A great time to fly, unless you're a major airline

For air travelers, this is the best of times.

Prices are lower than ever and choices abound, from a wide array of destinations to the style in which to fly - from Southwest's economy seat scrum to kicking back in the luxury of first class.

But for many of the airline industry's largest carriers, this is the worst of times. Fuel prices are skyrocketing, business travelers are still opting for economy seats, and the success of a string of low-cost carriers - from JetBlue to AirTran - are giving them a run for their money they never anticipated. Analysts have upped the industry's loss projections for this year from $500 million to $2.3 billion.

Put it all together and experts contend a transformation is under way that will make the American airline industry leaner, more efficient, and far more consumer friendly in the future - at least those carriers that survive.

"The airline industry has switched, along with every other industry, from being supplier driven to consumer driven and that's forcing a re-alignment. There's a mad rush to become low-cost producers," says Kevin Mitchell of the Business Travel Coalition in Radnor, Pa. "The major carriers are going to be in a state of long-term decline unless they reinvent themselves."

Just last week United Airlines signaled it needed more time to emerge from bankruptcy. American Airlines is gearing up for what are expected to be bitter labor negotiations that some analysts believe could make or break the airline. Delta, which is deeply in debt, just had its credit rating pegged down two notches due to its continued losses. And USAirways is still struggling to increase its revenues, despite just having emerged from Chapter 11.

Those traditional major carriers - known as the legacy network carriers - have been working since the 2001 recession and the Sept. 11 attacks to regain their footing. United and Delta started their own versions of the low-cost carrier to compete with JetBlue and Southwest. Bankruptcy allowed United to bring its labor costs down significantly, and American followed suit, after barely averting a Chapter 11 filing.

Slow to recover

Still, it's been a rocky road to recovery, stalled in part by the sluggish pace of the economy, lingering fears over terrorism, and increased hassles due to heightened security. In the past few months, spiking fuel prices have provided another unpleasant jolt, particularly to the carriers like United and USAirways, which are in the most precarious financial positions. Every penny per gallon increase in the price of jet fuel costs $180 million to the industry, according to John Heimlich, chief economist of the Air Transport Association, the major carriers lobbying organization.

"It's more bad news, and in my mind it erases any chance of industry-wide profits for '04 and makes it more [dubious] for '05 depending on what happens with crude oil in the next year," he says. "Looked at another way, it wipes out or offsets the lions' share of management of cost savings so far."

For years, the network carriers depended on big spending business passengers to underwrite their leisure travel fares. But during the recession and post Sept. 11 economic doldrums, business travelers discovered that it's easy to fly for less, thanks in part to the growth of Internet booking and the success of low-cost carriers. Some analysts believe that business travelers willing to pay five times as much as the grandmother sitting in the seat next them are gone forever.

That would leave the major airlines, which built their businesses around those high-paying travelers, with unsustainable cost structures.

"They really can't compete against low-cost carriers," says Rich Gritta, an aviation economist at the University of Portland, in Oregon. "For it to be possible, the unions have to be willing to cut back their demands major league, and management has to get their financial strategies in order."

Growth of low-cost carriers

Prof. Gritta notes that the low-cost carriers share of the market has gone from 16 percent last year to 25 percent this year, and some analysts are predicting they could account for as much as 40 percent of the market next year.

And with global competition forcing most American industry to compete for lower prices, business travel experts say their clients are now permanently sensitive to costs when they fly.

"The longer major network airlines delay in appreciating the new reality and accepting it, the more of the share they will loose to low-cost carriers," says Mr. Mitchell.

But other analysts are far more sanguine, contending that once the economy picks up steam those business travelers will be back in the high-priced seats, helping the major carriers to right themselves financially.

"For those people who are out there telling us that business travel has fundamentally changed forever, I say, 'No way!'" says Terry Trippler, an airline analyst for cheapseats.com. "I lived through the '70s when we were told we would 'never again' be able to turn our thermostats above 60 degrees, when were told we'd 'never again' be able to drive anything other than a Chevette because there would be no fuel for us. But look where we are today, you could put two Chevettes in the back of an SUV. It's cyclical, the business traveler will be back."

That said, Mr. Trippler contends that the majors' survival is also dependent on their ability to respond creatively to the increased competition from the low-cost carriers - so they can survive until that big-spending wingtip crowd does come back. He says that United, USAirways, and American have to come up with the kind of flexibility, team spirit, and penchant for penny pinching that have helped both Continental and Northwest weather recent turbulent years.

For instance, there's what Trippler calls the "battle for Philadelphia."

Battle for markets

Southwest will come into the market this spring, giving USAirways stiff competition. USAirways plans to drop its prices the day Southwest boards its first plane. But Trippler wants to know why USAirways is waiting.

"Why doesn't USAirways drop its prices right now and hook those people before Southwest comes in? Why wait?" he says. "If you lower your prices now, by the time Southwest comes in their lower prices won't be a big deal. This is what I don't understand about the legacy carriers."

Other analysts contend that at least a few of the legacy network carriers may end up in bankruptcy, USAirways possibly for a second time, simply because it's the easiest way to go through the painful process of restructuring for the large carriers to survive.

"We know that none of the legacy network carriers can survive with their costs in their current form because they can't charge the prices it would take to cover those costs," says Michael E. Levine, an airline expert at Yale University Law School. "Most likely we'll see more of these guys in bankruptcy; what we don't know is whether they'll succeed in their reorganization or go on to liquidation. And to a considerable extent that will depend on their labor forces."

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