Airlines, price competition, government’s pride and bail-outs

TANZANIA’S two long-haul carriers Boeing 787-8 and Airbus A220- 300 will soon join long routes to Asian destinations and later to other new end points.

By practice, airlines frequently struggle to get their marketing for new routes off the ground.

To survive swiftly with challenges, there are dynamic tracks that operators need to clinch on to keep operations not only on trajectory but to be able to break-even and remain costeffective.

Any airline business analyst would agree, notwithstanding incredible growth, airlines mostly have not come close to returning the cost of capital, with profit margins of less than 1 per cent on average.

Even though profits might not be a concern in the early stages of national carrier, restoration of commercial business and ability to breakeven is critical for survival of an airline setup or operation.

State-owned airlines receiving support from state coffers is not a new thing in sustaining operation.

A good example is from South African Airways that has not generated profit since 2011 and has already received state guarantees totalling nearly 20 billion rand.

South African Airways is the South African flag carrier airline. It serves 56 destinations in South Africa, Africa and worldwide and is centred in Johannesburg.

Its fleet consists of 47 aircraft, mostly Airbus A320-200, Airbus A319-100, Airbus A340-600 and Airbus A340-300.

Call for capital injection to help struggling state airline meet urgent financial obligations is not unique to SA, as each flag carrier face different capital injection need.

Another good example is from Switzerland.

Having run out of money, and with creditors threatening to impound airplanes of Switzerland’s national flag carrier, the Swiss government was required to help Swissair to resume operations following its emergency provision of up to 450m Swiss francs ($277m) from the Swiss government.

Swissair’s predicaments have also required Sabena, the national airline of Belgium, to seek bankruptcy protection and a bail-out from its state.

Other airlines around the world are cutting back on services while pleading for and often getting backing from their governments.

New Zealand has gone so far as to re-nationalise its flag carrier. Mexico is open-handed its carriers a 10% discount on jet fuel.

Equally in America, where the airline industry was deregulated 20 years ago, the government is having to choose how best to dole out emergency funds without noticeably trying to pick winners and losers.

Many of the world’s airlines are in an exposed state and governments are being forced to step in with financial aid.

For us as we enter into sky race, laying strategies to circumvent these active financials matters is vital.

The Daily News 27th December 2018 article captioned “Thanking heavens and Magufuli’s virtual wonders,” has stimulated me to pen down few issues.

Can airlines make money amid growing competition? In a letter to investors about airlines, Warren Buffett wrote, “Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers.”

He has called his investment in U.S. Airways one of his biggest blunders.

Within same context, Venture capitalist Peter Thiel promoted for creating and investing in potential monopolies, yet he described airlines as an example of a business where competition destroys all the profits.

Surrounded by such varied views and other arguments on how to break-even, led to a supposition that an average airline industry business profitability is mostly driven by five features.

These are clearly coined by famous Michael Porter’s five drivers namely supplier power, customer power, barriers to entry, threat of substitutes and interestingly industry competitiveness.

Much as I am full of pride of measures taken to restore Air Tanzania lost glory, I am also cognizant and aware that airline business is tough business.

It is unlike technology or pharmaceuticals business where intellectual property might confer a governmentprotected device as a hard barrier against new entrants, or consumer goods where trademarkacknowledgment is stronger.

In airlines, and especially at digital age with multiple possibility of buying ticket from anywhere, most clienteles are extremelyunpredictable and picky, profoundly on price,quality of services, standards rather than being loyal to any one carrier.

Although frequent flyer packageshave been thought-out to contest this, but very few people by nature would personally pay for a significantly more expensive flight just to collect miles.

There is neither uncle nor auntie in stiff business competition where each operative tries to preserve its market share let alone increase it.

Industry competition is what a really honestly hearted business analysts will tell you kills the airline industry.

And of particular interest, of all forms of competition related to airline business, price competition is the worst of all as it histrionically and disproportionately kills margins.

As stated before hand, clienteles are extremely pricesensitive.

On top of that, given its high capital equipment requirements, etc., the airline industry is abusiness with inherently high operating leverage very high fixed costs in comparison to variable costs, which stretches airlines strong incentives to preserve their planes full at all times.

Breakeven for flights if not well known is regularly around 80%+ capacity, resulting in a need for carriers to be hyper-sensitive to price competition, which in turn creates a cycle that drives long-run margins down to almost breakeven levels.

To my conclusion when well-run an airline business can make money.

A good example can be drawn from Southwest airline which is a major United States airline with its headquarters in Dallas, Texas regarded as the world’s largest cost effective carrier by industry standard.

This airline has more than 58,000 employees as of December 2018 operating more than 4,000 departures a day carrying the most domestic passengers of any United State airline and serving 10 additional countries.

In attempt to study its cost structure, it was clear from my analysis that for many years since established in 1967 this airline has sustainedsplendid margins.

One key element to remember is that airlines have very high operating leverage, with low variable costs relative to their fixed costs.

This implies that airline that do manage to outcompete the industry in growing and maintaining customers are able to earn outsized returns.

Generally, knowing facts and figures and business environment could help to design mitigate measures that could help to cope with reality on the grounds.

Apart from being capital intensive and labour intensive, airline business has high operating costs.

This is mare fact. For instance, a 1000 km short round trip by a medium sized aircraft A320/B737-800 would cost around US$ 20,000 and it would cost twice as much on a 2000 km round trip.

Costs of operations on domestic routes are by sector analysis slightly less due lower airport charges and no route navigation charges.

Airline business unlike other business as stated earlier on, has very high fixed cost because running an empty aircraft from point A to B costs almost as much as passengers sitting in it because all major costs linked with its operations are permanent such as airport charges, air navigation charges, ground handling charges, variable portion of labour cost, maintenance, insurance and depreciation/ hour etc.

Looking at it from a different angle, airline business is the riskiest since empty seats are perishable.

Alteration to other airports due to bad weather at destination airport may double the trip cost above and beyond distressing other operations planned for the particular aircraft.

Holding in the air for traffic sequencing costs between US$ 100 to 150 per minute.

Breaking out of viral diseases adversely affects demand for air travel bringing seat factor in a particular market, not mentioning warlike situation that likewise affect demand and cost of operations as insurance cost tends to go up etc.

The fact that airline business has more international business restrictionsfar more severe than any other business, airline business is oligopolistic forcing airlines to cut the prices to attract traffic away from competitors.

This without doubt results operations around break-even seat factor, which is around 80 per cent.

Average profit margins for are between 1-2 per cent. This is because capacity of the aircraft comes in bulk let say 150-300 seats whereas the passengers come in ones and twos.

Breakdown of major airline player’s audited financials shows that global airline industries financial typically suffer from 8 years business cycle.

These and many other factors are realisms ATCL should be prepared to face as it enters international routes in addition to growing domestic destinations.

Author: by Hilderbrand Shayo

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