testimony

Before the National Academy of Sciences, National Research Council, Transportation Research Board

12th INTERNATIONAL WORKSHOP ON FUTURE AVIATION ACTIVITIES

September 18, 2002

Good morning and thank you for the opportunity to address this distinguished group of commercial aviation industry experts.  It is an honor to present to you today the views and concerns of the corporate customer of the U.S. commercial air transportation system.

It’s rarely pointed out that no mass transportation system in the history of mankind has been profitable over time.  Is the U.S. commercial air transportation system predestined by some force of fate? Or perhaps the 19th century German philosopher Arthur Schopenhauer had it right when he said, "What people commonly call fate is mostly their own stupidity." 

The Airline Deregulation Act of 1978 democratized commercial air travel in the U.S., making it accessible to ordinary citizens.  Thirty million passengers flew on low fares in 1978; nearly 150 million did in 2000.  Low-fare airlines and the build-out of the hub and spoke system among major airlines were prime enablers of this revolution.

Deregulation has proven to be a bumpy ride though.  No matter how well air travel was democratized, many business travelers do not feel fairly treated when their tickets are six times more expensive than leisure fares.  The same hub and spoke system that provided low fares to leisure travelers evolved into a tangle of Fortress Hubs with supra premium business airfares.

Seeds Of Revolt

To be sure, macro economic and geopolitical forces influence airline industry financial results.  During the economic recession and Gulf War hostilities of the early 1990s, for example, major hub and spoke airlines lost billions of dollars.  Business travel levels plummeted as many corporations mandated across-the-board reductions in costs in response to falling profits.

However, as in previous cyclical downturns, business travel snapped back as soon as economic recovery appeared on the horizon.  The rebound in business travel in the early 1990s was supported by relatively low business airfares and a competitive imperative to get back on the road and secure "face time" with prospective customers.

By the late 1990s though, the efficacy of the U.S. commercial airline system was being questioned by corporate customers.  Travel management had moved from the corporate backwaters to a highly visible function that commanded the involvement of CEOs and CFOs.  These senior executives were growing increasingly frustrated and impatient with the commercial aviation system.

Arbitrary direct and indirect airfare increases, surcharges and forced contract amendments cast many major airlines as arrogantly indifferent to their best customers' needs and concerns.  Moreover, as business airfares were rising, customer service levels were eroding, giving momentum to passenger rights legislation.

If the Northwest Airlines' Detroit blizzard debacle in January 1999 was the "Fort Sumter" of the passenger rights war, then United’s pilot slowdown in the summer of 2000 was its “Fort Henry.”  The resulting gridlock nearly destroyed business travelers' confidence that they could accomplish day trips.  Increasingly, the aviation system looked more like an obstacle to conducting business than a facilitator.

A New Kind Of Response

With the recession all but confirmed by the end of 2000, senior managements took action.  However, across-the-board mandates to reduce spending by "X," common in previous recessions, were replaced with in-depth reviews. Invariably, teams comprised of staff from Travel, Purchasing, Finance, Information Technology and Human Resources were formed at the direction of CFOs on a mission.

These teams were tasked with understanding why and how companies traveled as well as examining alternatives to commercial airlines. They challenged the notion that employees had to be on the road physically meeting with customers in order to be productive. In an April 2001 BTC survey of major corporations, 86 percent indicated they planned to decrease airline spending an average of 28 percent that year. Seventy-six percent indicated that the cuts represented strategic reforms to policy and business practices versus simple near-term cost avoidance.

When BTC published the survey results in June 2001, major airlines dismissed the findings and declared that the industry would generate $1.5 billion in profits for the year.  Six weeks later, that figure was revised to a loss of $1.6 billion.  By August, analysts were projecting losses of $3.4 billion.  That's a bottom line miss of nearly $5 billion before the tragic events of Sept. 11. 

Clearly there are serious problems plaguing major network airlines beyond frustrated corporate customers and business travelers.  Cost structures have become bloated with runaway labor contracts and over-expansion.  Asset utilization levels -- labor, aircraft, gates -- are too low.  Spiraling business airfares only served to obscure these and other structural problems.

In Peril, In Denial

Some major airlines came to believe that they had pushed business fares too high and that they could induce demand with airfare adjustments.  But it was too late.  They had missed the strategic decisions corporations made in the spring of 2001, which no manipulation of airfares could reverse.  Increased investments in video conferencing and corporate aviation, and contracts with low-fare airlines were common responses.         

Major airlines have largely refused to acknowledge that their policies have backfired and that there is a backlash from customers whose loyalty was taken for granted, perhaps never really won.  To this day, airlines insist external forces cause their problems.  The Associated Press wrote on Sept. 13, 2002 of the Air Transport Association's comments on dismal August traffic, "The group attributed the drop off to the nation's economic troubles and traveler 'frustration' with airport security."

Many airline analysts now project that the industry will lose more money in 2002 than in 2001.  More than 18 months of data and analysis demonstrate that business travel demand has virtually dropped off a cliff.   

Importantly, major airlines are decades behind other industries that switched from pricing products based upon costs to costing products based upon what the customer is willing to pay.  Price cuts in response to falling demand would seem like an obvious strategy.  However, just after Labor Day, major airlines implemented what might be the largest price increase yet with their non-refundable ticket policy changes.

Many industry observers were confounded by this policy change. J.P. Morgan analyst Jamie Baker “criticized the industry for imposing fees and restrictions on airfares at a time when they desperately need to stimulate demand,” reported The Associated Press. “Baker cited 'a complete lack of industry recovery' and said he expects the nine largest carriers to lose $6.8 billion for the year, significantly worse than his previous estimate of a $5.4 billion net loss."

Just as major airlines missed the strategic nature of corporate decisions, they are missing it again.  Timing could not be more inopportune.  In October, CEOs will be approving 2003 budgets.  In response to this major indirect price increase, travel managers will likely be making recommendations to cut travel activity, especially commercial air travel, further in 2003 and find substitutes.

It is growing more likely that before major airlines acknowledge the causes and depth of their problems, and implement solutions, a major airline will fail.