=20 ---------------------------------------------------------------------- This article was sent to you by someone who found it on SFGate. The original article can be found on SFGate.com here: http://www.sfgate.com/cgi-bin/article.cgi?file=3D/news/archive/2005/01/17/f= inancial1216EST0035.DTL --------------------------------------------------------------------- Monday, January 17, 2005 (AP) Discount airlines get squeezed EVAN PEREZ and NICOLE HARRIS, The Wall Street Journal (01-17) 09:16 PST (AP) -- For years, discount airline AirTran Airways tormented Delta Air Lines by offering low fares its much-bigger rival struggled to match. As Delta battled pilots over contract terms, AirTran announced 2003 profit of $101 million, its biggest ever. The airline was flying coast-to-coast for the first time on a brand-new fleet. But last year AirTran, a unit of AirTran Holdings Inc., began to find itself tormented by even cheaper upstarts. Particularly irritating was Independence Air, a new discount carrier that planned to compete on AirTran's lucrative Atlanta-to-Washington, D.C., route with fares that seemed impossibly low. Also last year, Delta, which dominates Atlanta where AirTran has a hub, was accomplishing what once seemed unthinkable: wringing massive pay concessions from pilots and aggressively paring operating costs. Earlier this month, Atlanta-based Delta slashed its most expensive fares by as much as 50 percent, instantly erasing a chunk of AirTran's price advantage. AirTran and other discount airlines now find themselves in a squeeze that shows just how swiftly fortunes change in the modern U.S. economy. In market after market over the past decade, AirTran and other similar carriers have crippled entrenched airlines such as Delta with a combination of ultra-low fares, lean operating costs and clever marketing. But just as they were claiming victory in the airline wars, the discounters are getting challenged from below by a new crop of even-cheaper rivals, and from above by big traditional carriers that are finally getting more competitive. The nation's giant old airlines have retooled their operations and are n= ow mounting effective challenges. Last year, for example, UAL Corp.'s United Airlines won a series of pay concessions from pilots, mechanics and flight attendants and is seeking more. The world's largest airline, AMR Corp.'s American Airlines, threatened a bankruptcy filing in early 2003 to wring cuts from workers. US Airways Group Inc., the seventh-largest airline, has slashed pay so low that its pilots make less than their counterparts at Southwest Airlines, the most successful discount carrier. At the low end, a new crop of insolent insurgents including Independence; Virgin America, a planned discount carrier by Richard Branson's Virgin Group Ltd.; and Primaris Airlines, a new Las Vegas-based carrier, intend to beat the older discount airlines at their own game. For a time this winter, Independence, a unit of FLYi Inc., cut its $79 one-way fare from Atlanta to Washington Dulles International Airport by $20. AirTran and others followed suit, wrecking profits on the route. "The $59 fare is one of the silliest things I have ever seen," says Robe= rt Fornaro, AirTran's president and chief operating officer, referring to Independence. Never mind that back when AirTran was called ValuJet, it charged into the same market with a $59 fare. AirTran says its fare was only introductory. There's little doubt that discounters such as AirTran remain among the most promising players in the airline business. Two older airlines with high fixed costs are currently in bankruptcy court: United and US Airways. In 2004's third quarter, it cost these carriers an average of 10.3 cents to fly one seat a mile, a standard industry cost measure. That's a third higher than low-cost carriers. Discount airlines carry more than 30 percent of nonconnecting domestic passengers, based on statistics from 2004's first quarter, the most recent data available. They now reach markets containing about 85 percent of U.S. passengers, according to the Government Accountability Office, the investigative arm of Congress. Some bargain airlines are expanding into places previously untouched by their low prices, such as Mexico and the Caribbean. But the triumphant atmosphere that thrilled this group a little more than a year ago has now gone. ATA Holdings Corp.'s ATA Airlines filed for bankruptcy-court protection in October. JetBlue Airways, a highly successful low-cost start-up, has seen its operating margins crimped recently and expects to post a rare loss for the fourth quarter. "What worked in the past won't necessarily work in the future," says Gary Kelly, the new chief executive of Southwest. AirTran's CEO, Joe Leonard, says his company is "seeing intense competition from all elements." To the naysayers who think AirTran will be crippled by the industry's latest twist, Mr. Leonard says they're "dead wrong." He says many of these critics also predicted five years ago that AirTran wouldn't survive at all. Even in a notably cyclical industry, AirTran's roller-coaster fortunes stand out. The airline, which started flying in 1993 as ValuJet, challenged Delta by offering cut-rate fares out of Atlanta. ValuJet's "critter" logo -- the smiling airplane sketched on the side of its aircraft -- started cropping up all over, and profits rolled in thanks to rock-bottom costs. Its early success came to a halt on a Saturday afternoon in May 1996 when ValuJet flight 592 crashed in the Everglades, killing 110 people. Investigators blamed oxygen canisters loaded onto the plane. ValuJet shut down for three months because of the crash. By the time the airline could fly again, not even its budget fares could coax passengers into empty seats. In 1997, ValuJet merged with a smaller Orlando, Fla., carrier and took i= ts name. The new AirTran moved its headquarters to Orlando and began a period of conservative expansion. In 1999, when Mr. Leonard took the helm, AirTran was running low on cash after missing out on the late 1990s bonanza in business travel. Mr. Leonard installed a new management team and set about restructuring routes and using aggressive fare sales to fill planes. The Sept. 11, 2001, terrorist attacks took a toll on AirTran as it did a= ll other airlines. But AirTran was able to navigate the downturn better than the major airlines, partly because it had rebuilt its cash position, but also because of its low costs. By early 2004, AirTran had one of the youngest fleets in the industry and as older rivals struggled, low-cost airlines such as AirTran became leaders in the industry. Last summer, Delta insiders say, a top executive cited AirTran in a meeting with employees, declaring that Delta's mistake was letting "the camel get its nose under the tent." Told of the remark in an interview, Mr. Leonard retorted: "Nose under the tent? The camel's inside the tent!" Now, AirTran is experiencing something similar to what it did to Delta. Independence Air, formerly Atlantic Coast Airlines, used to be a profitable contract carrier operating regional flights on behalf of United and Delta. But when United tried to squeeze it for better terms as part of a bankruptcy restructuring, Atlantic Coast transformed itself into the first low-fare airline flying small regional jets. In June, rechristened Independence, it launched cut-rate service from Washington's Dulles and now reaches 38 cities. Independence has made a number of mistakes, including not initially maki= ng seats available on reservation systems used by travel agents, and since its relaunch has flown planes half-empty. Its parent, FLYi, lost $51 on every passenger it flew in the third quarter. The airline recently said it intends to cut its schedule and return 10 jets to lessor General Electric Co. But despite those stumbles, Independence is also working to secure a $19.5 million loan from GE, which will be enough to keep it going for months to come. Rick DeLisi, a spokesman for Independence Air, says his airline considers its main competitors big, older carriers such as United and US Airways, not low-cost airlines such as AirTran. Privately, executives of AirTran and other low-cost carriers recognize that a new, potentially bloody chapter in the airline battles is opening. Wall Street analysts say the next round will be particularly hard on companies such as AirTran, partly because their strategy relies on undercutting rivals' fares. In an October conference call with analysts discussing its third-quarter performance, Stan Gadek, AirTran's chief financial officer, warned of a continuing "weak revenue environment" for coming months "as long as airlines continued to add capacity without regard to financial performance or fiscal responsibility." Mr. Fornaro, AirTran's president, said competition with Independence Air cost AirTran as much as $6 million in third-quarter revenue. AirTran's third-quarter revenue was $245.6 million. More significantly to AirTran, Independence Air's rock-bottom fares to Washington have been hurting one of its more profitable routes. Virgin America, which hasn't detailed its routes, plans to match low far= es with stylish amenities, a segment of the industry where JetBlue and Delta's Song discount unit are already fighting it out. Primaris plans to model its operations on low-cost carriers but offer all-business-class service, possibly siphoning away big airlines' corporate travelers business and competing with low-cost business-class seats on AirTran and Spirit Airlines Inc., another discount operator. At the other end of the market, Delta's revamp is enabling it to become a more-viable competitor. After years of dismissing low-cost carriers as fly-by-night charter operators, Delta's top management, facing bankruptcy, last year mapped out a survival strategy based on cost cuts and a retooled domestic pricing structure. In August last year, the airline began a test of its new fare formula called SimpliFares in Cincinnati. Since its introduction, Delta's passenger traffic there is up about 30 percent, largely from customers who had been driving to other airports to avoid the airline's steep fares. "There's no doubt about it that the SimpliFares did it," says Ted Bushelman, a Cincinnati/Northern Kentucky International Airport spokesman. At Ohio's nearby Dayton International Airport, year-over-year passenger growth for AirTran, the third-largest airline there, slowed to 9.3 percent in November compared with 38 percent in August, the month Delta started its test. AirTran says the slowdown was typical of the post-summer falloff. In November, Delta pilots, then the highest-paid in the industry, approv= ed a 32.5 percent pay cut with the airline minutes from seeking bankruptcy protection. Delta also imposed deep cuts on other workers, including a 10 percent salary reduction for flight attendants. Altogether, it has cut more than $12 billion in operational costs since mid-2002. The cuts helped Delta introduce new low fares. A last-minute, one-way ticket between Atlanta and New York's La Guardia Airport now costs $389, down from $726. AirTran charges $199 on that route. There used to be an $870 difference between Delta and AirTran's price for an unrestricted, one-way fare from Atlanta to Los Angeles. That gap is now $213. Delta also ditched an unpopular rule requiring a Saturday-night stay for its cheapest fares. Delta hopes passengers will feel its prices are close enough to the discounters to justify using the bigger airline -- with its global route system, a well-known frequent-flier program and airport lounges. "Let it be clear, this is not a fare sale," Gerald Grinstein, Delta's chief executive, said earlier this month as he announced the SimpliFares program. "This is a fundamental change to our pricing structure." The changes are expected to cost Delta about $500 million in annual revenue. With the increased traffic, Delta thinks the impact on profits will be negligible. AirTran scoffs at the suggestion that the tables are turning. As Delta rolled out its new fare program this month, AirTran issued a series of written statements expressing astonishment at the fuss. "SimpliFares is about as simple as the U.S. Tax Code," it said in one. AirTran recently ran a spoof ad in the Atlanta Journal Constitution announcing a new line of jellies. The ads asked whether the airline's competitors are planning to copy those, too. Mr. Leonard, a 30-year industry veteran, says AirTran is about to mark t= he 12th consecutive quarter in which it lowered costs. "We're not backing away from anything we have planned, and we think we are well-positioned to take advantage of others' misfortunes," he says. "It ain't easy, but we're not afraid of the situation." Delta's latest fare moves, he acknowledges, may eventually affect margin= s, though they haven't yet. AirTran says it hasn't had to lower any of its fares to keep pace with Delta's new prices. Some of AirTran's more-recent problems have been unavoidable. It suffered more than most carriers from the four hurricanes that hit the southeastern U.S. last year. Florida is a critical market for AirTran and the repeated disruptions of about half its operations was one reason the airline swung to a third-quarter 2004 loss of $9.8 million from a profit of $19.6 million the previous year. Susan Carey and Melanie Trottman contributed to this article. ---------------------------------------------------------------------- Copyright 2005 AP