International Service Embraced as Best Bet for U.S. carriers

May 7--American Airlines spent more than a decade lobbying for the right to serve China, an effort that paid off this year when the carrier began flights between Chicago and Shanghai. The move came just months after American added service to Delhi, India.

And United Airlines, long the dominant U.S. carrier in Asia, recently expanded its international lineup, including more service between Chicago and Mexico, resuming a daily flight to Amsterdam and adding service between South Korea and San Francisco.

For each it was about much more than adding pins on their route maps.

Expanding international service is a crucial component of the carriers' strategies to return to profitability in the wake of major airline bankruptcies and heightened bottom-line pressure.

All of the large U.S. international carriers are deriving more of their revenue from international flights. For example, $27 of every $100 in operating revenue for American Airlines in 2003 came from worldwide operations. Last year, such flights accounted for $36 of every $100.

"Simply, we are following the growth model," said Athar Khan, director of American's Asia/Pacific operations. "The world's largest growth is in India and China. That's where the growth is; that's where business is moving."

Airlines are trying to leverage their hubs and route networks and find the right lineup of international destinations that will help drive traffic across their systems. Success means they will make more money than the price wars associated with intense domestic competition currently allow.

As prized corporate customers move their business to carriers that can get them to Asia, Europe and Latin America, airlines that can't offer the flight mix of global destinations get marginalized. Travelers will turn to another U.S. airline or their foreign competitors, such as Air France-KLM, British Airways or Asian carrier Cathay Pacific.

An international reach is also the single greatest advantage large carriers have over rival discounters like Southwest Airlines and AirTran Airways. Southwest may have the lowest fare to Phoenix, but it is not an option for the business person who needs to make a sales call in Hong Kong.

For the moment, international service can be a lucrative port in that storm.

Consider United Airlines. Last year, domestic passenger revenue fell 2 percent, to $8 billion, partly because of the carrier's efforts to reduce capacity in a bid to sustain higher fares. Revenue from international service during the same period grew to $4.9 billion, up 12 percent from the previous year.

Other airlines also are pursuing international strategies, each attempting to leverage strengths. Delta Air Lines, which lacks a large Asian presence, has been beefing up its European service. Northwest Airlines, known for much of its history as Northwest Orient, has attempted to capitalize on its strong presence in Asia, particularly its Tokyo hub. Continental Airlines is drawing on the strength of its Newark, N.J., hub, with flights from there to Asia and Europe.

Simply having international routes is no guarantee of profits. American, for example, lost nearly $279 million on its service over the Atlantic during the first nine months of 2005, according to federal transportation data. During the same period, Continental lost $333 million on its service over the Atlantic. But United had net income of almost $517 million on its European routes.

The opportunity for additional growth is one of the reasons Elk Grove Township-based United has placed so much emphasis on expanding internationally, particularly in Asia. Service to Asian-Pacific countries accounts for 25 percent of United's capacity.

They are routes that fetch a premium from travelers. A coach ticket on a United flight between Chicago and Beijing costs about $1,900 round trip. However, a seat in the business section of that flight is about $7,700. First class will fetch nearly $11,600.

As more service is granted to China, United will be among those seeking more access. During recent discussions with Chinese officials, "we expressed our hope that these talks will lead to new opportunities for United to begin additional service from our hubs to Beijing, Shanghai and Guangzhou," Chief Executive Glenn Tilton recently told employees.

The recent entry into China by American and Continental came only after Chinese and U.S. authorities agreed to open their skies to more flights from each country. Behind the scenes, U.S. airlines lobbied Chinese aviation regulators in Washington, D.C., for more access.

A fight for routes

Once new routes were approved, another pitched battle ensued. Carriers had to apply for the routes. Their arguments and appeals explained why they were the best choice, and why their competition was ill suited for the job. U.S. regulators awarded two new routes into China last year and more will be allowed in 2007.

Ft. Worth-based American, the world's largest commercial carrier, has made expanding its international network a tenet of its restructuring plan. It is there that "higher-revenue-generating opportunities currently exist," the airline said in its most recent annual report.

Not all international service is profitable, though. American dropped service to Nagoya, Japan, last fall. High fuel costs and competition that kept prices down on the route resulted in the carrier canceling the route.

"I wouldn't call it a relentless march of adding international capacity," said American's Joyner, explaining the carrier's strategy to identify the most-profitable destinations. "For us, it's strictly about commercial opportunity."

To win and maintain corporate customers, providing access to Asian markets is crucial, Khan said.

Before launching Shanghai service last month, American spent time with corporate customers, including Wal-Mart and John Deere.

"We're selling a portfolio of key destinations to corporate customers and frequent fliers who tend to want to have a primary relationship with one airline," Joyner said. "As we look at international growth, we're talking to corporate customers to understand where their employees are traveling and what destinations we can add to increase our share of their total business."

Access into a country is only a first step. Once there, passengers need a way to reach smaller cities that American and United do not serve. Both have been aggressive at forming partnerships with carriers in the countries they serve. In China, for example, United has relationships with Shanghai Airlines and Air China, while American has teamed with China Eastern.

Both also have formedinternational alliances. United is part of the Star Alliance, whose members include Air Canada, Lufthansa and Japanese carrier ANA. American is part of the OneWorld Alliance, which includes British Airways, Aer Lingus and Qantas.

Relationships with domestic carriers in the countries an airline serves and international partnerships are essential to an international strategy, said Graham Atkinson, United's senior vice president of worldwide sales and alliances.

"We've been working hard to acknowledge the fact that we can't do everything on our own," he said. "To exploit the opportunities in Asia, we really need to work with partner carriers ... the airlines that can help us expand to secondary cities in the same way Lufthansa helped us expand to in Europe."

Boost for domestic flights

Success ultimately is not measured only by how full the planes are when they leave the United States. Worldwide routes also increase domestic traffic, as travelers from cities such as Des Moines, Memphis and Indianapolis come to Chicago to make their connections to London, Paris and Shanghai.

Some of the increased revenue on international flights can be attributed to the fact that the passenger often is much different from those on domestic trips, said Henry Harteveldt, a travel industry analyst with Forrester Research.

"You've got a lot more business travelers on international flights," he said. "These aren't people who disregard price. But they are willing to put price in more of a perspective for the value they receive--their comfort, frequent-flier points, reliability--than those on a short-haul domestic flight."

Internationally, minor price differences in the fares offered between two carriers don't make as much difference as they do on a domestic flight to Orlando.

"On an international flight, dropping the price $20 is not going to significantly alter demand," Harteveldt said. "It's a bit more of a considered purchase."

But the discounters are expected to try to get in the game, said Aaron Gellman, a professor at Northwestern University's Transportation Center.

As additional bilateral agreements are reached making it easier to offer international service, discount carriers will be attracted by the same opportunities to make money that have driven the strategies of larger carriers, he said.

The challenge for the low-cost airlines will be finding the right-size aircraft and routes to maximize profits. The chance for big profits will compel them to solve that challenge, Gellman said.

"If [major airlines] keep fares up high enough, they'll attract low-cost carriers into the intercontinental world," he said. "And the big carriers are not going to love that."

At the same time, other countries' carriers likely will increase service to the United States, Gellman said. Ultimately, the prospects of airlines solving their financial woes by pushing service into Asia, Latin America and other parts of the world isn't a long-term solution, he said.

"International service is a temporary shelter in the storm," he said. "How sustainable it is remains to be seen."