In January 2010, Japan Airlines became the latest carrier to declare bankruptcy, joining the swelling ranks of insolvent airlines in recent years. Considering the vital nature of the service it provides and its invaluable contribution to making the world a smaller place, why is the airline industry synonymous with ongoing losses and insolvency? We list four reasons why airlines are always struggling.
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- Unprofitable Airlines Continue to Fly
An industry that has been unprofitable for decades would be eventually forced by market participants to undergo consolidation and rationalization in an attempt to find a better way to do business. Not so for the airline industry, for whom this basic business precept does not seem to fly, so to speak. Many unprofitable airlines continue to remain in business despite years of substantial losses, because various stakeholders cannot afford to let them close.
Closing down a large unprofitable airline would involve the loss of thousands of jobs, inconvenience to hundreds of thousands of travelers, and millions in losses for the airline's creditors. Not to mention the loss of national pride if the airline in question is a national carrier.
Because closing down a floundering airline is a politically unpalatable decision, governments will usually provide it with a financial lifeline to stay in business. But struggling airlines often have to resort to cut-throat pricing to fill up their excess capacity, and as a result, even the stronger players in the industry are adversely affected by this lack of pricing power. (If you're a long-time air traveler, you've probably noticed that flying means pulling out your wallet a whole lot more often. Find out what's fallen off the list of airline freebies in 7 Air Travel Perks That Used To Be Free.)
- High Fixed and Variable Costs
Aircraft are very expensive pieces of equipment, and airlines have to continue making large lease or loan repayments regardless of business conditions. Airlines also need large labor forces to run their complex operations, making payroll expenses another component of relatively fixed costs that have to be incurred month after month. With oil prices having quadrupled over the past decade, high fuel costs are yet another challenge that airlines have to contend with. Add in security costs that have skyrocketed after 9/11, and it is apparent that few airlines can surmount the formidable obstacle of their high-cost structure.
- Exogenous Events Can Suddenly Affect Demand
The airline industry is particularly vulnerable to exogenous events such as terrorism and volcanic eruptions, which can drastically affect their operations and passenger demand. For example, airlines are collectively estimated to have racked up losses in excess of $2 billion from the closure of European airspace in April, caused by massive ash clouds following a volcanic eruption in Iceland. The U.S. airline industry suffered losses of about $7.7 billion in 2001 despite massive federal aid, largely due to a plunge in passenger demand after the 9/11 attacks.
- Reputation for Hassles and Poor Service
Long lines due to security procedures at check-in, cramped seating, inconvenient schedules, poor service - the list of airline travelers' complaints is a lengthy one. The perception that air travel is an ordeal continues to grow, making it very difficult for airlines to charge the higher prices that are necessary to return to profitability. (This maligned sector is in better shape than most investors believe. Don't miss Airline Stocks Look Set To Soar.)
The Bottom Line
Airlines provide a vital service, but factors including the continuing existence of loss-making carriers, bloated cost structure, vulnerability to exogenous events and a reputation for poor service combine to present a huge impediment to profitability. While a handful of low-cost airlines have successfully managed to post consistent profits, by and large, profitable airlines are few and far between.
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