I. INTRODUCTION
Large corporations and organizations as well as some 9 million smaller U.S. businesses require a financially viable commercial airline industry to serve their customers and grow their businesses. Indeed, the airline industry is the one industry upon which virtually every other industry depends. The U.S. airline industry, however, currently faces the worst financial crisis in its history.

The purpose of this white paper is to help begin an industry discussion surrounding this current financial crisis, specifically the need for airfare structure reform. Without airline industry recovery, rental car, hotel, GDS, Travel Management Company and other sectors will not likely fully rebound. The white paper’s genesis sprung from Summits ACTE conducted in the aftermath of September 11 to identify strategies and ideas for travel industry recovery.

The majority of Summit participants--buyers, suppliers, distributors and vendors--thought that a critical strategy in ensuring a return of business travelers, in significant numbers and at profitable yields, was to consider reform to airline airfare structures. Indeed, in the intervening months, there has been a growing chorus of voices, including airline CEOs, acknowledging the need for such airfare structure reform.

To build upon Summit results, ACTE organized a working group of travel and purchasing managers to begin the process of fleshing out issues and opportunities associated with reform. Additionally, in collaboration with the Business Travel Coalition (BTC), ACTE sought a detailed understanding of the marketplace through a comprehensive survey of major U.S. buyers of commercial air transportation services.

The 2002 U.S. BUSINESS AIR TRAVEL SURVEY, (the “Survey”) sponsored by Unisys Corporation and conducted by BTC endeavored to understand: 1) anticipated air travel levels over the next 12-18 months; 2) barriers to businesses returning to higher levels of travel; and 3) the acceptance level of technological and non-technological substitutes to the commercial air transportation product. Some 184 corporations / organizations participated in the survey, representing $2.9 billion in annual domestic U.S. air transportation purchases.

As a general rule, there has never been unanimity among industry participants regarding industry problems, causes and solutions. So, it was not anticipated that all industry participants would embrace every point in this paper. Rather, it was hoped that through the development of an intellectual framework for analysis, supported by buyer research, an important industry discussion could begin and help point us in the direction of collaboratively reached solutions.

II. PROBLEM ANALYSIS
There is growing recognition that the domestic U.S. airfare structure is no longer adding value for the airlines, or for their very best corporate customers. Fundamental reform is urgently needed. The objective of any reform should be to induce sufficient business travel demand at high enough yields to return the airline industry to sustainable profitability as soon as possible. Major airlines have recently experimented somewhat with new business airfare programs, but few have attempted true reform.
Historically, airlines have been reluctant to pursue reform for a few reasons. First, some airline executives seem to believe that when the economy strengthens, business travelers will come back in full force, and there will be a return to the pricing power of the late 1990s. Second, most airline executives are concerned about taking a risk on a new approach to an airfare structure that would be weakly committed to by corporate customers and subsequently sabotaged by competitors. Third, other airline executives believe if business travelers are to return in significant numbers, then a part of any airfare structure reform must include lower business airfare levels. These executives, though, are at a loss as to how to lower business airfares.

Major airlines face a conundrum. Labor costs are too high and unsustainable for the current and foreseeable airline revenue environments; worker productivity levels are too low; and pilot scope clauses are too restrictive. A lower business airfare model is inextricably linked to reform of the labor model. Importantly, there is a perception among some labor leaders that there is no need to move toward a more rational labor model. Like some airline executives, they believe a rebound in business travel is nearly 100% tied to the economy.

However, there is growing evidence that this situation could change. While airline management and labor continue in their standoffs, major airline customers are busy moving forward with their own solutions. Many travel managers among the Fortune 500 report that what had been a slow migration to non-refundable tickets by their travelers has turned into a double time march. The use of non-refundable tickets has reached 57% of all tickets issued among the major corporations who participated in the Survey. Business owners and employees at the other 9 million U.S. businesses are in open revolt, climbing over the fences airlines place around their low-fare offerings and purchasing all manner of Web and restricted airfares.

Adding further pressure to the major airlines’ yields, the low-fare segment of the industry is resurgent with its highly productive workforces and attractive business airfare structures. Some 73% of Survey respondents reported using low-fare airlines more in 2001 than in 2000; 69% say they will further increase their use of low-fare carriers in 2002. Charter and fractional jet ownership programs are growing at double-digit rates, and corporations are intervening in the supply side of the market to implement competitive alternatives such as low-fare airline revenue guarantee programs and air charter networks.

The tragic events of September 11 only accelerated marketplace trends toward the use of technological substitutes to the commercial airline product. All companies participating in the Survey increased their use of these product substitutes in 2001. Some 32% increased their usage by up to 5%; 46% increased their use by more than 6%; and 23% increased their use by more than 11%. More than 85% of Survey respondents expect their companies will increase their usage of these substitutes in 2002.
In short haul markets, business travelers are more often choosing a relatively hassle free, 5 hour door-to-door trip in their cars for $75, versus a 6 hour, $750 hassle-prone airport experience. Survey results indicate that 77% of travel and purchasing managers are observing greater use by their travelers of cars, rental cars and trains in airline markets of fewer than 500 miles distance. Some 16% of companies are now requiring employees to drive in short-haul markets; 9% are considering such a policy.
Importantly, as previous recessions transitioned to recovery, corporations felt it necessary to get their employees back on the road and not let their competitors secure more “face time” with prospective customers. Today, some corporations are rethinking this premise. For example, salesperson “A” takes a two-day trip and visits with one customer and two prospects. Salesperson, “B” speaks by phone with several customers, conducts a Webcast for 45 prospects and facilitates a product review Web Conference among current customers--all on day one! So, while the competition is standing in airline security lines, salesperson “B” is getting the job done. Technology is changing the definition of what it means to be competitive.

All of these forces are gathering to encourage major airlines to consider fundamentally reforming the way they do business. Labor and management will soon see this integrated analysis evidenced in airline balance sheets as another $4 billion dollars or so is lost in 2002. The industry lost $2.4 billion in the first quarter alone. Many industry observers are reasonably confident that airline management and labor leadership will soon see that they cannot resist such powerful marketplace forces. It is in the self-interest of labor and management to be competitive with all manner of product substitutes available today to the customer.
While airfare structure reform is dependent upon labor reform, this paper focuses only the former and assumes airlines will succeed in the latter. Moreover, ACTE acknowledges that there are airline cost and inefficiency problems in addition to labor that need to be addressed in the furtherance of lower business airfares.

III. AIRFARE STRUCTURE DEFINITION
Often when airfare structure reform is discussed, it is narrowly focused on just airfare complexity, or airfare levels. However, true reform must broadly focus on the whole process from product offerings all the way through to customer relationship management. There are opportunities to remove costs, improve the airline product and repair damaged supplier-buyer relationships. In the end, the simple fact is that the country needs a financially viable commercial air transportation system.
The airfare structure broadly defined includes:

• The negotiating process
• Contract terms and conditions
• Pricing levels
• Pricing guarantees
• Fare structure design
• The role of the Travel Management Company
• Surcharges, change fees, etc.

IV. EVIDENCE OF NEED FOR REFORM
1. Major airlines were on track to lose $3.4B for the year 2001, prior to the horrific events of September 11. Some of this loss was attributable to the economy; a portion was based on corporate policy decisions in 2001 to make permanent, strategic reductions in travel activities. Some 74% of Survey participants indicated that some portion of travel spend reductions was intended to be permanent, i.e. kept in place well beyond 2002.

2. Airlines’ most valuable corporate customers are articulating a need for reform in growing numbers.

3. Some major airlines are acknowledging they have lost control over their pricing; business travelers are purchasing all manner of low-yield, restricted airfares.

4. The use of technological substitutes to the commercial airline product is on the rise. The vast majority of Survey participants reported increased use of these product substitutes.

5. The gap between leisure and business airfares is growing.

V. WHERE REFORM IS NEEDED
1. Overly Complex Airfare Structure. Complexity is expensive and can breed mistrust among customers. Up to 1 million airfare changes are made each day to some 30 thousand posted airfares. In the view of many, shopping and buying an airline ticket has devolved into a sort of shell game that can alienate business travelers. Importantly, expensive travel technologies cannot be deployed for optimum benefit in a complex airfare environment, and resources are often misallocated to managing complexity instead of improving productivity, or reducing cost.

2. Unpredictable Prices. Airfares are not generally guaranteed for the term of a contract, as with virtually all other products that corporations purchase. Many corporate discount programs are, is a sense, counterfactual in that discounts are tied to a floating ‘Y’ airfare that has generally trended up during the terms of contracts.

3. Reverse Customer Segmentation. The airline industry seems to pursue customer segmentation differently than most other industries. The airline industry tends to focus on building fences around the products a business traveler actually desires, versus building a product around customer wants and needs. Some airlines have recently responded to this specific issue by providing affordable airfares, without a Saturday night stay requirement, for businesspersons planning travel well in advance.
Indeed, the myth remains alive and well that business travelers almost always plan travel at the last minute; so therefore, seats must be priced high to keep them available. The fact is many corporations have average advance purchasing times for air travel of 15 days or more. That average could most certainly be pushed higher were there a major incentive in place for corporations to aggressively promote such programs.

An argument related to the overstatement that the business traveler plans travel at the last minute is that the business traveler demands high frequencies in a city-pair market. As a result, the argument goes, many excess seats end up in such a market. The extension of this logic is that to maintain the high frequencies, those extra seats need to be sold to leisure travelers for pennies on the dollar. In effect, some airlines posit the economic argument that leisure travelers are actually subsidizing business travelers, and enabling the high frequencies. Not everyone agrees.

As airline industry veteran Rolfe Shellenberger observes, “Airlines keep saying
that they create frequency to accommodate business travel demand, so business travelers should pay more. That old chestnut was popular back in 1975 when network airlines tried to defend their discriminatory pricing. But today, one look at a Southwest timetable shows that frequency pays off across the board without exploiting business travelers."

4. Arbitrary Surcharges. Many corporate buyers report that airlines thus far have refused to consider escalation and de-escalation clauses in their contracts with corporations to deal with rapid and high upward spikes in feedstocks such as jet fuel. This is a common purchasing practice in many industries that rely on volatile feedstocks. Instead, surcharges are a) just “announced,” versus negotiated in advance b) generally do not apply to leisure travelers, c) are not tied to any logical peg such as distance and d) tend to remain in place well after the feedstock price retreats.

5. Counterproductive Incentives. There is a common perception among corporate buyers that in the same way frequent flyer programs induced travelers to circumvent corporate travel programs, so do Web Fares. They encourage employees to purchase tickets on the Internet, negatively impacting fulfillment results for a corporate airline contract. Most of these airfares cannot be tracked from a data collection standpoint, nor are they credited to contract fulfillment obligations. (Some airlines are considering changes in this area.)

Since airline deregulation, airlines have wrestled with the issue of who their true customer is. There has been a costly ebb and flow as the Travel Management Company, the corporation and the individual traveler respectively, have been rotated on and off of the “Customer Pedestal.” What might appear “rational” to one airline, e.g., double frequent flyer points to induce travelers to book outside a travel program, can in fact be a counterproductive and zero sum strategy that increases costs for all industry participants.

6. Unaffordable Business Airfares. Many organizations--large and small--that fund business travel activities perceive current airfare levels to be too high for the value received, and too high in comparison with currently available substitutes to the commercial airline product. Often travelers, especially small business owners, simply find airfares unaffordable.

VI. WHAT CUSTOMERS ARE SEEKING
Customers are seeking an airfare structure with the following attributes:
A. Simplified Airfare Structure. There are several potential approaches to simplification, and some concepts such as zone, mileage block or per-mile pricing have been tried or investigated in the past. One model, which is a variation of the low-fare airline model, envisions five or six different airfare levels, while providing a graduated scale of discount for high volume purchasers.
B. Equal Access. Corporations desire the same access to Web Fares as the general public, and the purchase of such airfares to count against contractual obligations with airlines.
C. Guaranteed Airfares. Corporations are interested in guaranteed prices for the term of a contract, versus guaranteed discount percentages that do not support corporate budgeting and control.
D. Escalation and De-escalation Clauses. Corporations are interested in negotiating contract clauses that will make airlines whole when volatile costs spike up, or unforeseen circumstances arise that significantly impacts airlines’ cost structures. Likewise, such clauses would address circumstances where feedstock prices normalize.
E. Affordable Airfares. Corporate customers desire a more favorable price to value ratio. The customer’s view is that current business airfares are too high and that the pricing model penalizes airlines’ best customers.

VII. POSSIBLE PATHS FORWARD
As stated earlier, airlines have legitimate concerns about the risks associated with airfare structure reform. Most airline pricing executives would probably express that they could indeed develop an airfare structure with the attributes just described (assuming labor reform). The problem is the competitive response to such a program. The response to Value Pricing in 1992 cost the industry some $300 million dollars.

ACTE believes that a key enabler of airfare reform is ironclad customer commitments in return for airlines taking the risk of reform and providing the customer with new and long sought after benefits. In other words, if the customer truly desires a new airfare structure, and supports the premise that reform is risky business for the airlines, then the customer must be willing to take risk and make guarantees to partnering airlines.
There are several possible paths that could lead toward airfare structure reform that would reduce airline risks and validate the benefits of reform to buyers and sellers alike.
A. A willing airline could develop a program on its own, based upon the attributes above and including ironclad customer obligations, and invite customers to evaluate the program and consider partnering in its implementation.
B. A willing airline could work with interested customers to develop and test such a program, based upon the attributes above and including ironclad customer obligations, in a select number of city-pair markets.
C. A willing airline could test such a program, based upon the attributes above and including ironclad customer obligations, with a very limited number of corporations with strong travel management programs across the airline’s domestic U.S. system.

These, or other creative approaches, are worth pursuing in ACTE’s view. We must bear in mind that Value Pricing was sprung upon the industry (necessarily so because of antitrust constraints), and did not have the support of, let alone ironclad commitments, from airlines’ very best customers. Success with limited tests would likely encourage more airlines and customers to truly partner in a new way of doing business. The airline industry financial crisis is far graver than in the early 1990s. Strategies for inducing significant business traveler demand at profitable yields are few. The alternative to reform, maintaining the status quo, is the high-risk position for airlines, their customers and all sectors of the travel industry dependent upon the return of  the business traveler. The customer is willing to extend a helping hand, but, in return wants its problems solved in the process as well.