Uncertainty reigns over market elasticity as high oil prices force airlines to raise fares with unknown effects on demand
As airlines struggle to cope with record oil prices, one of the key questions they are facing is: how much of the cost can be passed on to passengers through fuel surcharges and fare increases before demand for air travel starts to wane? And the general mood among airline chief executives attending the IATA annual meeting in Istanbul in early June was one of uncertainty.
Willie Walsh, chief executive of British Airways, which increased its fuel surcharge on all tickets in early June, was one of those expressing uncertainty over future demand. "I think at some point [fare increases] have got to impact on demand," he said.
"It's not clear as to whether we're at that point yet but if you look at everything that's happening - you've got a softening economic environment and high oil prices - it's inevitable that prices are going to have to go up. It's not clear what impact that will have on demand and that's why I genuinely believe that we're in uncharted waters."
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"It's not clear what impact it will have on demand...we're in uncharted waters"Willie Walsh |
Surcharge hikes are "inevitably going to carry on as long as oil prices stay at this level", said bmi deputy chief executive Tim Bye. "It's difficult to know at what point the increase in the surcharge is having an effect on demand, or whether just the general economic trends are having an impact on demand.
"We're not seeing anything significant in the UK yet but the media is talking down the economy all the time and I think inevitably that's going to have an impact over the coming months." Bye added that as airlines get past the summer season and start taking bookings for the autumn, "people will start seeing how bad it really is".
Virgin Atlantic chief executive Steve Ridgway agreed that the worst could be yet to come: "There seems to be a message here that travel and traffic look OK through the summer but the real challenge is going to be the winter, and we'll have to see what happens there."
Ridgway added that there will have to be a "fundamental re-pricing" if fuel prices do not start to come down. "In terms of that re-pricing, what ultimately happens to demand is going to be the key thing," he said. However, Air France-KLM deputy chief executive Pierre-Henri Gourgeon believes fuel prices have increased too rapidly to be able to suddenly pass on the cost to the passenger.
Gradual Increases
"You can't multiply the price by two to cover fuel. You need time," said Gourgeon during an Air France-KLM event in Paris. Instead, Air France-KLM plans to gradually increase fares over a three-year period - a luxury the carrier's fuel hedging programme has afforded it. The Franco-Dutch carrier's chairman, Jean-Cyril Spinetta, points out that "if we increase fares in a not very good economic situation it will have an impact on demand, so we'll have to be prepared for that".
Chris Tarry of UK-based consultancy CTAIRA believes there are already signs of faltering demand for air travel, particularly among leisure passengers. "We are seeing people tighten their budgets," he said. "If we look at leisure travel, only 25% of a leisure traveller's discretionary spend is on the airfare, the rest is on accommodation and that's going to be the issue."
Demand for air travel will be affected in different ways depending on the geographic region and many expect Asia to fare better than the USA and Europe. Cathay Pacific chief executive Tony Tyler, for instance, was keen to point out that there is "a whole lot of the world out there where the economy is still strong", adding: "Let's not look at the world through a Europe prism."
When it comes to fare increases in the Asia-Pacific region, any adjustments should be introduced on a gradual basis so as to avoid shocking the market, according to Malaysia Airlines chief executive Idris Jala. "It is very difficult to put prices and fuel surcharges quickly into the market because that will send tremendous shocks through the system. You have to work very gradually."
But Jet Airways chairman Naresh Goyal stressed that for airlines to survive in the current environment, fare increases and fuel surcharges are a must. "If airlines want to make money they have no choice but to increase their fuel surcharge," said Goyal. "They will have to, otherwise they will go bankrupt." However, he is mindful of the impact this is likely to have on demand, particularly in Jet's home market of India. "Indians want to come to India - they will travel but they may travel less. The market may not grow as much, growth may go down. Indians instead of travelling four times a year might travel twice a year."
Emirsyah Satar, president of Garuda Indonesia, said there was "a limit to how much fuel surcharge you can get from the customer", adding that as fares go up "people will probably fly less for vacation and leisure, and probably fly to closer destinations".
IATA chief economist Brian Pearce highlighted the difficulties for airlines, especially in the USA, of raising fares in a weakening economic environment. "Any business has to make sure its product reflects the cost of production but now we're faced, particularly in the US, with the slump and we see it being extremely difficult for airlines to increase fares and add surcharges," he said. "Everybody is going back to the drawing board, looking for further ways to cut costs."
Pearce noted that passengers would react to fare increases, resulting in a negative impact on growth: "It's not true that passengers are not sensitive to pricing any more. Price sensitivity is certainly back for passengers and if oil prices remain at $135 a barrel we will see some decline in passenger growth." However, this was countered by a more optimistic Michael Bell of executive search firm Spencer Stuart, who said "the impact on elasticity will be relatively small".
Air New Zealand deputy chief executive Norman Thompson said airlines need to perform a balancing act when it comes to pricing: "It's certainly a fine balance - if you increase fares the market is only so elastic. You've got to get that balance in terms of being able to recover your costs for the huge increase in fuel and not turning off your markets."
For more on the impact of record high oil prices on airlines, go to: flightglobal.com/crisis
Source: Airline Business
