By DON DELUCA AND JOHAN PRINS

A generation ago the average person traveled for pleasure by car, train or bus (Greyhound). Only the wealthy could afford to fly.

Today it is assumed that everyone has the right to fly wherever they go—yet people expect to pay Greyhound bus prices.  How realistic is this?

Consider that fuel costs keep escalating and the cost of operating airplanes continues to increase, especially because highly trained and skilled crews must fly and maintain them. On top of that, airport expenses and security costs are skyrocketing these days.

The reality is that various airlines are bankrupt because the price of an airline seat as demanded by the public cannot match the basic economics of the airline industry. The airlines cannot sustain their business on a current “tech” business economic cost basis with historic “Greyhound bus pricing.” Furthermore, the capacity of air-traffic control and airport facilities (the infrastructure) cannot match the pace of the rate of growth of the travelling population. The industry on-time performance was 72% in 2004 and the outlook for 2005 is even worse. The customer service is at an all-time low.

Reason for concern in Charleston?

In 2004, 900,000 passengers arrived at Charleston International Airport; roughly 50% for business and 50% for leisure. Their spending generated more than $1 billion in revenue for the greater Charleston area.

We should be concerned by the state of the airline industry considering most of the airlines that serve our area (Delta, Northwest, United, Independence Air, US Airways and Continental) are either in a Chapter 11 situation or are facing one. US Airways and United are in bankruptcy courts, Independence is cutting flights to reduce their losses, and Delta recently announced a 2004 loss of $5.2 billion (the largest loss ever reported). 

Various local initiatives are based on a healthy growth of infrastructure facilities in our area. Approximately $48 million is being spent on a new parking garage at the airport, new hotels are opening in greater Charleston, new tourist attractions are being planned and knowledge-based businesses are actively being recruited to establish a presence here. All these initiatives are based on the idea that this area will continuously be served by professional, well-organized transportation companies. How will Charleston present itself as an international gateway for the Southeast with the threat of seriously reduced airline services in the future?

Why the airlines are in trouble

What has caused the financial predicaments at the major airlines? There are several reasons.

Over capacity in the airline industry. There are too many airlines with too much capacity. The domestic airline-industry has not been in market equilibrium for quite some time. There are too many airplanes, which are able to fly many more years than originally anticipated. Airplanes are rather easy to finance (lease) because aircraft keep their value.

Bankruptcy procedures are too lenient. A struggling airline filing for bankruptcy can reduce expenses dramatically in order to get approval from a judge to survive. But, consequently, they also force other airlines to reduce their expenses, which results in an even further decrease in customer services. The intent of a Chapter 11 situation is to allow a company to restructure their expenses and pay off their debts. Some airlines, however, repeatedly choose a Chapter 11 solution to survive. Judges should be courageous enough to pull the plug in case no long-term solution can be achieved.

High expenses at the legacy carriers. Most airlines were established long before deregulation in 1979, when the industry was regulated by a government body, the Civil Aeronautics Board, and carriers were allowed to fly only assigned routes with fares determined by government ruling. After deregulation, prices came under pressure and profitability diminished. With the entrance of low-cost carriers, prices became even more depressed and the need to adjust cost levels was unavoidable. The unions (most airline employees are unionized) were not willing to give in and the existing staff was not pleased with having to work harder for less money.

Various airlines have already indicated that they are unable to supply the required funds to their pension plans. This means that the Pension Benefit Guarantee Corp. will be forced to take over the huge liability, which will lead to an extra burden on U.S. taxpayers.

Management. In the past 25 years, the management of the legacy carriers hasn’t been able to show the required leadership. Instead of fighting the high costs of their companies, they often secured their own financial situation first; both short and longer term. Consequently, unions and other staff members were not willing to accept lower pay-schemes and higher productivity targets. Airline management has failed to set an example and act as a well-respected role model.

Conclusion

Nobody will be surprised with the conclusion that, yes, we have to be concerned. A failing airline industry is bad for our economy. This government must act aggressively in 2005. One of the tasks might be to appoint an airline taskforce with the authority to conclude binding recommendations for the failing airline industry.

Furthermore, legacy airlines have to realize that there are distinctive markets for point-to-point traffic, hub-and-spoke traffic and international traffic. Those distinctive markets have their own requirements and successful carriers will be able to deliver accordingly. Airline capacity should be offered on economic terms based on real customer demands. Consequently, some liquidation of United States domestic capacity is urgently required, allowing some airlines to die and, most importantly, to remain dead. Why can’t we have a few airlines that serve the market based on well-defined customer needs?

Restructuring of the airline industry is an issue of national interest. Isn’t it time for our local politicians to raise the flag and develop local initiatives in order to put additional pressure on the Secretary of Transportation to act professionally? A fundamental change must be made in the airline business model. We must reduce capacity, increase customer service, improve punctuality and acknowledge that it is not a basic human right to fly cheap. In case the air-transport conglomerate is not able to restructure itself, there might be a need to nationalize the industry.

Don Deluca has spent most of his career as the chief financial officer of several major public corporations; he is currently the chief executive officer of Charleston-based bio-tech firm, Cure Source, and serves on the board of advisors of The Citadel School of Business.

Johan Prins was the chief financial officer of North American operations for KLM Royal Dutch Airlines. In 1998, he joined PricewaterhouseCoopers outsourcing practice and specialized in airline issues. He currently lives in Charleston and has his own advisory practice.

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