Full-Service Airlines Are "Basket Cases"


The one-two punch of economic downturn and post-September 11 fear of flying caused a sharp reduction in domestic air travel, sending most airlines into a deep slump. But even when the economy rebounds and fear of terrorism recedes, one thing isn't likely to change for the U.S. industry: Low-cost carriers like Southwest Airlines (LUV) and JetBlue (JBLU) will still be nipping at the heels of full-service airlines.

A similar dynamic is playing out in Europe, courtesy of Ryanair (RYAAY), the Continent's top frills-free flyer. Michael O'Leary, the carrier's outspoken chief executive, is leading the charge to take market share from big names like British Airways and Lufthansa. When asked where he sees the industry headed, O'Leary, never one to mince words, predicts: "Down the toilet."

That might sound extreme, but like Southwest in the U.S., Dublin-based Ryanair and upstarts like England's easyJet are finding that customers in Europe are willing to give up a lot for lower fares.

Catering to cost-conscious travelers is paying off. Unlike the full-service carriers, Ryanair is projecting growth. O'Leary recently told investors to expect profit growth in the ballpark of 30% to 35% for the next two years. In its most recent quarter ended June 30, Ryanair reported a 58% rise in profits, to 40.1 million euros ($45.3 million), and a 29% increase in revenues, to 194.3 million euros ($219.6 million).

O'Leary shared his candid thoughts about the future of air travel in the U.S. and abroad with BusinessWeek Online's Amy Tsao. Edited excerpts of their conversation follow:

Q: How do the airline industries in Europe and the U.S. compare?

A: The industry in the States tends to run about 10 years ahead of Europe. But you can see Europe moving the same way, toward one large, low-cost airline and then four or five large connecting carriers. In the States, you'll have Delta, Continental, United, American, and Northwest controlling the hubs to connect traffic. In Europe you'll have British Airways, Lufthansa, Air France, and probably easyJet increasingly moving toward the middle-fare niche. Ryanair would be the Southwest [Airlines of

Europe].

Q: Are any of the recent shifts in strategy, such as code-sharing partnerships [which allow airlines to sell seats on each other's flights and offer passengers access to each other's frequent-flier plans and airport lounges], increasing fees to customers, and better union relations, going to help improve performance for the major carriers?

A: Code-sharing, alliances, and connections are all about "how do we screw the poor customer for more money?" People are just fed up with it, which is why you have huge migration to JetBlue and Southwest in the U.S. and Ryanair and easyJet in Europe.

Once you give them choice and low fares and efficient on-time service -- we're beating back customers over here. Our load factors in July and August were at 95%. Statistically, it's almost an impossibility.

Q: Is there anything full-service airlines can do to restore their health?

A: No. They're basket cases. They're incredibly high-cost, very inefficient, and they're locked into businesses where yields are in inexorable decline. These are stupid businesses for the amount of capital tied up in them. They never make any money.

Now, that's not to say they'll all disappear. Clearly they won't. I think they'll limp along from crisis to crisis, whereas strong, low-fare airlines like Southwest in the States or Ryanair in Europe, which operate at a fraction of the fares being charged by the high-fare guys, remain very strong growth models.

Q: With the slowdown in travel and the difficult economy, Southwest has taken a more cautious stance to growth. Do you see reason to build Ryanair at a slower clip?

A: Two things have to be said about that. Southwest may be more cautious, but it's still growing very strongly. At most of the other U.S. majors the traffic isn't growing at all. They're in decline. So Southwest is still showing a positive response to what has been an enormous shock to the system in the U.S.

Europe didn't suffer as much from September 11. I think we have had for years the kind of security after Lockerbie [in 1988, a bomb aboard Pan Am flight 103 exploded over that Scottish town, killing 259 passengers and 11 on the ground] that the Americans are just getting used to. And clearly because the low-cost market in Europe is younger, growth is clearly stronger. We're not nearly as big as Southwest is now.

Q: You're one of several low-cost carriers in Europe. How many low-frills airlines can the market support?

A: Right now it's just easyJet and us. Ryanair would be the low-fare Southwest [no frills, low-priced, and flying out of secondary airports] model, and easyJet is developing more like the JetBlue model, flying to the main airports. I don't think there will be anyone else. Next closest is Buzz, which does about 2 million passengers. [In 2002, Ryanair expects to carry 12 million passengers. In 2001, easyJet had 7.7 million.]

Q: Everyone is worried about business travel. What percent of business-class travelers do you think has permanently disappeared?

A: On short-haul travel around Europe, in the next four or five years, probably 100% of [how we define] business class in Europe -- drinking champagne at 6 in the morning and eating inedible crappy food that you paid $500 for.

If you look around the States on short-haul -- one-, two-, and three-hour flights -- even in first class you still don't get fed. I think the whole thing will migrate to an economy product. In five years on short-haul, no one will be fed -- maybe drinks and peanuts, but that will be about it. The age of quaffing champagne in the morning is just gone.

Air transport is just a glorified bus operation. You get on, you want to get there quickly, with the least amount of delays, and cheaply. Long-haul will always be different. But on short-haul, that's where it's going in Europe, and it has already gone there in the U.S.

Q: This isn't a short-term, economy-related phenomenon?

A: No. You can plot average airfares since about 1950 and see they've been declining year after year. They'll decline for another 20, 30, 40 years. There's nothing short-term about the economics here. The U.S. economy has just gone through the longest bull run in history. Now name me the number of airlines providing free meals and drinks in first class or business class in the U.S. Nobody. They're over.

Q: Do you think low-frills carriers will eventually have to deal with the same problems that the majors have?

A: If I were Southwest, I wouldn't be worried. Southwest is the equivalent of Wal-Mart. No one can outdo Wal-Mart. They have the pricing power. It's not a temporary phenomenon. We're competing in a market where most of our competitors are trying to charge prices of Bergdorfs or Saks. Air transport is just a commodity. All this nonsense that it's supposed to be some experience that can't be repeated is just rubbish.


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