Mon, Jun 03, 2002 page21

• Airlines need to shrink to avoid losses

  STRATEGY The leaders of major air carriers from around the world met to discuss basic supply and demand issues that have been plaguing companies since last year

  • BLOOMBERG
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  Airline chief executives, meeting yesterday as a group for the first time since the Sept. 11 attacks, face further losses on top of last year's US$17 billion unless they shrink the industry by a third, analysts said.

  British Airways Plc, AMR Corp's American Airlines and other carriers won't return to profit by trying to fill their planes and win market share with low ticket prices as they are now, said Chris Tarry, an airline analyst at Commerzbank.

  "It's a simple issue of supply and demand, but it's one that airlines have failed to address for 50 years," Tarry said. "This is an industry that's been suffering from mass delusion about productivity and costs."

  The airline industry's profit margin averaged just 3 percent from 1947 to 2000, even before the US attacks cut air travel by a third and led to losses that were greater than all the profit ever generated by airlines in the history of flying.

  While carriers are working to reduce costs to cope with the fall in demand, firing more than 10 percent of staff worldwide, they need to embrace fundamental change, said Rigas Doganis, an industry consultant and former CEO of Greece's Olympic Airways.

  "The traditional airline network model isn't sustainable," said Doganis. "It's overextended. The big airlines need to reduce their short-haul operations and the smaller ones need to cut back on long-haul flying."

  By reducing capacity in this way, carriers will be able to halt a decline in prices that's steadily eroding their average yield, or revenue per seat, and undermining their efforts to make a profit, analysts said.

  The gathering of industry chief executives at the International Air Transport Association's annual meeting in Shanghai will seek to address how carriers can develop their responses to the environment left by the attacks, said Doganis, who will chair one of the sessions.

  The industry needs to be reduced in size by at least 30 percent in terms of seating capacity to achieve sustainable profits, said Tarry, the Commerzbank analyst.

  Fares have fallen so much that the price of a 1,000 mile flight within Europe 10 years ago is the same as a seat across the Atlantic today. The reduction has meant that profits are no longer assured even when times are good, said Tarry, who predicts airlines will have combined losses of at least US$10 billion this year.

  UAL Corp.'s United Airlines, which lost a record $2.1 billion last year and cut 20,000 jobs, is the latest carrier trying to lure passengers with discounts, offering two free economy-class roundtrips to any of 729 destinations with every business or first-class booking between London and the US.

  British Airways, Europe's biggest carrier, was one of the few airlines to challenge established strategy even before the attacks, with former CEO Bob Ayling cutting routes and moving to smaller planes to focus on more profitable business traffic.

  Rod Eddington, Ayling's successor, continued the policy, only for demand on key trans-Atlantic routes to be hurt by a weak economy, an outbreak of livestock disease in the UK and finally by the attacks on New York and Washington.

  The London-based airline, once the industry's most profitable, posted a loss of ?142 million (US$207 million) in the year ended March 31, yet its best bet for survival is probably to slash its short-haul network still further, Tarry said.

  Excess capacity might be eliminated by consolidation, though government regulations now restrict mergers mainly to carriers from the same country. British Airways' repeated attempts to take over KLM Royal Dutch Airlines NV have stumbled on the rules restricting access to airports worldwide to national carriers.

  "Without the restrictions we'd get larger companies with sounder financial resources," said Doganis, a visiting professor at Cranfield University's College of Aeronautics in the UK.

  Even well known airlines are far smaller than leading companies in other industries, he said. AMR, parent of American Airlines, the world's biggest carrier measured by passenger traffic, has a market value of US$3.3 billion. General Motors Corp, the No. 1 carmaker, is worth more than 10 times as much.
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