Airline Industry Sees Pain Extending Beyond the Recession

By SUSAN CAREY The recession may have bottomed out, but big U.S. airlines worry that things will never return to the way they were. They may be correct. The industry has yet to recover from an across-the-board revenue drop that followed the 2001 terrorist attacks. If thrifty consumers and cost-cutting businesses are this recession's legacies, airlines will be forced to shrink even more. Growing smaller means parking planes, laying off workers and dropping destinations, meaning potential customers have fewer reasons to book. Earlier this month, Delta Air Lines Inc. cited a gloomy revenue outlook for the rest of the year in its plans to cut more management jobs. If passengers don't return to the skies and fares don't rise, some airlines could run low on cash, raising the specter of additional bankruptcies. Airlines are suffering huge revenue declines as customers put off purchases, trade down to cheaper fares and bank more personal income. Airlines fear that this behavior will stick, exacerbating the "new normal" the industry has been grappling with for the past eight years. For decades, U.S. airlines could rely on a remarkably stable relationship between their revenue and gross domestic product. Year after year, domestic revenue came in at 0.73% of GDP on average, and total passenger revenue was equal to 0.95% of GDP. That ended after Sept. 11, as travelers stayed home because of the jitters or were put off by new airport-security measures. For the year ended March 31, domestic revenue was 0.54% of GDP, while total passenger revenue was 0.76% of GDP. "It's not terrorism this time," said David Swierenga, an aviation economist. "It's a sea change in demand." Scott Kirby, president of US Airways Group Inc., said the rapid growth of discount airlines is the main culprit behind what he calls "a long-term secular decline" in the revenue-to-GDP relationship. Since Sept. 11, low-cost airlines have grown rapidly, putting downward pressure on fares, while travelers increasingly shop for the cheapest tickets on the Internet. The Transportation Department estimates that budget airlines now account for 40% of the domestic market, up from 22% in 2001. While lower fares stimulate demand, Mr. Kirby said, airlines still wind up losing revenue overall. As the larger carriers struggled after Sept. 11, low-fare king Southwest Airlines Co. continued to expand, and upstarts such as JetBlue Airways Corp. and AirTran Holdings Inc. unleashed big flocks of new planes. Searching for greener pastures, the larger airlines added many seats on big-margin international routes. It took a sudden run-up in fuel prices last year to force the industry to reverse course and begin cutting seats and deferring new planes to address the imbalance between supply and demand. But then came the crushing recession, which hit premium cabins on international routes the hardest. Now airlines are reducing capacity on those routes as well, and putting seats on sale. If the revenue-to-GDP ratio had stayed where it was pre-2001, the airlines would have raked in an additional $27 billion in revenue in the year ended in March, according to the Massachusetts Institute of Technology Airline Data Project. Trying to plug that gap, carriers are cutting costs and adding fees. While this "ancillary" revenue amounts to several billion dollars a year, it isn't nearly enough. "What has become clear is there is not enough demand to satisfy the current level of supply at price levels that can sustain profit for the industry as a whole," said Darin Lee, an aviation expert at LECG LLC. Discretionary leisure trips are one focus of the new frugality, forcing airlines to counter with deep, extended fare sales to try to stimulate demand. The picture is bleaker among business travelers, who traditionally produce more revenue. Their employers are cutting travel budgets and embracing videoconferencing. Continental Airlines Inc. said the number of its "high yield" customers -- who book costlier refundable tickets closer to their trips or have their travel arranged through corporate accounts -- fell by more than one-third in February through May versus a year earlier and was down 27% in June. Continental President Jeff Smisek, speaking last month after announcing a second-quarter loss, said that when it comes to revenue, "we do think we have hit the bottom. But we don't know how long we will bounce along the bottom and what the rate of decline will be." American Airlines parent AMR Corp. said it saw business travel decline more in the second quarter than its traffic overall or its unit revenue. After announcing second-quarter red ink, Chairman and CEO Gerard Arpey said he has lived through several down cycles but isn't optimistic about a quick recovery this time: "Whether or not this cycle will be similar [to] the past, I don't know." Write to Susan Carey at susan.carey@wsj.com