it will finish its Western expansion with service connecting California and the Pacific Northwest.
Look at what has happened with just one city pair, Seattle-Los Angeles.
Ever since Boeing started hauling mail, the Los Angeles route has been one of the heaviest traveled out of Seattle.
Before deregulation four carriers – United, Western, Continental and Hughes Air West – had been flying the route for years with relatively little change in frequency. Western and United flew eight to 10 round trips a day; Continental and Hughes flew the route two or three times a day. Scandinavian Airlines flew once a day – a continuation of a trans-Atlantic flight – from Seattle to Los Angeles.
The route was developing into a strong year-round business corridor, abetted in the summer by growing tourist demand.
The question was how much growth the city pair could stand. The answer was a lot. Since deregulation, the number of flights and passengers per day between Los Angeles and Seattle has doubled. There are on average now about 50 daily direct flights in each direction, carrying about 3,000 people each way. The numbers fluctuate by day and season, but were steadily upward until traffic fell in the recession of recent years.
When plotted, the traffic statistics form an upward curve, masking the volatility that was occurring. Over the past 20 years, 20 different airlines have flown the route and only one – United, the successor of Bill Boeing’s old company – has flown it each year.
The overall result of this growth for most of the airlines has been disaster. As the growth pulled more and more airlines into the market, fares plummeted. They are now a fourth of what they were before deregulation.
The route is a near-perfect illustration of what has happened around the country.
“For whatever reason, Carrier Number Two thinks they have a competitive disadvantage to Carrier One,” said Durham, the American Airlines financial officer. “They feel they have to offer something to the customer to get them to fly on them as opposed to Airline One. So they lower their price. So instead of $169, they say $129.”
Air-fare changes reach customers almost immediately. Anybody can call a travel agent, who as a group sell 85 percent of all air tickets, and get the price of every flight by every carrier. Because many fliers shop solely on price, a small price difference translates into a big shift in customers. So airlines almost always match fare cuts. As soon as the $129 fare shows up in its computers, Carrier One matches it.
“Carrier Two is back in exactly the same situation he was before, except the prices are $40 lower,” Durham said. “But he’s got his same, fundamental business problem. He can take one of a number of different alternatives at that point. He can say, `OK, they matched $129, lets see how they like $79.’
“And usually Carrier Two is a lower-cost carrier than Carrier One, so he says, `Maybe I’ll lose $10 a passenger at $79 but those slugs over at Carrier One, they’ll lose $50 a passenger.’
“Now Carrier One’s got a couple of choices. He quickly figures it out:
” `At $79, I’ll have a loss of $100,000 a month. If I don’t match $79, there are this many passengers that are going to fly and I’m at $129 and he’s at $79. This is how many he’s going to take and this is how many are left. Now how much am I going to lose if I stay at 129?’
” `Whoops, it’s more than I would lose at $79.’ So he goes to $79.
“Carrier Two, he’s stuck.
“He says: `I’ve got to fly back and forth here because this is a market that’s important to me, but I can’t seem to convince Carrier One to let me have a price advantage.’ So usually, after these machinations back and forth, you have some stability.”
Of course, the stability was achieved by cutting prices below costs, and both airlines are now losing money. The thing that is often lost in these skirmishes is that while they might result in untenable economic positions – people who lose money eventually don’t have any left to lose – they are often perfectly rational decisions.
On the West Coast, after an initial period of growth and consolidation, things settled down. Alaska emerged as a strong competitor. Frequencies were up. So was traffic. There was a period of stability in the mid-1980s. Then Southwest moved in from Texas and America West from Phoenix. Later, Reno Air and Morris Air began flying. Still later came Markair.
“When America West and Southwest went into California with their low fares we just couldn’t compete with our cost structure,” said Mel Olsen, head of scheduling at American. “Before that, after Delta took Western, USAir took PSA and we bought AirCal, the carriers all had similar costs. It was stable for a short period there.
“Then (after Southwest and America West moved in) we had a choice. We could lose a lot of money or move the airplanes.”
They moved the airplanes, largely abandoning the West Coast.
American’s problem, indeed, the industry’s problem, is that it has not been able to cut its costs enough to match fare cuts.
Ray Vecci, Alaska Airlines chairman, said fares have fallen so far the term “fare war” no longer has meaning. Low fares are the structure.
In a modern version of being on the wrong side of the tracks, Southwest is on the wrong side of the airport, and not even the right airport at that.
Southwest is headquartered about 100 yards west of the runway at dowdy old Love Field in Dallas. Love is the region’s secondary airport, subordinate to ultraslick Dallas-Fort Worth, which is out in the suburbs between Dallas and Fort Worth.
Love is an odd spot for what the U.S. Department of Transportation recently called the dominant airline in the country, which in itself is pretty weird, considering that Southwest flies only one-tenth as many miles a year as its cross-town neighbor, American Airlines, the world’s largest.
But almost everything about the airline business is pretty weird these days.
To get to Southwest you drive alongside a railroad track through a stretch of broken-down taquerias, a cupcake factory, and tough-looking night spots with no windows and names like “A Kickers’ Club” (“What kind of place is that?” a Southwest executive was asked. “I don’t know, and I’m not going to find out,” he replied.)
The only indication that Southwest is anywhere nearby is a tiny sign that also advertises a barbecue company and a warehouse. You turn at the sign onto a street that dead ends into a parking lot, which has another sign announcing itself as Southwest Airlines corporate headquarters.
The only visible structure other than the sign is a basketball hoop. You have to turn and drive through the lot before you catch even a glimpse of the offices, which are housed in a shiny new aluminum-and-glass low-rise.
Once inside the building, it is impossible to tell if it is a downtown skyscraper or a suburban shopping center, which is kind of the point of the entire Southwest business strategy.
Once you’re inside a modern airliner going from Point A to Point B, it is very difficult to tell what kind of airliner it is, who it belongs to or even where it’s going.
This is what Southwest has discovered: Airline seats are commodities. Most people can’t tell and apparently don’t care to distinguish one from another on any basis other than price.
Southwest is the only airline in the country to have remained profitable through the turmoil of the past decade. It has grown rapidly and made a profit every year. In addition to making money, it has resisted almost every other trend in the industry as well.
While other airlines tried to outdo one another with luxurious accommodations and gourmet, albeit frozen, food, Southwest was shoveling everybody into one cabin and feeding them peanuts.
While other airlines invested millions in complicated and expensive hub-and-spoke route systems that blanketed the globe, Southwest was flying from Lubbock to Abilene.
While other airlines were building whole families of jets, from broad-shouldered jumbos to tiny commuters, Southwest was stubbornly flying plain old 737s.
While other airlines were fighting with organized labor and complaining about high pay and low productivity, Southwest was building the most unionized work force in the industry, one of the best paid and by far the most productive.
While other airlines were alternately cutting one another’s throats with price wars and then, according to the Justice Department, colluding with competitors to raise prices, Southwest set its fares to compete with buses and automobiles.
While other airlines were paying independent agents anywhere from 10 percent to 50 percent to sell their tickets, Southwest urged customers to call the airline directly.
Wonder of wonders, it worked. All of it. Here’s one measure of how well. While all airlines have been struggling to contain costs the past couple of years, Southwest is experiencing substantial cost growth in two areas: profit-sharing and ticket-agent wages. The difference, of course, is that these are costs that only go up when sales do.
Here’s another measure. Every month the U.S. Department of Transportation measures all air carriers on three consumer-service categories: lost baggage, on-time performance and general complaints.
No other airline has ever had the fewest complaints in each of the three categories in one month. Southwest has done it 18 times and for the past two years was awarded a “Triple Crown” by the transportation department for leading the industry in each of the categories over the full year.
“It’s not that we’re any better, it’s that we really are in a different business,” said Kelly, Southwest’s chief financial officer.
That business, as it has been defined by Southwest Chairman Herb Kelleher, is short-haul, high-frequency, point-to-point, low-cost, low-fare air travel.
Their average flight is 375 miles compared to 700 for the industry. They fly with almost shuttlelike frequency between pairs of cities, often running 10 flights a day over the same route, in some cases as many as 30. They have everyday, walk-up fares as low as $29.
The combination of the low fares and high frequencies is powerful. Overall air traffic has tripled with Southwest’s entry in some markets.
The key to Southwest’s success isn’t the fares or the short flights. In fact, the low fares limit income and the short flights add to costs. Per mile, the cheapest routes to fly are the longest. What distinguishes Southwest is that it can charge low fares and make money.
Southwest’s much-envied secret is its extraordinary productivity. Southwest employees produce more flights per person than any other airline.
The average turnaround time between flights throughout the airline industry is 50 minutes. The average turnaround time for a Southwest jet is 20 minutes. Southwest’s airplanes sit on the ground less and fly more hours every day than those of any other airline.
“It’s an ongoing struggle,” Kelly said. “But it is almost like a religion and it is something you have to continually go to church about, review and discuss and cuss, and all those things.”
This is airline historian Henry Ladd Smith’s description of the aviation business in the 1920s. It could as easily be applied today.
Sometime in the last 20 years, the romance once again went out of flying.
“Now people can’t afford to be romantic,” said Boullion, the former Boeing executive. “The visionaries are all retiring, and the accountants are taking over.”
The irony is that as “the accountants,” supposed guardians of financial respectability, have come to power, profits have plunged. The guys in the cowboy boots made the money.
The Wall Streeters in their tasseled loafers are losing it, as one of them put it, “by the buckets.” Every effort they make to rationalize the business, to reduce it to arithmetic, ends up taking them deeper into debt. Virtually every marketing innovation airlines have devised in the past 20 years has had the overall effect of either cutting revenues or increasing costs.
For better or worse, most of those innovations have come from Texas. Except for the rash of leveraged buyouts begun by Frank Lorenzo at Texas International and the recent rise of Southwest, almost all the rest came from one carrier – American Airlines.
John Hotard, an American Airlines spokesman, said he expected to find pilots and airplane nuts at the company when he came to work there. “I wasn’t on the property 48 hours when I realized this isn’t an airline, it’s a marketing company,” he said.
In contrast to Southwest’s stealth headquarters, American Airlines’ offices, a collection of brown low-rises on a featureless plain south of the huge Dallas-Fort Worth International Airport, are visible for miles.
From the main office building, you can see various signs of American’s dominating local presence – the old flight attendant college, the subsidiaries’ offices, the international airport, from which American can fly you almost anywhere you would like to go on the largest fleet of airplanes this side of the U.S. Air Force.
“We took a carrier that had 200 airplanes, about $3.5 billion worth of revenue in the early 1980s and grew it to a carrier with 670 airplanes and about $13 billion worth of revenue,” said Durham, the financial officer.
Besides having the most planes, the most flights and the most passengers, American is recognized as the most innovative airline. It was the first to make wide use of deeply discounted fares. It invented computer-controlled ticket pricing. It had the first nationwide computerized reservation system.
It has also lost more than $1.5 billion in the last three years.
Many of the innovations at American were shepherded into being by Chief Executive Officer Bob Crandall. He is regarded within the industry as a brilliant, combative and frequently arrogant executive.
Until the last few years, he had reason to be anything he wanted.
One thing you cannot see from American’s offices is Southwest. You don’t have to. You can hear its presence in almost every utterance.
Employees tell a story of Crandall flying into a California airport and being greeted by the local manager with the news that Southwest’s Kelleher had just announced expansion plans.
“What’d Herb say?” Crandall asked.
He said Southwest was coming in here, the airport manager said.
“Then we’re leaving,” Crandall said, and that was that. American pulled out without so much as a blink. It has since abandoned almost all of its north-south network in the West.
American’s admission that it cannot compete with Southwest on Southwest’s terms marks a turning point in airline history, a triumph of small over big and a recognition that ambitions must be tempered.
All this leaves many customers feeling vaguely cheated.
It is a fundamental problem facing the industry. Customers have been trained to wait for fare sales, which invariably occur. Then passengers think the fare they paid is too high, that everybody else did better.
Consumers have come to regard air travel as simply a cost, a price they have to pay to get from here to there. This means that no matter how cheap the price is, they regard it as too expensive. But for most airlines fares are too low to make money unless they sharply cut costs, a task that has proved obstinate. Vecci of Alaska Airlines gives voice to what many in the industry fear, but refuse to say publicly:
“When a customer buys an airline ticket, they view it as a waste of money, an unequivocal waste of money.”
Brewer, United’s vice president for planning, gives an example. He arranged a trip for an aunt who wanted to fly to Italy.
“I find her a fare of $400, round trip from Boston to Milan.
“It costs us 10 to 12 cents per seat to move the airplane one mile. She’s paying $400; that’s a nickel a mile, half the cost. That’s a great deal.
“She says, `Can’t you find me anything lower?’ I want to say, `Lower? Why don’t you walk.’ “
How did the airlines get into this mess? How was the experience of flying in an airplane, once regarded as a treat – a kind of amusement park ride for well-heeled adults – transformed into “an unequivocal waste of money?” Largely, they did it to themselves.
Howard, the aviation economist, said the problem has its roots in the nature of what airlines sell, seats, whose value evaporates as soon the plane takes off.
Airline seats are the ultimate perishable commodity.
“In a normal business you bring in the inventory you think you’re going to have, you mark it according to what you think a certain segment of customers will pay,” Howard said. “A department store can bring in the product and at first cater to the people who will pay top dollar and progressively go down to the bargain conscious.”
Say you’re selling sweaters. You bring them in, price them optimistically and wait. If the sweaters don’t sell at the price you’ve set, you change it.
“You mark it down the next day. Mark it down again the next week. Then you mark it down to what you paid for it, maybe less, just to get it out of the store.
“Airlines are different. Once you fly that seat, it’s gone.”
The solution to the problem is as old as Bill Boeing’s decision to put passengers on his mail planes. You segment your product. You try to do all at once what the department store does over time. You mark the same product with different prices.
This is called yield management in the industry, a phrase that makes it sound more like harvesting corn than the educated guesswork it is.
Here’s the problem. In good times, an average airplane is going to be 60 percent full. That means four out of every 10 seats are empty. The seats are empty because the demand for airplane seats between any two cities varies by time of day, by time of the week and time of the year.
Airlines have discovered customers demand convenient flight schedules. This usually translates into at least three flights a day, morning, midday and early evening. The early-morning flight on Monday might normally carry 100 passengers. The noon flight 40 and the late flight 60.
Most of the passengers on the morning flight are apt to be business travelers. No airline wants to lose these customers to a competitor because they pay top dollar for tickets.
In order to capture all of the passengers it can, the airline will schedule at least a 100-passenger plane on the route. This means the morning flight will usually be full, the other two half-empty.
But it costs virtually the same to fly a half-empty flight as a full one. The incremental cost of adding passengers is maybe $5 per meal, “which is why you see all this discounting,” said one executive, “because you’d rather carry one more guy at 10 bucks than have the seat go out empty.”
Remember, too, that the difference between losing billions and making them is just a couple of passengers a plane.
“That’s what all airline managers are doing,” said Ray Vingo, chief financial officer of Alaska Airlines, “sitting there, thinking:
“How can I get that $10? Or one or two more passengers? If I can get just one or two more people on every flight.”
“That’s the leverage side of our business. I think that mesmerizes a lot of people. You do a few of those calculations and you think, `My God, this is an industry, we’re gonna make a bundle.’ “
So the airlines set prices to attract extra passengers to those half-full flights and they set up rules – advance purchases, the Saturday-night stay – to try to keep the full-price business passengers from leaking into the discounted seats.
This is where it gets complicated.
In the same way that General Motors makes Cadillacs for the rich, Chevies for the working stiff, and something for everybody in between, the airlines segment each plane into fare categories.
The segments are called buckets. Most airlines have at least seven buckets on each flight, ranging from the deeply discounted excursion fare to the full-price published fare.
No one pays full price except people who show up at the airport at the last minute without a ticket. All airlines try to reserve some seats for these go-shows (the opposite of no-shows), because they pay much more. For example, the average one-way ticket from Seattle to Los Angeles last year was sold for $134, according to the Department of Transportation. The current full fare for coach is $684.
“The difficulty of our business is of course we want to fill the airplane from high-revenue passengers to low-revenue passengers. And they call us in the opposite order,” one yield manager said.
“That is, the guys who pay more are the ones who have less flexibility and book closer ahead and the guys who pay less are the ones who call a year in advance to plan their annual trip to Hawaii.”
The object is to keep from selling too many cheap seats early so you’ll have higher-priced seats to sell later.
Airlines start booking seats as far as a year in advance of a flight. They allot a certain number of seats to each bucket. The allotments are based on the history of that particular flight.
Most airlines are prepared to say no to passengers all the way down the fare scale in hopes that passengers at the next highest bucket will call later. So the whole experience of filling an airplane is calculated on who to say no to, and when, all the while also trying to account for people who make reservations but never show up. Said the yield manager: “The process we go through is looking at how many people don’t show up over time and we know how expensive it is when more of them show up than we have seats for. We pay them vouchers. That costs us a lot of money.
“In general we say to ourselves it’s expensive to be wrong, either direction. It’s expensive to be wrong if you call me and you want to fly and I say, no, and then a seat goes out empty. That’s very costly. I’ve turned you over to a competitor, probably. I made a bad decision.”
In keeping with the notion that a seat is highly perishable, yield managers say of passengers who have been turned away that they have been “spilled” to another airline. If no one then shows up later to buy that empty seat, it is said to have “spoiled.”
The net result of yield management, done well, can be that the average number of passengers goes up and to serve them, the airline needs to buy another plane, which then becomes part of the fixed cost of operating the airline, which then has to be overcome by selling more seats. Said Vecci: “And you see how you can go bankrupt.”
The business has attracted, and humbled, some of the brightest business personalities of every era. It is filled with fast talkers and big egos. These are guys – and they are almost all guys – who wear suits and ties at the office, but decorate those office walls with photographs of fast cars. This is an industry whose leaders get together every summer at a dude ranch in Wyoming and go on moonlight trail rides dressed up as Spanish conquistadors. They are metaphorical warriors at work, too, wielding mathematical algorithms like swords. The algorithms have turned out to be double-edged.
As the business has grown more complex, solutions to its problems have grown ever more complicated. The system has taken on a sort of Rube Goldberg configuration of very clever solutions to particular problems, which add up to a very complicated mess.