five reasons why the airline industry will never be … industry profitability elusive ... us...

Five Reasons

Five Reasons Why The Airline

Industry Will Never Be Profitable

-25

-20

-15

-10

-5

0

5

10

15

20

25 1

99

1

19

93

19

95

1997

19

99

20

01

20

03

20

05

20

07

1Q

09

3Q

09

U.S. Passenger Airlines

U.S. Corporate Average

Airline Industry Profitability Elusive Pretax Profit Margin Highly Cyclical and Well Below U.S. Corporate Average

Pre

tax P

rofi

t M

arg

in (

%)

Sources: (1) IRS Statistics of Income (Historical Table 13) – “Net income (less deficit)” divided by “Total receipts”; (2) ATA Cost Index

www.airlines.org 3

Macro Scale Drivers

US Airline Net Profit

World Airlines Net Profit (from 1978 to 2009)

Aircraft

Profits

#1 It’s A Capacity Lead Business

Model

Causes Constant Over Capacity

QSI Market Forecasting Model

• Quality of Service Index

– Values a service relative to other service

offerings

– Allows forecasters to determine potential of new

markets and services

• Developed in the 1960s

• Very accurate

Basically a Share Model

• QSI for Montreal to Ft. Lauderdale

– Number of Nonstops x 1.0 5 5.0

– Number of Onestops x .33 1 .33

– Number of Connections x .03 30 .9

– Market QSI 6.23

Forecasting A New Service

• Montreal – Fort Lauderdale QSI 6.23

• New nonstop QSI 1.0

• New Montreal – Fort Lauderdale QSI 7.23

Demand For The New Service

New Service 1

YUL-FLL QSI 7.23 = .138 x 250 = 34.6

Passengers

Per Day

Market

Demand

Note: Demand for air travel historically grew at the

same rate as GDP.

Carriers Always Get Their Share

• Frustrates many a marketing department

– Steak and eggs

– More legroom in coach

– Food

– Widebody aircraft

• Why carriers focus on price not product

Impact On Current Services

Market share before 1

6.23

Market share after 1

7.23

5.5 Less

Passengers

per day

Standing Still Not An Option

• If others add, and you don’t, you lose

revenue

• Can’t grow revenue without adding capacity

first

• Doesn’t matter how good a product one has,

one always gets your share

This Simple Display Is To Blame

Cleveland to Orlando Service and Fare Display For All Participating Carriers

More service leads to more display space

Airlines are managing demand to

capacity, not capacity to demand

#2 Airplanes Don’t Go Away

They Just Become More Efficient

#3 Labour Leverage

Political Organization Can’t Manage

Economic Reality

Politically, Short Term Trumps Long

Term

• Timing of settlements

• Deciding how much is enough

Twelve Days Of Christmas

(Well, OK, fifteen)

It Takes Two To Tango

Contract Settlements

It Takes Two To Tango

Contract Settlements

It Takes Two To Tango

“Why would Management agree to a

contract they could not afford?”

#4 Input Costs Are Too Volatile

Revenue Cycle and Cost Cycle Out of

Sync

Cost Breakdown By Category

4.7%

7.1%

7.8%

8.0%

14.0%

25.0%

21.2%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

FUEL

LABOR

TRANSPORT-RELATED EXPENSES

PROFESSIONAL SERVICES

OTHER OP. EXPENSES

AIRCRAFT RENTS & OWNERSHIP

NON-AIRCRAFT RENTS & OWNERSHIP

INTEREST

UTILITIES & OFFICE SUPPLIES

NON-AIRCRAFT INSURANCE

ADVERTISING & PROMOTION

COMMUNICATION

PASSENGER COMMISSIONS

AIRCRAFT INSURANCE

MAINTENANCE MATERIAL

LANDING FEES

FOOD & BEVERAGE

Book Revenue Now, Buy Fuel Later Perc

en

t of

flig

ht

capacit

y b

ooked Ye Old Booking Curve

Fuel Volatility Very Difficult To Manage

Cost Volatility and Low Margins –

Not a Good Match

Total Cost By Year Indexed to

Year 2000

Even In Quiet Years, Cost Jump 20

Points

Total Cost By Year Indexed to

Year 2000

Not Impossible To Manage – Just

Unlikely

Need large cash

reserves to

manage volatility

Airline CEO’s Favorite Game

Hide The Cash!

#5 Nobody Really Wants It To Be

Fixed

Value Chain, Customers and

Governments Benefit From The Way It

Is

3

4

5

6

7

8

9

10

11

1968 72 76 80 84 88 92 96 2000 04 08 12

Inflation-Adjusted Price to Fly One Mile on U.S.

Airlines Average, in Constant 1978 Cents

Source: ATA analysis of data from the U.S. Department of Transportation and the U.S. Bureau of Labor Statistics www.airlines.org 34

International

Domestic

One Way Fares from Montreal in 1968

and 1982

June 2008 – Fares from

Montreal

Consumers Are Happy

Source: ATA analysis of federal tax code

Tax Bite on a $300 One-Stop Round Trip* Has Nearly Tripled

www.airlines.org 37

Airfare Taxes

* Sample itinerary assumes one-stop domestic round trip with maximum passenger facility charge (PFC) per airport; $300 total price includes taxes and fees.

2009 Taxes

20% ($60)*

1972 Taxes

7% ($22)*

1992 Taxes

13% ($38)*

Governments Are Happy

Best Way To Make Money –

Service The Airline Industry

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

0

5

10

15

20

25

Uptu

rn R

OIC

div

ide

d b

y D

ow

ntu

rn R

OIC

Ave

rage

RO

IC 1

99

6-2

00

4 (

%)

Average ROIC (LHS)

Volatility in ROIC (RHS)

Summary

• A capacity lead model fostering

commoditization

• Capacity never leaves

• Labour has leverage, but cannot manage its

responsibility

• Input costs are volatile and would require a

level of cash that is difficult to maintain

• Value chain does not want to see things

fixed

Five Opportunities

1. Capacity driven business model

2. Airplanes don’t go away

3. Labour leverage

4. Input costs too variable

5. Nobody really wants it to be fixed

It may be dull...

but never boring