Fear of Flying: Passengers and Airlines Can Expect Turbulent Times

A combination of lower air fares, government aid, new security measures and the passage of time will eventually ease the crisis that has crippled the airline industry in the aftermath of the Sept. 11 terrorist attacks, say Wharton faculty members and aviation experts.

But the faculty and experts say that airlines, acting alone, have few proactive options at their disposal to bring back passengers quickly and shore up frighteningly low levels of cash flows. Massive layoffs and other cost-cutting measures that already have been announced by the airlines will help. However, some airlines may be forced to seek bankruptcy protection in a matter of months if customers continue to stay away in large numbers, especially if another attack occurs. In a worst-case scenario, one analyst says, the federal government may have to consider creating a Conrail-like company to consolidate airlines that would otherwise cease operations.

Wharton management professor Peter Cappelli calls the crisis “unprecedented.” “The usual things that airlines do to attract people when business is down are probably not going to help them now” because the steep drop in passengers was caused by hijackings, not by the typical vagaries of business, Cappelli says.

“If demand doesn’t come back, there’s nothing they can do,” says Andrew Watterson, an airline consultant and principal in the Dallas office of Mercer Management Consulting. Watterson notes that the number of air travelers, especially lucrative business passengers, was already falling sharply in the months prior to Sept. 11, making it even harder for carriers to weather the storm prompted by the massacres at the World Trade Center and Pentagon.

Watterson offers some eye-opening statistics. The monthly percentage declines in the so-called load factor – the number of seats occupied on worldwide commercial flights compared to capacity – was greater from April through July of this year than it was from January through April of 1991, a time when the Gulf War kept many people from flying. The monthly load-factor declines in that four-month period in 1991 were less than 1 percentage point each. This year, airlines saw a drop of 2.5 percentage points in April, 5.1 points in May, 3.7 in June and 2.9 in July.

Industry figures for the decline in passengers since Sept. 11 are not available, but planes are nowhere near filled to capacity. Gordon M. Bethune, chief executive officer of Continental Airlines, has said that his company’s load factor was only 37% when air travel resumed a few days after the attacks. Before Sept. 11, the load factor for a major carrier would have been 70-75%, Watterson estimates.

According to Lee Mullin, chairman and CEO of Delta Air Lines, the industry could lose $4.7 billion in September alone. Prior to Sept. 11, he hoted, the industry had projected an $8.5-billion cash balance through June 30, 2002; projections now call for a negative cash balance of $15.5 billion. Airlines say the industry has lost about $330 million a day since Sept. 11 and expects to lose $24 billion in the next year.

The U.S. commercial airline system is a vital part of the economy. In 2000, commercial airline operations generated more than $30 billion in government revenues, according to industry figures. That same year, 1.2 million U.S. airline employees served approximately 670 million passengers traveling more than 700 billion miles.

The $15 billion aid package from Washington – $5 billion in direct grants and $10 billion in loan guarantees – will help carriers, but only in the short term. Congress reportedly will consider additional aid in the weeks to come.

“To keep airlines afloat, the $5 billion is necessary but just a drop in the bucket,” Watterson says. “That prolongs airline life by 40 to 50 days, which allows them to get past the most difficult period. If demand doesn’t come back, the airlines have to [further] reduce costs and that would be extremely difficult.”

One reason further substantial cost cutting is unlikely, Cappelli and Watterson note, is that labor unions, which granted concessions to carriers during difficult times in the 1980s, are less likely to be generous now. Since the 1980s, “the companies and unions haven’t exactly had good relations with each other,” Cappelli says. “The kind of cuts airlines would have to make at this point would be so phenomenal it’s probably not even worth contemplating.”

Carl W. Vogt, a senior partner in the Washington law firm of Fulbright and Jaworksi and a former chairman of the National Transportation Safety Board, agrees. “Major carriers are in the same boat as some highly unionized service organizations; they basically provide a pretty good living for their employees,” Vogt says, noting that airlines operate on thin profit margins of perhaps 5-6%. “When you have good times and are able to realize profits as [airlines] have for five or six years, the negotiating cycle tends to catch up,” with unions holding firm in their desire to make up for lost wages and benefits.

Not all airlines are in equally dire straits. Vogt says Southwest Airlines, JetBlue Airways and AirTran Airways, which specialize in low-cost, point-to-point flights, are among the healthiest. It is easier for them to withstand the shocks of a downturn than it is for the larger carriers: American, United, Delta, Northwest, Continental and US Airways.

Elizabeth E. Bailey, professor of business and public policy and a former commissioner on the U.S. Civil Aeronautics Board, says US Airways could be devastated if Ronald Reagan Washington National Airport, which has yet to reopen, is closed permanently. She says US Airways, which has 10 gates at National Airport, has invested close to $1 billion in that facility.

As of Sept. 21, the U.S. airline industry had announced more than 80,000 job cuts. These included 20,000 each at American and United, 12,000 at Continental, 11,000 at US Airways and 10,000 at Northwest. Delta said it would announce job reductions soon, perhaps between 12,000 and 16,000. In addition, Boeing, which makes commercial aircraft, has announced 30,000 layoffs.

As part of its cost-cutting effort, US Airways said Sept. 21 that it will shut down MetroJet, its low-cost carrier based at Baltimore-Washington International Airport, by December, the Washington Post reported.

The transportation crisis arising from the terrorist attacks goes well beyond the United States. British Airways has announced plans to reduce operations by 10% and to cut another 5,200 jobs, bringing to 7,000 the total number of reductions.

Swissair said it would eliminate 3,000 jobs at its catering unit in the wake of the attacks and cut its executive management team from 13 to six. This comes on the heels of a previously announced plan for a restructuring, including 1,250 job cuts, as a result of financial losses last year. Swiss officials were considering an aid package for the airline, 3% of which is owned by the government.

An increase in insurance premiums has become so worrisome that U.S. and European governments have stepped in to help. As part of Washington’s aid package, U.S. airlines are being provided with free war and terrorist risk insurance for 180 days as they renegotiate coverage with insurers.

European Union officials have agreed to help European airlines that had feared they would not be able to put planes in the air because of new insurance industry limitations on third-party war liability. Insurers had said they would be forced to limit the amount of coverage they could provide for damages to third parties to $50 million per airplane if commercial airliners were attacked. Before Sept. 11, third-party coverage for war and terrorism was typically more than $1 billion. But the EU said it would only cover third-party liability until new insurance contracts have been worked out.

Faculty members and analysts say that more passengers will be willing to fly again, once enough time has passed for them to feel secure. Official encouragement from federal authorities should also help.

“Airlines have got to sell safety more than they’ve ever sold it before,” says W. Bruce Allen, professor of business and public policy and director of the Wharton Transportation Program. “But it has to be an industry-wide safety effort, as opposed to individual carriers. Maybe the government can provide credibility here, too. You’ve got to convince the flying public that it’s safe to go back in the air again.”

“I think people will come back,” says Bailey. “Right now, if travel is at all discretionary, people don’t want to do it. Overseas travel will come back more slowly than domestically.” The best way to attract people, she adds, “is always by price.” Vogt says business “will start coming back unless there’s another attack.”

Additional security measures should help convince people to resume air travel, but it will not be easy to balance security concerns with civil liberties and passenger convenience. Vogt points out that, although the Sept. 11 hijackings of the four planes was horrific, the hijackers apparently did not violate any regulations. “The Sept. 11 crashes did not, in a technical sense, implicate the current security provisions,” he says. “As far as we know, if what they used were pocket knives and box cutters, those were within federal regulations … The system in place has been pretty effective.”

Vogt says that all airline security regulations, along with the training that pilots are given to deal with hijackers, are predicated on the assumption that the hijackers want to divert the aircraft to achieve some objective – and to stay alive while doing so. Officials now must devise ways to prevent or thwart hijackers who are willing to commit suicide.

In the future, Vogt says, it does not matter whether airport security is handled by local, state or federal employees, so long as the rules are set by the federal government and are implemented uniformly and thoroughly.

There has been talk of installing devices on planes that would allow air-traffic controllers on the ground to take control of hijacked aircraft. But Vogt says he opposes that idea because terrorists would then be tempted to break into control centers to commandeer planes. Nor does Vogt think that screening students who attend flight schools is part of the answer. “How can you do a background check on a guy to say that he’s a terrorist? Non-U.S. citizens who register for flight schools are probably going to be scrutinized, but I don’t think a flight school should make a determination based on the color of a guy’s skin.”

Instead, Vogt suggests that the government and airlines look at new technologies that improve the ability of machines to detect metal and other objects that can be carried onto planes. Vogt says he sits on the board of a small company that manufactures a machine that conducts thorough body scans. “You walk through the thing and it shows everything on top of your skin,” he says. “Not only does it detect metal but it will show visually what you’re carrying through. There’s a lot of room for the development of high-speed technology that reveals potential explosives and weapons. I think that’s the ultimate answer.”

Although some people object to using such equipment because it can show genitalia, there is a version of the machine that is not as intrusive, and Vogt says that could be effective. Both Vogt and Allen say the use of air marshals would be a good way to restore passenger confidence, as would stronger cockpit doors.

Cappelli, however, disagrees. “Relying on technology to try to solve this is a mistake,” he says. “Apparently, these hijackers didn’t break the doors down; they got the pilots to come out.” Cappelli argues that rigorous screening and questioning of passengers on the ground is the best way to avoid trouble in the air.

The faculty and analysts agree that low prices are also critical to filling seats. “After the downing of Pan Am 103 over Lockerbie [Scotland, in December 1988], I flew to Europe on Pan Am because the prices were rock bottom,” Allen says. “I think airlines could take a marketing approach today – being careful as they do it – that says something like, ‘To help America be mobile again, we’re offering low fares.’”

The faculty and analysts say that air travel remains the safest means of transportation and that it is probably safer than usual to fly today, given the heightened awareness following the Sept. 11 attacks. One additional enticement, Cappelli notes, is that it is also probably easier and less hectic to fly, given the many empty seats.

Watterson of Mercer Management Consulting says that, under an optimistic scenario, the travel industry will remain severely depressed for a couple of months. But as the economy improves and travel fears subside, people will start buying tickets again.

But Watterson also outlines a more pessimistic scenario: Demand remains low in the next two to three months. Demand then returns, but slowly, either because the economy has not picked up or people remain fearful. Smaller carriers like Southwest are surviving, but there is a series of bankruptcies among larger carriers. At that point the U.S. Justice Department, which a few months ago nixed the proposed merger of United and US Airways, begins to approve some consolidations. Or things get so bad that the government intervenes to establish an entity like Conrail, which was formed in the 1970s out of the ashes of bankrupt railroads in the northeastern United States.

In the months ahead, senior executives and boards of directors will have to scrutinize their current management strategies, says Robert E. Mittelstaedt, Jr., vice dean and director of Wharton’s Aresty Institute of Executive Education. “The boards of all airlines will not just have to look at simply the range of scenarios that could be devastating, they will have to refocus on what creating shareholder value really means,” Mittelstaedt says. “If all you can do is okay in a business with margins so thin that being out of business for a few days puts you on the verge of bankruptcy, you are not creating shareholder value.”

In the meantime, airline CEOs will also be looking at airport terminals to see if customers are returning. One customer, Wharton’s Bailey, says she’s willing to fly – but it depends on the circumstances. “I definitely am looking carefully at every trip. I’m not about to cancel my Thanksgiving trip [by air] to California to see my grandchildren. On the other hand, if I was going to Boston I might take the train.”

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