Published: February 09, 2005 in Knowledge@Wharton Delta Airlines cuts fares in a price war that Merrill Lynch estimates will sap $2.5 billion in revenues from the six largest airlines. US Airways and United file for bankruptcy, and almost every other airline -- Southwest is one of the exceptions -- reports significant losses. The cost of oil remains stubbornly high, adding significantly to cost pressures. The question is: How do you fix an industry littered with walking zombies?

Wharton professors have a few suggestions. First and foremost is to liquidate a few airlines -- allowing them to die, and most importantly, to stay dead. Only then will enough capacity be removed from the industry to let carriers turn a profit. "If one airline goes under it will strengthen the others," says business and public policy professor Elizabeth Bailey. "There are too many carriers and too much capacity. This industry hasn't been in equilibrium as long as I have been watching it." W. Bruce Allen, also a business and public policy professor, agrees. "My big complaint with this industry is that you ought to be able to die," says Allen, referring to the numerous lifelines thrown to carriers, like US Airways, by bankruptcy judges.

Airline executives acknowledge the industry's problems. "The revenue environment continues to be a challenge due to the glut of airline seats," said Southwest CEO Gary C. Kelly in a recent company earnings release. In a Delta earnings report, CEO Gerald Grinstein spoke of "the difficulties our airline will continue to face in 2005" while Continental CFO Jeff Misner noted that his airline has cut $900 million in costs and still lost $363 million in 2004.

Part of the problem is history. Legacy carriers such as American and United were formed when airlines were regulated, in part to provide stability for what was then a young industry. Under that system, airlines could break even running at 50% capacity.
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