Smaller aircraft, fewer frequencies and fewer destinations were cited by three industry executives as driving passengers to seek alternatives in a report released by the Business Travel Coalition, Airline Forecasts and former AMR CEO Robert Crandall, who called for a National Transportation Policy to improve the stability of the industry.

At a time when major airlines are looking to their international routes to provide stability in what one expert called the "hyper-competitive and fragmented domestic market," their competitiveness in the global marketplaces has been severely compromised for many reasons, not the least of which are their disastrous balance sheets and their dismal customer service, according to the report.

The three executives -- Crandall, Airline Forecasts CEO Vaughn Cordle and Business Travel Coalition (BTC) Chair Kevin Mitchell -- predicted that business travelers will continue to book away from the majors because of increasing hassles and the fact that alternatives and substitutes are becoming more mainstream. The group cited several incremental passenger inconveniences, that combined, are driving business travelers to find substitutes to the legacy carriers and their partners. Smaller aircraft now used on many routes along with fewer frequencies and fewer destinations, serve to render the aviation less usable and make web conferencing and video conferencing far more attractive, they said. Other incremental inconveniences include lack of on-board meal service, frequent flyer programs perceived as less valuable, high load factors and security hassles.

"Load factors are likely to stay high as airlines have perfected highly efficient methods of selling near-perishable seat inventory over the internet," said the three leaders in the report. "The commercial aviation customer service processes and system designed 30 or more years ago never envisioned sustained load factors at these levels. Cost pressures are eroding service levels resulting in growing public dissatisfaction. A less useful aviation system means slower U.S. economic growth in the future as the airline industry is a fulcrum over economic activity. There will likely be lower economic returns for labor and investors."

Crandall weighed in on the state of the industry. "There is a glaring absence of any concern at the national level about the erosion of service quality - frequency, availability, service levels - that has made the system vastly less useful and much more unpleasant," he said. "Additionally, there is a complete lack of concern for taking steps to assure the continued competitiveness of U.S. airlines. The problems are evident; what is lacking is any political interest in structuring a superior alternative."

Airline Industry Less Viable

Cordle questioned the viability of U.S. airlines, noting commercial air transport in the U.S. remains inefficient and unable to earn its cost of capital over a full business cycle. Not only are they at the bottom of the world's list in terms of overleveraged balanced sheets, they have underinvested during the last decade, and, now, do not have the wherewithal to invest given the high fuel costs in what he calls areas that improves the customer's value.

"Service is perceived to be poor relative to the financially stronger and better (service) quality of foreign competition," he said. "This suggests that U.S. airlines will, over time, continue to lose market share in world markets. Domestically, the majors still have significant cost disadvantage to younger, low-cost carriers that are growing fast, having reduced domestic capacity more than 20 percent since 9-11. Consolidation may be the best bet for the long-term survival for many U.S. old-line majors." The loss of competitiveness against foreign carriers is critical since many U.S. carriers are banking on international business as they spin off more and more of their domestic routes to regional operators.

Cordle warned U.S. airlines will likely see trouble again even as fuel prices decline largely owing to labor demands and management's tendency to "grow capacity too fast for the collective good of the industry." He expects any profit recovery to be short lived with most carriers "muddling through in what can only be described as a slow liquidation."

Cordle pointed out that foreign carriers have had fewer competitive battles because of less government liberalization and penetration of LCCs. He criticized greater foreign ownership of U.S. carriers. While said to be good for the consumer, it is actually marginalizing U.S companies on the world market. "Overleveraged balance sheets and the inability to improve the product relative to more financially fit foreign competitors is the fundamental problem," he concluded. "Bottom line: foreign competition is in better shape today because foreign governments are more oriented toward the welfare of producers than is the U.S. government. The challenge [for U.S. airlines] is to improve customer service and employee morale, especially in terms of managing future expectations."

Security

For his part, BTC Chair Mitchell called for a rational national public policy debate on airline security. "Current U.S. aviation security policy is an outgrowth of immediate post 9-11 political reactions resulting in new laws and mandates," he said. "We now have the Department of Homeland Security and the Transportation Security Administration but we have never had a rational public policy debate regarding the definition of the problem we are facing, i.e do we have an aviation security, a national security or a national defense problem? The need going forward is to get aviation security right, at the policy level, and in the appropriate overall context."

Mitchell said critical questions remain unresolved including the resources available for addressing prioritized risks and threats and what would be required tradeoffs in personal liberties. He also questioned who will be charged with protecting citizens against abuse and the institutionalization of compromises to personal liberty.

The three leaders said the fundamental shift in the commercial aviation marketplace predates 9-11 with a sustained period of declining monthly yields and average fares beginning in the spring of 2000. The terrorist attacks only served to accelerate the declining economics of the U.S. airline industry as management was forced to respond to the collapse of business travel yields, the fall-off of short-haul traffic, new security requirements, pandemic threats such as SARS, labor difficulties, bankruptcies, the growth of product substitutes such as web conferencing and aggressive low-cost carriers. All this was compounded by "persistent and unworkably high jet fuel prices."

Legacy carriers, which the three said were in denial about the shift, sought cost reductions by reducing in-flight amenities. Meanwhile, LCCs were closing the service gap by adding business class seating, on-board entertainment systems and frequent flyer programs blurring the distinction between their service and that of the majors. The LCCs "effectively established a pricing ceiling for the entire industry and largely prevented the majors from raising prices to offset fuel costs," the BTC report said, adding that majors, LCCs and regionals have collectively lost $54 billion in net earnings between 2001 and 2005 while industry revenues dropped to $20 billion.

In recounting the dramatic changes in the last five years, the report indicated that business traffic was 50 percent less than it had been in 2000. In addition, although airline yields have risen significantly since the lows in July 2005, they are still about 12% less than they were five years ago, despite rising traffic levels. In inflation- adjusted terms, average yields are down over 20%.

Business travelers face little risk of the industry returning to the pricing-power days of the late 1990s because of the dramatic penetration of the low-fare airline segment, the report indicated. It also cited the fact labor costs have been cut significantly. However, many analysts have said that the savings generated by the higher productivity and slashed wages and benefits have been completely spent on rising jet fuel costs of the last few months which are now more than three times higher than the average of the previous 20 years. Majors have shed 160,000 jobs, about 35 percent of the workforce as illustrated by United's metric that each aircraft once required 170 employes and now has 120 employees per aircraft.

The impact on the customer is seen in the diminished on-board service and a much less comfortable experience, said the report, citing less food, uneven customer service levels, longer security lines and cramped onboard conditions as reasons the business travel is either driving or using video conferencing. In smaller markets, the report noted, aircraft have been downsized, frequencies reduced and, in some cases, service has been completely eliminated. "While passenger traffic levels are back to year-2000 levels, the peak of the last business cycle, it takes, on average, fares that are 15 percent lower to generate this traffic," said BTC.

Continuing threats, besides fuel prices, include federally imposed taxes and fees, which the group cited as a material problem for the airline industry today. In addition, congestion has become a growing threat as regional aircraft replace mainline jets at many airports. In addition, the unpredictable security delays are losing business travelers significant productivity which impacts the competitiveness of their own industries.

Furthermore, AirlineForecasts, in a just-released report on oil markets and jet fuel prices, now projects that jet fuel costs will average around $1.80 per gallon in 2007, which is less than the $2.20 that most analysts are currently modeling. This will provide approximately $6.5 billion in cost relief for the 12 major airlines, much of which will be transferred to the consumer in the form of lower fares. Moreover, lower fuel costs will result in higher capacity growth in 2007 - 3.5% versus 1.5% - (domestic) which, in turn, will put downward pressure on yields and average fares.