Beleaguered USAir is laid low by its high costs, fare wars Will they Survive

THE BALTIMORE SUN

*TC Not long ago, before the flying public discovered it could get there for practically nothing, USAir thrived. It flew places everyone went, like Boston and the Bahamas, and spots practically no airline did, like Buffalo and Binghamton. It charged what it needed to make a handsome profit.

No longer.

Discount carriers are crisscrossing USAir's East Coast territory, spelling good news for passengers but wreaking havoc for the airline that has long depended on high fares to cover its high costs.

Fare wars -- now seemingly a permanent fixture on the aviation landscape -- are torpedoing USAir's efforts to recover from staggering losses of nearly $2.5 billion over the past five years.

Indeed, even while other struggling carriers started to rebound from the lingering recession last year, USAir stalled. And the airline that once possessed the keys to the East Coast kingdom faces a critical juncture that could determine whether it remains a major player in the U.S. airline industry.

"You cannot lose money quarter after quarter. Either it's going to be Chapter 11 [bankruptcy] or a very substantial cost restructuring," said Chris Fotos, a consultant with Avmark Inc., an Arlington, Va., aviation consulting business.

Because of fare-cutting and harsh weather, USAir, the largest carrier and economic linchpin at Baltimore-Washington International Airport, already is predicting pretax losses of $200 million in the first quarter, triple the loss of the same quarter a year ago, and total pretax losses for 1994 exceeding last year's $350 million.

Reinforcing USAir's precarious situation was a strong message its well-heeled partner, British Airways, sent last week: It will withhold its critical investment unless USAir quickly gets spiraling costs under control.

That prompted Arlington, Va.-based USAir to return to its labor unions seeking pay cuts, a move analysts say the carrier should have made long ago. But it faces tough going and might have to give the employees an ownership share to gain concessions, as United and other airlines have done.

With access to nearly $1 billion in cash and credit, USAir says it can get through the year without pay cuts. But the airline is running out of time.

"It's got to be done this year," said Patricia A. Goldman, a former senior vice president who retired from USAir in January. "We can't go on like this."

But returning to profitability hinges on a tricky combination: cutting costs while giving passengers the low fares they expect.

"It's a problem for United, Delta and American. It's a crisis for USAir," said Jon Ash, managing director of Global Aviation Associates, a Washington, D.C.-based airline consulting firm.

Nothing has worked for USAir.

Since 1990, the airline has laid off nearly 16,000 people, shed unprofitable flights, abandoned California markets, closed its Dayton hub, franchised its commuter operation to independent carriers and delayed orders for new planes.

"I have never seen anybody put on the brakes and take a turn the way they did," said Rose Ann Tortora, an airline analyst with Donaldson, Lufkin and Jenrette of New York. "They were headed for bankruptcy court."

"But the underlying fundamental difficulties are still there," she said. "It's a high-cost airline in low-fare environment."

On top of that, the airline is drowning in debt, largely because of its $1.6 billion acquisition of Piedmont Airlines in 1989. Its credit rating has been reduced to junk bond status, and financial institutions are growing uneasy.

Because of its work rules, wages and short-haul route structure, USAir's costs are higher than those of other major airlines and far higher than those of discount carriers such as Southwest and Continental Airlines.

For years, USAir dominated the East Coast markets, which account for 37 percent of U.S. air travel; it kept pricing high enough to offset its cost structure.

"Now, people like Southwest and Continental, with a much lower cost structure, are controlling it," Mr. Ash said. "And that puts pressure right square on USAir."

USAir spends 11.4 cents to fly a seat one mile. Continental spends 7.8 cents and Southwest, 7.1 cents. "At the end of the day, that's too big a spread," Mr. Ash said.

Overall, 17 percent of USAir's revenues -- nearly twice as high a proportion as for most other domestic airlines -- is exposed to potential competition from low-cost carriers, according to a study by Kidder, Peabody & Co. of New York.

That has forced USAir to launch Project High Ground, short-haul flights patterned on Southwest Airline's highly successful, quick-turn around strategy and to dramatically lower fares on roughly a quarter of its routes.

Project High Ground is designed to make more money using the same number of workers and planes. By gaining productivity, USAir hopes to narrow the gap that makes it so vulnerable to competition from Southwest and other low-cost carriers.

But USAir is no Southwest Airlines. And integrating Southwest-like service into its traditional hub-and-spoke operation will be challenging.

"If it were an easy solution, there would be 15 Southwest airlines flying around," Seth E. Schofield, USAir's 54-year-old chief executive officer said during an interview at his Crystal City office overlooking National Airport.

Yet, in an industry that has lost $13 billion since 1989, Southwest is the undisputed, moneymaking role model. The Dallas-based carrier flies directly from city to city. In contrast, USAir and other major airlines operate a maze of expensive hubs where passengers converge to connect for similar destinations.

Hubs require large ground crews, huge fleets with a mix of aircraft, more maintenance workers, more pilots and more training requirements for both.

To connect, flights tend to arrive at the hubs around the same time; employees work frantically at times, followed by inactivity. Gate workers sometimes wait an hour or more for the next flight to depart, and $125,000-a-year pilots get paid for sitting in airport lounges and hotels.

USAir and some other major airlines pay pilots for flying 85 hours a month, yet actual flying time is more like 45 hours, compared to 70 hours a month for Southwest.

"I'll spend eight hours of working and maybe only fly two," a USAir 737 pilot said. "What USAir needs to do is make us more productive."

USAir's pilot wage scale, negotiated during far more lucrative times, is among the highest in the industry. But labor unions contend that increasing the number of Project High Ground flights -- now only 90 of USAir's 2,500 daily flights -- will produce the savings USAir needs without pay cuts.

Opportunity missed

Two years ago, USAir missed an opportunity to get permanent wage concessions, accepting instead a one-year pay cut that expired in 1993. But USAir has long taken the position that wages are not its only problem.

"The work rules, wages and structure of the company all come together and produce a cost that is unacceptable in this competitive environment," Mr. Schofield said.

Nevertheless, USAir's labor costs remain the highest in the industry, accounting for nearly 39 percent of the airline's operating costs, compared with the industry average of 30 percent and Continental's 22 percent.

By most accounts, USAir has uncovered the obvious: The passenger today thinks fares, fares, fares.

"Our passengers are telling us that fares are too high," Mr. Schofield said.

Because of competition from discount airlines, USAir implemented its Project High Ground program in February, lowering fares, removing restrictions and offering quick, turnaround flights in numerous markets. This summer, it plans to add more of those flights and to become more service-oriented.

But some think USAir is unwilling to accept the notion that business-class travel, traditionally less concerned with price than service, has changed dramatically as economy-minded corporations use telecommunications, rental cars and even charter jets.

"USAir, like a number of carriers, seems to be stuck in this mentality that there's high-yield traffic out there and all they have do is find it," said one aviation industry observer.

It was, however, the business traveler -- willing to pay $600 for a round-trip ticket as he jumped on a plane from Baltimore to Rochester at the last minute -- that spurred USAir's growth from a regional carrier, named Allegheny Airlines, to the nation's sixth-largest airline.

When deregulation arrived in 1978, Allegheny gradually added unsexy, yet money-making, flights. A year later, it changed its name to USAir, reflecting a more national character as it tacked on flights to Southwest and Florida.

What followed during the 1980s was one of the real success stories of deregulation as USAir became the largest airline in the Northeast and Florida, with a fleet of 450 jets, serving five hubs, 270 cities in 40 states and seven countries.

Headed by Harvard-educated lawyer Edwin Colodny, USAir pursued a strategy of controlled growth as other carriers went through merger manias. But even after it became a major player, Mr. Colodny ran it like a regional carrier.

And the airline's failure to take several major steps in the 1980s left it ill-prepared for the coming recession that would devastate the industry.

While others, such as American Airlines, bought sophisticated computer systems, USAir spent virtually nothing on technology. That left the airline without the indispensable tool that airline planners need to assess which routes are most profitable.

While many carriers bought international routes and large planes, USAir shunned overseas business. It turned down an opportunity, to acquire a Pittsburgh-to-London route for free -- only to pay Trans World Airlines $75 million for the same route a few years later.

As a result, USAir had little international business to offset the domestic economic downturn.

"We're the mirror-image of problems like Pan Am, which had no domestic flights or small planes," said Ms. Goldman, referring to the now-defunct carrier.

Fearing a takeover, USAir entered the merger game late, acquiring Pacific Southwest Airlines in 1987 -- just as discount carriers started to force fares down on the West Coast.

Two years later, in the largest airline merger in history, it bought Piedmont Airlines, quadrupling its debt overnight -- just as the economy began to sputter on the East Coast.

"They got themselves into a hole, and by the time they tried to dig out, they were not in a good position to fight," said Mr. Fotos of Avmark Inc.

The Piedmont merger gave USAir new routes on the West Coast and in the Sun Belt. Yet USAir faced the Herculean task of intergrating three airlines, three different management teams and three vastly different corporate cultures -- the Southern, offbeat California and stodgy Northeastern.

By most accounts, it botched the job royally. Today, even with a consumer record as good as or better than those of other major airlines, USAir is widely remembered as the carrier that ruined Piedmont.

"They spent a lot of money trying to assimilate them and still had

a lot of heartsick consumers," Mr. Fotos said.

Pay scales transferred

Another legacy of the Piedmont acquisition has been far more enduring. Rather than renegotiate contracts, USAir transferred its work rules and pay scales -- negotiated during highly profitable times -- to Piedmont's 16,000 employees, who were accustomed to far less liberal benefits.

That marked the beginning of the severe costs problems it now confronts. When the recession arrived in 1990, USAir, like every other domestic airline, had too many workers, too few passengers and too many planes.

In the fall of 1991, Mr. Colodny turned over the job of running USAir to Mr. Schofield, vice president of operations, who had begun his career with the company as a teen-age baggage handler. Under Mr. Schofield, the pace in Crystal City quickened.

Despite his low-key, unassuming style, USAir employees saw more operating strategies emerge as Mr. Schofield began hiring talented managers from other airlines and allowed them to do things differently.

By that time, however, the airline was foundering. The year after Mr. Schofield took over, USAir recorded its largest loss ever -- $1.2 billion.

"Schofield inherited a . . . mess," said airline analyst Alex C. Hart of Ferris, Baker Watts Inc. of Baltimore. "He's doing a lot of things right, but he may wind up by default looking like the goat."

But Mr. Schofield at least kept the struggling airline on a tight, cost-cutting course. It was the first major carrier to retrench, as it cut thousands of jobs, negotiated labor give-backs that resulted in saving $230 million a year and deferred orders for new aircraft.

While East Coast markets did better than others, the airline continued to lose money nearly everywhere.

"Finally, we hit the bottom, pulled up our socks and shed some more unprofitable routes," said Ms. Goldman. "We were doing less and less worse up until the summer of 1992. Then [American Airline President Robert] Crandall's fare wars trashed all."

"We took a hideous dive," she recalled. "We had record boardings and lost our shirts."

To compete with low fares, USAir raised prices in markets it dominated, such as Philadelphia to Pittsburgh. That brought a significant drop in passengers.

As the downward spiral continued, USAir looked for a foreign partner that could give it access to desperately needed cash and international markets that it couldn't afford to enter.

Despite fierce opposition from United, Delta and American, its alliance with the prestigious British Airways was approved by the U.S. Department of Transportation in March 1993. It was a mammoth coup; stock prices doubled between December and April.

Finally, the airline saw a glimmer of hope.

In an Arlington movie theater, Mr. Schofield assured stockholders last May that the turnaround was at hand. First- and second-quarter revenues were significantly higher than in the same periods of 1992.

Its cash position was the best in years, thanks to $400 million sale of preferred stock to British Airways and a $230 million public common stock offering in May. By the end of June, USAir had more than doubled its shareholders' equity to $953 million.

But continuing losses and debt payments seriously eroded its improved financial position. Even as every other domestic carrier posted their first profits in years, USAir lost $177 million in the third quarter of 1993 and another $116.5 million in fourth quarter.

With a renewed sense of urgency, the airline moved swiftly in October to lay off another 2,500 workers, though privately conceding that might not be enough.

In fact, the company's viability seemed increasingly dependent on its politically charged alliance with British Airways.

"For unsecured lenders, confidence begins to end without BA's support," said Samuel C. Buttrick, an analyst with Kidder, Peabody.

Indeed, British Airways' warning last week shook investors who thought of the carrier as USAir's protection. USAir stock dropped to a 12-month low Friday, closing at $8.375.

"When you've been in a situation where you've lost more than $2 billion, I don't think anyone expects that that will turn around overnight," said Mr. Schofield. "USAir will definitely survive. No one should write it off."

But, as its losses continue to mount and its cash dwindles, how long does it have?

"They're doing the right things," said Mr. Ash of Global. "Whether they can get it done quickly enough . . . that's another question. They can't go on indefinitely."

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