Why's it so hard to make money running an airline?
Saturday, December 3, 2011
NEW YORK (AP) — Airlines may defy the law of gravity, but they can’t ignore math.
When American Airlines sought bankruptcy protection this week, it marked the 189th time a U.S. airline has done so since the government deregulated the industry in 1978. Most lived to fly again, as American probably will. Some were grounded forever.
Expensive labor contracts, erratic fuel prices and passengers used to cheap cross-country fares were to blame this time. Other times, costly planes, fears of terrorism and even outbreaks of disease have pushed airlines to the breaking point.
“It’s just a crapshoot,” said Bill Diffenderffer, CEO of Skybus Airlines, which stopped flying on April 5, 2008, after less than a year in business. It was the third airline that week to fail.
In the past decade, U.S. airlines have lost a combined $54.5 billion and failed to make money in seven of 10 years.
So why is it so hard to make money running an airline?
• Planes are expensive. A Boeing 737’s list price is about $80 million; leasing one costs about $300,000 a month.
• Oil prices are volatile. Fuel is an airline’s largest expense. American paid an average $2.32 for a gallon of fuel last year; it expects to pay $3.01 this year. Yes, some drivers pay more for gas, but consider this: American used 2.5 billion gallons of fuel last year.
• Pilots, mechanics and other employees have very specialized jobs demanding higher salaries. Government regulations and union contracts limit the length of workers’ shifts, often creating logistical challenges.
• Recessions. When businesses fold or vacationers lose jobs, the airlines lose passengers.
• The uncontrollable. Snowstorms, volcanic ash clouds, earthquakes, outbreaks of diseases like SARS and terrorism can ground planes or scare away passengers.
Besides all of that, airlines have to worry about what their competition does. If one carrier cuts fares, everybody else usually matches — even if it cuts into profits — because they know fliers will go for the airline that’s $10 cheaper.
Then there’s the brash, eager, entrepreneur who decides to siphon away passengers with a hip, new airline offering deeply-discounted tickets.
United and Continental used to fly more than half of the passengers out of San Francisco — 53 percent in 2006. Then Virgin America jumped into the lucrative transcontinental business. By 2010, less than 45 percent of passengers flew United or Continental. Virgin accounted for more than 6 percent of San Francisco’s traffic.
United had to lower prices to compete, and made less money off those passengers it did retain. The competition doesn’t even have to be profitable. Virgin America has lost $661.4 million since it started flying in August 2007.
“It’s a business where competitors enter your market at 540 mph,” Jeff Smisek, CEO of United Continental Holdings Inc., said in an October interview.
For American’s parent, AMR Corp., the strains were too much. By Tuesday, when it filed for Chapter 11 protection, it had $29.6 billion in debt and only $24.7 billion in assets.
The rest of the industry has managed through the ups and downs and is expected to turn a profit this year. That’s because airlines today are more willing to raise fares to offset fuel costs and are more cautious when deciding on whether to enter a new market, said Philip Baggaley, an airline debt analyst at Standard & Poor’s. And, as passengers know, the airlines don’t give much away any longer.
“They’ve found a new revenue source in all those annoying fees that passenger dislike,” he said.
U.S. airlines came of age at a time when the government dictated who could fly where and how much they could charge. Flying was expensive but airlines generated healthy profits.
“There was really no risk of bankruptcy,” said John P. Heimlich, chief economist at the industry’s trade group, Airlines for America which chronicles bankruptcies and liquidations on its website.
Then in 1978, the government removed the restrictions, allowing competition. Ticket prices fell, but so did profits.
Many older airlines tried to adapt but were weighted down by business models set up for another era. Braniff, Continental and Eastern all went through court-supervised restructurings. Newer airlines thought they could do things better — and a handful did — but most struggled to understand the complexities of the business and eventually failed.
PeopleExpress was one. Donald C. Burr founded the airline in 1981. It grew quickly and became a passenger favorite, filling planes with $19 fares — and turning a profit.
That didn’t last long. American introduced “Ultimate Super Saver” fares in 1985, “which basically killed us pretty much overnight,” Burr said. “It was like a Gatling gun against a Colt revolver.”
Less than two years later, Continental bought the struggling airline.
So, if it’s such a tough business, what makes anyone go into it?
“It’s not making toilet paper,” Burr said. “It’s a very sexy business. I don’t think that necessarily attracts the best and brightest, which probably go to Silicon Valley and universities and medicine ... that’s probably part of why the industry has problems.”