Orf 467 Transportation Systems Analysis

1. Orf 467 Transportation Systems Analysis “Troubled Airlines” What role for government? November 22, 2004 F. LORENZO

2. THE U.S. GOVERNMENT SHOULD NOT PROVIDE BAILOUTS OR HANDOUTS TO TROUBLED AIRLINES • The “troubled” major airlines have workable, and indeed attractive, business models; • But they have very uncompetitive cost structures; • “Troubled” carriers need to achieve cost restructuring, particularly given the rapid growth of low-cost carriers. Government intervention only postpones this process; • Nevertheless, there are government actions that should be adopted. 2

3. THE BASIC BUSINESS OF THE MAJOR AIRLINES IS ATTRACTIVE • There are many reasons put forth for the profitability of the newer fast-growing airlines, at a time when the majors are losing big money; • However, the majors have some stark advantages; • But the principle reason for the profitability difference is that the newer companies can offer far lower and simpler fares than the older network companies, because of their lower costs; • In general, the majors have cost burdens that make their businesses inherently uncompetitive. 3

4. LABOR COST OF MAJOR CARRIERS COMPARED WITH FAST GROWING LOWER-COST CARRIERS Source: UAL Chapter 11 Filing – December 2002 4

5. OPERATING COMPARISON: AIRTRAN VS. DELTABOTH ATLANTA HUB CARRIERS Source: Morgan Stanley Equity Research 5

6. OPERATING MARGINS RELATIVE TO COSTS JBLU LUV AAI CAL DAL FRNT NWAC AWA ALK U AMR UAL Source: Morgan Stanley Equity Research, Company Reports 6

7. AIRLINES HAVE A LONG HISTORY OF BLOATED COST STRUCTURES • Regulated airlines, during the years before deregulation, simply passed higher labor costs on to the public with Government approved fare increases; • Airline deregulation, passed in 1978, was bipartisan legislation conceived in the belief that only a marketplace could contain costs and provide lower fares and better service; • However, while the revenue side was deregulated, Congress did nothing to the expense side to aid carriers in adjusting to the new marketplace; • Railway Labor Act jurisdiction not eliminated . • Mutual Aid Pact among airlines was killed. • Eighties bring several important labor confrontations; • Prosperous nineties put labor cost concerns on the “back burner”. • Even labor buyouts at NWA and UAL fail to provide long-term solutions. 7

8. AIRLINES ENTER THE NEW MILLENNIUM • As we arrived at the new millennium, weaker economic conditions cut abruptly the business (unrestricted) travel of air carriers. In the case of UAL, in 1999, 41% of domestic passengers purchased business fares, compared to 20% in 2002; • Growth of internet and its “transparency” lowers average ticket prices. Over 20% of all bookings are now made on the internet, compared to only 5% in 1999 • Low-cost carriers grow rapidly such that they were 24% of total domestic passengers by early 2002; 8

9. PROPORTION OF DOMESTIC REVENUE FROM PREMIUM PASSENGERS HAS DROPPED SHARPLY Source: UAL Chapter 11 Filing – December 2002 9

10. PROPORTION OF REVENUE BOOKED VIA THE INTERNET HAS INCREASED SIGNIFICANTLY Source: UAL Chapter 11 Filing – December 2002 10

11. LOW-COST CARRIER GROWTH Source: UAL Chapter 11 Filing – December 2002 11

12. EQUITY CAPITALIZATIONS OF LOW-COST CARRIERS VS. MAJOR CARRIERS Low-Cost Carriers $19.0 Billion Major Carriers $ 5.3 Billion Source: ReutersBridge 12

13. AIRLINES ENTER THE NEW MILENNIUM • And then there was September 11th. Airline results turned extremely negative; • However, it’s important to realize that most major airlines had problems before 9/11 and would have had them without the attacks, albeit not as abruptly. 13

14. AFTER 9/11, THE U.S. GOVERNMENT CAME TO THE RESCUE WITHIN WEEKS • Direct cash grants of $5 billion were given to airlines solely based on miles flown in August 2001; • Congress also legislated $10 billion of loan guarantees to aid carriers, under very nebulous terms and conditions; • These U.S. Government actions were in stark contrast to assistance provided foreign carriers by their governments – which has been zero with regard to European carriers and very modest in the case of Canada. 14

15. THE U.S GOVERNMENT SHOULD PROMOTE A COMPETITIVE AIR TRANSPORTATION SYSTEM • The Government, in my view, should refrain from bailing out troubled carriers; • Only through having a competitive marketplace and the ability to fail, can labor costs be restrained; • If the Government takes away or postpones the ability to fail, through loan guarantees or other means like stretching out pension obligations (as is currently being considered), one of the few remaining “governors” on labor costs will be removed; • We need not fear liquidation of carriers that go through bankruptcy and are unable to reorganize. Other carriers, employing more efficient structures, will take over assets – many examples have already been seen; • Government cannot afford the alternative. How many Amtrak’s can we support? 15

16. STEPS THE GOVERNMENT SHOULD TAKE TO IMPROVE THE AIRLINE INDUSTRY • Labor Legislation – The airline industry is still a party to the Railway Labor Act (RLA), originally passed in 1926, which is clearly anachronistic in today’s environment. Airlines should be taken out from under the RLA and brought under Taft-Hartley. • Taxes – Airlines and airline passengers are overtaxed – ticket taxes and passenger segment fees need to be reexamined, although this has always been difficult politically. • Market Competition – Anti-trust enforcement against predatory actions of carriers, which typically enhance hub dominance, should be stepped-up. • Foreign Ownership – Current restrictions, limiting foreign ownership to 25%, should be raised or, even better, eliminated. 16