Old Airlines Struggle To Close the Cost Gap

Excerpted from WSJ, “Costs of Old Age Trip Up Airlines” By Scott McCartney, Apr 7, 2009

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Bankruptcies, restructurings, pay cuts and radical changes in airplane fleets and schedules were supposed to lower costs at older airlines so they could afford to match the cheap fares offered by upstart low-cost carriers. It hasn’t turned out that way. The “cost gap” between so-called legacy airlines that have been around for decades and younger low-fare carriers has remained …

[L]ow-cost carriers have been able to reduce their costs even more as their rivals tried to catch up. They maintained an advantage over bigger airlines in productivity, allowing them to fly seats at lower cost than rivals … For consumers, the aggressive cost-cutting at airlines has produced a prolonged period of very low fares. By slashing costs and improving efficiency, airlines have positioned themselves to better weather the recession … Layering on fees for everything from checking bags to redeeming frequent-flier tickets has helped, too.

That could change because of the persistent cost gap … For the past several years, strong business travel and demand for premium tickets on international routes gave higher-cost airlines enough revenue to overcome the cost gap. But the recession has drained high-dollar business travel, leaving higher-cost airlines to compete more directly with discounters for cheap-fare passengers …

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Airlines measure unit costs and revenue by spreading it over seat miles — each seat flown one mile … last year, when fuel prices were still high, revenue generated by American, Delta, Continental, Northwest, United and US Airways averaged 12.46 cents per seat mile … while costs were 14.68 cents per seat mile on average. On each seat mile, those airlines were losing money.

The average for AirTran Holdings Inc., JetBlue Airways Corp. and Southwest Airlines Co. showed how the low-cost airlines fared better. Average revenue per seat mile was 10.92 cents, just above average costs of 10.87 cents per seat mile.

Average costs of the legacy airlines last year were 35% higher than average unit costs of the low-cost carriers Some of the cost gap is unavoidable. Big international operations bring with them higher costs (but also higher revenue). Big hub operations are labor- and equipment-intensive and not nearly as efficient … Low-cost airlines typically avoid connecting scads of customers through big hubs and often empty and refill airplanes on the ground much faster.

The payoff for higher-cost airlines is supposed to be higher revenue. Lots of international flights attract high-dollar corporate fliers, for example, and extensive networks create more opportunity to connect more passengers. That has worked well for airlines when the economy is strong and business travelers are paying top-dollar for tickets.

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David Barger, chief executive of JetBlue Airways, says high oil prices last year overwhelmed airlines and made all carriers high-cost carriers … The key to keep costs low, he says, is growth — another area where the low-cost carriers have an edge. Airlines that grow add new airplanes that don’t yet have lots of maintenance costs or reliability issues … Conversely, airlines that are shrinking have a harder time reducing unit costs …

Low-cost carriers have been steadily capturing a bigger percentage of domestic air travel, carrying 26% of domestic passengers in 2003 and 31% by 2007 … Legacy airlines dropped from 56% of passengers in 2003 to 48% in 2007.

Edit by SAC

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