Coronavirus has created the greatest challenge the airline industry has ever faced. For the large legacy carriers serving intercontinental markets, the threat is comparable to the meteor that caused massive climate change and drove dinosaurs into extinction. While the industry was clearly viable prior to coronavirus, it faced a number of serious competitive and financial issues that will impede efforts to deal with the impact of the coronavirus meteor.
The industry requires major, painful restructuring. Baring staggering increases in taxpayer subsidies (beyond the $60 billion already pledged in the US), it is unclear how most (perhaps any) of these carriers survive under current ownership in anything like their current form. None of the changes needed to ensure the long-term efficiency and competitiveness of the airline industry are even being discussed at this point, and the processes needed to manage the needed restructuring do not currently exist.
The Financial Devastation Directly Caused by Coronavirus
Airline economics depend critically on extremely high capacity utilization. Small changes have huge profit leverage. US airlines filled 85% of their seats in 2019 (up from 58% when the industry was deregulated and 70% 20 years ago). Once an airline has committed to the costs of operating a given schedule, almost all of the lost revenue from a shortfall of passengers directly reduces the bottom line.
Coronavirus-driven traffic losses have been vastly larger than anyone could have ever imagined. Traffic through TSA checkpoints in US airports was down 96% versus the year before in mid April and 88% in mid-May. While the industry had faced demand shocks in the past (9/11 in the US, various wars, the original SARS outbreak in Asia), none were global in scope, and none were seen as driving permanent declines in demand. Never before has flying on an airplane required accepting serious medical risk. In a recent poll only 23% of US travelers thought flying on an airplane was safe. [FN1]
While no one knows what will happen, this analysis assumes that there is no widely available vaccine and no reliable way to prove individual immunity during 2020. Perhaps infection rates decline gradually and economic activity gradually increases. Perhaps there are new outbreaks and efforts to reopen the economy are put on hold. Perhaps economic activity declines seriously as companies realize that recent losses are unsustainable, and major new waves of layoffs and bankruptcies occur. But the idea of a rapid, “V-shaped” recovery to the January status quo seems wildly improbable.
The revenue losses have been even worse than the drop in passenger counts. Airline profits depend heavily on business travelers paying higher fares. But the gradual increase in domestic traffic appears to be almost exclusively leisure demand, such as pent up desire to visit family members. Corporate travel remains close to zero, [FN2] and the massive short-term substitution of videoconferencing may reduce business travel for years to come.
The profitability of the large US legacy carriers (Delta, United, American) also depends heavily on intercontinental traffic, which has fallen even further than domestic traffic. Cross-border travel bans have been key to slowing the spread of the virus, and the point where the mass market is no longer concerned with the health risks is somewhere in the distant future.
Profitability requires very tightly aligning an airlines’ cost structure with its revenue base. Airlines lock-in to most of their costs (e.g. fleet, airport facilities, IT infrastructure, corporate debt) on lower-cost long-term arrangements because historically they have had very high certainty about future demand. Contracts with labor and suppliers are similarly inflexible, with major penalties if they are suddenly terminated.
In the short-term (3-9 months) airlines might be able to readily shed 10-20% of their costs. Over two years, cost reductions of 30-40% might be possible, depending on the timing of contracts. But revenue can vanish overnight, while cost efficiency plummets and cost per passenger skyrockets. The much smaller demand shocks of the past (the post-dotcom and 2008 financial collapses, fuel prices suddenly exceeding $100/bbl) were highly traumatic, leading to years of major losses. The cost per passenger impact of the coronavirus “meteor striking Earth” magnitude shock is far worse, and (unlike previous crises) there is major risk that it may be many years before demand fully recovers. (...)
This industry financial crisis extends across the entire airline ecosystem. Airports, distribution providers (Expedia, Booking.com, Sabre, etc) and service contractors have all had revenues largely disappear, without having comparable access to multi-billion dollar taxpayer subsidies. Those contractors employ staff paid much less than airline employees. Since most have no access to payroll protection subsidies. they have implemented major layoffs. Current obligations to aircraft/engine manufacturers and lessors remain in place but are not sustainable.
The industry requires major, painful restructuring. Baring staggering increases in taxpayer subsidies (beyond the $60 billion already pledged in the US), it is unclear how most (perhaps any) of these carriers survive under current ownership in anything like their current form. None of the changes needed to ensure the long-term efficiency and competitiveness of the airline industry are even being discussed at this point, and the processes needed to manage the needed restructuring do not currently exist.
The Financial Devastation Directly Caused by Coronavirus
Airline economics depend critically on extremely high capacity utilization. Small changes have huge profit leverage. US airlines filled 85% of their seats in 2019 (up from 58% when the industry was deregulated and 70% 20 years ago). Once an airline has committed to the costs of operating a given schedule, almost all of the lost revenue from a shortfall of passengers directly reduces the bottom line.
Coronavirus-driven traffic losses have been vastly larger than anyone could have ever imagined. Traffic through TSA checkpoints in US airports was down 96% versus the year before in mid April and 88% in mid-May. While the industry had faced demand shocks in the past (9/11 in the US, various wars, the original SARS outbreak in Asia), none were global in scope, and none were seen as driving permanent declines in demand. Never before has flying on an airplane required accepting serious medical risk. In a recent poll only 23% of US travelers thought flying on an airplane was safe. [FN1]
While no one knows what will happen, this analysis assumes that there is no widely available vaccine and no reliable way to prove individual immunity during 2020. Perhaps infection rates decline gradually and economic activity gradually increases. Perhaps there are new outbreaks and efforts to reopen the economy are put on hold. Perhaps economic activity declines seriously as companies realize that recent losses are unsustainable, and major new waves of layoffs and bankruptcies occur. But the idea of a rapid, “V-shaped” recovery to the January status quo seems wildly improbable.
The revenue losses have been even worse than the drop in passenger counts. Airline profits depend heavily on business travelers paying higher fares. But the gradual increase in domestic traffic appears to be almost exclusively leisure demand, such as pent up desire to visit family members. Corporate travel remains close to zero, [FN2] and the massive short-term substitution of videoconferencing may reduce business travel for years to come.
The profitability of the large US legacy carriers (Delta, United, American) also depends heavily on intercontinental traffic, which has fallen even further than domestic traffic. Cross-border travel bans have been key to slowing the spread of the virus, and the point where the mass market is no longer concerned with the health risks is somewhere in the distant future.
Profitability requires very tightly aligning an airlines’ cost structure with its revenue base. Airlines lock-in to most of their costs (e.g. fleet, airport facilities, IT infrastructure, corporate debt) on lower-cost long-term arrangements because historically they have had very high certainty about future demand. Contracts with labor and suppliers are similarly inflexible, with major penalties if they are suddenly terminated.
In the short-term (3-9 months) airlines might be able to readily shed 10-20% of their costs. Over two years, cost reductions of 30-40% might be possible, depending on the timing of contracts. But revenue can vanish overnight, while cost efficiency plummets and cost per passenger skyrockets. The much smaller demand shocks of the past (the post-dotcom and 2008 financial collapses, fuel prices suddenly exceeding $100/bbl) were highly traumatic, leading to years of major losses. The cost per passenger impact of the coronavirus “meteor striking Earth” magnitude shock is far worse, and (unlike previous crises) there is major risk that it may be many years before demand fully recovers. (...)
This industry financial crisis extends across the entire airline ecosystem. Airports, distribution providers (Expedia, Booking.com, Sabre, etc) and service contractors have all had revenues largely disappear, without having comparable access to multi-billion dollar taxpayer subsidies. Those contractors employ staff paid much less than airline employees. Since most have no access to payroll protection subsidies. they have implemented major layoffs. Current obligations to aircraft/engine manufacturers and lessors remain in place but are not sustainable.
by Hubert Horan, Naked Capitalism | Read more:
[ed. See also: The Chilling Things Delta Said about the Airline Business, the 90% Collapse in Q2 Revenues, and Why Some Demand Destruction May Be “Permanent” (Wolf Street).]
