Thread: Airline woes
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Old October 21st, 2005, 11:13 AM
AR AR is offline
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Join Date: Sep 2005
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Those are good points. Here are what I believe are the answers:

1. As I said in the original post, the legacy carriers did an absolutely terrible job of managing their companies in the "good" years before the tech crash and 9/11. They ran outfits that were full of waste, they signed absolutely ridiculous labor agreements, many of which are either still in force (at the non-bankrupt companies) or have been reduced only somewhat as a result of bankruptcy filings. Pension plans? Don't even go there. But all this bad management was essentially masked by a period when the economy was robust, tech stocks were making everybody rich, and everybody was in the air.

2. Meanwhile, Southwest and its clones were running a very different business model, with good management, reasonably good labor relations, a "keep it simple, stupid" business plan, and a somewhat different target market than the legacy boys.

3. When 9/11 hit, the bottom fell out of the business, as everybody knows. But the legacy airlines got hit hardest because their expenses were greater than the discounts, and they didn't have any cash. Only the fittest survived. TWA got eaten by American, and now USAir has been eaten by America West. United has been the Cal Ripken of bankruptcies, and Delta and Northwest have recently succumbed. The better managed legacies (and "better" is definitely a relative term here), went on tremendous cost cutting programs to bring their companies more in line with the "new" business model that had succeeded so well for Southwest and its clones.

4. And then the fuel thing happened. Really cruel, because the surviving legacies had just started getting it back together. But because the old-line boys still didn't have any cash to speak of, they came out on the bottom again. That's because Southwest and some other discount carriers saw the fuel thing coming (like everybody else), but they had the cash to let them arbitrage their fuel purchases out for a number of years. In other words, if you've got cash money you can pre-purchase the fuel and lock in it's price. And that's what they did. They're paying three-year-old prices for fuel, while the legacies pay today's prices because they didn't have the cash to do the deals. I understand that Southwest's deal is so robust that it extends through 2007 or 2008.

5. The surviving legacies have altered their business models to the point that, absent the fuel issues, they would be back to profitability now. The discount boys are still profitable because they're getting cheap gas. And, by the way, on a percentage basis, the price increase for Jet A is considerably more than the increase in unleaded at the local gas station. Something to do with refinery capacity, as I understand it.

6. Because the discounts are still making money and charging low fares, the legacies can't raise their fares to meet their fuel costs, so they're stuck, despite the fact that their managers and their business models have improved. If they hadn't improved, they'd literally be gone by now. If the remaining legacies survive until the discount carriers' arbitrage deals run out, the playing field will be much more level, and it will be interesting to see what happens at that point.

So, bottom line, you're right in that the legacies were very late in understanding and adapting to the new industry model that was introduced by the likes of Southwest. They were arrogant, stupid, poorly informed and poorly run. In other words, they were typical big American companies. If they'd caught on sooner to the sea change in the air, things would be different now. At the same time, their inability to prosper despite coming to their senses, however late, has everything to do with the double whammy of 9/11 and fuel.

It's interesting, isn't it, that nobody has ever complained about not getting a meal on Southwest. It's all about what I call the implicit contract that you enter into with a discount airline. It goes something like this:

"OK, here's the deal: we give you a safe and reasonably reliable plane ride for a very fair price. In return, you don't bust our chops about the small stuff. You're just renting the seat for a couple hours, you're not marrying it. So sit down, smile, eat the peanuts and drink the Coke and we'll all get through this together. If you want music, bring your ipod. That work for you?"

And we all said, "Yup. Sure does."

The irony is that even though all lines' prices are now bunched pretty closely, we still want our meals from the legacies. It's all about conditioning and perceptions.
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