The Hindu Business Line : Airlines are rarely profitable

RICHARD BRANSON, the maverick CEO of Virgin Atlantic, famously observed: "How to make $1 million in airline industry? Start with $1 billion!" This remark sums up the treacherous nature of the airline industry, notorious for losing tax-payers' money when government owned, and giving private investors meagre returns in the US and Europe. Let us examine the nature of the airline business, the global trends, and the reasons why so few airlines are profitable.

Industry segments

The airline industry is classified into six segments: Majors, flag-carriers, cargo airlines, independents, low cost carriers (LCCs), regional, and leisure.

The majors are airlines which have annual revenues in excess of $2 billion; flag-carriers are the national airlines; regionals are the niche airlines limited to certain geographical parts; LCCs are the new breed airlines operating point to point with lower costs; and leisure are the charter operators.

An analysis of the top 150 airlines reveals that the majors have more than two-thirds share of the airline business. Their average operating margin is negative 3.9 per cent in 2003, while that of the LCCs is much better at 6.9 per cent. The majors grew in 2003 by only 4.4 per cent while the LCCs expanded by 28 per cent! Thus, the LCCs have grown profitably in 2003, showing way for the majors.

The cost side of the airline business has deteriorated considerably, as carriers soak up increased ATF (airline turbine fuel) costs which are indexed to prices of crude oil. In 2004, as crude oil went up from $35 to $55 a barrel, few airlines had hedged against such price rise. As per International Air Transport Association (IATA) forecast, the airline industry losses in 2004 would be $4 billion, in spite of improved traffic, mainly due to rise in ATF costs.

Private airlines in Asia have better financials

Privately owned Asian airlines, such as Cathay Pacific and Singapore Airlines, always had good financial conditions due to stronger growth, but the financials of US airlines are extremely poor.

Three of the leading airlines of the US among the Big Six — US Airways, United Airlines and Delta — recently filed for Chapter 11 bankruptcy protection; most others with notable exception of Southwest, clearly demonstrate the difficulty faced by US carriers as they fight to cope with the changed operational and financial environment. The US majors can survive only if they successfully cut costs to meet long-term reduced revenues, and reduce debts by bringing in fresh capital.

Airlines in India not consistently profitable till 2003

The government-owned Air India and Indian Airlines have been modest in their losses since the last five years. As per published financial results, Air India, India's international airline, 51st in 2003 in global rankings, in terms of revenue, had a negative operating margin on 2.6 per cent resulting in a loss of $33.3 million against a loss of $40.3 million in 2002.

Indian Airlines, ranked 73rd in 2003, with revenues $ 851 million, reported net losses of Rs 196.5 crore in 2003, 246.75 crore in 2002, and 159.17 crore in 2001, as per the DGCA.

India's largest private airline, Jet Airways, globally ranked 94th with revenues of $595 million, was reported to have made a net loss of Rs 244.5 crore, as per DGCA reports, in 2002-03, loss of Rs 13.4 crore in 2001-02, and a profit of Rs 12.4 crore in 2001, as per the DGCA. Air Sahara had a net loss of Rs 37.75 crore in 2002-03, loss of Rs 159.9 crore in 2001-02, and loss of Rs. 34.9 crore in 2000-01.

The domestic airlines are in losses despite the fact that they are an oligopoly with Indian Airlines and Jet Air, Air Sahara being the major players. India's only LCC, Air Deccan, is yet to make an impact on the national scene.

The boom in international arrivals, better financial performance of India Inc, and an increase in the incomes of IT professionals all contributed to a surge in domestic travel in 2004. Jet Airways recorded a net profit of Rs 259 crore for the nine months period ended on December 31, 2004, as per company sources. Air Sahara and Indian Airlines are also expected to turn in better performances this year. As the competition in India is so far limited, the fares in domestic sectors are considerably higher than international fares.

Airlines and aviation supply chain: The aviation supply chain consists of airlines, airports, airline equipment manufacturers, airline IT suppliers (like GDS), travel agents and the traveller.

According to an analysis of top 150 airlines' profitability with that of airports, aircraft manufacturers, and IT suppliers, airlines have the most adverse profitability margins.

Giovanni Bisignani, the new Director-General of IATA, has been complaining against monopoly airline suppliers such as air traffic controllers, airports, and GDS, IT vendors, aircraft manufacturers such as Boeing and Airbus, who benefit at the cost of airlines. "We do the flying and everybody else makes money out of us," said Mr Bisignani.

Why airlines are not profitable

The main reasons why airlines are rarely profitable are:

Highly capital intensive (with high fixed costs on aircraft, their maintenance, IT infrastructure, crew training, etc.) as well as labour intensive,

Governments usually like to retain partial control of the airlines and hesitate in liberalising ownership,

Low profitability — deflationary revenues and inflationary costs,

Cyclical nature with longer period of recession and shorter recovery,

Strong influence of external environment whether economic, political or environmental,

Very few professionally managed,

Complex pricing structures, restrictive conditions,

Steep fall in demand for business travel, especially post 9/11,

Reducing pricing power due to competition from LCCs,

Escalating fuel prices, and

Additional security and insurance charges after 9/11.

Some notable exceptions: Southwest Airlines of the US has never been in loss in the last 35 years of its existence, thanks to its pioneering low-cost model. Its model has been discussed widely and is available to anyone to emulate. But this is easier said than done as established airlines may not be able to reengineer their organisation. Air Asia, the Malaysian LCC, has lowered costs using the Southwest model, with cost consciousness that is typical in Asian societies. The chart shows the differences in costs per ASKM (Available Seat Kilometres) for different airlines, Air Asia has now the lowest costs of 2.5 cents per ASKM.

Is irrational exuberance for airline stocks justified?: In the 1990s , liberalisation of Indian skies saw a plethora of private airlines, such as Jet Airways, Damania Airways, East West Airlines, NEPC, UB Air and Archana Air taking to the skies.

However, most of these private airlines, with the exception of Jet Airways, have now ceased to exist. Were these private airlines formed before their time or did they pay the price for not understanding the low profitability, high capital cost implicit in the airline business?

Now, with income levels rising in urban India, private airlines have better prospects. Close on the heels of the success of Air Deccan, India's first LCC, many private airlines such as Kingfisher airlines, rechristened from UB Air; Royal Air, rechristened from ModiLuft; and Eastwest Airlines are readying to take off again, promising to bring down air fares and challenging the oligopoly of Indian Airlines and Jet Airways. Moreover, with liberalisation of bilaterals by the Ministry of Civil Aviation, the domestic private airlines such as Jet Airways and Air Sahara can now explore new horizons in the UK, Singapore, hitherto a preserve of Air India and Indian Airlines; with this development, the fortunes of the domestic airlines seem to be viewed in more favourable terms.

The industry's low profitability and its capital and intensivity, mean that airlines will struggle to earn profits, as forces of competition are unleashed.

Recently quite a few low-cost airlines in Europe such as Air Polonia (Polish), Volare (Italian), V-Bird (Dutch), Jet Magic (Irish) and Now and Duo (British) have gone bankrupt unable to sustain the cyclical pressures of the industry.

While the Indian air traveller looks forward to the launch of more airlines leading to more competition, lowering of airfares, the newly established airlines are advised to stay on course, by avoiding the air pockets of the airline business.

(The author is a Senior Consultant with Infosys Technologies Ltd. These views are personal.)

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