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Airline Industry

"This industry is always in the grip of its dumbest competitors"

Jul 19, 2009

The first decade of this new century is one that airlines will be eager to forget.

It has been marked by the 9/11 terrorist attacks, the SARS outbreak, skyrocketing fuel costs, the bankruptcy of five major North American airlines and the outright disappearance of the likes of Swissair, Canada 3000 and Jetsgo.

Yet it seems those setbacks weren't punishment enough for an industry hard-pressed to turn consistent profits even in the best of times.

Which these obviously aren't.

Last week, the International Air Transport Association (IATA), trade group for the world's major carriers, reversed an earlier prediction that the latest plunge in demand had bottomed out. Reacting to a further 9.2 per cent drop in May traffic, IATA now forecasts total industry losses of $9 billion (U.S.) this year on a likely 15 per cent decline in revenues.

To which Willie Walsh, CEO of British Airways PLC, shakes his head and says, "Too optimistic." BA, which posted a record loss of $615 million (U.S.) last year, is so determined to cut 4,000 positions from its workforce that it's prepared to take its first strike in a dozen years.

BA's survival is at stake, claims Walsh. For Calin Rovinescu, CEO of Air Canada since the ouster of his predecessor in April, at stake is averting a second trip through bankruptcy court this decade. Like its peers among large, so-called "legacy" carriers, Air Canada has cut capacity by abandoning routes and reducing frequency of flights.

But Air Canada, which lost more than $1 billion (Canadian) last year, finds that it cannot reduce capacity fast enough to keep pace with sharp declines in traffic. In the past year, Air Canada has cut capacity by 7.6 per cent. But in that time, passenger volume fell 9.1 per cent. Archrival WestJet Airlines Ltd. trimmed its available seats 2.5 per cent during that period. But demand has fallen 7.1 per cent.

The worst global recession since the Great Depression and the accompanying credit crisis have severely reduced volume in all price categories.

Penny-pinching corporate clients have been grounding their employees, using teleconferencing wherever possible. The leisure market has also taken a hit as blue- and white-collar unemployment soars across North America and Europe.

Even workers who remain employed are sufficiently fearful of job loss they're opting for "staycations" rather than flying to Disney World or Vegas.

Fuel costs have dropped this year, of course, but they remain far above 2006-07 levels. Even swine flu and a recent string of airline tragedies have given travellers more reason not to fly. (So far this year, there have been about 630 plane-crash fatalities, more than in all of 2008, though well short of the 1972 record of 2,374.)

BA chair Martin Broughton, who calls the past 12 months an "annus horribilis" for BA and other global carriers, says his industry is "crying out for consolidation."

And it's true that despite all the capacity reductions, there still are too many planes chasing too few passengers.

BA is doing its part with drawn-out negotiations to merge with Spanish flag carrier Iberia Lineas Aereas de Espana SA, and BA hopes later this year to add American Airlines in an alliance among the three carriers.

Deutsche Lufthansa AG, having absorbed the short-lived successor to the failed Swissair, is close to a deal to buy Austrian Airlines.

Air France-KLM Group continues its long flirtation with a chronically profit-challenged Alitalia SpA. Yet even after last year's combination of Delta Air Lines Inc. and Northwest Airlines Inc., the U.S. market remains over-served by six national carriers, along with scores of regional players and upstart discounters such as JetBlue Airways Corp. and AirTran Holdings Inc.

With its heavy debt load and fractious labour relations, United Airlines Inc. seems the likeliest candidate to sacrifice its independence.

Yet even if the industry's consolidation wishes are fulfilled, commercial aviation will still suffer the curse that economists refer to as "low barriers to entry."

Starting an airline is notoriously easy: You just rent or lease one of the hundreds of aircraft mothballed in the Mojave and you're in business.

No sooner do failed carriers such as Jetsgo make their last trip to the hangar than appear the likes of privately held Porter Airlines, based at Toronto's Island airport. Porter goes head to head with Air Canada on the busy Toronto-New York run. (Porter flies to Newark, N.J., one of the Big Apple's three major airports.) Just three years after its launch, Porter counts eight destinations, with a business plan calling for an eventual 17 ports of call.

And U.S. upstart JetAmerica, with a leased Boeing 737, will next month begin offering $9 (U.S.) flights from its Toledo base to Newark, and will also commence service to the sub-metropoli of Melbourne, Fla., Lansing, Mich., and South Bend, Ind. The Jet

America plan is to profit from a raft of "convenience fees" for checked baggage, ordering tickets by phone ($20 U.S.) or Internet ($10 U.S.) and round-trip assigned seats ($20 U.S.).

Upstarts are the curse of the industry, driving down fares enough on cash-cow routes to impoverish larger carriers that rightly fear losing market share if they don't match the lowest fare on offer. Trouble is, these legacy carriers are operators of high-cost networks, vying for passengers with low-cost startups.

It's not as though the established players can be credited with unerring discipline.

Calgary-based WestJet last week unveiled expansion plans for 11 new destinations in the U.S. and Caribbean for next winter. Air Canada, which Bay Street expects will lose money this year and next, making for three consecutive years of red ink, plans to add capacity on major routes in peak periods, citing its London-Vancouver run during the Winter Olympics in February as an example.

"Adding flights at this point in the economic cycle takes courage, believe me," Rovinescu told a Vancouver audience gathered for the unveiling of an Olympics-branded Boeing 777 last week.

Courage probably isn't the word for it. Air Canada needs $600 million (Canadian) in financing to stave off insolvency.

Already the world's 14th-largest carrier, with more than 330 aircraft, what Air Canada needs is a thorough restructuring to get its costs down to within shouting distance of WestJet's.

"In the interim," airline analyst Fadi Chamoun of UBS Securities told Canadian Press last week, "equity holders will likely bear the brunt of the costs related to securing sufficient cash resources to bridge the liquidity gap until the economy recovers."

Air Canada shareholders have already suffered an 80 per cent drop in the value of their shares over the past year.

We need Waylon Jennings and Willie Nelson to reprise their 1978 hit "Mamas Don't Let Your Babies Grow Up to be Cowboys." The vocation you want to steer them clear of is airline executive.

"This industry is always in the grip of its dumbest competitors," Robert Crandall, long-time CEO of American Airlines, once complained.

"We have no choice but to match whatever low fare anybody puts out there.

"And so it will get as bad as they want it to get."

"This industry is always in the grip of its dumbest competitors"
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