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Airline Shakeout

January 7, 2005 at 12:00 AM EDT
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TRANSCRIPT

JEFFREY BROWN: A new fare war has broken out among airlines, but this one could have major long-term consequences for the entire industry.

It began Wednesday when Delta Airlines, the nation’s third-largest carrier, announced it would slash fares and simplify its entire pricing system, reduce the ticket change fee to $50, and eliminate the Saturday night stay requirement and put caps on one-way fares for domestic flights, so that a customer buying a ticket even at the last minute would pay no more than $499 for coach and $599 for first class.

The move is a direct response to competition from low-fare airlines, such as Southwest and JetBlue, whose lower costs allowed them to turn a profit in 2004 even as the traditional major players lost billions.

Yesterday, one of those, American Airlines, followed Delta part way, by announcing fare cuts. And now others, including United and Continental, say they’ll reduce fares in many markets.

JEFFREY BROWN: Joining me now with more on all this is George Novak, program administrator for the Aviation Institute at George Washington University. Welcome to you.

GEORGE NOVAK: Thank you.

JEFFREY BROWN: We’re all used to the idea of a fare war, but this is something much more than that, isn’t it?

GEORGE NOVAK: It is. This is a major change in how the U.S. airlines are going to structure their fares. It’s a difference for passengers, how much they will pay, and it’s a difference for passengers in the restrictions.

So this is more than just the summer fare war we’ve seen in the past to get passengers in. This is a way of changing the way that our legacy carriers are doing business.

JEFFREY BROWN: What do we mean by simplifying the fare infrastructure? This is when we all get on planes and we all look around at each other and everybody has paid something different, correct?

GEORGE NOVAK: Correct.

JEFFREY BROWN: So why is Delta moving to a simpler system? What is in it for them?

GEORGE NOVAK: For Delta, simplification means cost savings for them. It also means less confusion for passengers.

And I think they’re hoping that this lower fare structure, along with a less confusing structure, when passengers are on the Internet, when they’re talking to their travel agents, this confusion, reducing that level of confusion, they hope is going to put passengers in their planes along, obviously, with the fare cuts.

JEFFREY BROWN: This is the way that these the low-cost carriers function right now.

GEORGE NOVAK: Right. There are only a couple types of fares when you fly a Southwest or JetBlue. You don’t have a confusing menu when you go to book on those airlines. I think that’s what Delta is trying for and I think the other carriers are following that now.

JEFFREY BROWN: The idea of instituting a fare cap. This is aimed at the last-minute customer. I assume that would mostly be the business market.

GEORGE NOVAK: In many cases but other times it’s leisure passengers. The majority of that will be business passengers and that’s why it has always been a high fare because business… they’ve always assumed business passengers could pay more because they had to get somewhere.

But this happens to leisure travelers also, where they need to get somewhere for a family emergency, for a last-minute vacation, and it frees up a lot of opportunities for people to fly. And again, the hope is that this will put people in the airplanes.

JEFFREY BROWN: And to what extent has that kind of leisure passenger or business passenger, the last- minute customer, moved to the low-cost carriers?

GEORGE NOVAK: There has been a migration of both business and leisure passengers to these low cost carriers. And they now control, depending on which figures you read, between 25 percent and 32 percent of the market, which is significant.

JEFFREY BROWN: So as we’ve said now some of the other traditional large airlines have moved in the same direction but not gone quite as far as Delta, correct? Tell us what’s their strategy. What are they doing now?

GEORGE NOVAK: Right now I think they’re reacting. And they’re in a mode where this took many of the carriers by surprise. They’re in a reaction mode.

So very quickly they’re trying to put together a package which says to the flying public, “Okay, you can get that deal on Delta. You can also get it here on American.”

And we’ll see moves by Northwest, by United, most likely by U.S. Airways in the coming weeks or so, which will say, “We’re instituting the same savings and the same structure that Delta have is –has started, so you can fly on us, too.”

JEFFREY BROWN: So far the fare cuts that they’re making are in these markets where there is a lot of competition.

GEORGE NOVAK: Yes. Where there is not competition, there is no… there is no incentive whatsoever for them at this time to lower their fares. And in this industry right now, they need revenues.

And so the average fare is going to have to remain about the same as it is right now, so the fares where there is no competition are very likely to increase – very likely to increase because these airlines have to make the money somewhere.

JEFFREY BROWN: Now, all of this comes, of course, at a time when the airline industry is bleeding and the notion is they need more revenue. The idea that lower fares could bring in less revenue, one of my colleagues said this looks like a mutual suicide pact. Is it possible to read it that way?

GEORGE NOVAK: It’s widely held right now that we are looking at a loss — additional loss of revenue in the coming year between two and a half and three and a half billion dollars because of these reduced fares.

Now, the hope is in the longer-term, beyond that year, in the two- year, maybe two-to-three-year period, that the number of passengers will increase. You’ll make that up in volume.

So the marginal revenue per passenger will decrease, but you’ll increase the number of people flying and eventually get back to the revenue level. So it could take some time, though.

JEFFREY BROWN: But the question is: can all of these airlines do it and survive for that period of time?

GEORGE NOVAK: My prediction is no. I don’t think that all the majors can survive a deep change in the way that they do business right now, particularly in a reduction in revenue at a time when they’re in trouble.

JEFFREY BROWN: So this shakeout that we have been hearing about for a long time, this action can really push that ahead?

GEORGE NOVAK: I think this is one of the major events. We’ve been waiting for this shakeout for some time. It has been predicted for years.

I think this may be the blow, that Delta’s change in their fare structure, in the way that they do business with their passengers, this may be the event that changes the industry and probably result in a loss of one or two major carriers in the United States.

JEFFREY BROWN: So for customers, let’s look at how this affects them. In the short term, this has to be good because prices come down. Is that right?

GEORGE NOVAK: Oh, definitely. I think passengers are going to enjoy the fares they see this spring, this summer, through the year. And I think that they now know what the carrier is doing and that the other carriers are going to meet that.

There is going to be competition and that competition is very likely to last for a year. Now, if it costs a couple of carriers their corporate lives in the meantime, passengers are going to benefit from that, but the carriers may not.

JEFFREY BROWN: Are there long-term risks for consumers?

GEORGE NOVAK: The long-term risks for consumers is if this does cost the United States a couple of their major carriers, particularly in rural areas, outside of the major metropolitan areas, if service is reduced, they’re going to be the first ones to suffer.

If service remains in those areas, they’re very likely to see monopolistic pricing, which is going to be very, very high, to get from one place to another. In the Dakotas, in the Midwest, anywhere outside of major metropolitan areas, they will see an increase in fares, which could take place fairly soon.

JEFFREY BROWN: For people even now, it’s winter, it’s cold, people are starting to think about summer vacation plans. What do they do right now?

GEORGE NOVAK: Well, I’d say book on the carriers you are comfortable booking on because the fares are low. Right now, in response to Delta’s actions, fares have fallen this week and American has followed Delta’s lead; Northwest and Continental will; United is likely to. USAir is likely to.

And so there will be very low fares for the coming months, but people should book and get those seats now because that is not an unlimited number of seats. Every seat on that aircraft is not at those low fares.

JEFFREY BROWN: But keep an eye on the airlines in the meantime over the long-term.

GEORGE NOVAK: Keep a very close eye. Watch the news.

JEFFREY BROWN: Ok, George Novak, thanks very much.

GEORGE NOVAK: Thank you, Jeff.