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In the parched air of Phoenix’s Sky Harbor airport, the rows of parked aircraft are growing. Over the last 18 months, scores of planes have landed, rolled to the end of the vast concrete taxiway, and stood waiting for a return to service. Some receive the call and fly back to their airline owners, but others, utterly forlorn with their wings stripped of engines and nose cones torn off for the removal of radar sets, will never move again.  

A visit to the Arizona airport is a primer in basic airline economics and lays bare the essential reason why airfares have fallen dramatically in the last two years – and are likely to continue a steady drift downwards. Sky Harbor is one of the ‘boneyards’ – homes for resting aircraft – that are dotted across the American Southwest in a belt reaching from eastern California across Nevada and the Mojave Desert. First chosen by the US military to store surplus combat aircraft because the dry air of the desert cut down on costly corrosion, the boneyard airfields have in the last 20 years made a lucrative business out of storing planes deemed surplus to the requirements of the world’s airlines.

They have never been busier than in the last two years. The September 11th terrorist attacks sparked an initial rush of aircraft to the desert as airlines trimmed their schedules to accommodate reduced demand. But the exodus did not stop there. Instead, it picked up pace with the outlook for the commercial aviation steadily worsening, pulled down by the malign influences of fears of terrorism, the threat and then reality of war in Iraq, the Sars virus and the accompanying slowdown of the wider economy. Two major European airlines, Swissair and Sabena, went bust, while United Airlines, US Airways and Air Canada – three of America’s largest carriers – were forced to seek court protection.

According to figures complied by the Airclaims consultancy, 2,100 aircraft, with a capital value of around $15 billion, are now sitting idle in the boneyards. The number of aircraft stored reached the 2,000 level in late 2002 but rather than declining, as many experts predicted, it has grown steadily – despite several hundred of the oldest aircraft being broken up completely for scrap and removed from the idle lists. The desert airforce now represents 12 per cent of the world’s western-built airline fleet.

The presence of this deep well of excess capacity exerts a strong downward pressure on airfares globally. As well as making available cheap aircraft for new entrants to the industry, it distorts airlines’ normal decision-making in the face of reduced demand. Airline executives are not able to take a simple resolution to reduce flights and retire aircraft, pushing up fares and company profitability. Instead, they are constantly haunted by the need to make some use of this expensive, idle asset. As soon as there is a good chance of an aircraft being able to earn enough revenue to cover the variable costs of its flights, then it is pressed back into service.

The case is not altered for those aircraft owned by financial institutions or specialist leasing companies: the imperative to get planes flying to earn some contribution to their cost of ownership is powerful. The boneyards are not the only hose-pipe flooding the aviation market with unfilled seats. While Airbus and Boeing have cut production in the aftermath of September 11th, each is still on track to repeat 2003’s production of around 300 new aircraft with a similar number in 2004. Desperate to keep their expensive production lines turning, the manufacturers are offering very attractive terms to those few airlines that have not imposed a total freeze of aircraft purchases, including help with financing, pilot-training, maintenance and, in some cases, absolute guarantees on operating and maintenance costs of their products.

The end result of this basic oversupply has been rapidly falling airfares. The American Express European Corporate Travel Index, which has steadily tracked business airfare increases through most of the last decade, recorded a sharp fall in the first quarter of 2003 – a fifth consecutive quarter of decline. Economy fares were down 5 per cent, restricted business class fares down 3.5 per cent and full-fare business class – the category in which airlines fiercely strive to keep prices up – down 0.9 per cent. All fare classes have remained very flat or fallen, with airlines under pressure to keep costs competitive in the uncertain market environment. “We usually expect to see fare increases in the first quarter as airlines adjust fare structures after the traditionally quiet Christmas period,” says Matthew Davis, director of global consulting services at American Express.

This time round, airlines have no pricing power. “The market pressures on traditional carriers has seen a fall in average economy class fares available for business travellers. With the boundaries becoming increasingly blurred between fares from traditional carriers and the ‘no frills’ sector in Europe, UK business travellers are in an excellent position to take advantage of deals from across the full airline spectrum,” says Davis.

In America, which has habitually led the world in aviation trends, airline executives and aviation analysts say fares are being depressed not only by excess capacity, but also by a change in business travel patterns and structural change in the industry.

The Air Transport Association, the trade body that represents America’s airlines, says business travel demand is still 15 per cent down on 2000, and sees no immediate rebound. “Businesses just don’t fly any more all of a sudden, there has to be a need,” says John Heimlich, managing director for economics at ATA.

Airlines have attempted to stimulate demand with fare sales and by removing some of the industry’s sacred cows. Several major US carriers have recently removed rules that restricted the use of discount business class tickets – a seemingly minor dispensation, but one that removes one of the pillars supporting conventional airline pricing policies. A key change has been the scrapping of the ‘use it or lose it’ rule that meant discounted business class tickets lost their entire value if travellers wanted to change their travel plans. Passengers have now been given a year’s grace in which to re-book flights. Kevin Mitchell, chairman of the Business Travel Coalition, a lobby group for business travellers, calls the ticket policy change “a huge retreat” by US airlines.

While the changes were dictated by airlines’ need to stay onside with passengers, they were in part forced by the inroads made by low-cost airlines into traditional carriers’ markets. In May 2003, Southwest Airlines, the budget airline credited with having started the no-frills craze, carried more domestic passengers in America than any other airline for the first time ever. Industry analysts say Southwest’s ascendancy, the first time a no-frills airline has topped the passengers carried rankings, is a watershed for the industry. Low-cost airlines now carry roughly one-quarter of all US airline passengers.

European budget airlines lag behind their US counterparts, but are catching up fast, adding to the relentless downward pressure on airfares. An analysis of the low-cost market by City stockbrokers WestLB Panmure showed that low-cost airlines now account for 10.6 per cent of the Western European market and are at their strongest on routes between the UK and the continent, where they now have more than one-third of the market. These inroads into full-service airline backyards will continue to grow, with West LB forecasting a 27 per cent growth in the number of low-cost airline seats offered by British and Irish low-cost airlines in 2003/04.

Full-service airlines have, until recently, relied on one weapon to fight the low-cost upstarts – discounting. They have cut leisure fares in the hope that their traditional service strengths, such as frequency of flights, lounges and ticket flexibility, will allow them to hang on to the all-important high-yielding business travellers.

But, more and more conventional carriers are realising that this strategy is of limited use, and may simply be staving off their inevitable decline on short-haul European routes. Some, notably British Airways, have begun the slow process of dismantling the costly apparatus of the full-service airline in an attempt to compete if not head-on, in terms of cost, at least on closer terms. BA has cut fares, removed restrictions that required travellers to stay a Saturday night at their destin-ation in order to qualify for cheaper prices, and stopped flying to many destinations that are not vital to support its long-haul network.

Some of the changes show how far the airline is prepared to go to mimic its low-cost rivals. No-frills airlines normally do not rely on travel agents to bring them passengers; and they pay no commission to middlemen. Full fare airlines until recently have paid a full 9 per cent or 7 per cent commission on fares sold through the trade, which remains an important source of supply, accounting for around 80 per cent of all tickets sold in the case of BA.

Selling costs, including commission, are generally airlines’ third or fourth biggest costs behind fuel, wages and aircraft. In August 2003 British Airways decided to cut the umbilical cord to the travel trade and slashed its commission rate to just 1 per cent to howls of outrage from high street agents. There is a strong suspicion that if the airline was not required to maintain some level of commission payment, in order to remain part of the international ticketing network maintained by the International Air Transport Association (IATA), it would have done away with commission altogether.

The combination of an excess of aircraft and structural changes in the industry means that the tumble in the price of air travel is likely to continue for the foreseeable future. The manufacturers Airbus and Boeing, two of the closest scrutineers of the prospects of the world’s airlines, each say in their most recent global market forecasts that they expect no significant upturn in carriers’ profitability until 2005, at the earliest.

Dominic O’Connell is industrial editor at the Sunday Times. He was part of the team that in 1998 launched Sunday Business, where he was transport correspondent and news editor. He worked on newspapers in his native New Zealand and in Australia before coming to Britain in 1988 and working on a number of trade journals, including Construction Weekly and The Engineer. For three years he was aviation correspondent at Travel Trade Gazette.

(This article was originally published in Director of Finance 2004 edition)