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Report to Congressional Committees: 

August 2004: 

COMMERCIAL AVIATION: 

Legacy Airlines Must Further Reduce Costs to Restore Profitability: 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-836]: 

GAO Highlights: 

Highlights of GAO-04-836, a report to congressional committees: 

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. 

GAO is making no recommendations.

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 (see fig. 
below). For several of the legacy airlines, their weakened financial 
condition combined with significant future financial obligations makes 
their recovery uncertain. 

Unit Costs for Legacy and Low Cost Airlines, 2000 and 2003: 

[See PDF for image]

[End of figure]

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.

www.gao.gov/cgi-bin/getrpt?GAO-04-836.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact JayEtta Z. Hecker at 
(202) 512-2834 or heckerj@gao.gov.

[End of section]

Contents: 

Letter: 

Results In Brief: 

Background: 

Airline Industry Facing Serious Challenges: 

In Response to Challenges, Legacy Airlines Reduced Costs and Cut 
Capacity, While Low Cost Airlines' Total Costs Increased Due to 
Capacity Expansion: 

Legacy Airlines' Financial Condition Has Deteriorated Relative to Low 
Cost Airlines: 

Low Cost Airline Growth Has Created Greater Competition in Many 
Domestic Markets: 

Concluding Observations: 

Comments: 

Appendixes: 

Appendix I: Airline Cover Letter: 

Appendix II: Airline Enplanements and Government Assistance Received 
Pursuant to P.L. 108-11: 

Appendix III: Regional Airline Financial and Operating Statistics, 1998 
through 2003: 

Appendix IV: Scope and Methodology: 

Appendix V: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Acknowledgments: 

Tables: 

Table 1: Distribution of $2.3 Billion in Federal Aid From P.L. 108-11: 

Table 2: Financial Plans Reported to GAO: 

Table 3: Regional Airline Financial Data, 1998 through 2003: 

Table 4: Regional Airline Operating Data, 1998 through 2003: 

Figures: 

Figure 1: Average Airline Bookings Per Distribution Method, 1999 and 
2002: 

Figure 2: Airline Group Market Share of Industry Capacity (ASMs), 1998 
through 2003: 

Figure 3: Airline Industry--Change in Capacity (ASMs), 1998 through 
2003: 

Figure 4: Percentage Change in GDP and Airline Industry Passenger 
Demand, 1979 through 2003: 

Figure 5: FAA Demand Forecasts (System traffic): 

Figure 6: Cost of Oil Per Barrel, 1998 through the 1st Quarter of 2004: 

Figure 7: Average Quarterly Business Fares, 2001 through 2004: 

Figure 8: Airline Cost Savings Reported to GAO: 

Figure 9: Change in Component Costs for Legacy Airlines, October 1, 
2001, through December 31, 2003: 

Figure 10: Change in Component Costs for Low Cost Airlines, October 1, 
2001, through December 31, 2003: 

Figure 11: Distribution of $2.3 Billion of Direct Assistance Under P.L. 
108-11, by Airline Type: 

Figure 12: Airline Stage Length Adjusted Unit Costs, 2000 vs. 2003: 

Figure 13: Unit Cost Differential, 1998 through 2003: 

Figure 14: Labor Productivity, Legacy Airlines vs. Low Cost Airlines: 

Figure 15: Asset Utilization: Legacy Airlines vs. Low Cost Airlines: 

Figure 16: Airline Revenues, 1998 through 2003, By Airline Group: 

Figure 17: Revenue Collected Per RPM (Yield), 1998 through 2003, By 
Airline Group: 

Figure 18: Percentage Change in Airline RPMS, Since 2000: 

Figure 19: Airline Profitability (In unit operating margin), 1998 
through 2003: 

Figure 20: Airline Profits and Losses, 1998 through 2003: 

Figure 21: Liquidity of Legacy Carriers vs. Low Cost Carriers, Moving 
Average 1998 through 2003: 

Figure 22: Liabilities as Proportion of Total Assets, Moving Average 
1998 through 2003: 

Figure 23: Out-Year obligations, Legacy Airlines vs. Low Cost Airlines: 

Figure 24: Top 5,000 Markets Were More Competitive in 2003: 

Figure 25: Low Cost Airlines Had Expanded Service to Additional Markets 
by 2003: 

Figure 26: Low Cost Airlines Gained Market Share (Passengers) from 
Legacy and Other Airlines: 

Figure 27: The Majority of Markets in the Top 5,000 Were Dominated from 
1998 through 2003: 

Figure 28: Dominated Markets Tended To Be Smaller Than Nondominated 
Markets: 

Abbreviations: 

ASM: Available seat mile: 

ATA: Air Transport Association: 

ATSB: Air Transportation Stabilization Board: 

BTS: Bureau of Transportation Statistics: 

CASM: Cost per available seat mile: 

DOT: Department of Transportation: 

FAA: Federal Aviation Administration: 

GDP: Gross domestic product: 

RPM: Revenue passenger mile: 

SARS: Severe Acute Respiratory Syndrome: 

SEC: Securities and Exchange Commission: 

TSA: Transportation Security Administration: 

Letter August 11, 2004: 

Congressional Committees: 

Since 2001, the U.S. airline industry has confronted financial losses 
of previously unseen proportions. Over the last 3 years, 2001 through 
2003, the airline industry reported losses of $23 billion, and two of 
the nation's largest airlines went into bankruptcy. Following the 
tragic terrorist attack of September 11, 2001, the U.S. government has 
provided struggling airlines with $7 billion in direct assistance and 
many billions of dollars more in indirect assistance in the form of 
loan guarantees, a tax holiday, and pension relief. In April 2003, 
under the 2003 Emergency Wartime Supplemental Appropriations Act (P.L. 
108-11) the federal government provided $2.4 billion of direct 
financial assistance to the airline industry.

The Congress, in the conference report accompanying the act, also 
directed that we review measures taken by airlines to reduce costs, 
improve their revenues and profits, and strengthen their balance 
sheets. Subsequent to the Supplemental Appropriations Act, in January 
2004, the Congress required under the Vision 100--Century of Aviation 
Reauthorization Act that we report on the financial condition of the 
U.S. airline industry. In consultation with the Congress, we agreed to 
answer the following key questions to help satisfy these mandates: (1) 
What have been the major challenges to the airline industry since 1998? 
(2) What measures have airlines reported taking to remain financially 
viable? (3) What is the current financial and operating condition of 
the airline industry? (4) How has the competitiveness of the domestic 
airline industry changed since 1998?

To help answer these questions, the Congress, in the conference report 
accompanying the 2003 Emergency Wartime Supplemental Act, directed the 
64 U.S. commercial airlines that received assistance under the act to 
provide us with a plan demonstrating how they would reduce their 
operating expenses by 10 percent. Working with airlines, we devised a 
data collection template for airlines to submit their financial plans 
(see app. I). Because of the amount of information and proprietary 
nature of these plans, for the purposes of this report, we focused our 
analysis on the 30 largest domestic airlines and aggregated the 
financial information contained in these plans into one of three 
airline categories--legacy airlines, low cost airlines, and regional 
airlines (see app. II for a list of these airlines by category).
[Footnote 1] The body of this report focuses on the cost-cutting 
activities and financial condition of the largest seven legacy and 
largest seven low cost airlines (in terms of passenger volume). 
Although regional airlines have carried more passengers over the past 
several years, they have done so largely under contract with legacy 
airlines. Hence, we present their results in appendix III. We also 
used airline financial and operating data as reported to the Department 
of Transportation (DOT) to examine airline financial condition and 
changes in competition in the largest 5,000 airline markets in the U.S. 
To assess the reliability of those data, we reviewed the quality 
control procedures that DOT applies and subsequently determined that 
the data were sufficiently reliable for our purposes. We also met with 
airlines and their trade associations, airline equity and credit 
analysts, government experts, and academics to discuss airline cost-
cutting efforts and the current financial condition of airlines. We 
had sufficient information to make informed judgments on the matters 
covered by this report. We performed our work between December 2003 and 
August 2004 in accordance with generally accepted government auditing 
standards.

Results In Brief: 

U.S. airlines, particularly legacy airlines, have faced an 
unprecedented set of challenges since 1998. These challenges were both 
internal factors that are reshaping the airline industry and external 
events that sharply reduced the demand for air travel. Within the 
airline industry, even before the events of September 11, the growth of 
the Internet as a means to sell and distribute tickets, the growth of 
low cost airlines as a powerful market force, and the shifting role of 
regional airlines were all transforming the industry. Coincidently, a 
series of largely unforeseen events--among them the September 11 
terrorist attacks, war in the Middle East, and associated security 
concerns; the Severe Acute Respiratory Syndrome (SARS) epidemic; global 
recession; and a steep decline in business travel--seriously disrupted 
the demand for air travel.

To meet the many challenges of the last several years, airlines sought 
to cut costs, enhance revenues, and obtain the assistance of the 
federal government. Legacy airlines collectively reported to us a goal 
of $19.5 billion in cost-saving initiatives between October 1, 2001, 
and the end of 2003--and actually achieved $12.7 billion in cost-
savings, or about a 14.5 percent reduction in operating expenses over 
the same period. These airlines reported cuts from a variety of 
measures, including reduced employee pay, a 12.6 percent reduction in 
capacity, and productivity measures. Conversely, low cost airlines 
reported very little cost-cutting, and their total operating expenses 
as a group increased about $1 billion, or about 10 percent. However, 
low cost airlines' capacity increased even faster, 26.1 percent. Both 
legacy and low cost airlines reported relatively modest amounts of 
revenue enhancement initiatives due to the weak demand for air travel 
and limited pricing power that airlines held during the period. Legacy 
airlines operating revenues actually declined 14.5 percent, while low 
cost airlines revenues increased 9.4 percent.

Since 2000, as a group, the financial condition and viability of legacy 
airlines has deteriorated significantly. Despite the cost-cutting 
efforts of legacy airlines over the last couple of years, legacy 
airlines' unit costs have not been reduced and low cost airlines still 
enjoy a cost-competitive advantage. After adjusting for differences in 
the average distances flown ("stage length"), low cost airlines have a 
67 percent unit cost advantage over their legacy airline competitors, 
as compared to 45 percent in 2000. Meanwhile, neither legacy nor low 
cost airlines have been able to significantly improve their unit 
revenue, owing to weak fare growth and overcapacity in the system. As a 
result of their weak performance and mounting losses, legacy airlines 
liquidity and solvency have also deteriorated, and they face 
considerable debt and pension obligations in the next few years. At 
least one other legacy airline may enter bankruptcy before the year is 
out and all legacy airlines remain vulnerable to potential future 
industry shocks.

Since 1998, competition in the domestic airline industry has increased, 
primarily due to the growth and expansion of low cost airlines. On 
average, the largest 5,000 domestic markets were more competitive in 
2003, compared with 1998, although total passenger traffic remained 
about the same. Low cost airlines, which have been found to reduce 
fares in markets they enter, expanded their presence from 1,594 to 
2,304 of the top 5,000 markets and had a presence in markets that 
served 84.6 percent of all passengers. Legacy airlines, despite 
financial problems and reduced capacity, continued to serve nearly all 
of the top 5,000 markets from 1998 to 2003, but they carried fewer 
passengers as they lost market share to low cost airlines. Legacy 
airlines continued to dominate many of the largest 5,000 domestic 
markets in 2003, but most of those were relatively small local markets 
to or from their hubs.

Background: 

In 1978, under the Airline Deregulation Act, the United States 
deregulated its domestic airline industry. The main purpose of 
deregulation was to remove government control and open the air 
transport industry to market forces. Prior to the Act, the Civil 
Aeronautics Board regulated all domestic air transport, controlling 
fares and setting routes. In this regulated market, airlines competed 
more through advertising and onboard services than through fares. 
Similar to other highly regulated industries, the airline industry was 
heavily unionized with a highly trained and stable workforce.

In the years since deregulation, many studies, including ours, have 
found that fares measured in real terms have fallen since 1978. For 
example, in 1999, we reported that overall airfares had fallen 21 
percent in constant dollars between 1990 and the second quarter of 
1998.[Footnote 2] However, while deregulation led to lower fares, it 
did not bring about the full measure of competition envisioned by its 
creators. Legacy airlines created unique hub-and-spoke networks that 
increased service for consumers but kept local market fares high at 
their dominated hubs. Generally, the legacy airlines earned a premium 
for operating their hub and acted in a highly competitive fashion (e.g. 
substantially increasing scheduled service and aggressive pricing) 
against intruders, including low cost new entrant airlines. In many 
ways, however, these legacy airlines continue to compete based on 
service rather than fares.

The U.S. commercial airline industry is capital-intensive, labor-
intensive, and has high fixed costs with revenues and profits closely 
tied to the nation's business cycle. Fixed costs, including labor union 
contracts that are in effect for several years at a time, comprise a 
large portion of airline expenses and airlines must anticipate their 
capacity needs several years in advance. As a result, airlines tend to 
place orders for aircraft during profitable years, but deliveries tend 
to occur during down years. This has contributed to the cyclic nature 
of industry profitability. For example, in the 1990s, the industry 
recorded historically high profits of $47.4 billion from 1993 through 
1999, during which time several airlines signed new agreements with 
their contract work force and ordered new aircraft. However, the 
industry has also experienced downturns at the beginning of each decade 
since deregulation. The airline industry reported losses of $2.5 
billion from 1980 through 1982, $7.7 billion from 1990 through 1992, 
and $23 billion from 2001 through 2003. It is during these lean times 
that legacy airlines such as Braniff and Eastern failed, and others--
such as US Airways and United more recently--filed for bankruptcy 
protection. It is also during these lean times that new entrant low 
cost airlines emerged. In the past, many of those new airlines quickly 
disappeared. In response to the latest downturn, the Congress provided 
several forms of financial relief, including direct grants and a 4-
month security fee holiday, and it set up the Air Transportation 
Stabilization Board to provide up to $10 billion in loan 
guarantees.[Footnote 3]

The U.S. airline industry is principally composed of legacy, low cost, 
and regional airlines; and while it is free of economic regulation, it 
remains regulated in other respects, most notably safety and operating 
standards. Legacy airlines are essentially those airlines that were in 
operation before deregulation and whose goal is to provide service from 
"anywhere to everywhere." To meet this goal, these airlines support 
large, complex hub-and-spoke operations with thousands of employees and 
hundreds of aircraft (of various types) with service to domestic 
communities of all sizes as well as international points at numerous 
fare levels. To enhance revenues without expending capital, legacy 
airlines have entered into domestic (and international) alliances that 
give them access to some portion of each other's network. Legacy 
airlines contract with or separately operate regional airlines to 
provide service to smaller communities; regional airlines typically 
operate turboprop or regional jet aircraft with up to 100 seats. Low 
cost airlines entered the marketplace after deregulation[Footnote 4] 
and primarily operate point-to-point service from "focus cities" using 
fewer types of aircraft. These airlines typically offer a simplified 
fare structure that was originally aimed at leisure passengers, but is 
increasingly attractive to business passengers because they do not have 
restrictive ticketing rules that make it significantly more expensive 
to purchase tickets within 2 weeks of the flight or make changes to an 
existing itinerary. Low cost airlines do not yet offer service outside 
Canada, Central America, and the Caribbean. DOT oversees industry 
competition and safety,[Footnote 5] including the air traffic control 
system. The Department of Homeland Security's Transportation Security 
Administration (TSA), which was formed after the September 11, 2001, 
terrorist attacks and was originally part of DOT, oversees industry 
security, including passenger and baggage screening.[Footnote 6]

Airline Industry Facing Serious Challenges: 

Although the airline industry was deregulated 26 years ago, during the 
last several years, airlines have been presented with a sweeping set of 
challenges. These challenges stem from the internal restructuring of 
the airline industry and from external factors affecting the demand for 
air travel. Internally, the impact of the Internet on how tickets are 
sold and how consumers can search for fares, the emergence of low cost 
airlines as a powerful market force, and the growth of regional 
airlines have had a major impact on the airline industry. Coincidently, 
a series of largely unforeseen events--among them the September 11, 
2001, terrorist attacks, war in Iraq, and associated security concerns; 
the SARS crisis; economic downturn; and a steep decline in business 
travel have seriously disrupted the demand for air travel.

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. Among the 
most significant factors affecting this change are the emergence of the 
Internet and a new breed of low cost airlines, and the growth of 
regional airlines have spurred the industry to reevaluate how it 
conducts business.

The Increased Use of the Internet Has Lowered Airline Distribution 
Costs but Created Price Transparency and Downward Pressure on Airfares: 

Since the mid-1990s, partly in response to increasing costs of global 
distribution systems, airlines have increasingly sold and processed 
tickets through Internet-based applications, such as airline Web sites, 
Orbitz, and other internet-based travel agencies.[Footnote 7] Through 
various incentives, airlines have encouraged some passengers to book a 
growing portion of tickets this way (see fig. 1). This distribution 
method is less expensive to airlines than traditional travel agencies, 
but it has also increased the ability of consumers to compare airline 
ticket pricing and scheduling and often gives consumers access to 
special low fares available only on the Internet. This increased price 
transparency has been a significant factor in the downward pressure on 
airfares, creating a real decline in airline passenger revenues at the 
same time that airlines are incurring cost savings.

Figure 1: Average Airline Bookings Per Distribution Method, 1999 and 
2002: 

[See PDF for image]

[End of figure]

Low Cost Airlines Have Emerged to Challenge Legacy Airlines: 

Another major factor in the internal restructuring of the U.S. 
commercial aviation industry is the growth of low cost airlines. Low 
cost airlines have increased their share of available seat miles (ASM)-
-an industry measure of supply--from 10.8 percent in 1998 to 17.5 
percent in 2003 (see fig. 2). Low cost airlines typically rely upon 
fewer types of aircraft and offer simpler fare structures than legacy 
airlines. Unlike earlier low cost airlines, many of which quickly 
disappeared, these airlines are well-capitalized and offer a good 
overall product. As relative newcomers in the industry, these airlines 
do not yet suffer from what is commonly know as "legacy costs," costs 
that older airlines incur simply due to their longevity. These include 
the labor costs of a more senior workforce as well as retirees, 
aircraft costs from maintaining several fleet types as well as older 
aircraft, and the costs of maintaining networks.

Figure 2: Airline Group Market Share of Industry Capacity (ASMs), 1998 
through 2003: 

[See PDF for image]

Note: Regional airline available seat mile capacity is provided under 
code share arrangements with legacy airlines.

[End of figure]

Regional Airlines Have Grown and Remained Profitable: 

During this period of turmoil for the legacy airlines, their regional 
affiliates have increased capacity and maintained profitability. 
Regional airlines, which operate in affiliation with one or more legacy 
airlines, may be wholly or partially owned by the partner airline or 
completely independent. Regional airlines primarily serve smaller 
communities with regional jet or turboprop aircraft through contractual 
arrangements with legacy carriers. Many of these contracts are risk 
free for the regional airline because the legacy partner pays a fee for 
the regional airline's service. From 1998 through 2003, the 16 largest 
regional airlines included in our study earned an operating profit of 
$3.3 billion. At the same time, regional airlines increased seat 
capacity 140.6 percent between 1998 and 2003 (see fig. 3). This growth 
and profitability of the regional airlines came about because legacy 
airlines transferred routes to them. Recently, two low cost carriers--
AirTran and Frontier--also partnered with regional airlines for 
regional jet service. In contrast, JetBlue plans to introduce 100-seat 
Embraer 190 regional jets into its own fleet for service in late 2005. 
However, changes are looming for regional airlines. Legacy airlines are 
seeking less expensive contracts with their regional partners. In the 
case of one of United Airline's former regional partners, Atlantic 
Coast Airlines decided to reinvent itself as a low cost carrier, 
Independence Air, instead of operating under a new contract with United 
or another airline.[Footnote 8] This may be the first of several shake-
ups in the legacy-regional airline partnerships, as Delta Air Lines 
contemplates a bankruptcy filing and US Airways struggles to avoid a 
second bankruptcy. (App. III contains additional financial information 
on the regional airlines.): 

Figure 3: Airline Industry--Change in Capacity (ASMs), 1998 through 
2003: 

[See PDF for image]

[End of figure]

External Shocks Have Depressed Demand for Air Travel: 

Demand for air travel began weakening in 2000 due to a number of 
external changes in the aviation environment. An economic downturn that 
began in 2000 precipitated a decrease in demand for air travel, while 
the terrorist attacks of September 11, the Iraq War, and the outbreak 
of SARS have compounded this trend. These events have accelerated the 
structural changes in the demand for air travel that is likely to 
suppress revenue for the foreseeable future, including the inability of 
airlines to charge premium business fares.

Airlines' financial problems of the past 4 years began with an economic 
downturn in 2000. As illustrated in figure 4 below, industry experts 
have long recognized a relationship between the nation's economic 
performance and the demand for air travel. The growth in the nation's 
gross domestic product (GDP) most recently peaked in 1999 before 
falling to 0.5 percent in 2001, and then rebounding in 2002. This 
coincided with a drop in demand for air travel from a high of 691 
billion revenue passenger miles (RPM) in 2000 to a low of 641 billion 
RPMs in 2002.[Footnote 9] While this time period includes September 11, 
quarterly year-over-year data reveals a clear downward trend in RPM 
growth prior to September 11; RPM growth reached a peak of 8.9 percent 
in the second quarter of 2000, with a recession in air travel beginning 
in the second quarter of 2001.

Figure 4: Percentage Change in GDP and Airline Industry Passenger 
Demand, 1979 through 2003: 

[See PDF for image]

[End of figure]

The terrorist events of September 11 compounded the decline in demand 
for air travel in the United States. Compared to the Federal Aviation 
Administration's (FAA) June 11, 2001, forecast of passenger demand (the 
last forecast made before the terrorist attack of September 11): 

* actual full year 2001 demand, as measured in RPMS, turned out to be 
about 4 percent less; and: 

* actual demand for 2002 was about 17 percent less compared with FAA's 
June 2001 forecast.

After September 11, FAA revised its forecasted demand downward 
considerably relative to its June 11, 2001, estimates.[Footnote 10] 
FAA's March 2002 demand forecast predicted RPMS would be an average of 
11.5 percent per year less from 2002 through 2012. FAA's March 2003 
forecast (prior to the Iraq War and SARS), predicted demand would be an 
average of nearly 19 percent per year less from 2003 through 2012, 
compared with FAA's estimates of June 2001.[Footnote 11] Figure 5 
presents FAA forecasts of RPMS for June of 2001 through March of 2004, 
and actual RPMS for 1998 through 2003.

Figure 5: FAA Demand Forecasts (System traffic): 

[See PDF for image] 

[End of figure] 

The effects of the war in Iraq and the outbreak of SARS on demand for 
air travel were relatively minimal compared with the effects of 
September 11. Actual demand in 2003 was about the same as it was in 
2002. FAA's demand forecast after the Iraq War began and the SARS 
outbreak was revised upward an average of 8 percent for 2004 through 
2012. FAA staff we interviewed thought that the SARS effect, while 
significant, was limited to Pacific air travel; year-over-year RPMs 
dropped 33 percent for the second quarter of 2003 in the Pacific 
sector.

The Iraq War and unrest in the Middle East also contributed to rising 
fuel costs for airlines. From the first quarter of 2002 through the 
first quarter of 2004, the price of oil per barrel increased from 
$20.98 to $32.97; an increase of 57 percent. However, oil prices are 
volatile by nature, and many airlines hedge some portion of their oil 
and fuel costs to lock in these costs. Figure 6 presents the cost of 
oil per barrel from 1998 through the first quarter of 2004.

Figure 6: Cost of Oil Per Barrel, 1998 through the 1ST Quarter of 2004: 

[See PDF for image] 

[End of figure] 

The decline in business fares is another factor that has contributed to 
the financial problems of the industry. During the late 1990s, legacy 
airlines' profitability became increasingly reliant on a very small 
percentage of last minute business travelers that paid fares much 
higher than the average leisure fare. As the economy soured in 2001, 
business travelers became less willing to pay premium fares. According 
to Air Transport Association (ATA) data reported by the DOT Inspector 
General, the number of business travelers declined 26 percent from 
December 2001 through December 2002.[Footnote 12] Moreover, the average 
one-way business fare also declined nearly 10 percent, from $672 in the 
first quarter of 2001 to $607, in the first quarter of 2004 (see fig. 
7).

Figure 7: Average Quarterly Business Fares, 2001 through 2004: 

[See PDF for image] 

[End of figure] 

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. Legacy and low-cost airlines collectively reported 
to us $20.3 billion in cost-saving initiatives from October 1, 2001, 
through December 31, 2003. For the nine-quarter period ending December 
31, 2003, legacy airlines collectively reported to us about $19.5 
billion in cost-saving initiatives; actual operating costs decreased by 
about $12.7 billion dollars, or 14.5 percent, during that time. 
Collectively, legacy airlines cut their capacity by about 12.6 percent 
during the same period. Conversely, low cost airlines reported 
relatively little cost-cutting and their total operating expenses as a 
group actually increased 9.8 percent; however, their capacity increased 
even faster at 26.1 percent. Both legacy and low cost airlines reported 
relatively modest amounts of revenue enhancement initiatives in 
recognition of the weak demand for air travel during the period. From 
October 1, 2001, through December 31, 2003, legacy airlines revenues 
actually declined about 14.5 percent, while low cost airlines revenues 
increased 9.4 percent. 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 Sought 20 Percent Cost Reductions to Restore 
Profitability: 

Legacy airlines accounted for the vast majority of all cost-savings 
reported to us. The 14 legacy and low cost airlines in our study 
reported that they expected to cut a total of $20.3 billion from 
October 1, 2001, through 2003.[Footnote 13] 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. If achieved 
this would have amounted to a 22 percent reduction in costs for the 
legacy airlines. Low cost airlines, in contrast, reported $803 million 
in anticipated cost-savings through December 31, 2003, or just 4 
percent of the combined total. Figure 8 presents expected cost-savings 
for each year by airline group.

Figure 8: Airline Cost-savings Reported to GAO: 

[See PDF for image] 

[End of figure] 

It is difficult to disaggregate the cost-savings reported to us into 
cost categories because airlines lacked uniformity in their reporting. 
However, based on these reports, discussions with airlines and industry 
experts, airlines generally sought cost-savings from cuts in capacity, 
changes in salary and benefits, vendor concessions, and productivity 
improvements. In particular, United Airlines and US Airways were able 
to obtain concessions from their unions through the bankruptcy process 
or, in the case of American Airlines, through the threat of bankruptcy. 
Immediately following September 11, legacy airlines parked planes in 
the desert in an effort to reduce capacity and save costs. In recent 
months, some of these planes have been returned to service.[Footnote 
14]

Actual Cost Cutting by Airlines Differed: 

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. Unlike the plans submitted to us, 
actual financial results reported to DOT can be disaggregated. Notably, 
legacy airline labor costs were reduced $5.5 billion annually, or about 
16 percent during this time period (see fig. 9). Legacy airlines also 
achieved $2.1 billion in annual savings from a 59 percent reduction in 
the commissions paid to travel agents, because those commissions were 
sharply reduced. Finally, legacy airlines reduced fuel costs by 18.7 
percent during the period, although the recent upsurge in fuel prices 
has likely reversed these savings. The only cost category to increase 
for legacy airlines was transport-related expenses, which doubled 
during the period, an increase of $3.9 billion annually. Increases in 
transport-related expenses for legacy airlines are largely due to fees 
being paid to regional airline partners for providing regional air 
service. In the aftermath of September 11, legacy airlines shifted some 
of their capacity over to regional airlines in an attempt to reduce 
seat capacity and costs on these routes.

Figure 9: Change in Component Costs for Legacy Airlines, October 1, 
2001, through December 31, 2003: 

[See PDF for image] 

Note: Annual change calculated by comparing the 4 quarters preceding 
October 1, 2001 (fiscal year 2001) and the 4 quarters preceding 
December 31, 2003 (calendar year 2003). Transport-related costs 
include, but are not limited to, fees paid to regional airline partners 
for providing regional air service, extra baggage expenses, and other 
miscellaneous overhead. Service costs include advertising and 
promotions, insurance, outside flight equipment maintenance, and 
communications. Other costs include fees, taxes, and other charges; 
filing costs, membership dues, and losses.

[End of figure] 

Meanwhile, low cost airlines used legacy airlines retrenchment as an 
opportunity to expand. 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. Low cost airlines' labor costs, these airlines' largest 
single cost component increased over $750 million annually, or 21 
percent (see fig. 10). Despite their growth, low cost airlines were 
able to achieve small reductions in some of their other costs, 
including commissions, passenger food, depreciation and amortization, 
and transportation related expenses.

Figure 10: Change in Component Costs for Low Cost Airlines, October 1, 
2001, through December 31, 2003: 

[See PDF for image] 

Note: Annual change calculated by comparing the 4 quarters preceding 
October 1, 2001 (fiscal year 2001) and the 4 quarters preceding 
December 31, 2003 (calendar year 2003). Transport-related costs 
include, but are not limited to, fees paid to regional airline partners 
for providing regional air service, extra baggage expenses, and other 
miscellaneous overhead. Service costs include advertising and 
promotions, insurance, outside flight equipment maintenance, and 
communications. Other costs include fees, taxes, and other charges; 
filing costs, membership dues, and losses.

[End of figure] 

Revenue Enhancement Measures Reported to Us Were Far More Modest Than 
Cost Savings: 

The revenue enhancement measures that were reported to us were small 
compared with the cost-savings reported by airlines. Legacy airlines 
reported $2.3 billion in expected revenue enhancement benefits for the 
period October 1, 2001, through December 31, 2004, with most of this 
amount ($1.6 billion) expected in 2004. Legacy airlines reported 
benefits from changes in ticketing policies and fare structures, 
schedule changes, and new code-sharing arrangements. From October 1, 
2001, through December 31, 2003, legacy airlines actually saw a decline 
of about $11.9 billion (14.5 percent) in operating revenue. Meanwhile, 
low cost airlines reported even less revenue enhancement, only $189 
million for the same period, but actually increased their revenue for 
the period by about $1.1 billion (9.4 percent), thanks to greatly 
increased volume. Airline officials and analysts indicated that fares 
have remained very weak during the period limiting revenue options for 
airlines.

Government Assistance Stemmed Airline Losses: 

Airlines also depended on federal assistance in 2001 and 2003 to 
counter their losses during the period. For example, in 2001 airlines 
received nearly $5 billion in assistance, and the industry was 
authorized up to $10 billion in loan guarantees under the Air 
Transportation Safety and System Stabilization Act, of which loans 
totaling $1.56 billion were extended to 9 airlines. In 2003, the 
federal government provided another $2.4 billion in assistance, of 
which $100 million was reserved for reimbursement of cockpit door 
reinforcements and the remainder provided to help U.S. airlines with 
their security costs. Of the $2.3 billion, three-quarters went to 
legacy airlines, as shown in figure 11.

Figure 11: Distribution of $2.3 Billion of Direct Assistance Under P.L. 
108-11, by Airline Type: 

[See PDF for image] 

[End of figure] 

The law did not establish how airlines were to use the assistance, but 
it did require TSA to certify that the 64 airlines that ultimately 
received assistance allocated the funds for security-related expenses 
or revenues foregone as a result of meeting federal security 
mandates.[Footnote 15] By accepting the funds, the airlines agreed to 
this certification requirement. As shown in table 1, most airlines 
reported to TSA that they used the funds for their ongoing security 
costs and core operations.

Table 1: Distribution of $2.3 Billion in Federal Aid From P.L. 108-11: 

Expense category: Ongoing security related expenses and core 
activities; 
Amount: $1,983,169,527; 
Percent of total: 86.6%. 

Expense category: Passed on to code share partners and other 
affiliates; 
Amount: $17,371,034; 
Percent of total: 0.8%. 

Expense category: Liability reduction; 
Amount: $8,278,794; 
Percent of total: 0.4%. 

Expense category: Short term assets or investments; 
Amount: $9,069,221; 
Percent of total: 0.4%. 

Expense category: Other; 
Amount: $271,374,057; 
Percent of total: 11.9%. 

Total; 
Amount: $2,289,262,633; 
Percent of total: 100.0%. 

Source: TSA.

[End of table]

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. Despite significant cost-saving initiatives and 
industry-wide traffic volumes approaching pre-September 11 levels, 
legacy airlines continue to lose money. Legacy airlines' unit costs 
(cost to fly one seat 1 mile) have not decreased since 2000 while fares 
have declined; as a result, these airlines have yet to regain 
profitability. 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.

Legacy Airlines Have Significantly Higher Unit Costs Than Low Cost 
Airlines: 

Legacy airlines, as a group, have been unsuccessful in sufficiently 
reducing their costs to make them more competitive with low cost 
airlines. Unit cost competitiveness is key to profitability for 
airlines because airlines have found it extremely difficult to increase 
their revenues in the current environment. While legacy carriers 
reduced their overall operating expenses over the last 3 years, 
capacity reductions have made it difficult for legacy airlines to 
achieve meaningful unit cost reductions. Conversely, low cost airlines 
have been able to reduce their unit costs through expansion. Low cost 
airlines' ability to maintain lower labor costs and lower asset-related 
costs accounts for the majority of the unit cost differences between 
low cost airlines and legacy airlines.

Equity and credit analysts suggested that one of the best measures for 
examining airline unit cost performance is to compare airline unit cost 
curves. These curves illustrate the relationship between airlines' unit 
costs and the distance flown ("stage length"). Figure 12 shows legacy 
and low cost airlines' unit cost curves for 2000 and 2003 and suggests 
that the gap between legacy and low cost airlines' unit costs has 
widened across all distances. For example, in 2000, at a 1,000-mile 
stage length legacy airlines' unit costs were 45 percent higher than 
low cost airlines'; by 2003, legacy airlines' unit costs were 67 
percent higher. Some of the legacy airline unit cost increase is due to 
the capacity purchased from regional airlines--an increase in operating 
expenses (the numerator) but without a corresponding increase in 
available seat miles (ASM) (the denominator) in the unit cost 
calculation.[Footnote 16] However, this does not account for all or 
even most of the gap between legacy and low cost airlines' unit costs.

Figure 12: Airline Stage Length Adjusted Unit Costs, 2000 vs. 2003: 

[See PDF for image] 

[End of figure] 

To account for this unit cost difference between legacy and low cost 
airlines, we also examined legacy and low cost airline unit costs over 
time and the various cost items that comprise total operating expenses. 
Overall, we found that the gap in aggregated (for all stage lengths) 
unit costs for legacy and low cost airlines has widened since 2000, 
from 2.1 cents per ASM to 3.8 cents at the end of 2003. The size of 
this gap may be somewhat overstated because of a change in the 
financial reporting requirements for airlines during this time. 
Beginning in 2003, airlines were required to report the cost of buying 
additional capacity from regional airlines under transport-related 
expenses. To calculate the legacy airlines' unit costs correctly under 
this new reporting requirement, the ASMs that the legacy airlines buy 
from the regional airlines should also be included in calculating their 
unit costs. We could not incorporate this into our calculation because 
the exact amount of capacity purchased by legacy airlines and the 
amount of money spent on capacity purchased from regional airlines are 
not reported in sufficient detail to do so. However, to indicate legacy 
airlines' minimum unit costs, we calculated legacy airlines unit costs 
excluding transport-related expenses (low cost airlines reported very 
little transport-related expenses). Accordingly, the unit cost 
difference between legacy and low cost airlines grew from 1.6 cents per 
ASM in 2000 to 2.5 cents in 2003. Figure 13 shows the gap between 
legacy and low cost airlines' unit costs, including and excluding 
transport-related expenses.

Figure 13: Unit Cost Differential, 1998 through 2003: 

[See PDF for image] 

[End of figure] 

The two primary cost components that comprise the unit cost 
differential between legacy airlines and low cost airlines are labor 
costs and asset-related costs. Legacy airlines have high labor costs 
owing to a highly tenured, unionized workforce. Low cost airlines are 
able to suppress unit costs by achieving higher levels of labor 
productivity than legacy airlines. Legacy airlines have higher asset-
related costs than low cost airlines because legacy airlines generally 
have older fleets and different fleet structures than low cost 
airlines. Additionally, because legacy airlines generally operate hub-
and-spoke business models in comparison to the point-to-point model 
generally operated by low cost airlines, legacy airlines are not able 
to achieve the same level of asset utilization as low cost airlines. 
Other costs that currently comprise the remaining unit cost difference 
between legacy airlines and low cost airlines include expenses for 
items such as fuel, passenger ticketing commissions, and passenger 
food.

Labor costs accounted for over 40 percent of the unit cost difference 
between legacy airlines and low cost airlines in 2003. Legacy airlines' 
high labor costs are the result of a highly tenured workforce, higher 
pension costs, and work rules that differ from their low cost 
competitors. Low cost airlines have been effective at keeping unit 
labor costs down by achieving higher labor productivity and paying 
less. Legacy airlines have made progress in improving labor 
productivity since 2001, but they continue to trail low cost airlines, 
which have steadily improved labor productivity since 1998. As Figure 
14 illustrates, in 2003 legacy airlines had improved labor productivity 
8.3 percent, compared with 1998, by increasing the number of ASMs 
produced per employee.[Footnote 17] However, in 2003 they still 
produced 7 percent fewer ASMs per employee than low cost airlines.

Figure 14: Labor Productivity, Legacy Airlines vs. Low Cost Airlines: 

[See PDF for image] 

[End of figure] 

Legacy airlines encounter higher asset-related unit costs than low cost 
airlines because legacy airlines have older fleets and more types of 
aircraft in their fleets than low cost airlines, and legacy airlines 
put their planes in the air fewer hours per day than low cost airlines. 
Legacy airlines own older aircraft than many low cost airlines; and 
older aircraft can be expensive to operate because they are less fuel-
efficient than newer aircraft, and they have higher maintenance costs. 
Additionally, legacy airlines usually have more types of aircraft in 
their fleets, adding to maintenance costs and pilot training costs. 
Moreover, because legacy airlines generally operate a hub-and-spoke 
business model, they are not able to operate their aircraft for as many 
block hours per day as low cost airlines.[Footnote 18] Low cost 
airlines typically operate a point-to-point business model that allows 
them to limit the amount of time a plane must spend on the ground from 
the time it lands until it is ready to take off again. Figure 15 
demonstrates the asset utilization differential that exists between 
legacy airlines and low cost airlines when measured in block hours per 
day per aircraft in service. Legacy airlines have improved asset 
utilization since the events of September 11; however, despite these 
improvements, they continue to trail low cost airlines with respect to 
asset utilization trends.

Figure 15: Asset Utilization: Legacy Airlines vs. Low Cost Airlines: 

[See PDF for image] 

[End of figure] 

Other operating expenses that explain the unit cost difference between 
legacy airlines and low cost airlines include items such as aircraft 
fuel and oil, passenger food, and passenger commissions related to 
ticketing. Together these items comprise approximately 20 percent of 
the unit cost difference between legacy airlines and low cost airlines.

Depressed Fares and Declining Traffic Have Weakened Revenues for Legacy 
Airlines: 

Overall industry revenues have not returned to pre-September 11 levels 
despite a return in demand for air travel. In 2003, passenger demand 
for air travel (as measured in miles flown by paying passengers) 
returned to 95 percent of the 2000 level. However, industry revenues 
only totaled $77 billion in 2003, which represents just under 80 
percent of the 2000 level. The revenue picture is significantly 
different when comparing legacy airlines with low cost airlines. Legacy 
airline passenger revenues are down 28 percent from 2000 through 2003, 
while low cost airlines have increased passenger revenues over 12 
percent. Figure 16 below presents the changes in total industry 
revenues from 1998 through 2003, as well as changes by the legacy and 
low cost groups.

Figure 16: Airline Revenues, 1998 through 2003, by Airline Group: 

[See PDF for image] 

[End of figure] 

Low airfares constrained revenues for both legacy and low cost 
airlines. Yields, the amount of revenue airlines collect for every mile 
a passenger travels, have fallen 19 percent industry-wide from the 
first quarter of 2000 through the fourth quarter of 2003 for the 30 
airlines examined in this study. Figure 17 presents the trends in 
yields for both legacy airlines and low cost airlines from 1998 through 
2003. The trends are similar for both the legacy airlines and low cost 
airlines; legacy yields dropped about 19 percent, while low cost 
airline yields dropped about 17 percent.

Figure 17: Revenue Collected Per RPM (Yield), 1998 through 2003, by 
Airline Group: 

[See PDF for image] 

[End of figure] 

In addition, the gap between the legacy airline yields and the low cost 
airline yields has narrowed. Legacy carriers are often able to command 
a higher fare--or "revenue premium"--compared with low cost airlines 
because passengers will often pay more for the benefits of a network 
structure. Accordingly, legacy airline officials have stated that they 
do not need to lower their costs to the same levels as low cost 
airlines because they can command a revenue premium. This ability to 
command a revenue premium, however, appears to be eroding. The revenue 
premium commanded by the legacy airlines has fallen from 9.8 percent to 
6.4 percent from 1998 to 2003--a 45 percent decrease. Moreover, this 
revenue premium is less than half of the 15 percent to 16 percent 
revenue premium one legacy airline stated that they expected to be able 
to command.

The primary factor differentiating legacy and low cost airline revenue 
performance is the change in demand. Demand (as measured in RPMs) is 
down 11 percent for legacy airlines from 2000 through 2003, while 
demand for low cost airlines has risen nearly 37 percent (see fig. 18). 
Low cost airlines have expanded their operations and market share 
enough to increase revenues in a lower yield environment and can do so 
profitably because of their lower cost structure. Legacy airlines are 
simply flying fewer people at lower fares, which represent decreases in 
both factors of the revenue equation. Although nearly as many 
passengers are flying as before September 11, they are paying less to 
do so and choosing to fly on low cost airlines more often.

Figure 18: Percentage Change in Airline RPMs, Since 2000: 

[See PDF for image] 

[End of figure] 

It appears low fares will continue to depress revenues during 2004 
since airlines continue to add capacity. A year-over-year comparison of 
ASMs for the first quarter of 2004 indicates capacity is up over 7 
percent from 2003. Airlines generally add capacity to compete for or 
defend market share. Legacy airlines are adding capacity because they 
possess excess capacity that can be added at relatively low marginal 
costs. Collectively, however, this strategy is problematic because the 
additional capacity depresses fares further. Credit and equity analysts 
we interviewed stated that the increase in capacity is likely to 
outweigh the increase in demand for air travel and continue to depress 
fare prices.

High Unit Costs and Depressed Fares Have Combined to Eliminate 
Profitability at Legacy Airlines: 

Weak revenues and the inability to realize greater cost-savings have 
combined to create unprecedented losses for legacy ailrines. At the 
same time, low cost airlines have been able to continue producing 
modest profits as the result of significantly improved cost 
performance. As figure 19 demonstrates, the unit-operating margin (or 
difference between unit revenues and costs) for legacy airlines turned 
negative during the second half of 2000 and reached its trough shortly 
after September 11. 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.[Footnote 
19]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. Further, an expected 
return to moderate profitability in 2004 for legacy airlines has not 
materialized due, in large part, to historically high oil prices.

Figure 19: Airline Profitability (in unit operating margin), 1998 
through 2003: 

[See PDF for image] 

[End of figure] 

As a result of the difference in operating margin, legacy airlines have 
lost $24.3 billion since the end of 2000, while low cost airlines have 
made a profit of $1.3 billion. Figure 20 presents airline profits and 
losses from 1998 through 2003. One industry estimate indicates the 
airline industry, as a whole, will again be unprofitable in 2004, 
losing in excess of $3 billion.

Figure 20: Airline Profits and Losses, 1998 through 2003: 

[See PDF for image] 

[End of figure] 

Legacy Airlines' Financial Condition Has Weakened Since 2000: 

Since 2000, the financial condition of legacy airlines has 
deteriorated. Both legacy airlines and low cost airlines built cash 
balances following the events of September 11; legacy airlines did so 
primarily through borrowing, while low cost airlines increased 
liquidity through borrowing and generating cash from operations. Since 
2001, legacy airlines have taken on more debt, relying on creditors for 
more of their capital needs than in the past. Higher debt levels leads 
to greater interest expenses and can make raising additional capital 
more difficult. Low cost airlines also increased their debt levels, but 
not as much, and their solvency (or long-term prospects of repaying the 
debt) has not deteriorated to the same extent as legacy airlines. In 
the process of taking on additional debt, several legacy airlines have 
used all, or nearly all, of their assets as collateral, limiting their 
access to capital markets.

Legacy airlines' liquidity has deteriorated overall and relative to low 
cost airlines. Liquidity is a measure of a firm's ability to meet 
short-term liabilities with cash or marketable securities. Both groups 
of airlines built cash balances immediately following September 11--for 
example, comparing cash and marketable securities to current 
liabilities, known as the cash ratio, rose for both types of airlines 
(see fig. 21). However, low cost airlines have built proportionally 
larger cash balances and did it primarily by generating cash from 
operations, as well as modest borrowing. In contrast, legacy airlines 
built cash balances after September 11, principally by borrowing. More 
recently, losses have depleted cash balances and legacy airlines' 
ability to meet current obligations has not improved. During 2002 and 
2003, low cost airlines built cash balances by generating cash from 
operations, while legacy airlines continued to lose cash from 
operations and compensated for operating losses by taking on additional 
debt. In 2003, low cost airlines generated approximately $2.2 million 
in cash per day while legacy airlines depleted their cash reserves at a 
rate of approximately $682,000 per day. Low cost airlines maintain more 
favorable liquidity measures than legacy airlines, and the differential 
between the two groups of airlines is widening.[Footnote 20]

Figure 21: Liquidity of Legacy Carriers vs. Low Cost Carriers, Moving 
Average 1998 through 2003: 

[See PDF for image] 

[End of figure] 

Since legacy airlines have issued debt to cover operating losses, they 
continue to be more highly leveraged than low cost airlines, indicating 
that low cost airlines are more likely to be able to fulfill their 
long-term financial obligations than legacy airlines, and the gap 
between the airline groups is growing. Both legacy airlines' and low 
cost airlines' debt have increased since 1998. As figure 22 
demonstrates, legacy airlines have financed 92 percent of their assets 
by issuing debt (priced at book value), while low cost airlines have 
only financed approximately 50 percent of their assets by issuing debt. 
However, as the graph also illustrates, low cost airlines' debt 
ratios[Footnote 21] have fallen since the end of 2002, and the gap 
between the two groups of airlines appears to be widening. In the 
process of taking on additional debt, several legacy airlines have used 
all or nearly all of their assets as collateral, limiting their access 
to capital markets. In addition, as legacy airlines' financial 
condition has deteriorated, credit rating agencies have generally 
downgraded airline debt, further limiting their access to capital 
markets.

Figure 22: Liabilities as Proportion of Total Assets, Moving Average 
1998 through 2003: 

[See PDF for image] 

[End of figure] 

Legacy airlines face large debt repayment obligations and pension plan 
contributions during the next 4 years. Figure 23 illustrates the 
looming long-term debt and capital lease (a fixed obligation similar to 
long-term debt) payments that legacy airlines face in comparison with 
their low cost competitors. While legacy airlines had approximately 
$6.8 billion in cash at the end of 2003, they face a total of $19.2 
billion in long-term debt and capital lease obligations during the next 
4 years.[Footnote 22] In contrast, low cost airlines had a collective 
cash balance of approximately $3.5 billion at the end of 2003 versus 
long-term debt and capital lease obligations of $2.1 billion coming due 
through 2007. A recently passed law postpones a portion of legacy 
airlines' requirements to make payments to their defined benefit 
pension plans in 2004 and 2005,[Footnote 23] but these airlines are 
still required to fully fund these plans in future years.[Footnote 24] 
Current estimates indicate that legacy airlines' defined benefit 
pension plans are underfunded by approximately $20.5 billion. Because 
legacy airlines' future access to capital markets appears to be 
limited, these airlines will need to begin generating cash from 
operations if they intend to fulfill their future financial obligations 
and avoid bankruptcy.

Figure 23: Out-Year Obligations, Legacy Airlines vs. Low Cost Airlines: 

[See PDF for image] 

[End of figure] 

Low Cost Airline Growth Has Created Greater Competition in Many 
Domestic Markets: 

Airline competition has increased in domestic markets since 1998 
because of the growth and expansion of low cost airlines. Between 1998 
and 2003, the number of effective competitors[Footnote 25] in many of 
the 5,000 largest domestic markets increased, even as the overall 
number of passengers remained about the same. Low cost airlines entered 
more of these markets and increased their share of total passengers, 
particularly in longer distance markets. 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. Legacy airlines 
continued to dominate many of the largest 5,000 domestic markets in 
2003, but most of those were relatively small markets to or from their 
hubs.

The top 5,000 city-pair markets we analyzed accounted for about 92 
percent of all domestic passenger traffic in 2003.[Footnote 26] Within 
this group, markets differ greatly in size, with passenger traffic 
concentrated in relatively few of them. In 2003, almost 23 percent of 
all domestic passengers flew in the 52 largest markets. Each of these 
large markets had at least 840,000 passengers annually and on average, 
over 1.5 million passengers flew in each. The largest market in 2003 
was Los Angeles--San Francisco, in which 5.1 million passengers flew. 
Throughout the remainder of this report, we define "large" markets as 
those 52 markets. Conversely, relatively few passengers flew in each of 
the smaller markets. At the opposite end of the spectrum from the 52 
largest markets are the 4,157 small markets, in which 24 percent of 
domestic passengers flew. Each of those markets had less than 85,000 
passengers annually and had an average of 20,569 passengers annually. 
The smallest markets in this group, which includes Oklahoma City to 
Savannah, had 4,840 passengers (about 13 passengers per day) in 2003.

Competition Has Increased Most in Larger Markets as Low Cost Airlines 
Have Expanded Service Beyond Their Traditional Markets: 

Although most of the top 5,000 largest domestic markets were already 
competitive in 1998, many had become more competitive by 2003 as low 
cost carriers ventured into new markets, more directly challenging 
legacy carriers and taking a larger share of passengers. The number of 
monopoly markets decreased, and the number of markets with three or 
more airlines providing service grew by 8.9 percent. Overall, the 
average number of effective competitors in the top 5,000 markets rose 
from 2.20 in 1998 to 2.36 in 2003. Figure 24 illustrates the number of 
effective competitors in 1998 and 2003 by market size.

Figure 24: Top 5,000 Markets Were More Competitive in 2003: 

[See PDF for image] 

[End of figure] 

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. 25). In 1998, low cost airlines were generally 
serving large, short-haul markets such as Dallas to Houston or Atlanta 
to Orlando. By 2003, as they opened operations in new cities, low cost 
airlines expanded into smaller markets by making connections available 
that did not exist before. In addition, low cost airlines evolved from 
serving mostly short-haul markets to flying transcontinental (e.g., in 
2003 JetBlue began service from Fort Lauderdale to Long Beach and 
Southwest began service between Baltimore and California). DOT has also 
observed that low cost airlines have been spreading service to smaller 
and longer-haul markets as well as competing more aggressively for 
business passengers. According to DOT, low cost airlines generate lower 
fares and an increase in passengers in the markets they enter.[Footnote 
27] Although legacy airlines have made large cuts in operating costs 
over the past few years, they were present in nearly all of the top 
5,000 markets each year.

Figure 25: Low Cost Airlines Had Expanded Service to Additional Markets 
by 2003: 

[See PDF for image] 

[End of figure] 

Low cost airlines' addition of more routes expanded the extent to which 
they competed directly with legacy airlines. In 1998, low cost airlines 
operated in 31.5 percent of the markets served by legacy airlines, and 
provided a low-cost alternative to 72.5 percent of passengers. By 2003, 
low-cost airlines competed directly with legacy airlines in an 
additional 698 markets. They operated in 45.5 percent of the markets 
served by legacy airlines and provided a low cost alternative to 84.6 
percent of passengers in the top 5,000 markets.

The entry of low cost airlines into new markets contributed to the 
shift in market share for legacy and low cost airlines. Overall, low 
cost airlines' share of total passenger traffic increased from 23 
percent in 1998 to 33 percent in 2003, while legacy airlines lost 
market share, falling from 69 to 65 percent (see fig. 26). Low cost 
airline total passenger traffic increased from 79.8 million in 1998 to 
117.1 million in 2003. Low cost airline passengers also increased in 
all markets sizes and market distances over 250 miles, with the largest 
increases in long haul markets. Legacy carrier passengers decreased 
from 242.2 million in 1998 to 231.6 million in 2003.[Footnote 28]

Figure 26: Low Cost Airlines Gained Market Share (Passengers) from 
Legacy and Other Airlines: 

[See PDF for image] 

Note: "Other" carriers are those that did not fit our definitions of 
legacy and low cost airlines. Current carriers in this category are 
Hawaiian and Midwest. In 1998, this category also included Midway and 
National, which have since ceased operations.

[End of figure] 

Fewer Markets Dominated by a Single Airline: 

With the increase in overall competition, the number of dominated 
markets declined by 279 between 1998 and 2003 (7.7 percent). However, 
during the financially difficult years of 2001 through 2003, the number 
of dominated markets increased by 63 (see fig. 27). And although a 
single airline may have carried more than half of the total passenger 
traffic in those dominated markets, 31.2 percent of those markets had 
service from three or more airlines in 2003.

Figure 27: The Majority of Markets in the Top 5,000 Were Dominated from 
1998 through 2003: 

[See PDF for image] 

[End of figure] 

As a group, dominated markets enplaned the majority of passengers from 
1998 to 2003, but individually they tended to be smaller than non-
dominated markets. In 2003, dominated markets enplaned an average of 
64,217 passengers each, while nondominated markets enplaned an average 
of 85,730 passengers each, a difference of 34 percent (see fig. 28).

Figure 28: Dominated Markets Tended To Be Smaller Than Nondominated 
Markets: 

[See PDF for image] 

[End of figure] 

Nearly 85 percent of the markets dominated in 2003 were dominated by 
legacy airlines. Additionally, a large percentage of the total number 
of dominated markets were "hub markets" of legacy airlines (i.e., 
travel originated or terminated in one of the legacy airline's hubs). 
In 2003, the 2,854 markets that were dominated by legacy carrier. Each 
had an average of 48,375 passengers. Low cost airlines dominated 458 
markets in 2003, and those markets tended to be significantly larger. 
On average, 158,378 passengers flew annually in markets dominated by 
low cost airlines. This difference reflects the low cost carriers' 
targeting of high-density markets and the nature of hub-and-spoke 
networks operated by legacy airlines.

Concluding Observations: 

While the airline industry was deregulated more than 25 years ago, some 
of the most significant competitive changes are only now occurring, 
brought about by the unprecedented challenges of the last 4 years. 
Before 2000, large legacy airlines, all of which predated deregulation, 
dominated the domestic airline industry. These airlines competed on the 
basis of their networks and onboard amenities as well as fares; profits 
were earned by maximizing revenues from high-value business travelers. 
While low cost airlines competed in some markets, as a whole, they 
never accounted for a significant segment of the industry and rarely 
took on a legacy airline directly. In the past, new entrant low cost 
airlines rarely survived an entire business cycle. However in recent 
years this pattern has changed, perhaps permanently. Significant 
structural change combined with severe demand shocks has presented 
unprecedented challenges to the airline industry, especially for legacy 
airlines. Legacy airlines, burdened by significant costs of labor 
contracts and pension plans negotiated during profitable years and an 
extensive and costly network infrastructure, have found it difficult to 
reduce costs quickly enough to restore profitability. The scale of 
cost-cutting reported to us by legacy airlines was not fully achieved 
and, most importantly, legacy airlines were no more cost competitive 
with low cost airlines in 2003 than they were in 2000.

Meanwhile, low cost airlines are using their cost advantage to expand 
their market share and challenge legacy airlines like never before. 
While industry traffic has recovered to pre-September 11 levels, 
profitability for legacy airlines has not, owing to higher costs and 
weak fare growth. Three years of losses have left legacy airlines in a 
weakened financial condition with large debt and pension obligations 
looming in the next few years. The potential for airlines to earn large 
profits during up-cycles to cover losses during down-cycles, as they 
did during the 1990s, appears to have come undone this decade. Whether 
legacy airlines can effectively compete with low cost airlines and 
regain profitability will depend on their ability to further reduce 
their unit costs and gain a revenue premium associated with network 
service that connects smaller U.S. communities with international 
destinations--a service that low cost airlines do not now offer. The 
survivability of legacy carriers may well depend on their ability to do 
so--certainly, they cannot continue to sustain losses like those 
incurred over the past few years. The growth of low cost airlines in 
recent years has benefited most consumers through increased 
competition, but the structure of the U.S. domestic airline industry 
remains very much in flux.

Comments: 

We provided a draft of this report to DOT for its review and comment. 
DOT officials provided some clarifying and technical comments that we 
incorporated where appropriate. We also provided selected portions of a 
draft of this report to the ATA to verify the presentation of factual 
material. We incorporated their technical clarifications as 
appropriate.

We provided copies of this report to the Secretary of Transportation 
and other interested parties and will make copies available to others 
upon request. In addition, this report will be available at no charge 
on our Web site at [Hyperlink, http://www.gao.gov]. If you have any 
questions about this report, please contact me or Steve Martin at 
202-512-2834. Other major contributors are listed in appendix 
V.

Signed by: 

JayEtta Z. Hecker, 
Director, Physical Infrastructure: 

List of Congressional Committees: 

The Honorable Ted Stevens: 
Chairman: 
The Honorable Robert Byrd: 
Ranking Minority Member: 
Committee on Appropriations: 
United States Senate: 

The Honorable John McCain: 
Chairman: 
The Honorable Ernest Hollings, Jr.: 
Ranking Democratic Member: 
Committee on Commerce, Science, and Transportation: 
United States Senate: 

The Honorable Richard Shelby: 
Chairman: 
The Honorable Patty Murray: 
Ranking Minority Member: 
Subcommittee on Transportation, Treasury, and General Government: 
Committee on Appropriations: 
United States Senate: 

The Honorable Thad Cochran: 
Chairman: 
The Honorable Robert Byrd: 
Ranking Minority Member: 
Subcommittee on Homeland Security: 
Committee on Appropriations: 
United States Senate: 

The Honorable Trent Lott: 
Chairman: 
The Honorable John D. Rockefeller: 
Ranking Democratic Member: 
Subcommittee on Aviation: 
Committee on Commerce, Science, and Transportation: 
United States Senate: 

The Honorable C.W. Bill Young: 
Chairman: 
The Honorable David R. Obey: 
Ranking Minority Member: 
Committee on Appropriations: 
House of Representatives: 

The Honorable Don Young: 
Chairman: 
The Honorable James L. Oberstar: 
Ranking Democratic Member: 
Committee on Transportation and Infrastructure: 
House of Representatives: 

The Honorable Ernest J. Istook, Jr.: 
Chairman: 
The Honorable John V. Olver: 
Ranking Minority Member: 
Subcommittee on Transportation and Treasury, and Independent Agencies: 
Committee on Appropriations: 
House of Representatives: 

The Honorable Harold Rogers: 
Chairman: 
The Honorable Martin Olav Sabo: 
Ranking Minority Member: 
Subcommittee on Homeland Security: 
Committee on Appropriations: 
House of Representatives: 

The Honorable John L. Mica: 
Chairman: 
The Honorable Peter A. DeFazio: 
Ranking Democratic Member: 
Subcommittee on Aviation: 
Committee on Transportation and Infrastructure: 
House of Representatives: 

[End of section]

Appendixes: 

Appendix I: Airline Cover Letter: 

United States General Accounting Office: 
Washington, DC 20548:

June 26, 2003:

Dear Carrier Representatives:

The conference report accompanying the 2003 Emergency Wartime 
Supplemental Appropriation Act (Act) directs the General Accounting 
Office to submit a report to Congress on measures taken by air carriers 
who received financial assistance under the Act to reduce costs and 
strengthen their balance sheets. As part of this effort, the conference 
report stated that carriers that obtained relief payments from the 
Transportation Security Administration (TSA) under the Act should 
submit a plan to the Comptroller General of the United States that 
would reduce annual operating expenses by an amount equal to the 
greater of 10 percent of that carrier's annual operating expenses or 
the amount of financial assistance that the carrier received. Under the 
conference report, carriers are to submit these plans within 90 days of 
enactment of the Act, i.e., by July 16, 2003. This letter outlines the 
general approach we will use to conduct this review. The enclosed 
template shows how we would prefer your plans to be structured and 
contains more specific instructions for preparing the plan and sending 
it to us.

We recognize that each carrier's financial position is unique and that 
many, if not all, carriers since September 2001, and possibly before, 
have been taking actions to reduce costs and/or improve revenues. 
Accordingly and consistent with the guidance and template enclosed, we 
intend to approach our analysis in two parts. First, we are asking each 
carrier that received payments directly from TSA (66 carriers) to 
provide us with information on the most significant cost cutting or 
revenue enhancing actions taken or planned subsequent to the enactment 
of the legislation (i.e., since April 2003), the actual or expected 
financial benefits, and the major operational impacts, of those 
actions. Secondly, we are asking these carriers to provide information 
on the major cost cutting or revenue enhancing initiatives undertaken 
between September 2001 and March 31, 2003, including the benefits 
achieved or to be achieved by those actions.[NOTE 1] In addition, we 
are requesting that you provide us certain financial and operational 
data that will help tie together and demonstrate the overall impact of 
these various initiatives.

This approach will allow us to include in our report our views on the 
various "self-help" measures the airlines have or are taking and the 
overall effect of the airlines' initiatives from both a financial and 
operational perspective. We understand that 
information you provide to us may be of a proprietary nature. We are 
prohibited from including any proprietary information in a publicly 
available report (See 18 USC 1905). Further, GAO routinely handles 
sensitive information and has in-place processes and procedures to 
safeguard that information. In addition, we will provide each carrier 
furnishing us with information the opportunity to review that portion 
of our draft report containing such information to ensure that we have 
reported it accurately and that we are not inadvertently disclosing any 
proprietary information.

If you have any questions about this data request or your plans, which 
we expect to receive by July 16, 2003, please contact Phil McIntyre at 
(202) 512-4373 or Steve Martin at (202) 512-3389. The enclosed template 
provides the details on how to submit your completed plans to us.

Sincerely yours,

Signed by: 

Linda Calbom:

Director, Financial Management and Assurance:

Signed by: 

JayEtta Hecker:

Director, Physical Infrastructure:

Enclosures:

[NOTE 1] We are using March 31, 2003, rather than the enactment date of 
April 16, 2003, because for most, if not all, carriers this date will 
coincide with either a monthly or quarterly closing of carrier 
financial records.

Air Carrier Contact Information:

Contact Name:

Email Address:

Phone Number:

Fax Number:

1. Post-Enactment Implementation Period:

In completing this section, list only the initiatives that were or are 
expected to be implemented after the enactment of the Act, i.e.,April 
1, 2003 through December 31, 2003. Initiatives that were begun in this 
time period but have not yet been completed are considered implemented 
in this time period.

Using your best judgment, (1) report only the most significant 
initiatives such as those that result in large dollar benefits or large 
operational impacts and (2) categorize initiatives into Cost Reduction 
and Revenue Enhancement categories for the Financial Improvement 
Initiatives and into Liquidity, Debt Management, and Other categories 
for the Balance Sheet Initiatives.

Chart 1A: Financial Improvement Initiatives Post-Enactment:

[See PDF for image]

[End of table]

Chart 1B: Balance Sheet Improvement Initiatives Post-Enactment: 

[See PDF for image]

[End of table]

2. Pre-Enactment Implementation Period:

In completing this section, list only the initiatives that were 
implemented after the terrorist attack, and before the enactment of the 
Act (October 1, 2001 through March 31, 2003). Initiatives that were 
begun in this time period but have not yet been completed are 
considered implemented in this time period.

Using your best judgment, (1) report only the must significant 
initiatives such as those that result in large dollar benefits or large 
operational impacts and (2) categorize initiatives into Cost Reduction 
and Revenue Enhancement categories for the Financial Improvement 
Initiative, and into Liquidity, Debt Management, and Other categories 
for the Balance Sheet Initiatives.

Chart 2A: Financial Improvement Initiatives Pre-Enactment: 

[See PDF for image]

[End of table]

Chart 2B: Balance Sheet Improvement Pre-Enactment: 

3. Net Effect of All Initiatives:

In completing this section, record the following operating statistics, 
financial data, and economic assumption, for the specified time 
period. This overall carrier performance will provide a contest in 
which we will evaluate the reasonableness and feasibility of the 
initiatives listed in this plan. This information is similar to that 
which is provided to the Department of Transportation's Bureau of 
Transportation Statistics on the Form 41.

[See PDF for image]

[End of table]

4. List the amount of airline relief payments you received on May 15, 
2003 from the Transportation Security Administration under the 
Emergency Wartime Supplemental Appropriations Act, 2003. (P.L. 108-11). If you distributed any portion of these funds to another carrier or 
entity, provide a listing of such payments.

5. Describe how the funds received from TSA were or are expected to be 
used.

6. Discuss here any other relevant information that you wish to 
highlight regarding financial improvement initiatives such as 
uncontrollable events or factors.

7. Once the plan is completed, submit it and any other supporting 
analysis or other documentation via overnight mail postmarked no later 
than July 16, 2003 to: 

Phil McIntyre: 
Room 5V21:
U.S. General Accounting Office: 
441 G Street NW: 
Washington, DC 20548:

We are expecting that we will be provided sufficient information to 
evaluate the reasonableness or feasibility of the initiative and 
underlying assumptions. During our review, we may follow-up with the 
contact person listed an page 1 to ask for additional supporting 
information or clarification of the information provided. If you have 
any questions or concerns, please call Phil McIntyre (202) 512-9373 or 
Steve Martin (202) 512-3389.

[End of section]

Appendix II: Airline Enplanements and Government Assistance Received 
Pursuant to P.L. 108-11: 

Legacy airlines: Alaska Airlines; 
2003 Enplanements: 15,046,919; 
Percent of total: 2.32%; 
2003 Assistance: $67,058,661; 
Percent of assistance: 2.93%. 

Legacy airlines: American Airlines: 2003 Enplanements: 88,798,446; 
Percent of total: 13.71%; 
2003 Assistance: $360,975,306; 
Percent of assistance: 15.77%. 

Legacy airlines: Continental: 2003 Enplanements: 38,474,938; 
Percent of total: 5.94%; 
2003 Assistance: $173,210,289; 
Percent of assistance: 7.57%. 

Legacy airlines: Delta: 2003 Enplanements: 84,076,432; 
Percent of total: 12.98%; 
2003 Assistance: $390,151,227; 
Percent of assistance: 17.04%. 

Legacy airlines: Northwest Airlines: 2003 Enplanements: 51,865,302; 
Percent of total: 8.01%; 
2003 Assistance: $205,000,407; 
Percent of assistance: 8.95%. 

Legacy airlines: United Airlines: 2003 Enplanements: 66,018,276; 
Percent of total: 10.19%; 
2003 Assistance: $300,231,855; 
Percent of assistance: 13.11%. 

Legacy airlines: US Airways: 2003 Enplanements: 41,250,548; 
Percent of total: 6.37%; 
2003 Assistance: $216,050,915; 
Percent of assistance: 9.44%. 

Legacy airlines: Subtotal: 2003 Enplanements: 385,530,861; 
Percent of total: 59.52%; 
2003 Assistance: $1,712,678,660; 
Percent of assistance: 74.81%. 

Low cost airlines: AirTran: 2003 Enplanements: 11,651,340; 
Percent of total: 1.80%; 
2003 Assistance: $38,061,041; 
Percent of assistance: 1.66%. 

Low cost airlines: America West: 2003 Enplanements: 20,031,976; 
Percent of total: 3.09%; 
2003 Assistance: $81,255,380; 
Percent of assistance: 3.55%. 

Low cost airlines: ATA: 2003 Enplanements: 9,386,902; 
Percent of total: 1.45%; 
2003 Assistance: $37,156,308; 
Percent of assistance: 1.62%. 

Low cost airlines: Frontier: 2003 Enplanements: 5,061,757; 
Percent of total: 0.78%; 
2003 Assistance: $15,573,165; 
Percent of assistance: 0.68%. 

Low cost airlines: Jet Blue: 2003 Enplanements: 8,949,744; 
Percent of total: 1.38%; 
2003 Assistance: $22,761,459; 
Percent of assistance: 0.99%. 

Low cost airlines: Southwest: 2003 Enplanements: 74,719,340; 
Percent of total: 11.54%; 
2003 Assistance: $271,374,057; 
Percent of assistance: 11.85%. 

Low cost airlines: Spirit: 2003 Enplanements: 4,105,929; 
Percent of total: 0.63%; 
2003 Assistance: $14,433,937; 
Percent of assistance: 0.63%. 

Low cost airlines: Subtotal: 2003 Enplanements: 133,906,988; 
Percent of total: 20.67%; 
2003 Assistance: $480,615,347; 
Percent of assistance: 20.99%. 

Regional airlines: Air Wisconsin: 2003 Enplanements: 5,865,638; 
Percent of total: 0.91%; 
2003 Assistance: $2,261,517; 
Percent of assistance: 0.10%. 

Regional airlines: Allegheny Airlines: 2003 Enplanements: 1,997,934; 
Percent of total: 0.31%; 
2003 Assistance: $645,050; 
Percent of assistance: 0.03%. 

Regional airlines: American Eagle[A]: 2003 Enplanements: 12,474,076; 
Percent of total: 1.93%; 
2003 Assistance: (Incl. in AA); 
Percent of assistance: N/A. 

Regional airlines: Atlantic Coast: 2003 Enplanements: 8,390,143; 
Percent of total: 1.30%; 
2003 Assistance: $1,520,495; 
Percent of assistance: 0.07%. 

Regional airlines: Atlantic Southeast: 2003 Enplanements: 9,205,348; 
Percent of total: 1.42%; 
2003 Assistance: $4,327,404; 
Percent of assistance: 0.19%. 

Regional airlines: Chautauqua: 2003 Enplanements: 4,624,335; 
Percent of total: 0.71%; 
2003 Assistance: $426,665; 
Percent of assistance: 0.02%. 

Regional airlines: Comair: 2003 Enplanements: 10,935,597; 
Percent of total: 1.69%; 
2003 Assistance: $3,814,004; 
Percent of assistance: 0.17%. 

Regional airlines: Executive Airlines[A]: 2003 Enplanements: 2,739,909; 
Percent of total: 0.42%; 
2003 Assistance: (Incl. in AA); 
Percent of assistance: N/A. 

Regional airlines: Express Jet: 2003 Enplanements: 11,227,944; 
Percent of total: 1.73%; 
2003 Assistance: $3,034,197; 
Percent of assistance: 0.13%. 

Regional airlines: Horizon: 2003 Enplanements: 4,934,769; 
Percent of total: 0.76%; 
2003 Assistance: $4,337,459; 
Percent of assistance: 0.19%. 

Regional airlines: Mesaba: 2003 Enplanements: 5,702,260; 
Percent of total: 0.88%; 
2003 Assistance: $2,373,104; 
Percent of assistance: 0.10%. 

Regional airlines: Mesa[B]: 2003 Enplanements: 5,241,877; 
Percent of total: 0.81%; 
2003 Assistance: (Returned aid); 
Percent of assistance: N/A. 

Regional airlines: Piedmont: 2003 Enplanements: 2,343,742; 
Percent of total: 0.36%; 
2003 Assistance: $1,138,230; 
Percent of assistance: 0.05%. 

Regional airlines: Pinnacle: 2003 Enplanements: 4,544,994; 
Percent of total: 0.70%; 
2003 Assistance: $999,913; 
Percent of assistance: 0.04%. 

Regional airlines: TransStates: 2003 Enplanements: 2,544,816; 
Percent of total: 0.39%; 
2003 Assistance: $958,172; 
Percent of assistance: 0.04%. 

Regional airlines: Subtotal: 2003 Enplanements: 103,493,130; 
Percent of total: 15.98%; 
2003 Assistance: $32,290,392; 
Percent of assistance: 1.41%. 

Grand Total[C]: 2003 Enplanements: 622,930,979; 
Percent of total: 96.17%; 
2003 Assistance: $2,225,584,399[D]; 
Percent of assistance: 97.22%.

Source: GAO analysis of DOT data.

[A] Aid to American Eagle and Executive Airlines was included with 
American Airlines.

[B] Mesa was awarded aid, but did not accept the aid.

[C] The total number of enplanements in the U.S. airline industry 
during 2003 was 647,761,545.

[D] TSA's July 9, 2003, memorandum cited total aid as $2,289,262,632.

[End of table]

[End of section]

Appendix III: Regional Airline Financial and Operating Statistics, 1998 
through 2003: 

Table 2: Financial Plans Reported to GAO: 

Oct. 1, 2001-Dec. 31, 2002: Estimated costing savings: $446,502,222; 
2003: Estimated costing savings: $629,541,586; 
2004: Estimated costing savings: $683,673,652; 
Total: Estimated costing savings: $1,759,717,460.

Oct. 1, 2001-Dec. 31, 2002: Estimated revenue enhancements: 
$19,113,222; 
2003: Estimated revenue enhancements: $151,552,715; 
2004: Estimated revenue enhancements: $335,779,305; 
Total: Estimated revenue enhancements: $506,445,242.

Source: Airline plans reported to GAO.

[End of table]

Table 3: Regional Airline Financial Data, 1998 through 2003: 

Total operating expenses; 
1998: $5,057,869,883; 
1999: $5,881,841,615; 
2000: $6,915,601,352; 
2001: $7,720,000,791; 
2002: $8,150,793,920; 
2003: $8,509,585,465.

Total operating revenues; 
1998: $5,783,674,129; 
1999: $6,636,592,689; 
2000: $7,483,755,692; 
2001: $7,332,342,090; 
2002: $8,690,621,788; 
2003: $9,619,103,662.

Operating profitability; 
1998: $725,804,247; 
1999: $754,751,074; 
2000: $568,154,341; 
2001: $(387,658,702); 
2002: $539,827,869; 
2003: $1,109,518,197.

Net profitability; 
1998: $442,994,024; 
1999: $479,620,812; 
2000: $315,474,270; 
2001: $(254,927,731); 
2002: $160,989,012; 
2003: $672,896,060.

Cost per available seat mile; 
1998: $0.199; 
1999: $0.189; 
2000: $0.190; 
2001: $0.194; 
2002: $0.166; 
2003: $0.139.

Revenue per available seat mile; 
1998: $0.227; 
1999: $0.213; 
2000: $0.205; 
2001: $0.184; 
2002: $0.177; 
2003: $0.157.

Source: DOT Form 41.

[End of table]

Table 4: Regional Airline Operating Data, 1998 through 2003: 

1998: Available seat miles: 25,443,959,344; 
1999: Available seat miles: 31,093,704,791; 
2000: Available seat miles: 36,466,550,000; 
2001: Available seat miles: 39,862,849,000; 
2002: Available seat miles: 49,113,092,768; 
2003: Available seat miles: 61,220,086,000.

1998: Revenue passenger miles: 14,907,428,829; 
1999: Revenue passenger miles: 18,450,932,577; 
2000: Revenue passenger miles: 21,972,811,000; 
2001: Revenue passenger miles: 23,521,349,000; 
2002: Revenue passenger miles: 31,438,127,438; 
2003: Revenue passenger miles: 40,733,293,000.

1998: Revenue departures: 2,886,675; 
1999: Revenue departures: 3,052,628; 
2000: Revenue departures: 3,097,984; 
2001: Revenue departures: 3,026,924; 
2002: Revenue departures: 3,225,374; 
2003: Revenue departures: 3,481,985. 

Source: DOT Form 41.

[End of table]

[End of section]

Appendix IV: Scope and Methodology: 

To identify challenges facing U.S. airlines since 1998, we relied on a 
variety of sources. We conducted interviews with airline officials from 
legacy airlines, low cost airlines, regional airlines, and 
representatives from airline trade associations. We also interviewed 
government experts from the Department of Transportation (DOT) and its 
agencies--the Federal Aviation Administration (FAA) and the Bureau of 
Transportation Statistics--and the Department of Homeland Security's 
Transportation Security Administration (TSA). Using DOT Form 41 and SC-
298 financial and traffic data, FAA aviation forecasts, and business 
fare data from Harrell Associates, we examined the effects of various 
events and time frames on airline traffic and finances. In addition, we 
interviewed credit and equity analysts, academic experts, and private 
consultants to gather their opinions and relevant studies.

To assess the measures taken by airlines to remain financially viable, 
we relied on a variety of sources. First, we used submissions provided 
by 64 U.S. commercial airlines that received assistance under the 
Emergency Wartime Supplemental Appropriations Act of 2003. 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. Working with airlines and airline trade 
associations, we devised a data collection template for airlines to 
submit their financial plans (see app. I). Because of the proprietary 
nature of these plans, and for the purposes of this report, we 
aggregated the financial information contained in these plans into one 
of three airline categories--legacy airlines, low cost airlines, and 
regional airlines. We then compared the plans with actual financial 
results as reported to the DOT on Form 41 filing for the same period to 
determine to what extent these plans were realized. We also interviewed 
airline trade associations and representatives of five legacy, two low 
cost, and two regional airlines to discuss their plans. Finally, we met 
with airline equity and credit analysts to discuss airline measures.

To review the financial condition of the U.S. airline industry, we 
conducted interviews with airlines and their trade associations, credit 
and equity analysts, government experts, and academics. We also 
reviewed DOT Form 41 and SC-298 financial and traffic data submitted by 
the carriers in our study. We obtained these data from BACK Aviation 
Solutions, a private contractor that provides DOT Form 41 data to 
interested parties. To determine airline stage-length adjusted cost 
curves, we contracted with Roberts Roach Associates, a consulting group 
that specializes in airline economics. We also reviewed airline cash 
flow data that DOT supplied directly to us in order to determine how 
airlines' cash balances have fluctuated in recent years and what 
airlines' main sources of cash have been in recent years. Finally, we 
used airlines' publicly reported Securities and Exchange Commission 
filings to determine airlines future financial obligations. To assess 
the reliability of these data, we reviewed the quality control 
procedures that BACK Aviation Solutions, DOT, and Roberts Roach 
Associates apply and subsequently determined that the data were 
sufficiently reliable for our purposes.

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[Footnote 29] 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. These data are collected by DOT based on 
a 10-percent sampling of tickets and identify the origin and 
destination airport, which we converted to city-pair markets for cities 
with multiple airports.[Footnote 30] Since only the issuing carrier is 
identified, regional airline traffic is counted under the legacy parent 
or partner airline. To assess the reliability of these data, we 
reviewed the quality control procedures DOT applies and subsequently 
determined that the data were sufficiently reliable for our purposes. 
According to DOT, these markets accounted for about 92 percent of all 
passengers and about 11 percent of domestic city-pairs in 2003. The 
smallest markets in this group ticketed 4,840 passengers while the 
largest ticketed 5.1 million passengers in 2003. To analyze changes in 
competition based on the size of the passenger markets, we divided the 
markets into four groupings based on 1998 passenger traffic: less than 
85,000 passengers; 85,000 to 289,999 passengers; 290,000 to 839,999 
passengers; and 840,000 and more passengers. Each group comprised one-
quarter of the total passenger traffic in 1998. To stratify these 
markets by the number of carriers operating, we used the following 
categories: 1, 2, 3, 4, and 5 or more carriers. To stratify the data by 
market distance, we obtained the great circle distance[Footnote 31] for 
each market using the BACK Aviation Solutions database and then grouped 
the markets into five distance categories: up to 250 miles; 251-500 
miles; 501-750 miles; 751-1,000 miles; and 1,001 miles and over. To 
assess changes in competition in these markets, we analyzed changes in 
passenger traffic by market type and airline type, changes in the 
number of markets according the various stratifications we developed, 
determined the number of dominated markets,[Footnote 32] and calculated 
the average number of effective competitors[Footnote 33] in each market 
for each year as well as the average annual number of effective 
competitors per market grouping.

We had access to sufficient information to make informed judgments on 
the matters covered by this report. We performed our work between 
December 2003 and August 2004 in accordance with generally accepted 
government auditing standards.

[End of section]

Appendix V: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

JayEtta Z. Hecker (202) 512-2834 Steven C. Martin (202) 512-2834: 

Acknowledgments: 

In addition to those named above, Paul Aussendorf, Tom Gilbert, David 
Hooper, Ron La Due Lake, Grant Mallie, Richard Swayze, and Pamela Vines 
made key contributions to this report.

(544073): 

FOOTNOTES

[1] While there is variation in the size and financial condition of the 
airlines in each of these categories, there are far more similarities 
than differences for airlines in each group. Each of the legacy 
airlines predate airline deregulation of 1978 and all have adopted a 
hub-and-spoke network model that can be more expensive to operate than 
a simple point-to-point service model. Low cost airlines have generally 
entered the market since 1978, are smaller, and generally employ a less 
costly point-to-point service model. The seven low cost airlines 
(AirTran, America West, ATA, Frontier, JetBlue, Southwest, and Spirit) 
had consistently lower unit costs than the seven legacy airlines 
(Alaska, American, Continental, Delta, Northwest, United, and US 
Airways). Regional airlines generally employ much smaller (under 100 
seat aircraft) and provide service under code sharing arrangements with 
larger legacy airlines for which they are paid on a cost-plus or fee 
for departure basis to provide capacity. Many regional airlines are 
owned by a legacy parent while others are independent. While 64 
airlines received assistance under the Act, we focused our analysis on 
the 30 largest airlines, which enplaned 96 percent of passengers in 
2002 and received over 97 percent of the assistance provided under the 
Act. 

[2] U.S. General Accounting Office, Airline Deregulation: Changes in 
Airfares, Service Quality, and Barriers to Entry, GAO/RCED-99-92, 
(Washington, D.C.: Mar. 4, 1999).

[3] The ATSB was created under P.L. 107-42, and as of June 3, 2004, had 
issued $1.56 billion in guarantees supporting loans of $1.74 billion, 
including guarantees for several of the airlines included in this 
study: America West, US Airways, ATA, and Frontier.

[4] Southwest is the obvious anomaly in this discussion as it operated 
within Texas before deregulation.

[5] 49 U.S.C. 41712 and 49 U.S.C. 40103.

[6] Aviation and Transportation Security Act, P.L. 107-71.

[7] For more information on this topic, see U.S. General Accounting 
Office, Airline Ticketing: Impact of Changes in the Airline Ticket 
Distribution Industry, GAO-03-749 (Washington, D.C.: July 31, 2003).

[8] Atlantic Coast also operates as Delta Connection and will terminate 
its Delta service later this year (2004). Atlantic Coast began 
operating as Independence Air on June 16, 2004.

[9] Demand is commonly measured in revenue passenger miles (RPMS)--this 
is the number of miles paying passengers are transported.

[10] Precise estimates quantifying the effects the terrorist attacks of 
September 11 and subsequent events had on demand for air travel are not 
possible since no one can know in fact what the demand may have been 
absent these events. Nonetheless, we decided to examine changes in FAA 
aviation forecasts as an indicator of changes in demand as a result of 
these events because FAA forecasts are generally quite accurate; FAA 1-
year RPM forecasts had an average absolute error rate of 1.6 percent 
from 1995 through 2000.

[11] FAA staff stated that the agency's March 2003 aviation forecasts 
did not account for the war in Iraq or SARS.

[12] Since airline ticket data do not indicate the purpose for which an 
individual is traveling, these data are based on the assumption that 
those passengers paying higher fares were traveling for business 
purposes, and those passengers paying lower fares were generally 
traveling for leisure. While this assumption may have been practical in 
the past for analytical purposes, it has become increasingly 
unrealistic over the past few years due to the introduction of 
simplified fare structures by low cost airlines. As a result, ATA no 
longer publishes these data.

[13] Airlines also reported expected cost-savings for calendar year 
2004; legacy airlines reported they expected to achieve $16.8 billion 
in cost-savings in 2004, while low cost airlines legacy airlines 
reported they expected to achieve $500 million in cost savings in 2004.

[14] According to Lehman Brothers, as of March 2004, there were 534 
parked planes, down from 595 in November 2003. This decrease 
represented 11.7 percent of the pre-September 11 domestic fleet.

[15] Two airlines were eligible for assistance but refused it.

[16] Beginning in the first quarter of 2003, DOT required airlines to 
report the amount they spent on capacity purchases from regional 
airlines as a transport-related cost but did not require airlines to 
report the corresponding amount of seat miles purchased.

[17] ASMs per employee are measured by dividing the number of ASMs 
flown by an airline in 1 year by the average number of full-time 
equivalents employed by the airline during the year. Airlines with high 
labor productivity generate more ASMs per employee than airlines with 
lower labor productivity.

[18] Block hours per day are defined as the number of hours per day 
that a plane is in service from the time it pulls away from its 
originating gate until it arrives at its destination gate. Highly 
productive airlines are generally able to achieve higher block hour 
utilization of their aircraft than less productive airlines.

[19] The profitability of legacy airlines in the third quarter of 2003 
coincides with the "security fee holiday" authorized by P.L. 108-11, 
which suspended collections of the passenger fee for security and the 
aviation security infrastructure fee for tickets sold during June 
through September of 2003. For further information, see U.S. General 
Accounting Office, Summary Analysis of Federal Commercial Aviation 
Taxes and Fees, GAO-04-406R, (Washington, D.C.: Mar. 12, 2004).

[20] Adding an airline's cash balance to its highly liquid, short-term 
investments and dividing by the airline's total current liabilities 
produces an airline's cash ratio. If an airline's cash ratio is greater 
than 1, this indicates that the airline is financially liquid enough to 
cover all of its current liabilities.

[21] "Debt ratio" is a measurement of an airline's total liabilities 
divided by its total assets. As an airline's debt ratio increases, the 
likelihood of that airline fulfilling its long-term financial 
obligations decreases.

[22] In addition, as noted in figure 21, legacy airlines must also meet 
considerable current liabilities.

[23] Pension Fund Equity Act of 2004 (P. L. 108-218, April 10, 2004). 
The law temporarily replaces the interest rate on 30-year U.S. Treasury 
Bonds with an interest rate based on the average rate of return on 
high-quality long-term corporate bonds and allows airlines to postpone 
part of their necessary contributions for 2004 and 2005. Because not 
all airlines have disclosed their minimum pension funding requirements 
pursuant to this law, these obligations are not included in figure 23.

[24] Defined benefit plans promise a fixed payment amount in the 
future. In contrast, the defined contribution plans employed by low 
cost airlines fix the current contribution amount, but the future 
payment amount depends on returns on the pension assets.

[25] The number of "effective competitors" is a numeric representation 
of the number of equal-sized competitors in a market. The number is 
derived from the individual market shares of all of the participants in 
a market, and effectively adjusts for the varying market strength of 
airlines in each market. For example, one market served by three 
airlines, each of which carries one-third of the total traffic, would 
have three effective competitors. A different market, also served by 
three airlines, but where one airline carried two-thirds of the 
passenger traffic and the other two airlines equally divided the 
remaining passenger traffic, is calculated to have two effective 
competitors. For additional information on the calculation of this 
construct, see app. IV. 

[26] Air service markets are usually defined in terms of scheduled 
service between a point of origin and a point of destination. The 
markets in our analysis included airlines providing both nonstop and 
single connecting service. Connecting service is not a perfect 
substitute for nonstop service and, therefore, may not provide 
effective competition for certain classes of service (e.g., business 
travel). Our examination of the data reliability procedures for DOT's 
top 5,000 market data indicated that they were sufficiently reliable 
for the purpose of discussing broad changes in competition in domestic 
aviation. Readers should note, however, that because this analysis uses 
the largest 5,000 markets, it excludes information on service to small 
communities (i.e., those often legislatively defined as being served by 
"nonhub" airports), because markets in which those communities would 
represent either a point of origin or destination are too small to be 
included. For more information on the data used in our analysis and 
overall changes in the top 5,000 markets, see app. IV. 

[27] Domestic Airline Fares Consumer Report, Third Quarter 2002 
Passenger and Fare Information, U.S. Department of Transportation, 
Washington, D.C.: July 2003. For example, between 2000 and 2002, in the 
New York-Los Angeles market, low-fare carriers grew their traffic by 
171 percent on a 19-percent decrease in average fare. Other carriers' 
traffic declined on a decrease in their average fare. As a result, low-
fare carrier market share rose from 8.6 percent to 22.7 percent over 
the 2-year period.

[28] Though our focus in this study is on the legacy and low cost 
airlines, we recognize the near disappearance of "other" carriers" from 
the top 5,000 domestic markets. Other carriers are those that did not 
fit our definitions of legacy and low cost airlines and include 
currently operating airlines such as Hawaiian and Midwest as well as 
airlines such as Midway and National, which declared bankruptcy and 
ceased operations. As a group, these carriers showed dramatic declines 
in markets served and passenger traffic between 1998 and 2003. For 
example, other carriers' overall passengers declined 73.7 percent, from 
28.6 million in 1998 to 7.5 million in 2003 as their market share 
declined from 8.2 to 2.1 percent. Additionally, these carriers served 
only 270 markets in 2003, which is a decrease from 1,901 markets served 
in 1998.

[29] Because there were often several markets with the same number of 
passengers at the low end of the passenger scale, it was not always 
possible to have exactly 5,000 markets in our database for each year. 
For example, in 1998,we included 5,002 markets whereas in 2003 we 
included exactly 5,000 markets.

[30] Multiple airport cities are Chicago, Dallas, Houston, Los Angeles, 
New York, San Francisco, and Washington, D.C. We have in the past 
analyzed the Washington, D.C., market both as airport pairs and as one 
market because we had found that the airports represented distinct 
markets for time-sensitive business travelers.

[31] The great circle distance is the shortest distance between points 
along the surface of the earth.

[32] Consistent with definitions that others (e.g., the Transportation 
Research Board) have applied in the past, we defined a market as 
dominated if a single airline carried more than half of total 
passengers.

[33] Effective competitors are the number of equal-sized competitors 
that would provide a degree of competition equivalent to that actually 
observed in the market-share data. We computed the number of effective 
competitors in each market by summing the squares of the markets shares 
of all airlines serving in the market (the Herfindahl-Hirschman Index) 
and then inverting this number.

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