The Great Shrink

Implications: I know of no example of an airline that shrank itself into profitability. After all, this is a business that seeks economies of scale.

Analysis: This airline business is not one that obviously follows the traditional behavior of other types of business.  On the one hand it is often run like a utility. On the other hand, it is a type of business that can be incredibly profitable.

As Continental and its industry peers cut back on people and planes, can they hope to get out of the death spiral they are in? The chances are slim, sorry to say. The primary reaon I think this is because we have an industry that is the epitome of oligopoly behavior.

In an oligopoly, the few competitors regulate each other. They do not compete on price. They like stable market shares. They like to keep everything stable. Sound familiar? Except in the US airline business you have some really messy things that spoil the party.

First is the success of the LCCs. These airlines drive the bigger ones nuts. Because they don't obey the "rules" and snatch market share where they can get it. This means the bigger airlines cannot hope to shrink neatly and keep market share stable. Therefore an industry shrink is going to very messy.

Second, one of the LCCs has grown very big; Southwest Airlines. So big that it now de facto sets fares. It also hedged its fuel very well - 70% at ~$50. So now Southwest can keep fares at levels that keep it profitable but bleed to rest to a slown death.

Third, as the bigger airlines shrink painfully, Southwest can cherry pick the cities that bigger carriers drop. It moves in, and for a small fare rise, picks up traffic it was unlikely to get without a fight. Examples are Dulles and Denver and soon to include Las Vegas. Customer loyalty to the bigger carriers is evaporating faster than a drop water in the desert.

Shrinking simply cannot be undertaken without massive adjustments. The best way the US airline can shrink is for one of the big airlines to simply close down. Of these, there are two candidates - United and  US Airways. Of these two, Southwest is bleeding both, and United is bleeding faster.

The horrible thing is that as these painful adjustments come through, tens of thousands of skilled people are going to lose jobs that may never come back. Pilots will need to find work overseas. Mechanics may never see jobs in the US again - unless Congress forces US airlines to use American mechanics. This may happen given outsourced errors that caused havoc at earlier this year.

As you read the headlines about pain at the airlines, focus not on the price increases faced by consumers. Think about the human dislocation - every bit as awful as that faced by the big automobile firms. Shrinking isn't just hard to do - it may be impossible.