Knowledge@Wharton Strategic Management Research Article

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Wharton professor Serguei Netessine's trip from Philadelphia to Dallas in May was an all-too-typical day in the sky.

After circling Dallas for an hour because of stormy weather, his flight was diverted to San Antonio where he spent several hours on the runway waiting for the storms in Dallas to clear and eating a bag of peanuts for lunch. He arrived in Dallas five hours late and missed most of his scheduled meetings, rescheduled his appointments for later in the day and succeeded in booking -- actually overbooking, as it turned out -- what he thought would be an evening flight back to Philadelphia. He had no choice but to fly home the next day after paying $400 for the only room available at the airport Park Hyatt.

Netessine is one of the thousands of airline passengers this summer who have been stranded on runways or sleeping in airports as a result of cancellations, chronic delays, maintenance problems and overbooking. While airline service is no longer the white-glove experience it once was, it has now gone beyond bad food and snappish flight attendants. Today, when passengers board an airplane, they might well question whether there is a reasonable chance they will make it to their destination in the next few days.

"Previously, airlines worried about dissatisfied customers. Now I don't think they worry about it because the customer service at all airlines is so horrible," says Netessine, a professor of operations and information management.

Airline consumer advocates contend delays are now a routine part of air travel. For the first five months of this year, the major airlines' on-time arrival rate was 73.5%, the lowest for that period in the past seven years, according to the U.S. Department of Transportation's Bureau of Travel Statistics. Complaints about airline service were up 49% from May 2006. As if that weren't troubling enough, airline consumer advocates have testified before Congress that DOT figures do not even measure the true extent of the problems.

The reasons behind the sharp decline in airline service are many. Chief among them is a reduction in airline capacity following years in which the industry hemorrhaged money and major carriers wound up in bankruptcy court because their costs were out of line with revenue. Now, with the supply of airline seats decreasing and demand rising, there are not enough seats to go around, particularly when weather or other problems disrupt schedules.

Wharton management professor Peter Cappelli crafted his own strategy to get around the current service woes on a trip to Birmingham, Alabama. So many of his prior flights had been cancelled that he booked a back-up flight on another carrier -- just in case. Indeed, when he arrived at the gate, he was told the original flight was cancelled because a crew was not available. He went home, got up early the next morning and caught the back-up flight. When he tried to get a refund for the original flight, he was told it eventually found a crew and took off a few hours later. He would not be getting a refund.

"The airlines lose money whenever they have excess capacity because they cut fares to fill planes, but then everyone cuts fares and they all bleed," Cappelli says. "The only time they make money is when demand is rising faster than capacity, which is what is happening now. The carriers are loath to add capacity at the moment despite the fact that demand is increasing. So the planes are jammed and there is no back-up capacity when there are problems."

Symphony or Cacophony?

From a business perspective, reducing capacity is exactly what the airlines should be doing, says Wharton transportation professor W. Bruce Allen.

Flights this summer are booked at historic high levels of nearly 90%. Before the industry was deregulated in 1978, flights typically ran 55% full. "If something happened back then, the airline could easily put you on the next flight because that flight was only half-full, too." He points out that an airline seat is not like canned soup or any other tangible product that can be shelved and sold later if demand is slow. As a result, airlines have honed operations to squeeze the most cash out of every seat they fly, including overbooking to make sure each seat has at least one customer. If airline operations "are running full-cylinder, then it's the most beautiful symphony you've ever heard," Allen notes. "The problem is it's scheduled so tightly that the minute something does go wrong -- wow!"

At the same time that capacity is down, demand has increased. "People have started to believe airline travel is safe again. We've not had any serious terrorism event for a little while, so demand is up," says Netessine, adding that weather is another factor. While bad weather has always been a problem for air travel, advances in weather tracking technology in the past two to three years may be causing airlines to cancel or delay flights in advance more often. "Previously, we would probably be flying in this kind of weather. This is potentially saving lives, but it may lead to preemptive flight cancellations."

According to Netessine, the current level of overbooking comes down to a simple economic trade-off. On one hand, the airline risks flying with an empty seat; that seat comes with a greater cost as fuel prices rise. The other side of the tradeoff is the cost of bumping a passenger. Current law requires airlines to pay passengers $200 if they are bumped but rebooked on another flight within two hours. If the delay extends beyond that period, the passenger gets $400. Department of Transportation officials are now considering several proposals to increase the bumping penalty. Under one proposal, payments could triple.

Built-in Delays

Todd Sinai, a Wharton real estate professor who has studied airlines, says the industry's current problems stem, in part, from the evolution of the current hub-and-spoke strategy. In this type of system, airlines collect large numbers of passengers and baggage into a single airport at once, collate them and send them off on connecting flights.

"What we're experiencing this summer is a reflection of a structural feature of how air travel works in the United States. It is all predicated on driving traffic to and from key airports and doing it at a particular time," says Sinai. "That makes the system very sensitive to hiccups."

Some delays, he notes, are even built into the schedule, so passengers may sit on the runway for 45 minutes -- or more -- waiting for their plane to take off and still arrive at the scheduled time. While that may be frustrating for the passengers, it is not, technically, a delay. "There's really not a lot that can be done," Sinai concludes. "You can increase airport capacity, which at least in the short run might help, but you can immediately expect airlines to add flights and bring it back to the point where the system is at capacity again."

He suggests a better solution is to operate fewer flights with bigger planes at lower frequency and eliminate low-demand destinations although, he concedes, "It's not clear that's actually better than the current situation."

Even if airlines wanted to add capacity, there are constraints. Netessine points out that current aviation rules prohibit planes from taking off before the flight ahead of them is 20 miles away. He says some airline experts have suggested the distance could be safely reduced, allowing carriers to add more flights.

Meanwhile, the nation's air traffic control system, designed in the 1970s, needs to be upgraded to accommodate more flights, but the cost would be enormous. Netessine says airlines -- many of them just emerging from bankruptcy protection -- would find it hard to lay out money to fund an upgrade of the system estimated to cost $40 billion.

Congress is considering legislation that would create a $25 user fee paid by both airlines and private jet aircraft that would replace the current system of fuel, ticket and departure taxes that goes into the Airport and Airway Trust Fund. The current payment system is set to expire on September 30. Commercial air carriers support the user fee because they contend the current system results in their passengers subsidizing the operation of corporate jets.

Another source of airline passenger angst is airport security, according to John Clifford, president of International Travel Management, a corporate travel consultant in San Diego. "Service is worse than ever and trending downward with few exceptions," says Clifford. "The world has changed since 9/11. It's a sad fact that part of the challenge in today's environment is dealing with international and domestic security issues."

Whatever the reason for their suffering, passengers have little recourse beyond bumping fees.

"Contrary to popular belief, airlines are not required to compensate passengers whose flights are delayed or canceled," according to Fly-Rights: A Consumer Guide to Air Travel, published by the U.S. Department of Transportation. "If the purpose of your trip is to close a potentially lucrative business deal, to give a speech or lecture, to attend a family function, or to be present at any time-sensitive event, you might want to allow a little extra leeway and take an earlier flight. In other words, airline delays and cancellations aren't unusual, and defensive counter-planning is a good idea when time is your most important consideration."

Various proposals to incorporate an Airline Passenger's Bill of Rights into legislation reauthorizing the Federal Aviation Administration, which oversees U.S. air travel, have made it through Senate and House subcommittees this summer. The proposals would require airlines to file a plan on how to cope with passengers stranded on the tarmac. Legislation had been proposed that would have required airlines to free passengers stranded on the runway within three hours. That provision did not make it out of committee, but could be added preceding a final vote on reauthorization that will take place before the current law expires September 30.

The airlines have objected to the plan because they say it will reduce carriers' flexibility to prevent additional delays, according to Elizabeth Machalek Merida, a spokeswoman for the Air Transport Association, which represents the major U.S. airlines. She said, for example, if a plane were on the runway for two hours and 45 minutes, and told that it would have a slot ready for take off in another 20 minutes, a three-hour minimum on the ground would force the plane back to the gate, causing additional delays. "We believe the pilots really should be the ones to a make those types of real-time decisions as opposed to a blanket rule that applies to everyone," says Merida.

Paul Hudson, executive director of the Aviation Consumer Action Project (ACAP), argues the on-time statistics generated by DOT do not reflect the true picture of problems in the airline market because they mischaracterize certain events. For example, he says more than 16,000 flight diversions were not counted as a delay. As Netessine discovered in San Antonio, diversions typically result in many additional hours in transit.

Ron Riley, founder of NorthWorstAir.org, a web site devoted to complaints about Northwest Airlines, says the major carriers consistently lie to passengers about the true time of scheduled flights, cover up delays by blaming them on the weather and other legitimate problems, and fail to provide basic services to stranded passengers. "I think the type of activities that Northwest and the other airlines engage in amounts to theft. At some point it becomes fraud. If smaller entities with less political clout did this they would be in jail," he states.

Roman Blahoski, a spokeman for Northwest Airlines, says most delays are caused by factors beyond the carriers' control -- including weather, air traffic control delays, mechanical problems and difficulties assembling crews. "Although cancellations do occur from time to time, Northwest strives to minimize the impact to its customers," says Blahoski. He adds that after a spate of bad weather and high employee absenteeism in June, Northwest is running more than 98% on schedule for its major routes in July.

Hudson says that, unlike consumers of most products, air passengers cannot necessarily vote with their feet. There really is no other substitute for air travel when a cross-country business trip is necessary. A better balance could be brought to the airline industry if it were not exempt from many state and local consumer protection laws as a result of its federal status and regulation by the Federal Aviation Administration, he argues.

According to Riley, many of the industry's problems are rooted in corporate cultures that do not value customer service. "It seems a handful have decided they can treat people really shoddily. They don't care if they lose a customer or a good employee."

But Wharton's Allen suggests that U.S. airlines are concerned about new competition from Richard Branson's low-fare airline, Virgin America, which lands in the United States later this summer. Over the long term, new foreign competition will enter the U.S. market, stirring up competition that may force airlines to improve service, Allen predicts.

Netessine is hoping the air traffic control system can be improved and that the rapid increase in the number of corporate jet take-offs -- related in part to poor service on commercial airlines -- tapers off. "The number of corporate jets is growing exponentially and they take basically as much time to depart as big airplanes. We need some kind of regulation to allow us to free up some space from smaller corporate jets for bigger commercial airliners."

However, he says, burdening air carriers with huge costs to upgrade traffic control may only force them into bankruptcy again.

The airline business will always be capital intensive and prone to boom and bust cycles, according to Allen, who says it seems particularly vulnerable to dramatic change in its financial fortunes. He says he has decided that airlines have a glamour factor that clouds normal business judgment that would smooth the ups and downs. "The rest of transportation is not sexy," he says. "It's dirty and icky and slow, but air has always had glamour. When we regulated airlines, it was separate (from the rest of interstate-transportation)."

Cappelli sees little hope that the airline business will ever find a sustainable, long-term model that will allow it to straighten out and fly right. "If I were a player in the industry," he says, "I'd be thinking about how to get out of it." 

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