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  WHY THE AIRLINE INDUSTRY CAN'T STRAIGHTEN UP AND FLY RIGHT.  
   
   
 

In 1978, the federal government deregulated the airline industry, cutting it loose from acres of red tape and allowing the free market to determine ticket prices, schedules and service levels. A quarter of a century later, the airline industry is a hopeless, money losing enterprise, squandering decades of government handouts and employee sacrifices.

How bad is it? If everyone in America sent the airline industry $100, it still wouldn't cover the nearly $30 billion the industry has lost since 2001. And it's always been this way. Since deregulation, the nine largest airline carriers have posted losses in 12 out of 26 years, racking up a cumulative loss of roughly $16 billion, according to data from the Air Transport Organization.

In a cyclical industry, these downturns are expected. But the current tidal wave of red ink has some carriers on the brink of destruction. United Airlines has been bankrupt for two years and there's no end in sight. US Airways is begging the court to break its labor contracts or it says it will have to liquidate. Delta Air Lines is fighting to avoid bankruptcy, as well.

This month marks the 26th anniversary of the Airline Deregulation Act. As another year passes and the losses mount, this is why the industry has failed and will continue to do so, unless drastic changes are made.

 

The Employees Are Irrational.

Ever since US Airways emerged from bankruptcy a year-and-a-half ago, airline experts and Wall Street analysts warned the company didn't cut deep enough and would probably have to file for

 
 

bankruptcy again. So, by the end of August, when company management warned the carrier would have to file Chapter 11 if unionized pilots didn't cut their pay, it didn't come as a surprise to many people.

Well, that is, except some of the more hardline elements of the pilots union, who didn't trust management's timeline, believing that more than $1 billion in cash could keep the airline afloat long enough to play hardball at the negotiation table. Nevermind the fact that the union's own advisors suggested the airline might get a better return on its investment by selling its assets and laying everyone off -- some pilots weren't about to cough up the $800 million in pay cuts and concessions management wanted, not after company executives squandered billions of dollars in sacrifices and cancelled their pension plan.

After years of horrible relations between labor and management, this enmity is not unique to US Airways. Yes, it's utterly unfair that pilots and other airline employees literally end up paying for management mistakes, but the harsh reality is that US Airways will die unless employees cut their pay. It's a damned if you do, damned if you don't situation. So in mid-September, after weeks of kick-down, drag-out

       
 

negotiations, the pilots union had a last-ditch chance to keep the airline from bankruptcy. They would give the rank-and-file a chance to vote on management's demands for concessions and see how it came out.

Under bankruptcy, the union's advisors warned that paycuts would be even deeper. But instead of saving the airline -- and in the process, making their own lives marginally easier -- radical union reps from Philadelphia and Pittsburgh blocked the general vote, telling their members: "We will not be party to what ultimately took the form of an opportunistic and wholesale rape of the US Airways pilots' working agreement."

The next day, US Airways filed its second bankruptcy in as many years. A few weeks later, the company asked the union for $950 million in concessions and filed a motion with the bankruptcy court to cancel its labor agreements, enabling it to rewrite contracts without any input from the union.

 

Management is Even More Irrational.

Supply and demand is an essential tenet of economics -- and one that airline management doesn't appear to understand. Despite the fact that demand for air travel is relatively static, carriers continue to

 
       

add flights and beef up their schedules to retain market share.

On the surface level, the tactic might appear successful. The Air Transport Association, the industry's trade group, is proud of noting the eight largest airlines filled a record 73.4% of their seats last year. But with so many carriers adding so much service, demand has grown weaker, forcing them to discount their tickets to fill planes.

For more than 25 years, ever since deregulation, fare wars have been the standard management response to increased competition. As a result, the nominal price of an airline ticket is up just 38% since 1978. The price of milk has jumped 111%. A college education is up 522%. But flying in a plane remains cheap, because some carriers are content to lose money every time they fly, if only to hurt the other guy.

Sadly, the money didn't roll in even when management could

 
  raise prices and charge thousands of dollars for business class tickets. In 1999, at the height of the dot com bubble, the industry had its most profitable year ever, turning a $5.3 billion profit -- about $2.5 billion less than Microsoft. The statistic is staggering. The nation's largest airlines, in an industry with millions and millions of customers that is also an inextricable part of modern life, were outperformed by a single software company.

And that's during the industry's best year.

 

They've Made Promises They Can't Keep.

Under government regulation, airline employees were de facto government employees. Like teachers and policemen, payscales, promotions and -- most importantly -- pensions were set according toseniority.

In a time before the invention of the 401(k) plan, these pensions didn't seem like such a bad idea, especially for a class of high-skilled employees in the still-fantastical world of commercial aviation. As the years passed, these old-style pension plans went out of style as employers moved to retirement accounts -- that is, everywhere except the airline industry, because unions refused to give up the perk.

The union stand on pensions makes sense. Pilots are forced to retire at the age of 60, with far fewer job options once they're officially grounded. From a fairness perspective, providing a healthy retirement plan makes sense, but from a business perspective, it's an utter nightmare. According to estimates from Airline Forecasts, the airline industry is $20 billion behind on pension plan payments -- and now that people are living to 85, the problem will only get larger in the coming years.

Ultimately, the issue a set of cement shoes that could sink the industry -- and stepping out of those shoes won't be easy. Unless government rewrites the rules surrounding pensions, airlines can only rid themselves of the obligation through bankruptcy, which is what US Airways did. Or, like United Airlines is trying to do, they can try to pass the buck to the Pension Benefit Guaranty Corporation, which is running massive deficits and may need a savings-and-loan-sized bailout from the government.

 

There's No Escaping the Price of Oil.

Jet fuel, a by-product of crude oil, accounts for 15% of the industry's costs, the second-largest expense after labor. And now that oil is approaching a record high of $54 a barrel, the entire industry is

 
 

suffering -- but no one is suffering more than those old-school carriers, the ones who existed before deregulation. According to research from Bear Stearns, every time the price of oil jumps $1, the industry's costs go up $425 million.

To avoid a spike in fuel costs, airlines have traditionally bought insurance -- or hedges -- to ensure they will have a steady stream of cheaper fuel. But the major airlines are so broke, they can't afford to buy much -- or any -- insurance. And those that did have hedges, like Delta Air Lines, bet that the price of oil wouldn't push much past $40 and decided to sell the hedges they had to raise cash. Needless to say, this was a bad bet for Delta.

Compare that situation to the one over at Southwest Airlines, which is an all-union shop and has still posted a profit in 53 consecutive quarters. In 2004, the airline hedged 80% of its fuel needs at $24 a barrel, while installing winglets to their planes to make them more fuel efficient, saving the company 35.5 million gallons of jet fuel annually. With jet fuel prices around $1.50 a gallon, that's $53.2 million a year.

Given the geopolitical situation --

       
 

Russia's oil companies are a mess, Venezuela's a powder keg, Iraq is a living nightmare -- and with experts warning that Saudi Arabia's production is topping out, the price of oil might not dip below $40 for years to come. Who's prepared for the future? Not the big carriers -- they're barely surviving in the present.

 

Management is Completely Fucking Clueless.

Because the government was one of the earliest institutions training pilots, it goes without saying the commercial aviation industry has its roots in the military. As a result, airline management has been

 
       

dominated by older white men who are used to giving orders and using brute force -- not necessarily smarts -- to win battles.

In that kind of environment, it's not easy to tell upper management that they've got their head up their ass. And so, for three decades, management blindly mocked the low-cost model pioneered by Southwest, believing that their brand names and massive route structure were enough to charge hefty premiums on tickets. For a while, especially

 
 

when flying held a mystique over those who had never done it before, this worked.

But over time, Southwest's simple approach, once derided as a "cattle car in the sky," made serious inroads with customers who simply wanted to go from A to B as cheaply and easily as possible, without sorting through all kinds of crazy fees and charges. It didn't matter that Southwest didn't offer food or fly to Jakarta -- its employees were happy, gave great service and customers were fine

 
 

with picking their own seat once they're on the plane.

The indifference to the low-cost model highlights how resistant airlines are to making any change whatsoever. Think about it. JetBlue became an overnight success by simply putting TVs into the back of headrests. Honestly, why hadn't anyone else done this sooner? The technology was there. America West simplified prices because customers were confused. Today? The same carriers who once

       
 

defended having dozens of fare classes are now moving to simplify as well.

More than anything else, uncreative, ho-hum management is the airline industry's biggest problem. Airline executives are lemmings, all too willing to use the same tactics to boost business: add flights, discount tickets and if that doesn't work, cut employee pay. And like lemmings, these carriers are being led right off the edge of a cliff.

 

In a previous life, Eric Gillin covered the airline industry extensively.