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Flight into the red

Major airlines got into a financial quagmire through basic supply and demand: too many seats and too few passengers willing to pay full fare. Many carriers are experimenting with simpler fare structures to try to stimulate sales.

By STEVE HUETTEL, Times Staff Writer
© St. Petersburg Times
published March 23, 2003


TAMPA -- Capt. Kraig Baum was elated to see his jet filling up with customers for American Airlines' second flight of the day from Tampa to Dallas.

On slow days, he had flown with 30 or 40 passengers in the MD-80 -- so few that most people could have an entire row to themselves. "It was pretty dismal," said Baum, a 17-year veteran of American.

But this sunny December day, nearly three out of four seats on American Airlines Flight 1225 were taken. The first-class cabin was nearly full. Nineteen passengers were flying on pricey full-fare tickets -- four times as many as on the average November flight.

Yet, Flight 1225 was another money loser for American, the world's largest airline, which is burning through cash at a rate of $5-million a day.

Too many passengers bought bargain tickets for American to cover its costs for the routine flight connecting a large metropolitan area with its sprawling hub at Dallas-Fort Worth International Airport.

The deal was sweet for passengers such as Kathy Leggiero of Palm Harbor, who landed a $183 round-trip ticket to Kansas City just a week earlier.

But there just weren't enough passengers like Bob Guevremont of suburban Dallas, who had to drop everything to check on a break-in at his parents' Clearwater house and paid $453 the night before for a one-way trip back home.

Revenues fell short of the $13,500 American paid for the 928-mile trip, everything from $4.21 per passenger for food and drinks to $2,900 for the pilots and flight attendants. The airline lost $226.

Informational graphic: The Economics of Flight 1225- click graphic to enlarge.
[Times art: Amanda Raymond]

The story of Flight 1225 explains in a nutshell how the airline industry got into such a financial mess. And a protracted war could push American and other carriers into bankruptcy.

It's a basic problem of supply and demand: too many seats and too few passengers willing to pay full-fare prices. During the last downturn a decade ago, carriers lost more than $13-billion. Since the Sept. 11 terrorist attacks, airlines have lost $18-billion and project a loss of $10.7-billion more this year, counting the effects of a war with Iraq.

That's enough to wipe out the industry's cumulative profits since commercial aviation took wing at the end of World War II.

Ticket demand dropped as the economy weakened in early 2001. Then came the Sept. 11 terrorist attacks. Higher security, insurance and fuel costs followed. If the war drags on, airlines expect more red ink will flow as people cancel or postpone travel plans.

Economic ups and downs have long plagued commercial aviation. But some problems run deeper and could permanently reduce revenues for major hub-and-spoke airlines.

The expansion of low-fare carriers such as Southwest Airlines, AirTran and JetBlue keep air fares in more and more cities in check. And the growth of travel Web sites lets consumers browse thousands of fares, once the exclusive domain of airlines and travel agents.

American and other carriers are testing ways to fix maddeningly complicated fare structures and attract more high-paying business travelers. Their goal: Cut the price of the full-fare tickets so more people fly instead of driving or doing business through teleconferencing.

With US Airways and United in Chapter 11 bankruptcy, and American a possible candidate to join them, major hub-and-spoke airlines have taken a knife to costs. Most are leaning on employee unions to cut labor costs, their biggest and fastest growing expense.

How much worse is it now? The St. Petersburg Times looked at the same trip 10 years earlier: American Flight 369 from Tampa to Dallas on Sept. 29, 1992, flown with a similar aircraft during the last airline slump.

Flight 1225 cost American $1,100, or 8.8 percent, more to operate than that flight a decade ago. Certain expenses grew much faster. The cost of Flight 1225's crew was $2,900 -- 45 percent higher than the airline paid for the crew of Flight 369.

* * *

Flight 1225 taxied away from Gate F77 at Tampa International Airport at 8:30 a.m. on Dec. 11 with 95 passengers in 129 seats of the silver-skinned jet with red, white and blue stripes down the sides.

Once airborne, coach travelers got a Quaker chewy granola bar. In first class, flight attendant Tina Regalado gave out all seven salsa omelets and served two other passengers corn flakes with mixed fruit.

Most people sipped juice or coffee or sodas. One had a Bloody Mary and two Bailey's Irish Cream liqueurs with coffee.

One in three passengers only went as far as Dallas-Fort Worth. The rest would catch connecting flights to two dozen different destinations, including Tokyo and Tucson, Oakland and Oklahoma City.

If each passenger paid $142.11 for the Tampa-Dallas leg, Flight 1225 would have broken even. But 33 coach passengers were flying on sale or Web fares and paid an average of $62 for the flight.

Twelve had AAdvantage frequent flier award tickets. American books $64 in revenue for each to reflect the amount credit card companies, hotels and other companies pay for miles they give customers. Five American employees, retirees or relatives paid only government fees and taxes.

Airlines usually pick up extra cash from what they carry in the plane's belly. But despite Tampa International's steady volume of air cargo -- mostly farm-grown tropical fish and human remains -- American shut down the local cargo terminal in 2000, saying it was unprofitable.

Carriers also are hurting from post-Sept. 11 rules that prohibit them from accepting U.S. mail weighing more than 16 ounces.

American's diminished load of morning mail on Dec. 11 all went on an earlier Dallas flight. So, the only revenue from the cargo holds on Flight 1225 was $100 that a passenger paid for an extra checked bag.

Still, Flight 1225 had one big advantage: lots of passengers like Wit Ostrenko, director of Tampa's Museum of Science and Industry. Fort Worth's Museum of Natural History hired him as a consultant and supplied a $1,063 full-fare coach ticket.

With businesses reining in travel costs, full-fare travelers are rare. Each time it took off in November, Flight 1225 carried an average of just more than four people paying full fare.

This day, 19 passengers flew on the pricey tickets and paid a combined $6,799. But when American added up revenues from the Tampa-Dallas leg of each passenger's ticket -- a process that takes a month -- even those big fares couldn't push Flight 1225 into the black.

"It was a good day," said Scott Nason, American's vice president for revenue management. "And we almost broke even."

* * *
Informational graphic: Connecting flights- click graphic to enlarge.
[Times art: Amanda Raymond]

So, why doesn't American just charge a few dollars more for each ticket?

Because the airline likely would end up losing money if any competitor didn't bump up its own price for the route, Nason said.

Say, for example, that American added $10 each way onto a $200 round-trip ticket and another carrier held firm on its price. That means American would need to get 10 people to pay the higher fare to make up for each customer that left for the cheaper carrier.

"It's very easy to believe that at least one in 10 people would flee from us because we're $10 more," Nason said. "The idea that we can charge more and be profitable is wrong."

That starts to explain why setting airline fares is such a delicate and complicated art. But filling up a plane with all kinds of different fares during nearly a year takes a computer called Odyssey.

Using historical data, Odyssey estimates how many people will buy tickets between various cities where American flies. The goal is to ensure seats are available for people like Bob Guevremont, the guy who bought the $453 one-way ticket home the night before Flight 1225 took off.

Depending on demand, Odyssey might limit the number of seats for Tampa-Dallas passengers on Flight 1225, keeping space for passengers taking more expensive connections.

"The worst thing would be to let the flight carry a local passenger and not let the Tampa-to-Tokyo passenger on," Nason said. "We want to hold enough seats for the full-fare passenger to Seattle, the full-fare passenger to San Francisco."

Meanwhile, American is continually tweaking fares for as many as 20,000 combinations of cities where the airline flies. Revenue managers look at how much customers historically paid for each flight, then factor in recent trends and what competitors charge on the same routes.

They set a minimum price for each segment and sell tickets at fare categories that produce at least that amount. If the price for a Tampa-Dallas flight is $120 and for Dallas-Kansas City is $60, American will sell a Tampa-Kansas City ticket for $185 or more.

"Almost from scratch, we say every night, 'What is that seat worth?' " Nason said.

Fares almost always start low and get higher, although American never came close to selling all 140 tickets it could for Flight 1225. (Like all airlines, American oversells flights to compensate for people who cancel reservations or don't show up.)

Three months before Flight 1225, American sold just 10 tickets -- all at a deep discount. One week before the flight, only two of the 69 seats had been sold at full fare. That included a Times reporter's $854 Tampa-Dallas round-trip ticket.

The last seven days almost put Flight 1225 over the top. American filled three full-fare, first-class seats at an average of $476 each for the flight and 14 coach seats at an average of about $330.

But like fresh fruit or seafood, airline seats have a limited shelf life.

American wants to fill every possible seat before a flight leaves the gate. But not in a way that tips off travelers who might pay a high fare to look for bargains a few days before the trip.

So, the airlines sell cheap, last-minute tickets on the Internet. American usually does this on "opaque" Web sites such as Priceline and Hotwire, where customers can't pick a specific airline or route to their destination.

But specials also leak out elsewhere. A week before Flight 1225, Kathy Leggiero went on the Internet to find a flight to Kansas City for a long weekend of scrapbooking and romantic movies with her best friend.

She checked three Web sites and scored on Travelocity: a $186 round-trip ticket. "When you call the airlines, it's not as cheap," Leggiero said. "So, why bother?"

But airline professionals worry that as more business travelers find bargains on the Internet for personal trips, they become more outraged by sky-high full fares.

Returning home to suburban Dallas from a customer conference in Tampa, Microsoft salesman Paul Warren groused about his $520 ticket, which included a corporate discount. The only perk: two open seats beside him.

"I don't think they left them open for me," Warren groused. "But I am going to lie down on them."

* * *

Business travel fell off steeply in 2001 and hasn't bounced back, either in the number of passengers or how much they pay.

Companies increasingly shun full-fare tickets that are fully refundable, don't require Saturday night stays and allow for upgrades to first class, said Kevin Mitchell of the Business Travel Coalition, which represents large buyers of business travel.

In 2000, his clients bought cheaper, nonrefundable tickets just 24 percent of the time. The share last year was 58 percent, he said, and airlines are recognizing the shift could continue after the economy recovers.

"The airlines did not expect to find such a falloff," Mitchell said. "Late last winter, they realized something was fundamentally wrong."

Some of their business switched to low-fare carriers. American's Flight 1225 has to compete not only with Delta's nonstops from Tampa to Dallas but also with AirTran, which sells round-trip tickets as low as $258 and no higher than $658.

Passengers have to connect in Atlanta, making the trip a lot longer. It's a tradeoff more and more businesses don't mind. They make full-fare, nonstop trips off-limits to all but certain top executives.

"The question is when the economy rebounds, will the number of people allowed to fly full-fare, nonstop grow a little or a lot?" Nason said.

In the meantime, American and competitors like Delta, United and Continental are experimenting with simpler, lower fare structures to see if they stimulate more sales.

American cut full-fare coach rates in November by 40 percent in 23 domestic markets, including Tampa-Dallas. The top coach price dropped from $1,410 to $854.

But the lower fares still cover less than 1 percent of American's routes. The airline isn't ready to declare whether the test is a success, but recently canceled the discount on all Tampa-Dallas flights.

* * *

Richard Halsall usually flies in the front of the plane. But the Airbus A300 captain for UPS is in the back of Flight 1225 this day, pontificating about the financial dilemma facing American and other big, traditional carriers.

In boom times, they've made money by soaking travelers who buy tickets shortly before the flight, Halsall says. But that formula doesn't work in slow times.

Big airlines can't ride out the bad times because of high fixed costs, such as aircraft payments, expensive hubs and employee contracts that lock in salaries and benefits.

"That's why they adopted this ridiculous fare philosophy," Halsall says. "They're trying to distribute the profitability of this airplane among travelers willing to pay to book at the last minute."

The $13,500 American paid to fly Flight 1225 encompasses a wide range of expenses. The $2,400 in overhead costs includes a slice of the airline's advertising, corporate administration and airport rental fees at Tampa International.

But the biggest single expense for the 21/2-hour flight, American says, was $2,900 for the flight crew. That was $900 more than the airline paid for the crew of Flight 369 a decade earlier. And that crew had one more crew member: a navigator aboard the Boeing 727.

With nearly 2,600 daily flights, the numbers pile up fast. After targeting $2-billion in other expenses, American in February told unions it needed to cut $1.8-billion a year in salaries, benefits and work rules to avoid filing for bankruptcy reorganization.

Capt. Kraig Baum, the 53-year-old pilot of Flight 1225, has mixed feelings about the airline. He loves the company and his job. But after years of bitter union and company relations, he doubts the airline's financial condition is so dire. Baum and fellow pilots say it's not all their fault.

American wants employees to work more hours. The airline's pilots average only 39 hours of flying a month. At Southwest, pilots average 62 hours, considered the industry's most productive.

American blames restrictive works rules in the pilots' contract. Baum says the airline has about 2,000 more pilots than it needs, including many reserve pilots on call to fill in for regulars who are sick or miss connections. Baum thinks pilots and other workers will end up accepting cuts.

Still, he doesn't understand how things went so bad, so fast. Late last year, experts said American was among the industry's strongest carriers.

"To have the situation go 180 degrees to the point of going into bankruptcy, it's kind of mind-boggling," he says.

-- Researcher John Martin contributed to this report. Steve Huettel can be reached at huettel@sptimes.com or (813) 226-3384.

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