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Airlines: strategies of the world’s largest carriers
Worldwide, airline passenger volumes have been increasing steadily for decades, with only the occasional temporary downturn. Air transport of both passengers and freight is vital for the globalized economy. In the BRIC countries and other emerging economies, personal incomes are rising and making air travel accessible to a greater proportion of the population. This ought to be a good time to be in the airline industry, right?
Wrong. Airline profit margins are among the thinnest of any industry sector. According to IATA data, the global industry had an average operating margin of just 2.2% over the 2000-2015 period. The average net margin was close to zero. The years from 2010 have seen some improvement, with a forecast of 4% for net margin in 2015.
Profits are being squeezed because key costs are difficult to reduce, while intense price competition makes it hard to raise fares to compensate.
The biggest element of operating cost is fuel. IATA data shows that for the global airline industry, fuel accounted for 14% of total costs in 2000. In 2015, this had risen to 28%: an improvement on the 36% figure seen in 2008 at the height of the commodity boom, but still high by historic standards. Employee costs are also significant, especially where unions retain strong bargaining power.
Airlines can compete on service quality. However, especially on short-haul routes where the low-cost carriers are significant players, price competition is intense. The entry of Middle Eastern airlines like Etihad, often suspected of receiving state subsidy, is making it more difficult to maintain load factors on Europe-Asia routes. These factors mean that it is far from easy to translate the increased demand for air travel into top-line growth.
MarketLine’s latest case study examines the strategies of the world’s 10 largest airlines (in terms of passenger-km) to these profitability challenges. The companies fall into three categories.
Legacy carriers in developed economies focus on high service quality, with frequent flyer schemes to retain customers and see off competition from Middle Eastern challengers. They are generally keen to work within alliances and joint ventures to expand their offering through code-shares.
Legacy carriers in China have revenues currently dominated by domestic flights, where demand is rising steadily, but they are seeing faster growth in the smaller, international market. The benefits of alliances will become more obvious as their international revenues grow.
Budget airlines Ryanair and easyJet focus on short-haul flights in Europe, and eschew alliances and partnerships. Middle Eastern carriers with their long-haul focus are not a major threat. Also, they carry no cargo, which allows fast airport turnaround. Their fleets use a strictly limited range of aircraft models, to rationalize maintenance costs. Competing almost exclusively on price, they do not offer frequent flyer schemes.
All these airlines are investing in more fuel-efficient planes, which should cut their per-passenger-km costs, with the added bonus of reducing carbon dioxide emissions.
How effective have their strategies been? Over the 2010-2014 period, seven out of the ten airlines had average net margins higher than the global industry. Ryanair was the star performer, with net margins above 10% in each of those years.
The results show the importance of senior management having a deep understanding of their business model, identifying the most relevant opportunities and threats, and formulating strategic responses. But the next few years, in which oil prices are likely to start rising again, will put their current strategies to the test.