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   Vol. 18 No. 78
Wednesday December 11, 2019
Chasing Change Impacts Profit Margins
Airlines Chasing Change

     Sir Richard Branson, the British billionaire entrepreneur who launched Virgin Atlantic, summed up his experience in the airline business with a pithy quote – “How do you change a billionaire into a millionaire? Make him buy an airline.” His observation speaks to a real puzzle:
     Why is the airline industry, even for someone with the experience and business chops of Sir Richard, such an underperforming sector?

Thirty-Year Cycle

     Despite alleged subsidies and actual government programs, studies indicate that U.S. commercial aviation as a whole has run at a loss for the last 20-30 years, its stock price lagging other mature industries.
     What is it about this business that keeps it in the financial doghouse?

The Questions

     If you ask airline executives, they blame their low margins and inconsistent results on a host of outside factors, anything from general economic conditions to unfair competition; trade disputes to currency valuations; terrorism, Boeing, government regulations, unions, pilot shortage, fuel prices . . . anything but their own leadership.
     Setting aside those excuses, any quick analysis will show that airline profits are fundamentally cyclical, rising to heady peaks before crashing down into negative territory, and any slightly deeper analysis demonstrates that behind this cyclicality lie poor management decisions motivated by an obsession with two success metrics – market share (you grow or you die) and peak period profitability (making the most of the good times).

Some Answers

     We all know that airlines are extreme fixed-cost, perishable businesses, and in Econ 101 we were all taught that you don’t grow a business based on cyclical peaks. So why do airlines continually flout this common sense to build their fleets and facilities in the run up to peak profitability?
     The answer rests in their success metrics – market share and revenue maximization in the peak cycle. While outside factors can take a financial bite, most of airline underperformance arises from chasing these metrics at the cost of long-term vision.

The Chase

     Trying to time investment and expansion to capture business on the upswing may goose profit projections short-term, but it sets airlines up for a nasty situation once the lean times hit, as they always do. Forced to meet high fixed costs that can’t be quickly shed, they are forced to cut back on the one thing that the public cares about, quality of service.
     They chase nickels through any cut they can think of, including cutting personnel costs (through layoffs and pay cuts), cramming in more seats (which they then overbook), lowering the quality of their meal service, and making frequent flyer point redemption into a hassle of restrictions and forms.
     Then they chase dimes by introducing charges for everything – meals, checked bags, boarding preference, seat selection, you name it – EasyJet and Ryan Air even considered putting in coin-operated toilets. They do this to survive because they made the wrong decisions in the peak times, and passengers pay the price in a degraded and degrading flying experience.
     This opens the door for new airlines with lower costs to enter the market, triggering price wars which bankrupt weaker carriers, ground aircraft, eliminate low-profit and shrink the industry overall.

The Alternative

     Is there an alternative? In my view, a better airline strategy begins with changing success metrics from market share and peak period profit to consistent performance and steady, sustainable growth.
     A few major passenger airlines, as well as UPS and FedEx, have managed to survive and overperform thanks to this mentality.
Bill Boesch

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