Is the Sky the Limit? An Examination of the Airline Industry

By Sumantra Banerjee (New York University) & Sarah You (Western University)


Table of Contents


Synopsis:

  1. Briefly introduces the airline industry and addresses key players

Industry analysis:

  1. Part 1: External analysis: external factors around the world that influences performance of the airline industry using PESTLE analysis

  2. Part 2: Internal analysis: examines strengths and weaknesses within airline industry using Porter’s Five Forces model

Significant trends:

  1. Identifies major recent and ongoing trends that influence the airline industry

I. Impact of COVID-19

  1. The COVID vaccine and implications on the airline industry

  2. Differences in performance recovery across nations

II. Impact of oil prices

Conclusion:

  1. Summarizes main points discussed in this report and gives overall judgement on outlook


Synopsis


The airline industry is pivotal to the global economy by enabling and facilitating tourism and trade, having contributed to over 87 million jobs globally and $3.5 trillion (around 4.1 %) to the World’s GDP. Unfortunately, the ongoing COVID-19 pandemic has undoubtedly significantly limited corporate and individual travel, threatening airlines and their ability to generate revenue, employee retention, and market position. Additionally, the industry is deeply tied with oil prices, which is fluctuating almost on a whim.



External Analysis


To analyze external factors impacting the airline industry the PESTLE model was used. This framework is useful in understanding the macro environment of the landscape by scrutinizing political, environmental, social, technological and legal drivers.


Politics plays a key role in travel and tourism, as in many countries, airlines operate in an environment with stringent regulations. These regulations are often tightened by trade policies, war, terrorism, and disease outbreaks such as COVID-19. Government intervention is thus required in aviation to maintain passengers’ safety.


Moreover, following 9/11 and the subsequent recent terrorist attacks, airlines have increased security measures to assure customers about their safety. These measures may inconvenience customers considering they require earlier arrivals to airports and more buffer time spent between entering the airport and reaching the gate. While inconvenient, airlines cannot afford to compromise on security measures following the significant losses from events such as 9/11.


In order to reduce the financial burden the pandemic has brought to the airline industry and workers, the US government issued $58 billion in grants and loans to major airlines as part of its CARES (Coronavirus Aid, Relief, and Economic Security) Act, passed in March 2020. European airlines have sought over €42 billion in relief funding as of January, with German airline Lufthansa receiving €7 billion, the greatest amount out of any European airline.


Economically, most of the air travel industry is heavily dependent on traffic from individuals. This makes the industry as a whole quite cyclical, meaning the industry depends on global economic performance. If a country enters a recession, airlines face significant losses in revenue. As world economies remain unstable following the COVID-19 pandemic, revenues of these airline companies are likely still going to be stifled.


As profits began decreasing due to the maturity of the industry, a new model of delivering flight services emerged. Pioneered by Southwest Airlines, low-cost carriers adopted a model meant to minimize costs at every level, including elimination of most services on standard fleets and high reuse of few aircraft. Although not exactly an untapped territory, the rise of low-cost carrier airlines is still a new phenomenon, and has immense room for growth and generating consumer value.


Many societal factors have also impacted the industry. Impeccable customer service is essential for airlines to stay competitive, as consumers have increasingly demanded better and more comprehensive services from flights. This trend has heightened competition between carriers, as only the top airlines have the capacity to provide enough comforts to customers at low prices. Additionally, customers have become more economically-minded; coupled with the advancement of communication technologies, corporate clients have less need to send their employees abroad on business class trips.


Airlines are increasingly utilizing technology to reduce costs and remain competitive. Implementing technology-related infrastructure and personnel is a costly investment, but the high cost can be offset by the potentially significant reduction of expenses. For example, airlines can use machine learning algorithms to help forecast demand and mitigate revenue losses from spoilage (which refers to seats not sold). Moreover, airlines can utilize artificial intelligence and predictive analytics to improve airplane health as nearly 30% of total delay time is caused by unplanned maintenance. By predicting maintenance issues, airlines can reduce delays and improve both revenue and customer satisfaction.


Airlines must comply with legal requirements and regulations set by countries in order to stay in business and retain their reputation for having safe flights. Transportation services and companies may often face difficulties in navigating international and domestic laws. Thus, many businesses spend on hiring aviation attorneys to ensure they do not face legal damages. Airlines may also need to consult legal professionals to handle customer-related issues, such as injuries, accidents, loss of property, etc.


Finally, operating airlines have significant impacts on the environment. One of the airline industry’s greatest and most significant expenditures is fuel, and airlines must invest in fuel-efficient infrastructure to protect both environmental and financial health. Airlines must work to reduce their carbon footprint, as carbon emissions lead to global warming and disarranged weather patterns. In fact, British low-cost airline EasyJet became the first major airline with net zero carbon emissions in November 2019. Coupled with awareness of climate change growing and epitomized by climate activists such as Greta Thunberg, airlines will likely follow suit to EasyJet to prevent customers from flying less whilst staying competitive amid changing societal values.


This analysis, although thorough, is still subject to limitations of the PESTLE framework, namely the omission of the complex and fickle relationships within the airline industry worldwide; a more internal examination of the industry is required for further evaluation of the micro and macro backdrop.



Internal Analysis


In order to understand internally how the airline industry works, the Porter’s Five Forces model is employed to examine relationships within the industry through intensity of competition, ease of entrance for newcomers, ease of substitution, power of suppliers, and power of buyer groups.


As a mature, highly saturated industry, competition is fierce among the flagship carriers, and the increasing adoption of the low-cost model would only serve as further threats and disruption to the industry. Although over 65% of the US market is held by American, Delta, Southwest and United Airlines, internationally, the same “big four” account for less than 20% of the industry market share.


Figure 1: Breakdown of global major airlines by market share, circa 2019. (T4)


Most of the market share is held by the hundreds of carriers operating in different countries, as such there is no player that can significantly impact the industry on a global scale.


The air travel industry requires a high fixed cost base in the form of purchased aircraft and corresponding maintenance, generating economies of scale. Additionally, incoming airlines also face additional barriers with eligibility to operate in airports. One such barrier involves the way airlines earn revenue by signing long-term exclusive gate leases with air travel companies, leaving few openings for incomers to land their planes. Additionally, for international flights, governmental approval must be received to operate within their respective airspaces, a process that can take months. These three factors contribute to the extremely high barriers of entry and low potential of newcomers eroding market shares.


Though there are many airline suppliers, they far outnumber the airlines they sell to, an asymmetry that puts considerable power in the hands of airlines. Suppliers thus have low bargaining power and must maintain quality relationships with their customers, as airlines, especially large players such as Delta or American, represent large proportions of the suppliers’ sales volumes. While airlines can easily switch suppliers, suppliers cannot afford to lose their large clients.


Despite flight services provided between companies being indistinguishable, the mode of transportation has effectively no close substitutes when it comes to transporting people and time-sensitive cargo, as the high value for each unit of the good offsets the very expensive prices for air freight. Regardless if they provide service for people or goods, air travel companies possess a service that has no close substitute in terms of efficiency.


For the US, 75% of airline revenue comes from commercial passengers; most of which are business travellers, who are on average twice as profitable as a leisure traveller, sometimes making up three-quarters of an airline’s revenue. Most business travellers are more concerned over the time and the overall comfort, so they are much more willing to pay higher prices. Airlines can attract remaining travellers with heavy discounts and partnerships with travel agencies to fill up each plane and minimize potential losses. As such, airline companies can operate without worrying over any particular pressure exerted from significant buying groups.


Once again, although this model provides a highly structured outlook of the internal environment of the airline industry, it overgeneralizes the complex operational models employed within the airline industry. Additionally, the model is overly rigorous when it comes to analyzing aspects of the industry where relevant information is not readily available such as concrete revenues made from passengers by flight class.



Significant Trends


The COVID-19 pandemic has not only led to government intervention and companies going remote, but also the fear of travel among consumers, contributing to the loss of many jobs in the airline industry. The US airline transportation-related employment has seen a reduction of over 100,000 jobs according to the US Labor Department, much higher than post-9/11 or the 2008 recession. Furthermore, according to travel and hotel data analytics firm Cirium, 21 years of global passenger growth were wiped out by the downturn caused by the pandemic. At the end of the day, airlines are struggling to make profits, as lobbying group Airlines for America declared that American carriers are losing more than $180 million per day as of December 2020. As seen in Fig 2., US ticket sales are on a slow recovery, but still down over 57% year-over-year. Passenger traffic went down 67% in 2020 from 2019, revenue passenger kilometers (RPKs) decreased by 5.8 trillion, and over 40 airlines shut down or suspended operations, with more expected follow in 2021.


Figure 2: Tickets issued by American travel agencies and booking companies (CNN)


While a strong 2021 summer is all but necessary for airlines’ financial health, the slow vaccine distribution and continued consumer discomfort may imply another weak travel season. However, as distribution progresses and governments open up borders, airlines may benefit from a revived desire and comfort with travel and see a crucially successful end of the year. Nevertheless, according to Ben Baldanza, former CEO of low-cost US carrier Spirit Airlines, at least one US airline will file for bankruptcy protection within the year due to the unsustainable rate at which airlines are experiencing losses.


However, airlines’ current struggles with the pandemic are not universal. In China, where cases have declined much earlier and faster, air travel has seen nearly a full recovery. By August 2020, domestic arrivals were 86% of their 2019 levels. Chinese airlines have utilized the country’s strong domestic travel market and aggressive low pricing strategies to boost demand and help China become the first major country to see a revival in aviation.


An ongoing trend affecting the air travel industry in the long term involves oil prices. As one of the major costs for air travel companies, fluctuations in oil prices have significant impacts on the industry’s performance. For example, from 2014-2016, oil prices faced a worldwide drop for a variety of reasons, both economic and political. Since no major recessions occurred for most of the world, the industry enjoyed slow but steady returns. As the global economy slowly returns back to normal following the deployment of vaccines, the airline industry would still be able to take advantage of the initial oil slump from the steep price drop in 2020.



Conclusion


The airline industry still enjoys some benefits as a highly oligopolized industry, such as high barriers of entry, low potential for substitution, and limited power of suppliers and customers. However, after deregulation of the industry beginning in the late 70s, the market has become increasingly more competitive, with some regions much more fierce than others. Additionally, as an industry with a high fixed cost base and an almost luxury service, the airline industry is heavily influenced by external political, economic and social factors, as shown by the recent COVID-19 pandemic. Although airlines are adapting to new technologies and operation models to optimize their performance, the horizon is still not looking promising.


There are still a few means by which current players in the air travel industry can increase profitability, with the most optimal strategy being the adaptation of a low-cost flying model to eliminate any inefficiencies. Additionally, as more manufactured goods today become increasingly time-sensitive, air shipping will still be an untapped market with immense room for growth. As for aspiring entrants, however, one might find better opportunities in other industries.