Discount airlines fly high on low costs
In a business in which everyone sells the same thing, the low-cost producer usually comes out on top. It took 25 years, but that is exactly what has happened in the airline business. The discount carriers have won the war. The insurgents have taken the capital.
The discounters demonstrated their newfound clout last week when Southwest Airlines initiated a round of fare cuts, a role typically played by the major carriers.
''The low-cost guys are the price leaders now," said Robert Mann, an airline consultant in Port Washington, N.Y.
The established airlines had to match the reduced fares, no easy job for companies with significantly higher expenses. United, Delta, and US Airways are all in talks with their unions for the umpteenth time, asking for still more wage and benefit concessions.
Management's message to the workers is blunt: Either we find a way to get our costs in line with the discounters or we throw in the towel.
Give the major airlines credit: They managed to hold off the challengers for an awfully long time. They used their muscle at big airports to deny gates to the upstarts. They employed frequent-flier programs to build brand loyalty. And they kept a stranglehold on the business traveler, the guy who would pay $2,300 to fly roundtrip from Boston to Los Angeles.
''Business travelers were ticked off by the pricing," Mann said, ''but aside from bluster, what could they do? They didn't have real options."
Over time, however, options emerged. The discounters kept getting bigger. In 1993 they flew 8.4 percent of the nation's passengers. By 2003 their market share was up to 21.7 percent. More important, they expanded the number of cities they served.
United's experience is instructive. In 1990, 13 percent of United's passengers could choose a low-cost competitor, according to a report prepared by Daniel Kasper, a Cambridge consultant. Last year more than 72 percent of United passengers had a low-cost option, even if they sometimes had to travel to smaller airports in Manchester, N.H., or Long Beach, Calif., to get bargain fares.
At some point -- it is hard to say exactly when -- the industry reached a tipping point. Business travelers found they too could use the discounters, which meant the majors could no longer charge outrageous prices. The loss of pricing power dealt a huge blow to the established carriers. Their higher costs, always a burden, became a weight that threatened to sink them.
United has been on a cost diet. Its employees have already agreed to $2.5 billion in wage and benefit cuts. But it isn't enough.
''We need to dig deeper on costs," a company executive told employees last week. According to Kasper's report, United's operating cost per mile was just over a dime in the first quarter. The comparable number for Southwest was 7.8 cents; for JetBlue, 6.08 cents.
Part of the cost gap is a function of productivity. Southwest's pilots fly about 75 hours a month compared to about 50 hours for pilots at the old-line carriers. Because it doesn't operate a complicated hub-and-spoke system, Southwest can keep its planes in the air for more hours and operate with fewer employees than its establishment rivals.
Paychecks explain the rest of the gap. Nearly all the older carriers provide traditional pension plans and retiree health benefits. The discounters offer neither. In the days when competition was gentler, the airlines could afford those generous benefits, much the way the steel and auto companies could. In today's harsher climate, generosity is a competitive disadvantage. The betting is the airlines will trim their pensions or in a worst-case scenario, dump the obligations on the government in bankruptcy proceedings.
The slow-motion triumph of the discounters is not a unique story. Wal-Mart got its start in 1962. It took decades for the company to build the critical mass necessary to vanquish its rivals. Like the discounters, Wal-Mart found a way to deliver the goods to a mass audience at a lower price. As Kasper put it, ''At the end of the day, low costs prevail."
Charles Stein is a Globe columnist. He can be reached at stein@globe.com.
