William S. Swelbar is a research engineer in the Massachusetts Institute of Technology’s International Center for Air Transportation, where he is affiliated with the Global Airline Industry Program and Airline Industry Research Consortium. Swelbar holds a Bachelor of Science degree in economics with honors from Eastern Michigan University and an MBA with a concentration in finance from The George Washington University.
Airlines for America SmartBrief editor Angela Giroux Scheide spoke with William about the future profitability and growth of the U.S. airline industry.
Globally airlines are profitable, but U.S. airlines have not enjoyed the same level of profitability. Why is that?
If this were 2009, that statement would have been true not only for the year but for the entire decade that preceded it. But today it is not the case. Actually, U.S. airlines are more profitable than their European peers and slightly less so than airlines based in Asia. The International Air Transport Association (IATA) forecasts that the global airline industry will earn $6.9 billion in 2011 and $3.5 billion in 2012. In each year, only the Asia-based carriers are forecast to outperform North American carriers. In fact, the European-based carriers are forecast to lose money in 2012.
Despite the negative signals from the economic indicators we rely upon to determine the direction of U.S. airline revenues and profitability, the industry is performing admirably. Maybe even incredibly given the economic headwinds it faces. At the heart of the industry’s performance are the positive results being realized from consolidation and a religious adherence to capacity discipline. The industry is performing very well, yet the consumer has little to no confidence in the direction of the economy.
An example of the industry’s improved financial performance can be found by comparing financial results in 2008 to expected results in 2011. The U.S. airline industry yearns for its earnings to be relatively stable like those of corporate America; steady with minor ebbs and flows impacted by economic cycles.
Instead, the airline industry has followed a boom and bust pattern — mostly bust. Look at 2008 when, as oil ran to $147 per barrel, the industry lost 17 cents on each dollar of revenue. In 2011, the industry is paying more for oil on average than in 2008, yet is expected to earn one penny for each dollar of revenue.
This is a remarkable result particularly given the negative economic underpinnings, the price of crude oil and the price to refine a barrel of crude into jet fuel. Ancillary fees have helped most airlines, but are still secondary to consolidation and capacity discipline incrementally adding to profitability.
Whereas capacity cutting became a necessity after oil began its march during the first half of 2008, the U.S. industry really began to fix itself with the bankruptcy filings of each U.S. Airways (twice), United, Delta and Northwest between 2002 and 2005. Bloated labor contracts from a regulated era continued to exist among the network carriers well into the third decade of deregulation.
It was precisely these contractual inefficiencies that deregulation was supposed to address. Deregulation itself was not successful but the hammer of a bankruptcy proceeding along with the structural realities that ushered in new cost models that fundamentally changed labor costs and productivity.
Labor and fuel are the two largest costs for any airline. One is controllable and one is not. Bankruptcy cannot restructure fuel costs, but it can restructure labor costs. If the U.S. industry was to be profitable, airlines had to reduce labor costs and increase labor and fixed asset productivity, as well as identify and remove unprofitable flying. Between 2000 and 2010, network carriers removed 849 mainline aircraft from the system. Over the same period, the network carriers shed 151,061 jobs. Airlines were finally taking on the inefficiencies deregulators identified.
Over three decades, the U.S. airline industry has lost its leadership position. It became U.S.-centric and as a result committed its capacity to the domestic sector that yielded revenue economics that could not compensate for high cost structures.
Now it is incumbent on the Europeans to look inward and begin the process of restructuring cost just as the U.S. carriers have. U.S. low cost, new entrant carriers caused the network legacy carriers to look within. In Europe, it is the carriers emerging in the Middle East that should be causing them to look within.
Economic cycles will always affect earnings in the global airline industry. In this cycle, it is the U.S. carriers that have prepared themselves better than others to withstand the economic and oil headwinds. How different.
What could the U.S. government do to facilitate the growth and the sustained profitability of the U.S. airline industry?
The best place for the U.S. government to start an examination of its own policies would be a study of what is taking place in the United Arab Emirates. There, pro-aviation policies embrace the airline industry’s role as an economic facilitator. Those policies should serve as a lesson to all governments that seek to tax their respective carriers into oblivion. In order to compete with this new world order, cutting costs and reducing taxes must be the mantra for the network airlines in the United States.
According to The Economist: “These pro-aviation policies stem from a conviction that aviation could act as a spur to Dubai’s economy, by facilitating trade, financial services and tourism. At Sheikh Ahmed’s prompting, the government has implemented a highly liberal open skies policy encouraging other countries to open routes to Dubai and allowing Emirates to build its network. It has streamlined immigration and visa policies, making it easier for people to pass through or stay. It has made sure that airport and air traffic control capacity has kept ahead of demand.”
The Economist goes on: “The government’s approach is to say, ‘Whatever you do, don’t restrain aviation in any way.’ ”
In the U.S., by contrast, we open the skies then tax the hell out of them.
The government must get out of the business of the airline business. Safety regulation is one thing. Most other rule-makings cite consumer protection as the basis for regulation and in most cases the negatives from unintended consequences outweigh any possible benefit that the regulatory action seeks. The government has skewed the interests of airline companies, airline customers and those that serve the airline industry — all in the name of consumer protection.
The government does a disservice to the market when it claims that consumers are disserviced by the airline industry. In this industry as in any other, you get what you pay for. Regulators overstep their bounds with oppressive taxes, fees, the 3-hour tarmac delay rule and most other unnecessary burdens imposed on the industry in the interest of making headlines for politicians. Now the government wants “full transparency” on fees in a way that will impose yet another administrative burden on airlines. To what benefit?
To add insult to that injury, the administration’s 2012 budget proposal proposes to levy a $100 fee for every airplane departure in controlled airspace, costing passengers and the industry more than a billion dollars a year. It also seeks to double the “security tax” paid by passengers to $5 per one-way trip, and triple the tax to $7.50 by 2017. The total price tag for that proposal: $25 billion — $15 billion of which would be diverted for deficit reduction. The proposals together will cost passengers and the industry $36 billion over the next 10 years.
Isn’t it ironic that the government is seeking to put an incremental $36 billion in taxes over 10 years on an industry that lost $65 billion over the past 10 years? That’s no path to recovery.
Let’s not forget, also, that the airline industry is the third greatest producer of economic activity in the U.S. There is no way the industry can absorb this level of financial and regulatory pressure without negatively impacting airlines and their role in driving economic activity. The industry’s first response would be to remove marginal capacity. And much of that capacity reduction will likely be the elimination of many small airport markets — the very service that many elected officials seek to protect.
Too often, anecdotal evidence and emotion driven by a populist appeal drives regulatory policy in the United States. With the airline industry already in fierce competition for customers and revenue, the industry is more than capable of addressing most of its issues on its own. But Congress is too quick to seek a legislative solution, and the executive branch to seek a regulatory action, where the private sector should prevail. And in these cases, it is clear that very little thought is given to the unintended consequences of this knee-jerk policy formulation.
More time should be spent in the halls of government on how to enable the U.S. airline industry to again be considered a world leader rather than the direction many are heading: a second-class system designed to feed traffic to carriers proudly flying other nations’ flags.
Images courtesy of William Swelbar.
This question-and-answer session was produced as part of SmartBrief’s 2011 Best Of reports, which capture the year’s most important stories in each industry. Sign up now for Airlines for America SmartBrief to get tomorrow’s report on the top must-read stories from the aviation industry.