One Year After 9/11, Change Is in the Air

As the first anniversary of September 11 drew near, I was overcome by the urge to indulge in some weighty reflection and predictions. Clearly we are in the midst of the most tumultuous period in the history of the travel industry since the effects of the 1978 Airline Deregulation Act percolated through commercial aviation, radically changing the way travel was delivered, distributed, and priced.

I have some ideas as to what we can expect, but first, here’s some background:

An industry in disarray

For all the furious cost-cutting, huge losses continue buffeting the major carriers, which lost nearly $1.4 billion during the second quarter of 2002, following a $2.4 billion loss in the first quarter. And for 2001, if the post-9/11 federal bailout loans are factored out, the U.S. airlines were in the red to the tune of $11 billion.

As of early August 2002, the combined market value (share price multiplied by the number of shares outstanding) of the nation’s six largest airlines was slightly more than $5.5 billion. By contrast, Southwest’s market value exceeds $9 billion. And tiny upstart JetBlue, at $1.6 billion, had a market cap only a few million less than the world’s largest carrier, American Airlines.

Market value reflects share price, which in a rational world reflects anticipated future earnings. So the stock market is telling us, emphatically, that Southwest and kindred carriers will succeed, and that the old-line airlines won’t.

The majors are between a rock and a hard place. Travelers, with easy access to cheap fares available from no-frills carriers, are increasingly price sensitive. But the majors, with their crushing overhead and uncooperative labor unions, can’t get their costs down. So it’s Sophie’s choice: Charge higher fares and lose customers to Southwest & Co., or sell below cost to maintain market share. There’s no profit down either road. As Continental’s chief Gordon Bethune summed it up, “The marketplace has changed; we haven’t changed.”

But change they will.

Delta’s Leo Mullin recently said that low-cost airlines like Southwest and AirTran pose a greater competitive threat to Delta than do mainline carriers like American and United. Although no specifics were revealed, in late July, Delta discussed with its board members plans to launch its own low-cost operation.

At American, which now competes against low-priced carriers in 70 percent of its markets, Don Carty has vowed to hold nothing sacred in a thoroughgoing review of the airline’s business model.

Where do we go from here?

That exclusive club of mainline airlines, once the pride of American aviation and the envy of the world, is now a kennel-full o’ sick puppies. How did these high flyers fall so far, so fast? And what will air travel look like six, 12, and 24 months from now?

Rather than let fly with my own observations and predictions, this historic occasion cried out for counsel of a higher order: the wisdom that derives from greater age and more experience than I possess, from those who have slogged through business cycles and fads, Gulf wars and fare wars.

So I turned to the Rolodex, cross-tabbing “P” for “pundits” and “B” for “been there, done that,” in search of a few good men who might have transmuted their great experience into great insight.

Kahn: “Difficult to predict”

Alfred E. Kahn is former chairman of the Civil Aeronautics Board, and currently the Robert Julius Thorne Professor of Political Economy, Emeritus, at Cornell University. He’s the author of “Whom the Gods Would Destroy, or How Not to Deregulate.”

Professor Kahn has been called the architect of airline deregulation, which makes him the godfather of the industry’s current structure. The inevitable question for Kahn: Are we now in a period of radical transformation, akin to that in the years following deregulation? Or is this simply a predictable down period in the business cycle, to be weathered by keeping costs under control until there’s an equally predictable rebound in demand?

His response: “There’s a good chance that it’s the former.” But just as “it was uncertain how the industry would evolve in 1978,” the official beginning of the deregulation era, “so is it now difficult to predict what’s at the end of the tunnel we’re in.”

As to the causes of the industry’s current crisis, Kahn sees September 11 as a contributing factor, but stressed that the tragedy’s aftermath represented “the intensification of something that would have happened anyway.”

Although he couldn’t say who or when, he deemed airline bankruptcies “likely.” On the other hand, “If wage structures can be got inline, then there is a chance for survival.”

Kahn suggested that the majors’ current “finely differentiated fare structure” was unsustainable. But he doesn’t see mono-pricing as likely either, noting that even Southwest’s ticket pricing has tended toward segmentation.

In Kahn’s estimation, frequent flyer programs have proved to be “a powerful factor in permitting the previous system to continue, by extending the loyalty of business travelers.” But he went on to cite their “diminishing effectiveness,” calling them “insufficient given the current unwillingness to pay high prices.”

Notwithstanding his prominent place in the history of commercial aviation and his stature as an economist, Kahn suffers the insults of air travel along with the rest of us. He lamented the scarcity of first-class upgrades, and admitted that the airlines’ discontinuation of senior discounts was “positively painful.”

Robert Crandall: “More revolutionary than evolutionary”

Robert L. Crandall was elected president and CEO of American Airlines in 1980 and added the title of chairman in 1985. He retired in 1998 and currently sits on the board of MilePoint, an Internet company facilitating the buying and selling of airline frequent flyer miles.

On the question of the extent of the industry’s eventual change, Crandall foresees a significant transformation. “We’ve been thrust into an environment which requires a revolutionary response, not just cost-cutting at the margins.”

“And it’s much more than just 9/11. There is an array of factors at play: recession, electronic substitution, modification of the distribution channel, good-fare hunting on the Internet, more low-cost carriers.”

Because he expects the changes to be so far-reaching, he declined to make specific predictions. “I’m not smart enough for that.” He does foresee a period of experimentation by an industry trying to determine “what’s needed by the public. What evolves will be a function of how the public votes on product ideas the airlines set forth.”

What advice does the most successful top manager in airline history have for today’s aviation heads? Rather than a laundry list of specific tactics, Crandall reverts to his customer-focus mantra, insisting that airlines must engage in “intensive interface with their customers. Be prepared to take risks and redefine existing products.”

Are frequent flyer programs on the endangered-services list? Not according to the man on whose watch they were introduced, in 1981. “The programs have been wildly successful, and now even the low-fare carriers have them. They’ll be among the last to go.”

Lastly, Crandall warned that the traveling public should be prepared to be “unpleasantly surprised. As price becomes the sole determinant, service will inevitably decline. There’s less today, and will be less still tomorrow.”

Grosvald: “Follow the money”

Stevan Grosvald is the founder and principal of Grosvald & Associates, a Tulsa-based consulting company specializing in travel-industry loyalty programs. Previously, he worked for United Airlines for 21 years and oversaw the launch of the Mileage Plus frequent flyer program. He was a senior marketing executive with Continental as well.

Grosvald’s predictions for the industry are provisionally optimistic. Critically, business travel will rebound. “The business traveler will not convert to teleconferencing. There may ultimately be fewer business travelers, but not that many fewer.”

The changes arising from the current turmoil will be incremental and evolutionary, not revolutionary. And the overarching theme of those changes will be cost-cutting. He expects to see increased use of regional jets, more two-class instead of three-class cabins, and fewer free limousine services for premium international passengers.

Just as the major carriers won’t be transformed beyond recognition, neither will their frequent flyer programs. In response to the oft-heard complaint that frequent flyer programs just add to the airlines’ expenses and thus increase ticket prices, Grosvald counters that loyalty programs are every bit as necessary as advertising. “And they’re the most effective marketing programs ever developed.”

More bankrupcties? Grosvald thinks they are likely, to the extent that airlines suffer from mismanagement at the top and union intransigence in the workforce, “Where senior management is out of touch with employees and customers, and where unions have an unreasonable sense of their own importance.”

Ostrowski: “Evolutionary, but structural”

Peter Ostrowski is senior vice president of NFO Plog Research, a market research firm specializing in the travel industry. He was formerly an executive with United Airlines.

“After 9/11, there has been a lot of concern and discussion about security. What we should be discussing is the airlines’ fundamental business model. That’s where the action is.”

Regarding the likely changes to that business model, Ostrowski expects them to be “evolutionary, but structural.” He sees the majors cutting costs—”They can’t afford to do otherwise”—but stopping well short of abandoning their fundamental full-service approach in favor of the Southwest model. For example, he predicts the majors will maintain their hub-and-spoke networks, while increasing point-to-point flights in markets that can support them. And he expects to see more smaller, fuel-efficient jets.

Must the majors match the low-cost operators’ prices? “No, because members of the majors’ frequent flyer programs will pay a small premium to fly with their primary carrier.” (He distinguishes between two types of mileage program—the “hold-your-nose” programs offered by Southwest and JetBlue, and the robust programs exemplified by American’s AAdvantage and United’s Mileage Plus.) But the mainline carriers must lower costs enough to operate profitably with tickets priced only a few dollars higher than the low-fare competitors’. And there’s a formidable obstacle to such cost-cutting: the airlines’ labor unions.

Bankruptcies? “If the unions don’t give up ground, we will see airline bankruptcies.”

The take away: Less is less

While there was some quibbling, partly semantic, as to whether the changes to come will amount to wholesale transformation or mere modification, there was broad agreement that tomorrow’s mainline carriers will look more like Southwest than they do today.

We’ll see more focus on point-to-point service and less on hub and spoke, more regional jet service, fewer inflight amenities, and simpler pricing. And good news: Frequent flyer programs aren’t likely to be relegated to the trash heap of airline-marketing history anytime soon.

The causes? September 11 was a trigger, an accelerant. The recession was a contributing factor, as was the availability of Internet fares and the spread of discount airlines. The unions participated by demanding higher wages than could profitably be sustained. And airline management was woefully out of touch with consumers and its own labor force.

When all the parsing of cause and effect is done, it comes back to the consumer, to us, and how much we’ll pay to fly. Because we are willing to pay only for less, less is exactly what we will get. Less comfort. Less convenience. If airline travel ever was “something special in the air,” it will be decidedly less so in future.

This suggests a sobering motto for the coming era of air travel: “Be careful what you wish for.”