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Pointing Fingers
The conventional wisdom is that the decline of the major carriers began after the terrorist attacks of Sept. 11, 2001. Not so.

As early as the third quarter of 2000, following a long-term boom in airline profitability, the large carriers' average cost per seat-mile climbed above revenue per seat-mile (two key measures of carrier performance) for the first time in nearly a decade—a sure sign of the beginning of their current decline, according to an analysis by consultants Booz Allen Hamilton.

Part of the problem back then was rising fuel costs, and that's still a concern today. More intractable, however, were the fundamental technological disruptions that confronted the big airlines.

The business model maintained by large carriers, such as American, Delta, Northwest Airlines, British Airways and Alaska Airlines—called hub-and-spoke, or network, airlines, because they route flights to smaller destinations through central airports—is essentially designed to take anyone from anywhere to everywhere, seamlessly.

At its peak, in the decade or so after airline deregulation in 1978, this remarkably reliable approach produced lower ticket prices, greater productivity and, in most years for most airlines, consistent profits.

It also produced a suicidal addiction to yield-management systems, which had been created by the techno whiz-kids at the airlines to adjust dynamically, minute to minute, the pricing of seats as reservations came in and as the flight date got closer. Because of these computer programs, the airlines were able to charge a business flyer, often a late booker, $1,000, while a tourist sitting next to him was paying $250.

Before long, this technology became a primary profit driver for the carriers, thereby elevating the lucrative business traveler, a by-product of yield management, to the status of Most Important Passenger, responsible for as much as 60 percent of revenues and more than 100 percent of earnings.

That profitable arrangement ended with the arrival of the Internet, or more specifically, buying tickets on the Web. The emergence of sites such as Travelocity and Expedia in the late 1990s made the shadowy and perplexing world of flight ticketing transparent.

Travelers, from families visiting granny to businesspeople, could view fares from multiple carriers in an instant and, not surprisingly, usually chose their least-expensive option. In other words, seats became a commodity, and control over pricing shifted in key ways from the carrier to the customer.

As a result, prices began to fall for all types of passengers—just as the nation's lengthy economic expansion, fueled in part by the Internet, came to a halt. That, in turn, meant corporate belt-tightening and fewer business travelers.

"Yield-management systems made it possible to have more fare types than seats on an airplane," says Henry Harteveldt, a vice president at Forrester Research Inc. "But the airlines got greedy, and their bad pricing strategies caught up with them when the Internet exposed the pricing structures."

With revenue falling, the airlines tried to cut costs—usually by demanding labor concessions or trimming airline perks—but their complex system of hub airports, flexible ticketing, multiple connecting flights to every possible location and huge employee pools made that difficult.

Meanwhile, the discount airlines, such as Southwest Airlines, JetBlue Airways and AirTran Airways, which generally offer nonstop, point-to-point flights, often from smaller airports, faced none of these constraints. The result: As the large carriers stumbled, the low-cost airlines entered their greatest period of growth. With a much simpler business model and newer operations, the low-cost carriers could bring to bear newer technology, such as the Web, internal networks and productivity enhancers, to handle many of the administrative, operational and customer-facing activities that the large airlines had to trust to aging legacy systems or manual processes.

As a result, the low-cost carriers have kept their costs down—freeing them from having to concentrate too much on increasing revenue, especially during difficult economic periods—while riding discounted ticket prices to profitability. In 2000, the discount carriers' cost per seat-mile was 7.2 cents lower than that of the hub-and-spoke airlines.

Most telling, 65 percent of that cost advantage was the result of savings in scheduling, operational processes and ticket distribution systems, according to Booz Allen Hamilton.

By the third quarter of 2004, after firing thousands of workers and extracting salary and benefit cuts from those employees who kept their jobs, the large carriers had trimmed the cost per seat-mile differential with low-cost airlines to 4.8 cents. But revenue per seat-mile for all the carriers was still well below 1998 levels, and the top seven hub-and-spoke airlines reported operating losses, on average, of 7.6 percent of sales. By contrast, the much healthier low-cost carriers produced an average profit margin of 3.6 percent.

United and US Airways are still in Chapter 11—the first time two major carriers have sought bankruptcy protection at the same time.

The large carriers, experts say, suffer from a common business problem: They know they have to cut costs, but they have not been self-critical enough—at least not until very recently—to attack their most stubborn expenses, because doing so would require a fundamental change in the way they operate.

The big airlines keep slashing at the obvious expenses—labor, a frill or two, an underused hub—but continue to sidestep the more pressing need to purge their systems of the overwhelming complexity that makes true cost-cutting so difficult. To do that would require tearing down old systems—hardware and software—and rethinking, like many industries have in the past couple of decades, the role of technology and automation to improve productivity and customer service.British Airways is among the leaders in that effort, but even it has not yet landed safely.

"For a lot of airlines, technology has been something appended to their business—an add-on application that's little more than window dressing—when in fact technology is as central to the success of an airline as the lift underneath the airplane's wing," says Forrester's Harteveldt.

The most obvious potential cost savings are in ticket distribution and interaction with customers. Through Web ticket sales and check-in, as well as airport self-service kiosks for handling baggage and boarding questions, airlines can save as much as $15 a ticket and significantly cut employee expenses. Alaska Airlines (along with sister Horizon Air) claims to have been the first domestic network carrier to book a seat over the Internet, in 1995, as well as the industry pioneer in Web check-in and airport kiosks.

Since then, most carriers have followed suit, although usually without as much success, either because they haven't made Internet booking a priority, or because integrating Web check-in with their internal systems has been too difficult, and the resulting customer interface is sluggish, or not attractive enough to catch on widely with customers.

This article was originally published on 02-05-2005
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