Airline industry: Sinking funds into bottomless pit

Warren Buffet in one of his popular quotes said the worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. WOLE SHADARE writes why airlines are perennially troubled

Perennial trouble

Why are airlines perennially troubled? That is the question agitating the minds of many stakeholders. Amid the gloom, many are still interested in investing in the business only to express their frustrations and regrets a few years into the business.

Some, citing the dismal state of the industry, believe greater government regulation is called for. The most central question is whether airlines are for-profit commercial businesses any longer.

Few industries can claim sixty years of increasing demand and falling unit costs, yet still fail to post a profit, let alone cover the cost of capital.

Commercial airlines have low-profit margins, with the sector average at a meagre 2% or less. Such is the capital-intensive nature of the industry, coupled with extensive competition as fluctuating demand contributes to these low margins in the Nigerian aviation industry

In recent times, the airline industry has taken a hit as far as profitability. With multiple avenues directed towards increasing costs for the industry, along with specialized circumstances of the present create a unique environment for lower profit margins.

Rising fuel prices, multiple taxes, Forex scarcity and stricter safety regulations have made the cost of operation soar while profitability remains low as travel limitations stay in place. It is necessary to recognize how this time is more challenging for the airline industry and what can be done to pave the way for a better financial future.

In Europe, the United States and Asia, the story is the same. While in Nigeria and other parts of Africa, airline operators are exhausted looking for where to get help, these other nations have a more favourable environment for businesses to thrive.

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Slightly different in other climes

Airline businesses in Europe and the United States are more sophisticated as many of them have either joined one alliance or the other. Some have formed mergers to remain not only relevant but profitable. They daily invent and innovate to see how they can consolidate.

American Airlines and US Airways merged in 2013, leading to the retirement of the US Airways brand. The merger brought together two of the oldest airlines in the United States. It created the world’s largest airline at the time. This article looks back at the two airlines before they merged, the details of the merger, and its challenges.

The “big four” US airlines – American Airlines, Southwest Airlines, Delta Airlines, and United Airlines – have by far the most capacity, accounting for 74% of US airline seats, a total of just under 73 million between them.

At the time of the Air France-KLM merger, the coming together of these two airlines formed the world’s biggest carrier by revenue. It changed the shape of aviation, not just in Europe, but in the US too. Why did these airlines make the decisions they did and go ahead with such a merger?

To understand the impetus behind the KLM and Air France merger, it’s important to understand where these airlines were coming from. Particularly KLM had been one of the earliest pioneers of alliances, seeing the benefit in strategically aligning with airlines elsewhere both for its revenue prospects and for the convenience of its passengers.

Wyman’s analysis

According to an analysis by Oliver Wyman at the Wall Street Journal, many of the carriers in Europe and America only make $164 for every $16,400 they spend on the typical domestic flight, according to an analysis by Oliver Wyman at the Wall Street Journal. That’s a ridiculously low 1% profit margin.

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The rest of the money goes to fuel (29%), salaries (20%), ownership costs (16%), government fees and taxes (14%), maintenance (11%), and other (9%)

The biggest thing eating away at profit is fuel, which has grown steadily more expensive. You can figure out what will happen if it keeps rising.

In Nigeria, a typical air ticket costs between N75,000 and N80,000 (About $70) for an hour flight depending on the time of purchase. What goes to an airline is less than N30, 000 notwithstanding the padding of the costs showing the breakdown of the entire costs and what goes to various agencies including suppliers of jet fuel and others.

Nigerian carriers’ are in dire straits

A breakdown of flight tickets on domestic routes gives the components of airfare which include the base fare, surcharges, taxes, and service fees, among others. In most cases, the surcharges are higher than the actual fare.

An analysis of an airline return economy ticket from Abuja to Lagos showed that the total cost is N70,000  but only N25,400 of the total cost is charged for the ticket fare, with the remaining N45,000 going as either surcharges, taxes, or fees.

Chief Executive Officer of Aero Contractors, Capt. Ado Sanusi said that the taxes and charges payable to the government were usually clearly defined on the ticket, adding that fuel surcharges also formed part of the add-on charges.

While jet fuel is skyrocketing, the high cost of aircraft maintenance with the scarcity of foreign exchange and the devaluation of the Naira has further worsened the precarious situation of the airlines and one that has wiped off any marginal profit they rely on to remain in business.

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Experts’ views

Something must surely give the Chief Operating Officer (COO), Mr. George Uriesi stated at the Aviacargo conference held last year in Lagos.

According to him, insurance, one of the dollar-based payment components of any airline business is a sine qua non, and with the rising cost of the dollar so increases the losses.

He stated that the airline’s losses are those accumulated in dollars due to rising costs.

He said,” Insurance is a growing problem and because we cannot fly an uninsured aircraft we have no choice but to hang in there and source for the dollars to do the insurance.

Expressing his frustration at the airline business in the country, he said, “I don’t know but there is a point we get to, we may not be able to do it again but I hope we don’t get there.”

On raising fares to reflect current realities he said,” You cannot increase fares ad-infinitum, at some point you get to where na only you and your aeroplane go dey fly‘ so you have to first struggle where you are. We have not raised fares because at this point, if you attempt to do it, you’d be flying empty.

Last line

Airlines provide a vital service, but factors including the continuing existence of loss-making carriers, bloated cost structure, vulnerability to exogenous events and a reputation for poor service combine to present a huge impediment to profitability.

 

Wole Shadare