Since price and therefore demand side is more volatile, it is more desirable especially for financial institutions funding airlines, to observe what’s going on at the supply side, since it is more rigid. This enables easy forecasting of cycle changes, as well as enabling to forecast aircraft manufacturers business.
Airline industries can change across time as well. Looking at the Canadian industry for example, it generated $ 7.6 billion in 1991, and employed 53,000 people, as well as carrying 32 million passengers. The industries suffered major losses however in recent years. In the USA alone, since 2001 (due to terrorist attack fears) the airline industry lost around $30 billion. Not being able to forecast demand adequately, coupled with the fact that airline firms characteristically increase their supply by buying new planes just to increase their market share (in a competitive environment), results in demand growing weaker, and the firms having to cut their prices substantially just to fill up their planes. This is shown below as a shift from price P0 to price P1. This results since demand is generally static in the short run in the industry.
Some of the losses from September 11 were resulted in bankruptcy for many
firms, including Swissair, Sabena, U.S. Airways, and United Airlines. 100,000 airline employees in the United States alone lost their jobs. Some argue that it may have been this weakening of the ‘giants’ that weakened barriers to entry and gave way for the low-cost end of the spectrum (budget airlines) to flourish. Easyjet boosted revenues in 2002 by 35 percent, and Ryan Air (Ireland) increased before tax profits by 71 percent. One of the fundamental questions however, is how long will this effect (terrorist fears) last? These low cost airlines are also to be blamed for sever cost cutting and price wars, since consumers can fly to the same destination for sometimes a tenth of the price charged buy the larger airline firms. This means that these larger firms have to significantly alter their business models both for now and the future. One of the major differences in business models adopted by these two types of airlines is that the low cost airlines use a point-to-point system. They focus on bringing the lowest cost travel between two points (using second-hand aircrafts, since aircrafts have a slow depreciation rate), and do not attempt to provide an integrated flight service. Also the reduced hassle at regional airports (in terms shorter lines due to fewer passenger per flight) have also attracted customers.
Manufactured parts are also an issue in trying to cut down on costs. This
continuous pressure to reduce costs and maintain profit margins for the larger firms (BA, Lufthansa and so on), in the longer term, will force them to look for cheaper parts elsewhere in the world. This is already seen by firms approaching areas such as Eastern Europe and China (‘the world’s factory’), which will eventually danger aircraft parts manufacturers in Western Europe and the USA. Many analysts predicted that these disruptions in the supply chains of the airline industry would not recover until 2005. However, this is taking even longer now, because of an unforeseen circumstance, that is, the rapid rise in the price of oil which occurred this year, in 2006.
Jet fuel (kerosene) alone accounts for 15% of the industry’s costs, the second highest after that of labour. A recent estimate suggested that every time the price of oil increases by $1, the costs to the industry go up by $425 million. The airline industry often takes part in the futures market in order to hedge for future rises in the price of oil. The danger in doing this however, is that oil prices are so volatile, that they may go the other way in a short period of time, and actually cost the industry more money. If it does work however, hedging can save a lot of money. Southwest Airlines for example (USA based budget airline) hedged 80% of its fuel requirements in 2004, and saved itself $53.2 million a year. Now, global airline cumulative losses as a result of oil price hikes are estimated at $ 42 billion, since 2001.
In conclusion, the airline industry needs heavy structural reforms, to be able to fight several battles. Low cost budget airlines on the one hand, and extremely high oil prices on the other (with OPEC planning to cut production soon so as to bring about an internationally ‘fair’ oil price of $60). Security assurance also needs to be developed so as to increase consumer confidence (or stop people from fearing flying due to terrorist attacks).
Word Count: 1025.
Bibliography
A.T. Kearney, “The Emerging Airline Industry,” A.T. Kearney, Inc, 2003.
Bouille, O. “World Airline Industry: Over-Capacities in Question.” BNP Paribas Publication, March 2004.
Gillin, E. “Why The Airline Industry Can’t Straighten-Up and Fly Right,” , accessed 20/11/2006
Odette, M. “The Canadian Airline Industry: Its structure, performance and prospects,” Depository Services Program, Economics Division, Feb 1993.
Done, K. “Oil Prices Destroying Airline Profitability” Financial Times, May 30 2005.
Gillin, E. “Why The Airline Industry Can’t Straighten-Up and Fly Right,” , accessed 20/11/2006
Bouille, O. “World Airline Industry: Over-Capacities in Question.” BNP Paribas Publication, March 2004.
Bouille, O. “World Airline Industry: Over-Capacities in Question.” BNP Paribas Publication, March 2004.
Odette, M. “The Canadian Airline Industry: Its structure, performance and prospects,” Depository Services Program, Economics Division, Feb 1993.
Gillin, E. “Why The Airline Industry Can’t Straighten-Up and Fly Right,” , accessed 20/11/2006
A.T. Kearney, “The Emerging Airline Industry,” A.T. Kearney, Inc, 2003.
Bouille, O. “World Airline Industry: Over-Capacities in Question.” BNP Paribas Publication, March 2004.
Gillin, E. “Why The Airline Industry Can’t Straighten-Up and Fly Right,” , accessed 20/11/2006
Done, K. “Oil Prices Destroying Airline Profitability” Financial Times, May 30 2005.