As Airlines Cut Back, Who Gets Grounded?
THE MIDDLE SEAT
By SCOTT MCCARTNEY

June 6, 2008
What do all these announcements of massive airline cutbacks mean for consumers? Higher fares.

By grounding planes and removing flights from schedules, airlines hope to limit the supply of seats in the skies and force people to pay more to fly. Planes are full now largely because airlines have to discount prices a lot in order to fill seats, especially in a weak economy. Airlines have been like automakers offering big discounts on SUVs and other vehicles piled up on dealership lots. At some point you have to stop making so many trucks if you can't sell them at a profit, and so airlines are shutting down their ``factories'' some – grounding airplanes and reducing the number of flights they offer for sale.


Despite more than a dozen ``fare increases,'' the fares that people actually are paying haven't yet gone up enough to come close to covering higher fuel costs for most airlines. In April, the most recent month reported, the average price people paid to fly one mile domestically was up only 4.3% over last year, according to the Air Transport Association. Fares likely were 7% to 8% higher in May than a year ago, according to some preliminary reports from airlines, but that's a far cry from paying for the 66% increase in the cost of fuel, which now amounts to about 40% of an airline's total costs.

Why? Because raising airfares isn't like raising the price of milk at the grocery store. Consumers have almost perfect information for price comparisons – the Internet can hunt the cheapest fare worldwide in seconds. If one carrier has some empty seats to fill, it will have to cut the price because getting something for that seat is better than flying it empty. And there's lots of competition in the industry – some airlines have lower cost structures than others, or better fuel hedges, and can absorb more of the higher costs than others.

Cutting the number of seats to sell is the only way to significantly raise prices. Not only can airlines raise ticket prices, but also they can sell fewer seats at discounted prices, and leave more seats in higher-priced fare ``buckets.'' Demand for seats will drop since there won't be as many cheap seats out there, but the planes that actually fly should generate more revenue. That's the only way for the industry to get back to profitability.

Continental Cuts Jobs, FleetSo which flights will get cut? Most of the cutting will come after the busy summer. Weak international routes are first to go, in general. The longer the trip the more fuel affects the profitability of the flight. AMR Corp.'s American Airlines already said it would end its daily service between New York and London's Stansted Airport, for example. AMR launched that flight in response to start-up business-class carriers using secondary London airports like Standsted. But high fuel costs and limited credit for airlines have already killed the London trans-Atlantic start-ups like Eos and Silverjet.

UAL Corp.'s United Airlines has erased its Los Angeles-Hong Kong flight from its schedule – San Francisco-Hong Kong flights do much better, and United can carry Los Angeles traffic over to San Francisco. Continental Airlines Inc. has been aggressively expanding internationally, and some routes have done better than others. Expect the weak ones to get suspended.

Domestically, airlines likely will thin schedules rather than abandon cities completely. Instead of five or six flights a day, they may cut back to four. Fewer seats will enable them to charge more.

But there's a cost to all this for airlines, too. Shrinking can raise the cost to operate each flight, on average, because lower-paid employees are the ones to get laid off and planes that sit often still need to be paid for, unless there's a bankruptcy filing or a way to sell them or turn them back to leasing companies. The aircraft market worldwide is strong, so many planes that U.S. airlines are grounding may well find new homes overseas.

In addition, all the cuts create opportunity for discount airlines that are still growing. Southwest Airlines Co. has historically been very opportunistic, filling in when bigger carriers cut. Southwest is expanding aggressively in Denver, for example. Frontier Airlines is already operating inside bankruptcy court protection, and United has said it will kill its ``Ted'' lower-cost airline-within-and-airline, which is based in Denver. Expect Southwest to continue its Rocky Mountain assault. That should provide travelers with different options, and even some lower-priced options.

In the end, airlines that can fly people at lower costs will gain in this financially challenging environment, and higher-cost carriers will continue to shrink. The staggering cost of oil may eventually bury a big carrier—they are very much in survival mode.

Former Continental CEO Gordon Bethune used to illustrate the challenges of running an airline with a joke: A bear is chasing two men, and one stops to put on running shoes. ``What are you doing? The shoes won't help you outrun the bear,'' the other man says.

``I don't have to outrun the bear,'' his friend responds. ``I just have to outrun you.''

The faster runners among airlines will continue to provide lots of service for consumers. It will just be at higher fares.

Write to Scott McCartney at middleseat@wsj.com