Continental Keeps the Little Things,
And a Risky Bet Brings Big Rewards

By SCOTT MCCARTNEY
Staff Reporter of THE WALL STREET JOURNAL

After the Sept. 11 terrorist attacks, most airlines prepared for hard times by slashing traveler extras, eliminating many meals, pulling magazines off planes and closing some ticket offices and airport clubs. Not Continental Airlines. The Houston airline, heavy with debt and lacking even a basic bank line of credit, instead took a jumbo-jet-size risk: It decided cabin comforts were more important than saving a few bucks.

Shortly after the attacks, Continental Chairman and Chief Executive Gordon M. Bethune helped lead the industry chorus calling for a federal bailout. But once Congress approved a multibillion-dollar cash infusion, he quietly went his own way, pushing ahead on projects intended to woo travelers. Continental spent aggressively to add security checkpoints and self-service check-in kiosks. While others pinched pennies, Continental offered free in-flight movies and free drinks in its airport clubs.

A greatly expanded terminal at Newark International Airport -- crucial to Continental's gains in the New York market -- was completed in December, only after Continental decided to pay more than a month of overtime to construction workers. Recently launched commuter-train service at Newark will allow more people to get to the expanded terminal more easily. Meanwhile, UAL Corp.'s United Airlines and Delta Air Lines both have suspended terminal-construction projects in New York since Sept. 11.

As he did with his mid-1990s turnaround of Continental, Mr. Bethune is again demonstrating that there can be a cost to too much cost-cutting. In December, Continental's traffic was down only 10.6%, the smallest decline among the six biggest airlines. In the fourth quarter, Continental's planes were more full than those of its competitors. Its losses were proportionally far narrower than rivals that, like Continental, funnel passengers through hub cities.

A Disastrous Year

UAL's record annual loss of $2.1 billion, reported Friday, capped a disastrous year for the airline industry. (See related article¹). All told, the nine major carriers tallied net losses of $7.24 billion, even after the federal rescue. While Southwest Airlines, a low-cost carrier that flies passengers point-to-point, was the only major airline to remain profitable last year, Continental's annual loss of $95 million paled among the big full-service carriers. Four of the six biggest airlines each had annual losses exceeding $1 billion.

Continental estimates that in the fourth quarter its higher percentage of seats filled yielded $100 million in extra revenue, far more than the $7 million or so that would have been saved by scrimping on meals last fall. "Now is not the time to take the cheese off the pizza," says Mr. Bethune, returning to the sort of slogan he used while engineering Continental's turnaround eight years ago. "If available business traffic gets scarce, wouldn't you put more amenities in to get them?"

Travelers have noticed the difference at Continental. Howard Z. Brooks, travel manager at Sony Music Entertainment Inc., says Continental is picking up more of his business. Leslie Leventman, head of travel for MTV Networks, a unit of Viacom Inc., says workers have surprised her when they come back from trips with praise for Continental's food. "It's a big deal that they're still providing food," she says.

'The First Guy to Make Money'

Mr. Bethune is so confident of his company's position that he predicts Continental will begin making profits again in March, before any other big hub-and-spoke carrier, and will be in the black in the second and third quarters this year. "Who's going to be the first guy to make money again?" Mr. Bethune asks, with characteristic swagger. "You're looking at him."

To be sure, Continental may have benefited in recent months from travelers staying away from United and AMR Corp.'s American Airlines, both targets of terrorist attacks on Sept. 11. If it existed, that advantage probably has faded with time. And Continental still faces other challenges. In New York, it must battle American and United for lucrative corporate contracts. Globally, both American and United offer far more reach, with more extensive ties to international partners. Continental has largely tried to go it alone overseas.

Still, Continental has suffered less than most of its rivals, even though its flights are heavily concentrated on the East Coast, which has been harder hit than the rest of the country by the post-Sept. 11 travel slump.

The company, like its competitors, was clearly in trouble after Sept. 11. It had $1 billion in cash, enough to weather a recession but not the severe Sept. 11 fallout. The federal bailout that gave the industry $5 billion in cash and $10 billion in potential loan guarantees brought $263 million to Continental, after taxes, and, just as significantly, reassured Wall Street. Since then, the nation's fifth-largest airline has rebuilt its cash position with stock and convertible bond offerings. Add in the $100 million revenue premium Continental associates with its strategy of not scrimping, and the carrier won't need federal loan guarantees, Mr. Bethune says.

Slashed Schedules

In response to their massive losses and bankruptcy-threatening cash drains, most airlines slashed schedules about 20% to reflect sharply lower passenger demand. Continental cut flights a bit more surgically than some competitors.

When it saw Houston rival Southwest hold its flight schedule firm, Continental reduced its flying into the city by only 4.5%, compared with a system-wide average of 14.9%, for fear of losing market share. In November, domestic passengers boarding at Houston's Hobby Airport, where Southwest dominates, declined 14.7%, while domestic passengers at Bush Intercontinental, where Continental dominates, fell just 7.4%, according to the Houston Airport System.

Since they were pleading for a federal bailout, most carriers thought it appropriate to tighten their belts in visible ways. US Airways Group Inc. removed all blankets and pillows from its planes to save on the laundry bill.

American says its savings from removing food from some flights have been "substantial," although no airline will break out actual dollar amounts. "It was a time of economic crisis, and significant changes needed to occur," says Todd Burke, an American spokesman.

Delta cut onboard service, including food on many flights, and closed 11 airport clubs, but says that hasn't cost it customers. The amenities "are satisfaction drivers, but they don't drive ticket sales and they don't move passengers from one airline to another," says Delta spokeswoman Catherine Stengel.

But other carriers acknowledge they did lose ground to rivals, and several have restored food and other services on some flights, particularly ones to New York and other East Coast business centers. US Airways brought back pillows and blankets after customers complained, as well as some meal service. American resumed serving food to some heavily traveled business routes. "We got feedback from folks that [not having food] was not going to work," says American's Mr. Burke. United, too, reinstated food service in markets where competitors were still offering it, spokeswoman Chris Nardella said.

In the highly competitive New York market, which accounts for more than 40% of Continental's business, the carrier is gaining from the new airport rail service. In October, the Port Authority of New York and New Jersey opened a new station two miles from Newark Airport, linking the airport monorail to the Northeast rail corridor. For $11.15 one way, a traveler can ride a New Jersey Transit commuter train to Penn Station in Manhattan in about 20 minutes.

Continental officials aggressively lobbied the Port Authority for the train service as a way to ease several huge headaches that have handicapped Newark airport -- and hindered the carrier's business there. Taxi service is often a hassle and expensive, while getting through the Holland Tunnel linking New Jersey to Manhattan at rush hour is unpredictable. Traffic snarls can lead to missed flights.

The train has convinced Martin Wragg, sales director for MGM Home Entertainment, a unit of Metro-Goldwyn-Mayer Studios Inc., to use Newark for all his trips, whether bound for London, Los Angeles or St. Louis. New York's La Guardia Airport is "shambolic," the native of Scotland says, adding, "I avoid Kennedy [Airport] like the plague" because of its distance from Manhattan and the traffic.

When he planned a recent sales meeting in New York, Mr. Wragg made sure all of his 16 attendees would use Newark and the train. That way, the conference could run longer, without building in extra time for the uncertainty of local travel. "I know what train they need to get, and I plan the meeting accordingly," Mr. Wragg says.

Monica McKenzie also switched her business to Continental at Newark because of the train. She checks in at Continental's ticket counter at the monorail station and rides to the terminal knowing she won't have to deal with airport check-in lines. "It's smart. It's clean. It's fast. It's like a little ride at Disney," says Ms. McKenzie, a model with Wilhelmina Models in Manhattan.

In December, an average of 2,142 people a day took the train to the airport, the Port Authority says. "We're seeing steady growth," says Bill Decota, the authority's director of aviation. "We haven't done ridership surveys yet, but the people taking it look like business travelers to me."

Continental thinks as many as 10,000 people a day may eventually ride the train to and from Manhattan, says Larry Kellner, the airline's president. He expects this will help Continental in its struggle against American, Delta and United for profitable corporate contracts in New York and for business overseas. "Is it something that will move 10 points of market share? No," he says. "But each point it does move is a huge amount of money."

Over the past five years, Continental's share of the New York market has grown to 20.3% from 17.6%, while American's has grown far more slowly, to 17.7% from 16.8%. Delta's has slipped to 12.5% from 13%.

Between New York and Los Angeles, a huge market for airlines, Newark had 40% of the passengers in November, compared with 35% in November 2000. That gain came at the expense of Kennedy, which saw its market share fall to 48% from 54%.

Major Renovation

While the train link to Newark was being built, Continental undertook a major $1 billion renovation and expansion of its Newark terminal. Continental increased the size of its Terminal C by turning the two-level structure into three stories: one for arrivals and baggage claim, one for international check-in and one for domestic check-in.

By taking over a parking lot from the Port Authority, Continental squeezed another wing onto the terminal, adding 19 gates. In all, the carrier doubled its square footage in the three-and-a-half-year project. And at the front of the building, six traffic lanes for drop-offs and pick-ups are being expanded to a total of 15.

"This wasn't, 'Build it and they will come.' People were already here, but they were elbow-to-elbow," says Richard J. Smyth, head of the project for Continental.

Several long-planned improvements proved prescient. Continental installed a new $80 million baggage system as part of the renovation, which proved invaluable when new federally mandated security precautions for luggage screening went into effect last month. With so much more space available in its terminal, Continental is expanding security screening even more than it originally planned. It now operates 22 pairs of magnetometers and X-ray machines.

At Houston's Bush Intercontinental Airport, Continental removed some ticket-counter space and shrank a 12-foot exit doorway last fall so it could double the number of security checkpoints to 10. At its Cleveland hub, the airline moved a wall to add two more checkpoints to three existing ones. And the carrier has been among the most aggressive in the industry at pushing self-service kiosks, where travelers can check themselves in and get boarding passes. In all, Continental now has 607 kiosks at 92 airports.

Still, Mr. Bethune has plenty of work ahead. Continental is currently in contract negotiations with its mechanics union, which wants a big raise after seeing hefty gains for mechanics at other airlines in the past year. After that, talks will begin this fall with its pilots, who have joined the big Air Line Pilots Association.

Competitors aren't standing by, either. American has its own $1 billion terminal-construction project under way at Kennedy Airport, although it won't be completed until 2006. A link from the subway to JFK, currently under construction, may blunt some of Newark's edge, too.

Stung by traffic losses and Mr. Bethune's bravado, American's CEO, Donald Carty, also has launched an initiative to improve American's on-time performance -- a longtime Continental strength, which it has maintained in recent months. Airlines that run on time, Mr. Carty said in a recent message to employees, "are considered superior airlines."