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Fri December 16, 2011
Why Airlines Keep Going Bankrupt
The airline industry consistently breaks the number one rule of business: The job of the company is to make money.
"The industry in aggregate has lost about $60 billion over the 32 years since deregulation, " says Severin Borenstein, an economist at the Haas School of Business at U.C. Berkley.
Borenstein has crunched the numbers, and he says the airline business is notoriously difficult. Planes are expensive. Fuel prices jump around a lot. It's hard to predict how many people will want to fly next year.
But all airlines face these challenges and only some file for bankruptcy. He says its usually a certain type — the legacy airlines.
Legacy airlines date back to the days when interstate airlines were heavily regulated by the government. And it does seem like they've had a particularly hard time.
American declared bankruptcy last month, following in the footsteps of Delta, Northwest, United, US Airways and Continental. Some of them have gone through bankruptcy twice.
Before 1978, life for the legacy airlines was pretty sweet. The government set ticket prices. If regulators didn't think airlines were making enough money, ticket prices would be allowed to rise. Instead of competing to offer the lowest ticket prices, the airlines offered more and more amenities things like bigger seats. Some 747s even had piano bars.
All that changed with deregulation in 1978. Bob Crandall was working at American Airlines at the time, and he remembers what it was like.
"Somebody decides to start a new airline and they come into the business and decide that they are only going to charge $29 for a seat," says Crandall. "Then I don't have any choice, I have to charge $29 for my seats too, even if a seat cost me $100."
Those new, low-cost carriers — such as AirTran, Southwest, and JetBlue — have a key advantage over the legacy airlines, according to Borenstein.
"They get much more productivity out of their workers," he says. "The jobs are defined more broadly and their workers tend to be able to cover more of the work load."
But Crandall, who ran American Airlines, says it was clear to him that labor contracts were a big part of the problem.
"If you cannot tolerate a strike because you will run out of money during the strike, then you give the union what it wants, " says Crandall.
This is where bankruptcy comes in: It allows airlines to renegotiate labor contracts.
Parts of union contracts written before deregulation have persisted for decades, according to James Sprayregen is a partner at the law firm Kirkland and Ellis who worked on the bankruptcies of United Airlines and TWA.
"Those contracts, albeit amended dozens and probably hundreds of times, they sort of grew on themselves almost like a coral reef and a lot of inefficiencies got built into those," he says.
In bankruptcy, work rules that determine how many hours a pilot can fly can be changed, vacation days can go away, and pensions and benefits can be reduced.
"Unfortunately bankruptcy is all about breaking promises," says Sprayregen.
Breaking those promises means the legacy airlines have come to look a lot like the newer, low-cost carriers.
Southwest is already bracing for that.
"The sloth-like industry you remember competing against is now officially dead and buried," Southwest CEO Gary Kelly recently wrote in a letter to employees. "We fought them and we won. Now the enemy is our own cost creep, our own legacy-like productivity, and our own inefficiencies."