Strange goings-on in the airline industry

The four big carriers reported 2Q results last week. Here are a few thoughts:

  • They all made money. As the WSJ reported (paywall), “Those announcements came as American, United and Southwest reported record-setting second-quarter results, building on Delta’s solid performance a day earlier.”
  • How did they do this? Again, the Journal:

Airlines are prospering as mergers have reduced competition, making it easier to keep prices high and raise billions from extra fees. They used bankruptcy to squeeze costs from employees and suppliers such as the smaller carriers that operate regional flights.

  • Competition is definitely down. The four legacies now control 82% of domestic capacity.
  • Another way they make money is by shrinking themselves down to those routes and those aircraft where they can make a profit. This means fewer flights to fewer destinations, at least domestically.
  • If they aren’t investing in new capacity, what are they doing with their money? Well, customer service may be in the pits, but shareholder service is great. All four are buying back shares, and three of the four — all except United — are paying dividends.
  • And finally, virtually all the profit made by the four majors came from fees. In other words, the price of the ticket covers just the cost of the seat.* Profit has to come from something else. This raises the interesting question, so beloved of MBA professors, of what business are they actually in?

All this cash is attracting a flurry of start-up activity. As the Journal also reports (paywall), a reincarnated People Express is now flying to Newport News, a route that Southwest abandoned, and a new Paris – Newark all-biz-class service has taken to the skies. Another all-business is preparing for London – NY service. In addition, there’s an attempt to resuscitate the Eastern name, and

Other applicants include a company that wants to fly 581-seat 747 jumbo jets domestically, a charter company that intends to start scheduled service between the U.S. and destinations such as Curaçao and Guyana, and one that wants to base itself in Carlsbad, Calif.

As the Journal notes, it will be tough. Of the 332 new airlines approved by the government since 1978 and which actually operated flights, 68 are still flying. On the other hand, that would give odds of about 20%, which for new business start-ups isn’t bad.

I still feel pretty good about my prediction for Imperial Class.  Shrinking down is not a formula for long-term success unless you can redefine the market. The big four, or at least the legacy three, can never be alternatives to the bus, but they might become alternatives to private jets. As for the rest of us, average household incomes have been stagnant for a generation, and median net worth is down (PDF) about 35% (from $87,992 in 2003 to $56,335 in 2013 — mean incomes are down less than 9%, reflecting how how much better the customers for business and Imperial class are doing). So I think that within the next few years, the surviving majors will simply abandon the starving masses.


*It isn’t quite this simple: Airlines don’t charge most of these fees for business / first class, and they also make money from cargo and charters. But the basic point is that without ancillary fees, and at the same fares, the legacies would be just breaking even.

 

7 thoughts on “Strange goings-on in the airline industry

  1. At some point in the past, airlines split their plane operation and the tickets/reservation into different business units where financials were organized that nearly all profit was in tickets/reservation … the plane operation could even loose money while the parent company makes a profit (because of the way the financials were split between operating a plane and selling a ticket).

  2. Chet,

    It does appear that the fact that fees do make money for now at least prevent the creation of an Imperial Class. Profit is profit, even if it does tick off the average flyer.

    Some questions are:

    – As the rich become richer, will there simply be no Imperial class and just more private jets? This may prevent an Imperial class from ever popping up. I note that First Class on many of the international carriers is in decline.
    – How much will coach class be shrunk too? It may stabilize in size at some point – the airlines would naturally want to get a stable fee profit.
    – The long term impact of oil prices on air travel.

    It could be that the airlines are transitioning to something that is stable.

    I suppose one other factor working against Coach though is that the US middle class is in decline, which limits flight expenditures.

    – Chris

    • Chris — Thanks, all that is possible. One day, on an international flight, I noticed that business class took up more than half the real estate on the plane. Coach was being compressed to an ever smaller section at the rear. At some point, coach gets so small that it just isn’t worth it, at least for the legacy majors.

      Plus, as you note, with middle class incomes stagnant, net worths down, and retirement looming, the market for coach class will also shrink.

      I’m not predicting that coach will disappear, but it will move to airlines that have the cost structure to support it, the Wal-Marts of the sky. As for Southwest, I don’t know. They are busting at the seams to get into business class, and except for the seats themselves, they already offer many of the other amenities. To keep with their egalitarian roots, they might start with all-business-class flights with no assigned seating.

      Chet

    • Private jets will take some of the market, but models capable of comfortable intercon travel — NY area to Frankfurt, for example — start at around $40 million plus $4,000 / hr and up for operating expenses. If you’re thinking transpacific or NY – Dubai, you’re probably in the market for a G650 or so. The Gulfstream runs $63.5 million, and they’re sold out until 2017. There are ways to cut this cost somewhat by, for example, leasing it out when you’re not using it, but it still ties up a big chunk of capital. Here’s an article that breaks out the costs of owning your own jet, just in case you want to pursue it: http://www.forbes.com/sites/wheelsup/2010/06/21/what-your-own-business-jet-really-costs-the-formula-explained/

      If you’re a billionaire, no problem. But if you’re only modestly wealthy, say in the $50 million – $500 million range, why not fly Imperial Class, get a private suite and attendant, and experience sybaritic luxury the whole way? And don’t forget the Rolls straight to the plane.

  3. Chet,

    It’s hard to say in the long run as you’ve noted what will happen. Oil prices for example are hard to predict.

    But outside of the US, there does seem to be a decline in first class. I am not sure about business class though. Emirates for example has been cutting First and Business class seats on certain routes. It may very well be different with each route.

    Specific nations have their own oddities. In China for example, once considered one the largest growth markets, the high speed rail system is providing competition for airlines. That’s something I’d like to see the US build in the long run too.

    I suspect that there will be a large segment for renting/chartering jets for the very wealthy.

    It’s interesting to note that as manufacturing left the US, so did the middle class. By contrast, Asia has created a middle class. That and the role of excessive money put into the military-industrial complex, which is essentially economic rent.

    A final consideration is the flying experience itself. Flying has become more and more miserable. Excessive security, the seats shrinking, fees, angry people on board, and other problems have made flying that much less attractive overall. I personally try to avoid flying unless I have to. Basically if it is within 2 days drive, I’d very much prefer to drive to a location or a train. There’s just so much better ways to spend your money for leisure.

    – Chris

    • Chris,

      Basically if it is within 2 days drive, I’d very much prefer to drive to a location or a train. There’s just so much better ways to spend your money for leisure.

      I think more people are starting to agree with you. The US, though, is such a big place that often there’s no choice but flying if you want to go there. That’s where you’ll see the flying Wal-Marts. For shorter trips, bus companies have an opportunity: I’ve gone from Savannah to Atlanta, about 250 miles, by Greyhound. It cost about a quarter what Delta wanted, offered leather seats and adequate wifi, and took about an hour longer door-to-door. Much longer than that, though, bus really isn’t an option for most people.

      For that reason, we can probably just write off air service to smaller cities west of the Mississippi.

      If, on the other hand, all you want is a little time with Grandma, there’s Skype & Facetime.

      So what I’m seeing is the legacies for business & upscale travel, particularly transcon and intercon, with private jets becoming more of an option as net worth ascends into the stratosphere.

      Chet

  4. For that reason, we can probably just write off air service to smaller cities west of the Mississippi.

    The big losses come from the small to medium sized cities, who will see airline coverage reduced, if not eliminated altogether.

    As I said, I think a rail system would be a good investment. High speed rail does not make sense for small towns, but a slower traditional rail system could definitely help.

    The real thing I hinted at earlier is, I don’t want to fly if I can. It just is really stressful. Although it is more time to use the train, the security is not as bad, the seats are way more comfortable, and there’s other amenities like free wi-fi. Bus service too is more comfortable than planes with moderately large seats and amenities like air conditioning. Plus I like just looking out the window and seeing the trees go by.

    Flying just is an unpleasant experience. You are far more likely to get air sick than train or bus sick (not to mention from going at higher altitudes in a pressurized cabin), the food is awful, the flight attendants are angry, and after flying, your body feels comfortable because you were so cramped.

    I wonder how much revenue the airlines have lost by making flying so miserable. I think what is needed for longer haul flights is something in between economy and business class. Something like what the “old economy class” was. There does seem to be a movement in that direction towards what is called “premium economy”. We’ll see though.

    Chris

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s