Airlines must consider business models from other industries if profitability is to improve
The message is crystal clear: If your savings are just sleeping in your bank account, invest them in the right place—that is, in a nutrition, health and wellness company, not in the airline industry. The remark comes not from a financial analyst but, unexpectedly, from Tony Tyler, director general of the (IATA). Of course, he uses more diplomatic language, and does not say anything frankly negative about his own business, but expresses great disappointment about the airlines' inability to achieve decent profitability.
According to IATA's latest financial forecast, the airline industry's net post-tax profits this year are expected to increase to an estimated $10.6 billion, up from the $8.4 billion predicted a few months ago. Such an upgrade, IATA economists say, “is driven by stronger revenues and a return to moderate growth in cargo.” Moreover, world GDP growth forecasts for 2013 are stronger (they have been recently increased to 2.4%), contributing to higher confidence in the future.
Optimism is supposed to be back. IATA believes the bottom of a global industrial cycle was reached in the third quarter of 2012, opening the door to better times. In the same vein, the industry's overall growth rate is predicted to remain at a robust 5% per year for the next two decades. In other words, the airline industry is in significantly better shape than it was, and fuel prices, although very high, are now stable.
But here comes a serious touch of pessimism. Profitability is now—and is expected to remain—anemic, and the numbers clearly are misleading. A profit of over $10 billion looks impressive at first glance, but represents no more than a 1.6% margin on $671 billion in revenues.
Tyler's comment is the best reality check we have heard in the past several years. “The improvements in industry profitability are encouraging but must be kept in perspective,” he says. And he notes a distressing fact: Last year, Nestle, a nutrition company, made a $11.5 billion profit on $100 billion in revenues, suggesting it is more rewarding to produce candy bars than seat-miles. But Tyler is merely supplying a piece of information; he is not analyzing the airline industry's weaknesses.
At this point, returning to basics is unavoidable. It is true that oil prices are such that fuel makes up 33% of direct operating costs. And the tax burden on airlines is higher than ever, as aviation remains most governments' favorite cash cow. But since this situation is not going to improve in the foreseeable future, perhaps the time has come to consider fares in a new light. These adverse cost trends imply that travelers should accept higher fares to enable airlines to achieve better financial results, satisfying their shareholders as well as the financial analysts. Fares should reflect reality, and artifices to make bottom lines look better than they really are should be abandoned. For example, deceptive fuel surcharges should be considered part of operating costs and included—once and for all—in fares.
Especially in Europe, major players charge fuel supplements in a desperate effort to make their fares look artificially low. In doing so, they are trying to convince passengers that the Organization of Petroleum Exporting Countries is the problem. Yields are not what they should be, although they have increased slightly in the past few years. According to ID Aero, a Paris-based airline consultancy, yields this year will increase by a minuscule 0.4%. ID Aero also expects passenger traffic worldwide to grow by a healthy 5.4%, despite the maturity of many markets. However, such a promising forecast will do little to enhance the airlines' bottom lines.
Tyler and his staff should now devise an innovative strategy incorporating both the candy bar producers' business models and the traveling public's expectations; one that would enable IATA members to enter a new era based on fares covering all costs, resulting in realistic yields and decent profitability. Tyler's wish-list should also avoid tricks of the trade used by low-cost carriers and advance long-awaited pricing transparency. After all, Nestle seems like a good model for a cohesive set of strategic priorities focused on the achievement of business objectives. Eventually, the strategies used by candy bar makers—if they can be successfully adopted—could show airlines the way to long-overdue prosperity.