Long Flight: How Airlines Resisted Change For 25 Years, and Finally Lost --- After Deregulation, Carriers Failed to Cut Labor Costs; Internet Helps Upstarts --- US Airways' Turbulent Ride
By Susan Carey and Scott McCartney 2,558 words
5 October 2004
The Wall Street Journal
A1
English
(Copyright (c) 2004, Dow Jones & Company, Inc.)
When Congress deregulated the U.S. airline industry in 1978, many fares came down, flights increased and air travel took off.
But one side of the business changed much less: airline costs. To keep their grip on the market for more than two decades without rewriting expensive labor contracts or improving efficiency, big airlines used a bag of tricks: frequent-flier plans, the "hub" system of controlling key markets and international alliances to keep business customers. The airlines often gouged business travelers, their best customers, and bedeviled vacation travelers with restrictions and fees.
Now the airlines have run out of tricks. As upstart carriers spread across the nation with across-the-board cheap fares, the traditional higher-cost carriers are struggling to transform themselves into versions of the low-cost model. The most desperate to change is US Airways Group Inc., which entered bankruptcy last month for the second time. No other airline has tried as many gambits to avoid the day of reckoning as US Airways, and no other airline is in as much danger.
In an era where business moves at warp speed, it turns out airlines are an anomaly. The rise of efficient, low-cost airlines and the ever-expanding benefit for consumers are just what deregulators envisioned -- it merely took a quarter-century.
"It's a change we predicted in 1978, and we all scratched our heads wondering why it has not gone faster," says Michael E. Levine, a former executive at several airlines who helped push deregulation as an official in the Carter administration.
Airlines, Mr. Levine says, proved "far more ingenious in defending themselves than we thought."
The mistake of the established airlines -- and those who invested in them -- was to imagine that this death-defying act could continue forever. They defeated the first crop of low-fare airlines easily in the 1980s and worried more about strikes than new competition. So labor contracts that kept expenses high and productivity low stayed in place.
Sept. 11, high oil prices and the Internet, which showed customers when they were getting a bad deal, delivered the coups de grace. US Airways warned in a recent court filing that it might have to liquidate by February without emergency labor savings. Other higher-cost airlines are also in bad shape as fuel costs rise.
UAL Corp.'s United Airlines has been under bankruptcy-court protection for nearly two years, having failed to get financing to resume operating as a normal company. Delta Air Lines says it is sliding toward a bankruptcy filing if it can't restructure its $20 billion debt and win concessions from its pilots. AMR Corp.'s American Airlines barely escaped bankruptcy last year in an out-of-court restructuring, but its cost-cutting is already falling short. American says it's spending $1.1 billion more on fuel this year than it had planned. Northwest Airlines is urgently seeking concessions from its unions.
These airlines are expected to survive. But they'll need to become more like the low-cost leaders such as Southwest Airlines and JetBlue Airways, which themselves have proven lately that their bottom lines aren't immune to high fuel prices and bruising competition. Indeed, America West Holdings Corp.'s budget carrier America West Airlines warned last night that it expects to report significant third- and fourth-quarter losses due to price pressure and fuel costs.
Under the old regulated system, the federal Civil Aeronautics Board set fares and parceled out routes. Like electric utilities, airlines could ask the board to raise prices whenever their costs went up. The board, where Mr. Levine served in the late 1970s, effectively made it impossible for newcomers to compete nationally since they couldn't get quick approval for a route network.
The Carter administration pushed deregulation as a way to lower consumer prices during the high-inflation years of the 1970s. Over the objections of most major airlines, Congress voted to allow carriers to choose their own routes and fares.
By the 1980s, new airlines such as People Express Airlines had emerged offering rock-bottom fares. But Robert Crandall, the legendary chief of American Airlines, invented a key weapon in the big airlines' counterinsurgency arsenal: the frequent-flier plan. For years, it engendered deep loyalty among big-airline passengers.
American and United both built centralized reservations systems that favored their own flights over others. By working closely with travel agents, who got a 10% commission on ticket sales and bonuses for delivering extra market share, the big airlines got the lion's share of corporate business.
International alliances also sealed business travelers' loyalty. All the major airlines created networks of regional carriers to feed traffic to and from their hubs.
Such gambits made it hard for low-cost carriers to get a foothold. Some had poor strategies themselves, trying to compete with insufficient capital to ride out fare wars. They alienated customers with old planes and inconvenient schedules. Most went bankrupt.
The initial wave of postderegulation competition did claim a few big-airline victims. During the deep recession of the early 1990s, big carriers such as Eastern Airlines and Pan American World Airways closed their doors.
But most of the big airlines survived, and their twisting course toward the current disaster is well illustrated by the travails of US Airways, now the smallest of the higher-cost flock. For the past 25 years, business for US Airways -- once called Allegheny Airlines, then US Air -- has been an endless game of dodging radical change.
In the early days of deregulation, US Air was one of the nation's most profitable airlines, thanks to its monopoly routes to small cities in the Northeast. But a wave of consolidation was sweeping the industry. Trans World Airlines bought Ozark Airlines and Delta snapped up Western Airlines. US Air faced the choice of "standing still or growing bigger," recalls Edwin Colodny, the chief executive from 1975 to 1991. So it bulked up with back-to-back purchases in 1987 of Pacific Southwest Airlines and Piedmont Aviation.
The two deals turned the company into the nation's No. 6 airline. In hindsight, they also represented US Air's first big failure to overhaul its business. The airlines it acquired both had lower costs and better service. But instead of adopting their culture, US Air introduced high living to them.
Workers at the two acquired airlines got large raises that brought them into line with US Air's employees. US Air's costlier work practices also spread to the newly acquired companies. For instance, Piedmont customer-service agents who earned $6.75 an hour also worked on the tarmac, directing planes in and out of gates. At US Air, a mechanic who earned at least $18 per hour performed that job. US Air had to hire 400 mechanics to serve the added Piedmont flights.
Imposing the lower-cost system on US Air employees would have involved a nasty fight, and that is why Mr. Colodny says he didn't force the issue. "Everybody remembers how difficult it is to take strikes in this industry," he says. United's pilots, for example, had staged a 1985 strike to defeat management's attempt to put newly hired pilots on a "B scale" with lower pay and more hours.
But the cost of buying labor peace was steep. Unable to compete with Southwest Airlines in California, US Air in the early 1990s scaled back and ultimately pulled the plug on most of its routes within the West, essentially writing off its acquisition of Pacific Southwest Airlines.
US Air still had a leading position in the East and controlled hubs in Pittsburgh, Philadelphia and Charlotte, N.C. Travelers living in those cities had little choice but to pay US Air's high fares.
US Air needed every dollar it was bringing in. The acquisitions had given the company unneeded maintenance bases, reservations centers, training facilities and crew bases -- and it failed to close them. It also had many different types of planes, in contrast to discounters that saved money on maintenance, training and scheduling by having fewer types. Headquarters functions were scattered from Winston-Salem, N.C., to Pittsburgh to Arlington, Va., the company's actual headquarters.
Mr. Colodny's successor, Seth Schofield, thought a global alliance might be the answer. He sold 24% of US Air stock to British Airways in 1993 for $300 million. Such deals had become popular: KLM Royal Dutch Airlines owned a piece of Northwest; Continental Airlines had teamed up with Scandinavian Airlines System and Air Canada.
But only a couple of years later, British Airways became fed up with US Air's lack of domestic breadth and money-losing ways. It sold its shares. In 1995, after the collapse of labor talks aimed at cutting expenses, US Air tried to sell itself to United or American, but both passed.
The next year Stephen Wolf, a veteran airline turnaround specialist, joined US Air. Before he took the job, Mr. Wolf, a former CEO of United, told the board there was no place in the industry for a high-cost, midsize airline. "Short of open warfare with labor, where everyone loses," Mr. Wolf says, "consolidation was the only viable alternative" for US Air.
So he set about making the company more attractive. Lifted by the soaring economy in the late 1990s, it returned to profitability. Mr. Wolf renamed the company US Airways, ordered a huge fleet of Airbus jets, expanded European flying and closed some of the redundant facilities. He also indulged US Airways in another industry fad by creating a low-fare division called MetroJet. The experiment failed at US Airways and elsewhere because companies didn't have low costs to match the fares.
Alfred Kahn, who brought about deregulation as chairman of the Civil Aeronautics Board, says the brief booms that airlines occasionally enjoyed in the 1980s and 1990s encouraged them to believe that radical change wasn't necessary. Change "didn't happen faster because it was always a moving target," he says.
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Mr. Wolf belatedly convinced the pilots' union to let the airline buy smaller regional jets for its commuter affiliates, making US Airways more competitive with its rivals. But he had to make other concessions to stave off two strikes. Labor contracts signed in 1997 and 1998 gave most of the workers parity with the four largest airlines plus 1% -- in retrospect a very expensive proposition.
"The unions kept demanding higher pay and perks," says Kevin Hughes, a unionized US Airways dispatcher and 34-year veteran. "Management, in order to buy labor peace, kept acquiescing."
That view is shared by some in the rank and file, but union leaders say management should bear the blame for failing to cut nonlabor costs faster and attract more business. "Since the early 1980s, all of airline labor has been taking concession after concession," says Robert Roach Jr., vice president for transportation at the International Association of Machinists union. He notes that some successful airlines such as Southwest and Continental are mostly unionized.
All along, US Airways endured, thanks to its ability to charge extremely high fares to businesspeople. But the rise of the Internet undermined this advantage. Previously, only travel agents had access to computerized reservation systems. But with pricing information available at the click of a mouse, passengers could quickly find a $200 ticket on a route for which US Airways wanted to charge $2,000. In many fliers' minds, the mileage awards, airport lounges, first-class cabins and other amenities offered by the big carriers no longer justified the higher fares.
In 2000, US Airways pulled a final trick out of the bag by agreeing to be acquired by United for $4.3 billion and the assumption of $7.3 billion of debt and leases. But the Justice Department deemed the combination anticompetitive a year later.
Then came Sept. 11, 2001. Still midsize, US Airways was hurt more than its peers by the travel slowdown, and, under a new CEO, it entered bankruptcy in August 2002. Thanks to $900 million in loan guarantees from the federal government, it emerged from bankruptcy in March 2003. It excised about $2 billion from its annual expenses while under court protection but once again failed to take strong enough measures to ensure its viability. Its cost to fly a seat a mile -- a common industry benchmark -- remained the highest among airlines.
US Airways' old nemesis, Southwest, moved in for the kill. US Airways was continuing to charge high fares on flights to and from Philadelphia, its most profitable hub. While there was talk of Southwest entering the market, US Airways didn't change its high-fare policy, assuming its rival would use the less-convenient airport in Allentown, an hour north of Philadelphia. Instead, Southwest moved into Philadelphia itself this past May. US Airways was forced to add flights and cut fares in response. Four months later, it was back in bankruptcy court.
Today, it seems US Airways finally gets it. In a court filing earlier this month, the company acknowledged that during its previous stint in bankruptcy it "did not accurately anticipate the magnitude of the structural shift" caused by the growth of low-cost carriers. In the first bankruptcy proceeding, US Airways said it expected it could succeed if it competed well against other higher-cost airlines. "Now, it is clear that US Airways cannot survive unless it can compete effectively against the low-cost carriers as well," the new court filing says.
It must, in essence, become another Southwest. In an attempt to do so, US Airways is de-emphasizing its Pittsburgh hub and adding direct flights between nonhub cities. That follows the model of discounters, which have found that the hub-and-spoke model of flying a flock of planes into an airport at the same hour and then departing in a mass rush is inefficient. US Airways is also lowering its fares and trying to push more customers to its Web site. It is demanding $950 million in added annual savings from its unions, hoping to survive the slow winter months and buy time to become a true discounter. Yesterday, the company announced deep pay and pension cuts and job reductions in its salaried and management work force.
Competitors and airline analysts think the company's chances of survival are poor, citing the reluctance of the unions to agree to more givebacks and US Airways' precarious cash position. And there are doubts about whether the rest of the old-style carriers can make the leap to the low-cost model. Bruce Lakefield, CEO of US Airways since April, says he hopes employees are seeing the light. "Sooner or later," he says, "people have to realize that the paradigm has shifted."
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Reinventing Itself
How US Airways is copying low-cost carriers:
-- Seeking an additional $950 million in annual savings from unions
-- Simplifying pricing
-- Pushing travelers to make reservations on the Web
-- De-emphasizing hubs to reduce time aircraft sit waiting for connecting
passengers
Source: the company (See related letters: "Letters to the Editor: Unions, Government Downed the Airlines" -- WSJ Oct. 14, 2004)
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