The Airline Business – An Introduction

To be an effective commercial pilot, it is important that you have an understanding for the economic and business environment in which you operate. Though this report is focused on airlines, look out for Executive Jet and Helicopter Operation versions that are yet to be released.

The Airline Industry is HUGE!

Airlines have annual revenues of approximately $665 billion. By 2026, it is forecast that aviation will contribute $1 trillion to world GDP.

Nearly 63 million jobs are supported worldwide in aviation and related tourism. Of this, 9.9 million people work directly in the aviation industry.

In 2015, nearly 3.6 billion passengers were carried by the world’s airlines, and between 25 and 30 per cent by value of world trade each year. Therefore, aviation is among the primary facilitators of global economic growth.

It’s big, but is it profitable?

Airlines’ industry-wide net profit margins are not big. The International Air Transport Association (IATA) announced its airline industry outlook for 2016 had an average net profit margin of 5.1% being generated with total net profits of $36.3 billion.

So, why are profit margins so small?

  • An airline is basically a service industry
  • An airline is very capital intensive
  • An airline is labour intensive. (labour costs 35-45% of total costs)
  • An airline operation is often seasonal 

Profit

The difference between the amount of money earned and the amount of money spent in operating an airline can be calculated like so:

Profit = Revenue – Cost

Source IATA

This graphic demonstrates that after costs are accounted for there is a very meagre profit per passenger flown of approximately $6. Note the airfare alone is not enough to break even!

Let’s take a look at a hypothetical flight and break it down by costs covered.

PJ-BH720A_MIDSE_G_20120606215401.jpg

EBIT means Earnings before Interest and Tax.

In this graph, you can see the impact of key events in aviation;

  • 2001 had the 9/11 terror attacks in the US. 
  • 2008 was the start of the Financial Crisis.
  • When figures are available, we will certainly see a significant drop during 2020. 

However, the key trend from this graph shows that overall airlines are becoming more effective at generating profit margin. They are evolving into leaner, more efficient and more profitable companies, often through mergers to create economies of scale via a sprawling connected network.

Cost of Travel Reducing

So, margins are up, despite a very significant trend of airfares reducing consistently. Since the deregulation in the late 1970s, we’ve seen increased competition in aviation which has given customers much more choice and offered much more affordable travel.  

How do airlines maximise profitability?

  • Revenue Management. They charge different prices for seats depending on many factors from days until departure, time of day, special events, booking patterns. 
  • Increasing seat numbers on aircraft.
  • Seat overbooking with careful analysis and algorithms .
  • Seat cost discounting with careful analysis and algorithms.
  • Scheduling to maximise yield
  • Fleet Planning. Selecting the correct aircraft.
  • Leasing versus Acquisition.

Five main business models:

  1. Legacy carriers or legacy airlines (also known as full service network carriers)
  2. Low cost carriers (LCCs)
  3. Charter airlines (holiday carriers)
  4. Regional airlines
  5. Cargo Airlines

Additionally, new hybrid carriers. Combine more than one of the above.

(From Airline Basics, 2014)

There are of course other AOCs, for example: Executive Jet, Fractional Ownership and ACMI. 

Legacy carriers

Legacy carriers (in the US) are large airlines that existed prior to the Airline Deregulation Act 1978.

The term ‘legacy carrier’ is imprecise. ‘Network carrier’ is more descriptive. This is correct as it distinguishes airlines which primarily operate hub and spoke networks.

(Straight and Level; Practical Airline Economics, 3rd ed.)

  • Prior to the year 2000, network carriers relied almost entirely on the willingness of business travellers to pay high fares, for its profits 
  • Trans-Atlantic business traffic is still a key driver of profit for US and EU legacy carriers
  • Full service
  • Hub and spoke with franchises often flying the spokes.

POL16G2.jpg

Hub and Spoke

Why Hubs can be advantageous for Legacy carriers?

  • Point to Point is generally a higher cost base and low potential market.
  • Hubs allow higher frequencies and fill larger, more economical, aircraft. 
  • The passenger density isn’t high enough to offer point-to-point services from many regional airports. 
  • Grandfather rights over slots are one of the few areas not liberated by aviation deregulation.
  • Therefore, airlines are able to defend their position through controlling slots at their hubs. 

Furthermore, Hubs also afford airlines the possibility to gather traffic from a wide geographical area. By operating through a hub most passengers remain online and the airline gets both chunks of revenue

Low Cost Carriers

More accurately referred to as Low Fare Airlines as that’s what passengers care about. Every airline is focused on low costs but certain airlines place low fares at the very centre of their brand identity.

(Straight and Level; Practical Airline Economics)

Impact of low cost carriers on London – Toulouse return fares ($)

AirlineRoute/special conditions1234
 Out Mon 15, back Wed 17, Apr 2002Out Mon 14, back Wed 16, Apr 2003Out Tue 2, back Thu 4,
Dec 2003
Out Mon 4, back Wed 6,
Apr 2005
RyanairStansted-Carcassonne187180109112
British AirwaysGatwick-Toulouse910273183193
Air FranceHeathrow-Toulouse910606185discontinued
British Airwaysif staying Saturday night246198239211
Air Franceif staying Saturday night234193185discontinued
easyJetGatwick-Toulouse   91

(Source: The Airline Business – Riga Doganis)

Low-cost airlines have also provided significant traffic growth to the aviation industry. A general rule of economics is that of elastic demand. The less a product costs the greater the demand. 

They have proven to be good performers even in times of economic recession, bucking the trends of all other airline models. The low cost model has shown steady growth over 20 years.

How do LCC make money?

  • No food, No magazines/newspapers. No lounges. No Frequent Flyer Program. Only the essentials to keep everything low cost.
  • Fuel costs – new aircraft preferred for further efficiency.
  • Generally, only one aircraft type, reducing maintenance and training costs.
  • Single class seats, higher seat density, more seats.
  • Ticket sales exceed number of seats – percentage overbooking.
  • Fare booking system, revenue management, fares generally increase near the date of travel. But also, depending on time of day, season or special events.
  • Ancillary revenue from seat booking, baggage, insurance, food and drinks, blankets and WIFI.
  • Restricted tickets, little flexibility and no refunds means more revenue when passengers need to change plans.
  • Use secondary airports which are generally cheaper and less congested than primary airports
  • Maximise aircraft utilization with quick turnarounds and efficient planning, keeping the aircraft in the air.  

Low Cost Long Haul

Why doesn’t it work? All of the gains made in the short haul low fares environment are proportionally less beneficial in long haul:

  • Landing Fees – Aircraft only achieving 2 landings per 24 hours so less saving 
  • Aircraft Utilisation – Most long haul aircraft will achieve 2 sectors per day. Impossible to make an additional sector regardless of how short your turnarounds are or how efficient the route planning is.
  • No-frills for long haul – are passengers happy with no frills for 10 hours plus?
  • Point-to-point – Is the traffic density on a route high enough to fill a long haul aircraft
  • Seat density – Will you accept 28in seat pitch for a 10 hour flight?

Low Cost Problems

Competition

There is a lot of competition and so, retaining market share can prove difficult.

Safety

There is a general consumer belief still that LCC don’t have the same standards. Therefore, any incidents or accidents are even more damaging to the brand.

Landing Fees/Airport Charges

Regulation change has reduced the financial incentives available to airlines from airport operators looking to attract their business. 

Taxes

Environmental and passenger taxes are generally a fixed fee and are therefore proportionally larger for LCC when compared to the airfare. Therefore, they have a bigger impact on passenger demand. Price elasticity. 

Charter Airlines

Historically, the Charter Aviation sector was a very simple business with only a single activity: selling blocks of seats to tour operators. 

The modern day charter airline is a different business entirely. For example, TUI which is the world’s largest charter airline, offers scheduled and charter flights from Europe to destinations in Europe, Africa, Asia and North America. 

Meaning, an overall Low Operating Cost. Therefore, Charter Airlines can compete with Low Cost Airlines on price and undercut conventional carriers.

Load factors generally high

When Load factors are low they can cancel services or combine them with another destination to maintain high load factors, whilst continuing to offer the lowest fares to long haul destinations due to low operating costs.

Long haul destinations not attractive to Low Cost rivals. The long haul, low cost market has been tried unsuccessfully many times, unfortunately Norwegian Air is the most recent casualty. 

Highly seasonal destinations are not attractive to scheduled operators therefore can maintain market share.

However, generally charter airlines have been tied to travel agencies and have been slower to fully embrace online bookings. As a result, they have higher travel agency fees and rely on third parties to market and sell some of their flights.

Alliances

The reason that alliances are so critical is simple: they allow carriers to place more of their products on more shelves, to expand the scope and reach of networks more efficiently. But, we are also in the business to make money and alliances allow us to generate additional revenue with minimal capital outlay.

Andrew Lobbenberg, Manager Corporate Development, Delta Airlines

Airline Alliances essentially aim to tap into the benefits associated with greater size.

(E.g Star, One World and Sky Team.)

Benefits can be divided into 2 distinct areas:

  1. Economies of Scope – The revenue benefits of cooperation, primarily brought about by a greater marketing presence.
  2. Economies of Scale – The reduction in cost brought about by the increase in size.

(Source: Airline Business, Rigas Doganis)

Brand Management

Airlines invest a great amount in identifying their customers Apparent and True needs and develop their Brand Management Strategy accordingly. 

It takes many years to build a successful brand but it takes seconds to destroy one. It is of vital importance that an airline adopts a consistent strategy emphasising strong, core brand values on a long-term basis.

A strong brand can add value to a carrier, build customer loyalty and provide an airline with an opportunity to control their distribution channels. 

The power of branding in the aviation industry cannot be overemphasised.

Summary

Margins in the airline industry are small; airlines have to evolve to stay competitive.

As pilots, you are the senior managers on board. A broad understanding of the economic environment in which you operate is essential to the business.

This has been a brief overview of the Airline Business. To further your understanding, please also review our Airline Economics resources.


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