Young Investor

Why airlines run into rough weather

Adarsh Gopalakrishnan | Updated on November 12, 2017 Published on November 19, 2011

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A massive and volatile fuel bill, maintenance-intensive aircraft, staff with high-skill level and expenses such as handling baggage, landing, take-off and docking make running airlines a challenging business.



The Indian airline space has attracted a lot of attention over the last six months. First it was the debate over how to rescue Air India. The airline was teetering on the edge following years of mismanagement, a bloated cost structure and botched merger. Now it is Kingfisher Airline's turn to face the heat.

A slew of ill-managed cancellations and losses since inception six years ago have raised the question: Are several Indian airlines such poor performers by virtue of bad regulation or inept operations? A quick history lesson illustrates that it takes intense discipline, favourable regulation and friendly governments for sustained success in this business.

Running airlines is a challenging business. You've got a massive and volatile fuel bill to manage.

A large fleet of maintenance-intensive aircraft, staff with high-skill level don't come cheap and a chock full of expenses include handling baggage, landing, take-off and docking. For every airline which has pulled off sustained success such as Southwest Airlines, Singapore Airlines or Ryan Air, there is a casket full of companies such as Delta Airlines, Continental Airlines, JAL, KLM which have been in and out of bankruptcy courts in an effort to stay afloat. It is little wonder that Warren Buffett (who had a near capital-death experience with US Air in the 1990's) once remarked: ‘The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favour by shooting Orville down.' So in a business this testy what has worked or failed?

HARD TIMES

The last decade has been trying for airlines. In 2001, the 9/11 attacks hurt demand and pushed several industry players into the red. This was followed by rising oil prices which severely dented the narrow margins of several airlines. Legacy costs which include regular, volatile tussles with unions over pay and massive pension obligations has also hurt the profitability of several airlines.

The emergence of low-cost (LCC) airlines which cut-back on the frills such as meals and business class seats in favour of single class, low-cost service also ate into the market share of full-service airlines.

Companies were forced to merge with more cash-rich counterparts. A few deals included KLM merging into Air France and Delta Airways taking over Northwest Airlines. India also saw its share of mergers with Air India-Indian Airlines, Kingfisher acquiring Deccan Airlines and Jet Airways acquiring Sahara Airlines. However, mergers were seldom the first option. Several airlines (some of which later merged) were forced into bankruptcy. At one point, 50 per cent of the US airline capacity was under bankruptcy protection! This included venerable names such as Delta Airlines, US Airlines and United Airlines.

HIGH FUEL BILLS

Jet fuel (kerosene) is one of the highest cost components with taxes accounting for a sizable chunk of selling price. Crude oil volatility takes a huge toll on the slender bottom line of airliners. Surging oil prices have also left several Indian carriers in the red over the last few years. As a result of heavy national and State taxes, India jet fuel prices are estimated to be 40-50 per cent higher than global prices.

Airlines which have been more successful in dealing with volatile crude prices include Southwest Airlines whose aggressive hedging has kept the company afloat when peers sank. ‘Legacy' issues facing several airliners include high wages for pilots, crew and handling staff. This was cited as one of the key reasons for the bankruptcy of Delta Airlines in 2005. Government-owned Air India (including Indian) has also been paralysed by cripplingly high employee costs enforced by entrenched unions. A successful example is Ryan Air's rather nimble and opportunistic approach to picking airports and managing labour has kept operating costs in check much to the chagrin of Lufthansa and other European airlines.

COMPLEX CHOICES

The third crucial cost is in the choice of aircraft. Airliners have a vast choice in the size and type of aircraft they can operate. This includes employing smaller planes on shorter routes to enable higher usage or more sophisticated aircraft on ultra-long flights with limited seating yet very high fares.

The challenge is to decide what plane is best suited for which route and can make money for an airline in the long run rather than just on a seasonal basis. Several LCC's have competed effectively by choosing to purchase a single type of aircraft for their entire fleet. Ryan Air operates 275 Boeing 737-800's. This choice enables them to keep maintenance costs as low as possible considering their engineers and ground staff has only one type of plane to service and stock up spares for. Indian carrier Indigo has opted for a similar approach deploying 46 Airbus A320's (very similar to the Ryan Air Boeing's). Kingfisher Airlines, on the other hand, has eight variants to maintain and Air India maintains ten variants.

Singapore Airlines is one of the few who have managed a large and diverse fleet with sustained success. A disciplined approach which includes replacing old aircraft with new and more efficient aircraft keeps the average age and service costs low. They are nimble in cutting back on routes during slack demand.

Both of which has catapulted Singapore Airlines to the second in terms of market cap among global airlines. A lean structure on the ground to handle baggage and other services thanks to relatively lower wage bill has been among the key for Emirates (Dubai) to compete with great success against far more experienced airlines such as British Airways (another victim of unions) and Air France. Helping Emirates' cause are far lower levels of taxation both on fuel and companies at home. Both Singapore Airlines and Emirates are also beneficiaries of government largesse in the form of spanking airport infrastructure. Again much to the annoyance of European peers, Emirates is also the recipient of rather generous low-cost loans for buying new aircraft.

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Published on November 19, 2011
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