The nine major U.S. airlines have blown through most of Washington's $5 billion cash bailout, and their bleeding continues.
The financial carnage is so bad that the industry could be headed for a major restructuring, with well-capitalized airlines already sizing up faltering carriers or their gates and facilities. Delta Air Lines Chief Executive Leo F. Mullin has suggested that government regulators will now have to lose their aversion to airline mergers. Airlines will have to address long-standing and now worsening problems with labor costs and the shortcomings of the hub-and-spoke system.
"We're losing millions of dollars a day, and I don't see an end in sight," says Tom Horton, chief financial officer at AMR Corp.'s American Airlines. "Costs have probably reached a level, at least in the near term, that is unsupportable."
Including last week's grim results from UAL Corp.'s United Airlines, the industry's third-quarter losses totaled $2.4 billion — after booking half of the government's $5 billion, less taxes. Without that money, losses would have reached $4.2 billion.
The fourth quarter, historically slow for lucrative business travel, will be worse — and will easily absorb the remainder of the cash bailout. Losses are forecast to exceed those of the turbulent July-September period, when airlines' operations were normal for most of those three months.
What rebound there was in passenger traffic has flattened amid anthrax attacks and warnings of more terrorism, despite lower fares. Revenue plunged 45 percent in September, and October's drop appears to be even deeper. Cutting costs helps only so much: Eliminating 20 percent of its flying shaves only 12 percent of costs at Continental Airlines, for example.
The industry's miserable math is calling into question the future of several companies and of the industry itself. America West Holdings Corp., which is losing as much as $2 million a day, had just $144.5 million in cash at Sept. 30. That won't last through the year at the current burn rate.
UAL has suffered more than $1.6 billion in operating losses during the 12 months ended Sept. 30, and burned cash at a rate of $15 million a day in October. Its new chief executive, John Creighton Jr., took over last week after employees and directors lost confidence in chief executive Jim Goodwin, who angered unions with his prediction that United would run out of money next year.
Airlines are hoping for a miraculous rebound in traffic that would allow them to raise fares and restore profitability. But many industry officials say it's more likely that several carriers will have to shrink either through bankruptcy proceedings or mergers that eliminate redundant back-office and maintenance operations and give them stronger networks and pricing power.
More consolidation, however, will also lead to greater monopoly control of hubs and far fewer jobs — and probably to higher fares and fewer choices for consumers. Moving airlines from high-cost to lower-cost structures won't go over well with travelers or politicians, who prefer low fares, attentive service, plenty of seats and lots of high-paying jobs over healthy profits for airlines.
In exchange, they have been willing to accept a highly cyclical, low-margin business where some players fail spectacularly in each downturn. In the past six years, the greatest boom in the history of commercial aviation, the U.S. industry eked out a net profit margin of 3.5 percent.
According to Multex.com, a financial-research firm, the average net profit margin during the past five years for companies in the Standard & Poor's 500-stock index was 11.5 percent.
What airlines have found in the aftermath of the Sept. 11 terrorist attacks is that their conventional cost-cutting isn't working this time around. The easy moves have been made: US Airways Group Inc. cut $15 million by negotiating cheaper rates at hotels for its crews. American quit stocking magazines on its planes and cut out caviar for first-class international travelers last month — a move that will save about $2 million a year. Many carriers quit serving food altogether in coach on most domestic trips in September.
But making substantial, long-term changes in the industry's current structure has proved to be much like the children's game of pick-up sticks — move one stick and several others are jolted. Cutting one flight from hub-and-spoke systems can remove passengers from connecting flights and lower revenue further. Furloughing pilots under union rules leads to higher training costs as pilots are reassigned to new planes.
One cockpit change — moving from a Boeing 727 captain to an MD-80 captain, for example — can trigger retraining for as many as six pilots at some airlines.
Even though the industry has grounded about 20 percent of its flights and enjoyed lower fuel costs, operating costs actually rose 9.3 percent in the third quarter for the nine major carriers, those with at least $1 billion in revenue from scheduled service.
Airlines can't — and don't want to — close 20 percent of their gates or mothball 20 percent of their airplanes because they can't easily get them back when the recovery comes.
When airlines shrink, they "cannot get out of every single dollar of cost," says Doug Steenland, president of Northwest Airlines.
As airlines grapple with organizational issues, security and insurance costs are soaring. Mercer Management Consulting estimates that U.S. carriers' insurance costs rose to $1.9 billion annually from just $615 million before Sept. 11. What's more, the longer ground time required for security procedures is making hub networks less efficient.
"The increased costs are far in excess of any cost savings the airlines have been able to put in place so far," says Mercer consultant Peter Walsh.
So deep is the travel depression that the nine major U.S. airlines have a combined stock-market value of $21 billion — about the same as the supermarket chain Safeway Inc. And that includes Southwest Airlines and Alaska Airlines, which are doing better than the pack.
"Airline costs are coming out slower than capacity, fewer people are traveling and security requirements are increasing. In this economic climate, the fundamental question for the major carriers is can they generate reasonable profits?" says Greg Brenneman, the former president of Continental. "Unless things change, I think the answer is 'no' for most of them."
The only way out of the death spiral is to fundamentally cut costs to match the level of traffic and the fares passengers are willing to pay.
"A big restructuring is coming," says Jonathan Ornstein, a former Continental executive who is chairman and chief executive of Mesa Air Group Inc., a regional carrier. "I don't think the economy is going to bail everyone out this time."