Turbulence Ahead

Flying off into the sunset—or anywhere else—isn't what it used to be. That's especially true for America's troubled domestic airlines. Slowed by a bad economy as well as rising oil and jet fuel prices, the industry thought it could consolidate its way out of trouble. Apparently not. Last week United Airlines and US Airways, which both sought to create operational efficiencies by joining forces, called off what would have been the biggest merger in the industry's history. Why? With oil prices topping $130 a barrel and jet fuel up more than 82.5 percent since last year, the CEOs of both airlines said that in the current economic climate the risks of a merger outweighed the benefits.

What does that mean for travelers? Nothing good. Even as some international and luxury carriers offer gourmet meals and cashmere blankets, domestic airliners are cutting every corner. Already accustomed to paying fuel surcharges, passengers are also starting to be hit up for checked bags and for in-flight meals and beverages. Adding insult to injury, many industry analysts are warning travelers to brace for fare hikes of up to 20 percent this summer. It's no wonder a new survey released last week by the Travel Industry Association shows that 78 percent of flyers believe the air travel system is either broken or in need of moderate correction.

"The industry is sitting on the edge of a knife," says Roger King, an airline analyst for the research firm CreditSights. "Will they be able to raise fares high enough to cover the cost of oil? We'll watch to see if they stabilize before they run out of cash. One or two airlines are probably going to stop flying." Industry losses this year are expected to top $7.2 billion, according to a recent JPMorgan Chase report.

While smaller and regional airlines are most at risk, even the country's legacy carriers are in for some rough times. To cut operating costs American Airlines recently announced a reduction of its domestic flight capacity (number of seats offered) by 11 to 12 percent for the fourth quarter of 2008, its biggest cuts since the 2001 terror attacks. American is eliminating 75 planes from its fleet of 954 and will probably resort to layoffs in the near future.

Consolidation was supposed to help struggling carriers cope. And while it didn't work out for US Airways and United, others are still hoping that mergers will cut costs and generate profits. Northwest and Delta, for example, are still headed to the altar, pending regulatory approval. Mergers can give combined airlines enough market power to reduce competition, eliminate redundant routes and increase fares, says Anthony Pagano, an assistant professor of management at the University of Illinois at Chicago.

Not everyone agrees. "I wish mergers were the answer," says Clifford Winston, an economist at the Washington, D.C.-based Brookings Institution. "There's not anything in the past that proves mergers make carriers a hell of a lot more efficient." Winston says he doesn't oppose airline mergers, just that companies with already problematic labor and management issues can sometimes create "one big inefficient carrier." Part of the snag in merging United  and US Airways was apparently difficulty in combining the companies' labor contracts.