When the airline industry was deregulated in 1978, it gave rise to a new breed of upstart carriers such as People Express (LUV), Southwest Airlines, and AirTran Airways (AAI). All were able to offer low prices by employing nonunion workers while flying in and out of underused airports. After the 2001 terrorist attacks, traditional carriers including United (UAUA), Delta (DAL), and US Airways (LCC) toppled into bankruptcy, and several analysts predicted the discount carriers would send the dinosaur airlines into permanent retreat.
Instead, it's now the upstart airlines that have hit turbulence. The combination of soaring fuel prices, unforgiving credit markets, and a pullback in leisure travel has pushed carriers such as Frontier Airlines into Chapter 11 and prompted the liquidation of others, including Skybus Airlines, ATA Airlines, and Aloha Airlines. Even survivors AirTran, Spirit Airlines, and JetBlue (JBLU) are shedding routes to cut costs. They're also raising fares up closer to those of the major carriers. "For many, their sales pitch was just price, and that isn't much of an advantage for them anymore," says Ray Neidl, an airline analyst for Calyon Securities (USA).
Why the reversal of fortunes? Clearly, soaring fuel prices have taken their toll, forcing the discounters to raise fares roughly 5% over the past year just to cover costs. While the so-called legacy carriers including Delta Air Lines and Continental Airlines (CAL) have also been hammered by the oil spike, they tend to ferry a higher proportion of business travelers who are more willing to absorb the higher fares. By contrast, executives at the discounters—one of whom boasted that he had stolen customers not from the big airlines but from bus operators like Greyhound (FGP)—have seen demand fall as some of their most cost-conscious clientele head back to the bus.
But the discounters' challenges extend beyond the pump. The wave of bankruptcy filings by major carriers since 2002 has allowed them to narrow the cost advantage enjoyed by discounters. According to Calyon's Neidl, the difference in operating margins between the traditional airlines and the discounters has shrunk since 2004 from 7% to 2%. That has prompted the traditional carriers, who are sitting on larger cash hoards amassed after bankruptcy, to take the offensive against discounters. "For the first time in a while, we're willing to duke it out on routes that the [low-cost carriers] have owned," says an executive for one major airline. "In this cycle we have the better hand, and we're going to leverage it."
For their part, executives at several low-cost carriers remain sanguine about their prospects. For one, they say that the uniformity of their fleets—AirTran and Southwest fly variations of the Boeing (BA) 717 and 737—give them an edge in maintenance and pilot training costs over the mainline carriers, which still juggle a mishmash of aircraft accumulated over the decades. Their workforces also tend to be younger—and cheaper—than their larger brethren. But even the mighty Southwest, which has been insulated by shrewdly timed fuel hedges, admits it needs to boost its revenues up to 30% in the next few years to cover costs as its favorable contracts expire. The options: flying more, fees from booking hotels and rental cars on its Web site, and fare hikes. "I don't think anyone is immune in this environment," says Gary Kelly, chief executive of Dallas-based Southwest.
Even with oil prices easing, the recent wave of bankruptcies may make it tough to woo the investors needed to get the next generation of AirTrans and JetBlues off the tarmac. "If these conditions remain, you're not going to see many new upstarts," says Robert Fornaro, chief executive of Orlando-based AirTran Airways.
Given the quixotic allure of the airline industry, though, some entrepreneurs continue to try. After founding Skybus in 1999—and watching it fold earlier this year—John Weikle is trying to raise funds to launch a new carrier, Jet America. "An investment banker told me once, 'Plan an airline during a recession, fly during a recovery,' " says Weikle. That could be good news for customers. But airline investors may be slow to jump on board.
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Times are tough for discount carriers north of the border, too. Canada's Zoom Airlines suspended operations in late August, leaving passengers stranded around the world. In a CBC report, executives blamed the country's sagging economy and the "horrendous" increases in fuel prices. Halifax Airport officials got permission to seize one of the carrier's grounded planes, pledging to hang on to it until Zoom paid its bills.
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