US airlines moved closer to the razor’s edge during 2012 after collectively recording a profit margin of 0.1%. While the 10 largest airlines in the country may be commended for sustaining a three-year profit streak amidst record high fuel prices, they could find it tough to find creative ways to continue to achieve profitability as the potential to tap ancillary revenues reaches its peak.
On top of the seemingly everlasting threat of fuel price volatility, US carriers also face various forms of pressure from the US government, with looming threats of tax increases, as well as possibly significant operational disruptions triggered by bipartisan stalemate in budget negotiations.
Data compiled by US airline trade group Airlines For America (A4A) show the country’s largest carriers earned USD152 million during 2012, a 64% slide from the USD418 million in net income recorded the year prior. ExxonMobil earned around that much each day in 2012.
The 4.7% increase in airline expenses outpaced a 4.5% rise in revenue growth as fuel prices reached an average of USD128 per barrel during 2012. A4A estimates US carriers recorded USD50 billion in fuel costs during 2012, a 28% rise year-over-year.
US carriers' spend on fuel: 2000 to 2012
Even as the financial results seems paltry compared with other industries, US carriers did manage to eke out a profit during 2012 at similar fuel price levels to those applying in the 2008 and 2009 time period, when they collectively bled USD24 billion and USD2.6 billion.
Fuel costs continue to be nettlesome at the beginning of 2013
So far during 2013 fuel prices continue to be vexing as A4A in mid Feb-2013 estimated that fuel prices per gallon were USD3.26 versus an average in 2012 of USD3.06.
While carriers have pushed through some fare increases to combat the higher fuel costs, the reality is from 2000 through 3Q2012 inflation-adjusted fares fell 15%. Factoring in ancillary revenue gains, fares dropped 10%.
Fuel pries per gallon (1991 to mid-Feb-2013) and prices per barrel (02-Jul-2012 to 07-Feb-2013)
Average domestic airfares (round-trip): 2000 to 3Q2012
Delta headed the yield improvements in 2012
Among the 10 airlines tracked by A4A – Alaska, Allegiant, American, Delta, Hawaiian, JetBlue, Southwest, Spirit, United and US Airways – Delta had the highest yield growth of 5% while Alaska, Hawaiian and Allegiant saw their yields fall by 1%, 0.8% and 2.8%, respectively. United had the weakest yield performance among the US major carriers at 1.2% growth compared with a 5% increase at Delta, a 3.5% rise for US Airways and American’s 4.6% growth.
US carrier year-over-year change in revenue and yield performance: 2012
|Carrier||Revenue 2012/Year-over-year change||Year-over-year yield change 2012|
|Alaska||USD5 billion 8%||-1.1%|
|Allegiant||USD909 million 16%||-2.8%|
|American||USD25 billion 4%||4.6%|
|Delta||USD36 billion 4%||5%|
|Hawaiian||USD2 billion 19%||-0.8%|
|JetBlue||USD5 billion 11%||2%|
|Southwest||USD17 billion 9%||3.4%|
|Spirit||USD1.3 billion 23%||1.9%|
|United||USD37 billion 0.1%||1.2%|
|US Airways||USD14 billion 6%||3.5%|
Not surprisingly fuel and labour costs accounted for the majority of airline expense during 2012 at 36% and 24%, respectively. Maintenance expenses had the largest year-over-year growth of 9%. Both JetBlue and Spirit during 2012 faced increases in maintenance costs as JetBlue’s fleet of Airbus narrowbodies and 100-seat Embraer 190s continued to age and Spirit faced rising expenses from start-up costs associated with a seat maintenance programme and higher depreciation and amortisation expense related to aircraft heavy maintenance.
For the full-year 2012 JetBlue’s top-line maintenance expense increased 48% while Spirit recorded a 45% increase.
Potential for more ancillary sales products could be limited as government threatens new 'look-over-there' rules
With volatile fuel costs now a permanent fixture in the airline business landscape, ancillary revenues continue to play a crucial role in airlines’ efforts to sustain profitability. Data collected by the US Department of Transportation (DoT) for 3Q2012 show that US passenger carriers collected USD924 million in baggage fees and USD652 million in reservation change fees. But that only scratches the surface of what carriers actually net from product unbundling as US airlines do not report to the DoT revenue they collect from the sale of other ancillary items, including seat assignments, onboard food sales and the sale of entertainment.
Research from US consultancy IdeaWorks and partner Amadeus shows that United, Delta and American were the top carriers recording the largest amounts of ancillary revenue during 2011. United garnered the most revenue from ancillaries at USD5 billion followed by Delta at USD2.5 billion and American at USD2.1 billion.
With various products now for sale ranging from seat selection to lounge access, it is tough to determine exactly how much further airlines can push the envelope with ancillaries and the associated product unbundling without meeting, or arguably increasing, customer resistance. One possibility to expand the ancillary push is rebundling products for sale.
And as Washington's legislators fiddle, the regulators have their eyes firmly fixed on regulating the growth of this recently-lucrative market. There will be a strong attraction to embark on "look-over-there" moves to embarrass airlines with obscure examples of "gouging" through the use of unbundled charges, while the politicians themselves are busily wreaking havoc on the economy. The airlines are certainly often guilty of a lack of transparency consistent with the level of consumer understanding when applying ancillaries, but the last thing they need now is to have the heavy hand of the regulator creating a maze of rules to navigate.
Fare bundling is becoming an attractive, if paradoxical, manifestation of unbundling
One approach that does provide a greater level of transparency and which is certainly usually easier for consumers to understand is the repackaging, or bundling of products associated with different fare levels. Both American Airlines and Canadian carrier WestJet have recently unveiled plans for fare bundles, and American has stated part of its aim in developing the fare groupings is to simplify the booking process for customers and to ease anxiety over passengers feeling nickel-and-dimed. WestJet is taking a different approach to the development of its fare bundles by crafting the groupings to appeal to a range of customers from budget conscious travellers to premium passengers that require maximum flexibility.
WestJet has estimated once its three fare bundles are fully implemented it would garner roughly USD51 million to USD81 million in additional annual revenue. But WestJet in particular is starting from a lower base in targeting corporate travellers with its fare bundles – the carrier estimates it only has an 11% share of the corporate market in Canada. Larger network carriers that have deeper penetration into the corporate market and well-established ancillary revenue streams could find themselves left without much room left to manoeuvre in the ancillary space.
Bracing for operational havoc as government spending cuts loom large
Compounding rising oil prices at the beginning of 2013 is an apparent stalemate between the Presidential administration of Barack Obama and the US Congress over automatic spending cuts that are scheduled to take effect on 01-Mar-2013 if the two sides cannot reach an agreement to prevent decreases in defence and discretionary domestic spending. Even allowing for some political hype from the regulator, if a deal cannot be reached the US FAA says is bracing to cut USD600 million from its FY2013 budget, which would include cutting midnight shifts at more than 60 air traffic control towers across the country and furloughing employees working within the agency’s air traffic control organisation for one day per pay period until the end of Sep-2013.
US Transportation Secretary Ray LaHood remarked the potential spending cuts could trigger significant flight delays and cancelled flights beginning in Apr-2013, and warned flights to the large areas of New York (a hub for Delta at JFK and United at Newark), Chicago (a hub for American and United) and San Francisco could suffer from delays of up to 90 minutes during peak hours due to fewer controllers on staff. The cuts could also result in longer wait times at airport security checkpoints.
Delays at those major airports could trigger operational disruptions throughout the networks of the largest carriers operating hubs at the facilities, leading to cancelled flights and lost revenue for an industry already operating on thin margins. Passengers will end up placing all the blame on the airlines rather than the government for the inevitable delays and disruptions, which will create not only financial challenges for carriers but unnecessary negative publicity as well.
Previous proposed tax hikes could rear their ugly head
Since his re-election President Obama and his administration have largely been mired in bottlenecks with Congress over the expiration of certain tax breaks or impending spending cuts, which has left little time to focus on long-term fiscal issues. During his first term, US carriers averted a proposed USD100 tax on every flight and a tripling of security taxes over a five year period.
Airlines in 2011 escaped having those taxes imposed after a special Congressional committee failed to reach an agreement on deficit reduction. But there is no guarantee once the immediate budget issues are resolved that the administration will not resurrect the proposed taxes. In 2012 the taxes were again proposed in the FY2013 budget, but have not yet been imposed. Previously, A4A has warned that the proposed taxes would cost US carriers USD36 billion over a 10-year period.
As the Obama administration during the President’s first term began tabling a proposed tax hike for the airline industry A4A and its members responded by mounting a campaign to develop a national airline policy, arguing that a framework for tax and regulatory reform, and infrastructure improvements could help put US carriers on a par with their counterparts in other countries where government support of commercial aviation is stronger – most notably Singapore and the United Arab Emirates.
So far a policy has yet to materialise, but the association continues to push for greater government support of US carriers through the development of a formal airline policy.
Other more pressing items have diverted the government’s attention away from increasing aviation taxes during the last couple of years. But once those issues are resolved US airlines could once again face a distinct possibility of new tax burdens as the collective margins of those carriers steadily fall – something that fuel prices seem un-inclined to do.