James C. May, President and CEO
Air Transport Association of America
Aero Club of Washington, D.C.
September 29, 2004
It’s a great honor and pleasure to be here. I am very aware of the proud history of this club. For almost 100 years, this has been the audience for an aviation policy speech here in Washington.
Back in 1909, when the Aero Club of Washington was founded, it recognized an enormous credibility problem. Not only had people stopped caring about heavier-than-air flight; they stopped believing that the miracle at Kitty Hawk had even happened. Most people in this country had come to conclusion that the whole thing had been dreamed up by enthusiasts or fools who had never heard of the law of gravity. This club helped to change all of that – setting a wise future course for aviation policy.
Today, the industry faces a new credibility problem that is almost as big. After finally accepting the possibility of heavier-than-air flight, the skeptics now ask: Is commercial aviation, as we know it, sustainable when so few carriers seem to be able to make money doing it? That raises the core questions I want to talk about: What is ailing the airline industry and what should we do to correct it.
The financial numbers are indeed frightening. Two years into a recovery, and more than three years after 9/11, we have a growing crisis. From 2001 through 2003, U.S. airlines lost more than $23 billion. Losses this year will exceed $6 billion. We have long-established major carriers that are running short of cash and are at the outer limits of their borrowing capacity. Even the non-legacy carriers are projecting sharply reduced earnings or even losses.
Some critics think there’s a simple answer to the question of why the airlines are hurting so badly. A business writer for the Denver Post put it this way: “A is for Airline. B is for Bankruptcy. C is for Cost, which most major airlines fail to control. Those are the ABCs of why United is in bankruptcy, why US Airways filed its second bankruptcy last week and why Delta isn’t too far behind."
That simple analysis reminds me of a pearl of wisdom from Albert Einstein. He said, and I quote, “Everything should be kept as simple as possible, but no simpler.”
Let’s begin by sorting out fact from fiction. I will address five major elements in the story. Then I will tell you what I think needs to be done to restore health to the industry.
Here are the five. They contain some myths, some half-truths, and – I will be the first to admit it – some uncomfortable and painful realities:
- “Oh, no don’t tell me they want another bail-out?”, and its corollary: “Aren’t the airlines already heavily subsidized by the government?"
- “Why can’t these dinosaurs get it through their thick heads that hub-and-spoke operations represent yesterday’s business model?”
- “The airlines don’t give a damn about their customers.”
- “It’s the passengers, not the airlines, that are bearing the cost of increased taxes and fees.”
- And here I borrow the words of a recent editorial in USA Today: “Business as usual keeps old airlines from gaining altitude.”
Let’s look at each in turn.
No. 1: Has the government been forced to quote “bail out” the industry?
That is a half truth at best. The reality is that the airlines have gotten comparatively little help from the federal government.
There were two pots of federal money set up after 9/11. There was $5 billion to reimburse the airlines for costs incurred due to the federal government’s decision to shut down the airspace, plus terrorism-related losses through 12/31/01. Of that amount, under $4.5 billion went to passenger airlines, a healthy portion of which was soon handed back to the IRS in the form of income taxes on those reimbursements! Let me emphasize, this was a reimbursement, not a hand-out. Second, Congress moved to provide up to $10 billion in special loan guarantees for distressed airlines. However, only $1.56 billion of that – or less than a fifth – was taken by six airlines (America West, ATA, Aloha, Frontier, US, World).
Of those few loans that were guaranteed, Frontier, America West and others have already repaid much or all of their loans – with fees and interest and warrants for equity. In fact, as of today these guarantees have produced a net profit of more than $100 million for the federal government.
And what about the corollary question about government subsidies to the airlines?
The reality is just opposite. On an ongoing basis, the airlines are subsidizing others. Through excess taxes and fees, the industry has been subsidizing other users of our civil aviation system for years, including general aviation, business aviation, and government users. What’s more, if you accept a principle that has been preached if not practiced by Congress and the federal government – the principle that airline and airport security is, indeed, national security – then the airlines have been subsidizing national security as well.
As a result of unfunded security mandates, U.S. carriers will take a hit amounting to almost $4 billion in 2004. And that’s not even the worst of it. Federally imposed taxes and fees now account for about $52 on a $200 domestic roundtrip ticket. That’s 26 percent. It’s nearly twice the rate on commercial air travel from a decade ago and more than triple the rate of 30 years ago.
Taxes and fees now represent an annual burden of $14 billion on an industry with not much more than $100 billion in annual revenues. It is true that many of these dollars provide services the airlines depend upon…but billions more represent what we in the industry see as a deadweight cost.
No. 2: Are hub-and-spoke operations “yesterday’s business model”? Are they a big part of the problem?
This is a myth, pure and simple. The reality is that there will never be nonstop service from Peoria to Prague, or from Tucson to Tallahassee. All big airlines – including Southwest – provide a mixture of hub-and-spoke and point-to-point service. Every day, in operating between the coasts, Southwest routes thousands of people through different hubs in the interior, such as Chicago Midway, Nashville and Phoenix. That’s typically the only profitable way to do it. Right now, the legacy airlines are “de-peaking” hubs because most passengers, in choosing between lower price and tighter connection times, have signaled a clear preference for lower price. People may have to wait a little longer to catch the onward flight, but they get the benefit of lower price, less congestion, and fewer delays in takeoffs and landings. As an all-important further plus, they continue to get the ability to get from almost any city in the United States to any other city with only one or two stops.
Hub-and-spoke operations will continue to evolve and change. They won’t go away, because they exist to satisfy a definite and compelling need. And they play an integral role in today’s expanding global economy.
No. 3: “The airlines don’t care about their customers.”
Though it hurts to say it, that is, the perception of millions of flyers, particularly those who have paid premium prices. There is nobody in this room who doesn’t hear complaints almost every day from people they know about the quality and level of airline service. Yet the further reality is that we do care and we are aggressively making improvements. As we speak, a number of carriers are actively upgrading the premium services that they provide to premium customers. At the same time, the public needs to understand that they cannot expect premium service at a heavily discounted price. If you pay $99 to fly coast to coast, you shouldn’t expect champagne and caviar along the way, and you shouldn’t be surprised if you wind up in the middle seat of a fully loaded cabin. And while we’re at it, let’s give the airlines credit for some of the things that they have done to make low-cost air travel as hassle free and enjoyable as possible. That begins with the continued modernization of their fleets, and it also includes innovations such as the airport kiosks that dispense boarding passes with little or no waiting time.
No. 4: “It’s business as usual. The airlines continue to make the same old mistakes they’ve always made.”
While it has been anything but business as usual for the last three years, there is no question that decisions made years ago have continued to inhibit productivity. In some ways, we have been our own worst enemy, plagued by a too often unbalanced and unhealthy relationship between labor and management. In contract negotiations through the 80s and 90s, every new ceiling became a floor and every floor built to another ceiling. Meanwhile, restrictive work rules continued to stifle much needed increases in underlying productivity.
But today’s airlines have been aggressively attacking costs and doing everything in their power to boost revenues and traffic. Since 9/11, airlines have laid off 123,000 U.S. airline workers – about one out of every six employees – and negotiated cuts in both wages and benefits with surviving workers. Carriers have slashed annual operating expenses by 13 percent and capital expenses by 62 percent. In the midst of all this cost-cutting, they have found ways to increase the average load factor to an all-time high of 73.4 percent in 2003.
It wasn’t too long ago that a union leader stated, “We don’t want to kill the golden goose, but we do want to squeeze every last egg out of it.” I doubt that there are many airline employees today who don’t realize they are subject to a new order. To make a light-hearted remark about a serious matter, I will suggest another fowl analogy: None of us can afford to play chicken anymore with the future of our companies at stake.
No. 5: “The airlines are merely collecting taxes and fees from the customers. They aren’t paying them.”
As a practical matter, that is totally untrue. It assumes that a tax or fee imposed by the government on the passenger will have no consequence to the revenue stream that goes to the carrier. That ignores the reality that low price has become the overwhelming driver in our industry as a result of extreme competitive pressures, combined with the total transparency in pricing provided by the Internet. Airline tickets are a perishable commodity. On-line, individuals and businesses have instant access to the latest and the most detailed and extensive price lists for flying from Point A to Point B.
And everyone knows that a seat that flies empty represents revenues that are lost forever. Time and again over the past few years, airlines have tried to raise ticket prices in response to higher taxes, fees and other uncontrollable costs. And time and again, they have been unable to make them stick. This demonstrates a total lack of pricing power. And it explains why any tax or fee directly hits the bottom line – either reducing profits or deepening losses.
So let’s go back to the question: Why do the airlines continue struggle three years after the terrible hammer blow of 9/11?
There has been an element of bad luck or bad timing – especially if you consider the Iraq war and rising oil prices. But the bad luck has been grossly compounded by the escalation of taxes and fees. It has been exacerbated by price wars, extending into cyberspace, and aggravated by ever increasing debt loads. And, finally, the industry is suffering as a result of historic costs stemming from a long legacy of difficult labor relations.
Add it all up and U.S. carriers are caught between a rock and a hard place. On the one hand, they are being bombarded with rising costs over which they have no control – fuel, taxes and fees and unfunded security mandates. On the other hand, they are unable to pass these same cost increases through to consumers in higher fares, with the result that many carriers are experiencing heavy losses and all carriers are now encountering ever-increasing financial turbulence.
Certainly, Congress should eliminate the fuel tax. However, apart from that, there is little that any of us can do about rising oil prices – now up to $50 a barrel, short of increasing supply. As to other taxes and fees, it is clear that Uncle Sam takes a bigger bite out of the sale of an airline ticket than he does on the sale of alcohol, tobacco, and firearms, the so-called “sin taxes,” designed to discourage certain activities. Think about it. We have an anti-consumption tax policy that treats air travel like smoking or drinking, only it is still more punitive! Though this was not the intent, the government has in fact acted in a way that has adversely and severely affected air travel and the health of the airline industry.
Those policies are nutty when you consider how beneficial and important commercial aviation is to the U.S. and world economies. The airlines are the heart and hub (I must say I like that word) of America’s just-in-time economy. They are broadly responsible for more than 10 million jobs in the U.S. travel and tourism industries and more than 8 percent of U.S. GDP.
In some ways, the competitive landscape in the airline industry resembles the situation facing the Big Three automakers in Detroit when Toyota, Honda, and Nissan began building new plants in the south and other parts of the country geared to low-cost production of high-quality cars. Over the years, the Japanese plants have fared extremely well. But guess what? Detroit hasn’t done so badly either – lowering its historic high-cost structure and introducing higher levels of fuel efficiency, safety and innovation. In other words, they changed and adjusted, and have learned that it is a hard and continuing process. The same process has begun in our industry, and is in fact, well developed.
On another front, global business must have access to global capital. Thus, we believe that serious consideration must be given to calls for increased foreign ownership of U.S. air carriers – up to the 49 percent level endorsed by the ATA board. At the same time, labor and management must continue to work together to maximize efficiency and to provide the high level of service that customers have every right to expect.
Let me be loud and clear on one point. What isn’t needed is an aerial Amtrak. We don’t need nationalization or re-regulation. To the contrary, we need less, rather than more, government interference with business decisions.
Having given you my take on what is ailing the industry, let me now turn to what needs to be done to turn it around. There are four main points:
- The federal government should pay for aviation security, period. All security measures, adopted by Congress as a Federal responsibility, should be paid with Federal funds – more specifically, general funds, not through taxes on travelers or shippers.
- We need a disciplined, analytical approach to decision-making in the security that is analogous to what we’ve long had in safety. There are many good ideas for improving security systems. We simply cannot implement every one of them. We must be prepared to make hard choices in allocating limited resources.
- We need to reinvent and modernize the air traffic management system to meet growing demand. In so doing, we must eliminate outdated infrastructure and increase reliance on cockpit innovation. The new system must be run in a business-like manner, with strong cost accountability. And finally, FAA should give top priority to public convenience.
- There should be a searching and complete overhaul of tax policies and the elimination of many of the taxes and fees that have been heaped upon our industry. We need to ensure that tax dollars collected from the industry are channeled into expanding our infrastructure and accommodating growth, not suppressing it or subsidizing government responsibilities or programs.
Self-help has been, and will continue to be, a necessary and critical component of restoring the airlines to good health. But as I said in recent remarks to the Airports Council International, it isn’t the total solution. That can only come from the entire aviation community recognizing the gravity of the current crisis and pulling together to create a whole new political and economic environment – one that invites changes and allows all of us to move forward together.
If I may quote what the great Winston Churchill said in a time of crisis, “This is not the beginning of the end, but it is the end of the beginning.”
Those words seem especially appropriate in this venue – before a club whose members have long seen the need for vigorous action in defending an industry that is crucial to the well-being of the nation and world.