September 2008 - Jet fuel costs nearly ruined the U.S. airline industry this year. Down but not out, carriers have made many moves to survive. One of the more publicized and likely the most consequential involves sizable domestic capacity cuts, which have yet to take full effect.
For the rest of 2008 and throughout 2009, reduced airline operations will mean teeming planes, high ticket prices and ripple effects across the travel industry. In turn, corporate airline sourcing and travel program management will become tougher for many organizations. A disadvantageous negotiating environment may be the last thing travel buyers need at a time when a growing number of their firms already decided to trim travel budgets amid macroeconomic concerns.
In strict numerical terms, airlines around the globe will offer 7 percent (or nearly 60 million) fewer seats and operate 7 percent fewer flights in the fourth quarter versus a year earlier, according to airline data provider OAG. The U.S. domestic market accounts for one-third of the global capacity decline and 32 of the 275 airports worldwide to lose service entirely. "The data speaks for itself," said OAG COO Steve Casley, who noted that the last global economic slowdown, in 2001, required three years' recovery time for commercial aviation.
In the United States, traffic already is slowing and capacity already is declining. Through July 2008, United Airlines and Northwest Airlines each cut domestic seat miles at least 5 percent Delta Air Lines had cut 4 percent, and American Airlines and US Airways each cut at least 3 percent.
Their overall service reductions will become much more apparent. "The amount of capacity that is coming out of the domestic system is unprecedented," said Delta president Ed Bastian. "We are seeing reductions of the magnitude we saw post-9/11."
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"Clients are upping the level of their [internal travel] policy enforcement but are running into major challenges trying to find the appropriate inventory available to book the preferred rate."
— Bob Brindley, Advito vice president
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At American Airlines, "Shrinking our operation will eliminate some of the flying we are doing at a loss, and at least partially address the imbalance between supply and demand in the marketplace," according to a July 16 letter from CEO Gerard Arpey to employees. "That should help us as we seek to increase fares and make those increases stick."
United detailed capacity reduction plans, saying fourth quarter available seats would be down 20 percent in Los Angeles, 16 percent in Denver, 12 percent in Chicago, 11 percent in San Francisco and 3 percent in Washington, D.C.
Even chronically profitable Southwest Airlines, the operator that handles the most domestic U.S. passengers, said it "may not grow" capacity in 2009.
In contrast to years of flooding markets with numerous flight frequencies, oftentimes flown by small jets carrying just a few dozen passengers, airlines as a group are in the midst of a "shift away from the 'frequency is king' mindset," according to a July BCD Travel report. "Fewer flight frequencies combined with larger aircraft help airlines increase revenues while lowering costs." The situation provides an opportunity for airlines to replace older gas-guzzling planes with more efficient aircraft.
But there also is a growing list of routes from which carriers will pull out entirely. In the United States, many of those are to secondary and tertiary airports or such leisure markets as Florida and Hawaii. Bigger business markets generally offer higher yields and are within the travel patterns of many of the airlines' most important corporate customers.
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Total Available Seat Miles
| Airline |
Capacity change |
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| United
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-13.0% |
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| American
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-12.8% |
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| Delta
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-12.2% |
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| Continental
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-11.2% |
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| Northwest
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-5.2% |
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| US Airways
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-4.9% |
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| AirTran
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-4.6% |
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| JetBlue
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-1.2% |
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| Alaska
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+0.5% |
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| Southwest
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+1.2% |
Note: JetBlue more recently said that by September it would cut capacity by 10 percent year over year. Source: Sabre Holdings, based on OAG data as of July 14, 2008
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But not all business-oriented markets will avoid the chopping block. And while international routes traditionally have been more lucrative for airlines, the high cost of fuel is making many of those services cost-prohibitive.
Ramifications
Compared with the recent past, fewer flights will mean crowded planes, fewer nonstop options, fewer operators on some routes and less convenient connecting itineraries. And it also certainly will mean an increase in published airfares and pressure on corporate accounts' contractual performance.
Even before all the capacity cuts were announced in mid-2008, when U.S. carriers still were growing, fares had been on the rise. Seeking an immediate revenue boost to offset fuel, the industry since last year achieved many widespread price hikes, applied ever-higher fuel surcharges, added a variety of new service fees and reinstituted ticketing restrictions (like Saturday night stay requirements) meant to nudge business travelers into higher-priced fare buckets.
Now, more price increases seem inevitable. According to travel distribution firm Sabre Holdings, "capacity cuts alone are not likely to provide enough for airlines to break even, and the result is likely to be increased fares, which typically result in reduced volumes of bookings."
While business travel demand is not as elastic as leisure demand, it is not immune to price jumps, which would be most evident in markets losing service and/or competitors.
With published pricing up and supply down, some buyers likely will encounter airlines that are demanding more volume and share shift but offering smaller discounts. "Buyers will need to reconsider the definition of 'savings' with regard to managed corporate air programs," according to BCD Travel's report. "Because of market price inflation, it is unrealistic to expect improved negotiations and program design to lead automatically to year-over-year reductions in average fares."
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"The number of trips taken will have to decrease if companies are to stay within their travel budgets."
— Jeff Smisek, Continental Airlines president
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Capacity cuts, of course, also reduce availability--a particularly frustrating development for organizations that have spent months negotiating preferred airline agreements only to find they can't always take advantage of them, or for organizations trying to move large numbers of travelers to meetings and other group events in the most cost-effective manner. "Clients are upping the level of their [internal travel] policy enforcement but are running into major challenges trying to find the appropriate inventory available to book the preferred rate," according to Advito vice president Bob Brindley. "The preferred ends up spilling that business to nonpreferred suppliers."
Meanwhile, business travelers this fall and into next year may feel that limited flight schedules and crowded planes mean they are getting less as their firms pay more.
"We're already sitting in middle seats," said Shell Oil U.S. travel services manager Debra Reid, speaking this summer during a
Financial Week webcast. "You may have to combine more trips, or allow more time to do trips, if you have connections to a city where there used to be service nonstop."
What To Do?
From a sourcing perspective, "it never is a good time and never a bad time" to go out to bid for preferred airline contracts, said Mitch Cwanger air practice leader for American Express Advisory Services, during a panel discussion in July at a National Business Travel Association event. "It depends on the individual needs of companies. Who knows what the industry will look like six months from now? Things can change drastically very quickly."
In some cases, buyers may want to consolidate spending with fewer preferred airlines to meet or exceed contractual targets and maintain or improve discounts. In other cases, companies may look to "increase flexibility of travel policy, with greater use of best fare on day" strategies simply to minimize spending, according to travel management firm HRG.
"There is also a trend for corporates to avoid booking highly restrictive fares and preferring, where possible, to select the lowest mid-range fare, which has flexibility," as a means to avoid ticket change fees and cancellation penalties, said HRG director of client management Stewart Harvey.
Other approaches include such "demand management" tactics as requiring new or higher levels of approval before allowing travelers to book, asking employees to explain the reason for each trip and pushing remote conferencing options. "Although not mandatory, we are seeing certain companies asking us to offer their travelers a videoconference alternative at the time they request a flight booking," Harvey noted.
More familiar strategies that recently have been emphasized at many organizations include limiting the number of employees attending meetings, disallowing premium-class ticket purchases and encouraging travelers to book well in advance to obtain one of a dwindling number of the available lower fares.
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"Many carriers are making changes to their business models with unprecedented frequency and scope, and that, combined with lower economic growth, is creating uncertainty."
— Steve Barnhart, Orbitz Worldwide president and CEO
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"We are already seeing consumers travel differently in response to announced capacity reductions and the higher ticket prices that are anticipated," said Orbitz Worldwide president and CEO Steve Barnhart. "Air bookings less than 30 days in advance are down as a percentage of mix and greater than 60 days are up as a percentage of mix."
Trickle Down
Across the travel industry, many are bracing for the side effects of diminished airline service levels. "It's going to take a while for those seats to come back online," said Travelport CEO and president Jeff Clarke. "It will be a pretty tough next two or three quarters in the aviation and aviation service industries."
The impact also likely will hit the regional operators that provide feeder services for major airlines from smaller markets, as well as airports, airline employees and other related groups. It also will spread to other travel sectors. Hotel companies and car rental firms, for example, have been forecasting with expectations of airline health, and their corporate business will trend
similarly to that of the airlines.
"We project that domestic enplanements, which are a principal determinant of on-airport rental volumes, will decrease in 2008 compared to 2007 amid airline capacity reductions and a weak macroeconomic environment in second-half 2008," according to Avis Budget Group.
"Transient pace is slowing down and could slow further as the airline cutbacks happen in Q4," said Starwood Hotels and Resorts CFO Vasant Prabhu.
Of 244 senior managers in the meeting and event industry-- both planners and suppliers--polled this summer by Meeting Professionals International, nearly half expected a "modest negative impact" from recent trends in airline flight scheduling on their organizations' plans for the rest of 2008. Another 16 percent expected a "significant" negative impact.
All these ramifications would follow an increase in "discretionary" budget slashing first precipitated late last year by the slowing U.S. economy.
Continental Airlines hasn't been "hearing of many companies increasing their travel budgets to compensate for higher fares," said president Jeff Smisek. "The number of trips taken will have to decrease if companies are to stay within their travel budgets."
In addition to anecdotal reports by airline executives describing modest corporate travel cutbacks and others pointing to more pronounced ones, hard statistics are helping paint a picture of falling demand. In absolute terms, United (-7.2 percent), American (-4.5 percent), Northwest (-3.5 percent), Delta (-3.3 percent), US Airways (-2.9 percent) and Continental (-2.0 percent) each reported lower domestic traffic during the first seven months of 2008 versus the prior year.
Travelport GDS, which provides systems used by business travel agencies to book tickets for clients, said booked segments dropped 9 percent in the second quarter year over year. In the first half of 2008, the firm's Galileo and Worldspan systems together handled 21 million fewer segments than a year earlier. "July was down single digits, as we saw in Q2," said Travelport's Clarke. "The first 10 days of August, however, have been more negative. We are now seeing closer to double-digit year-over-year declines. Ten days doesn't make a trend, but it is something we are watching quite closely."
According to Orbitz's Barnhart, "Many carriers are making changes to their business models with unprecedented frequency and scope, and that, combined with lower economic growth, is creating uncertainty."
That uncertainty breeds caution. At NBTA's tradeshow this summer in Los Angeles, there was an underlying effort by suppliers to put on a brave face despite the troubles that appear ahead. Some attendees even suggested that certain suppliers were fearful that any discussion of corporate travel cutbacks would produce more of the same.
Though some analysts point to gradually retreating crude oil prices this summer as reason for 2009 optimism, at least as far as potential airline profitability, they don't expect carriers to rebuild operations too hastily.
"We consider these cuts to be largely permanent, in many instances," according to a research note from JPMorgan analysts. "Longer term, we could be mistaken, but for now the taste of $4 [per gallon jet fuel] is thought to have sufficiently shortened the life expectancy of many CFOs, to the point we're confident they'll succeed in keeping their fleet planning departments in check."
If it pans out that way, corporations will have air sourcing and travel program management challenges well into the future.
