Carriers Slash U.S. Capacity

Domestic airline industry downsizing continued in recent weeks as several carriers announced steep capacity withdrawals, employee reductions and fleet retirements to cope with unrelenting fuel costs. Industry analysts said further reductions are likely—as are higher fares, more crowded planes and reduced schedules.

United Airlines this month said it would reduce mainline domestic capacity by 14.5 percent in the fourth quarter and 18 percent in 2009. Continental in September plans to initiate its latest round of capacity reductions after the peak summer travel season, expecting fourth-quarter mainline domestic departures to be down 16 percent from the same period last year, with domestic seat miles reduced by 11.4 percent from that time. American Airlines last month said it also plans a drastic fourth-quarter mainline domestic capacity slash of up to 12 percent.

"The airline industry is in a crisis," Continental CEO Larry Kellner and president Jeff Smisek told employees in a memo this month. "Its business model doesn't work with the current price of fuel and the existing level of capacity in the marketplace. We need to make changes in response."

Calling fuel expenses a "$3 billion challenge to overcome," United said the capacity reductions "will offset that challenge by 2009, assuming the industry as a whole takes similar actions." Kellner and Smisek spelled out the industry logic: higher fuel means higher fares, higher fares mean fewer passengers, and fewer passengers means fewer seats.

"We certainly are in an era of very high load factors already and when you start taking those large chunks of capacity out the system, load factors go higher," said Management Alternatives corporate travel consultant John Heilner. "That means more hassles at the airport, less room on board and the ability for airlines to control pricing better."

Mike Boyd, who heads the Boyd Group aviation consultancy, said, "At $125 a barrel of oil, we don't have a system that can meet the demand and make a profit, so we have to thin it out. Instead of nine flights, you'll have eight in a market—that sort of thing. I think we'll see more of that. We have to, only because we can't carry as many people as we used to at the fares we used to have. Fares have to go up."

The other legacy carriers have noted possible domestic capacity cuts beyond the reductions they already announced in 2008. Delta in the second half of the year is targeting capacity cuts of up to 10 percent, US Airways aims for mainline capacity to go down by 4 percent in the second half of the year, while Northwest plans to shed 8.5 percent domestically for the full year.

Boyd said the capacity cuts are more a matter of "thinning out the route system—not wholesale cuts like some people are saying." Though Boyd said the capacity reductions are "going to be significant," he noted, "it's not going to be a severe hit on the flying public, other than fares are going to edge up, but they're going to do that anyway."

Continental and United at press time had yet to detail the schedule changes that will facilitate the capacity forecasts. American late last month said it would discontinue Chicago-Buenos Aires service in September, Chicago-Honolulu service next January and Boston-San Diego service in September. The carrier said it would "assess the location- and route-specific impacts of those changes." United said changes would include "modest reductions of underperforming markets" and "frequency reductions while retaining a commitment to all five U.S.hubs."

Aviation consulting firm R.W. Mann & Co. president Robert Mann said airlines are pulling back available seat miles, while trying "to preserve the hub structure," though there will be smaller markets where carriers exit completely.

"There are some limitations to how much you can do," said Mann. "You notice United's number is 17 or 18 percent by the end of 2009, and buried in that press release is a 10 or 11 percent increase in their express flying, which means they're trying to maintain the network connectivity in some of these markets where they pull out 737s. That's really a limiting factor—in the old days you just pull out a 737 or a DC-9 and plop in a 50-seat jet. When fuel was 90 cents a gallon that was no big deal. You can't do that anymore. They're uneconomic."

Some aviation analysts, including JP Morgan Chase's Jamie Baker and Calyon Securities' Ray Neidl, said a 20 percent reduction in capacity would be necessary to yield profits for the domestic industry this year.

"There's kind of a 20/20 objective: Cut capacity by 20 percent so prices can be raised by 20 percent," Mann said. "Although we're not talking perfect unit elasticity, those are probably pretty round numbers that are on the order of necessity." Instead of 20 percent, Mann is estimating an aggregate 9 percent reduction in overall domestic capacity in the fourth quarter,"net of backfill" from carriers picking up cut services.

"When you go into 2009, that's when you see full-year impact and also some additional trimming," he said. "There may be people who take United's message to heart and introduce their own second-level cuts. You may see other carriers come along."

While some carriers, such as Southwest Airlines, have grown through past down cycles by filling the vacuum left by legacy airlines, Boyd said that likely won't happen this time.

"All the academics say, 'This is going to leave big opportunities for the low-cost carriers.' No, it's not. They're bleeding too—and American going from nine flights to eight from Denver to Chicago doesn't do squat to open up an opportunity."

Southwest continues to expand, though the carrier scaled back capacity growth this year from 8 percent to 6 percent, with further slowing possible, the carrier said during its first-quarter earnings call. "I wouldn't say it's beyond a stretch of the imagination to say that if slots become available at airports like LaGuardia, they would be buyers," Mann said.

American, Continental and United are making sweeping changes to fleets and reducing employee headcount as their operations shrink. Continental said it is removing the least-efficient aircraft from its network, retiring the Boeing 737-300 and 737-500 fleets. In addition to six of those aircraft already removed this year, Continental plans to take out 37 more by the end of the year and another 30 next year. Taking delivery of 16 new—and more fuel-efficient—versions of those aircraft, Continental said it would end 2008 with a total fleet of 354 aircraft.

United plans to jettison its "oldest and least fuel-efficient jets," removing an additional 70 aircraft from its mainline fleet on top of the 30 previously announced. By the end of 2009, United will retire its 94-plane Boeing 737 fleet and six Boeing 747s. The carrier also said it would kill its carrier-within-a-carrier product, Ted, folding those 56 Airbus A320s into mainline operations and installing first class cabins on those planes beginning next year. American said it plans to retire up to 45 mainline aircraft, mostly MD-80s and "some Airbus A300 aircraft," in addition to up to 40 regional jets and turboprops from regional affiliate American Eagle.

Continental's capacity reductions mean 3,000 fewer jobs, "including management positions," this year. Continental said it would embark on "voluntary and involuntary separations, with the majority expected to be through voluntary programs." Continental said it soon would release further details. United's reductions also extend beyond aircraft. The carrier expects to reduce "salaried and management employees and contractors" by up to 1,600 people, which includes 500 previously announced job cuts. "The company will determine the number of front-line employee furloughs as it finalizes the schedule over the next month," United said.

American said its reductions in capacity would result in job losses, though the carrier at press time was "assessing the scope and location-specific impact of any workforce reductions resulting from the capacity reductions."

jboehmer@btnonline.com