Legacy Airlines Take on Burdens, Lower Fares

The nation's airlines have posted operating losses north of $22 billion since the start of 2001. And the flood of red ink - at the heart of the impending showdown between Northwest Airlines and its mechanics' union - shows no sign of stopping soon.

Most airlines saw their per-gallon fuel costs jump by more than a third in the first quarter of this year. And fuel costs have continued to rise as oil prices hover near $60 a barrel.

So, what has happened to fares? Well, they've plunged, on average.

At Tennant Co., a Golden Valley, Minn., floor-maintenance-equipment manufacturer, employees are flying for about 20 percent less than they did in the fourth quarter of 2004.

"We are seeing record-low fares," said corporate travel manager Marty Wahoske. "It's a very illogical, commodity-type business."

The lack of pricing power by airlines is a huge factor in their continuing losses, which are inflaming battles with unions over billions of dollars in wage and other givebacks and threatening to send more airlines into bankruptcy. And there's the risk that more carriers racking up huge losses will follow the lead of United and US Airways and dump their hugely underfunded pension plans, perhaps requiring a taxpayer bailout of the agency that insures the plans.

Low-fare airlines are setting pricing for their "legacy" rivals, such as Northwest.

"Southwest and other low-fare carriers are the price setters," Northwest chief executive Doug Steenland said during an appearance at the University of Minnesota's Carlson School of Management in early July. "If we raise fares and they don't match us, we have no choice but to roll them back."

Some travelers will pay a premium for nonstop service, assigned seats, flight frequencies and other benefits. But many won't. Some consumers will opt for a one-stop flight on a low-fare airline to save $10.

"A good number of customers have told us loud and clear that what they value more and more is price," Steenland said.

Legacy carriers face quite a conundrum, says John Pincavage of the airline consulting firm Pincavage & Associates in Westport, Conn. They haven't been making money with the fares they've been charging. But they fear if they raise fares, gains from fare increases may be exceeded by revenue losses from customers who choose to book lower-priced tickets on other carriers.

"It's a war of attrition," said Pincavage. "The guys who need the price increases the most have the biggest costs. Meanwhile, the low-fare carriers don't want to - or don't have to - raise fares."

The bankruptcies of United and US Airways have also played into the downward spiral of fares.

Air carriers involved in reorganizations usually discount fares substantially to maintain cash flows and enhance continued customer loyalty, Northwest has said in SEC filings.

With the Internet, consumers can hunt down the lowest fares with just a few mouse clicks.

That, of course, puts more pressure on carriers to compete on price.

"By and large, people view air travel as a commodity," said Tom Bach, Northwest's vice president of network planning and revenue management. "They say, 'I will get to Florida safely and with my bags with just about anybody. Who's the cheapest?'"

In most cases, Northwest has matched or reduced fares on routes where it has low-fare competition. Northwest's domestic yield in the first quarter of this year fell by about 8 percent, compared with the same quarter in 2004. Its fuel costs rose 40 percent in the quarter, and they're still rising.

Prices could firm up if airlines put fewer seats in the air, said Vaughn Cordle, chief analyst with Airline Forecasts LLC and a pilot with a major airline. Lower the supply, increase the price.

If domestic capacity falls by 10 percent to 15 percent, airlines might get some serious pricing leverage and offset more of the spike in fuel costs.

It won't be long, Cordle suspects, before the airlines with the worst balance sheets and greatest losses have to pull down domestic capacity to stem losses.

To make a little bit of profit, the industry would have to see a 9 percent to 10 percent increase in fares overall, he estimates.

"The guys who are winning are the guys with the deep pockets, Southwest," Cordle said.