Airlines don’t make profits

Over the last forty years, airlines have not been profitable. Despite the massive and ongoing growth in air travel, the whole industry has manged to return an average of about 0.1% on revenue, which is as close to zero as makes no difference. So what happened and what’s going to happen when airlines start getting serious about their carbon emissions?

These numbers come from the International Air Transport Association’s Vison 2050 report, which is a great study with a gaping hole, but more on that later. It’s an awesome long-term review, looking at the whole value chain across the industry and asking why the hell is happening when the airline industry can bring in $12 trillion dollars over it’s history and still not be a good investment. Sure, airlines can pay their bills overall, but the only airlines that do better than breaking even seem to do so through luck or one-off factors.

There’s a solid breakdown of airline competition using Porter’s “Five forces” analysis that point to a whole bunch of factors that drive profits down. We’re all pretty aware of what the internet has done to the bargaining power of customers – I can haul up any number of price comparison sites to find out the cheapest tickets on whatever airline. There’s little customer loyalty, a seat is a seat, so no premium prices there.

And then there’s the matter that seats are perishable – the plane is going to be flying anyway, so any seat sold is extra income, thus we have sites like Grabaseat or Last Minute, specifically to find buyers for the last few seats. That increases how full the planes are, but it also drives down customers’ expectations of what flights should cost and thus how many people are willing to pay the full prices that let airlines make a profit.

But those are just factors on the customer side, there’s also a whole heap of other factors driving prices down. There’s inherent overcapacity – when airlines go bankrupt, their planes get sold on and flown by another airline so capacity doesn’t go down. It’s difficult for airlines to get out of the market, there’s plenty of flag carriers who won’t vanish because of national pride (Air NZ, anyone?) and bankruptcy rules in the US let bankrupt airlines keep flying. Conversely, deregulation means it’s easy to set up new airlines and there’s advantages to doing so – you can follow the easyJet model of just flying one model of the newest, lowest-cost to operate plane and start kicking competitive arse, for a while at least.

Thus ticket prices keep going down and the number of people flying keeps going up. So where’s the money going? Who benefits? Well, to a large part, most of the benefit goes to customers – decade on decade, we’ve got cheaper mobility as most of the cost-cutting in airlines gets passed on to us as lower prices. A good deal of the mobility goes to airline employees – airlines jobs pay substantially more than other sectors of the economy because employees are still highly unionised. (Here’s your first take-home message from this report – join a union.) Who else? Airports are local monopolies, if you’re flying into Wellington, you’re flying into Wellington airport and there’s no competition in that, so airports inherently do well.

So yeah, great analysis in the report of why the industry doesn’t make profits. As for the vision, the report tries to ask “how can the airline industry carry on growing and improve profitability?” That’s where they really drop the ball, coz they pretty much ignore the elephant in the room that is climate change. There’s lip-service given to the idea that planes will get more efficient, use less fuel, and emit less carbon. Well, duh, they’ve been doing that for fifty years. What’s needed is some credible projections of rates of improvement and the report fails copiously to provide that. This is the key point for the long term future of the industry and the entire coverage in the report is “[biofuels] coupled with the aircraft and engine improvements, has meant an effective reduction in total aviation CO2 emissions to substantially less than half of pre-2005 levels, even though air traffic has greatly increased.” And that’s it. No mention of where those biofuels might come from, of the emissions from producing those biofuels, the knock-on effects on food production, or the rates of improvement in aircraft or engine efficiency. Basically, they’re calling for a miracle.

*headdesk*

Oh, and carbon offsets, apparently.

The key questions are how rapidly are planes going to improve their carbon efficiency, what kind of emissions trajectory will that cause, how can the industry respond to limits on greenhouse gas emissions, and how does that response affect profitability? And then what do those answers mean for the vision of the industry?

Right then:
*rolls up sleeves*

1) How rapidly will planes improve their carbon efficiency? About as fast as they’ve been improving for the last fifty years, so about 1.5% per year. There are no credible solutions that might deliver big reductions in emissions – in 2050 we’ll still be flying in airliners powered by energy-dense liquid fuels. Hell, the average service life of an airliner is 25 years, the planes we buy now will still be flying in 2038 so we’re locking in present-day efficiencies.

As for biofuels, the research summed up in Lee’s paper on “Bridging the Aviation CO2 gap” suggests we’re looking at a saving of possibly 5% by 2050, 15% tops if biofuels are everything we hope for. That’s a reduction in emissions of maybe 2% per year.

2) What kind of emissions trajectory? While all of these efficiency and biofuel improvements are happening, if passenger numbers carry on upwards at 5% per year, as they have done for the past few decades, then total emissions from the airline industry carry on going up. Now, we’re hoping for a world with ever-falling emissions and various scientific bodies have pointed to the need for 50% overall emissions cuts by 2050 if we want to avoid the worst of climate change. So there’s a gap there. Just a tad.

3) So what would be a credible response for the aviation industry? It isn’t one that ignores increasing emissions. If they had some guts, then they could stand up and say clearly “aviation is awesome and, no matter what the cost, people are going to continue to want to fly”. You can, I think, make a credible position that emissions from aviation are going to go up and that’s ok, because the benefit of more aviation outweighs the impact on the climate.

If the IATA had said that, they’d have some credibility.

In that case, if you want a global cap on total emissions, and you do, then airlines need to be paying other sectors to reduce the emissions from those sectors, above and beyond what those sectors would do anyway. That’s the basis of emissions trading – it doesn’t matter where emissions reductions come from, it’s just a case of joining up emissions reduction opportunities with emitters who are willing to pay for that reduction. That’s covered in the “Bridging the Aviation CO2 gap” paper, where they talk about the role of market-based mechanisms for reducing emissions from the aviation sector. That’s just economist speak for airlines buying emissions rights off other companies and that’s fine.

4) How does this affect profitability? That’s where this starts to get tricky for the airlines, but for the rest of us, the last forty years have shown that planes are going to be flying anyway, whether they are making a profit or not, because planes are awesome.

3 thoughts on “Airlines don’t make profits”

  1. In my understanding the airline (and civilian aircraft) industry has *always* lost money for its owners since the first passenger aircraft flew. (In this it’s a forerunner of the Internet / new media industry).

    As you note, there’s always a fool in the market willing to lose money and undercut the competition.

  2. Hey Jez, interesting review. From the US perspective, the big problem here is lack of hi-speed rail (outside the northeast corridor) which forces reliance on air for most domestic travel over 3-400 miles (i.e. anything more than 5-6 hours in a car).

    Most small cities (<1m population) have an airport with connecting flights to a hub. Hell, even small towns (100k) in rural states have an airport with half-a-dozen flights per day (usually turboprop, so slightly better on emissions than jets). The federal government mandates some of these services be provided, even though the planes are often empty and the airlines have been lobbying to shut them down. It often comes down to congressional tricks and kick-backs – congressman X votes for a certain bill on condition that air service to his little town is maintained.

    This even goes on for large cities…. for Rochester NY (~1m) where I live, Senator Chuck Schumer is lobbying to have Delta take over daily service to Altanta (major hub) after the small airline currently providing service announced it would stop this summer. A lot of places also have "hangover" service to politically important places from the days when they had large industries with powerful lobbies… for example here we have 10 flights a day to Washington DC and NYC, mostly because the folks at Kodak and Xerox (both pretty much imploded now) used to go there a lot. It's convenient and nice, but not exactly necessary.

    The way to drive down passenger #s is to simply cut back on the # of landing slots at major airports, and give priority to those catering to business instead of leisure. There are some hints that this may already be happening with the US budget sequester on federal air-traffic controllers. When faced with a choice between taking off a plane full of business-people essential to the local economy, or a plane full of tourists on their way to a Caribbean island for vacation, there's obviously some room to "trim the fat".

    1. Yup, the IATA has a good deal to say about the difficulty of airlines getting out of unprofitable routes and, in the US at least, the ease of bankrupt airlines remaining as zombie fliers. There’s an asymmetry in how the market responds to demand and supply – excess demand pushes up capacity very rapidly, but that capacity falls only slowly in response to excess supply. So while cutting back on landing slots would push up prices, from the point of view of any particular airport, more landings means more income to that airport, so there’s no strong incentive here for individual airports to act in support of the overall industry.

      And what could be said about high-speed rail in the US could fill several volumes of face-palming. I’ve seen estimates putting the cost of building rail in the US at twice that of the cost per km in Europe, mostly down to bureaucracy and an excess of people clipping the ticket before a single rail is laid. In other news, China is building a thousand kilometers of high speed rail each year.

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