The 'Nasty, Rotten' Airline Business : Planet Money On today's podcast, we try to answer the question — why do airlines keep going bankrupt?
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The 'Nasty, Rotten' Airline Business

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The 'Nasty, Rotten' Airline Business

The 'Nasty, Rotten' Airline Business

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MIKE VOGEL: (As Dean Lowry) Welcome, ladies and gentlemen. This is your captain speaking. Today you get to share a bit of history with us here at Pan American. This is the maiden voyage of the newest clipper jet in the Pan Am fleet. If you've ever flown on a jet to Europe before, you're in for a real treat.


FRANK SINATRA: (Singing) Come fly with me, let's fly, let's fly away. If you can use some exotic booze, there's a bar in far Bombay.


Hello, and welcome to PLANET MONEY. I'm Alex Blumberg.


And I'm Caitlin Kenney. Today is Friday, December 9. That was a clip from the TV show "Pan Am" you heard at the top. On the show today, in the wake of the American Airlines bankruptcy, we are going to try to answer this question - why do airlines keep going bankrupt?

BLUMBERG: We have answers for you. But first, the PLANET MONEY indicator with Zoe Chace.




CHACE: All right. Today's PLANET MONEY indicator - it is three, as in 3 percent, as in the new fiscal pact out of Europe this morning. I pulled it...

KENNEY: It's here.

CHACE: ...Out of there.

BLUMBERG: All right.

CHACE: So exciting, right? New fiscal pact is out. I checked it out. So here's the first thing. You guys remember, with this pact, it's all about making new rules that countries will actually follow and not be in like a death spiral of debt. So the 3 percent rule is a German special. Basically, there's a new rule that a country's deficit has to be small - no more than 3 percent of GDP - if it's in the eurozone.

KENNEY: But wait. I thought they already had that rule.

CHACE: Yeah, they did. But now it comes with sanctions.

BLUMBERG: Oh, OK. So there's, like, an enforcement mechanism. What are the sanctions?

CHACE: Yeah, that's the thing. I don't actually know. I mean, I read through the document a bunch of times. Like, here's what I know about the sanctions. They're automatic, and they're coming. And that's it.

BLUMBERG: But they're not here yet?

CHACE: That's all I know.

BLUMBERG: They're coming at some point.

CHACE: Exactly. But actually, to me, one of the more interesting and sort of new things that is coming out of this pact is that the countries actually now had this oversight where they make their national budgets - right? - but then they have to send the budgets to Brussels, which is kind of like the capital of the European Union. Technocrats in Brussels look over the budgets. They vet them. They cross this out. They add this or that. Then they send them back to the countries to be passed through their parliaments. And that is a really big change.

KENNEY: Wait. So you're telling me - say, Italy has a proposed budget, and they want to spend 8 million on police. And the people at the EU can just look at this and say no way; you can't do that.

CHACE: Yeah. I mean, that's a pretty good example. Don't you think? That's pretty much how it's going to go. These countries are going to come up with their budget and see what Brussels thinks.

BLUMBERG: I have a question.


BLUMBERG: So this is the rule that came out this week. When does it go into effect?

CHACE: Well, there are 17 countries - right? - that have to sign off on this. So what I would call this is a pledge. This is a pledge that these things are going to happen. And then 17 parliaments have to ratify these things. And that could take months.

KENNEY: And the parliaments have to vote to basically take power away from themselves. Like, they're passing something that doesn't give them as much budget control as they used to have.

CHACE: Yes, that is right.

KENNEY: Sounds good.

BLUMBERG: All right, we'll see what happens. Thanks so much, Zoe.

CHACE: All right. Bye, guys.

KENNEY: Thanks. OK, onto the podcast. Last week, American Airlines filed for bankruptcy. And they've got a lot of company. Almost every major full-service U.S. airline has declared bankruptcy.

BLUMBERG: Wait a minute. Is that really true? Are you telling - what about like - I don't know. I'm just going to throw some out at random.

KENNEY: OK. Let's go.

BLUMBERG: What about Delta?

KENNEY: 2005.


KENNEY: 2002.

BLUMBERG: U.S. Airways?

KENNEY: 2002 and 2004.

BLUMBERG: Wait. They declared bankruptcy twice in three years?

KENNEY: Yeah. And so did Continental in 1983 and 1990.


KENNEY: Yeah. It kind of makes you wonder, why would anyone want to be in this business in the first place?

BOB CRANDALL: Well, that's a good question. It's been a great mystery for many years.

KENNEY: This is Bob Crandall. And Bob Crandall would know because he's the former CEO of American Airlines. He also worked for TWA.

BLUMBERG: And we went to him to help us answer this question - why does anybody run an airline? And he's sort of semi-legendary because while he was running his airline, he called it a nasty, rotten business. And now that he's retired, he's actually even more candid. We asked him about some of these recent entrants into the domestic airline business - JetBlue, Virgin America. What are they thinking getting into this business?

CRANDALL: Every now and then, of course, somebody succeeds. But for the most part, it's an expression of ego and a desire to get your instant aviator kit. You know, when you start an airline, you get a leather helmet, a silk scarf and you get to walk around outside the terminal and sniff the kerosene.

KENNEY: Is that what attracted you to the business?


KENNEY: Crandall says he found the airline business stimulating. He actually enjoyed the challenge of it. And by most accounts, he did a good job running American. But he was always skeptical about the industry at large.

CRANDALL: I always was told our employees not to buy the stock - that it's a great company, and it does useful work, but it's not a good investment.

KENNEY: Why not?

CRANDALL: Because airlines don't make money.

BLUMBERG: Now this sounds crazy. How can you have this huge industry with hundreds of companies that brings in billions of dollars a year, operates all over the country - it's been in existence for decades, and it doesn't make money? That sounds like hyperbole. But turns out it's not. We talked to Severin Borenstein. He's an economist at the Haas School of Business at UC Berkeley, and he's spent years studying the airline industry. And he says that if you look at the industry over the last three decades, it's pretty staggering.

SEVERIN BORENSTEIN: The industry, in aggregate, has lost about $60 billion...

KENNEY: That's...

BORENSTEIN: ...Over the...

KENNEY: Is there another industry like that - that's lost that much money?

BORENSTEIN: I don't think so.

BLUMBERG: All right. So Caitlin, let's just think about what this means for a second. That means that the owners of airlines have, in the aggregate, over the last 30 years, been paying their own money for the privilege of flying people around the country, you know? In that sense, that's what that means. They've been paying $2 billion a year on average to fly their planes. They've made less money than they've spent.

KENNEY: It's so crazy to think about. I mean, they violated the number one rule of business. The one thing you have to do as a company...

BLUMBERG: Wash your hands as an employee?


BLUMBERG: Oh. What's the number one rule?

KENNEY: (Laughter) Make money, Alex.

BLUMBERG: Oh, right.

KENNEY: Obviously...

BLUMBERG: That is the number one rule, right.

KENNEY: And they have not been doing that.

BLUMBERG: All right. And so to explain why they have not been doing that, we need to go back in time to a time when the airline business was very different. It's a time before baggage fees and time before you had to pay for peanuts - a time when flying wasn't a hassle, but it was glamorous.

BORENSTEIN: When the 747 was originally introduced in the 1960s, many of them came with a piano bar upstairs.

KENNEY: Wow. Really?

BORENSTEIN: So they had room for people to walk around and, supposedly, were supposed to act as if they were just in a lounge and enjoying themselves.

KENNEY: Doesn't that sound great? I mean, this was a time when people used to get dressed up for their flights. And you would get on the airplane. And it wasn't a rare thing to have a whole row to yourself. Flights were a lot less full.

BLUMBERG: One other difference - fights back then were really expensive. Today it's about 40 percent cheaper to fly somewhere than it was back in the '60s and '70s. And the reason for all these differences - all these differences that we're talking about - the flights being less full, more expensive - back then, airlines were really highly regulated.

KENNEY: That's right. The government told you how many planes you could fly, where you could fly them to and even how much you could charge for tickets. It might seem like that would be a good situation for you as a passenger. If the government's regulating how much the airlines can charge, it seems like they would make them charge as little as possible, so your tickets would be cheaper.

BLUMBERG: But it actually didn't work that way. What the airlines - the airlines would tell the regulators, hey, listen. We can't make a profit at these prices that you're setting for us. So the regulators would then let the airlines raise their prices. And then if some other airline tried to charge prices that were lower than what the government set, the other airlines would take them to court and make them raise their rates.

So what does that have to do with the situation today? Well, think about it. There's all these airlines. They can't compete on price, but they still needed to attract customers. So what do they do?

BORENSTEIN: They tended to compete by increasing service, both the number of flights that were available and some of the onboard service. They're increasing the size of the seats and the other amenities. And all of that drove up costs.

KENNEY: Airlines had more planes than they needed, more people on staff than they probably needed. But it didn't matter because they could charge what they needed to for a ticket, and they were safe for competition. They knew no one was going to undercut them on prices.

BLUMBERG: But at the end of the '70s, the Carter administration deregulated the airline industry. And a bunch of new airlines sprang up that could charge whatever they wanted. Bob Crandall was the CEO of American back then, and he remembers what that was like.

CRANDALL: Fact of the matter is that the public buys airline seats based on price. So if an airline, somebody decides to start a new airline and they come into the business and decide that they're only going to charge $29 for a seat, then I don't have any choice. I have to charge $29 for my seats, too.

BLUMBERG: Even if you're not making a profit on that $29?

CRANDALL: Even if the seat cost me a hundred dollars, I still have to charge 29.

BLUMBERG: This sounds like the voice of bitter experience. Did this happen to you?

CRANDALL: Oh, of course.

BLUMBERG: (Laughter).

CRANDALL: Happens to every airline executive every day.

BORENSTEIN: The legacy carriers have costs that are about 50 percent higher than the newer startups - what are often referred to as the low-cost carriers,- such as AirTran and Southwest, Virgin America, JetBlue.

KENNEY: That's Severin Borenstein again. Legacy carriers are the big national carriers that were around during regulation.

BORENSTEIN: That cost difference is a big part of why these carriers haven't been able to make money. There's no question that a big part of the cost-control problem was in labor relations and, in particular, not so much in the wages they pay because Southwest pays about the same wages as the legacy carriers for similar aircraft, but in the work rules.

If you look at what the low-cost carriers do that's different, they get much higher productivity out of their workers. The jobs are defined more broadly. And their workers tend to be able cover more of the workload. As a result, two things are really evident. One is they need less labor per passenger they carry. And the other is they get more hours of usage out of every aircraft they own. And that accounts for a big part of the cost difference between the low-cost carriers and the legacy airlines.

KENNEY: So in other words, the legacy carriers grew up under a system that didn't encourage cost-cutting. In fact, it encouraged the opposite. It encouraged them to keep spending more and more money on services and people. And then everything just flipped on them.

BLUMBERG: And add to that - this is a business everyone says is notoriously difficult, even under the best circumstances. You know, you have to spend a lot of money just to get the planes. Fuel prices are notoriously volatile. They jump up and down everywhere. And you know, us people, we want to go every damn place.

KENNEY: But still, come on, Alex. I mean, now that American has announced bankruptcy, there is not one legacy airline that's still around today that hasn't gone through bankruptcy - not one. And this is after they've already cut back on services. They charge us now for our food and for our luggage. Why can't they get it together? We asked Bob Crandall about that and then quickly wished we hadn't.

It seems really extreme that the only way these companies are able to get their costs in control is by going through bankruptcy. I mean, they've been in business for a long time. Why haven't they learned over the years how to keep costs in line?

CRANDALL: Well, I'll tell you what. Why don't you try it?


CRANDALL: That's a foolish question. I mean, you can't keep your costs in line if you have labor unions that can go on a strike. And if you cannot tolerate a strike because you will run out of money during the strike, then you give the union what it wants.

KENNEY: So why have some of the lower-cost carriers, as they're known in industry, been able to do well and been able to seemingly keep their costs in control...

CRANDALL: There are very few of them that have. Southwest is about the only one that has a long track record. And Southwest costs have been steadily rising. So if you look at Southwest cost today and Southwest fares today, you'll find that in a great many markets, Southwest is not the low-fare carrier anymore. That's because their costs have been creeping up over time.

KENNEY: We tried to get an interview with Southwest. But so far, they haven't gotten back to us. But the company's CEO recently sent employees this letter after the bankruptcy of American Airlines that echoes a lot of what Crandall said.

BLUMBERG: Yeah. We have it here. It's actually a really interesting letter. It gives you this really interesting insight to the relationship between Southwest's owners and the unions. And you get sort of a little bit of an insight into sort of the Southwest culture, you know? He talks about Southwest being this maverick airline. And he talks about, like, they have a warrior spirit. And they're constantly fighting for market share. But basically, he's making this argument that now that American is the last legacy carrier to fall - to go through bankruptcy - he says, quote, "the term legacy carrier no longer will apply."

And then, he goes on to say the sloth-like industry you remember competing against is now officially dead and buried. We fought them. And we won. Now the enemy is our own cost creep, our own legacy-like productivity and our own inefficiencies. Fighting this cost enemy is an imperative to remain the maverick. We will fight, and we will remain the maverick.

KENNEY: I do like how he tells it straight.

BLUMBERG: I mean, it's really rare and sort of bracing to hear a CEO being sort of this upfront. Here's - people, here's what we're in for basically.

KENNEY: Yeah. But it does sound like other parts of the letter kind of sounds like he's getting ready to sit you down if you're one of his employees and be like, listen, Alex, you're a real asset to the company, but that raise you were thinking about getting?


KENNEY: Yeah, not going to happen. He says, actually, in the letter, our labor rates are now far and away the highest in the industry. Through bankruptcy, very large new airlines have been emerged with lower rates than us and better productivity. I mean, that sounds like no raises to me.

BLUMBERG: Right. Because one person's raise is another person's cost creep. Bob Crandall for his part is one of those rare corporate executives who yearns for the days when his industry was regulated. He actually told us that he wishes the industry would be re-regulated. He wants to go back to those days. He wants the government to re-regulate the airline industry. He misses it and not just because it was better for him and other CEOs, but because he thinks it was better for us, the passengers.

The service is worse today. The planes don't go to all the cities they used to go to. And, you know, something you see a lot of - consolidation - you know, one airline merging with another airline. That's happening over and over and over again. He thinks if it continues, that ticket prices might start to go up again as the number of carriers decreases.

KENNEY: But Severin Borenstein, the economist, doesn't see it that way at all. He thinks maybe it's fine if airlines don't go to all the places that they used to. And he looks at these bankruptcies and says, this happens in every industry.

BORENSTEIN: It's a necessary thing. It's going to happen. Of course, during the process of bankruptcy - the process itself is pretty ugly and pretty inefficient, actually. And it hurts a lot of people. The workers in the industry are pretty unhappy about it. But I think that it does help to move the industry towards a more efficient structure. Airlines that can't make money are going to go bankrupt. And that's going to force change in the industry. And the change is almost certainly going to end up benefiting consumers.


ALISON GOLDFRAPP: (Singing) Fly me away on an airplane high in the sky. Want to see you again.

KENNEY: Before we go today, we want to say a very special welcome to the newest member of the PLANET MONEY family, Asher Arrow Banbury Davidson (ph). Adam Davidson and his wife Jen recently had a very cute little boy. And we're really excited for him.

BLUMBERG: We are, indeed, really, really excited. Congratulations, you guys.

KENNEY: All right. That's going to do it for us today. As always, email us your thoughts, questions, concerns.

BLUMBERG: Or you can find us on Facebook and Twitter. I'm Alex Blumberg.

KENNEY: And I'm Caitlin Kenney. Thanks for listening.


GOLDFRAPP: (Singing) This crazy life, this crazy world we're living in is magical.

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