U.S. Airlines' Fortunes Improve

Resurgent demand has been the most important factor in airlines' changing fortunes. As passenger levels fell and failed to achieve consistent growth earlier in the decade because of terrorist attacks and a struggling economy, airlines were forced to cut airfares to the point where none, save JetBlue and Southwest, could consistently turn a profit—and many never turned a profit. Passenger levels took off again in 2004 and have since climbed consistently. Employment levels are high and disposable income is on the rise, leading to more recreational travel. Business travel has also picked up along with the global economy.

Summer 2006 proved to be the busiest on record: 207 million passengers flew, an increase of 3 million over 2005. This occurred despite a decline in capacity, suggesting the increase was pure demand growth and not a result of more options available to consumers.

With higher demand, airlines have been able to raise airfares. A steady stream of small increases have been passed on to customers, usually at a rate of $5–10 per flight. While not every rate increase has stuck, airfares have surpassed their pre-September 11 levels, resulting in a significant boost to revenues.

Concurrent with burgeoning demand is aggressive cost-cutting by airlines. This has been no easy feat, as the price of jet fuel has skyrocketed—up more than 125% since the beginning of 2004. Carriers have found ways to save on fuel, such as taxiing on one engine, making modifications to aircraft to increase fuel efficiency, and altering in-flight routes to take advantage of helpful wind currents and decrease the total distance traveled. Airlines have also renegotiated contracts with global distribution services (GDS), the firms that distribute fare information to travel agents. GDS costs account for a significant portion of airlines' expenses, as they pay a fee for every ticket bought through a GDS. Deregulation now allows airlines to withhold certain fares from a GDS, giving them increased bargaining power to reduce fees.

Airlines are also looking to reduce labor costs. Under bankruptcy protection, several were able to scrap old contracts and negotiate sharp pay and benefit cuts. Others jettisoned costly pension programs. This has been accomplished without any disruptive labor action, at least so far. Northwest flight attendants have come close to enacting random labor walk-outs, and some regional subsidiary airlines may still experience strikes or other labor disturbances. Airlines have shed 5% of their labor force since June of 2005, and the remaining force is leaner, more flexible, and cheaper.

Capacity cuts are part of the cost-cutting package, as well. Despite the record number of passengers over the summer, the number of flights were down 10% from a year earlier. Domestic available seat-miles were down almost 5%; the only significant capacity expansions came in more lucrative international routes. In the search for ever lower costs, maintaining a weak route for the sake of feeding local hubs is increasingly unattractive. Along with outright cancellations of some routes has come a push to more efficiently allocate seats to less-traveled routes by using smaller planes.

Lower costs and higher fares have greatly improved the financials for U.S. airlines. With summer travelers buying their tickets and airfares rising for the busier travel period, the second quarter is traditionally the best quarter for airlines. Even during the lean years, some posted sporadic second-quarter profits. But profit and revenue figures have taken a large jump over 2005, suggesting serious improvement for the industry.

*The current US Air is the result of a merger between US Air and America West,
so there is no direct comparison.
**$179 million profit without large charges related to restructuring.
***$175 million profit without large charges related to restructuring.

While the outlook is certainly more optimistic for airlines than it has been for a long while, there are still plenty of risks. Jet fuel costs remain high and further increases could undo much of the gains that airlines have made. Terrorism remains a threat, as well. The August discovery of a plot to target aircraft using liquid explosives resulted in strict new security regulations. Early evidence suggests revenues and demand have already suffered a bit due to the added inconvenience of air travel. Further threats could have additional negative impacts.

by John Scholle