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Cute New Planes, Same Old Problems


Executives at United Airlines Inc. (UAL) are patting themselves on the back over Ted, their new discount subsidiary that took off from Denver on Feb. 12. In its first four days, 81% of seats were filled and 90% of flights left on time. Better yet were the compliments from happy passengers, who snapped up gift bags of "Ted Tunes" CDs, Ted bears, and other goodies.

Looks like a winner, right? Well, not exactly. Ted and Delta Air Lines Inc.'s (DAL) similar low-cost airline wannabe, Song, are no cure for what ails the network carriers. Sure, these sub-brands should have an edge. With lower-paid flight attendants and 9% more seats on each Song plane, for instance, Delta figures that Song's unit cost -- or the cost of flying one seat for a mile -- is 23% less than for a Boeing 757 in the parent operation.

But analysts question whether the costs will be low enough to truly compete with the likes of fast-growing discounters Southwest (LUV), JetBlue, (JBLU) and AirTran, especially if these units aren't subsidized by their parents.

More important, Ted, which will grow from four aircraft today to 45 by yearend, and the 36-plane Song are just a sliver of the size of their ailing parents. Worse yet, they could prove costly distractions to the main event: the need to dramatically lower the costs of the parent airlines, which are still fighting for long-term survival. "If you're going to fix the factory, fix the factory. Don't create a sideshow somewhere else," says airline consultant Robert W. Mann Jr. of R.W. Mann & Co. That's a sentiment shared by American, Northwest, and Continental, which have shunned sub-brands after watching similar efforts fail before.

While it's true that the network airlines are enjoying a recovery of sorts, they're hardly in the clear. After three years of massive losses and painful cost-cutting, they could almost break even this year. And by 2006, they could earn $3 billion or more, predicts analyst Samuel C. Buttrick of UBS (UBS). But, he notes, "that would not constitute a great return on capital."

Unfortunately, the cost-cutting hasn't gone far enough in the face of spreading low-fare competition and continued penny-pinching by business travelers. United pilot and airline analyst Vaughn Cordle of Airlineforecasts LLC reckons that the six biggest network airlines will bring in $11 billion less in revenue in 2005 than in 2000. He also figures that their total costs per employee are still 40% higher than those of their low-cost rivals. And while the biggies' first-class cabins, globe-spanning networks, and other amenities allow them to collect a premium for each seat flown a mile, that revenue premium is now about 15% and dropping.

"CRIPPLED". On top of those problems, the Big Six have piled up $20 billion more in debt since 2000 and face $20 billion in unfunded pension liabilities. "They will be financially burdened at best and perhaps crippled in some cases throughout the next business cycle," says credit analyst Philip A. Baggaley of Standard & Poor's (MHP).

Certainly, airline managers aren't blind to their troubles. But it's difficult to shed unneeded hubs and aircraft, hidebound work practices, and expensive senior employees to match the low-cost carriers. "The risk is that you blow up the airline trying to do that," says Daniel M. Kasper of economic consultancy LECG Inc.

Indeed, United is drawing the ire of its flight attendants as it tries to cut retiree benefits as part of its bankruptcy reorganization -- after slashing overall labor expenses by 30% last year. And struggling US Airways Group Inc. (UAIR) faces another labor showdown as it seeks more concessions after its bankruptcy and two rounds of givebacks.

Against this bleak backdrop, Ted and Song seem like so much marketing buzz. And buzz won't help the carriers fly though the inevitable industry transformation that lies ahead. By Wendy Zellner in Dallas, with Michael Arndt in Chicago


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