Finshots Special: The Airlines' Curse
In today's newsletter we talk about the lopsided economics of running an airline and offer a spirited defence for the industry.
The Story
"If you want to be a Millionaire, start with a billion dollars and launch a new airline"—Apparently something Richard Branson said.
Let me preface this story by stating explicitly that I have strong opinions about airfares and air travel in general. I think I am paying too much while being offered a sub-optimal customer experience. My flights are often delayed/cancelled either due to technical snags or because the crew couldn’t be ferried to the appropriate location on time.
Airlines could radically minimize the frequency of disruptions if they built contingency plans i.e. keep extra aircraft or crew on standby. But they don’t. And once I am on the aircraft I get too little legroom, the staff is discourteous, they overcharge me for everything and I have to just put up with it.
But this is an emotional assessment. It’s not an assessment based on reason.
Because despite my personal opinion about prices, Indian airlines offer some of the cheapest flights you could find anywhere on the planet. And they've managed to do this in large part by cutting costs across the board. Granted they could always operate a spare crew/aircraft or throw in a couple of freebies. But that would inevitably translate to higher fares. And it's a price that Indian consumers (like me) have refused to pay.
In return, low-cost airlines have obliged by cutting fares and pairing it with sub-par customer experience. In fact, airlines that have attempted to offer a more high-end refined experience [Kingfisher] have consistently failed to make profits in the face of intense competition.
You know why? Because people, by and large, prefer low prices.
As the popular digital news magazine Vox notes — “A pleasant airline to fly on would routinely have empty seats on its planes so nobody would have to get bumped and it would be easy to reschedule…[However], wherever competition has reared its head in the industry, people have clamoured for low prices above all else, followed by a vigorous culture of collective complaining when something goes wrong.”
And it’s not just regular patrons like me who do the complaining. Even parliamentarians get in on the act.
On December 26th 2018, Derek O’Brien, the former chairman of the Parliamentary Standing Committee on Tourism and Aviation launched a scathing attack on Indigo Airlines calling it the worst-performing airline for consumers. The committee’s grouse was in large part attributed to how Indigo behaves with its customers, charging patrons excessively for overweight baggage and the exorbitant pricing structure employed by most airlines during the festive season. According to Derek O’Brien, the committee also batted for cancellation charges to be capped at 50% of the basic fare and he finally topped it by saying — “Airlines are charging too much.”
But the ironic bit is that this statement came against the backdrop of a financial quarter that saw Indigo making its biggest loss ever. So if the most profitable airline company in India is in fact fleecing customers, how on earth did they turn a loss?
And it’s not just Indigo. It’s a recurring theme across the industry, across the globe. In fact, the U.S. civil aviation market has seen over 100 airline bankruptcies and it doesn't look like the trends is about to buck anytime soon.
So while the popular perception remains that airlines charge too much, they seem to be going down like flies.
Don’t take it from me. Take it from Warren Buffett.
The legendary investor once noted — “The worst sort of business is one that grows rapidly, requires significant capital [money] to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers [brothers who created the first aircraft]. Indeed, if a farsighted capitalist had been present at Kitty Hawk [the place where they first took flight], he would have done his successors a huge favour by shooting Orville [Wright] down.”
So in effect, investors don’t like the business because there’s no money to be made. Entrepreneurs rarely dabble with it because so many players have already gone bust. The incumbents who keep flying can’t seem to make consistent money. And parliamentarians keep trying to put price caps despite there being scant evidence of price gouging from the industry.
So why does the government think it can bully airlines into further reducing airfares despite these enduring problems?
Simply because it can. In the event that the government forces airlines to cap prices, airlines can’t go anywhere. After having invested significant capital (money), the only seeming exit option for most airlines is declaring bankruptcy or subjecting itself to an acquisition in the event an opportunity presents itself. But outside of that, there is no helpline for airline grievance redressals. So, the prospects of making consistently healthy profits are rather limited so long as the watchful eye of the government looms large over the sector. Derek O’Brien in his tirade against private airline players made another observation. Brien said that the national carrier, Air India had the best luggage policy and that other private airlines should also enhance the baggage limit. Might I also note that Air India is a loss-making entity — an entity whose loss-making operations are funded by the taxpayer? So in a way, people still end up paying for all that excess baggage (even the ones that don’t fly), albeit indirectly.
Now I am not saying Airlines are faultless or that they act in the best interest of the end consumer. I am not saying that the government shouldn’t insist on price caps right now (which they have) or that we should offer airlines a free pass.
What I am instead suggesting is this — If airlines don’t make it through the crisis alive, it doesn’t matter if you have price caps, because there won’t be anybody left. The airline industry was already operating with razor-thin margins. And then COVID completely ruined them. So we have an industry that is running below capacity with small fleets still employing hundreds and thousands of people who are putting up a brave face despite the looming threat of the virus.
Meaning policymakers and consumers ought to be mindful of the precarious problems plaguing the industry. Because if a couple of airlines in this country go bust, we will effectively be reduced to a monopoly. It’ll probably be like going back to the 80s when we had two profitable state-owned airlines ruling the roster.
Only problem — It was exclusively for the rich.
Not for me…
Not for you…
Never forget!!!
Until next time…