As talk of recovery grows, Chris Tarry of CTAIRA assesses how far the industry has actually got in the work to make a fundamental downward shift in the cost base
With the first hints of recovery now spurring many in the industry towards thoughts of growth, it is worthwhile taking a moment to review just how wisely carriers have used their time during the downturn in fixing their cost base.
Unless there is a sudden and unlikely upward shift in fare levels, then the reality for many airlines is that although traffic volumes may look more encouraging, the revenue pressure continues.
For any business there are at least three basic aims in life: to survive, to compete and to prosper. Over the last couple of years for some the main focus has been on survival and not all have succeeded. The entry and exit rate of new start-up airlines also remains as high as ever. Carriers have always sought to compete but there is real evidence that the nature of competition has changed and it has taken some airline managements longer than others to recognise this and respond. Customer requirements are quite different from those of just four years ago.
Then there comes prospering. Few of the mainline carriers can yet tick this box, but as the recovery unwinds it is likely that those that do thrive are the carriers that have got down to some fundamental reworking of their costs.
Here it is important to make the distinction between tackling the underlying cost structure, rather than simply sitting back and waiting for unit costs to improve as capacity rises. When airline markets recover there is a near overwhelming temptation for the industry to do the latter and "grow its costs down". The recent raft of growth announcements raises the prospect that we should again expect to see some of this. Adding capacity in the expectation of growing costs down also has a negative effect on yields. The last thing that the industry needs is to add more capacity into already price-sensitive markets.
This inevitably leads to the well-worn litany about the need for cost reduction to be structural and the only outward, visible sign of this in the current yield environ-ment is an unchanged break-even load factor.
There are indeed many examples of carriers making structural cost reductions in order to cope with the reduced scale of the business, but perhaps most encouragingly a few where this has been brought about as a result of changes in the underlying business process.
But even where success has been achieved, airlines may face constraints. British Airways is a case in point. It has achieved considerable success with its Future Shape and Size programme over the past two years. So much so that the market now expects BA's short-haul business, which has lost £1.1 billion ($2 billion) over the last 10 years, may now be trading at close to break even. It has achieved this in a fundamentally changed revenue environment, and where it has not been able to tackle changes in working practices in areas where the benefits could be significant but the costs of getting there are regarded as too high at present.
Elsewhere in Europe, Aer Lingus has been transformed beyond all recognition. The latest preliminary results show an operating margin of 9.4% for its 2003 financial year, up from 6.1% in 2002. The target for 2004 is 10% - clear evidence of the extent of the change and the emergence of a genuine new model airline that survived, now competes and prospers.
The experiences of the Dublin-based management team will inevitably be contrasted with those at Alitalia, where management continues to encounter problems and outside interference as it tries to implement its latest programme for change. In northern Europe, SAS is embarked on a fundamental change programme in a market that has seen particularly dramatic structural change - the end result should emerge over the next year now that the carrier has agreed new contracts with most of its 39 unions.
Across the Atlantic it is a mixed picture. The latest indications are that United Airlines will remain in Chapter 11 for longer than had been expected, yet the latest results show the progress that others, and in particular American Airlines, have made on the cost front. In addition to the issue of pension funding, where it appears help may be at hand from the government in terms of granting relief, fuel is again an issue, with airlines warning of its effects, exacerbated by an inability to pass on the rise in the fuel price through surcharges.
While some progress has been made on the cost front, it is still going to be a long hard road for the industry collectively to make meaningful profits, given the difficulties in taking more cost out. It is ever more dependent upon "revenue pull".
After net losses of some $30 billion over the last three years, the industry is expected to make a profit in the current year of perhaps $2 billion, a return of less than 1%. There is a long way to go before the industry offers compelling investment opportunities on a broad front.
Source: Airline Business
