M I T I n t e r n a t i o n a l C e n t e r f o r A i r T r a n s p o r t a t i o nM I T I n t e r n a t i o n a l C e n t e r f o r A i r T r a n s p o r t a t i o n
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WHAT’S WRONG WITH (SOME) US AIRLINES?Recent Airline Industry Challenges
Dr. Peter P. BelobabaProgram Manager
MIT Global Airline Industry Program
January 2005
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Recent Airline Industry Challenges
US Airline Industry Since 20009/11 Attacks and Subsequent EventsImpacts on Capacity, Traffic and Profits
Pricing and Revenue ChallengesLower Total Industry RevenuesGrowth of Low-fare CarriersFare Simplification
Cost and Productivity ChallengesUnit Cost ComparisonsStage Length and Aircraft UtilizationShifts in Operating Cost Categories
Key Questions for the Future
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US Airline Industry Before 9/11
Current industry “crisis” began before 9/11:Dot.com bubble burst, stock market slide, and softening economy led to unprecedented decreases in yields and business traffic bymid-2001Industry losses forecast for 2001 even before 9/11 attacks
Other airline industry concerns at the time:Air transportation system capacity constraints led to record flight delays in 2000 Consumer perceptions of poor service and airline indifference, exacerbated by delaysDominance of large network airlines, accusations of anti-competitive actions vs. new entrantsDifficult labor/management relations, with labor demanding a share of 1990s airline profits
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Impacts of 9/11 Attacks and More
Most airlines reduced operations almost immediately after 9/11:
80,000 layoffs by US airlines alone, many more since thenUS airline capacity (ASMs) cut by 25%, hundreds of aircraft retired/parkedUS airline traffic (RPMs) initially dropped by 45% due to passenger fears, security hassles
Post-9/11 setbacks haven’t helped:Invasion of Afghanistan (October 01)Iraq War (March 02)SARS epidemic (March 03)Airline fuel prices increased 60% in 2004US Terror Alerts keep security concerns in passengers’ minds
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3 Years Later, Traffic Has Recovered
US airline RPMs returned to 2001 levels in mid-2004But August 2004 US airline capacity 7% lower than August 2001Average load factors in 2004 are now above pre-9/11 levels –83.5% ALF in July 2004 is highest month on record
Almost no expectation of US industry profits in 2005:Revenue mix of traffic is extremely weak, despite recovery of traffic and load factorsAverage fare (yield) is still running about 14% lower than in 2000
US airline bankruptcies United, Hawaiian in Chapter 11American threatens, but achieves cost reductionsUS Airways emerges, but files for 2nd timeDelta on the brink
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US Airline Capacity Still Down 7% from 2001
Source: ATA data
CAPACITY: Available Seat Miles
55
60
65
70
75
80
85
January February March April May June July August September October November December
Billions
2001 2002
2003 2004
Source: ATA Monthly Passenger Traffic Report
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Domestic Traffic Now Back to 2001 Levels
TRAFFIC: Revenue Passenger Miles
30
35
40
45
50
55
60
65
70
January February March April May June July August September October November December
Billions
2001 2002
2003 2004
Source: ATA data
Source: ATA Monthly Passenger Traffic Report
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Load Factors are at Historical Record Levels
Source: ATA data
LOAD FACTOR: Percent of Capacity Utilized*
55%
60%
65%
70%
75%
80%
85%
90%
January February March April May June July August September October November December
2001 2002 2003 2004
Source: ATA Monthly Passenger Traffic Report
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US Industry Losses Over $30 Billion Since 2000
US Airlines Operating and Net Profit
(15,000)
(10,000)
(5,000)
0
5,000
10,000
15,000
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Year
Pro
fit ($
mill
ions
)
OperatingNet Profit
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Pricing and Revenue Challenges
Industry profits in late 1990s driven by improved revenue generation through pricing and distribution:
Multiple price levels, restrictions and effective revenue management of low fares led to higher load factors and unit revenues ($/ASM)
Revenue power of legacy airlines has virtually disintegrated, with little relation to 9/11:
Business passengers no longer willing to pay 5 to 8 times the lowest available fareInternet distribution channels give more passengers more information about air travel optionsCutbacks have reduced service quality differences between network and low-cost carriers
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US Airline Industry Revenues
Source: Air Transport Association
$60
$70
$80
$90
$100
$110
$120
$130
$140
US
$ B
illio
ns
93 94 95 96 97 98 99 00 01 02 03
Total industry revenues dropped by almost 20% and are still 12% lower than in 2000
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Domestic Unit Revenues Are Down 15%
Source: ATA data
R A S M -- M a in lin e D o m e s tic1 2 M o n th s E n d e d
8 .0 0
8 .5 0
9 .0 0
9 .5 0
1 0 .0 0
1 0 .5 0
Jan-
96 Jul
Jan-
97 Jul
Jan-
98 Jul
Jan-
99 Jul
Jan-
00 Jul
Jan-
01 Jul
Jan-
02 Jul
Jan-
03 Jul
Jan-
04 Jul
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Growth of Low Fare Carriers in US
Recent conditions favorable for low-fare airlines:Less business travel overall, reduced willingness to pay for premium servicesMore stable demand for price-sensitive leisure travelLeisure travel demand less affected by post 9/11 “hassle factor”
Low-fare carriers threaten the viability of Majors:Share of domestic passengers flown by low-fare carriers increased to almost 25% in 2004, from 16% in 2000 and only 5.5% in 1990Largest low-fare carriers continue to increase both capacity and traffic, in sharp contrast to most MajorsMajor airlines are looking for new “business models” to respond to changed environment and to compete with low-fare airlines
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Legacy and Low Fare Airlines
LOWFARE AIRLINES
WN – Southwest Airlines
HP – America West Airlines
AS – Alaska Airlines
TZ – American Trans Air (ATA)
B6 – JetBlue Airways
FL – AirTran Airways
These airlines carried another 18% of US traffic.
LEGACY AIRLINES
AA – American Airlines
UA – United Air Lines
DL – Delta Air Lines
NW – Northwest Airlines
CO – Continental Airlines
US – US Airways
Legacy group carried 73% of US passenger RPMs in 2003.
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Changes in Market Share by Carrier
Change in % Market Share from 1st Qtr 99 to 3rd Qtr 03
-4.00%
-3.50%
-3.00%
-2.50%
-2.00%
-1.50%
-1.00%
-0.50%
0.00%
0.50%
1.00%
AA UA DL NW CO US
While 4 out of 6 network carriers have lost market share since 1999, all low-fare airlines
gained market share during this
period, led by Southwest and
Jetblue
Change in % Market Share from 1st Qtr 99 to 3rd Qtr 03
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
WN AS HP TZ B6 FL F9 NK
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US Airline Yields (Revenue/RPM)
Yields began decreasing prior to 9/11 and have shown little sign of recovery
$0.0900
$0.0950
$0.1000
$0.1050
$0.1100
$0.1150
$0.1200
$0.1250
$0.1300
$0.1350
$0.1400
19991
19992
19993
19994
20001
20002
20003
20004
20011
20012
20013
20014
20021
20022
20023
20024
20031
20032
20033
20034
Top 6 MajorsLow-Fare Majors
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All Legacy carriers have lost revenues; UA and US revenues have dropped by
over 30%
Change in Passesnger Revenues -- Legacy Carriers 2003 vs 2000
-40
-30
-20
-10
0
10
20
30
40
50
60
AA CO DL NW UA US
%
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Lowfare group maintained or increased revenues – biggest % gains at JetBlue,
AirTran
Change in Passenger Revenues -- Lowfare Carriers 2003 vs 2000
-40
-30
-20
-10
0
10
20
30
40
50
60
AS HP TZ WN B6 FL
%
845%
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Differential Pricing Theory (circa 2000)
Market segments with different “willingness to pay” for air travel
Different “fare products”offered to business versus leisure travelers
Prevent diversion by setting restrictions on lower fare products and limiting seats available
Increased revenues and higher load factors than any single fare strategy
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Differential Pricing and Airline Fare Structures
Differential pricing was embraced by all airlines:Charge more for flexibility and highest-demand flights while selling off “excess” seats at lower but more restricted faresEven low-fare carriers offer differentiated price levels and practice some form of revenue management/seat inventory controlDifference with traditional airlines is that their differentiated prices are both less restricted and closer in ratio of fare levels
Example of a “traditional” fare structure shown on following slide for Boston-Seattle market (2001):
Highest unrestricted economy fare (Y) is 5 times that of lowest discount fare with restrictionsAll fares with any meaningful discount from the unrestricted fare require advance purchase and a Saturday night stay
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BOS-SEA Fare StructureAmerican Airlines, October 1, 2001
Roundtrip Fare ($)
Cls Advance Purchase
Minimum Stay
Change Fee?
Comment
458 N 21 days Sat. Night Yes Tue/Wed/Sat 707 M 21 days Sat. Night Yes Tue/Wed 760 M 21 days Sat. Night Yes Thu-Mon 927 H 14 days Sat. Night Yes Tue/Wed 1001 H 14 days Sat. Night Yes Thu-Mon 2083 B 3 days none No 2 X OW Fare 2262 Y none none No 2 X OW Fare
2783 F none none No First Class
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Fare Simplification:Less Restricted and Lower Fares
Recent trend toward “simplified” fares – compressed fare structures with fewer restrictions
Initiated by some LFAs and America West, followed by Alaska Most recently, implemented in all US domestic markets by Delta, matched selectively by legacy competitors
Simplified fare structures characterized by:No Saturday night stay restrictions, but advance purchase and non-refundable/change feesRevenue management systems still control number of seats sold at each fare level
PODS simulations of impacts show traffic mix and revenue impacts of simplified fares:
Revenue impacts of “simplified” fare structures
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BOS-SEA Simplified Fare StructureAlaska Airlines and American, May 1, 2004
Roundtrip Fare ($)
Cls Advance Purchase
Minimum Stay
Change Fee?
Comment
374 V 21 days 1 day Yes Non-refundable 456 L 14 days 1 day Yes Non-refundable 559 Q 14 days 1 day Yes Non-refundable 683 H 7 days 1 day Yes Non-refundable 827 B 3 days none No 2 X OW Fare 929 Y none none No 2 X OW Fare
1135 F none none No First Class
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PODS Simulation Results:Traditional “Restricted” Fare Structure
5:1 fare ratio; all fare classes below “full fare” have Sat. night stay and 7/14/21 day AP restrictions
74.6% load factor; total flight revenue $64,7165% revenue gains from use of RM booking limit controls
Loads by Fare Class
20.2
3.8
9.2
41.3
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
45.0
$625 $405 $240 $125Fare Class
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PODS Simulation Results: “Simplified” Fare Structure
Fare ratio compressed to 3.5:1; Sat. night stay restriction removed from all but lowest fare class; advance purchase restrictions retained
Load factor increases to 77.8%; but total revenues drop by 15% to $55,221% Revenue impact of RM controls increases to over 8%
Loads by Fare Class
16.6
4.06.6
9.2
33.0
8.4
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
$450 $375 $240 $180 $155 $125
Fare Class
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Impacts on Differential Pricing Model
Drop in business demand and willingness to pay highest fares
Greater willingness to accept restrictions on lower fares
Reduction in lowest fares to stimulate traffic and respond to LCCs
Result is lower total revenue and unit RASM despite stable load factors
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Summary: Revenue Challenges
Pricing actions by traditional airlines have increased unit revenues, but not to previous levels:
Price cuts to stimulate leisure demand and reduce restrictions on business fares returned load factors to 75%, but did not improverevenue qualityRecent experiments to decrease unrestricted fares have likely succeeded in re-attracting some business passengers But, fare simplification still leaves unit revenues 10-15% below levels of 2000
Conclusion: Pricing actions alone cannot return the network airlines to profitability
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Cost and Productivity Challenges
Post 9/11 operating costs increased substantially:Lower aircraft utilization due to schedule cuts affected productivity and increased unit costsAdded security requirements and associated delays Security fees and higher insurance costsFuel prices in Q1 2004 were 50%+ higher than in 2001
Given 15% shortfall in unit revenues, legacy airlines must cut costs and increase productivity:
Low-cost carriers often used as “benchmark” for unit costsChanging work rules, reducing workforce and cutting wage rates are all options for reducing labor unit costs ($ per ASM)But, unit cost differences are also due to aircraft productivity, as determined by configuration and pattern of operations
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US Airline Unit Costs (per ASM)
Unit Costs differences between network carriers and LCCshave continued to increase despite cost-cutting efforts
Cost per Available Seat Mile (CASM)
6
7
8
9
10
11
12
13
99 1 99 2 99 3 99 4 00 1 00 2 00 3 00 4 01 1 01 2 01 3 01 4 02 1 02 2 02 3 02 4 03 1 03 2 03 3
Cen
ts p
er A
SM
Netw ork Carriers LCCs
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Airline Operating Cost Components
U N IT C O S T B Y C AT E G O R YC ents per A S M
0.00
0 .50
1 .00
1 .50
2 .00
2 .50
3 .00
3 .50
4 .00
Labo
r
Fuel
Ow
ners
hip
Prof
essi
onal
Serv
ices
Land
ing
Fees
Food
&
Beve
rage
Mai
nten
ance
Mat
eria
l
Pass
enge
r
Com
mis
sion
s
Insu
ranc
e
Ad &
Prom
otio
n
Utils
& O
ffice
Supp
lies
Oth
er
Source: ATA data
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Fuel Prices Up 90% Since Q1 2002
F U E L C O S T SC ents per G a llon
40
50
60
70
80
90
100
110
120
1Q90
1Q91
1Q92
1Q93
1Q94
1Q95
1Q96
1Q97
1Q98
1Q99
1Q00
1Q01
1Q02
1Q03
1Q04
Source: ATA data
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Travel Agency Commissions All But Eliminated – Down 85% Since 1994
P A S S E N G E R C O M M IS S IO N C O S T SC ents pe r R P M
0.00
0 .40
0 .80
1 .20
1 .60
2 .00
1Q90
1Q91
1Q92
1Q93
1Q94
1Q95
1Q96
1Q97
1Q98
1Q99
1Q00
1Q01
1Q02
1Q03
1Q04
Source: ATA data
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Food and Beverage Costs Cut in Half
Source: ATA data
F O O D & B E V E R A G E C O S T SC ents per R P M
0.25
0 .30
0 .35
0 .40
0 .45
0 .50
0 .55
0 .60
0 .65
1Q90
1Q91
1Q92
1Q93
1Q94
1Q95
1Q96
1Q97
1Q98
1Q99
1Q00
1Q01
1Q02
1Q03
1Q04
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Unit revenues dropped below unit costs in 2001 for legacy carriers
Unit Costs and Unit RevenuesLegacy
$0.06
$0.07
$0.08
$0.09
$0.10
$0.11
$0.12
1999 2000 2001 2002 2003
CASMRASM
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AA and UA have made biggest unit cost cuts, DL unit costs surged in 2003
Unit Costs / Legacy Carriers
0.07
0.08
0.09
0.1
0.11
0.12
0.13
0.14
0.15
1999 2000 2001 2002 2003
AACODLNWUAUS
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Lowfare carriers RASM also down, but lower CASM continues to decrease
Unit Costs and Unit RevenuesLowfare Carriers
$0.06
$0.07
$0.08
$0.09
$0.10
$0.11
$0.12
1999 2000 2001 2002 2003
CASMRASM
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Lowfare carriers have lowest CASM across all average stage lengths
C A S M v s . S ta g e L e n g th 2 0 0 3
A A
C O
D L
N WU A
U S
A S
H P
T Z
W N
B 6
F L
$ 0 .0 5
$ 0 .0 6
$ 0 .0 7
$ 0 .0 8
$ 0 .0 9
$ 0 .1 0
$ 0 .1 1
$ 0 .1 2
$ 0 .1 3
$ 0 .1 4
$ 0 .1 5
0 5 0 0 1 0 0 0 1 5 0 0
S t a g e L e n g t h ( m i l e s )
CA
SM
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Aircraft Utilization and Productivity
Aircraft “utilization” measured in block-hours/day:Southwest historically achieved system-wide utilization rates 5-10% higher than other Majors, despite flying shorter stage lengthsPost-9/11 cutbacks reduced aircraft utilization at Top 3 Majors more dramatically than at Southwest
Aircraft “productivity” measured in ASMs generated per aircraft per day:
= (# departures) X (average stage length) X (# seats)
Example: B737-500 aircraft operated by CO, UA, WN:Each WN aircraft generates 37% - 51% more ASMs per day, with more seats per aircraft, more departures, and more block-hours
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Daily Aircraft Utilization by Legacy Carriers Plunged After 9/11 (not for Southwest)
8
8.5
9
9.5
10
10.5
11
11.5
12
98-1 98-2 98-3 98-4 99-1 99-2 99-3 99-4 00-1 00-2 00-3 00-4 01-1 01-2 01-3 01-4 02-1 02-2
Blo
ck H
ours
/Day
AAUADLWN
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Boeing 737-500 Productivity (2nd Quarter 2002)
400,1601224008.210.2Southwest
264,3471095644.37.5United
291,6261047193.98.3Continental
ASMsper Day
Seats
Avg. Stage Length
Flights per Day
Daily BlockHoursAirline
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Lowfare carriers lead in aircraft utilization at all average stage lengths
Aircraft Utilization 2003
AA CODL
NWUA
US
ASHP
TZWN
B6
FL
8
9
10
11
12
13
14
0 500 1000 1500Stage Length (miles)
BH
s/ a
ircra
ft d
ay
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Labor Costs: A Big Part of the Problem
Labor costs account for 1/3 of airline expenses
Real unit labor costs 21% lower today than 1980But RASM are 32% lower than 1982—costs exceed revenues
Unit labor costs of low cost airlines about 50% below top carriers
Wage movements out of synch with revenue movements
Past labor cost reductions provided short term relief but not long term improvements in operational performance (productivity or service)
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Legacy carrier employment down by 25% since 2000, a loss of over 100,000 jobs
Airline Em ploym ent 1997-2003
0
50000
100000
150000
200000
250000
300000
350000
400000
450000
1997 1998 1999 2000 2001 2002 2003
LegacyLow-fare
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Lowfare carrier salaries/benefits per employee 25% lower than legacy carriers
Salaries and Benefits per Em ployee
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
$80,000
$90,000
1997 1998 1999 2000 2001 2002 2003
CPI
Adj
uste
d to
200
0
LegacyLowfare
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Growth in Pilot Wage Rates vs. Growth in Revenue per Employee: 1993-1997 vs. 1997-2001
Pilot Wage Rate Changes Averaged Across Four Aircraft Types at 21 Airlines
4%
24%
18%
-8%-10%
-5%
0%
5%
10%
15%
20%
25%
30%
% Change 1993-1997 % Change 1997-2001
Pilot Wages
Revenue per Employee
Source: Department of Transportation Form 41 (from Database Products, Inc.) and Airline Industrial Relations Conference
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Summary: Cost and Productivity Challenges
Unit cost differences not entirely due to labor costs:Differences in aircraft productivity can account for up to one half of difference in aircraft operating expenses per ASMTranslates into about 25% of total unit cost difference between traditional carriers and LCCs
Network carriers are exploring alternatives for increasing aircraft productivity to reduce unit costs:
Continuous connecting banks to reduce ground times at hubsHigher density seating options (e.g. removal of First Class)More “point-to-point” flying to increase aircraft utilization
Successful new “business models” will depend on reducing both aircraft and labor unit costs
In addition to fine-tuning fare structures to maximize unit revenues
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US Airline Performance Since 2000
US airline industry is in the midst of its greatest transition in history
Fundamental shifts in airline business modelsMore efficient new entrants with much lower costs Changes envisioned by architects of deregulation more than 25 years ago
9/11 was not the primary cause of this “crisis”It did lead to increased operating costsOther unfortunate events have not helpedBut new competition is transforming the industry
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Key Questions for the Future
What industry structure will emerge from this crisis?Will (most) network carriers be able to adapt and survive?Or, will several network carriers have to cease operations, leaving LCCs as domestic carriers, and only a few international hub airlines?
What are the new revenue/operating paradigms for network carriers?
Are LCC pricing and operating models broadly applicable?Can network carriers reduce operating costs to competitive levels?
What will be the impact on small markets?Most domestic O-D pairs can only be served with a hub network
Should the government intervene?Stability and sustainability of air transportation system; vs.Disruption of “re-structuring” process spurred by market forces