The Coming Shakeout in Airlines
by Jürgen Ringbeck and Daniel Röska
The demand for air travel dropped significantly at the start of the financial crisis, and few airlines were prepared. Since the last severe shakeout, in 2001–02, almost all carriers have been focused on short-term results. Many are entering this new crisis with fundamental and capital-intensive legacy problems, including aged fleets, the wrong mix of leased versus owned equipment, and misaligned systems and processes that constrain operational and service performance.
And many airlines are in serious financial jeopardy. In January 2009, Booz & Company conducted a study of the profitability of 37 publicly traded airlines. Only five were in robust financial health: Ryanair, Singapore Airlines, easyJet, AirAsia, and Southwest Airlines. These are mainly low-cost carriers that focus on short-haul traffic and have the lowest operating costs in the industry. Many of the others — more than 40 percent of all airlines — were in poor financial health. They have little room to maneuver; it is doubtful that even substantial efforts to improve performance will put them on solid footing in the current environment. Some already face bankruptcy or government intervention.
Exacerbating the current outlook is an additional set of medium-term challenges. Most forecasters expect oil prices to again climb as high as $70 per barrel. Environmental taxation is on the rise. And persistent capacity bottlenecks at critical airports create delays, missed connections, and scheduling inefficiencies in aircraft rotations that result in rising costs.
In the face of these conditions, only three outcomes are possible. The first is a return to an era of state-owned carriers (in parts of Europe and Asia) and highly regulated markets everywhere. For travelers and the industry as a whole, this would be a very unattractive prospect; experience suggests that costs would rise and service would decline. The second outcome would be “muddling through,” in which most airlines cut back service and exit unprofitable markets. However, such situations often lead to a downward price spiral that further endangers profitability and increases competitive pressures. And when airlines reduce capacity, they lose the economies of scale associated with efficient scheduling of planes, crew rotations, and fuel cost distribution. The third possible outcome would be a consolidated industry in which the strongest airlines — those that are either the most profitable or the most favored strategically — pursue mergers, acquisitions, and alliances to improve their market positions.
This latter outcome is the only one that would lead to a healthier industry. Increased economies of scale would enable the remaining competitors in each market to better serve their customers and invest in new opportunities. The added customers on consolidated routes would also allow airlines to use planes that are larger and thus more cost-efficient and to bundle more traffic from more destinations through large hubs, increasing utilization and yield. This is exactly what occurred in Europe’s long-haul flight market, which today is essentially directed through three major airline gateways by British Airways, Lufthansa, and Air France. History proves that consolidation can also provide airlines with a variety of functional synergies. In 2005, Lufthansa merged with Swiss International Air Lines; two years later, in 2007, the market capitalization of the combined airline had risen 70 percent, and it outperformed the industry benchmark index by 10 percentage points.
Consolidation will probably take place first among national and regional airlines, following the examples of Delta and Northwest in the U.S., and Kingfisher Airlines and Air Deccan in India. Across intercontinental boundaries, where economies of scale in airline mergers are more difficult to achieve, we will probably see the global alliance model extended into transcontinental joint ventures that share critical assets like brand, seat capacity, sales and distribution channels, and operations.
Historically, the promise of airline consolidation has remained unrealized because of regulatory restrictions. Governments naturally seek to remain in control of their airlines for reasons of strategic value and aviation safety and security, and because so-called flag carriers (whose planes are often literally painted with the country’s flag) are a tangible symbol of a nation’s reputation and strength. The recession will strengthen that resolve as governments try to safeguard local employment. Nevertheless, further consolidation in the liberalized regional markets would be the most beneficial outcome for the survival of this industry, as well as the best way to preserve jobs. And it is likely to happen soon. Those airlines that do not move to secure their futures quickly as this consolidation takes place may be left out in the cold.
- Jürgen Ringbeck is a senior partner in Booz & Company’s Düsseldorf office. He focuses on strategy and transformation for companies in global transportation industries, such as airlines, tourism operators, postal and logistics companies, and railways.
- Daniel Röska is a senior associate in Booz & Company’s Frankfurt office. He specializes in business strategies and implementation for global aviation, tourism, and transportation organizations.