Structural Changes Have Altered Historical Industry Trends

Since 1998, the U.S. airline industry has faced internal changes that have  fundamentally altered the domestic airline industry. 1). 2). The decline in business fares is another factor that has contributed to the  financial problems of the industry. 7). In Response to Challenges, Legacy Airlines Reduced Costs and Cut Capacity, While Low Cost Airlines’ Total Costs Increased Due to Capacity Expansion

To meet the many challenges of the last several years, airlines have sought  to cut costs, enhance revenues, and obtain the assistance of the federal  government. Airlines used the $2.3 billion in security assistance  provided under the 2003 Emergency Wartime Supplemental Appropriations  Act to fund their security and operating costs, with 75 percent of the  assistance going to the seven legacy airlines. Legacy airlines reported that they expected to reduce operating costs by  about $19.5 billion through December 31, 2003, or 96 percent of this total. Actual Cost Cutting by Airlines Differed

Legacy airlines cut operating expenses by $12.7 billion between October 1,  2001, and December 31, 2003. Legacy Airlines’ Financial Condition Has Deteriorated Relative to Low Cost Airlines

The financial condition of U.S. airlines since 2000 has followed two very  different paths. Meanwhile, low cost airlines  continue to expand market share, enjoy a greater unit cost advantage over  legacy airlines than they did in 2000, and in all but one quarter have  collectively earned a profit. The weak performance of the legacy airlines  over the last 3 years has significantly diminished their financial condition;  as a result, some of these airlines are vulnerable to bankruptcy, especially if  there are additional shocks to the industry. While the  operating margin for legacy airlines recovered in 2003 from its post- September 11 low, and losses in 2003 are not as great as in 2002, these  airlines have experienced operating losses in all quarters but one since  September 11, 2001.Meanwhile, low cost airlines maintained a positive  operating margin between 2001 and 2003, with the exception of the fourth  quarter of 2001—the immediate aftermath of September 11. Legacy carriers continued to serve nearly all of these markets, but  they carried fewer passengers in 2003 than in 1998, and their overall share  decreased. Increased competition in domestic air service is largely attributable to the  growth of low cost airlines, which increased the number of markets served  from 1,594 in 1998 to 2,304 in 2003, an increase of 44.5 percent (see fig. 26). Meanwhile, low cost airlines are using their cost advantage to expand their  market share and challenge legacy airlines like never before. The total number of enplanements in the U.S. airline industry during 2003 was 647,761,545. To assess the measures taken by airlines to remain financially viable, we  relied on a variety of sources. The Act and its  accompanying conference report tasked airlines with providing us with a  plan demonstrating how they would reduce their operating expenses by 10  percent. To determine how the competitiveness of the U.S. airline industry has  changed since 1998, we obtained and stratified DOT quarterly data on the  top 5,000 city-pair markets for calendar years 1998 through 2003 and then  determined shifts in competitive factors overall and for markets with and  without low cost airlines as well as for legacy and low cost airlines.
Why GAO Did This Study

Since 2001, the U.S. airline industry has confronted financial losses of previously unseen proportions. From 2001 to 2003, the industry lost $23 billion, and two of the nation's biggest airlines have gone into bankruptcy. To assist airlines, the Congress provided U.S. airlines with $7 billion of direct financial assistance--most recently in the form of $2.4 billion of financial assistance under the 2003 Emergency Wartime Supplemental Appropriations Act. Under the Act and its accompanying conference report, the conferees directed GAO to review measures taken by airlines to reduce costs, improve revenues and profits, and strengthen their balance sheets. The Congress also tasked airlines receiving assistance to report their cost-cutting plans to GAO. GAO was also required to report on the financial condition of the U.S. airline industry by Vision 100--Century of Aviation Reauthorization Act, which became law in January 2004. In consultation with the Congress, GAO agreed to satisfy these directives and report to the Congress on (1) the major challenges to the airline industry since 1998, (2) measures airlines report taking to remain financially viable, (3) the current financial and operating condition of the industry, and (4) how the competitiveness of the domestic airline industry has changed since 1998.

What GAO Found

U.S. airlines, particularly major network or "legacy" airlines, have faced an unprecedented set of challenges since 1998 that are reshaping the industry and demand for air travel. The decline in business travel, followed by the September 11, 2001, attacks, caused a significant loss of operating revenue for many airlines. In response to these new challenges, the legacy airlines reported a goal of $19.5 billion in cost-cutting measures to restore their profitability through 2003. As a group, legacy airlines actually reduced their operating costs by $12.7 billion over the last 2 years. For legacy airlines, cost cutting was greatest in labor and commission costs. Meanwhile, low cost airlines, which as a group grew 26.1 percent during the last 2 years, reported little cost cutting. Since 2000, legacy airlines financial performance has deteriorated significantly, while low cost airlines have used their comparative cost advantage to expand their market share. Low cost airlines maintained their unit cost advantage over legacy airlines between 2000 and 2003, despite concerted cost cutting efforts by legacy airlines. For several of the legacy airlines, their weakened financial condition combined with significant future financial obligations makes their recovery uncertain. Competition in the domestic airline industry has increased since 1998, primarily owing to the growth and expansion of low cost airlines. Between 1998 and 2003, low cost airlines expanded their presence from 1,594 to 2,304 of the top 5,000 domestic markets and now have a presence in markets that serve about 85 percent of passengers. Legacy airlines, despite financial problems and reduced capacity, continued to serve nearly all of the markets in 2003 as in 1998, but carried fewer passengers as they lost market share to low cost airlines.