Aviation: fuel costs drive airlines to seek creditor protection

Delta and Northwest airlines both entered into Chapter 11 administration yesterday under the USA's insolvency legislation, the companies now have a period of time to sort out their finances before creditors are able to attack. They join US Airways and United Airlines which are already under Chapter 11 protection.

Both airlines are complaining not just about fuel costs but also about the competition that is driving down fares in what is an increasingly overcrowded airline market.

Despite a number of the USA's airlines turning to cheap foreign labour for cabin crew (there is a significicant increase in the number of Indian cabin crew being trainied to work on US airlines, for example) costs continue to rise.

But there may be some form of politicking going on: for when a company becomes insolvent, there are threats to its pension fund. This threat does not come from plundering, but from the fact that it will no longer be making contributions to the fund, resulting in a possible diminution of value for the workers, many of whom expect to retire in the foreseable future.

Workers in the US airline industry have been exhibiting growing militancy in recent years and strikes have become more common. Increasing demands have disrupted services, irritated passengers and added costs. The companies have tried restructuring but even the small gains they have made have been eaten up by increasing fuel costs.

The companies are having problems adding the fuel burden to the ticket price. Increasingly, customers are seeing travel as a commodity. Unless an airline is can demonstrate an exceptional differential, then passengers will, simply, go where they can get the cheapest flight.

United Airlines started the ball rolling on the pension scheeme concern when it closed its fund in April this year. Now there is concern that the other big airlines will do the same. The airlines say that, at times of falling revenues and increasing costs, running an airline is becoming a zero sum game and fripperies like staff benefits have to go.

The woes are not confined to the USA but in Asia there remains a national brand loyalty to airlines and also an issue over hub arrangements. For example during summer 2004 restrictions on foreign airlines operating in Cambodia meant that, Malaysia Airlines was not permitted to sell a ticket from Phomh Penh to Kuala Lumpur.

And Asian government tend to exercise a closer regulatory role over what airlines can add as surcharges so both Cathay Pacific and Malaysia Airlines had to seek government approval to add a fuel surcharge to ticket prices.

Of course, airlines are looking for other ways to boost revenue: one way is to be more strict on baggage allowances because weight costs fuel.

Another is to share costs by code sharing. But passengers are becoming wise to code-share flights that don't give full points on loyalty programs and declining to purchase tickets, even on the same plane, if the points are not awarded. For example, a flight on a code-share KL-Bahrain flight does not give the Malaysian Enrich points if the MAS allocation of seats is full and the customer has to buy the ticket from the code-share partner that operates the flight. For business travellers, that is a significant loss of benefits and makes it less likely that such a purchase would be made again.

Ironically, budget airlines are doing better business and actually making profits. How can they do this?

It's simple: even though they, too, add fuel surcharges the total price remains lower and the percentage differential between the low cost carrier and the full service carrier becomes greater. And that percentage, as well as the total overall cost, is what the customer looks at. Whilst few would want to travel on most budget airlines for more than a couple of hours, for short flights, even business passengers are now turning to them, again driving up demand.

And many budget airlines fares are not significantly different to full fares, unless customers get in quickly for the loss leaders. In December 2004 Air Asia was quoting more for certain dates for KL-BKK-KL return than was Royal Thai Airways. But such is the image of budget carriers that no one seemed to notice. The Air Asia price, incidentally, fell dramatically nearer the dates concerned.

That's no help to the full cost carriers of the USA which have, so far, not felt the full ravages of European low cost airlines model. The pioneers of that approach in the US all collapsed. But the time may be ripe for someone to try again. Maybe one of those in liquidation could scale back and adopt the same approach. It would be radical but, let's face it, increasingly they have nothing to lose.

UPDATE: as the US markets opened today, airline shares fell sharply with some falling as much as 50%