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The Airline Industry – An Overview

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President Jimmy Carter's signature on the Airline Deregulation Act of 1978 was like a gunshot signaling the start of the most frantic air race in history.

After decades in which the airlines operated much like utilities with protected routes and regulated pricing, they were thrust into a free market in which they could enter and exit routes virtually at will and charge as much or as little as the market would allow. For the first time, the way was clear for new carriers to rush in with innovative services, fares, and corporate structures that might better suit new and changing markets while those that could not compete effectively were left to fail.

And rush in they did. Bold, innovative carriers took on the established giants like modern-day Davids and Goliaths. In the past, the airline industry had always attracted risk-takers and those with a spirit of adventure (the old barnstorming image), but now risk comes not so much from flying as from the business itself. Risk affects entrepreneurs and employees alike; new as well as old carriers may fail or be swallowed up.

Prior to 1978, only 36 carriers were certificated by the Federal Aviation Administration (FAA), of which 20 are still operating. If all the carriers that have been certificated since 1978 were still operating, there would be 200 carriers today. But, in 1990, only 133 were actually operating. Even the largest and oldest carriers are not immune to failure, as the demise of Eastern Airlines proves.

At the start of the decade, there were only 13 major carriers, which prompted new fears that deregulation has produced less competition-an oligopoly of sorts-instead of more and renewed the debate over the need for governmental regulation. Indeed, it is estimated that three "mega-carriers," American, United, and Delta, control more than 60 percent of the market and that each virtually monopolizes travel at its major hubs.

Intense Job Competition

There were 330,000 employees working for U.S. scheduled airlines in 1978, just prior to deregulation. By 1989, a total of 506,728 people were employed by the airlines, with another 300,000 indirectly employed by entities serving the airlines. Payroll totaled $30 billion. Despite the growth of the industry, competition for jobs is probably more intense in this segment of the travel industry than in any other. Finding a job, therefore, takes considerable resourcefulness.

Deregulation opened up career opportunities with the scores of new carriers and new types of services that were spawned. And, by radically changing the structure and economics of the industry, deregulation also changed the volume, nature, and even location of employment. Competition brought a sudden demand for marketers. Proliferation of fares and services, all changing at mind boggling speed, forced a shift toward computerized information and reservations systems, creating demand for computer experts as well as analysts and yield management experts. (There were 117 million ticket price changes up until August of 1990, averaging 700 a day then, when Iraq invaded Kuwait, fare changes soared to more than 1 million to 2.5 million a day). The profit/loss quagmire that the carriers found themselves in fostered a need for a new breed of financial whizzes.

Cost efficiency became the key to survival in the new environment. The major airlines (carriers doing more than $1 billion in revenue a year), which essentially had always flown point to point (city to city in a line), found that they could operate more cost effectively with a hub-and-spoke system, funneling traffic from secondary cities to a central station (hub) for connecting flights. Almost overnight, cities like St. Louis, Dallas, and Atlanta that had had only limited air service became major hubs, vastly increasing the number of reservationists, station personnel, and maintenance people located in these centers.

The hub and spoke system also proved a windfall for regional and commuter carriers, particularly those that entered into partnership with the major carriers. The 150 regional and commuter carriers, which generated $3.5 billion in sales in 1990, saw their passenger counts grow by 170 percent during the 1980s, according to the Regional Airline Association, while the major carriers lost a substantial share of the domestic airline traffic (much like network television lost share to cable operators).

Roller Coaster Profits and Losses

The airline business can be like a roller coaster, with one year of astronomical profits and the next of spectacular losses. The U.S. scheduled airlines scored record operating profits of $2.3 billion in 1984, but just four of 36 airlines (United, American, Delta, and USAir) accounted for 60 percent of the amount. In contrast, 1990 produced a record loss of $2 billion on total operating revenues of about $70 billion despite record passenger traffic, according to the Air Transport Association. In just the first quarter of 1991, with the world embroiled in the Persian Gulf War, the airline industry lost another $1 billion.

The airline business is not unlike a three-dimensional chess game in that the key strategic element the aircraft can be moved quickly and fairly easily. You are selling both a service and a price- sensitive commodity. An airline seat is one of the most perishable products in the world, Once the airplane pulls away from the gate, the seat the airline's product is gone forever. There is no opportunity for a "mark-down" sale later, to get rid of excess inventory. This fact puts intense pressure on planners to predict demand, decide on how much capacity (how many seats) to offer, and determine a price that will attract enough people to cover costs and make a profit (the yield management field is one of the principal growth areas in aviation). In fact, demand shifts depending upon the time of day, day of week, and season of year (which is why there are so many different fares between two points).

Then, just when you think you have your market figured out, you have to predict what the competition will do, and the competition is changing all the time. Unlike hotels and factories, which take years to plan and build and cannot be moved from place to place, an aircraft can be shifted almost at will so that the competitive environment facing the airlines changes constantly. One moment five carriers may be offering 1,000 seats altogether to Honolulu, a market that may have demand for 1,200 seats. Everyone is doing well until five more carriers, perceiving an opportunity, jump in, doubling the number of seats available for sale per day. Then, all of the carriers are forced to cut fares sharply, increase advertising in order to attract passengers, and probably operate at a loss.

Moreover, the airlines have to work within parameters. An airline may have an aircraft fleet that works most efficiently on a certain length of flight and that has a certain number of seats. The transcontinental (New York-Los Angeles) market may thus be so critical for the carrier that the carrier may resort to "kamikaze" pricing (offering tickets below cost) in order to protect the market from predators.

Airlines are vulnerable to any number of conditions. Fuel is the second highest expense for an airline after personnel; a penny change in the price can save or cost a major airline millions of dollars. In 1990, Iraq's invasion of Kuwait and the Persian Gulf War sent fuel prices soaring from 60 cents to $1.40 per gallon every penny change in the price cost U.S. carriers $150 million (airlines spent $7.8 billion on fuel that year) and contributed heavily to their $2-billion loss.

Strikes, accidents, terrorism, and economic declines all seriously impact on demand for the airlines' services. Indeed, the Persian Gulf War, besides sending fuel costs skyrocketing, caused fear of terrorism and, coupled with a recessionary economy, sounded the death knell for Eastern Airlines, thrust Pan Am into bankruptcy, and caused TWA to teeter.

The market for airline travel divides into two roughly equal parts: (1) nondiscretionary travelers, primarily people who have to travel for business purposes and who are not as much concerned about price as convenient schedules and good service, and (2) discretionary travelers, people who travel for vacation or pleasure or to visit friends and relatives, and who are very much swayed by price and can choose to travel or not. By balancing out these two markets-business travelers and leisure travelers-through calculated use of fares, schedules, and routes, airlines can increase their load factors (the percentage of seats occupied by paying passengers) and maximize the utilization of their fleets, both of which are critical for achieving profitability.
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