U.S.: "Not So Friendly Skies" overview article on air economics

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Headline: Not So Friendly Skies

Source: DismalScientist.com, 27 Mar 2001

URL: http://www.dismal.com/todays_econ/te_032701_2.asp

NOTE: I recommend going to this website to see the graphs, they are very revealing. Also there are lots of other interesting articles to be found at www.dismal.com.

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The current slowdown in the U.S. economy promises turbulent times for the domestic airline industry. Airlines' razor thin profit margins make them extremely sensitive to economic shocks. Recent profit warnings by most major airlines are testament to this, and can be attributed to softening consumer demand, rising jet fuel prices, and a negative backlash caused by contentious labor negotiations. As such, the much sought after "soft landing" may not materialize for airlines.

Demand for airline travel is softening. Overall consumer confidence as well as the Conference Board's "Vacation Intended within Six Months" index have both fallen since the middle of 2000. Particularly troublesome, the "Vacation" index reflects future behavior, which may not manifest itself in the airline industry for several months. Consumers can book travel reservations with airlines as much as a year in advance, so wavering demand indicators may take several months to become evident. Airlines are also traditionally tight-lipped about future bookings.

Air traffic, as measured by revenue passenger miles (RPMs), was down 1% in February year over year, in sharp contrast to the constant growth airlines experienced in 2000 (see chart). One RPM is one paying (i.e. revenue-generating) passenger flown one mile, and is a standard measure of traffic used by airlines. It appears that sliding confidence is finally catching up with airline bookings, a clear sign of a slowdown.

As if wavering demand was not enough, carriers are also facing rising costs. This could be a recipe for disaster, as operating costs are the one component on which airlines at least try to keep a tentative grasp. Labor is the largest piece of the airline cost equation, and its share of total operating expenses has risen consistently since 1990. The cost of fuel is the most volatile component, the price of which has reached 1990 levels, further stressing airline finances.

The last time airlines faced this cocktail of negative market forces was during the last recession in the early 1990's. Consumer confidence plummeted, which severely impacted demand for air service.

At the same time, the war with Iraq caused a spike in fuel prices, and hemorrhaging in the airline industry commenced. From 1990 to 1994, the airlines bled a collective $13 billion, which is more than the $8.5 billion they made in total from 1947 to 1989. Airlines shed jobs at an alarming rate and forced unions to accept wage concessions.

The industry's tough competitive climate is evident in the death of TWA, which is being purchased by American Airlines. Now, AMR will have to absorb the enormous cost of assimilating an airline that has not turned an annual profit since the 1980s. Intense competition, volatile costs, and poor strategic planning all led to TWA's landing on the bankruptcy chopping block.

US Airways is singing the same tune in trying to convince regulators that its proposed merger with United Airlines is critical to the airline staying aloft. Realizing that labor costs are spiraling upwards, airlines are in a constant struggle with labor unions over wages that have increased consistently over the past few years.

Northwest and its mechanics, Delta and its pilots, and American and its flight attendants are all locked in tense negotiations that management realizes could have grave consequences to their economic well being.

What effect will this multitude of factors have on the airline industry? Demand for air travel will decrease in the short term, hurting bookings well into the summer. Airlines can ill-afford a traffic slump in the summer, which is their busiest season. Airline consolidation talk is a natural outgrowth of the current environment, and will only intensify as Continental, Northwest, and Delta do not want to be left out in the cold.

So what about the flying public? Since we are choosing to fly less often, airlines will have little room to raise fares in the face of flat demand, no matter how badly they may want to. Airlines might attempt to boost fares in markets they dominate, with business fares getting less of a break than leisure travelers, as business travel tend to be less price sensitive. Airlines are well aware this, and will charge them accordingly.



-- Andre Weltman (aweltman@state.pa.us), March 29, 2001


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