Why Airlines Aren't Profitable

By Greg McFarlane | September 02, 2014 AAA

It’s one of the most enduring folk wisdom dicta in all of commerce. “The airline industry, in its history, has never made money.” The truth of that statement is not so easy to confirm. If we restrict ourselves to passenger airlines, and ignore the first few decades of flight (when airlines were spawned and folded as quickly as the planes could fly), the profitability of the industry as a whole has been somewhat variable. Until 1930 or so, flight was mostly a way to drop insecticide or deliver mail. At first, it didn't make economic sense to ship people.

Technological advancement, especially in the areas of speed and airliner capacity, created so much demand that passenger travel was eventually seen as nearly a public utility – something to be preserved and maintained through down periods, even at taxpayer expense if necessary. Today several unprofitable routes to and from small towns throughout the United States are still kept afloat by legislation, subsidized to the tune of as much as $800 per passenger per flight.

The landmark event in U.S. commercial aviation history – as important as the incorporation of sound was to motion pictures, or the forward pass was to football – was the Airline Deregulation Act of 1978. Prior to its passage, the federal government set rates, fares and schedules, guaranteeing profitability to each oligopolistic airline but doing its best to thwart innovation. Since the act’s passage, prices have dropped about 40% and ridership has increased dramatically. Complaining about flight delays and waiting-room inertia has become a rich mine of material for uninventive comedians and everyday kvetchers, but the alternative would be a world in which the cheapest flight from New York to Los Angeles would cost over $1400. In the pre-regulation days, the concourses were roomier and more sparsely populated than they are today, if only because hardly anyone could afford to fly.

When airlines became subject to competition, the industry necessarily underwent transition. Some airlines folded (Pan Am, Eastern), others were subsumed by larger competitors (TWA, Piedmont), and still others advanced from regional or nonexistent into positions of national importance (Southwest [NYSE:LUV], JetBlue [Nasdaq:JBLU].) Undergoing the most displacement of all, however, were the so-called “legacy” carriers – the decades-old stalwarts who had benefited most from regulation.

In the decade from 2002 to 2011, the 3 largest legacy airlines – American [Nasdaq:AAL], United [NYSE:UAL] and Delta [NYSE:DAL] – each filed for bankruptcy. Not only that, but each has or had merged with another large carrier – US Airways, Continental and Northwest respectively – that had also sought legal protection from creditors. The official reasons given ranged from the dubious (increased fuel prices, which would seem to affect every player in the industry equally) to the more candid (competition from low-fare rivals.)

Bankruptcies have become a way of life for the older carriers in the U.S. aviation industry, every major one having to reorganize in recent years. And yes, it’s true that large-carrier losses have more than offset newer-carrier profits in recent years. However, it’s no longer even accurate to use the term “large-carrier” in reference to the legacy airlines. With Southwest and JetBlue among the five biggest airlines in the United States, that means the upstarts haven’t just uprooted the big players, but have supplanted them to some extent.

You don’t need to graduate with honors from Wharton to know that your average business would prefer guaranteed profits to ones that it has to fight for in the marketplace. Former American Airlines CEO Bob Crandall, who ran the airline until 1998, even admitted as much:

"The consequences of deregulation have been very adverse. Our airlines, once world leaders, are now laggards in every category… market forces alone cannot and will not produce a satisfactory airline industry, which clearly needs some help to solve its pricing, cost, and operating problems."

Three years later, Crandall’s former employer announced it was seeking bankruptcy protection. That’s what’ll happen when a corporation loses $2 billion one year, and $2 billion in the previous 2 years, to say nothing of $2 billion in the subsequent year. Fuel indeed got more expensive during that time, but not certainly enough to explain such staggering losses.

Contrast Crandall’s comments with those of Herb Kelleher, the founder of Southwest Airlines, testifying before federal regulators:

"The Airline Deregulation Act of 1978, literally made the Southwest Airlines of today, and the other low fare carriers I speak for, possible. Some people will just never get over that. Southwest and the very existence of low-fare competition is the only "crisis" of which they truly complain."

Hard to believe those two are nominally in the same industry, yet they are. By the way, Southwest earned $754 million in 2013, making that its 41st consecutive year of profitability. JetBlue, which was founded in 1999, has made money five years in a row.

Meanwhile, Southwest and JetBlue’s larger competitors continue to lumber, fall, fail to adapt, and essentially parallel everything their sauropod equivalents did in the Cretaceous era. United, for instance, spends staggering amounts on union labor and, not coincidentally, lost $723 million in 2012.

Some older airlines eventually do figure it out, however. 2013 was an exceedingly profitable year for Delta, as the company made $11 billion on sales of $38 billion. Delta paid off debt, started issuing a dividend again, and rejoined the Standard & Poor’s 500 eight years after filing for bankruptcy. That’s a far cry from the mid-2000s, when Delta had amassed as many consecutive losing years as JetBlue has profitable ones.

The Bottom Line

The airline industry remains subject to profound change, even after decades of growth and consolidation. Until mankind not only develops the next transportation breakthrough, but then makes it commercially viable, we’ll continue to see movement, fluctuation, and in the case of the smart carriers who know how to maximize revenue while keeping costs low, some profitability too.

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