Hoover Daily Report

The Revolution in Air Travel

Monday, December 2, 2002

A visit to JFK airport is a poignant illustration of the transformation sweeping U.S. air travel. The beautiful TWA terminal is silent, boarded up, surrounded by ugly chain link. United's old terminal now bustles with passengers on JetBlue. Wall Street thinks the traditional airlines are jokes—United's market capitalization is only $146 million, compared to $10.6 billion for Southwest.

Airlines operating under the old model say they just need givebacks from their highly paid employees to stay in business. But that claim understates their economic plight. In the most recent quarter, United reported an operating deficit of 13 percent of its revenue. United deploys airplanes and other capital worth about $21 billion. To retain that capital, United needs to earn a profit of 11 percent of its revenue. Thus, its economic deficit is not 13 percent but 24 percent. United's payroll is 47 percent of its revenue. So the employees would have to give back more than half their pay to make United viable in the longer run. That's most unlikely to happen. United needs a radically new model.

When the traditional airlines compete with JetBlue and other airlines operating under the new model, they accept fares that fall short of costs or they abandon routes to the upstarts. Southwest has pushed United out of many markets in the West, including the California corridor that United once dominated. United has matched JetBlue's fares from Oakland to Washington, D.C., but loses money on every flight, even full ones. As JetBlue and others continue to expand rapidly, the traditional airlines will suffer further reductions in profit unless they update their models. At the same time, the new airlines will adapt their models, especially as they begin to pursue the business flyer.

Southwest has locked itself out of the business market for all but short flights because its seats are cramped and cannot be reserved. JetBlue is a serious rival to the traditional airlines in transcontinental markets because it reserves seats. Other key features of the JetBlue model are a strong commitment to operating on time, operational efficiencies based on simple fares, and the lack of food service. By putting seats where old-fashioned airlines have galleys, JetBlue and Southwest have raised their revenue per planeload substantially. And nobody misses airline food.

But JetBlue cannot penetrate the upper echelons of the business market until it provides more space. Business travelers still pick the traditional airlines if they have a chance at business- or first-class because the single biggest factor in comfort on longer flights is the space between the rows of seats. The next step for JetBlue is to put in six rows of spacious seats in its planes and to charge a premium for them. By the same token, to survive, the traditional airlines need to rip out their galleys, simplify their fares and service, and copy the operational efficiencies of the upstarts.

The air traveler will see rapid changes in the next few years. Either American, United, and the other traditional airlines will adopt and improve the JetBlue model, or they will go the way of Eastern and Pan American.