The proposed $17.7 billion merger of Delta (NYSE: DAL ) and Northwest (NYSE: NWA ) may have stolen headlines, but airlines on the whole are coming off a terrible week. Some of the lowlights:
- AMR (NYSE: AMR ) management is facing open revolt among its pilots and reported a massive $1.32-per-share loss in its first quarter. Fuel prices, up 45%, obliterated the bottom line. Tens of millions more could be lost in Q2 because of canceled flights arising from maintenance trouble.
- Continental Airlines (NYSE: CAL ) didn't do much better. Fuel was up 53%, leading to an $0.81-per-share loss versus a $0.22-per-share gain in last year's Q1. Continental plans to retire 14 planes this year and next to further trim costs, Forbes reports.
- Southwest Airlines (NYSE: LUV ) wasn't hit as hard on fuel because of an expansive hedging program. Yet the discounter still saw its first-quarter EPS decline 58% over last year's Q1.
And now for the obvious, child
But we've known for years that airlines make for awful investments. Warren Buffett explained why in this year's letter to Berkshire Hathaway shareholders. Airlines, Buffett wrote, have an "insatiable" appetite for capital that, too often, gets wasted without producing a penny of profit.
Industry executives largely concede this point when they emphasize cost cuts. What they don't talk about -- not nearly as much, anyway -- is raising revenue. Most airlines have done so recently. But that's less a result of adding services than it is of increasing fares to counter skyrocketing fuel prices.
Executives know this, too. Higher costs are why we're seeing Continental and others shave aircraft from their fleets. Lower capacity should, in theory, make it easier to raise fares. Trouble is, when capacity shrinks, we're all paying more to ride planes that are stuffed like a Thanksgiving turkey.
But, again, necessary. The Bureau of Transportation Statistics reports that, in the third quarter of 2007, fares were still 2.9% below their pre-9/11 high for any third quarter. Which is to say that they've been falling for years.
The oh-so-profitable Tao of Steve
Airlines have arrived at an inflection point. Either they'll (1) scale back their operations so completely as to offer little more than a high-speed bus ride or (2) figure out how to earn more from what they have.
I'm strongly in favor of option 2. To get there, carriers need to start thinking more like retailers -- Apple (Nasdaq: AAPL ) , specifically.
Retailers and airlines have more in common than we think. They certainly measure success similarly. Airlines distill revenue and expenses into available seat miles, or ASM, which isn't much different from square footage. The goal for each is to maximize profit from each unit of space where selling occurs.
No one in the retail world benefits from this formula more than the Mac's daddy. Here's why:
- Embrace the simple. Apple Store employees carry wireless checkout devices and can email your receipt. The result? More revenue and more time for customer service.
- Experience is everything. Glass cases? That's soooo Best Buy (NYSE: BBY ) . Apple encourages customers to try its on-display products. Play with them, even. Artificial barriers to buying -- e.g., how do I know if I'll really like this? -- are thereby removed and more buying occurs.
That's what carriers need: more buying. One way to get it is by offering in-flight upgrades. United Airlines could offer this on long-distance flights when its Economy Plus cabin has available seats.
I've received plenty of mail criticizing this idea since presenting it on, ironically, April Fool's Day. Too impractical, some of you said. Balderdash. Install a seatback screen with menu options. List seats available for upgrade and corresponding prices. Interested? Click on the screen and get in the virtual line. Flight attendants will be by to collect your credit card information and reseat you after the aircraft reaches cruising altitude.
There's more. The same screen could be used for:
- Selling premium entertainment.
- Selling premium meals and snacks.
- Try-and-buy access to geekery that promises to make your flight more comfortable, such as Bose headsets or contoured neck pillows. Stuff you'll find in that terrible tease known as SkyMall.
And so on. You order; flight attendants deliver, which means fewer elbow-crushing aisle carts and more revenue for the carrier serving you.
The mathematical reality
For airlines, pocket money can mean the difference between meager profits and staggering losses. Witness American's results. The carrier lost $328 million in the first quarter, or roughly $1,638 per flight. (American operates 2,200 flights a day. Q1 had 91 days.)
Now, if we assume that the average AA flight seated just 100 passengers, then we'd need $16.38 more in revenue -- per customer, per seat -- to wipe out that loss.
Sixteen freaking bucks.
Impossible, you say? Only if the airlines, unlike Apple, fail to think differently.