The major expenses that affect companies in the airline industry are labor and fuel costs. Labor costs are largely fixed in the short term, while fuel costs can swing wildly based on the price of oil.
For this reason, analysts pay more attention to fuel costs in the near term. Two-thirds of the costs of flying an airplane are fixed, so changes in fuel costs can swing a flight from profit to loss depending on how many people are on the flight.
Historically, the airline industry continues to be brutally competitive, even though the business of flying people all over the world and country has become an integral part of human life. The cost of flying continues to trend lower. The Internet has also created greater price transparency, reducing margins.
- While you may think that airline tickets are pricey, much of the fare goes to cover costs.
- The biggest costs for airlines include labor, equipment, and fuel.
- Here, we take a closer look at these expenses that airlines must face.
Cost of Labor for Airlines
Labor accounts for approximately 35% of the total of airlines' operating expenses. Operating expenses account for roughly 75% of all non-fixed costs.
During downturns, management looks to cut labor costs by laying off workers or reducing their pay or benefits. This is a consequence of being in a competitive business where customers have little brand loyalty—airlines generally have to compete on price rather than quality. Since growing profits is difficult, companies are forced to cut costs to be more profitable.
Some of the lesser expenses for airlines are maintenance, parts and labor, handling luggage, airport fees, taxes, marketing, promotions, travel agent commissions, and passenger expenses. As a whole, these account for nearly 55% of total operating costs.
Cost of Fuel for Airlines
Fuel costs account for 10% to 12% of operating expenses. Many companies have programs to hedge fuel costs. They buy futures contracts to lock in their costs for a set period of time, turning it into a fixed expense. When fuel prices rise, this behavior is rewarded. When fuel prices decline, this is punished as the market price of fuel is less than what they are paying.
Some of the worst times for airlines have been when oil prices spiked up. Airline companies can prepare for slowly rising prices by charging more for tickets or by reducing the amount of flights, but sudden moves higher lead many airlines to lose money.
In 2008, oil hit a high of $147 per barrel, a new all-time high. Airlines were unprepared, and many went through serious restructuring to survive. At that time, the NYSE ARCA Airline Index (XAL) had fallen to around 16. By comparison, the index was at 56 in January 2007 when the price of oil was $60 a barrel. The drastic changes underline the inverse relationship between oil prices and the value of airline companies at that time.
The period from 2009-2014 saw an improving economy and oil prices that slowly climbed higher before plateauing around $100 from 2011-2014.
The drop in oil prices from 2014-2017 was particularly beneficial for airlines; unlike previous drops in oil, the economy continued to strengthen with travel increasing. Falling costs and rising revenue are desirable for any type of business.