One of the most striking things about IATA’s robust industry profit outlooks over the last couple of years has been the way the extra capacity airlines have added has been soaked up without derailing profitability.
While IATA has just trimmed its industry net profits guidance for 2014 by $1 billion, the $18.7 billion it expects airlines to generate would still represent the most profitable year on record (now that restated ICAO data puts the 2010 industry profit at $17.3 billion).
Coming on top of the of the near-$13 million profit estimated for 2013 and marking a fifth consecutive year of profit, it is a far cry from the red ink-dominated first decade of the century.
Almost half this year’s profits are expected to come from North American airlines and it is no coincidence that tight capacity discipline – in part fuelled by consolidation – has driven a remarkable turnaround in the financial fortunes of these carriers. North American carriers have not lifted annual passenger capacity more than 3% since 2010. That trend is expected to continue this year, with capacity to be raised just 2%.
Collectively, the industry raised capacity 4% and 4.8% in 2012 and 2013, respectively. Capacity is expected to increase 5.5% this year. Thus far, the industry has met the challenge of filling the capacity without diluting its profitability. That is likely to come under even more pressure as airlines continue to add capacity.
“In a game where market share is seen as an important component, airlines are always going to some extent be in the market share chasing game,” says IATA director general Tony Tyler. “To some extent, we are always going to be chasing our own tails a bit. If an airline takes delivery of an aircraft, it needs to fill it.”
Tyler that the increasing lead-time on aircraft deliveries, given the high order backlog, makes this even more of a long-term bet. “If demand is weak, you have to find a way of filling it,” he says. That means stimulating the market, usually through promotional fares and increasingly sophisticated revenue management. “Airlines have got very good at filling the aircraft, but it does mean a lot of this growth we see forecast is going to be filled that way.”
IATA figures demonstrate the extent to which airlines are filling aircraft. Despite a variety of challenges over the last decade, industry load factor increased in all but one of those years, rising from 73.5% in 2004 to an estimated 79.6% in 2013. IATA is forecasting industry load factor will pass the 80% mark for the first time this year.
“In the past, it has been a real problem appropriately matching capacity with demand,” said IATA chief economist Brian Pearce during the association’s March profits outlook briefing confirming the industry is set to record its best-ever year of profits in absolute terms in 2014. “[In recent years] airlines have been much better at adding appropriate capacity with the market demands.”
He notes that while passenger capacity was increased further in January, this was more than matched by increased traffic: “We are seeing an acceleration of capacity being added in 2014, but at the moment that seems to be matched by the demand for air travel. So, at the moment, it looks like quite a sensible addition.”
While improving load factor is an encouraging metric, it does not in itself follow that this will lead to improved profitability. “There is no direct correlation between load factors and profits. It has to be related to pricing as well,” says Peter Morris, chief economist with Flightglobal advisory service Ascend. “For example, you can get a regional airline that can make money with lower load factors but higher prices.”
That higher load factor trend also reflects the spread of the low-cost model – both in geography and number of operators, as well as influence. Many of the strategies of the low-cost operators – including operating fuller aircraft – have been embraced by network rivals.
Morris maintains that the differences in pricing, fuelled by low-cost carriers’ different cost structure and freedom from the complications of historic network carrier pricing strategy, will always remain: “There are at least two markets – and while at the edges they are getting a bit fuzzy – there are inherent cost structures that will be significantly different.”
Industry yield growth has stalled in recent years. IATA figures for 2013 shows industry yields fractionally down. The association expects a similar outcome this year. Those yield figures will come under more pressure as capacity is added at greater rates.
“I think airline management and owners have seen returns are better when capacity discipline is being exercised,” says Tyler.” But if your market share goes down, you lose clout in the market, you can’t charge a premium in the business market. So it’s a balance.”
Nowhere is that dilemma more evident at the moment than in Australia, where Qantas’s profitable domestic business is struggling in the face of fierce competition from rival Virgin Australia. Both sides continue to add capacity in the battle to retain market share – a market in which Qantas continues to stick to its 65% market share line in the sand.
“It’s hard for all of the players to do much about it, because if they weaken their grip, the other will be onto them. But that’s business,” says Tyler.
Morris notes that the key driver in securing market share is the ability it gives an airline to get the service elasticity that can command higher yields. “If you are trying to be profitable, you only chase market share if you marginal cost is lower than your marginal revenue. There is no point in getting more passengers on board if you cannot make any money from it,” says Morris.
“You have to have critical mass in markets. People choose flights by income and price but also service levels,” he says, noting that convenient flight timings then come into the equation. “Once you get critical mass, you are credible in the market and that service elasticity works for you. But what you are talking about is service elasticity, not so much market share. You can get a higher yield from operating higher frequency,” he says.
Whatever the positives on yields, one of the brightest spots for industry comes from its ability to make money even when economic growth is relatively constrained. Industry profits in 2012 and 2013 came despite global GDP growth at around 2.5%.
“When economic growth falls below 2%, this is when airlines have tended to lose money,” says Tyler, noting it is unlikely that industry fortunes will ever decouple from economic growth. “But robust growth of passenger traffic does provide some reassurance the industry has a lot of resilience.”
Source: Cirium Dashboard
