Airlines Regaining Pricing Power

Airlines in recent months have regained some of the pricing power they've lost in the past year, as airfares inched upward from their lowest point in a decade toward what travel management companies predict will be even higher levels in 2010.

"There's no doubt that prices are firming," said Rick Seaney, CEO of airfare tracking firm FareCompare. "Basically, what we saw was an absolute freefall in prices from November through May—both domestic and international. Beginning in June, we had our first domestic airfare hike of the year. For some context, there were 15 hikes in 2008 and 17 hikes in 2007. We had a very steep bottom at the end of May and sort of a firming over the three or four months."

In an alert issued late last month, FareCompare said carriers attempted three fare hikes in as many weeks to close out October. The last of those, a modest $6 to $10 roundtrip increase initiated by AirTran, was matched on overlapping routes by American, Delta, United and US Airways, and not only matched by Continental, but expanded. That was the sixth successful fare hike of 2009, all of which have occurred since June.

"I definitely think they've bottomed out," said Bob Harrell, president of air consultancy Harrell Associates. According to data from the Harrell 100, an index of fares on 100 major domestic routes, business fares since June have been down year over year by only single-digit percentages in most weeks, and even witnessed a few modest increases in October and early November.

Leisure fares, however, since June have been down by as much as 22 percent from 2008 levels. Still, like business fares, that pricing has strengthened. Since early August, when leisure fares, which represent the lowest fares available, were down 21 percent from last year's levels, fares each week have further flattened, and during the second week in November those fares were down by only 4 percent annually.

"This data shows that the fares are strengthening," Harrell said. "There are two things going on here: First, capacity continues to go down. The other is that the economy is strengthening a little bit."

U.S. capacity has remained down for more than a year, and carriers continue to cut and refine their networks (see story, p. 6). According to OAG data released last month, North American frequencies in October dropped 4 percent year over year, with capacity down 5 percent. Those built on dramatic cuts that spread in fall 2008, when some airlines slashed capacity in excess of 10 percent.

"If you look back two to three years, it's still relatively cheap," Seaney said. "While the airlines have done their best to cut capacity to a level where they can keep planes full, the problem is they're keeping them full of lower-paying passengers because business travel dropped off dramatically."

With supply down, demand has begun to improve, according to airlines and others. Executives at the five largest domestic carriers last month pointed to various signs of business travel recovery, claiming that corporate clients are taking to the skies in greater numbers, companies are easing restrictions and travelers in some cases are booking closer to travel dates and increasingly selecting full fares.

UBS aviation analyst Kevin Crissey in a recent research note summed up the carriers' recovery rhetoric: "There is evidence of improving travel demand, including from corporations."

"First you've got to see traffic recovery, and ultimately traffic recovery is what puts the industry in a position to get yields to recover," United CFO and senior vice president Kathryn Mikells said during the carrier's third-quarter earnings call on Oct. 20. "We're clearly seeing signs of traffic recovery. We're not yet seeing what we'd like to see in terms of yield, but it puts us as an industry certainly in a better position to get there."

"Clearly, in the fourth quarter the declines compared to 2008 are a lot less than we saw in the first half of this year, but part of that was that the prices already started to decline in the fourth quarter of 2008. I do see things starting to stabilize," Advito vice president of business solutions Bob Brindley said. "Load factors are still high. Two things are happening: They've again cut capacity, which is allowing carriers to turn off the lower fares sooner. That's really the big impact of the big price declines we saw this year. It's not that published fares went down that much, but carriers were holding low-fare inventory for an unprecedented amount of time."

Still, airlines have a huge hole to dig out of when it comes to pricing. According to data released by the U.S. Department of Transportation's Bureau of Transportation Statistics late last month, average domestic airfares in the second quarter hit their lowest point for that period since 1998. The 13 percent drop from last year's second quarter was the largest year-to-year decline on record, DOT said. The second-largest was the 11.8 percent drop in the fourth quarter of 2001, following the 9/11 attacks.

Most airfare forecasts show pricing gaining further momentum in 2010. Advito forecasts North American economy class fares to rise 6 percent next year on regional trips and 3 percent on intercontinental routes, with business class fares up 3 percent regionally and 5 percent on international flights.

American Express predicts U.S. domestic and short-haul economy fares to increase 2 percent to 7 percent and international and U.S.-originating long-haul business fares to rise 3 percent to 8 percent in 2010 from 2009.

Egencia, meanwhile, projects average ticket prices to annually increase in nearly all top North American business travel markets in 2010, with some cities even expected to experience double-digit percentage-point hikes.

The National Business Travel Association, however, is the primary outlier, as it projects domestic airfares in 2010 to range from 2 percent lower to 3 percent higher than the 2009 average.

Brindley this month said, "The consensus has started to shift that we are going to see some mid-single-digit increases, especially in the North American market."

Though momentum is swinging upward, pricing power remains tenuous, and Brindley said some buyers are trying to capitalize on that uncertainty, noting a flurry of account activity.

"Even on the air side, we have a lot of clients—even if their deals are expiring in late 2010—looking at a window of opportunity to take advantage of the current market conditions that if the economy does stabilize, then it may be a much more difficult negotiating environment," Brindley said. "To take advantage of that opportunity, the client needs to show that they're driving premium share and marketshare to their preferred carriers, especially in a declining volume market, marketshare is even more important."