Airlines, shaken, face more shakeout

Airlines in the United States are about to record their worst year in history. Losses at the major carriers are estimated to be between $8 billion and $9 billion - the largest the industry has ever sustained in a single year, according to the Air Transport Association, the major carriers' trade group.

And with aviation recovery a dim hope on the horizon, it looks like a turbulent ride into 2002 as well.

Some of the weaker airlines are expected to go under. Others could be forced into bankruptcy. And while the likes of United and American are currently enticing customers into the air with some of the lowest fares in decades, that may not last long.

Those bargain-basement prices are adding to the red ink. At the same time, the new security measures, along with higher insurance rates, are expected to jack up costs.

The potential for a strike by United's mechanics could complicate things even more.

"Everybody is waiting for six months to see if things get better, but even the optimists are thinking in the two-year range," says John Strong, an aviation expert at the College of William & Mary in Williamsburg, Va.

People like Mitch Krasner help explain why recovery could be so difficult. A corporate software executive, he logged more than 300,000 miles last year getting his business up and operating. This year, he's flown a fraction of that - partly because of the economic downturn, but mostly because of the fallout from the terrorist attacks.

"About 30 to 40 percent is just a slower business environment, and the rest is a disinclination on my part to get on a plane," says Mr. Krasner, of Compliance Tools Inc., a New York-based software firm.

That "disinclination" - call it the confidence factor - is a new variable in an industry long known for its boom and bust cycles. Historically, its ups and downs have been tied to the business cycle, with airlines usually taking off about six months after the rest of the economy. Today, however, that confidence factor is adding an extra drag on the airlines, giving experts pause in predicting exactly when there will be a turnaround.

"If we were only looking at income and price as the drivers for demand, I'd say that we'd recover relatively quickly," says David Swierenga, chief economist for the Air Transport Association. "But that third factor, confidence, is the overwhelming factor today, and we just don't know [what effect it will have.] We've never experienced anything like this before."

The closest thing was the Gulf War, when there was a fear of flying on international flights, and the economic slump of the early 1990s. During that five-year period, the airlines lost a total of $12.8 billion dollars. It took another five months - in addition to the usual six-month lag - for passenger confidence to rise enough to bring air traffic back to normal levels.

The drop in demand since Sept. 11 has been twice as severe, and it's hitting both domestic and international flights. As a result, Mr. Swierenga predicts, it could take almost twice as long for the confidence factor to come back up.

In the meantime, the airlines are losing millions of dollars a day, even though they've cut their capacity by 20 percent and laid off more than 80,000 people.

While their financial woes have certainly been exacerbated by Sept. 11, the economic downturn had taken a serious toll long before then.

As far back as a year ago, business travel started on a steep dive. That hit the heart of the major airlines' revenue base, because these travelers, who often fly last-minute, pay on average about twice as much as the pleasure flier.

But this year's recession may change businesses' travel patterns permanently, and that could spell even more trouble for the big carriers.

When corporate purse strings started to tighten, business travelers started bargain-hunting. The Web made it easier with sites like Priceline.com and Hotwire.com. There, if you're willing to go whenever a flight is available, bargain-basement prices are available the day before a trip.

"In times like these, people learn to do without, and then when they have more money again, the notion of paying 2,500 bucks for a round trip to the coast is just unacceptable," says Michael E. Levine, a former airline executive who now teaches at Harvard Law School in Cambridge, Mass.

That leads Mr. Levine to conclude that the airlines have a broken pricing model, "because they have a level of costs that are unsustainable without business travelers willing to pay these prices.

"They're praying for rain, hoping the business traveler can again be persuaded to pay these fares again," says Levine. "I think they're wrong."

If that's the case, the major airlines that have extremely high fixed costs - such as interest on long-term debt and labor costs - could find themselves in a serious bind. There's been some talk about union-wage concessions. But many workers have already had their seniority rolled back and with it, their pay. Many are balking at the notion of taking what would amount to another pay cut.

The airlines could try to take advantage of the low interest rates to refinance some of their debt. But Rich Gritta, an aviation economist at the University of Portland in Oregon, says that could be difficult. Some of the majors are carrying debt loads in the billions of dollars, which could be difficult to restructure with the industry in such deep financial trouble.

"It's going to take quite a lot of creative thinking on their part," he says. "There are no simple answers in this one."