Airfares Hover Below True Cost Of Flying
2008 is already shaping up to be the worst year in the history of the American airline industry: Losses are projected to be as much as $13 billion. Nine smaller carriers have declared bankruptcy, and the sky-high cost of fuel is threatening the viability of almost all major U.S. carriers.
Despite mounting losses, airlines have so far tried to keep airfares from ballooning out of reach for customers. Instead, they have added ancillary charges for services such as checked bags and snacks, and begun using smaller aircraft to offset rising costs. Even so, airlines are often losing money, not making it, on the passengers they transport.
"I don't think we've ever seen the kind of stress put on the industry — and I'm including the time after 9-11," says Dan Garton, executive vice president in charge of marketing for American Airlines.
In order to compete with discount carriers, airlines like American have kept airfares as much as 25 percent below their true market value. If a passenger is currently paying $375 for a round trip ticket, for example, the airline needs that price to increase to $470 round trip for it to break even — that price being the discounted fare. And that helps explain why, despite flights that are often packed, American is losing $300 million each quarter.
Much of those losses are due to skyrocketing fuel costs. "One day this last June, the price of oil shot up $11 a barrel in about an hour and a half. For us that's $80 million," Garton says.
The vast majority of American Airlines' competitors are in the same position. Only Southwest is earning a profit because of its advantageous fuel hedges. The other airlines — United, Delta, Continental and U.S. Airways — all need to raise fares, or they will go bankrupt. While federal law prohibits the CEOs of airlines from colluding to set prices, the logic and the math are inescapable — airfares have to go up.
Garton says the reason airlines have not yet raised airfares is because they are worried that all their full airplanes wouldn't be as full anymore.
A decade of inexpensive oil and the Internet have created this trap for the airlines.
Dave Castelveter, of the Air Transport Association, says consumers share in the responsibility for the airline crisis. He says airlines have to keep airfares below their market price in order to remain competitive online. When consumers visit a travel Web site like Expedia or Travelocity, they often view flights by clicking on a button that says "list flights by lowest fare."
While airline executives would like to make a profit, they're busy trying to stay on the first page of those search results — and they can't do that if they hike their fares. This is part of the reason they've begun adding "hidden" costs for checked luggage and aisle seats, for example. Those ancillary fees do not affect a flight's price position on Travelocity and Expedia.
Still, the math is inescapable: Garton says airlines are going to have to begin increasing fares and slowly bring customers around to this unhappy reality. Over the next several months, carriers are going to cut capacity first, then raise fares.
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