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Why Is 20% The Magic Number?

Wed Sep 19, 2001 8:00 am

If it weren't for desparate times like these, my eyebrow would be raised... The fact that most airlines are cutting capacity by 20% would seem like a collusionary tactic irrespective of last week's events.

In the aftermath, most airlines have settled on about 1/5 system capacity cuts.

I believe AA was the first to announce it would resume operations at 80%... Then CO announced it was laying of 12,000 (a little over 20%) of its workforce.

Why 20%?

One would think that one airline would leave capacity up as everyone else is ramping down their ops... to take advantage of market share opportunity.

Personally, I think that this is a concerted tactic by the airlines to receive generous financial support, such as interest-free loans.

Not that this is wrong--the airline industry is one of the key drivers of our economy. It serves as the vital transportation link for people, personnel, and products.

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I Agree With You

Wed Sep 19, 2001 8:12 am

What I will say may make some angry, but it is merely a thught that crossed my mind and I want to share it. Please forgive me if it is wrong.

Continental, which I heard was one of the airlines in the best financial shape, announced the first cutbacks in routes and employees. This was happening at the same moment Gordon Bethune, whom I think is a financial genius, was appealing to Congree for financial aid to the airlines. Was the announced cutbacks a necessity, or was it simply a way to show the government that they desperately need the money?

I agree that the law of supply and demand will prevail. The need for air travel will bounce back, and with so many airlines cutting back, it seems as if there will be the opportunity of some airlines to pick up some of the business that others have cut back on.

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RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 8:49 am

If you think about it...pre-WTC load factors for most airlines were in the upper 70% range. I personally think they may have just been waiting for a reason to drop 20% of their flights, thus boosting load factors near 100%. Planes, airports, ... will become more crowded as travel picks back up, yet there will be a lot more revenue seat miles compared to total seat miles. Not saying they're just taking advantage of the situation, but thats why I see 20% as being the magic number instead of something else.

RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 9:04 am

The basic requirement to receive a handout from the government is to show a need. The airlines, with Gordon acting as pointman, took advantage of this horrible attack to justify a major shift in their business plans, a shift that might otherwise have come about more gradually over the next few years.

It should not go unnoticed that CAL took one of the biggest hits (in percentage loss)on Monday, despite it's superior performance in the past year. All this changed suddenly when Gordon opened his mouth. Note, too, that the other stellar performer, SWA, has just plugged away, focusing on restoring full service, and their stock fared much better than the others on Monday. Remember last winter, when the new administration was waltzing around the word recession? So many politicians were saying how irresponsible it is for leaders to think and speak negatively...for fear it will drag down the economy. Well, this is exactly what Gordon did when he spoke. Rather than speaking in positive terms to restore confidence in flying and minimize the damages, he shifted gears and aimed straight for that big bucket of money in DC.

What I find most troubling about this is that, with governmental intervention into the marketplace, the weaker, less efficient (and often more price-gouging) airlines are "saved", making it that much harder for the better managed airlines to survive and prosper. One person's government intervention is another person's government interference; it often has a short-term upside coupled with a long-term (and much more significant) downside.

The significance of "20%" is that this is probably a fair estimate of the present over-capacity in the industry, with the economic downturn and the capacity boom of the past few years. Question: If the AAL merger had been nixed and TWA had simply been allowed to die, would we still be this much over-capacity, and would the overall industry be healthier?

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RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 9:25 am

The curious timing of Mr. Bethune's announcement that CO will cut capacity and jobs by 20% left me wondering if it may have been a deliberate attempt to manipulate the federal governement into bailing out the airlines for not only the effects caused by the tragic events of 11Sep01 but also for the managerial ineptitude that was resulting in troublesome losses -- in spite of load factors in the 75-80% range -- at most if not all of the full-service majors months before the WTC and Pentagon tragedies.

As for 20% being "the magic number" it does, indeed, suggest the possibility of collusion among the full-service majors (note that both Southwest and JetBlue were operating 100% of their pre-11Sep flights within 72 hours after the skies were re-opened to airline traffic, and plan to continue at the same level).

It is at least as likely, if not more so, IMO, that the "magic number" of 20% is not so much a matter of collusion as it is a case of the "monkey see, monkey do" mentality of mindless conformism that pervades the executive suites at the full-service U.S. majors.
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RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 9:34 am

I agree with Tango-Bravo. I thought all the majors making the same 20% announcement was strange. It's clearly a case of "monkey see, monkey do". One airline determines 20% is the right number, the others match it to show the same apparent focus on cost reduction and to buttress their share prices.

Indeed, Air Canada also announced a 20% cut for their transborder flight network (Canada-US) although they're still working on the details.
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Wed Sep 19, 2001 11:08 am

Great point about Southwest. They always do their own thing, and by doing so usually surpass the majors in the process. I have not yet heard them take oin the role of victim. Why do you think this is? Granted, they are so financially sound. Also, they are so well run. Why haven't they had to cut back flights or lay off employees?

By the way, has SWA ever laid off an employee?
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RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 12:14 pm

Great posts, guys...this thought provoking discourse is what makes airliners.net really worthwhile.

Lsjef... that is a very pertinent question. Not only would American be further from the 'dire straits' it is in now (it will run out of cash about as soon as United at this rate, and United was hemorrhaging losses), but TW's assets could have been more equitably distributed. Indeed, much of the TW system would probably have been dismantled, and service left unresumed.

Now that AA has committed to the W1W Expansion Project at STL, it seems as if the need for STL in the first place has been negated. ORD and DFW will no longer be as clogged due to cut flights.

Tango-Bravo & Yyz717... because the airline industry is an oligopoly, yes, naturally their gut reaction is "monkey see monkey do". But is there a threshold to their 'cooperation'... and behind the scenes, are they really colluding against the consumer? EIther way, I think they are in the driver's seat right now. We need the airlines, and cannot allow them to whither. My sympathies for the industry, also, as being one of the most historically unprofitable.

MCOtoATL... good question about LUV. I really don't know, although from reading Hard Landing, I tend not to think that they've laid anyone off, other than for violation of procedure, or crime, etc.

For an educated look at how long each major has to live... check out this Planebusiness analysis:


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Wed Sep 19, 2001 12:50 pm

That was a great article about the financial analysis of the majors. I was impressed with the numbers for Alaska Airlines. They must be well managed.

By the way, you mentioned the book "Hard Landing," which is probably the best aviation-related book I have ever come across (and I have read quite a few.)

I don't think that the public's fear of flying will last (unless, heaven forbid, we have another attack.) In fact, I myself am taking advantage of low fares as the airlines realize the supply curve now is not in their favor. I will be flying Delta in a few weeks between Orlando and Atlanta (Md-11 and 777.) I am flying round trip for $99 (thanks to a $25 voucher.) Up until this past week, the lowest fare during the past month was $171.

We need air travel, and this slump will not stay down. Some people are saying that the airline industry will crumble. But this could never happen. Sure, some majors may "go under," but the demand is there, and as long as someone will meet the demand, air travel wil continue.

Now they are facing problems for various reasons:

1. last week's attack has the general public a bit nervous to fly

2. even prior to the tragedy, the airline industry was suffering

3. a post-attack recession may occur, which further hurts the airlines

4. the possibility of conflict in the middle east may cause fuel prices to skyrocket

5. low load factors mean lower prices, which mean more struggles

6. I would argue that many airlines were not prepared for a crises and the above-mentioned reasons, coupled with this, mean bad news for many.

To be honest with you, while we say that the smaller carriers will suffer, some of them actually have the chance to do very well. For one thing, it is much easier for them to get re-situated after this mess. Secondly, thier costs structures are generally more favorable.

For example, if Delta struggles and pulls out of some cities, Airtran is there to take care of the demand. Obviously, Southwest is still chugging right along, as will Jetblue and some others.
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RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 1:02 pm

One thing I find curious, is that, while the estimates are that the 10 major US carriers will lose around $5 billion this year, here they are begging Congress for a $24 billion dollar bailout! They're not only asking to be bailed out, they're asking the US taxpayer to take them back to their high levels of profitability they enjoyed in the not-too-distant past.

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RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 1:55 pm

AA took the lead of announcing 20% cut back. This cornered the other airlines into announcing similar numbers to please the Wall Street analysts. If the others cut more than AA's 20%, analysts would hammer their stock stating they were 'conceding market share' repeat again in sonorous sounding voice!. If they cut less, they would be hammered for 'not downsizing appropriately to the market conditions', so basically the Wall Street MBA's who never did anything to actually earn a living, took AA;s 20% as 'gospel' forcing all others to follow suit.

Regarding the cash positions of the airlines, it is a fact that 1bn in cash reserves for CO and NWA will only last one month if they loose 30MM per day. Worse is the cash flow effect--with advance purchases of tickets down so substantially, the airlines do not have the customers' advance cash to finance their operations! Once airline is already drawing down its 1.3bn line of credit to put the cash in the bank. But that is all they have available from the bankers! Without the customer advance cash--now you know why airlines discount prepaid 14 and 21 day fares!--they would need a lot more bank lines of credit to maintain operating cash flow during tough times, and frankly none of them haveb unused lines of credit that are all that large! And right now is certainly not the time to go and tell your banker that the airline business is 'a great and profitable business' and 'so please increase my credit limit by another couple billion' to tide my airline over , until the travelling public overcomes its fears!

Gordon Bethune is absolutely correct. Faced with 1bn in cash reserves, limited extra bank lines of credit, and 30mm a day in losses, without massive and immediate cuts in expenses, he is right in saying alternative would be Chapter 11 at end of October. Unless you can find a million college students willing to plunk down TODAY a couple hundred dollars each for trips to Mexico resorts for spring break 2002, Mr. Bethune is right on in pushing for govt support. I don;t see the business community rushing to buy airline tickets!

Things will recover but it could be a year to two years before overall numbers exceed last years. I still predict that by 2005 air traffic in USA/Worldwide will still average 5-7% annual growth, in spite of a negative 2001. The 9-11 events are so awful in their effect on airline cash flow over the next 90-120 days, that there are grounds for govt support. The US government did massively subsidize the Shipping Industry from 1940-1970 as a result of WWII war sinkings, and this is no different. The US Govt does reserve the right to use much of the civil air capacity in real times of need, such as during Gulf War. There is a national interest in keeping a strong viable domestic air industry.
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RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 2:27 pm

Even IF the airline industry receives assistance from the government, they'll still be in financial trouble....NONE of them were doing well this year anyhow. BUT if the government is going to assist the airlines, the travel agencies, hotels, and convention location providers, e.g. Disney, will be in hot pursuit....what justifies in a de-regulated airline industry giving direct financial subsidies to the airlines?
The airlines are going to try to milk what they can in this financial crisis. And these events are going to put the U.S. in a recession and airlines will declare bankruptcy and furlough.
I am curious to see how things will be in the next six months. And what about Midway Airlines??? Will they, too, qualify for this financial free-for-all?
I do not disagree with financial assistance to the airlines, I just question it since the cut-backs are inevitable.
And how come they're so quick to furlough, they have not had time to research how many employees may want to take a few months/years on unpaid leave!!!! Many cannot afford that, but many can- and would welcome it! I sure wouldn't mind being given an unpaid leave of absence to pursue something else with the chance of being reinstated in better times. I would love if I were put on a few years leave with the company's flight privileges, now that would be nice  Wink/being sarcastic
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RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 6:04 pm

SFOintern, I have to agree with you. I think that it is just a way to get money from the government.
And if it is true, who will be able to say that competition is not fair, because in the USA, companies are private... And in Europe, they are backed by their governments....  Wink/being sarcastic
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RE: Why Is 20% The Magic Number?

Wed Sep 19, 2001 9:49 pm

don´t say that european airlines are generally backed by their governments. take a look at British Airways and Lufthansa, which are wholly privatized...
however, i do agree that government backing in europe is still quite present, but still, in times like these it may certainly be a good thing and i do hope that governments won´t hesitate too long (à la Ansett) if any carrier runs out of funds just because of the recent events.

i must admit, that i do agree with the above posted statements and in particular with the statements about the airlines looking for a shrink-down to profitability.

to some extent, i do think that airlines (mis-)use this "bad timing" and i´m pretty convinced that many airlines had already plans in their drawers to cut down its workforce and their schedules (US, UA come to my mind).
but i don´t want to heat up any sentiments right now...

however, i do think that air travel will again pick up within the near future and so i do think that airlines which survive this will emerge ever stronger when the day comes...
so although aviation seems rather bleak at the moment, this is just a temporary, imho...

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