Source: The Street
Author: Ted Reed

Once the biggest airline in the world, United is shrinking dramatically.

In size it now ranks fourth, behind Delta, American and AirFrance/KLM. Between 2000 and 2008, its fleet shrank by a third, its workforce shrank by half and its passenger count shrank by 38%.

Further cuts are anticipated. First-quarter revenue shrank 22% from a year earlier. And United is the only one of the 10 largest airlines in the U.S. that does not have an aircraft order in place.

"I once worked for a company that flew to all 50 states," says Rich Delaney, president of District 141 of the International Association of Machinists, the airline's biggest union with 17,200 members. "It had the largest reach and was the premier carrier. The watchword was 'benefit from the economies of scale.' Nobody talks about that anymore."

In shrinking, United is ahead, but not alone. Since early 2000, American, long its arch competitor, has reduced its mainline workforce by 23.5% and its mainline fleet by 11%. Overall between 2000 and 2008, the U.S. airline industry's capacity grew by about 10%: Established network carriers scaled back, but low-cost carriers and regional carriers grew. During the two years ending Sept. 30, United was second to American in capacity reduction, with a 3.9% cut, according to figures compiled for TheStreet.com by Innovation Analysis Group.

For the network carriers, reducing capacity has come to be viewed as a panacea for every manner of ailment. The carriers cut back after the Sept. 11 terrorist attacks, then began to rebuild. They returned to cutting in earnest in 2005, when US Airways and America West merged in bankruptcy, seizing the opportunity to shed unwanted aircraft to reduce costs.

United, Delta and Northwest also scaled back in bankruptcy, enabling the industry to turn profitable in 2006 for the first time in six years.

In 2008, capacity reduction became the chosen method for shielding carriers from the ravages of sharply rising oil prices. Late that year, as the economy slowed, reductions continued in the face of declining demand for travel.

While it seems clear that airlines have responded effectively to a cascade of problems, it is not so clear that continuous contraction offers a path to maintaining a franchise as a leading global airline.

By many measures, United's most successful CEO was Stephen Wolf. Between 1987 and 1994, he presided over unprecedented international growth, expanding from 11 international destinations to 33, and ordered hundreds of new airplanes, including the first 777 jets produced by Boeing.

In a recent interview, Wolf recalled that when he arrived, United did not have a single European route and that it lobbied hard for a Chicago-Tokyo route. "We won it, a major coup for us, and we almost immediately put two 747s a day on it," he said.

Yet Wolf was forced out, largely because of conflict with the pilots union. A quarter-century later, the airline's unions are growth advocates, but the airline is "not even reinvesting at the rate of depreciation," says aviation consultant Robert Mann. "Instead, they seem to be on anorexic alert."

Regarding Wolf, "regardless of what you think of his management style, the point is that he envisioned United as an airline," says Jay Heppner, spokesman for the United chapter of the Air Line Pilots Association. "The problem today is that management has no vision for the future.

"When the economy turns around, how are we going to recapture market share if we don't have the aircraft and the employees to do it?" Heppner asks.

On United's first-quarter earnings call, Morgan Stanley analyst William Greene questioned a future where planned capital expenditures do not keep pace with depreciation. CFO Kathryn Mikells responded: "For better or for worse, we've been capital constrained for a number of years, and what I tell you is we're very focused on where we spend the capital. ... We have galvanized the entire company around focusing on only a few goals."

The areas do not include new aircraft, but Mikells noted that "from a fleet perspective, our retirement of the 737 is in part being backfilled with new RJ 70s." Those 70-seat regional jets are placed in the fleets of regional partners with lower pay scales. "That is a terrible thing, from a mainline employee perspective," Mann says. For United, not so bad.

As for the reluctance to buy new aircraft, Mann says, "If you figure the company has been for sale for years, then the way it would be the best possible acquisition target is to not have any major aircraft acquisition commitments. The problem is that the longer you starve yourself, the less interesting you are as a network."

At the same time, were United to decide to place an aircraft order, the present would be an opportune time, because a rash of cancellations and deferrals has created an opportunity to secure extremely favorable pricing.

"The irony is that if you look at where they are, it's not a terrible place to be, unless you view it from the standpoint of a mainline employee," Mann says. "In that case, you see the place literally evaporating in front of your eyes."