Think Again: Airlines

"The Airline Industry Is Going to Collapse"

Never. Given the headlines of the past few years, it’s not surprising that people think airlines are on the brink of disaster. Household names such as Canadian, Swissair, and TWA have disappeared. During the past five years, the industry has hemorrhaged more than $1 million an hour, racking up losses in excess of $43 billion. But total collapse is not on the horizon. More than 2 billion people fly each year, a number that grows by nearly 6 percent annually. More than $3.2 trillion worth of cargo is transported by air each year. Simply put, globalization, as we know it, would cease without the airline industry.

It is true, however, that many airlines are limping along. Today, 50 percent of the U.S. airline industry has filed for bankruptcy, including major players such as Delta, Northwest, and United Airlines. Last year alone, North American carriers lost well in excess of $8 billion. But the rest of the world doesn’t have it so bad. European airlines are breaking even, with some even turning a profit. And Asian carriers are actually enjoying their fifth consecutive year in the black, with $1 billion in profits in 2005. To be sure, in a competitive industry with tight profit margins, every airline faces challenges staying aloft. But U.S. airlines have it far worse than most, because of hypercompetitive domestic markets and a labor force that is reluctant to change with the industry.

Countless businesses have been buoyed by the lowering of trade barriers, but airlines suffer because they still face enormous hurdles. The airline industry was among the first to operate globally, but it is still waiting for the benefits of globalization. Do we purchase cars or medications based on the nationality of a company’s shareholders? If an Egyptian can spend a night at a Singaporean hotel in Hamburg, why can’t an Australian fly a Brazilian airline from Mexico City to Miami? Airlines support 29 million jobs and $2.9 trillion worth of economic activity worldwide. Few industries so vital to the health of the global economy remain so restricted by archaic ownership rules.

"The Airline Industry Can Never Be Profitable"

Not so. A complex mix of factors has led to the industry’s current state of crisis. For starters, an enormous amount of an airline’s costs is fixed. Ten percent of costs go to monopoly suppliers such as airports and air navigation services. Labor is stubbornly difficult to control, accounting for an average of 20 percent of costs in Asia, 30 percent in Europe, and 38 percent in the United States. And one expense that is extremely volatile for airlines — the price of oil — has skyrocketed. Fuel is now a $97 billion bill that takes up an average of 25 percent of costs. If last year’s oil prices were at the 2002 level of $25 a barrel, airlines would have made a profit of 5 percent. Airlines have responded with deeper cost-cutting and streamlining, but it’s like fighting a serious illness with cosmetic surgery.

Airlines would become profitable if they were run like an equally strategic global industry, telecommunications. As the telecom sector was deregulated in the 1990s, key markets, such as Britain, Germany, and Japan, saw the price they could offer consumers decline by 30 percent or more. Airlines experienced the same drop in prices. So why is the global telecommunications industry so healthy while airlines continue to lose billions? Again, the answer is consolidation. A handful of telecommunication companies have developed into global businesses. Look at the British company Vodafone, which operates under its own brand in practically every major market in the world. No airline is allowed to approach anywhere near that model of success. Most countries remain content to treat airlines like cash cows, forever milking them with national prerogatives and taxes that raise the cost of doing business. Profitability will not be possible until governments get out of the way and allow airlines to join the globalized world that they were instrumental in creating.

"The Demand for Air Travel Remains Soft"

No. Despite severe shocks in recent years — including the attacks of Sept. 11, 2001, and outbreaks of avian flu — the demand for air travel is at record levels and is expected to grow an average of 6 percent each year for the foreseeable future. People need to fly. More important, people want to fly. World air travel declined only twice in the past three decades. The first time was during the first Gulf War, when four major American airlines went bankrupt; the second was 2001 through 2003. Less than two months after the World Health Organization gave the all-clear for travelers in SARS-affected regions, the number of passengers flying into Hong Kong’s airport had more than made up for losses during the scare.

If history is a guide, the world’s airline industry will double in size every 15 years. That means that by 2020, passenger numbers will grow from 2 billion to 4 billion. Cargo will increase from 39.5 million tons to 79 million tons. Moreover, air traffic typically grows at twice the rate of gross domestic product. Therefore, in booming economies, the demand for air travel will be particularly high. Air India has ordered 68 Boeing planes, one of the largest aircraft orders ever. And new, no-frills airlines such as Kingfisher and SpiceJet have taken off in India, where passenger demand is expected to grow by almost 12 percent annually during the next four years. The rate will be even higher in China. Nearly 30 million Chinese traveled abroad last year; the World Tourism Organization predicts that figure will exceed 100 million in 15 years. Its inbound traffic will increase too, as China becomes the No. 1 destination for foreigners with 137 million visitors expected in 2020.

"It’s Never Been Safer to Fly"

Yes, but some regions are less safe than others. Despite financial difficulties, airlines still offer the safest form of transportation. In 2004, 428 people lost their lives in air accidents. But airlines carry 2 billion passengers annually. Compare that to 1945, when 9 million people flew with a similar number of fatalities. Airlines have steadily become safer over the course of decades.

But the reality today is that the record differs greatly from region to region. The accident rate in Africa, for example, is almost seven times higher than the global average. African skies carry only 4.5 percent of total global traffic, yet they account for 25 percent of accidents. As with other industries, many countries in the developing world simply don’t have enough money or staff to devote to safety oversight. Moreover, airlines with limited resources often operate older aircraft, which require more rigorous maintenance. Still, for most of the world, safety has never been better. The first international standards audit for airline safety management is making improvements in all regions. Although only two years old, already 140 airlines, representing 70 percent of global traffic, have signed on to this industry-run program.

The same cannot be said for security. There is no doubt that airline security has been stepped up since the 2001 terrorist attacks, particularly in the U.S. domestic market. But, governments’ failure to harmonize measures around the world makes this progress more cumbersome than necessary. Travelers are familiar with the hassle of long airport security lines. But they may be less aware of the complex data processing that goes on behind the scenes. Many governments require airlines to submit passenger information in advance of arrival, and ask for similar data in multiple formats to different divisions within the same department. Out of a $5.6 billion security bill each year, more time and money is spent by airlines on battling bureaucracy than helping governments guard against terrorism.

"Airlines Need More Regulation"

Absolutely not. Many people mistakenly believe that deregulation is at the root of airlines’ troubles. They think the only solution to save the industry is to re-regulate, throw up barriers to market access, and turn airlines into something akin to a utility. But governments never truly deregulated airlines in the first place; they’ve only installed half-measures that offer the illusion of unfettered competition. Carriers remain at the mercy of monopoly suppliers — airports and air traffic control — that account for a bill of more than $42 billion each year.

Airlines do not need handouts, special treatment, or government subsidies. They simply need the basic freedom to do business like any other business — to serve markets where they exist, to merge or consolidate where it makes sense, and to make money or go bankrupt and die if necessary. Instead, airlines are stuck with absurd 60-year-old ownership rules that largely prevent them from consolidating across borders. This antiquated bilateral system was designed during an era in which many carriers were run by the state and international air travel was reserved for the elite. Airlines were beholden to Cold War foreign policy. That simply won’t work in a world where airlines are intensely competitive businesses operating a mass transit system for billions of travelers.

Governments need to review the international regulatory framework that controls air transport. Airlines ostensibly operate in a free market, but so far only Europe has truly liberalized. There has been some successful cross-border consolidation, with the merger of Air France and KLM in 2003 and Lufthansa’s gradual takeover of Swiss. But even they were cumbersome arrangements that didn’t allow for maximum economic benefit. The United States and the European Union are in negotiations to permit greater airline access across the Atlantic. Such an "open skies" deal will help, but governments could lift restrictions on the flow of commerce even further.

"Low-Cost Airlines Will Save the Industry"

Not Really. Any frequent flyer knows that air travel has never been cheaper. Relative newcomers such as the United States’ JetBlue, Malaysia’s Air Asia, and Brazil’s GOL have burst onto the scene in the middle of the airline industry’s greatest financial crisis — and have met with success. Southwest is the most profitable airline in the United States, and Ireland’s Ryanair consistently posts net profit margins of more than 20 percent. These airlines have forced change that is good for consumers and for the industry. Passengers can increasingly find comparable fares on major carriers and young upstarts.

Airlines are in a race to evolve into a low-cost industry, but the low-cost airlines alone won’t be equipped to get us there. Their model works most successfully only on voyages that are less than three hours. These flights also often avoid major hubs. By doing so, they can’t connect into networks that span the world. Furthermore, these airlines began with a big cost advantage because they didn’t have the legacy of decades of labor negotiations. This edge will erode as time progresses, as operations develop complexity and costs creep into the process.

The cost gap between low-cost carriers and the major airlines has narrowed from 93 percent to 66 percent in just three years. The success of Southwest and Ryanair are exceptions in the low-cost sector. Most of their competitors don’t generate enough money to cover their costs of capital. And even though some low-cost carriers may be profitable, many more go bankrupt. More likely, low-cost and traditional airlines will coexist — or merge. That will become even more evident as competition in the industry heats up.

"There Is No Room for Innovation in Air Travel"

Wrong. There are already fresh ideas to make flying more pleasurable and efficient in the future. The concept of all premium-class flights is gaining speed. Traditional carriers such as Lufthansa, as well as startups Eos and Maxjet, operate on strategic trans-Atlantic routes with planes that offer only luxury seating. Boeing recently completed the world’s longest nonstop flight, a 23-hour trip eastward from Hong Kong to London. Airlines from 13 countries have placed orders for the double-decker, 555-passenger Airbus A380, which is scheduled to fly commercial passengers this year. Some of these planes may include private bedrooms and spa services. Virgin Atlantic CEO Richard Branson has proposed sending tourists into space, and he plans someday to use plant waste to fuel his fleet. And a handful of startups are building ultralight jet planes that could service small regional airports as air taxis.

Some airports have already evolved from utilitarian flight terminals to grand shopping malls. The economic returns from filling a passenger’s time in the airport with good food and shopping has helped reduce the need for high landing fees. The next step is to ease a passenger’s ability to move through an airport. Today, you may be asked to pull out your passport and ticket as many as five times to board a plane. Biometric technology that scans your face and matches it to your flight information will someday offer a one-stop check-in. Long lines at airports could become history.

Twenty years ago, no one could have imagined that Dubai International Airport would be a hub for global travel. In 2025, the busiest markets could be locations that seem on the periphery today. Airline traffic in Asia could easily replace North America and Europe in size and importance. We will probably have fewer carriers. And not every country will have its flag on an aircraft tail. If unleashed, commercial forces will find the best way to safely and inexpensively move people and goods around the planet. Ultimately, for the airline industry, that is the only way to fly.