Rough Air

RAY SUAREZ:

It's been a bad week for the airline industry. Terence Smith has that story.

TERENCE SMITH:

That bad week got worse yesterday, when United Airlines declared it may go bankrupt as early as this fall. The nation's second largest airline is losing a million dollars a day. United says the only way to avoid Chapter 11 is for its unions to accept steep financial concessions. USAirways recently sought similar concessions, and failed.

It declared bankruptcy on Sunday as part of a restructuring effort. Still, the airline plans to return to profitability by early next year. It sought to reassure its customers with these newspaper ads Tuesday. That same day, American Airlines revealed its own bad news: 7,000 layoffs — about 7 percent of its workforce– and cutbacks in its flight schedule.

TIM DOKE, Spokesman, American Airlines:

In an industry that's absolutely bleeding cash right now, we've got to do whatever we can to cut our costs.

TERENCE SMITH:

But fewer flights means fewer options for passengers on the world's number one carrier.

PASSENGER:

I'm an American flyer but the more inconvenient it becomes I'm going to switch.

TERENCE SMITH:

The hard times for the airlines began well before September 11, as labor problems and the recession hurt profitability. After the terror attacks, passenger demand fell by as much as 25 percent. Airlines pared back their flight schedules. They also laid off some 100,000 workers in September alone. To bolster the industry, which lost $10 billion since 9/11, Congress provided $5 billion in cash grants that helped companies like America West stay afloat.

W. DOUGLAS PARKER:

We most certainly will file bankruptcy. In today's economic environment, it's unclear as to whether we could have made it through a bankruptcy.

TERENCE SMITH:

Lawmakers also set aside $10 billion in loan guarantees, to help airlines borrow from private banks. The guarantees are subject to federal approval. So far, the government has provided $380 million in loan guarantees to America West and given conditional approval for $900 million more for U.S. Airways. United Airlines wants a loan guarantee, too, of $1.8 billion. The company lost $2.1 billion in 2001, the worst year ever in the business.

Despite the red ink for the major carriers, several low-cost airlines are making money. That includes Southwest, the airline of no food, no assigned seats, and no major hub cities, and a new airline, JetBlue, which economizes by flying just one plane model, the Airbus A320.

TERENCE SMITH:

Joining me now are Michael E. Levine, a professor of law at Yale University and former senior airline executive and Paul Dempsey, director of the Institute of Air and Space Law at McGill University. He is vice chairman of the board of directors for Frontier Airlines. Gentlemen, welcome to you both. Michael Levine, what prompted United's announcement that it might have to proceed to bankruptcy?

MICHAEL LEVINE:

Well, United is in an unusual situation. They are actually owned 55% by some sub groups of their employees, and those employee groups are unionized in democratic unions. And what's clearly a problem for United is that the labor force does not accept that United is in the kind of trouble it's in.

United had been trying to negotiate with this labor force and not getting very far. Even the well advertised concession deal from the pilot was a 10 percent wage cut this year followed by three raises of seven and eight and eight percent so in effect at the end of three years they'd be making a lot more money than they were making this year and they'd have gotten another 10 or 15 percent of the company. So they have a real problem persuading their labor force that they need to do something drastic.

TERENCE SMITH:

Is that, Paul Dempsey, because the labor force doesn't take them seriously, doesn't read the numbers in the same fashion?

PAUL DEMPSEY:

Well, there's a tremendous sense of denial within the company. And it's longstanding. I mean the company has always had a corporate culture that it could never fail. It was simply too big; until recently it was the world's largest airline. And the employee ownership really was a missed opportunity I think for the company.

It should have been an opportunity for management and labor to come together and run their company collectively for their collective good will. Unfortunately, what happened was there was a drift away between labor and management and animosity created between the two groups. The employees owned 55 percent of the company. It should not have turned out this way. I think you have a situation at United that is very dysfunctional and on a collision course, I think, with reality.

United Airlines is losing money, some project it at the rate of about $4 million a day. They have $2 billion in cash roughly but they're going to have to return about $800 million of that to the banks in the Fall. And they simply are in a position where they have to come to grips with their liquidity position and the cost control issues and they're not getting what they need from the other side of the bargaining table in terms of concessions.

TERENCE SMITH:

Michael Levine, broadening this out to the industry as a whole, it lost some $11 billion last year. What's the fundamental problem?

MICHAEL LEVINE:

Well, the fundamental problem is actually pretty simple. The airlines really had a period in the '90s when business customers especially would pay almost anything to fly and airlines ordered a bunch of planes, got in a bunch of capital projects going and gave a number of very generous labor settlements.

They basically built in a cost base that they can now not cover in the revenue base. You had a recession. You had the effects of September 11. You had the growth of discount carriers in part because the fare structure was so high. The result is customers have choices. They don't feel as rich as they felt in the '90s and are unlikely to feel that rich again for some time. And the airlines simply can't bring in enough revenue to cover the cost commitments they made in the '90s.

TERENCE SMITH:

Is the problem, Paul Dempsey, now restructuring all those agreements in order to make profitable what is not now profitable?

PAUL DEMPSEY:

Well, the agreements have to be restructured. That's absolutely true. It's impossible for a company to pay pilots $1,000 an hour to fly. It's not sustainable but it's more than that. The companies have to restructure themselves. They need to rethink their route structures. Companies like United perhaps ought not be flying a lot of short haul routes.

They shouldn't be co-chairing with other carriers that have a lower cost basis and focus on what they do well, which is long haul and international transportation. We have about 17 interior hubs in the United States. That's more hubs than the country reasonably can sustain. Some of those hubs probably have to disappear. And a lot of the capacity that's being flown has to go away too. That means airplanes need to be parked in the desert in larger numbers than we've seen so far since September 11.

TERENCE SMITH:

Michael Levine.

MICHAEL LEVINE:

I disagree.

TERENCE SMITH:

Go ahead.

MICHAEL LEVINE:

I disagree very strongly with that. I think if the airlines restructure their commitments most of the hubs are viable, perhaps one or two might not be. I think that the larger airlines can continue to provide the service they provide, which is frequent… connections through the hubs for people in smaller and medium-sized cities, and I think that airplanes parked in the desert will just come back in the hands of discount carriers unless someone is going to have an orgy and blow them all up, which isn't going to happen.

TERENCE SMITH:

Paul Dempsey.

PAUL DEMPSEY:

Well, if this were just a situation that had happened in the last two years, I might agree with you. But this whole scenario played out from 1989 to 1993. In those years we had five major airlines fall into chapter 11 bankruptcy. Two of those were liquidated, Pan Am and Eastern. And a couple of those probably would have been liquidated — TWA eventually — had American Airlines not acquired it and America West recently received a government loan. Otherwise there are some analysts who believe that America West was in jeopardy. So this seems… the airline industry seems to be particularly prone to get hit hard during times of economic recession.

TERENCE SMITH:

Michael Levine, in the midst of all this bleak news of course you referenced earlier the success of some low-cost airlines like Southwest and Jetblue. Explain that. What are they doing right that the others aren't?

MICHAEL LEVINE:

Well, they do two things. One of which they've been helped in, as I say, by the big airlines. They offer particularly people who want to take trips on relatively short notice or may not want to stay a Saturday night some very attractive fares made more attractive by the fact that the fares charged to those same short term business travelers had gotten to really preposterous levels.

They went up 40 percent between 1998 and 2000 at the big carriers. This provided a pricing umbrella. That's what sort of really started the discount sector moving. Southwest, of course, has been growing but all these other airlines began growing as well. They operate particularly Southwest on a sort of a different basis. They say to the passenger, "look, we won't go from a convenient airport necessarily.

We won't let you reserve a seat in advance so you're going to have to stand in line if you don't want to sit in the middle seat in the back of the plane. We won't coordinate connections for you. But we ll be cheap, safe and clean. For many leisure travelers that's adequate.

For business travelers faced with the choice of paying $2,000 to go round trip coast to coast or to pay $500 or $600 on Southwest, giving up conveniences is easily worthwhile. So what Southwest has done is to offer a very attractive alternative at a time when the bigger network airlines basically walked away from a good piece of the market. And they've really prospered. Imitators have prospered as well.

TERENCE SMITH:

Paul Dempsey, can the others either reshape themselves into that model or alternatively provide some other, somewhat more commodious travel for other customers?

PAUL DEMPSEY:

Well, I think we're going to see. American Airlines is talking about establishing a continuous hub in Dallas, and with three domestic hubs in the United States there will be an opportunity to construct operations whereby connections will flow over either Chicago, St.. Louis or Dallas, all of which are cities in which American has an enormous presence, and reduce costs significantly on the Southwest model but with a network carrier.

The problem of the hubs is that they are very inefficient in terms of their use of the flying resources of the company and the labor resources of the company and fuel and time. But they are very good at revenue generation because they do offer the marketing people enormous opportunity to sell a plethora of origin destination markets. And a lot of revenue is generated on that basis. So therein lies the yin and the yang.

I mean, the revenue of the hubs is wonderful. The cost of the hubs is terrible. Right now the two things that airline management has to focus on, is number one liquidity. They do not want to run out of cash. Number two they want to focus on cost. And costs are at levels at the major airlines — many of the major airlines that are simply not sustainable in the long term.

TERENCE SMITH:

Michael Levine, look ahead for us a little bit, will you, as to what we should expect as consumers, as fliers. More bankruptcies, more difficulty — what do you anticipate in the coming months?

MICHAEL LEVINE:

I think the major airlines one by one will have to restructure at the beginning especially as we've just seen with U.S. Airways and I think we're likely to see with United, I think that restructuring is more likely to be in chapter 11 than outside it.

As time goes on and people get the idea that this restructuring is going to happen one way or the other, we may see more voluntary workouts but they will be done in a sense in the shadow of chapter 11 with the understanding that if the airline can't achieve costs that are able to be covered by customer revenues, they'll have to declare chapter 11 and let the judge help them do it.

If that happens, I believe we will see four to six surviving, large hub airlines perhaps as many as there are today, which is six, which will operate much the kind of service we see today perhaps a little less in the way of on-board amenities, which customers have not shown much interest in paying for. If they can't do that, the ones that can't will go out of business. Some of their capacity will be replaced by other hub airlines and some of it will move to the discount sector.

I think we're really at an important turning point in the industry. One thing I'd like to add: This business of trying to reengineer hubs to make them a little more like Southwest is a very risky move. Most of the big airlines have studied this before and concluded they would lose more revenue from connections from small cities, inconvenient connections, than they would gain in costs. American clearly has come to a different conclusion. It will be very interesting to see.

TERENCE SMITH:

We'll have to follow it as well. Thank you both very much.