Posted in Marketing & Strategy Articles, Total Reads: 34089
, Published on 11 March 2011
When asked how to become a Millionaire, Richard Branson said, “You start off as a Billionaire and then open an Airline.”
How funny! And how true!
Airline industry has always been very different from other industries, in all markets and in all times. Here I would list and analyze 10 reasons which I think make the Airline industry so unique (and loss making; to justify the wisdom in Richard Branson’s statement).
1) A capital intensive industry with high fixed costs: A business is considered capital intensive depending on the ratio of capital required to the amount of labor. The airline industry is considered among the top of the high capital intensive industries. Airline industry also has high fixed costs as compared to revenues. This puts the industry to higher risk because in case it is not able to attain an economy of scale or if there is a downturn in sales, the high fixed cost can’t be covered and the business becomes unprofitable. Such a condition to some extent is also prevalent in automobile industry, but for an airline it becomes very critical. This is why there has been much higher frequency of bankruptcies in the airline industry and also a compellingmerger and acquisition route to gain competitive advantage. This factor makes it a unique industry.
2) Low profitability: As an industry, airlines have seen low profitability. It is said that in the US, the airline industry has made cumulative losses in the last 120 years. Even Warren Buffet is said to have acknowledged his mistake in buying shares in US Air, blaming the industry which loses money.
Every time fuel costs rise, or a new tax is imposed, or a staff strike happens; or there is an inability to raise the fare proportional to the rising input costs, their profitability is hit hard. Such an unexpected hit hurts the expansion plans and the whole fiscal planning goes haywire. But some companies have been able to make above industry-average profits using their unique business models. For example, when low-cost no-frills airlines emerged towards the end of the last century, it posed a serious threat to the legacy airlines. The new business model made almost the whole conventional full-service providers run for their money and traffic.
Due to combinations of high fixed costs, low profitability, and high competition, a lot of airlines have gone bankrupt and keep getting bankrupt. Also, this has resulted in new business structure: where there are holding companies or PE firms controlling them and airlines becoming merely operating units without much decision controls. In some markets very few airlines have remained without filing for bankruptcy.
3) High vulnerability to the state of the economy : global slowdown or recession: Airline industry is too much dependent on the global economic scenario. Every time an economic slowdown or recession happens, flyers go for cheaper options like trains or road; there are few tourists travelling; fewer business travels planned; and airlines have to run with empty seats. As a result, they face severe liquidity crisis.
Fuel makes 35-40% of costs of an airline, higher than this for low-cost-airlines, and any global crisis impacts the fuel prices too. Like any political turmoil in the oil producing nations causes the prices to go high above the roof. E.g. Jet fuel prices which were about USD 83 in August 2010 in Singapore are now USD 129 at around March 10, 2011 (Source: moneycontrol.com). This is 55.4% higher in only 8 months! Analysts are predicting that global airlines’ net profits will half this year in 2011, due to rising oil prices (due to crisis in Egypt, Libya and others). Fluctuating prices of petrol are beyond the airline industry.
Also, domestic airlines depend heavily on the state of the national economy. If there is good GDP growth and the country is witnessing rising prosperity, it will see a very bullish growth for the airlines. The current surge in air passengers in India is because of this very reason. But if economic growth falters, people would choose other modes of travel and airlines would come in the red.
4) Nationalization of Airlines: Many countries have national airlines. Governments own and operate these airlines. At times they have nationalized private airlines to be able to have a national carrier. For example in India, the airline industry was pioneered by Tata Airlines in 1932 as a division of Tata Sons. But after independence, the government of India acquired majority stakes in Air India. Air transportation industry was nationalized in 1953, with domestic operations transferred to Indian Airlines.
In France, it started off as an air mail service in 1919. It was bought out in 1927 and renamed as Aéropostale. The airline became a major international carrier. But in 1933 Aéropostale went bankrupt and it was nationalized and merged with other airlines, making way for Air France.
Most governments rightly understand the strategic importance of airline industry at the time of crisis and wars and hence want to keep running national carriers despite the losses at times. Due to the nature of the business and the risks, many times airlines are prone to become victim of government interventions and bailouts, making the industry unique.
5) Frequent bailouts: It is interesting to see how the US airlines fared in the aftermath of 9/11 terrorist attacks. Between 2000 and 2005 US airlines lost USD 30 Bn with wage cuts of over USD 15 Bn and 100,000 employees laid off. The US federal government provided USD 4.6 Bn in one-time subject-to-income-tax cash payments to 427 US airlines, with no provision for repayment. In addition, they also approved loan guarantees to six airlines totaling approximately USD 1.6 Bn. A similar situation prevails in India where government supports the national carrier Air India, no matter how much loss it makes. Analysts have been critical of this practice of “dumping” tax-payers money into the airline industry just for the sake of preventing bankruptcy. But so far, governments have always come to the rescue of the industry. This is a unique thing with the airline industry.
6) High barrier to entry and regulations in the markets: Typically airlines are highly regulated due to political, economic and safety concerns. In such regulated markets, new airlines find it difficult to come up and establish them. Also, due to restrictive practices new airlines find it difficult to obtain slots at airports.
The entry barriers are low in deregulated markets, with dozens of airlines starting up from nowhere in no time. With time, the industry is seeing higher deregulation with US leading in 1978 and the Europe following up with deregulation. Deregulation increases the competition and promotes more players to enter the market.
Another interesting fact is that during economic slowdowns, it is easier for new airlines to establish themselves and gain grounds. They can find quick delivery of aircrafts, easier access to contracted services and facilities, and also trained and experienced staff who are laid off from other established airlines.
7) Low switching costs for customers: It is very hard for airlines to develop a loyal customer base, particularly in markets like India. This is why all major airlines have been enthusiastically running Frequent Flyer Programs and other customer loyalty schemes. For a flyer, it is just a click of a button to go book on a competitor’s flight. And airline customers are often very sensitive about service. Once the flight is delayed or service is unsatisfactory, they can make a resolve of not flying by that airline again. This is because the high competition in the airline market has given the flyers too many options and almost no switching costs. The customers also gain because of the prevailing price wars.
8) Being central to ‘globalization’: Due to its central role, the airline industry has grown with and can be identified with globalization. It facilitates global trade, international business, tourism, and hence helps economic growth of all nations. It is hard to imagine if today’s world would be as much globalised, or localized, without fast, efficient and convenient airlines.
Tourism and hospitality sector is one which stands out with being enabled because of airlines. Tourists from all over the world travel long distances in less time to reach exotic destinations, often in developing countries, and hence help these emerging economies. With time, these locations also get developed and their own citizens go on to visit other parts of the world – thereby completing a cycle. And their preferred mode of travel is again airlines. So airlines and tourism has a symbiotic relationship, one helping the other.
9) Unprecedented safety concerns: Because of the nature of air travel, the risks are high and in case of accidents the human casualty mounts. So the airline industry has to maintain strict safety standards and can’t be relaxed even for a moment. In many accidents the reason is found to be human error, which makes the case for stringent norms very strong. The 9/11 terror attacks in the New York in the year 2001 brought another angle to the already stringent safety concerns. The airlines have to maintain very high personal checking system to avoid repeat of terror activities. Even before 9/11, airplanes were used for terror activities many a time. For example the hijacking of aircrafts has been a common tactics used by terrorist groups, and they even try to bomb or blast the planes. (e.g. Kandahar hijack of IC-814 in 1999 and Air India Emperor Kanishka bombing in 1985)
Apart from accidents and terror threats, the air route has also been used by criminals, smugglers and traffickers for their activities and hence safety and security is always a concern for airlines.
10) Alliances and optimization: If we look at the competition in the US market which was deregulated quite early, we would realize how smaller players have found it too hard to survive competing against big airlines. For example, Midway Airlines was a small carrier tried to compete against US Airways and Eastern Airlines and it failed miserably. Ultimately it had to file for bankruptcy. It is said that Southwest survived because it avoided the markets dominated by big players like American and United. In such a competition, and due to the inherent risks unique to the airline industry, a new phenomenon came into being which is hardly seen in many other industries. It is ‘alliances’.
Star Alliance was world’s first largest airlines alliance to come up in 1997, though smaller alliances were conceived in as early as 1930s. Star Alliance was founded by five of the world’s big airlines Lufthansa, Scandinavian Airlines, Thai Airways International, Air Canada, and United Airlines. Currently there are 27 member airlines in the alliance with 4023 aircrafts, 21000 daily departures, covering 1160 airports in 181 countries. All together, Star Alliance carriers handle 603.8 million passengers and amount to USD 150.7 Bn. (Source: http://www.staralliance.com/en/about/airlines/ Accessed on March 11, 2011). The other two largest passenger Airline Alliances are SkyTeam and Oneworld. Today, apart from Star Alliance’s 27 members, SkyTeam has 13 members and Oneworld has 12. (Air India has announced to join Star Alliance anytime in 2011)
Alliances are agreements which help individual airlines save costs because of sharing of offices, maintenance and operational facilities or staff, and even cost of purchasing because of collective volume discounts. Airlines alliances also help customers because the traveler gets lower prices, more destinations and more options of departure times to choose from. This win-win business model has interested more airlines to join forces. Indeed, such successful alliances are again unique for airline industry.
About the Author: Kumar Rahul, B.E. (NIT, Durgapur), MBA (NMIMS, Mumbai), is a Consultant with a leading IT firm. Views are personal. He can be reached on rahulbemba[at]gmail.com. He also has a blog http://rahulbemba.blogspot.com/
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