A position report that examines how the airline industry is faring after the terrorist attacks on the World

Trade Center in 2001. 2,180 words, 4 sources, APA, $ 68.95 USD Paper Summary: This paper shows that the decline in airline revenues post-9/11 served to further exacerbate the rise of low-cost airlines and the financial fragility of airlines with high fixed costs. As 9/11 devastated revenues for large airlines with high costs, low-cost airlines flourished. Further, the trend toward low-cost airlines seems to be here to stay, illustrating the dangers of inflexibility and high fixed costs in the cyclical airline industry. The paper presents a literature review of articles and websites on the topic. From the Paper: "In the fallout following the events of 9/11, several major airlines filed for bankruptcy, including Swissair, U.S. Airways, United Airlines, and Sabena. Airlines struggled to reduce high fixed costs, and cost-cutting initiatives quickly followed apparent revenue decreases, as close to 15 percent of the industry workforce lost their jobs in the last quarter of 2001. In the six months after September 11th, close to 1,000 aircraft were grounded, and some companies had close to 50% reductions in both flight frequency and routes. These cost reduction efforts were often successful, as Delta reduced costs by U.S. $1.1 billion, and United reduced costs by U.S. $1.2 billion (A. T. Kearney, Inc.)." Keywords: passenger aircraft apa Discusses impact on airline of downturn in travel after 9/11. Reduction of passengers & flights. Steps that need to be taken to maintain profitability. SWOT analysis. The Southwest concept. Recommends building up leisure market & business travel & continuing military fare discounts. Necesity of advertising & marketing. Competitive position. From the Paper: "Southwest and the Airline Industry After September 11 While the airline industry had been falling victim to higher fuel prices and lower load factors even before September 11, the grounding of all airlines flying in, to, or from the U.S. for two days and the public's increasing fear of flying has caused billions of dollars in losses, and not merely in the U.S. Swissair, for generations the epitome of "class" among international airlines , stopped flying until it was rescued by a $380 million bailout by Swiss banks- and then only until October 28. Nearly every airline in America cut back its schedules and laid off or furloughed thousands of workers. Until now, the one beacon of continuity was Southwest Airlines, a highly successful short-hop airline- perhaps the most profitable in the U.S. But now, even this airline has had to make some..."
U.S. Department of Transportation

Research and Innovative Technology Administration

Issue

Brief
Number 13 December 2005

Todays airline industry presents a different picture than it did prior to the events of September 11, 2001 (9/11), with more passengers flying low-cost carriers, fewer empty seats, and a smaller workforce. Airline passenger travel and capacity (measured in terms of available seats) fell drastically after the terrorist attacks of September 11th, when our national air space was temporarily closed. The numbers of airline passenger and seats remained low in subsequent months, but have recovered in the following years. Available seats have increased more slowly than air passenger travel, and have only recently reached the pre-9/11 peaks; in contrast, air passenger travel reached its pre-9/11 peak in July 2004 and has continued to grow. Thus the aviation industry has accommodated passenger growth with few additional seats, which means fuller planes. At the same time that the industry was facing this large-scale drop and subsequent recovery in the number of passengers, there were shifts in the size of different segments of the industry. In particular, the low-cost carriers grew significantly and air fares decreased through this period. Network carriers responded to the pressures on the domestic market by reducing available seats and shifting some capacity to the international market. They also dramatically cut employment in order to reduce costs. Passengers Return In the August preceding 9/11, the airline industry experienced what was then a record high in the number of airline passengers for a given month when 65.4 million travelers took to the air. After 9/11, that number trailed off dramatically, and it took nearly 3 years, until July 2004, for the industry to match and finally surpass the pre 9/11 levels. But the number of available seatsan industry measure of capacity in July 2004 was just 98.3 % of its August 2001 peak. By July 2005, the number of airline passengers had reached 71 million.

Airline Travel Since 9/11

BUREAU OF TRANSPORTATION STATISTICS
Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05

0 10 20 30 40 50 60 70 80 Deseasonalized Actual Millions

U.S. Domestic Airline Passengers Actual & Deseasonalized

Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 0 20 40 60 80 100 Deseasonalized Actual Millions

U.S. Domestic Airline Available Seats Actual & Deseasonalized

Note: These graphs present both actual data, and data that have been seasonally adjusted in order to clarify the trends over time. The data cited in the text represent actual (unadjusted) values. Source: U.S. Department of Transportation, Research and Innovative Technology Administration, Bureau of Transportation Statistics, T100 SEGMENT data Nov. 21, 2005.

Airline capacity (expressed in available seats) has increased more slowly than the increase in airline passenger travel. Low-cost carriers represent a growing portion of the domestic aviation market. This change has been accompanied by decreasing fares. Network carriers have responded by shifting capacity to international markets and by reducing employment to cut costs Fewer Empty Seats In the comeback from post 9/11 lows, capacity has risen more slowly than growth in passenger numbers. Available seats hit a peak of 90.6 million in August 2001. But after 9/11, capacity dropped dramatically as airlines grounded planes and reduced flights to match falling demand. Only 67.5 million seats were available in September 2001. In July 2005, the number of available seats exceeded the pre 9/11 level for the first time at 91.1 millionan increase of about 0.6 percent compared with an increase of about 9.7 percent in passengers over the pre 9/11 high. Because the airlines have accommodated the surge in passengers with only a minimal increase in the number of seats, aircraft are flying with fewer empty seats. Fewer Employees Current employment levels for network and low-cost carriers 1

are 28% below July 2001 levels as many airlines strive to reduce costs. Employment for network and low-cost carriers stood at 534,767 in July 2001.2 But 4 years later, in July 2005, employment had fallen 28 percent to 383,859. This drop was driven by a decline in employment by the network carriers compared to increased hiring by low-cost carriers. Network carrier employment fell by 34 percent, from 465,198 in July 2001 to 308,714 in July 2005. During this same time period, low-cost carrier employment increased by 8 percentfrom 69,569 to 75,145. Market Changes One response U.S. network carriers made to the post 9/11 market conditions was to shift capacity from domestic to international markets. International service represented 12.0% of seats on network carriers in May 2001, increasing to 15.2 % in May 2005.3 The shift of available seats toward the international market occurred as the network airlines were reacting to the rising dominance of low-cost carriers in the domestic marketplace. The low-cost carriers vigorously added capacity while the network airlines reduced domestic flight operations to reduce costs. Annual available seats on low-cost carriers increased by 24%4, from 182 million in 2000 to 226 million, in 2004, and passengers increased by 27%, from 124 million to 158 million, during the same period. At the same time there have been changes in the domestic aviation pricing structure reflecting the growing impact of low-cost carriers and other factors. Widely available, relatively inexpensive air fares have contributed to the increase in passenger travel. For example, the Air Travel Price Index (ATPI), which tracks changes in prices paid for airline tickets, showed in the first quarter of 2005 the lowest fare index of any January-to-March period since 1999.
Number of Employees in July for Passenger Airlines, 20012005
Total (excluding regional Network Low-cost and other Regional Other July carriers carriers carriers) carriers carriers Total 2001 465,198 69,569 534,767 2002 394,686 71,263 465,949 2003 332,376 74,025 406,401 44,280 8,277 458,958 2004 325,436 75,994 401,430 58,038 12,668 472,136 2005 308,714 75,145 383,859 60,738 13,631 458,228 Note: Includes the total of full-time and part-time employees. Airlines that operate at least one aircraft with the capacity to carry combined passengers, cargo and fuel of 18,000 pounds must report monthly employment statistics. The other carrier category generally reflects those airlines that operate within specific niche markets, such as Aloha and Hawaiian Airlines that serve the Hawaiian Islands. Source: U.S. Department of Transportation, Research and Innovative Technology Administration, Bureau of Transportation Statistics. www.bts.gov/ press_releases/2005/bts042_05/html/bts042_05.html as of Nov. 21, 2005.
1

Network and low-cost carriers do not include regional carriers. Network carriers are the traditional hub-and-spoke carriers. 2 Employment at network carriers and low-cost carriers, based on data from RITA-BTS,

OAI, monthly P-1(a) Form 41. Data are incomplete for regional and other carriers in 2001 and 2002. Regional and other carrier data for years when regional and other carrier data are complete is shown in the accompanying table for July 2003 through July 2005. 3 U.S. Department of Transportation, Research and Innovative Technology Administration, Bureau of Transportation Statistics, T100.SEGMENT data, Nov. 21, 2005. 4 Ibid.

1999-Q 1 2000-Q 1 2001-Q 1 2002-Q 1 2003-Q 1 2004-Q 1 2005-Q1 90 95 100 105 110 115 120 Index: 1995 Q1 = 100 U.S.-origin ATPI

Air Travel Price Index

Were on the WEB! www.bts.gov

answers@dot.gov Info line:1-800-853-1351
For More Information: Ken Notis, Economist U.S. Department of Transportation Research and Innovative Technology Administration Bureau of Transportation Statistics 400 7th Street SW, Room 4125 Washington, DC 20590 Phone: 202-366-3576 Fax: 202-493-0568 Ken.Notis@dot.gov
Source: U.S. Department of Transportation, Research and Innovative Technology Administration, Bureau of Transportation Statistics, Nov. 21, 2005.

The paper looks at the success of low cost carriers such as JetBlue Airways and Southwest Airlines in the light of the current financial dilemmas affecting the major North American network of carriers. 5,437 words, 15 sources, MLA, $ 139.95 USD Paper Summary: The paper analyzes how successful airlines like Southwest, JetBlue and the other low cost carriers have basically kept their costs down and satisfied the consumer demand for reasonably priced airline travel while maintaining consistent profits. The paper explores the significant factors that keep the major airlines in debt. The paper concludes that the major airlines need to make drastic changes, such as control costs and capacity, in order to overcome their financial predicaments. Table of Contents Problem Statement Significance of the Study Assumptions Limitations Review of Relevant Literature and Research Research of Airline Industry Stocks Jet Blue and Southwest Population Results Discussion in regard to 9-11 Conclusions Recommendations References From the Paper:

"Moving into the twenty-first century, commercial aviation has been on a steady decline. Profits have dried up and overall passenger travel miles are down. To make matters worse, the lingering effects of September 11, 2001 have almost completely ruined the entire commercial aviation industry. United Airlines is in the brink of nearly shutting its doors forever. American Airlines, Continental, Delta, US Airways, American West and Northwest all are experiencing their worst financial difficulties in their corporate histories."
Airline Industry Survival Air travel remains a large and growing industry. It facilitates economic growth, world trade, international investment and tourism and is therefore central to the globalization-taking place in many other industries. In the wake of recent world events major airlines are facing significant losses and potential bankruptcy, the largest annual loss in the history of the industry. As a result of terrorism the industry is faced with a global economic slowdown, structural weaknesses, high fuel costs and labor problems. The current crisis cannot be blamed solely on the events of Sept. 11, 2001. Even before the world witnessed the disastrous hijacking of four commercial airliners, the airline industry was close to financial ruin. The terrorist attack, elimination of flights and the need for major investments in airport security have pushed the airlines into nothing short of a fight for survival. The economic aftershocks of the Sept. 11 attack is widespread; in addition to the airline industry, tourism, insurance and shipping are also sure to suffer substantial losses. Passenger volumes have dropped drastically among concerns about security. Airlines have already undertaken aggressive action to reduce capacity and Airline Industry Analysis Industries such as the US airlines are a very valuable and are used throughout the world as an easier way of transportation. Some would call this industry an oligopoly. The airline industry is classified by the government and is based on the amount of revenue that is generated from operations. This type of industry is categorized in 4 different sections: major, regional, national, and cargo carriers. All of these categories have ways of displaying and executing services to interested consumers. Major airlines are also called truck carriers. They are considered nationwide. National airlines are scheduled airlines for the planned consumers and travelers. Like the major airlines, national serve to medium and large size jets. Regional airlines focus mostly on transporting major travelers between major cities and small communities near by. This class has bee seen to have the fastest growing and most profitable segment of the airline industry. Lastly there are the cargo carriers. They are part if the industry that focuses on the passengers and their cargo. The airline industry has a main focus and that would be their customers and the satisfaction that is relayed to them. Their mai

us airline industry Athens University of Economics and Business Department of Business Administration

Discussion questions for case three: The US Airline Industry in 2002 1. Use Porters Five Forces of competition framework to show how the structure of the airline industry has caused low profitability during the past twenty years. Since domestic deregulation occurred in 1978, competition in the airline industry has intensified and become more concentrated. This situation can be analyzed through Michael porters framework of the five forces of competition. This framework views the profitability of an industry as determined by five sources of competitive pressure. These five forces of competition include three sources of horizontal competition: competition from substitutes, competition from entrants, and competition from established rivals and two sources of vertical competition: the bargaining power of suppliers and buyers. Competition from substitutes: the price buyers are propense to pay for one product depends, in part, on the availability, and on price-performance of substitute products. The airline industry faces competition

A discussion of the impact on the airline of the downturn in travel after 9/11. 1,800 words, 6 sources, $ 63.95 USD Paper Summary: Discusses impact on airline of downturn in travel after 9/11. Reduction of passengers & flights. Steps that need to be taken to maintain profitability. SWOT analysis. The Southwest concept. Recommends building up leisure market & business travel & continuing military fare discounts. Necesity of advertising & marketing. Competitive position. From the Paper: "Southwest and the Airline Industry After September 11 While the airline industry had been falling victim to higher fuel prices and lower load factors even before September 11, the grounding of all airlines flying in, to, or from the U.S. for two days and the public's increasing fear of flying has caused billions of dollars in losses, and not merely in the U.S. Swissair, for generations the epitome of "class" among international airlines , stopped flying until it was rescued by a $380 million bailout by Swiss banks- and then only until October 28. Nearly every airline in America cut back its schedules and laid off or furloughed thousands of workers. Until now, the one beacon of continuity was Southwest Airlines, a highly successful short-hop airline- perhaps the most profitable in the U.S. But now, even this airline has had to make some..."

Aviation Security and Terrorism: A Review of

the Economic Issues

Cletus C. Coughlin, Jeffrey P. Cohen, and Sarosh R. Khan Protecting this system demands a high level of vigilance because a single lapse in aviation security can result in hundreds of deaths, destroy equipment worth hundreds of millions of dollars, and have immeasurable negative impacts on the economy and the publics confidence in air travel. Gerald L. Dillingham, United States General Accounting Office, in testimony before the Subcommittee on Aviation, Committee on Commerce, Science, and Transportation, U.S. Senate, April 6, 2000

he terrorist attacks exploiting weaknesses in

U.S. aviation security on September 11, 2001, did indeed produce the catastrophic results identified in the prophetic testimony cited above.1,2 Immediately after the attacks, security issues rose to paramount importance in the nations policy agenda.3 Despite general agreement on what aviation security entails and the goals of an aviation security system, public controversy abounds on how to regulate and provide this important activity. If airplanes and passengers, as well as property and people on the ground, are to be protected, potential perpetrators of aviation terrorism must be prevented from breaching security checkpoints and gaining access to secure airport areas and to aircraft. Given the interconnectedness of the air transportation system, a sufficiently high level of security must be provided throughout the entire system. Flexibility to respond quickly to new information about aviation security threats is a must. Moreover, incentives must be offered to both the regulators and security providers so that aviation security improvements can be devised and implemented. At the same time, however, the costs associated with providing security must be incorporated in the decisionmaking process and weighed against the benefits. In this paper we examine the economic issues relevant to airline and airport security in the United States, a topic that has received little attention from economists. Understanding the key economic issues is crucial in evaluating the various methods of regulating and providing aviation security and for appraising the conflicting positions over the appropriate

scope of governmental involvement in this effort. We begin our examination of the economics of aviation security by highlighting the key features of the airline industry, one of which is its network structure. As a result, security at one airport can affect security elsewherean example of a network externality.4 Next, we use elementary economics to show that unregulated private markets will likely provide too little aviation security, which sets the stage for an examination of the alternatives for regulating and providing aviation security. We review the key features of the recently passed Aviation and Transportation Security Act and the characteristics of the resulting security policy. A summary of our major points completes the paper.
Four planes were hijacked by 19 terrorists on September 11, 2001. Two of the flightsAmerican Airlines flight AA 11 and United Airlines flight UA 175departed from Bostons Logan International Airport. The former flight crashed into the north tower and the latter into the south tower of the World Trade Center. The third flightAmerican Airlines flight AA 77departed from Washingtons Dulles International Airport and ultimately crashed into the western side of the Pentagon. The fourth flightUnited Airlines flight UA 93departed from Newark International Airport. Following passenger actions against the hijackers, it crashed in Stony Creek Township in Pennsylvania. The hijackings led to the deaths of more than 3,000 people, including all the passengers and crew on the four flights. 2 We distinguish between aviation security and aviation safety. Aviation security issues require a perpetrator whose malicious intent is to advance his/her interests or that of a group, quite possibly by destroying lives and/or property. Aviation safety issues arise because of accidents due to human errors and mechanical failures. 3 Aviation security is part of the larger issue of transportation security, which, in turn, is part of homeland security. Security policies in the United States, as well as elsewhere, have effects throughout the world. See Flynn (2000) for a recommendation that U.S. transportation policymakers pay increased attention to U.S. vulnerabilities and Flynn (2002) for a discussion of the globalization issues associated with security policies. 4 An externality, also termed a spillover, is said to exist when either the consumption or production activity of one consumer/firm affects directly either the utility or production activity of an external party. In other words, some benefits or costs are experienced by a party that is not part of a specific consumption or production decision. The crucial economic feature of an externality is that its benefits or costs are not reflected in market prices.
1

I appreciate the opportunity to speak before the distinguished members and guests of the International Aviation Club of Washington. It is indeed an honor and a privilege to address you. For those of you who don't know me, I'd like to note that I have a long association with the industry, both on a professional and a personal basis. The most significant or notable professional experience comes from my tenure as head of the PBGC during the 1980s. In that capacity, I had significant dealings with the airline industry, in general, and with distressed airlines, in particular. On a personal note, my wife Marywho's here todayhas worked in the industry for 31 years. She is a flight attendant with Delta. This is her final week, as she is retiring on December 1. I have to add that she was flying out of Boston on the morning of September 11 on a 757 headed to the west. It was a very long hour for me before I learned that she was not on either of the two Boston 757s that struck the World Trade Centers. In the meantime, I had to focus on the more than 3,000 GAO and Army Corps of Engineers employees in our headquarters building. Some of you may not be familiar with the agency that I lead. The U.S. General Accounting Office, better known just as GAO, is in the legislative branch of government. Our mission is to help the Congress maximize the performance and assure the accountability of the federal government for the benefit of the American people. Simply stated, we try to make government work better for all Americans. At GAO, we are uniquely positioned to focus on longer range and cross-governmental issues, including ways to improve the economy, efficiency and effectiveness of the federal government. Our scope includes everything the federal government is doing or thinking about doing anywhere in the world, from taxes to transportation, national security to Social Security, and health care to human capital. Our audits, investigations, evaluations, policy analyses and legal services can also include reviews of key sectors of the economy, including the commercial airline industry. In this regard, the Congress has had a long-standing interest in the functioning of the industry, while it was regulated by the Civil Aeronautics Board and since the industry was

deregulated in 1978. The Congress has been particularly active in connection with airline industry issues in the aftermath of the tragic events of 9/11, and GAO has been there to help. As some of you may know, GAO was actively involved in Congressional deliberations that led to the Act which established the Air Transportation Stabilization Board. We testified on September 20 on overall principles for federal assistance. On the basis of GAO's institutional experience with other assistance programs (e.g., Chrysler, NYC), these principles included: 1. The need to get a clear understanding/definition of diverse challenges confronting industry (e.g., separate effects of economic downturn from actions by the federal government on Sept. 11-13 to close the National Air Space) 2. The need to identify the best tools for addressing distinct problems (e.g., grants vs. loan guarantees vs. other federal intervening mechanisms) 3. The importance of designing appropriate mechanisms to protect federal government and taxpayers 4. o suggested oversight board o discussed possible structure of assistance and eligibility and evaluation criteria Of course, my reward for these efforts was to be tapped as a member of the Stabilization Board--a non-voting member. I don't believe that any the Board's members sought the honor of this appointment. GAO's position was that, if the Congress wanted to include me on the Board, it should be as a non-voting member. This was appropriate for both our institutional independence as well as my personal time management. Having said that, I need to note that I am not speaking for the Board, and today's comments represent my personal perspectives on selected key challenges facing the airline industry. It's appropriate that I make a few comments about the events of 9/11 first.

September 11 served as a wake-up call for all Americans. We're now in a world that is very different from what it was on September 10. As citizens and as a country, we realize that we are going to have to do things differently. We will need to be more vigilant and in some cases, like at airports, more patient as we conduct our affairs. At the same time, we must get on with our lives and not live in fear. While many have been affected by the events of 9/11, the airline industry has been one of the most seriously impacted. Clearly, it is in the national interest to have an aviation industry that is vibrant, stable, efficient, and competitive. The real questions are: What is the best way to accomplish this, and what should be the proper role of government in the industry's future?

As you all know, industry profitability has been cyclical over time and negative since 9/11.

Between 1990 and 1992, major U.S. carriers lost about $10 billion. All but one major airline reported losses. Three major carriers--Braniff, Eastern, and Pan Am--went out of business and three others--TWA, Northwest, and Continental-entered bankruptcy proceedings. In 1992, Congress established the National Commission to Promote a Strong and Competitive Airline Industry. The commission made recommendations concerning FAA's structure, the airline industry's financial health, and foreign ownership limits. Between 1993 and 1999, nearly all major U.S. carriers reported annual operating profits. Most major airlines also reported net operating profits during each quarter of calendar 2000.

The events of 9/11 accelerated and aggravated negative financial trends already evident in the airline industry. That is, the industry was experiencing major net operating losses before 9/11. Over the long run, the airline industry must be profitable to sustain its financial health. Without profits, cash will not be generated internally and industry access to the capital markets will be limited. As we all know, net income is important, but cash flow is key! In order for the industry to return to profitability, several steps must be taken to (1) increase consumer demand for air travel, especially business travel, (2) control costs, and (3) address certain pricing issues. In addition, certain other public policy issues should be considered. More on this later. The Congress has enacted and the President has signed into law several measures aimed at helping us to recover and respond to terrorist attacks. All are necessary, but all will cost money. The most recently visible, important piece of federal legislation is the landmark airline and airport security bill that the President signed on November 19. That bill is an important part in overall efforts to restore consumer confidence and for alleviating travelers' apprehension about flying. Two other acts certainly merit attention: 1. Congress provided $40 billion for the federal response to the terrorist attacks, including funds for increased transportation security. 2. Congress passed the Air Transportation Safety and System Stabilization Act, which provided a means to stabilize the industry at a time when it was financially reeling. This act provided a framework for federal financial assistance, including: 3. o $5 billion in direct compensation, o up to $10 billion in loan guarantees,

o o

insurance assistance, and liability protection

There are critical differences between the types of assistance. The $5 billion is to compensate the carriers for direct losses associated with the federal action taken on 9/11 and for incremental losses accrued during the remainder of the calendar year. Of the $5 billion, DOT has issued approximately $2.4 billion to 112 air carriers. DOT plans to release another $1.75 billion in the near future. (No time is certain yet.) GAO reviewed whether the $5 billion figure was reasonable and found that, in the aggregate, it was. We also reported that, given the formula under the act, questions would arise regarding how to deal with industry segments (e.g., cargo) and carriers who do not incur losses equal to or in excess of their applicable caps. My own observation is that there are no procedures for any reallocation of funds associated with carriers whose losses may not reach their caps; therefore, I suspect that the entire $5 billion will not necessarily be disbursed. GAO has also been asked to assess whether actual losses incurred by major individual carriers through December 31 equal or exceed individual grant amounts to those carriers, as well as reasonableness of amounts claimed by airlines for insurance premium increases. We expect to answer these questions with a report in the summer of 2002. The purpose of the loan guarantees is to assist air carriers who suffered incremental losses due to the terrorist attacks of 9/11 and to whom credit is not otherwise reasonably available. The Stabilization Act established the Air Transportation Stabilization Board to oversee the loan guarantee program. Along with the Chairman of the Federal Reserve Board and the Secretaries of Transportation and Treasury, I am a member of that Board. However, as previously noted, I am the only non-voting member. The other Board members so far have delegated their day-to-day responsibilities to other staff members. I have not done so because, as the only non-voting member of the Board, I will not be involved in the review of individual carriers' applications for loan guarantees. All decisions regarding the Board's criteria, processes, approvals, and terms and conditions will be made only by the Board's three voting members. This is appropriate because such decisions should be made by executive branch officials. Several major events have occurred to date:

OMB issued final regulations for the loan guarantee program effective October 12, 2001 Applications are being made available by the Treasury Department America West has applied for a loan guarantee

The Board also has to protect the interests of the federal government and American taxpayer. It is authorized to determine first whether to approve a loan guarantee and, if

so, what terms and conditions will attach to the federal credit instrument. The Stabilization Act requires the Board to ensure that the government is compensated for its risk in assuming guarantees and authorizes the Board to enter into contracts under which the government would participate in any equity gains. There are major challenges concerning the Board's decision-making and actions. Let me emphasize again that this is only my personal view and not that of the Board! One obvious and critical policy question that the Board will have to face concerns the issue of how to define when a carrier has access to credit on "reasonable terms." What does that mean? Another key policy question involves the more philosophic question of how the Board might look at applications from different carriers. One possible framework that might be useful is to think of the industry as divided into three categories of carriers, on the basis of their current financial health and long-term viability:

Category 1: carriers that were viable before 9/11 are still viable after 9/11 and can obtain commercial credit on reasonable terms Category 2: carriers that were viable before 9/11, but are considerably worse off financially since then. These carriers may not be able to obtain increases to credit on reasonable terms but may be able to provide reasonable assurance to the Board that any guaranteed loan would be repaid. Category 3: carriers that were facing significant financial challenges before 9/11 and that may be facing extreme financial challenges now. These carriers may not be able to obtain access to credit on reasonable terms, and may not be able to provide a reasonable assurance that the loan would be repaid.

It is unclear at this time what impact the loan guarantee program might have on the airline industry's competitive structure. The Board should carefully consider the possible impact on competition of its actions. It should not pick winners and losers. Rather, the burden should be on the carriers to demonstrate that they are in category 2. GAO's role is not just oversight, but insight and foresight. In fact, I consider GAO's competitive advantage to be looking at longer range and cross-cutting issues. The GAO Strategic Plan identifies broad themes and trends such as increasing globalization, changing security threats, and a range of quality of life issues. Thus, there is a place for GAO in raising broad issues for possible congressional consideration. I would offer the following: Commercial aviation seems to be at a critical juncture in its history. The structure and relative competitiveness of U.S. commercial aviation is unlikely to resemble what existed prior to 9/11. Why?

Major pressures on the industry for consolidation and cost control

Possible long-term shift in demand particularly by critical business travelers

Any such major structural upheaval will raise a number of business issues for carriers and public policy issues for consideration by the Congress. The maintenance and application of economic merger analysis for domestic and international mergers, consolidations, and alliances. Public policy needs to be guided by sound principles. It is important to examine the substantive effect that mergers and alliances may have on competition in general and on consumers in particular. International alliances may have a somewhat different form than domestic mergers, but may have the same substantive effect on competition and thus appear to merit similar review and oversight. In general, I am a believer in a substance versus form doctrine. Government needs to continue its reviews of various consolidations, using sound, traditional economic-based merger analysis. It should do so at all times, including times when the industry is experiencing financial difficulties. The Transportation Research Board's 1999 report on Entry and Competition in the Airline Industry recommended that all collaboration plans among major U.S. airlines be subject to traditional, economic-based merger analyses by the Dept. of Justice. Clearly, both DOT and Justice need to be involved in this analysis. However, who should be in charge? TRB also recommended that Justice have distinct approval authority with international aviation agreements, in addition to the approval authority vested with DOT. GAO is completing work on the potential impact on competition of the proposed international airline alliance between American and British Airways. The key issues concern the extent of the potential benefits to consumers and how those can be weighed against the potential competitive harm. We expect to issue our report on this issue in the near future. Controls on the exercise of market power at major hubs. Congress may want to examine new approaches to large market shares at major airline hubs. As you know, the Senate took up this question last spring with S. 415. In general, we agreed with the overall thrust of that legislation--to increase competition in the market, especially at dominated hubs--but raised a number of concerns that it may not achieve its intended results. A related issue is how a restructured industry will serve smaller communities. In many communities, airlines have reduced the amount of service they provide via their regional affiliate carriers. How should these communities be connected to the national network? How much air service is truly needed vs. wanted in connection with these communities?

GAO has work underway on the issue of small community service. Since the terrorist attacks, we have re-designed that work and expect to issue the first of a series of reports on air service to smaller communities at the beginning of 2002. Pricing and allocation policies for slots at congested airports. The events of 9/11 provided a respite from the congestion that plagued the industry over the past several years. Even with sharply reduced forecasted growth, most believe that traffic will eventually return to pre-9/11 levels. The only question is when. That means that congestion will return. There are real limits to the extent to which FAA can alleviate congestion--especially at key selected facilities--through current air traffic control technology and adding additional runways at existing airports. However, in addition to its management of air traffic and airport development, FAA policies and actions also affect competition and congestion. Moreover, current FAA restrictions on airport pricing and policies for allocating slots at congested airports have adverse effects on competition. For competition to be healthy, new airlines have to have the ability to enter and compete in key markets. Current slot controls at major U.S. airports have long represented major barriers to entry for new carriers. The government may need to take a serious look at how access to those key facilities is provided. Restrictions on foreign ownership and operation of U.S. based airlines . We live in a global economy, with global enterprises. We need to look at issues differently now--with a global framework. We are sensitive to the legitimate security concerns raised by the idea of foreign ownership of U.S. airlines and airlift capacity. Particularly in these times! However, to a certain degree, our airlines are already international carriers, operating with foreign partners in international service. Now, it may be time to raise the question of whether to easenot eliminatethe limits on foreign capital. To induce new competition into domestic markets or, in the event of a financial failure of a large airline, to provide the capital needed for a competitive large network of airlines, the U.S. might need to reexamine current limits on foreign ownership. Access to new sources of capital could allow weaker U.S. carriers to reduce debt costs, invest in new aircraft, and compete more effectively. Federal law and policy limits foreign investment in U.S. airlines to 25 percent of the voting stock and limits foreign investors' ability to elect members of boards of directors and other key officers. GAO has a long history of involvement with, and analysis of, key issues in the deregulated commercial airline industry. This includes issues relating to safety, security, airports, air traffic control, and domestic and international airline competition.

In the past year, GAO reported on the proposed merger between United and US Airways and on American's acquisition of TWA. We reported on how changing ticketing rules regarding back-to-back and hidden-city ticketing may affect consumers, especially in smaller communities. We testified on consolidation in the industry, and the possible exercise of market at major airline hubs. We will continue do to our part to help Congress make timely and informed judgments on key issues. I thank you for your time and attention and would be happy to answer your questions.

Airline Performance 2001

Weakening economy and air traffic before 9/11 Impacts of 9/11 on traffic and capacity into early 2002

The Challenges Ahead

Prospects for industry profitability Operating cost and revenue obstacles

Working Towards Recovery

Airline security issues Impacts on airline operations Labor/management relations Overview of todays program

MIT ICAT MIT ICAT Airline Performance Before 9/11

ATA forecasted $1.5 billion net loss for US airlines in

2001 after disastrous second quarter reports. Softening economy had a substantial revenue impact:
Average yield in August down 12.5% over previous year Revenues from business-type fares down by almost 30%

US airlines capacity was up 2.6%:

Average load factors were about 2 points lower than in 2000 Impacts cushioned by discount and web fares to fill seats

Operating expenses climbed due to labor and fuel:

Labor costs increased by 9.7% on average among US majors Fuel prices up an average of 8.9% through July

MIT ICAT MIT ICAT IATA Passenger Traffic Growth

(RPM)
-2% 0% 2% 4%

6% 8% 10% 2000 Q1-2001 Q2-2001 International US Domestic

MIT ICAT MIT ICAT IATA Traffic by Category 2001

vs. 2000
-20% -15% -10% -5% 0% 5% 10% 1st Qtr 2nd Qtr First Business Coach

MIT ICAT MIT ICAT Other Industry Concerns Before

9/11

 Air transportation system capacity constraints

Aircraft delays peaked in 2000, still 80% higher in 2001 vs. 1997 Forecasts of continued traffic growth, limited capacity increases

Customer dissatisfaction with airline service

Growing perceptions of poor service and airline indifference Exacerbated by operational problems associated with congestion and delays Some calls for re-regulation of selected airline competitive practices

Difficult labor/management environment

Labor demands for share of airline profits from late 1990s Employee morale and impacts on customer service Prolonged contract negotiations and strike threats

MIT ICAT MIT ICAT Impacts of 9/11 Attacks

 Most North American and European airlines reduced capacity and staffing almost immediately:
80,000 layoffs by US airlines alone February US airline capacity down by 13% from previous year Traffic has rebounded, but still 11% lower than in February 2001

US airlines posted 2001 net losses of $7+ billion. Few expectations of industry profits in 2002:
Revenue mix of traffic is extremely weak, despite some recovery of traffic and load factors Average load factors were actually 2 percentage points higher than last February, on reduced capacity But, average fare (yield) is at least 13% lower than in 2001

MIT ICAT MIT ICAT

Annual Change in System RPM and ASM

Source: ATA Monthly Passenger Traffic Report

(35.0%) (30.0%) (25.0%) (20.0%) (15.0%) (10.0%) (5.0%) 0.0% 5.0% 10.0% Mar-01 Apr-01 May-01 Jun-01 Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 RPMs ASMs

MIT ICAT MIT ICAT

System Load Factor Year-over-Year

Source: ATA Monthly Passenger Traffic Report
55% 60% 65% 70% 75% 80% 85% Mar-01 Apr-01 May-01 Jun-01 Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 2000/01 2001/02

MIT ICAT MIT ICAT

Annual Change in Average Domestic Fare

Source: ATA Monthly Airfare Report

-20% -15%

-10% -5% 0% MAR APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB

MIT ICAT MIT ICAT Prospects for Profitability

Industry profitability depends heavily on US economic recovery:

Return of business travel to improve revenue performance Recent evidence that economic recession is over is encouraging

Passenger confidence in airline security is also key:

Absence of new terrorism and stabilizing military situation Increased security measures and uncertainty about associated passenger delays affect business travelers most

Implications for airline operating costs

Increased security costs and impacts on aircraft turn-around times

and utilization Uncertainty about future fuel, labor and insurance costs

MIT ICAT MIT ICAT Airline Profitability Model

CASM CASM RASM RASM

9/11 9/11-9/13 9/13 Time

Time

$/ASM $/ASM
Security costs Security costs

Quick Recovery Quick Recovery Insolvency Insolvency Slow Recovery Slow Recovery

MIT ICAT MIT ICAT Obstacles to Recovery: Costs

US airline annual net profits averaged $3.5 billion during 1995-2000 period of economic boom:
Minor fluctuations in fuel prices before major jump in 2000 Airline labor cost index increased by 13.5% over 5 years

 Record profits have been driven by improved distribution efficiency, along with aircraft utilization and productivity gains

Post 9/11 operating costs raise substantial questions:

Lower aircraft utilization due to schedule cuts will affect productivity and increase unit costs Added security requirements and associated delays Increasing labor costs introduce tremendous uncertainty Last falls fuel price decreases were an unexpected bonus, but fuel prices are on the rise again

MIT ICAT MIT ICAT Bigger Obstacles to Recovery:

Revenues Recent profitability driven by improved revenue generation through pricing and distribution:
Fare structures in which business travelers pay 5 to 10 times the

lowest leisure discount fares Revenue management systems used to maximize network revenues and increase overall load factors to a record 72.4% in 2000 Expanding e-commerce channels to fill empty seats with incremental traffic and revenue

Business demand is estimated to be down by 30%:

Current recovery of traffic and load factors appears to be driven by leisure travelers paying extremely low fares Profitability of traditional airlines depends on return of business travelers willing to pay premium class and full economy fares

MIT ICAT MIT ICAT Return of Business Travel is

Key Several factors have limited business travel recovery:

Overall economic downturn and corporate cutbacks Inconvenience and uncertainty caused by increased security

measures is a major concern Also, some evidence that willingness to pay premium fares has eroded

Reducing business travel inconvenience is key:

Most traditional network airlines cannot survive on high load factors and low yields Lower business fares will not stimulate enough traffic and revenue to cover increased operating costs Without high-fare business travelers, an alternative business model could well be required for airline profitability

MIT ICAT MIT ICAT Working Towards Recovery

Cross-section of industry stakeholders assembled here today to discuss progress toward recovery - How has airline security improved?
Customer perceptions, reality, and future directions

 What impacts on airline operations and efficiency?

Impacts of security changes operating expenses and safety How quickly will the system return to previous levels of congestion and delay

Will labor/management relations adapt?

How can employee morale, customer service and productivity be improved, given pressures to reduce operating expenses?

MIT ICAT MIT ICAT Overview of Todays Program

Developing A Perspective
Recent Passenger Booking Trends

Airline Security Whats Next? Airline Operations Return to Previous Levels? Airline Management/Labor Relations Helping or Hindering Recovery?

 Future Outlook The Airline Industry Tomorrow

Implications for Industry Structure and Competition Role of Low-Cost Carriers Market Outlook for Air Travel