Setting the Scene: Never waste a good crisis! Why haven’t more airlines disappeared?
The airline model is complex. It is typically a hybrid, with many variations on the theme. With a handful of exceptions, the common feature is that airlines are commercially unviable. A JP Morgan report stated some time ago, airlines are “deeply serial value destroyers in the long term, to be owned only in the up-cycle. The network airline industry’s long term profitability is fundamentally flawed”.The “traditional" airlines, or flag carriers, are supported by governments to a greater or lesser extent – if only by the inherent protectionism in the regulatory structure. By contrast the more recent low cost models are mostly independent and unsupported, having to crash through barriers to grow. Yet all perpetuate the myth that they can operate profitably. It’s a house of cards, but one on which millions of jobs depend, which stimulates global economic activity, underwrites a global tourism industry and generates jobs and profits for a long chain of suppliers.
For many countries, and not just developing nations, the national flag carrier is iconic, a vital fixture, sometimes loved sometimes despised. It is – or has been – relied on to deliver connectivity and has an economic and a social importance well beyond its direct commercial relevance. So it’s a heavy burden to carry when it is also expected to make profits.
To paraphrase Germany’s Finance Minister when bailing out Lufthansa last year, “we will do whatever is necessary to secure the future of our aviation industry. Flag carriers may not be “too-big-to-fail” but they can be “too-important-to-fail”.
Remarkably, fewer than five large airlines are able to achieve more than junk bond credit ratings; and it is rare that more than five qualify as investment grade. That alone speaks volumes. A couple of those are European LCCs; the others achieved the status because they have strong (protected) domestic markets. Paradoxically, only one is a “flag carrier”.
After 75 years of evolution we might have expected better. How is such an industry able to survive?
Quite amazingly, even the massive upheaval of COVID hasn’t yet been sufficient to dislodge the airline industry. Instead, today all hopes are pinned on restoring the same old - uncommercial - ways. The only “strategy” goal to be heard is “getting back to normal”.
So, we’re in serious danger of wasting a good crisis, the biggest the modern industry has ever confronted. The only saving grace is perhaps the small mercy that the pandemic hasn’t yet run its course. The shock waves of such an upheaval take years to work their way through the system. As The Economist magazine observed last year, “a merely illiquid firm can quickly become a truly insolvent one as its earnings stagnate while its debt commitments expand. A rise in corporate and personal bankruptcies, long after the apparently acute phase of the pandemic, seems likely, though governments are trying to forestall them.”
Ownership & Control and the Constant shock syndrome
In the airline industry there is a frightening constancy about the “beyond-our-control” – exogenous - shocks. They are never expected, less still planned for; with rare exceptions the annual struggle to make a viable return on capital occupies all of management’s bandwidth, without squirreling away enough nuts to help them survive the next “shock”. And anyway, governments have usually been there to give them a helping hand in their hours of need.
Take the US as an example, the home of commercial airline operations, where government subsidy of airlines is abhorrent. Over the course of just the past two decades, there have been numerous responses to support the US industry.
After 11 September 2001 airlines were still staggering from the tech bubble burst and loss of high value business travellers, were bailed out by the US government. Despite this, a series of Chapter 11 bankruptcies (also considered by international competitors as bailouts) followed. Writing off debts under the bankruptcy proceedings facilitated more consolidation, greatly strengthening those major airlines left standing.
The result was an oligopoly operating in a domestic market strictly protected from foreign competition or ownership, then able to generate half of the total world’s airline profits, despite only accounting for about 15% of global RPKs.
Clearly such an immense profitability imbalance had to be due to some special status that other airlines didn’t possess.
That alone offers a key pointer to how to create economically sustainable airlines – allow them to merge, with a protective barrier against foreign investment or competition! (even though hundreds of billions of dollars in subsidies were still needed to lubricate the process). Hardly a solution for the world, but the importance of the ability to consolidate shines through. Removing nationality controls is the key issue internationally.
In this context, Southeast Asia may actually be provoked into a moderate form of ownership liberalisation, the more so because it faces a continuing disastrous outlook. IATA has forecast traffic levels in Asia Pacific for the full year 2022 will be around 11% of 2019 levels. If anywhere near correct, that spells catastrophe for most network airlines, as border uncertainty persists. Even the 60-70% projected for global recovery is near-disastrous.
To quote IATA CEO Willie Walsh on Asia, “...it's a major, major problem. Several airlines have accessed the capital markets, either through raising debt or equity, but not all have been able to do that. …. the scenario we've painted for 2022 is going to leave a number of airlines in a very precarious financial position. And we know that they're on the brink at the moment. So I think governments will have to understand what's likely to happen if these airlines do collapse, because it's going to take a long time for the infrastructure to be rebuilt.”
In essence, something has to give.
Being a leader in accepting cross-border joint ventures - where the “effective control” element of the bilateral requirement for “substantial ownership and effective control” frequently did not reside nationally - has greatly helped in the expansion of Asian airlines for both LCCs and full service airlines’ subsidiaries. That offers a hint of a solution.
Moderator: CAPA - Centre for Aviation, Chairman Emeritus, Peter Harbison
- Emirates, President, Sir Tim Clark
- Etihad, Group CEO, Tony Douglas
- Kenya Airways, Group MD & CEO, Allan Kilavuka
- SAS, President & CEO, Anko van der Werff
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