The U.S. commercial aviation sector seems to always tread water. Years in the red recently outnumber profitable ones as the industry careens from one crisis to the next. Preferring a stable supply chain to the perpetual mess that is the airline industry, corporate buyers often are hard-pressed to find incremental savings opportunities when negotiating with carriers, especially when their organizations' business travel volumes are down sharply.
A tumultuous decade that began with a general market downturn exacerbated by the blindsiding events of 9/11 and continued with sky-high fuel prices that killed off some competitors and laid low all others is ending with what many airline executives describe as an unprecedented drop in demand. Slumping business travel precipitated by the latest global economic meltdown has been a primary culprit.
Because they must, airlines have adapted. They've pared schedules, abandoned routes, grounded aircraft, cut their workforces, sought out merger partners and tight-knit partnerships, unbundled pricing to boost revenue and brought more rigor and discipline to corporate contracting. To some degree, these efforts have succeeded, at least in keeping most competitors afloat and minimizing red ink. The result is a shrunken industry certain to downsize further in the coming months.
New episodes of terrorism, pandemic and jet fuel spikes, should they occur, would push more airlines to the brink. Even without any new external shocks, cash reserves are dwindling. Absent an influx in capital, fresh bankruptcy filings for some carriers are not out of the question. More big mergers--following Delta Air Lines' acquisition of Northwest Airlines last October-also may be on the horizon.
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In addition to cutting capacity and enacting a slew of other cost-saving measures, airlines have been both aggressively discounting fares to stimulate leisure traffic and picking their spots to push through price hikes. "Following a first quarter that saw no fare increase attempts, in the second quarter we saw several successful fare increases," said Thomas Horton, CFO of American Airlines parent AMR Corp. "However, it remains to be seen whether this trend will continue as we progress through the year."
What is clear is that airline efforts to drive ancillary revenues through fees on checked baggage, preferred seating and other services and product attributes will intensify. While incremental revenue can help carriers survive challenging economic conditions, a July Procurement.travelpoll found that added fees and surcharges topped the list of buyer challenges for managed airline programs.
Nevertheless, airline executives said fees have not impacted customer demand, which is tied instead to macroeconomic conditions and, at least on the leisure side, fare sales. In July, the execs continued to suggest that demand trends were showing signs of stabilizing. In other words, the situation was still bad but not worsening.
"We've seen some stability for roughly 90 days--May, June, July," Southwest Airlines CEO Gary Kelly said in July, "but the issue is business travel. "There is no reason to believe, based on history, that business travel will pick up sharply anytime soon," Kelly continued. "It certainly didn't in '91, and didn't in 2001. This recession seems to be much deeper and could be much more prolonged. The job picture is bearish. We're prudently planning a very cautious outlook." He noted that Southwest's short-haul, high-frequency, business-oriented markets "are off in alarming numbers."
Continental Airlines' numbers also seemed to suggest that the business travel decline had leveled. Year over year, business revenue in June dropped 35 percent, versus 38 percent drops in both April and May, while business passenger count in June retreated 27 percent, compared with 36 percent in April and 34 percent in May.
But such mild improvement from severely depressed levels won't be enough to pull the industry out of its latest tailspin. "Our success is highly correlated with the return of business travel, and we haven't seen signs of that yet," said incoming Continental CEO Jeff Smisek. "We have seen stabilization in business demand and have seen a bit of an uptick, but it is very early to try to call that fact a trend," added Delta Air Lines CEO Richard Anderson. "We do not see any meaningful recovery in 2009."
AMR CEO Gerard Arpey attempted to strike a less pessimistic tone. "At a certain point, corporations recognize that people were actually traveling not for pleasure; they were traveling for a business purpose, and it takes a while for the consequence of that business purpose to manifest itself. When companies realize, 'Well, our folks weren't out there goofing off; they were actually out there traveling to generate business for our company,' they tend to restore travel levels to previous points," he said. "Whether or not this cycle will be similar in the past, I don't know, but that's been my experience."
For all their problems, airlines have achieved improvement in some areas, becoming more fuel efficient and punctual. Though such improvement can be attributed to the significant drop in passenger volumes and flights operated, it nonetheless has made life a little less stressful for those still taking to the skies. For example, airlines in the 12 months through May 2009 operated more than 78 percent of their flights on time (within 15 minutes of schedule), a five percentage point improvement over the previous 12 months, according to the U.S. Department of Transportation. Also in May, airlines as a group achieved noticeably lower ratios of mishandled baggage and drew fewer complaints per passenger, compared with May 2008.
In general, customer service issues experienced by travelers and account management issues experienced by corporate buyers were among the least cited challenges to managed travel programs, according to Procurement.travelresearch.
Buyer-Supplier Relationships
But for some travel management and procurement professionals, questions seem to outnumber answers. How can an organization confidently work with a supplier that may be heading toward insolvency (perhaps not for the first time in recent memory); that may cut the flights preferred by its travelers or end all service to the cities to where it must travel; and/or that no longer offers the favorable contract terms it once did? How far should buyers push a spot-buying strategy over biases for preferred carriers? Are global alliance rosters finally settled and capable of providing value above and beyond individual deals?
Because they must, organizations of all kinds stomach the turmoil that plagues their airline suppliers and attempt to answer those questions as best they can, based on their own circumstances. Though lessened in the past 12 months, business travel for many remains mission critical. And despite a chaotic few years, many things have not changed much, if at all.
For example, market share among the major airlines has moved little, at least on an aggregate level. In terms of purchasing habits, eight in 10 corporate buyers said as much or more of their organizations' airfares thus far in 2009 have been covered by negotiated agreements with preferred carriers, as compared with a year earlier, according to Procurement.travelresearch. Moreover, many survey respondents who issue requests for proposals to airlines said the process had not changed much in recent years.
But others have seen changes--positive and negative--stemming both from altered airline tactics and internal influences. On the latter, respondents noted greater involvement by their organizations' finance departments, an effort to consolidate to fewer suppliers, challenges in enforcing compliance to preferred carrier policies and program expansion as businesses globalize--prompting negotiations with airline alliances rather than just individual carriers, or contracts with a global rather regional scope.
Regarding airlines' contracting terms and techniques, buyers generally have faced tougher conditions this year, according to the research. When asked about recent changes to their airline negotiations, some respondents pointed to lower discounts provided and increased market share demanded by carriers. Capacity cuts and schedule adjustments, meanwhile, can add much complexity. "Dynamics of airline contracts must change," according to one survey respondent. "Share goals must be fluid, based on QSI [quality of service index, which measures an airline's share of seats in a market, weighted by several variables] and the constant pull down of schedules from the airlines."
What Next?
As buyers and suppliers attempt to maintain meaningful relationships, the state of the airline industry is likely to deteriorate further during the remainder of 2009 and into early next year. That could prompt fresh Chapter 11 filings and precipitate industry consolidation. It almost certainly will mean additional and sizable capacity reductions that could further strain an organization's ability to retain a steady stable of preferred suppliers. Some major carriers already announced more cuts beginning this month.
"I see no evidence that we would want to restore any of the capacity cuts we've made last year and the ones that we've announced this year," said AMR's Arpey. "If anything, we continue to look at capacity in the other light, in terms of whether we have done enough given the economic climate."
Moreover, airlines like Southwest and JetBlue, which previously grew operations to capitalize when major network carriers retrenched, themselves are scaling back.
For 2010, JP Morgan Securities analysts in July wrote that "the pace of incremental capacity declines will in fact wane, as managements instead eye the survival prospects of the industry's weaker players." Nevertheless, JP Morgan estimated industry capacity in 2010 would be down about 7 percent from 2009's already depressed levels.
"We believe there's a reasonable possibility that US Airways and/or United may be forced into Chapter 11 or some sort of prepackaged shotgun marriage with each other," according to the JP Morgan report. "One thing is certain, in our minds: The size and shape of the industry may radically change over six to 12 months, with leaner winter months witnessing the greatest potential upheaval."
Speaking on a July webinar sponsored by Orbitz for Business, UBS Investment Research senior airline analyst Kevin Crissey said the revenue environment "now is every bit as bad as it was after 9/11" and "could get a little bit worse before it gets any better."
For that reason, Crissey told corporate buyers that "now is about as good as you are going to get," as far as striking deals with carriers. "If things stay terrible, you will see the potential for bankruptcy filings or liquidations. That would take seats out and potentially raise prices."
Also speaking on the webinar, TRX Travel Analytics vice president Dan Pirnat said "savings opportunities still exist, but generating savings undoubtedly will become increasingly difficult," especially for the "large corporations that have historically been aggressive in sourcing and optimizing airline programs. This decreasing overlap among major competitors certainly is not favorable for buying power if you are a corporate travel buyer."