Outlook 2012: Airlines May Be Headed for a Bumpy Ride

Remember empty middle seats? Until further notice, you may consider them an endangered species.

Airlines in the U.S. are showing unprecedented discipline in keeping capacity very tight. After many, many lessons, they’ve learned that high profits and high market share do not go hand in hand.

These days, “airlines are more focused on profit than on ego,” Henry Harteveldt, an analyst with Atmosphere Research Group, said.

Unafraid to cut
Airlines also are keeping a closer eye on the ball, he said. Whereas they traditionally made major changes to routes and frequencies just twice a year, airlines are now “much more aggressive” about managing capacity and deployment of resources. Today’s airlines tweak their networks monthly or quarterly.

Harteveldt expects this trend to continue throughout 2012, with airlines having little hesitancy to cut unprofitable flights or routes.

In some cases, membership in a major alliance – Star, Oneworld or SkyTeam – and key interline or code-share relationships will allow them to make such cuts without losing the customer altogether, since airline partners can pick up the slack.

The future for AA
Jamie Baker, an airline analyst with J.P Morgan, believes the Chapter 11 filing by American Airlines in November will lead to further shrinkage of what was once the nation’s largest airline.

Airlines have consistently used Chapter 11 as a means of culling unproductive, unprofitable flying, he said in a research note. As “the only loss-producing airline of size,” American will have plenty of options for cuts, and its Chicago hub, which it shares with United, is a likely target.

Overall, he said, J.P. Morgan anticipates a 10% cut in capacity at American.

That could lead to some opportunistic moves by other airlines, Harteveldt said. Even before the bankruptcy filing, Delta was nipping at the heels of American in several markets, including its former hub in St. Louis. After the filing, it announced service increases at New York La Guardia, Miami and Dallas.

But American is likely to defend its turf “vigorously,” Harteveldt said.

More fare hikes likely
In 2011, the U.S. airlines attempted to hike fares 22 times; nine attempts were successful. Rick Seaney, chief executive officer of FareCompare.com, a site that tracks fare history, said they are likely to continue their attempts throughout 2012.

It’s arguably not about greed; it’s about the price of oil, which ended the year at close to $100 per barrel. Airlines have had to learn how to break even in this era of high oil prices, a feat that would have been considered impossible back in the 1990s.

But, Seaney said, “there is a wall” beyond which airlines cannot take their pricing if they want to keep those middle seats filled. In the new economic model, aisle and window seats belong to frequent flyers or full-fare passengers, or they are for sale as “ancillary products.”

Lower fares are necessary to make middle seats palatable to discretionary travelers.

Where moguls play
If fares are pushed too high, airlines run the risk of stirring the interest of would-be airline moguls, who so often fail to notice the many corpses of new-entrant airlines littering the countryside. For unfathomable reasons, aviation buffs with money to burn – and burn it will – are able to convince themselves that they can get it right.

There have been a few success stories on that front – JetBlue, Allegiant and Spirit, for example – but they are few and far between. However, even short-lived airlines can do a lot of damage to incumbents.

Looming challenges
There is, of course, no dearth of other perils that threaten the airlines’ well-being, not the least of which is the price of fuel. The carriers have done a good job of maintaining equilibrium even under the burden of sky-high oil prices, but there are limits to their ability to cope.

In its 2012 airline outlook assessment, IATA pointed to another trouble spot: the eurozone crisis, whose hangover has prompted tough austerity measures. Even a “relatively benign” outcome will not prevent a recession in Europe, IATA said, and that is likely to serve as an uncomfortable reminder that we live in a global economy.

Europe would be hardest hit, while capacity cuts “are providing some protection to profitability” in North America, IATA said. In Asia, “we expect significant profits generated by high load factors on China’s expanding domestic market.”

A worried IATA
If the European debt crisis spirals out of control, “we doubt any region will be able to escape losses,” IATA said. It said losses to the airline industry could reach $8.3 billion in 2012, based on analysis of the Organisation for Economic Co-operation and Development, a group that promotes policies that will improve the economic and social well-being of people worldwide.

IATA is troubled by the decline in freight, which has been a good indicator of wider economic weakness in the past. In addition, premium passenger traffic tends to follow the trends of international trade, which has stopped growing.