	U.S. These challenges have  come from within the industry as well as from external factors affecting  the demand for air travel. The airlines’ increased use of  the Internet to reduce ticket distribution costs. The emergence of well- capitalized low-cost airlines has also been a significant challenge. An economic downturn that began in 2000  depressed airline revenues, and the terrorist attacks of September 11th,  the Iraq war, and the outbreak of Severe Acute Respiratory Syndrome  (SARS) have compounded this trend. In Response to Challenges, Legacy Airlines Reduced Costs and Cut Capacity, While Low- Cost Airlines Grew

Airlines responded very differently to the challenges of the last few years. Legacy airlines faced with mounting losses and curtailed demand for air  travel sought to reduce capacity and along with it their operating  expenses. Legacy airlines cut operating expenses by $12.7 billion between October 1,  2001, and December 31, 2003. This 14.5 percent reduction in operating  expenses exceeds the percentage reduction in seat capacity of 12.6  percent during the same period. 1). In the aftermath of  September 11th, legacy airlines shifted some of their routes over to  regional airlines in an attempt to reduce seat capacity on these routes. The seven low-cost airlines increased seat capacity  by 26.1 percent during the same period that legacy airlines cut capacity by  12.6 percent, but total operating costs for low-cost airlines increased by a  more modest 9.8 percent, or a little more than $1 billion. 2). Low-Cost Airlines Have Significantly Lower Unit Costs Than Legacy Airlines

Legacy airlines, as a group, have been unsuccessful in sufficiently reducing  their costs to make them more competitive with low-cost airlines. Low-Cost Airlines Are Profitable Owing to Lower Costs

Low-cost airlines have been able to use their relative cost advantage to  remain profitable at a time when fares are down throughout the industry. Legacy Airlines’ Financial Condition Has Deteriorated Since 2000

Since 2000, the financial condition of legacy airlines has deteriorated. Both  legacy airlines and low-cost airlines increased their cash balances  following the events of September 11th; legacy airlines did so primarily  through borrowing, while low-cost airlines increased theirs by generating  profits as well as borrowing. Since 2001, legacy airlines have taken on  more debt, relying on creditors for more of their capital needs than they  have in the past. Three years of losses have left legacy airlines in a  weakened financial position with large debt and pension obligations  looming in the next few years. Instead, the airline industry  is being transformed into two industries, profitable low-cost point-to-point  airlines that continue to grow and extend their reach into ever more  markets and the major network legacy airlines that account for the vast  majority of the industry’s losses. This is a work of the U.S. government and is not subject to copyright protection in the  United States.
Why GAO Did This Study

Since 2001, the U. S. airline industry has confronted financial losses of previously unseen proportions. From 2001 through 2003, the industry reported losses of about $23 billion, and two of the nation's largest airlines went into bankruptcy. Since September 11, 2001, the U.S. government has provided struggling airlines with $7.0 billion in direct assistance and many billions more in indirect assistance in the form of loan guarantees, a tax holiday, and pension relief. Under the 2003 Emergency Wartime Supplemental Appropriations Act (P.L. 108-11) and Vision 100--Century of Aviation Reauthorization Act (P.L. 108-176), Congress mandated that GAO review measures taken by air carriers to reduce costs, improve their revenues and profits, and strengthen their balance sheets. Later this year, GAO will provide a report to Congress in response to these mandates. This statement provides a preliminary summary of that work and focuses on three main questions: (1) what have been the major challenges to the airline industry since 1998; (2) what costcutting measures have airlines reported taking to remain financially viable; and (3) what is the financial condition of the airline industry?

What GAO Found

U.S. airlines, particularly major network or "legacy" airlines, have faced an unprecedented set of challenges since 1998 that have reshaped the industry and reduced the demand for air travel. Within the industry, the growth of the Internet as a means to sell and distribute tickets and the emergence of well-capitalized low-cost airlines as a powerful market force have created unprecedented pressures on how airlines operate and price their products. Coincidently, a series of largely unforeseen events--among them a steep decline in business travel, the September 11th terrorist attacks, war in the Middle East, and global recession--have combined to seriously disrupt the demand for air travel. To counter these challenges, airlines undertook very different strategies. Legacy airlines sought to cut costs, while low-cost airlines took advantage of legacy airlines' retrenchment and expanded. Legacy airlines collectively reported a reduction in operating costs of $12.7 billion (14.5 percent) between the October 1, 2001 (immediately after September 11th) and the end of 2003. The reductions occurred in nearly all areas of operations, but 43 percent of the savings came from labor. Legacy airlines reduced their seat capacity by 12.6 percent as they reduced operations and shifted service to their regional airline partners. Conversely, low-cost airlines increased seating capacity by 26.1 percent as they expanded their operations, and operating expenses actually increased by just over $1 billion (9.8 percent). Since 2000, the financial condition of legacy airlines, as a group, has deteriorated significantly. Despite their cost-cutting efforts, legacy airlines' unit costs have not declined, and low-cost airlines enjoy even a greater cost competitive advantage. Meanwhile, neither legacy nor lowcost airlines have been able to significantly improve their revenues owing to weak fare growth and overcapacity in the system. As a result, legacy airlines have recorded nearly $25 billion in operating losses since 2001, while low-cost airlines have remained profitable throughout. Two major legacy airlines have already declared bankruptcy; others may follow.