Making fares fairer: why airline pricing can't be fundamentally changed without an overhaul of industry cost structures

CFO: Magazine for Senior Financial Executives,  Sept, 2002  by Lori Calabro

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America West could afford it, according to CFO Bernie Han, because full walkup fares account for only 5 percent of its total revenue. There was "greater-than-expected retaliation by competitors," he says. But for the Phoenix-based carrier, the plan seems to be working; second-quarter revenue fell only 7 percent, half the plunge of the large airlines.

Meanwhile, Frontier Airlines narrowed the gap between its low- and high-end fares in July, and was immediately followed by United, part of what was then seen as a rare experiment by a major airline to gauge the effect of cutting business fares. At the end of the month, however, $445 million Frontier announced its first quarterly loss in four years, $2.9 million in the red, compared with a $7.7 million profit the previous year.

CFO Tate, however, maintains that Frontier can offer significantly lower fares going forward because of its lower cost structure. In the March quarter, "our break-even load factor was 55 percent, which means we needed to fill 55 percent of our available seats on average on every flight in order to break even. United's was 91 percent!' United's handicap is that "it's very difficult to build up an economies-of-scale-type infrastructure when you try to be all things to all people."

WHAT WON'T FLY Universal appeal, of course, is what attracts business travelers to the major airlines, and why those carriers can charge more. Their hub systems meet scheduling needs, and frequent-flier programs inspire loyalty.

To date, few majors have copied the fundamental price restructuring of America West or low-fare leader South-west. Doing so, says Gillespie of Travel Analytics, means fundamentally addressing "the three major costs to an airline: fleet, labor, and jet fuel." While fuel cost may be beyond an airline's control, he maintains that airlines can influence the other two factors.

Costly labor contracts, for example, force most major carriers to charge higher-margin business fares. Labor accounts for 40 percent of total expenses at American, for example, versus 30 percent at Southwest and 25 percent at Frontier. So airlines soon will have to negotiate more employee givebacks. Frontier cuts costs and increases pricing flexibility by using a single jetliner model instead of the varied fleets of most rivals. And the hub system can also be a cost albatross, requiring multiple crews, baggage handlers, and gates to remain idle while awaiting connecting flights.

American's latest plan involves eliminating all 74 Fokker 100 jetliners and "de-peaking" its Dallas-Fort Worth hub. De-peaking its Chicago hub last April increased productivity by spreading connections throughout the day. Senior vice president and CFO Jeffrey Campbell says the changes allow fewer aircraft to be used and cut the need for gates. He adds that in other cost-saving changes being reviewed, "there are no sacred cows."

How fares will fare in the future is uncertain, especially with the bankruptcy scenarious unfolding before us. Much may depend on whether there are mergers and capacity reductions to go with the cost cutting. And while experts expect a fundamentally different pricing approach to emerge within two years, they debate whether airlines or Washington will initiate the changes.