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DAVID FLIES OVER GOLIATH
By Joe Brancatelli
October 14, 2009 -- The nation's airlines begin reporting third-quarter earnings tomorrow, and the results are a foregone conclusion: The big, so-called "full service" airlines will cumulatively lose about $1 billion, and the smaller, more nimble, supposedly "low frills" carriers will make a few bucks.

The earnings-call patter will also fall into an all-too-familiar pattern: Big Five CEOs and CFOs will stress the rise of ancillary revenue like baggage fees and boast of their comparative success in raising fresh capital to burn during the traditionally brutal winter months. They'll moan about fuel prices, slash route networks again, and promise additional cost-containment measures to squeeze already-demoralized employees and irate passengers. The smaller carriers will underplay their successes and keep their corporate heads down.

This quarterly Kabuki isn't just boring and predictable. It masks an unprecedented development in the nation's commercial air-travel system. The once-almighty "legacy carriers" with the famous brand names and the historic lineage dating back to Charles Lindbergh have become, for want of a better phrase, too small to be too big to fail.

Even as recently as the September 11, 2001 attacks, the carriers that were flying at the dawn of airline deregulation in 1978 still controlled nearly 85 percent of the U.S. skies. This year, after the methodical assimilation of Northwest Airlines into Delta Air Lines, only five so-called legacy carriers will be left, and their combined market share has fallen below 72 percent.

The post-9/11 financials are even worse. Despite five Chapter 11 reorganizations, two mergers, the elimination of perhaps 250,000 jobs, and a string of debt and pension defaults, the legacy carriers lost a cumulative $38.5 billion between 2001 and 2008. And that, say number crunchers at Airline Financials, is before tens of billions of dollars worth of goodwill write-downs and hundreds of millions of dollars of reorganization costs. (United Airlines had the longest and most expensive stay in Chapter 11 in U.S. history.)

And the skies ahead are decidedly unfriendly. OAG, the airline industry's schedule keepers, says that there are 21 percent fewer seats for sale this month than in October 2000. And more cuts are coming this winter as the legacy lines grapple with the aftereffects of a massive international expansion that kicked in just as business travel plummeted after the financial meltdown of 2008.

Before we talk about which airlines will pick up the slack—hint: think JetBlue, Southwest and AirTran—it's worth spending a moment considering the collapse of the legacy carriers.

The six surviving airlines that merged and negotiated their way through the deregulated skies of the 1980s and 1990s—American, United, Northwest, Delta, Continental, and US Airways—were already hurting before 9/11. There had been some profits (about $17 billion between 1993 and 2000, says AirlineFinancials), but their fleets were old, they had pushed business fares too high, and top management was paying itself lavishly while ignoring the day-to-day deterioration of the in-flight product.

Even a no-strings-attached infusion of $4.5 billion in taxpayer funds immediately after the terror attacks that brought down two United and two American jets couldn't stem the rot. The carriers began to shed routes or shift them to commuter carriers. They switched to smaller, slower, more-cramped regional jets from full-sized aircraft. And they forced more passengers to fly through crowded, delay-prone hubs. Service continued to decline as the bankruptcies piled up.

Travelers found alternatives. Southwest Airlines, which didn't fly outside of Texas when the skies were deregulated, already had captured nearly 7 percent of the market by 2001. After 9/11, it expanded quickly, kept fares low, and cheekily promoted its no-frills, no-hassles, no-fees style of service. It made a habit of attacking the legacy carriers at its weakest hubs. The legacy lines usually beat a hasty retreat rather than duke it out with the disciplined interloper. The result: Southwest now commands nearly 9.5 percent of the U.S. market and this year began moving into big markets such as Boston, New York, and Minneapolis.

JetBlue, which launched in 2000 with a fusion of Southwest's operational simplicity and cool new frills like free live TV, grew rapidly too. It drove competitors out of many Northeast-Florida markets, found a niche on transcontinental flights, and successfully positioned itself as an antidote for the shoddy service offered by legacy lines. It wasn't among the nation's 30 largest airlines on 9/11, but now it's the seventh largest and controls 3.63 percent of the market.

Two other carriers, Alaska Airlines in the West and AirTran Airways in the Southeast, also dared to challenge the legacy airlines. Based in Seattle, Alaska now flies coast to coast and has grown to nearly 3 percent of the market. Ditto AirTran, which grew right under Delta's nose in Atlanta.

These four carriers represented just 9.6 percent of the market on 9/11. Today they account for 18.57 percent of the nation's traffic.

Of course, the legacy carriers won't disappear anytime soon. And they aren't quite as small as they look on paper. Although the Big Five now combine for just 71.79 percent of the market, they control 6.84 percent more through their commuter airlines, which are a mix of independent franchisees and wholly owned subsidiaries.

Still, the legacy carriers have gone from 100 percent of the market in 1978 to 85 percent on 9/11, and they've lost upwards of an additional share point each year since. Nothing in the third-quarter numbers will help reverse the trend. And should a horrific winter drive the Big Five back to the edge of serial bankruptcy, there's not likely to be much sympathy for another taxpayer bailout.

That's what happens when you become too small to be too big to fail.

The Fine Print…
Only one legacy carrier, Continental, has a shot at a third-quarter profit. Analysts say it could earn a penny a share. Continental is also the only legacy line that has grown since 9/11. It controls 11.22 percent of the market compared to 9.81 in 2001. United has contracted fastest: In 2001, it was the nation's largest carrier with 18.84 percent of the market; it has shrunk to 13.75 percent. American has fallen to 15.83 percent from 17.05 percent. Including Northwest, Delta represents 23.2 percent of the market; it had a combined share of 27.46 percent in 2001. US Airways, which merged with America West in 2005, is at 7.79 percent compared to its combined market share of 10.56 percent in 2001. (Statistics are based on "revenue passenger miles," the industry's key indicator of turnover.)
ABOUT JOE BRANCATELLI Joe Brancatelli is a publication consultant, which means that he helps media companies start, fix and reposition newspapers, magazines and Web sites. He's also the former executive editor of Frequent Flyer and has been a consultant to or columnist for more business-travel and leisure-travel publishing operations than he can remember. He started his career as a business journalist and created JoeSentMe in the dark days after 9/11 while he was stranded in a hotel room in San Francisco. He lives on the Hudson River in the tourist town of Cold Spring.

THE FINE PRINT This column is Copyright © 2009 Condé Nast Inc. All rights reserved. Reprinted with permission. JoeSentMe.com is Copyright © 2009 by Joe Brancatelli. All rights reserved.