Tuesday, January 03, 2006

Airline Industry News: Independence Air Shuts Down

So you probably heard today that FLYi.com was shutting down. That's Independence Air for the rest of us. A small low cost airline that started two years ago by splitting off from a feeder arrangement with one of the regular larger airlines. They thought they could make it but couldn't.

The fact is that, this shutdown is really a symptom of a far bigger problem within the airline industry.

So, what does this have to do with rationality in politics? The answer is several billion dollars of taxpayers money that was handed over to the airline industry.

Update 1/6/06 - Seems that JetBlue is trying to fill the new market opportunity already. Good move Jetlue.

The story goes back farther then most of us realize. Think dot com boom. Yep, late 1990s. What happened there was that with the huge growth of the internet and with all the IPOs happening on Wall Street, billionaires (albeit some of them temporary) being made overnight. Secondary industries were experiencing some of the effect as well. Remember the words New Economy anyone?

Well, with all the VC money flowing into the tech companies small and otherwise, air travel increased as some of that money was spent flying engineers, salesmen, investors and executives to various meetings. Ticket prices shot up and the airlines didn't have enough planes to meet the increased demand. You've leased all the planes you can and there still aren't enough seats.

So, imagine yourself an airline executive facing all this passenger demand growth and the shareholders are expecting you to make sure that you take advantage of it. What do you do? Simple, you buy more planes. This is the New Economy folks. The old rules no longer apply and we have entered into a new stage of growth for the 21st Century.

The only problem with buying airplanes is that you amortize aircraft purchase costs over decades - a typical number is 20 years. You're going to have to make payments for 20 years. No problem say the airline executives. The New Economy will make that decision a no-brainer. The planes will pay for themselves in a fraction of that time at this rate.

The end result was that the commercial airline industry overexpanded and bought too many planes and had way too much capacity. When the dot com boom busted, the tech industry passengers disappeared. By the time mid 2001 arrived, the airlines were already in unpleasant shape. September 11th happened and you know where the rest of the passengers went.

So why did they do it? Why did the airline execs make those sorts of decisions? The answer lies in the fact that short term growth was happening and the CEOs were looking forward only a quarter or two and wanted to show their shareholders that they were taking full advantage of the passenger growth by generating better numbers revenue and profit wise - even if it meant taking on more debt. They just couldn't leave that money on the table for some other competitor to get. So, they chose to be stars for the moment at great risk for the long term. We make heros of contrarians in the investment markets that are right. The problem was that there was not one executive at a major airline that was willing to be a contrarian during that time. Go take a look at airline exec compensations during the late 1990s.

The major airlines set themselves up for a big problem and it came with a vengence in the form of a terrorist attack and a nationwide no fly zone for several days. Sure, you can make the case that the terrorist attack was not directly their fault but their weakened state was their own creation. There is no way that the natural economic state of air travel at that time could justify the existence of that large a capacity between all the major airlines. The correct level of capability and capacity was much lower. The airlines were all into survival mode to outlast each other in the medium term. The market was fit for a reduction in both capacity and the number of airlines. It should have happened and bankruptcy filings were either in or on the way.

Then the towers were hit and the govenment gave billions of dollars outright to save at least two major airlines and made billions more in loan guarantees. They opted to save jobs that would have gone away naturally and they used taxpayers money to save an industry that was overdue for a natural adjustment. Then they gave more money to those families that lost loved ones so that those families wouldn't sue the airlines into bankruptcy.

They should have left the airlines to succeed or fail on their own. The nation would have been better off if one airline had closed down but instead, the government decided to take extraordinary measures to keep all of them on life support. This is economic interference at an unbelievable scale. It was a political decision - not a sensible one.

Even today, there are too many empty seats and too many planes that are not meeting their monthly loan payments. The price of jet fuel is extrememly high and that can only make a sick industry worse.

Independence Air is only the tip of the iceberg and you can watch the airline industry limp along for the next decade until they decide to bite the bullet and fix the real problems. In the meantime, they still have our billions.


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