Major U.S. airline capacity growth continued to moderate in September ahead of planned service reductions in the coming months and throughout 2006. With the price of jet fuel running at unsustainably high levels (see charts, page 8), some operators are concluding that a more cost-effective strategy simply is to ground certain aircraft rather than fly them.
For years, capacity cuts have been considered one of the more effective remedies for the floundering airline industry. Now that they are beginning to take hold, reductions are expected to help struggling carriers survive the leaner winter months by providing a degree of pricing power and stronger revenue performance. That does not bode well for some corporate buyers constrained by tight T&E budgets.
For business travelers, service reductions can be both beneficial and problematic. On one hand, they help to mitigate air traffic congestion and relieve operational delays. On the other, capacity cuts combined with still-strong travel demand translate to higher load factors and a less comfortable inflight experience. Moreover, service cutbacks can mean less convenient schedules for many business travelers.
"There are draconian changes that have to occur," said one airline executive.
Delta Air Lines, for example, during a recent two-week period cancelled lightly booked flights as part of an "emergency fuel conservation effort." After jet fuel supplies stabilized in the southeastern United States, the carrier resumed its full schedule. Cancellations generally impacted early morning and late evening flights on routes with multiple daily frequencies.
Before its reversal, Delta's decision caused concern throughout the corporate travel sector and exemplified the plight faced this winter by all airlines.
American Airlines this month suspended a total of 15 daily roundtrips on 14 routes from primary hubs in Chicago and Dallas/Fort Worth. At the end of the month, it also plans to discontinue nonstop service between Chicago and Nagoya, Japan, following recent international service suspensions announced by Northwest Airlines
(BTN, Oct. 3). American is reducing service to such rival hubs as Atlanta, Denver, Houston, Minneapolis, Newark and Washington Dulles, among other cities, but in most cases will continue operating several daily roundtrips. The airline said it would again evaluate its schedule at the end of the month.
Meanwhile, bankrupt Northwest again reduced its late-fall schedule and said fourth-quarter domestic mainline capacity would be down as much as 10 percent from last year. International capacity will be down as much as 5 percent. Systemwide mainline capacity in the first quarter of 2006 is expected to be cut by as much as 13 percent year over year. Northwest warned that mainline capacity gradually may be reduced by more than 15 percent.
"Routes that might have been commercially viable with oil at $40 per barrel are not profitable at $60 per barrel or higher," said CEO Doug Steenland.
Northwest has returned seven aircraft to lessors and identified 100 more that "are candidates for return" unless the company can secure lower lease rates.
Meanwhile, despite some airline assertions to the contrary, sources speculated that carriers may decide to further downsize secondary hubs. Delta, which previously deconstructed hub operations at DFW and recently announced significant reductions in Cincinnati as part of an overall move to eliminate 20 percent of its domestic capacity by 2007, could look to trim service through Salt Lake City. Northwest already has begun to cut regional flying. More of the same could endanger its Memphis hub.
J.P. Morgan Securities analyst Jamie Baker overall expects a 2 percent domestic capacity decline for next year, including a 6.6 percent reduction among the eight largest carriers and a shutdown of financially strapped Independence Air. "Put differently, mainline legacy operators are expected to remove more capacity next year than JetBlue will operate in total," Baker said. "Driving the charge towards less capacity are the recently bankrupt, though with jet kerosene topping $100 per barrel, we explicitly anticipate further declines in planned legacy capacity once [third-quarter earnings] reporting seasons begins."
On the most basic level, fewer seats in the market generally translates to upward pressure on airfares. "Given the significant exit of domestic seats next year, we anticipate the torrid pace of fare increases to slow as carriers shift their focus towards traditional revenue management," Baker said.
That once again could lead to fewer seats available in lower fare buckets and a wider gap between the lowest and highest prices on any given flight. "We are seeing fare discrepancies cause a lot of concern among corporate travel managers trying to deal with the airlines," said Barry Rogers, senior consultant with TCG Consulting in Chicago.
"The airlines may be concluding that they are better off pricing higher and getting a little less volume," added Scott Gillespie, CEO of Cleveland-based Travel Analytics, "but airlines will resist providing improved discount terms and many small-market buyers simply will be out of luck."
For larger-volume accounts, however, reduced capacity could become a negotiating item, especially if contract performance is hindered as an airline reduces its share of seats in a given market. "One of our customers is using a contract-loss report and having our agents note whenever their preferred carrier is sold out," said Keith Taylor, TQ3Navigant senior vice president of sales and account management. "At the time of contract renewal, that report will be discussed between the account and the account manager."
Though some airlines and travel managers negotiate automatic adjustments to contract hurdles when a supplier reduces service in a given market, most do not. "Carriers usually have a fixed market share that is baked into the contract, and if there is a significant change in service by that carrier, it is incumbent upon the corporation to go back to the carrier and get that adjusted," said Dale Eastlund, regional manager for Carlson Wagonlit Travel's Solutions group.
He also cited off-peak capacity reductions in a corporation's key markets, which presses travelers to find seats on busier peak-hour flights. "You end up getting forced into higher prices, because there is less inventory available at lower fares," Eastlund explained. "It does become a discussion point, and for those carriers with which you can negotiate, it becomes a good time to negotiate guaranteed fares and put a cap on what you will spend in the market."
Many corporate buyers have said that they expect and are willing to pay a little more than would individual leisure travelers for slightly superior airline service, including ticket flexibility and a wider array of flights from which to choose. As airlines cut routes and reduce frequencies, however, the convenience for their travelers is jeopardized, leaving some buyers wondering why they should pay more.
Thinner schedules minimize flexibility, forcing travelers to choose from fewer flight options, and, in some cases, rely on connecting service where nonstop flights once were available.
As seats come out of the system while demand stays strong, load factors are unlikely to decrease, prompting more inflight frustrations. On the rise for the better part of the decade
(BTNonline, Sept. 22), load factors last month again were higher at every major U.S. carrier except America West.
Driving this trend, some airlines are replacing larger aircraft with regional jets on many routes. "One example is American, which is using more regional jets to service more markets, including Northeast shuttle markets," said Nick Vournakis, director of air solutions in North America for CWT. "There is an abundance of travel managers who consistently provide feedback that when the competition is using a mainline jet and you are using a regional jet, they prefer mainline service. American has had to deal with that feedback."
Considering smaller planes, less low-fare inventory, fewer frequencies and some service suspensions, travelers need to work harder when planning their trips, according to TQ3Navigant's Taylor. "Many are spending more time on the road in certain situations because they are pulling trips together to consolidate their travel," he said.
Travelers also need to be more conscious of their standby options when changing their itineraries, since fewer seats would be available on many flights. Some airlines recently altered their standby policies
(see story, page 10).
The news is not all bad. In fact, domestic system ontime performance in September improved to 84 percent—a 7 percent month-over-month change—while the average delay was 11 percent shorter, according to recent data compiled by Portland, Ore.-based FlightStats. "The end of the summer travel season, the reduction of flights to offset high fuel costs and reductions due to bankruptcy reorganizations appear to have relieved congestion throughout the system," FlightStats said, noting a 15 percent month-over-month reduction in total scheduled flights.
In particular, Delta from August to September reduced flight operations 20 percent, improved ontime performance 13 percent and reduced average delays 28 percent to 41 minutes, FlightStats reported. Similarly, Northwest trimmed operations by 18 percent, improved ontime performance 7 percent and cut its average delay 9 percent to 49 minutes.