Air Pocket in the Revolution

By George Russell

For more than a year, the wings of high-flying People Express had been drooping under the heat of intense competition. In the first six months of 1986, the revolutionary discount airline lost an estimated $103 million, an alarming deterioration compared with a $5.7 million deficit for the same period last year. Finally, said Donald Burr, 45, People's founder and visionary chairman, "we had to do something." Last week Burr did. In a tersely worded statement he announced the possible upcoming sale of part, "or under certain circumstances even all," of the country's fifth-largest airline, which had 1985 revenues of nearly $1 billion. Thus came to an uncomfortable reckoning, if not an end, an experiment that in only five years of low-cost, no-frills travel profoundly shook up the U.S. airfare structure and challenged the longtime dominance of the major airlines.

In an interview with TIME, Burr clarified his position, declaring that "it's not really my intention to sell the whole airline. First we'll sell some assets and cut our costs." He added, "We've been tested before. We'll find a way to deal with this setback too." The stock market, however, ( remained skeptical. People stock, which had been trading fitfully in the $9 range since January, was pummeled in the past two weeks on Wall Street down as low as $4.88. Five days after Burr's announcement, People shares closed at only $6.75. There was considerable irony in the challenge that Burr and his brainchild were facing. Almost from its inception, People has been an air- industry legend--and headache--as Burr made air travel more accessible than ever before with his drastically lower fares. By last week Newark-based People had grown from a three-aircraft service in 1981 into a 117-jetliner network spanning 107 North American cities and including Brussels and London. But the company had strayed seriously from the keep-it-simple formulas that had made People a case study at business schools across the U.S. Only nine weeks after People installed a semiswank VIP lounge in its dowdy North Terminal at Newark, the company was on the verge of becoming a casualty of the very same fare- cutting wars that it had provoked.

The fare battles continue with no sign of a cease-fire. Budget flyers could still fly from New York City to Los Angeles last week for as little as $99, from Atlanta to Seattle for $129. Boston to Miami could be bought for $109, Dallas to Chicago for $89. From January to May, according to industry analysts, only about 11% of U.S. passengers who stepped aboard a commercial airliner paid full fare for their ticket.

Because of cheap fares, red ink has flowed more widely across the skies than coffee, tea or milk. In the first quarter, United Airlines, the largest U.S. carrier, lost $103 million. TWA did even worse, dropping $170 million. Long-troubled Pan American, which sold off its Pacific routes to United for some $750 million last year, lost $118 million. Indeed, in the entire U.S., only three sizable airlines showed a first-quarter profit: Southwest, which squeezed $7.1 million into the black; American ($4.2 million); and Aloha ($1.8 million). Says Michael Derchin, an airline expert for the First Boston investment firm: "It's become a Darwinian environment up there."

Despite all the corporate misery that they seem to be creating, the fare fights still have their boardroom defenders. One is Frank Borman, who steps down this week after 9 1/2 years as chairman of ailing Eastern Airlines, which is merging with Texas Air. He is also a victim of cut-rate competition: Eastern took a $111 million loss in the first quarter of 1986. Yet as Borman prepared to assume the largely titular role of Texas Air vice-chairman, he said last week that attractive prices and sharply increased passenger traffic have made the current competitive environment "a lot better than had we stagnated with high fares. I think society's better off."

For quite a while People Express was better off. The number of passengers taking the airline surged from 1 million in 1981 to nearly 12 million last year. But People bought planes and added flights so rapidly that the percentage of seating capacity used dipped from a 1983 high of 75% to an average so far this year of 60%. The company needs to fill 65% of its seats to break even. As Burr puts it, "Right now we're simply offering more than the public wants."

Burr saw rapid growth as a survival tactic in an air-transportation market dominated by bigger rivals. No other U.S. airline, though, has ever expanded as quickly as People. Burr was confident in the price advantage that People's low-wage, nonunionized employees produced over other carriers: 5.28 cents to fly a passenger one mile last year, vs. the industry average of 8.6 cents. He was overly blithe as he pushed his company into Atlanta and Dallas/Fort Worth, the territory of two major rivals, Delta and American. People gained size but it failed to gain strength.

Traditional carriers retal-

iated against the deep-discount threat with a blizzard of their own special offers. They had on their side a powerful weapon that People lacked: the sophisticated, highly computerized reservation systems linking them with at least 20,000 U.S. travel agents. The systems allowed the airlines to launch myriad discounts, usually on advance purchases with high (as much as 50%) penalties for failure to show up for the seat. For its part, People operated more like a mass-transit company. It offered two cheap daily fares--peak and off-peak--to most destinations, sold few tickets in advance and frequently overbooked its seats. Later this summer People will finally insert its flight schedule into the sophisticated computer networks managed by American and United.

The Newark airline has earned the nickname "People Distress." Its North Terminal center, once deservedly known as "the Pit," has improved over the years, but it still resembles a bus terminal at rush hour. A replacement facility is a year to 18 months away from completion. Horror stories have spread along the discount-fare grapevine of endemic baggage losses on People flights and of travelers stranded for hours in Newark, Denver or San Francisco. Chairman Burr protests that "we're as professional as any airline out there," but the stories have evidently hurt. One People way of fighting back: a two-month-old frequent-flyer program known as Travel Reward, which awards free flights to steady customers in the same manner as standard airlines.

People might have stayed out of financial trouble had it not been for Burr's $305 million purchase last November of Denver-based Frontier Airlines. Frontier, a conventionally priced, full-service carrier, was already battered at its hub by competition from Texas Air subsidiary Continental and from United. Burr's Denver foray violated one of the initial ingredients in People's formula for success: offer no-frills travel in areas away from heavy competition. Says Burr in retrospect: "When we bought Frontier, our competitors decided Denver was going to be a battleground. It still is."

People speedily turned Frontier into a no-frills carrier. Unfortunately, that move just as speedily alienated the Denver airline's traditional customers. Frontier's competitors, especially Continental, responded with discounts of their own, and Frontier's amenities were soon restored--but not until the airline underwent a bashing that still continues. Says First Boston's Derchin: "They now feel they have People Express on the ropes. They're not going to let up."

Another People move, the February takeover for an undisclosed sum of Britt Airways, a Midwest commuter line with hubs in Chicago and St. Louis, has made more sense. Britt provides People with important feeder traffic into its Newark base.

The final sign that People Express was feeling the competitive squeeze came last month. Suddenly and without forewarning, the airline seemed about to drop its entire spartan philosophy. Burr announced that People would upgrade all its services, install leather seats in its aircraft, and offer --horrors!--luxury flying in newly installed first-class seating. At the same time the determinedly upscale VIP lounge was set up in North Terminal. The counterrevolutionary campaign was a clumsy attempt to woo the slice of the airline market that People had never served, the business traveler. The change in style came on the heels of a brief People effort to raise fares, a move that was reversed within seven weeks.

The ploy, says one Manhattan investment analyst, was "a major strategic ) error." For one thing, he notes, People was "going after the smallest sector of the flying public," since only about 11% of all airline passengers fall into the business and luxury classes. For another, the seduction was bound to fail, since such well-heeled travelers could often get more reliable and comfortable service, albeit at higher prices, from conventional airlines.

Many investors still expect People Express to survive in some trimmed-down form. Says Peter Lynch, manager of the Fidelity Magellan Fund, which has invested in People from its inception: "They may have to abandon Denver and shrink their company by a third." Nonetheless, he adds, "they're still in a dominant position in New York, the largest market in the country."

If People is bought by another airline, the intensity of the industry's fare wars will probably ease somewhat, but cheap air travel will almost certainly not disappear. The carriers can afford to keep fares low because their costs are dropping dramatically. For one thing, the industry expects to save $2 billion on its fuel bills this year as a result of declining petroleum costs. In addition, the airlines are curbing payroll expenses through staff attrition and employee wage concessions. The cost of carrying a passenger for a mile on traditional airlines averaged only 7.7 cents during the first quarter of 1986, an 11% decrease from 1985. Wall Street analysts predict that as traffic picks up during the peak summer travel season, the industry will enjoy a turnaround and make a profit for 1986 as a whole.

What virtually ensures the continuation of discount fares is the law of supply and demand. In 1978, when the industry was deregulated, U.S. airline capacity amounted to 382 billion so-called seat miles, representing the total number of passenger spaces available multiplied by the total route mileage that could be flown. Today that capacity has reached 547 billion seat miles, a 43% increase. There are plenty of seats, in other words, to go around. Says Julius Maldutis, an airline analyst for Salomon Brothers investment firm: "The airlines are locked into a low-fare environment from which there is no return." No matter what happens to People Express, its impact on air travel will not be easily undone.

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With reporting by Frederick Ungeheuer/New York