[Severin Borenstein] Why U.S. Airlines Need to Adapt to a Slow-Growth Future

By Severin Borenstein Jun 3, 2012 7:01 PM GMT-0300

As the economy recovers and fuel prices ease, U.S. airlines are doing better. Prospects for the summer and the rest of 2012 look brighter, particularly because there are fewer carriers after the mergers of the last five years.

Yet U.S. airlines face a long-term challenge that should concern industry executives as well as investors. That impediment isn't wages, fuel prices or a stagnant economy. It's growth in demand for air travel, which has been anemic at best for more than a decade, even when the economy was expanding.

Steadily dropping fares are the only reason traffic has grown at all since 2000. And without substantive cost-cutting innovation in the industry, that pace isn't sustainable. Coca- Cola Co. can't increase its business through constant price cutting, and neither can airlines. If inflation-adjusted fares hadn't dropped 17 percent from 2000 to 2010, my research suggests that domestic travel would have declined.

To understand why this is happening, just think about the last time you flew. It's a fair guess that the trip took longer than the same journey would have taken 30 years ago and was less comfortable. In-flight entertainment is better today -- TVs and Wi-Fi -- but almost everything else is worse: less leg room, less food, less service, more-crowded planes and more time wasted getting through the airport.

Commuting Time

You might think air travel is like other luxury goods in that people will want more of it as they get richer. That's not necessarily true because consuming air travel takes time, and that is something we aren't getting more of. Among experts who study commuting, there is a rule of thumb that in any society the average commute to work -- whether by foot, donkey or automobile -- is about 20 to 30 minutes. The explanation is that financial budgets might expand, but we still only get 24 hours each day.

As a person moves from poor to middle class, they probably will want to travel more. This is why air travel is growing rapidly in the developing world. But as a person's wealth continues to increase, they probably won't want to spend more time in airports and on airplanes. Life is too short.

The same goes for business travel. As a company grows, it doesn't retain all its workers in one location and require them to travel more. Instead, it opens up satellite offices closer to its customers. Why? Because flying is expensive downtime.

Airlines (UAL) find themselves in this dead end because there has been almost no industry innovation in decades that has improved the customer experience. That's why airlines can still fly airplanes that were manufactured 30 or more years ago. (Safety is better than it was in 1980, but it was actually quite good then, and few people were deterred from flying by safety concerns.)

If airlines are going to overcome the time barrier to growth in demand, air travel has to take less time or be less unpleasant.

Sadly, the prospects for increasing flying speeds aren't good. The only commercial airliner ever to fly faster than sound, the Concorde, was grounded almost a decade ago. There are no imminent plans to bring back supersonic transport, partly because it requires much more expensive technology and is even less spacious than standard jetliners. In any case, the sonic booms they created meant they couldn't fly faster than sound over populated areas.

The only real hope for shrinking travel time is on the ground. Security screening may improve, allowing you to get to the gate more quickly. And air-traffic control may finally adopt modern technology -- a slightly higher-tech version of the global positioning system available in automobiles -- that reduces congestion and keeps more flights on time. But even in the best-case scenario, the flying and airport time from New York to Los Angeles will be about the same as it was in 1980.

Less Painful

The airlines are trying to make travel time less painful, but so far the results aren't too impressive. Wi-Fi and TVs are nice, but the real barrier to making travel time more fun or productive is space. Squeezed between two strangers, wondering when the seatback you are facing will suddenly slam into your knees (or into your laptop), isn't a good environment for relaxation or getting work done. The newest major airlines -- JetBlue Airways Corp. (JBLU) and Virgin America Inc. -- seem to recognize this. They are increasing leg room and leading innovation in in-flight entertainment.

For the most part, the legacy airlines are just giving up on domestic-demand growth and focusing instead on international travel, where prospects are better, at least for now. One U.S. airline chief executive officer recently told me that his company merely hoped to break even on service within the U.S., which he regarded as a tool to feed lucrative international flights.

That strategy is problematic because U.S. carriers only have the right to fly to and from the U.S., not within or between other countries. And even on those routes, there are strong home-country carrier biases: Americans prefer U.S. airlines on a trip to Korea, and Korean travelers tilt toward their own jetliners when coming to the U.S. So, with American travel demand closer to saturation, the biggest growth will be among the markets and customers most difficult for U.S. carriers to reach. Growth prospects may be better than inside the U.S., but they are still not great.

This doesn't mean U.S. carriers can't make money. Many companies earn a good living in low-growth markets by focusing on serving existing customers, with higher quality and at lower cost. Those companies don't get the thrill, or the earnings growth, of being out in front to catch the next demand spike. Still, that's likely to be the slow-growth environment of the future for the U.S. airline business.

(Severin Borenstein is E.T. Grether professor of business administration and public policy at the Haas School of Business at the University of California, Berkeley. He is a contributor toBusiness Class. The opinions expressed are his own.)

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To contact the writer of this article: Severin Borenstein at borenste@haas.berkeley.edu

To contact the editor responsible for this article: Max Berley at mberley@bloomberg.net