Introduction
Airline Industry
“It’s a dire situation,” “says Joe Leonard, chief executive of low-fare carrier Air Tran Airways, who is scheduled to testify”. “I’ve never seen anything like it”. This excerpt comes from an article written by Martha Brannigan, which sums up the hostile economic environment that airline carriers play in. Playing is just what the majority of the airlines are doing. However, at the other end of the table sit such sound companies as Jet Blue and Southwest. The mere existence of such companies proves that airline carriers can be viable business entities. I aim to prove that troubled airlines such as United Airlines and US Airways can see brighter skies in the future, by minimizing costs and maximizing revenues. Nevertheless lowering costs and raising revenues cannot effectively fix the struggling airlines problems if the airlines are not able to operate in a free market environment.
Discussion
The airline industry is a service industry. The airlines are in the business of transporting people and their belongings as well as products. The major characteristics of the industry include the following: capital intensive, high cash flows, labor-intensive, highly unionized, seasonal. These characteristics are the cause of the industry’s then profit margin. In fact “airlines, through the years, have earned a net profit between one and two percent, compared to an average of above five percent for U.S. industry’s as a whole”. Due to the industry’s thin profit margin, it comes as no surprise that the history of airlines has been a rocky one.
The airline industry has been for the most part profitable for the last sixty years. However, a thin profit margin has been a major problem throughout the industry’s history. The majority of the airlines are unable to profitably deal with extreme economic events such as depression, recession, war, and of course the September 11 attacks. Furthermore, they are unable to profitably deal with changes in the industry such as, the government deregulation that occurred in the early ’80s. The results of such events are larger than average declines in profit compared to higher profit margin industries.
This fact can be seen in the annual reports published by the Air Transport Association. In 1978 net profit for the industry was 1,196,537,000. This profit dropped sharply over the next four years to (733,435,000). This decrease in profit was due to the government deregulation of the industry in the ’80s. Another example is the industry’s incapability of dealing with rising fuel cost during Desert Storm. Profits went from 1,811,267,000 in 1989 to (2,444,460,000) by 1992. Yet another example is the drop in passengers due to the terrorist attacks. The industry’s profits dropped from 6,998,931,000 in 2000 to (10,063,889,000) in 2002 . However, there are companies such as Southwest who have managed to stay profitable through even the worst times. These companies have done this by maximizing revenue.
Southwest and other profitable companies have achieved their profitability through maximization of revenue. There are several ways to increase revenue. The easiest of which is to increase passenger load factor. Southwest flew at a 68.1 percent load factor in 2001. Non-profitable companies such as United Airlines and U.S. Air Ways flew at less than 50 percent load factor. The passenger load factor is extremely important since “75 percent of the U.S. airline industry’s revenue comes from passengers” according to the Air Transportation Association. Of that 75 percent, “nearly 80 percent comes from domestic travel”. For this reason, airlines should focus more on domestic travel. Southwest currently offers no foreign departure. U.S Air Ways on the other hand fly’s to almost as many foreign destinations as it does domestic destinations. Another way that airlines can increase revenue is by finding a niche in the market.
Southwest does this by targeting price consciences travelers. By finding a niche in the market companies are able to keep ongoing relationships with customers by serving the target markets needs better than the competitor does. Airlines can also increase revenue by cutting out the middleman such as travel agents, who receive a commission on each ticket sold. This idea is important since 80 percent of tickets sold are done so by travel agents. By selling tickets directly, airlines are able to pocket a larger portion of the ticket fare. All airlines have done this through the help of the Internet. Maximizing revenue alone does nothing if the cost is not taken in to effect. To be profitable a company must also be able to minimize costs.
To be profitable the airlines need to minimize their costs. There are a number of ways this task can be achieved. I will focus on the three costs that seem to be troubling the industry the most. Labor costs are the largest cost for the industry. “Labor accounts for 35 percent of the airlines operating expenses and 75 percent of the controllable cost. This high cost is mainly due to the fact that the industry is highly unionized. Many of the troubled airlines will not be able to succeed if they cannot control their labor costs. I believe the best solution for fixing this problem area is to de-unionize the industry.
This action will, of course, be met with much opposition. Costs associated with the operation of aircraft are the second largest cost in the industry. This cost should be watched closely. The troubled airlines need to cut out unprofitable destinations or at least those destinations that do not meet the break-even load factor. Southwest for instance only serves 59 airports while U.S. Air Ways serves 203. The last cost I will discuss was also introduced in my section on revenue. The cost is that of commissions paid to travel agencies. Commission costs are the third largest cost for the industry. Airlines should lower the commission they pay to travel agencies. The result fewer agencies will exist and direct ticket sales through the Internet will increase.
There is one last cost that deserves special attention. The cost I’m referring to is that of security costs. I have saved this for last because of the costs devastating effects on the industry. Security costs have increased drastically since the terrorist attacks. This cost becomes even more troubling when a decrease in revenue resulting from a drop in passengers is taken into effect. I believe that the U.S. Government should pay for the additional security costs incurred by the airlines due to the attacks. My reason for this is that the increase in costs is a result of increased government regulation. Minimizing costs and maximizing revenues alone cannot save the industry. Airlines must also be able to operate in a free market environment.
Free markets are essential to the survival of the airline industry. The economic environment contains many variables for any one person or group of people to control. This has been seen throughout the history of the world. Such an instance is the extreme devaluation of the Peso in the ’90s that occurred in Mexico. The importance of a free market is the reason for the failure of both the Communist and Socialist regimes. The airline industry has seen tremendous growth since the deregulation of the industry starting in 1979. However much of the industry still remains regulated. If the airlines were looking to the future health of the industry, they would be lobbying Congress for more deregulation and not for loans.
Conclusion
The airline industry has entered its most turbulent time in history. Many of the airlines are on the verge of disaster. If they are to survive, the troubled airlines need to start emulating sound carriers such as Southwest and Jet Blue. Troubled airlines such as United Airlines and U.S. Airways can see brighter skies in the future, by minimizing costs and maximizing revenues. Nevertheless lowering costs and raising revenues cannot effectively fix the struggling airlines problems if the airlines are not able to operate in a free market environment.
Works Cited
Brannigan, Martha. “As Their losses Mount, Airlines Lobby Government for More Aid.” The Wall Street Journal 23 Sep. 2002: A1.
U.S Airways fact sheet. 2 Oct. 2002 http://www.usairways.com/about /corporate/profile/factsheets/index.htm
Southwest fact sheet. 2 Oct. 2002 http://www.usairways.com/about_dwa/press/factsheet.html
AOL Investment Research. Financials 2 Oct. 2002 Http://research.web.aol.com
Air Transport Association. Publications 1 Oct. 2002 http://www.airlines.org/public/publications/display1.asp?nid=964
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