The industry has tended to look at traffic, load factor and the economy to indicate its fortunes, but these indicators need to be revisited, writes Chris Tarry
As airlines head into a new year, it is evident that the industry is still undergoing fundamental change against the backdrop of some real uncertainties, both political and economic. In such times there is more need than ever to review and challenge accepted wisdom. In particular, there are questions about the underlying pattern of industry traffic growth and its relationship with profitability.
It has been a long-held convention that world passenger traffic grows at a multiple of around twice the rate of the world economy. This relationship with GDP is more of an observation than an economic theory. And, indeed, charting world statistics over the past 30 years, it does look as though traffic growth has tended to average such a multiple. But world averages can, at times, be dangerously misleading.
Looking more closely at the movement of the relationship over time, reveals that the GDP multiplier has itself followed the peaks and troughs of the industry cycle. As might be expected, the multiple is at its highest when the industry is struggling to fill capacity in the wake of a major slump but against the background of still weak economic growth. So the peaks of the past 30 years have come in 1982 and again a decade later in 1992. During times of more robust GDP growth, such as in the late 1990s, the multiple has tended to sink back to 1.5 or less.
Price stimulation then would seem to be as much a driver of high-end traffic growth as underlying economic conditions. There is good evidence that the explanatory power of price in the traffic forecasting equation has doubled over the last 10 years.
The world average also disguises some marked regional differences. Traffic in the mature US domestic market, for instance, was growing at a GDP multiple of perhaps only 0.8 before going into the present crisis. And there are signs that air travel spend could be hitting a ceiling in terms of the share it takes of overall economic activity. That is hardly a surprising conclusion. Most industries follow a long-range cycle of maturity, demand saturation and finally stability. It is worth noting that at an aggregate level, the US share of consumer expenditure devoted to transportation other than by road declined by almost half a percentage point between 1997 and 2000.
But traffic growth is not everything. As became clear in previous cycles, at times when supply runs ahead of demand the efforts to fill seat capacity produce headline traffic increases but at the expense of yields. And if costs are not brought down this simply results in profitless growth.
Even so, accepted industry wisdom continues to suggest that there is a correlation between load factor and profit. While this may look persuasive in terms of brute numbers, taking a more sophisticated view of returns on sales or assets, the picture that emerges is less convincing. In fact, the relationship between margins and load factors seems to be somewhat weak.
There has clearly been an almost inexorable rise in world load factors over the last few decades, climbing from around 50-60% in the early 1970s, to 70% or better over the past few years. Yet, at the same time, the profit margin has continued to follow a pronounced and different cyclical pattern. The suggestion is that load factors in isolation are not a particularly good guide to economic and financial well-being. It is rather the relationship between the achieved load factor and the break-even load factor that is fundamental.
Again, the picture will vary depending on the maturity of the markets in which a carrier principally operates. For the major US and European carriers, which account for some 60% of the industry, there would appear to have been a basic change in the causal relationships underlying demand. How that translates into financial stress will depend on the level of capacity that remains in the market.
The need is for a fundamental rebasing of the level of seats on offer and of the underlying unit cost. The industry as a whole went into the present crisis carrying perhaps 20-30% too much capacity, which had been built up over the previous two decades as carriers chased illusory growth. The consequences of this excess are all too evident in their financial performance.
If, as seems likely, there are hard limits to growth, the need yet again is to focus on cost and capacity. As a general observation, the industry as it heads into 2003 still needs less of both.
Source: Airline Business
