For more than a year now, the airline industry has been waiting for the lucrative business travel market to rebound, telling investors that its well-heeled clientele will return when corporate profits do. In the meantime, the major airlines are losing money fast, handcuffed to a fare structure that uses high-priced business fares to subsidize deeply discounted leisure tickets. Such discounting has been a double-edged sword, boosting demand yet encouraging everyone, including business travelers, to book last-minute Internet deals. "With the economy in the state that it's in, it's very difficult to justify a last-minute, $2,000 cross-country business trip," says Con Hitchcock, industry veteran and chairman of Orbitz's consumer advisory board. "Airlines need to find a way to save money. So everyone will be taking olives out of the green salad." Instead of waiting around for a savior that may be flying coach, American Airlines' announcement that it will slash jobs and reduce capacity shows a renewed focus on costs instead of fare prices. On Tuesday morning, AMR ( AMR), parent of American, the largest U.S. carrier, announced that it would cut 6% of its workforce, or 7,000 employees, to help cope with the loss of business travelers. In addition to the labor cuts, over the next two months AMR will reduce capacity by 9% from this summer's levels, retire 74 Fokker 100 jets and nine TWA 767-300 aircraft, and defer 35 aircraft deliveries this year. "We grasped the need for fundamental change in the airline industry some time ago and have undertaken both long-term structural change and measures responsive to current industry conditions," said CEO Donald Carty in a statement. "This latest round of initiatives is yet another step toward more solidly positioning American for success in the long term." Including cost-cutting efforts already under way, American said it will save $1.1 billion annually, without factoring in capacity reductions. Over the first six months of 2002, American racked up $1 billion in losses, and it isn't expected to turn a profit until 2004 at the earliest. "What we see here is that a carrier has a different strategy which provides the same capacity but with fewer people and fewer airplanes," says David Swierenga, economist with the Air Transport Association, an industry trade group.
The renewed focus on cost-cutting comes just days after American was burned in a fare war with Northwest Airlines ( NWAC). But unlike previous attempts, where airlines reduced margins on leisure travel, American sacrificed the golden calf: business travel. The Wall Street Journal reported in early August that American had made a stealthy grab for a bigger share of the lucrative business travel market by slashing select last-minute, full-price business fares by 10%. The move was especially sneaky because American didn't publish the lower fares in its computer system, a move that would tip off rivals. Instead, American offered the cut-rate fares through select travel agents. "In general, the strategy is to try to give incentives to travel agents to generate new business," explains Swierenga, "and that is really the motivation for all kinds of airfare discounting. Right now, what we really need the travel agencies to do is find new customers for us. We don't need them to write tickets for someone who is in the store." (American declined to comment on its pricing initiatives.) The move drew the ire of Northwest, which retaliated on Aug. 2, but instead of matching lower fares through its agents, Northwest took the fight public and published the fares through its computer system. American, which says Northwest initiated the fare wars by going public, then placed discounted business fares on its computer system. Over the past two weeks, the pair played high-stakes poker, calling bluffs and upping the ante on discounting until someone folded. On the first Sunday in August, Northwest reduced fares by 20% after learning that American was offering double discounts -- 10% through agents and 10% through its system. Other airlines, such as Delta ( DAL), UAL's ( UAL) United and Continental ( CAL), followed suit. The discounting reached its nadir this weekend, when Northwest announced discounts of 41% on select business fares. In a weekly note to employees, AMR CEO Don Carty called the fare war "true madness," and just as quickly as it began, the fare war ended. On Saturday, Northwest restored its business fare structure to pre-Aug. 1 levels, with a 5% to 10% discount for those travelers booking through the airline or a select agent -- matching AMR's original deal -- and taking discounts private again.
Black Eyes for Everyone
While American's renewed focus on cost-cutting and retreat from business-travel discounting show a new willingness to bite the bullet, the airline industry will continue to suffer. Carriers have failed at least four times to raise domestic leisure fares, which are now down 9.8% from year-ago levels and off 13.7% from 2000, according to the Air Transportation Association. Furthermore, traffic is down significantly. In the month of July, U.S. Airways ( U), which just filed for bankruptcy , reported that traffic was off 17.6% year over year, while United, which many suspect will soon file for bankruptcy , was off 12.3%. For the month of August, the OAG, an international fare tracker, reported that the number of domestic flights is down 7%, according to published schedules. The problem will get even worse because traffic traditionally slumps after Labor Day, which is one reason why carriers will move now to control costs. And because carriers have already discounted fall fares, deeper discounts are all that's left to prop up demand -- at the expense of heavier losses. "In the airline business, you need to make money in the second and third quarters or it's going to be a long, cold winter," says Hitchcock. "The airlines lost a lot of money this summer. And that's not a good sign for the next six months."