What Ails US Airline Industry

[2007]
What Ails US Airline Industry and How to Overcome It

PRITAM DEY
pritam.dey@gmail.com

What Ails US Airline Industry? Pritam Dey

ABOUT THE AUTHOR

Pritam Dey has an extensive background in IT and business consultant. He has designed
and developed IT solutions for customers across domains and technology platforms.
Having joined Tata Consultancy Services in 1999, Pritam has handled complex project
assignments for Global Insurance and Financial Services firms. With specialization in
Internet technologies and object-oriented design principles, Pritam has led cross-
functional teams to execute IT projects for clients such as Tata Internet (India), Prudential
Financial (USA), ING Bank (Netherlands) and A.P. Moller-Maersk Group (Denmark).

Pritam has also played a significant role as a business consultant. To maximize his
education during the MBA program, Pritam has led and mentored teams to provide data-
driven business consulting and recommendation to deliver bottom-line results to his
clients. He has executed a wide array of projects on business strategy, market research,
business process analysis, competitive landscape study, new market entry and pricing
strategies. He has consulted for Fortune 500 organizations such as 3M, UnitedHealth
Group, Thomson-Reuters, and Northwest Airlines (now Delta). Post his MBA program,
he has also consulted for a plethora of non-profit and startup organizations and has
created marketing and business development opportunities for the respective
organizations.

Pritam is passionate about playing a major role in creating executable IT strategies and
roadmap that increase the value of IT projects and that strive to reduce the gap between
IT and business objectives. He spends a great amount of time following the latest
technology trends and understanding how technology is going to drive business and
consumer needs in future. He intends to use this knowledge to create effective IT
solutions for his clients.

Pritam holds a BE degree in Electrical Engineering from Maulana Azad National Institute
of Technology at Bhopal (India) and an MBA from University of Minnesota at
Minneapolis.

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TABLE OF CONTENTS

Industry overview ··············································································································· 4
Problem/Issue Formulation ································································································· 4
Model Building ··················································································································· 5
Model 1: Continental Airlines ··········································5
Problem/Issue ···················································5
Continental Airlines Today ··········································6
Key Success Factors ···············································6
Model 2: Hawaiian Airlines············································7
Problem/Issue ···················································7
Hawaiian Airlines Today ············································7
Key Success Factors ···············································8
Comparison of the two models ··········································8
Model Application ·············································································································· 8
Problem Solving ················································································································· 9
Labor ··························································9
Fuel ···························································9
IT/Reservations/Customer Service ······································10
External Distribution/Commissions······································10
Fleet/Maintenance ·················································10
Pension ························································10
Other Opportunities ················································10
Business Travelers·················································10
Alliance························································10
People ·························································11
Customers ······················································11
Strong Argument to support the Solution ········································································· 11
Claim ·························································11
Reason ························································11
Evidence ·······················································12
Reservations ·····················································12
Qualifiers·······················································12
Conclusion ························································································································ 13
Sources: ····························································································································· 14

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WHAT AILS THE U.S. AIRLINE INDUSTRY AND HOW TO OVERCOME IT

Industry overview
In 2005, U.S. airlines recorded a fifth consecutive year of net losses, at $5.7 billion – a
five-year total loss of $35.0 billion. The 2001-2005 period has been exceptionally
challenging for airlines of all shapes and sizes. Airlines have been unable to recover their
expenses and, in particular, have been over-whelmed by inflated fuel costs. Today, most
of the major airlines have undergone cost restructuring, with United Airlines obtaining
employee concessions in exchange for equity ownership. Some airlines, such as
Northwest Airlines, sought the protection of Chapter 11 bankruptcy to restructure and
reduce costs and then emerge as strong low-cost competitors.

Problem/Issue Formulation
The following are the symptoms currently seen on the U.S. Airline Industry:
• Major U.S. Airlines consistently losing money.
• The weak performance of the legacy airlines (airlines from pre-deregulation) over
the last few years has significantly diminished their financial condition; as a result,
some of these airlines are vulnerable to bankruptcy.
• The overall volume of business air travel demand has decreased.
• Labor productivity has been consistently low.
• Emergence of low-cost airlines has been a significant challenge to legacy airlines.
• Congestion and growing flight delays.
• Issues of aviation safety and security.
• Increased security checks and uncertainty of passenger processing times.
• The new security procedures have increased operating costs and induced more
security-related flight disruptions and delays.
• External shocks (9/11, the Iraq war, SARS, etc) have depressed demand for air
travel.
• Intense pressure on airlines to cut costs.
• High competition.

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• The U.S. Airline industry received $5.0 billion in direct assistance from the U.S.
government in 2001.
• Extreme price-cutting to fill up seats.
• Several carriers failed and ceased operations including such high profile operators
as Pan American Airways and Eastern Airlines.
• High oil price drove up operating costs of airlines.
• Many legacy airlines remain highly leveraged.
• Airline business highly responsive to economic cycles.
• Labor costs are very high.

All the symptoms mentioned above point to the fact that the U.S. Airline industry is
going though a very tough phase. A series of significant changes and unforeseen events
during the last several years has presented the airline industry with its most significant
challenges since it was deregulated 25 years ago. These challenges have come from
within the industry as well as from external factors affecting the demand for air travel.
The problem that is being investigated here is, ‘What ails the U.S. Airline industry, and
how to overcome it?’

Model Building
In exploring appropriate solutions to the problem, two particular models seem relevant
here.

Model 1: Continental Airlines

Problem/Issue
In 1994, Continental was facing its third bankruptcy. Employees were disgruntled about
their work environment, their pay, and their airline; they had even taken pay-cut in an
effort to keep the airline afloat. Customers did not think much more about the company,
as Continental was considered simply the worst among the nation’s ten biggest airlines.

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Continental Airlines Today

• Continental Airlines is now recognized as one of Fortune Magazine’s “100 Best
Companies to Work for in America”, even moving up from the 40th position to a
very respectable number 23 on the list in 1999.
• Continental is also now considered to be a respected airline and company, not
only in the airline industry but also across all industries both nationally and
worldwide.
• Continental can boast consecutive record and yearly earnings since 1995.
• On-time bonuses were paid in excess of $95 million to employees.
• Absenteeism has been reduced by 31 percent, and employee turnover has dropped
52 percent.
• Continental has won various awards and accolades from the prestigious J.D.
Power, to the Fortune’s “100 Best” Frequent Flyer Program of the Year.

Key Success Factors
Continental Airlines came up with four plans to lead this turnaround:
• Fly to Win
Continental implemented the code-sharing strategy with other major airlines to
attract more customers. It also entered into alliance with other airlines to attract
customers. At the same time, it continued to eliminate the non-value-added costs.
Frequent Flyer Program was restored.
• Make Reliability a Reality
The plan aimed to have an industry-leading product Continental would be proud
to sell. Continental worked hard to consistently rank among the top in the industry
in four key Department of Transportation (DOT) measurements: on-time arrivals,
baggage handling, complaints, and involuntary denied boardings. In order to
provide this service, the employees had to want to provide it. There were easily
measured goals and the reward came in the form of cold hard cash.
• Working Together
Continental managed to improve the employee morale which took a deep dive
because of constant cost-cutting measure. They were rewarded with hard cash

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every month for their good performance. Expectedly, happy employees took good
care of customers.
• Fund the Future
Continental lowered its debt level and reduced interest payments on loan and
aircraft leases. It also developed franchise hubs to reduce costs. Increased focus
was laid on the fleet plan, development of hub real estate and the generation of a
strong cash flow and improved financial flexibility. Leases were renegotiated,
payments were postponed, debts were refinanced, and pricing structure was
changed.

Model 2: Hawaiian Airlines

Problem/Issue
Hawaiian Airlines filed for Chapter 11 bankruptcy protection on March 21, 2003 with
operations still continuing, and was overdue for $4.5 million USD worth of payments to
the pilots’ pension plan. Within the company, it has been suggested that the plan be
terminated.

Hawaiian Airlines Today

• The turnaround of Hawaiian Airlines has earned international acclaim with the
company’s management winning top honors for finance at the 2005 Airline
Strategy Awards.
• Hawaiian Airlines restructured while keeping its commitments and thereby set an
example for the industry.
• Hawaiian Airlines, the nation’s number one on-time carrier, is recognized as one
of the best airlines in America.
• Business travelers recently surveyed by Conde Nast Traveler rated the airline as
having the best in-flight service and meals of any U.S. carrier.
• Hawaiian was recently ranked fourth best in the nation overall by Travel +
Leisure.

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Key Success Factors
Critical success factors for the turnaround of Hawaiian Airlines are:
• The newly acquired fleet produced savings of $41 million in aircraft maintenance.
• Increased use of Hawaiian’s web site and direct booking saved some $10 million
in distribution costs.
• Hawaiian Airlines also introduced several technology-based initiatives that
improved its operational efficiency including a full conversion to e-ticketing, the
installation of Self Check-In Hele On (Hurry Up) terminals at all Hawaii airports
to speed transits, and the introduction of Web Check-In Hele On at
HawaiianAir.com allowing customers to check in from home or the office up to
24 hours before departure.
• Revamped its customer service. Today, Hawaiian is the nation’s most punctual
airline as well as one of the most profitable.

Comparison of the two models
The comparison of the two above models shows that the Continental Airlines model is a
better one suited for this situation. This is because, firstly, Continental Airlines
incorporated a grander turnaround model that had an impact on each operational aspect of
the airline. Secondly, to be successful, an airline must be effective in four general areas: 1)
attracting customers, 2) managing its fleet, 3) managing its people, and 4) managing its
finances. Continental’s turnaround plan touched each of these above areas. On the other
hand, the Hawaiian model touched only a few aspects, namely, the fleet, people, and
customers. Furthermore, the enormity of the problem Hawaiian faced was a small
fraction of what Continental actually faced. Therefore, the Continental model seems to be
better model in this case.

Model Application

The situation currently faced by major ailing U.S. Airlines such as Northwest Airlines is
similar to the one Continental Airlines faced years ago. In fact, these airlines are going
through the same bankruptcy plan that Continental went through earlier in its history.
Therefore, the Continental model is apt for the current U.S. Airline industry. However, it

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must be noted that blindly copying a model is not going to guarantee success. A model
must be modified to suit the present circumstances. Even though the Continental Model is
good enough for the problem under investigation, nevertheless, it needs to be revised to
increase the chances of success. We can implement key success factors from other
profitable airlines to complement our solution.

The model needs to be modified in the following aspects to make it sounder for the
current situation.
• Profitable airlines are prerequisite for recovery in the aircraft industry. Bring unit
costs closer to those of low-cost airlines and align their services with fares that
passengers are willing to pay for “anywhere to everywhere” networks.
• Adjust operations by establishing and improving yield-management systems, which
price seats in a more discriminating way, and by outsourcing more services.
• There are two alternative strategies that have succeeded in keeping costs
considerably lower and have been good at attracting leisure travelers.
o Highly efficient utilization of aircraft.
o Purchase of low-cost used aircraft.

Problem Solving
A detailed plan for implementing the proposed solution is described below:

Labor
Management should negotiate contracts with labor union in order to reduce labor costs.
Currently, labor costs account for a bulk of the cost of operating an airline. Currently, 40
percent of an airline’s expenses are used to pay pilots, flight attendants, baggage handlers,
dispatchers, customer service, and others.

Fuel
Fuel savings initiatives such as single-engine taxing, more efficient fuel-reserve practices,
and installation of winglets can result in significant cost savings.

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IT/Reservations/Customer Service
Technology-driven enhancements to airline websites and self-service kiosks can reduce
the cost of bookings and passenger handling.

External Distribution/Commissions
Renegotiate contracts with global distributions systems (GDS), reduce travel agent
commissions, encourage travelers to book directly with carrier websites.

Fleet/Maintenance
Continue the fleet rationalization program. Replace older, maintenance-intensive, fuel-
guzzling fleets with new aircrafts. This can reduce training, spares, and maintenance
expense.

Pension
Even though this sounds difficult, airlines need to explore whether they can reduce the
pension expenses. Adopt the Pension Benefit Guaranty Corporation (PBGC) to shift the
burden of funding the airline workers’ pension. According to the PBGC, airline pensions
today represent at least 38 percent of PBGC claims – but airlines paid just 2.6 percent of
premiums.

Other Opportunities
Explore opportunities to earn more revenue from transporting cargo, selling frequent flier
miles to other companies, and ‘up-selling’ in flight services.

Business Travelers
Value your business travelers because they are more likely to travel several times
throughout the year, and they tend to purchase the upgraded services that have higher
margins for the airline.

Alliance
Increase alliance with other airlines to improve the load factor, i.e. fill up the empty seats.

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People
Focus on improving the employee morale. A motivated employee is the key to have a
happy customer.

Customers
Improve customer service. Improve the on-time arrivals, improve baggage handling,
reduce complaints, and reduce involuntary denied boardings. In order to do so, airline
guidelines might need to be modified so that managers are empowered to use their heads,
rather than manuals, to solve customer’s problems.

Strong Argument to support the Solution
A strong solution should have the following components:
1. Claim
2. Reason
3. Evidence
4. Reservations
5. Qualifiers

Claim
Turnaround the ailing U.S. Airline industry by applying and further refining the
Continental Airlines Model.

Reason
The reasons for supporting the claim are:
• Continental Airlines was able to turnaround its airline by using this model.
• Other airlines such as Hawaiian Airlines, Delta Airlines, etc are using part of this
model to restructure their airlines.
• Currently, the problems faced by major U.S. Airlines are similar to what
Continental Airlines faced years ago.
• The enormity of the problems currently faced by major U.S. Airlines is similar to
that of Continental Airlines.
• The industry is located in the U.S.; hence the Continental Model is appropriate for
this case.

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• The symptoms and underlying issues are similar.
• The market conditions are similar.
• The external conditions such as the governmental deregulation, terrorism fears, oil
prices, etc are similar.

Evidence
The evidences supporting the reasons and claims are:
• Continental Airlines went through a bankruptcy process to turnaround itself.
Similarly, most of the major U.S. Airlines are undergoing Chapter 11
bankruptcy reorganization. Northwest is expected to come out of the bankruptcy
reorganization sometime in 2007.
• Even today, labor and fuel costs account for the bulk of the expenses.
• Northwest Airlines is going through a restructuring plan similar to what
Continental Airlines went through.

Reservations
The reservations of the solution are:
• The time period, U.S. and global economy, and the business environment are very
different as compared to the Continental Airlines’ turnaround period. Hence, the
model might not be applicable now.
• The oil prices have skyrocketed in recent times, driving up the operating costs of
running an airline. Therefore, it is much more difficult to turnaround ailing
airlines now.
• Weather is variable and unpredictable. Extreme heat, cold, fog, and snow can shut
down airports and cancel flights (which costs money).
• The socio-political and economic conditions can delay the process of turnaround.

Qualifiers
In order for the solution to work, we have assumed that:
• There will be no significant drop in future level of air travel.
• There will be no significant drop in future passenger traffic and yields.

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• Unpredictable pricing environment is minimized.
• There will be stable cost of security.
• Cost and availability of aviation insurance coverage and war risk coverage will
remain stable.
• General economic conditions of the United States and other regions of the world
will not hamper the airlines’ recovery.
• The price and availability of jet fuel will be stable.
• The possibility of additional terrorist attacks or the fear of such attacks,
concerns about SARS, Avian Flu, or other influenza or contagious illnesses is
less.
• Labor strikes, work disruptions, labor negotiations both at other carriers and the
company will not delay the turnaround process.
• Low cost carrier expansion, capacity decisions of other carriers will not be as
rapid as so make the turnaround much harder.
• Actions of the U.S. and foreign governments, foreign currency exchange rate
fluctuations, inflation and other factors will remain predictable and stable.
• The weather conditions will remain predictable and manageable. Disasters such
as Hurricane Katrina could make the turnaround slower and harder.
• The airlines have the capability to go through the change.

Conclusion
Assuming that the struggling airlines implement the steps mentioned above, there is
ample opportunity to turnaround and recover from the current situation. Continental
Airlines had done it. Hawaiian Airlines had done it. Airlines in other countries have done
it too. With proper action plan, governmental support, industry alliance and support (in
terms of price-cutting, code sharing, etc), there is no reason why the airlines cannot turn
around. The outlook for the travel industry is one of strong growth. Forecasts suggest that
the number of passengers will double by 2010. Successful airlines will be those that
continue to tackle their costs and improve their products, thereby securing a strong
presence in the key world aviation markets.

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Sources:

1) PBS, ‘Continental Airlines’ Turnaround’, March 19, 1998
2) U.S. Government Accountability Office, ‘State of the U.S. Commercial Airline
Industry and Possible Issues for Congressional Consideration’, November 28. 2001
3) Peter R. Costa, Doug S. Harned, Jerrold T. Lundquist, The McKinsey Quarterly,
‘Rethinking the aviation industry’
4) Stephen S. Doig, Adam Howard, Ronald C. Ritter, The McKinsey Quarterly, ‘The
Hidden Value in Airline Operations’
5) Air Transport Corporation, 2006 Economic Report
6) The Industry Handbook, The Airline Industry
7) Andrew B. Steinberg, U.S. Department of Transportation, U.S. Airline Industry
8) Richard M. McCabe, Graziadio Business Report, ‘Airline Industry Key Success
Factors’
9) Northwest Airlines, ‘Northwest Airlines Files Its Plan Of Reorganization’

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