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Long-Awaited Cut in Airline Capacity May Not Help Sagging Industry

Posted on: Sunday, 2 October 2005, 15:00 CDT

By Trebor Banstetter, Fort Worth Star-Telegram, Texas

Oct. 2--FORT WORTH -- With airlines slashing flights in response to high fuel costs and bankruptcy filings, the beginning of a long-anticipated reduction in airline capacity may finally have arrived.

Whether that decline will be financially good for the industry, particularly over the long run, remains in question.

In theory, cutting flights and routes reduces the supply of airline seats and pushes up prices. That would increase revenues and help the industry -- including Fort Worth-based American Airlines -- recover.

But some analysts say it's more likely that cuts at Delta, Northwest and other carriers will ultimately create growth opportunities for low-fare airlines like Southwest Airlines, based in Dallas, JetBlue Airways and AirTran Airways. If those carriers fill the void, it will push average fares lower and make the domestic market even more competitive.

"Overall, reduction in capacity is good for the industry as a whole," said Stuart Klaskin, an airline consultant with Klaskin, Kushner & Co. in Coral Gables, Fla. "But eventually that domestic capacity will be filled in by the low-fare airlines, and that's going to make things even harder on some of these airlines."

Delta executives say they plan to cut that airline's domestic schedule by as much as 20 percent as it restructures in bankruptcy. Northwest is also expected to make steep cuts in flights.

Friday, American jumped into the game as well, temporarily cutting 15 flights, most from Dallas/Fort Worth Airport, in response to high fuel prices. The airline also permanently eliminated service between Chicago and Nagoya, Japan, again due to the high cost of fuel.

There's no question that the airline industry has grown immensely in the past 25 years. Between 1984 and 2004, the industry's total capacity, measured in miles flown by every seat on every flight, swelled nearly 90 percent, according to the Air Transport Association.

Until now, many airline executives have complained about too much capacity in the marketplace.

"Further industry capacity growth this year is likely to exacerbate an already poor revenue environment," Gerard Arpey, American's chief executive, told analysts during an earnings conference call in April.

At the time, he said that an airline merger could help American "if it takes capacity out of the industry."

In the past, the airlines have been able to make money even with lots of flights in the air. In August 1999, for example, the industry's total capacity was about 78 billion seat-miles. It was almost unchanged in August 2005, according to the latest numbers available from the transport association.

But in 1999, the airlines as a whole earned a profit of $5.3 billion. This year, analysts expect the industry to lose billions of dollars.

What changed: primarily, intensified competition from low-fare carriers and, more recently, high fuel costs. With cheaper tickets, the same number of passengers produces less revenue.

Mike Boyd, an industry consultant, pointed out that during the summer, airplanes flew more than 80 percent full, on average.

"Existing airlines are already running full," he said in a recent report. "That means for all intents and purposes, there isn't excess capacity."

Delta's cuts, announced days after it filed for bankruptcy protection, are substantial. The Atlanta-based airline will slash domestic flying by 20 percent and restructure its hubs and routes. That should save the airline more than $1 billion, according to Delta executives.

But some analysts say the biggest benefactors won't be American or United Airlines or other big competitors. They say the biggest winner will be AirTran, which operates a low-fare hub in Atlanta and is a fierce competitor of Delta's.

AirTran also competes with American at Dallas/Fort Worth Airport, offering service to five cities from two gates.

"Significant revenue dividends are estimated to be heading AirTran's way," analyst Jamie Baker of JPMorgan Securities said in a report this week.

Northwest Airlines, which also filed for bankruptcy this month, is also expected to slash some of its domestic schedule.

The nation's largest low-fare carrier, Southwest, is also likely to benefit from reductions at Delta and other bankrupt airlines.

"If these various carriers shrink or continue to shrink, clearly that's a scenario that provides opportunities for us to expand," Gary Kelly, Southwest's chief executive, told analysts in New York this week.

Other discount carriers such as JetBlue, Spirit Airlines and Frontier Airlines are also likely to take advantage of cuts in competitors' flights.

That likely means more pressure for the so-called legacy carriers such as American, those with lengthy histories, Klaskin said.

"The legacy carrier tide is going out, and the low-fare tide is coming in," he said. "This could be the beginning of the tidal wave."

Most of the large carriers are finding some relief in international flights, for which there is little competition from discount rivals and for which ticket prices remain high. Part of Delta's plan includes a 25 percent increase in international flights even as it cuts its domestic schedule.

But that shift in capacity from domestic to overseas flights also heightens competition on those routes.

Baker said Delta's plan to boost international service "will negatively impact American, Continental, Northwest and United."

To cope, the big airlines will have to continue to cut costs and find other ways to boost revenues. American and Continental are ahead of the pack, both reporting operating profits this summer despite high fuel costs.

It's impossible to predict, however, which airlines will ultimately survive and thrive. Even the low-fare airlines are threatened as they continue to grow and increasingly compete with each other.

"The low-fare carriers will be forced to learn how to manage their growth, and if they don't they won't survive," Klaskin said.

In the short term, however, there will be one group that benefits the most.

"It's going to be great for the consumer, because we'll see more penetration of low fares," he said.

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Copyright (c) 2005, Fort Worth Star-Telegram, Texas

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Source: Fort Worth Star-Telegram (Fort Worth, Texas)

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