U.S. Airlines Lose Tolerance for Money-Losing Flights as Fuel Prices Rise

For the past eight years, few American Airlines flights have lost as much money as Chicago to Beijing. No matter what airplane it used — the larger Boeing 777 at first, or the smaller and more fuel efficient Boeing 787-8 in later years— the route never clicked.

Yet American kept the route in its “strategic flying,” portfolio —  something Vasu Raju, American’s vice president for planning, defined earlier this year in an interview as, “a euphemism for losing money but telling yourself it’s OK.”

There’s some rationale for this approach. The U.S. and China limit flights between the two countries, and while there’s now more supply than demand — meaning fares are low — carriers figure someday that will change as more Chinese travelers visit the United States. American didn’t want to stop flying Chicago-Beijing only to have a competitor take the rights, move the flight to another airport, and make major profits in 2025.

But American is giving up. In October it will end the route, and though it has asked the U.S. Department of Transportation to let it keep the rights, so it can use them in the future, there’s no guarantee the government will grant its request.

“We had made a tremendous investment in China,” American President Robert Isom said May 22 at the Wolfe Research 11th Annual Global Transportation Conference. “We’ve taken a look and said, ‘Hey, you know what, the losses of tens of millions of dollars per year isn’t something that’s sustainable right now.’ And so we’re not doing it. We’re pulling back.”

This is not an isolated case. Airlines often cancel poor performers so they can use aircraft elsewhere, but they may tolerate some money-losers if they believe they need them for strategic reasons. However, with fuel prices rising — the price of a barrel of oil is up roughly $20 since last June — the math is changing. United Airlines estimates every $1 increase in the cost of a barrel of oil represents a $100 million increase in operating costs — so a marginal performer can quickly become a disaster.

“What really determines how long a carrier will invest in strategic flying is the level of losses and how close to the expected ramp up performance the route is achieving,” said Mark Drusch, a former executive at Delta Air Lines and Continental Airlines and now a vice president for aviation consulting firm ICF. “As fuel prices go up, money-losing strategic flying will usually lose more money, becoming more expensive to maintain.”

American recently also dropped some flights to Brazil, another market that someday could be a big money-maker, as it was before the country’s 2014 financial crisis. But not every airline wants to wait.

This winter, American will send Boeing 787-8s — an aircraft with flat beds in business class suited for flights to Asia, to Cancun and Honolulu. With a strong U.S. economy and robust travel demand, those destinations are more likely to make money than Chicago to Beijing.

“We’re taking a look at our entire network to make sure that there’s certainly nothing out there that’s cash negative or that we can’t really defend in terms of investment flying, and we’re taking a look at that,” Isom said.

Alaska Airlines Also Culling Its Network

At Alaska Airlines, executives are reacting similarly to high fuel prices, focusing on some routes Virgin America launched for strategic reasons.

Before Alaska acquired it, Virgin America was a small airline focused on San Francisco, and it wanted to fly key business routes from the Bay Area, whether they made money or not. Business travelers, Virgin America figured, wanted to fly an airline that could get them everywhere they wanted to go. If it didn’t fly them to Denver, it feared customers wouldn’t book its money-making routes to New York.

Alaska sees it differently, so it recently has cut Denver, Minneapolis, and Mexico City, along with leisure-centric flights to Cancun and Fort Lauderdale. Alaska is also dropping what were Virgin America’s flights from Dallas Love Field to New York LaGuardia and Washington Reagan. All might be top performers some day – the three big-city airports are capacity controlled, making them challenging for new entrants— but for Alaska, they didn’t work.

“Alaska walked away from slots at constrained airports in big cities … because those slots don’t work for them,” Hunter Keay, an analyst at Wolfe Research, wrote in April. “That’s the type of move that’s often lacking in the airline industry. Bottom line: Alaska is re-focusing on its core markets, customers, and areas of strength while de-emphasizing areas of weakness.”

Not all the strategic flying mishaps came from Virgin America. Alaska also struggled in Cuba last year once it started flying Los Angeles to Havana.

After the Obama Administration dropped restrictions on who could travel to Cuba, U.S. airlines added flights, even though they knew they might lose money short-term. They hoped early investments someday would create profits —a similar strategy to what long-haul airlines have been trying in China.

It hasn’t worked out as planned. The Trump administration has taken a harsher view toward Cuba, scaring some travelers from visiting, though even before that happened, travelers weren’t rushing to book.

“It was pretty bad,” Alaska CFO Brandon Pedersen said at the Wolfe Research conference.

Some airlines are sticking with Cuba, particularly from South Florida. But from the West Coast, Alaska said it made no sense to keep flying, and it dropped the flight in January.

“It was really hard to know how that market was going to perform,” Shane Tackett, Alaska’s senior vice president of revenue management and e-commerce, said at the Wolfe conference. “It was going to be slot-limited. There were no flights that were going to come off the West Coast. I think a lot of the reasons that we got into it made sense. I’m proud of the company for moving quickly though to turn it off once we realized the political dynamics had changed, the traffic wasn’t going to be there.”