22 External Factors Impacting Airline Profits

22 External Factors Impacting Airline Profits

The airline industry is a tough business with razor thin profit margins. Airlines face many challenges in remaining profitable, and external factors outside of their control can greatly impact their financial performance. Some of the major external factors affecting airline profitability include:

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Fuel Costs

Fuel is one of the largest operating expenses for airlines, accounting for 10-30% of total costs on average. Jet fuel prices are highly volatile and subject to global supply and demand dynamics. When oil prices rise, it immediately impacts airlines’ bottom lines. Fuel hedging can help airlines lock in prices, but hedging doesn’t fully eliminate exposure to price fluctuations.

Several factors determine jet fuel prices, including:

  • Crude oil prices – Jet fuel is closely tied to crude oil prices, which are driven by global economic growth and OPEC supply cuts or increases. Any geopolitical events disrupting oil supply impact fuel.
  • Refinery capacity – The ability of refineries to produce sufficient jet fuel supplies affects availability and prices. Refinery outages, capacity issues, and seasonal turnarounds can all cause price spikes.
  • Inventory levels – Low jet fuel inventories tend to bid up prices through worries about future availability. High inventories alleviate concerns and reduce costs.
  • Transportation logistics – Transporting jet fuel to airports via pipelines, tankers, trucks, and storage adds costs that influence the final price airlines pay. Disruptions to transportation infrastructure can severely impact availability and pricing.
  • Taxes – National and local taxes levied on jet fuel production or consumption, such as Japan’s Oil Tanker Tax, also affect fuel expenses for airlines.

Airlines have little control over global oil markets. Rising fuel prices directly lower an airline’s profits, while falling prices provide a profit boost. Long-term high fuel costs force airlines to enact measures to mitigate fuel price risk.

Labor Costs

Labor is another significant cost for airlines, comprising 15-25% of operating expenses. Salaries, wages, benefits, and pensions for unionized pilots, flight attendants, mechanics, and other staff weigh on bottom lines. When unions negotiate higher compensation, it cuts into profits.

Several factors impact airline labor costs:

  • Union agreements – Most airline labor forces are unionized, giving them substantial bargaining power over wages and work rules. New contracts typically increase pay rates.
  • Staffing requirements – Airlines must maintain adequate staff to serve routes and comply with safety regulations. Having surplus staff relative to operational needs raises costs.
  • Pension obligations – Airlines with defined benefit pension plans face ongoing funding requirements affected by plan asset returns, interest rates, and actuarial assumptions. Underfunded pensions put pressure on financials.
  • Scope clauses – Contract scope clauses restrict airlines’ ability to shift routes and aircraft to lower cost regional carriers. Keeping flying in-house raises labor expenses.
  • Personnel productivity – Allowing staff scheduler flexibility and increasing worker productivity helps curb unit labor costs. Rigid union work rules prevent maximizing productivity.
  • Training requirements – Significant training mandated for safety makes labor more costly. Longer required training hours reduces productivity of new hires.

Airlines try controlling labor costs through better workforce planning, automation, and technology. However, required crew levels, union power over wages, and pensions make labor a major expense vulnerability.

Maintenance Costs

Performing timely maintenance is critical for flight safety and operational reliability. Maintenance represents 10-15% of an airline’s operating costs. As fleet age increases, maintenance requirements also rise. Airlines with newer fleets have an advantage.

Several factors influence airline maintenance expenses:

  • Fleet composition – Operating a fleet with many different aircraft types raises maintenance costs due to need for specialized equipment and technicians training. Fleet complexity drives up expenses.
  • Aircraft utilization – High aircraft utilization necessitates more frequent maintenance. Aircraft that fly longer average stage lengths accumulate flight hours faster, needing maintenance sooner.
  • Fleet age – Newer fleets require less maintenance for a period. As fleets age, replacement parts and required maintenance events increase substantially.
  • Maintenance intervals – Following manufacturer recommended maintenance intervals is essential. Deferring or extending intervals risks operational impacts that offset costs savings.
  • Labor rates – Maintenance labor is highly specialized, driving up wage rates. Unionization also pushes up labor costs for maintenance functions relative to non-union competitors.
  • Outsourcing – Airlines can control maintenance costs through outsourcing work to third party maintenance, repair and overhaul (MRO) providers, both domestic and overseas. But outsourcing too much risks operational control.
  • Technology – Investments in predictive maintenance and other innovations help optimize maintenance scheduling, improving aircraft availability and reducing unexpected repair costs.

Maintenance is unavoidable for airlines, so the focus is on controlling expenses through fleet simplicity, optimal maintenance programs, and selectively outsourcing labour-intensive work.

Regulations and Taxes

Government regulations and taxes are a significant cost factor impacting all airlines. Safety and security regulations help ensure passenger well-being, but drive up operating costs. Airlines must collect and remit various taxes that negatively impact fares and profitability.

Key regulations and taxes affecting airlines include:

  • Safety regulations – Safety measures such as minimum equipment lists, maintenance requirements, and crew training all have costs. Regulations get more stringent over time, raising expenses.
  • Security restrictions – Enhanced security screening requirements raise airport operating costs for airlines. Compliance with Air Marshals programs and No Fly List checking also add costs.
  • Route authorities – Bilateral agreements and route authorities dictate what markets airlines can serve from their country, limiting growth opportunities and competitiveness.
  • Passenger facility charges (PFCs) – These local airport taxes and fees levied on each departing passenger raise total ticket costs, affecting demand for air travel.
  • Excise taxes – Governments apply excise taxes on the sale of air travel, making fares costlier. Ticket taxes vary globally, ranging up to 30% of base fares.
  • Airport fees – Landing fees, terminal rents, and other airport charges all get passed on to consumers through higher fares, impacting airline demand.
  • Emissions charges – With climate change concerns, governments are imposing new taxes on carbon emissions which increase fuel and operating costs.

Navigating the regulatory and tax burdens are a necessary cost of doing business as an airline. Shifting regulations present an ongoing risk and cost management challenge.

External Shocks

Airlines are vulnerable to many external shocks outside their control which drastically impact profitability. These include events like:

  • Pandemics – Global health crises like COVID-19 cause massive demand destruction almost overnight for air travel as borders close and economies decline.
  • Terrorist attacks – Acts of terrorism create air travel security concerns reducing demand. Attack directly targeting aviation infrastructure also raise costs.
  • Natural disasters – Hurricanes, volcanoes, or other events can force airport closures causing flight cancellations and lost bookings which airlines cannot recoup.
  • Oil supply shocks – Geopolitical risks in key oil producing nations can cause spikes in fuel prices and jet fuel availability challenges squeezing airline finances.
  • Economic downturns – Air travel demand has high income elasticity. In recessions demand drops sharply. Business travel is also highly cyclical with the economy.
  • Geopolitical conflicts – Wars, embargos, or political instability can shut airspace access and routings airlines rely on, driving up operating costs. Currency volatility also ensues.
  • Epidemics – Health crises close borders denting travel demand. government restrictions may limit ability to serve impacted regions entirely.

These unpredictable events massively disrupt normal airline operations and profitability. While uncontrollable, airlines try mitigating external shock impacts through operational flexibility, demand forecasting, and maintaining strong liquidity and balance sheets.

Intense Competition

The airline industry is fiercely competitive with a multitude of rivals competing in every market. Existing competitors and new entrants threaten market share and pricing power. Competition squeezes airline profit margins.

Key drivers of competition in the airline industry include:

  • Existing rivals – Major network airlines aggressively compete on routes, price, loyalty programs, and product amenities as they vie for passengers.
  • Low-cost carriers – LCCs like Southwest, JetBlue, and Spirit offer low base fares the majors must match to attract budget leisure flyers.
  • New entrants – Startup airlines constantly emerge with new models, expanding competition. Foreign LCCs and majors also expand into more overseas markets.
  • High fixed costs – Airlines have high fixed operating costs for fleet, facilities, and labor. Cuts must come from variable pricing when competition is fierce.
  • Commodity product – Airlines seats are largely indistinguishable commodities. Brand and scheduling differences matter most to consumers choosing airlines.
  • Price transparency – Internet booking facilitates instant price comparisons so airlines must aggressively match rivals’ fares to win bookings.
  • Alliances – Global alliances like Star, SkyTeam and Oneworld allow joint marketing and codeshares, expanding competitive reach of members.

To thrive, airlines must adapt business models, optimize networks, and leverage innovative pricing strategies to stay ahead of tough industry competition.

Government Policy Changes

Airlines must contend with frequent government policy changes on taxes, regulations, airport access, and competition rules. Policy shifts can rapidly alter airline operating economics. Some key policy risks include:

  • Travel restrictions – Governments closing borders or limiting visas can curtail important travel markets, as happened during COVID-19 restrictions.
  • Fare regulation – Some governments impose fare controls on domestic routes which hampers airlines’ ability to price competitively and manage yields.
  • Traffic rights – Adjusting bilateral traffic right limits can reduce access to key long-haul markets airlines depend on for transfer traffic to their hubs.
  • Subsidies – State subsidies to domestic rivals distort competition. Government bailouts with heavy strings attached after crises also carry policy mandates airlines oppose.
  • Airport slots – Changes to slot restrictions at capacity constrained airports limits growth opportunities. Privatization may drive up airport fees.
  • Consumer rules – Passenger rights regulations, like EU-261 in Europe mandating compensation for delays, increase operating costs for airlines.
  • Security rules – Ever-changing security rules are a frequent headache driving up screening and IT costs for airlines and passengers.

Airlines work to influence policy through industry groups. But they must ultimately adapt operations to political realities in each country they serve.

Macroeconomic Trends

Broad economic trends shape passenger demand patterns over time. Economic growth expands air travel markets through rising incomes and globalization. Downturns have an outsized impact on lucrative premium class demand.

Key macroeconomic factors determining airline profit cycles include:

  • Economic growth – Air travel demand moves with GDP and employment trends. Stronger growth enables higher fares and profits. Weak growth squeezes airline earnings.
  • Business cycles – Demand fluctuates through economic cycles. In recessions, premium class travel drops sharply. Leisure demand is more stable through cycles.
  • Consumer confidence – When households feel good about the economy and personal finances, they spend more on discretionary items like vacations and air travel boosting airline revenues.
  • Globalization – Trade, foreign investment, and global supply chains stimulate business travel. But pandemics and political conflicts causing deglobalization dent airline demand.
  • Exchange rates – Currency shifts influence foreign travel. Stronger US Dollars deter incoming USA travel while boosting outbound demand for cheaper foreign trips.
  • Corporate profits – When corporate earnings grow, companies spend more on business class air travel. Falling profits cause travel budget cuts crimping airline yields.
  • Industry trends – The growth of industries like high tech and e-commerce foster business travel. Declines in sectors like manufacturing reduce associated travel.

Tracking macro trends helps airlines forecast demand cycles, optimize capacity, adjust fleets, and manage profitability over the highs and lows.

Weather Events

Extreme weather events increasingly disrupt airline operations materially impacting costs and profitability. Severe storms force route closures, flight cancellations, and aircraft damage resulting in heavy financial impacts.

Major weather risks to airline profits include:

  • Hurricanes – Powerful cyclones cause extensive airport closures throughout affected regions. For example, a major storm disruption in Florida has wide US impact.
  • Thunderstorms – Summer thunderstorms routinely disrupt Northeast airspace causing daily delays and cancellations rippling nationally.
  • Snowstorms – Heavy winter storms close airports across northern latitudes. Deicing aircraft causes gate holds and knock-on effects.
  • Crosswinds – Strong winds limit runway access and curb airport arrival/departure rates, reducing flight capacity for all airlines.
  • Tornadoes – Tornado damage to aircraft on the ground and airport infrastructure creates enormous costs for airlines and airports.
  • Volcanic eruptions – Volcanic ash is extremely hazardous to aircraft engines. Eruptions cause massive airspace shutdowns when ash spreads on jet stream winds.
  • Fog – Low visibility frequently disrupts airports across the world. Long fog delays waste fuel and result in complex passenger re-accommodation.

Airlines plan irregular operations programs for inevitable severe weather disruptions. But events are increasing in frequency and severity with climate change, posing an escalating threat to profits.

Fuel Hedging Outcomes

Many airlines use fuel hedging instruments to mitigate volatile fuel expense risk. But hedges can also backfire and amplify losses when fuel prices drop below hedged levels. The intrinsic gamble in hedges creates accounting losses.

Fuel hedging risks include:

  • Price declines – If fuel prices decrease, hedges lock in higher fuel costs compared to market, amplifying losses. Airlines must recognize the paper hedging losses.
  • Margin calls – Some hedges require posting margin collateral if prices fall below strike levels. This ties up large amounts of cash airlines could deploy elsewhere.
  • Basis risk – Jet fuel prices diverge from crude oil benchmarks used in many hedges, resulting in imperfect offsets. Geographic price differences also create gaps.
  • Accounting volatility – Marking hedges to market value introduces accounting income statement volatility as hedge values change, though cash flows are unaffected.
  • Counterparty risk – If hedge counterparties default, airlines are exposed to full market price risk, magnifying losses in falling markets.
  • Administrative costs – Complex hedging programs require investment in systems, staff, and advisory services, adding costs not present without hedges.
  • Inflexibility – Hedges lock in set prices, preventing airlines from benefiting from spot price declines.

Ultimately hedges are speculative bets. Savvy hedging strategies can pay off, but they can also compound fuel cost burdens tying up cash and producing losses on paper.

Aircraft Financing Terms

Airlines make huge capital investments in fleet renewal and growth. Aircraft loans and leases are the primary financing methods. Interest rates and financing conditions affect fleet costs and airline profits.

Key factors around aircraft financing terms include:

  • Interest rates – Airline fleets are largely debt financed. Rate hikes raise interest costs on loans for new aircraft purchases.
  • Loan periods – The duration of equipment loans determines repayment schedules. Shorter durations require paying loans down faster, increasing near-term cash needs.
  • Lender terms – Tighter credit requirements by lenders may restrict loan access for weaker airlines. Stronger airlines get better rates and loan-to-value ratios.
  • Loan covenants – Lenders impose financing conditions like cash reserves and appraisal values. Breaching covenants causes loans to default.
  • Credit ratings – Airlines with lower credit ratings face higher interest rates and financing barriers due to lender risk perception.
  • Credit availability – Tighter credit markets during financial crises reduce overall lending to airlines, delaying purchases.
  • Lease rates – Increased demand for leased aircraft pushes up market lease rates. Weaker airlines may only have leasing options.
  • Residual values – Declines in projected residual (resale) values raises effective lease costs. Older leased aircraft carry higher residual risk.

Favorable interest rates and aircraft financing terms facilitate fleet renewal at reasonable costs. But shifts in rates, credit conditions, and values alter the financing economics.

New Environmental Regulations

Climate change concerns are driving increasing environmental regulations on airlines to reduce emissions, noise, and other impacts. Though improving sustainability is important, new rules raise operating costs.

Some emerging environmental regulations affecting airlines include:

  • Carbon taxes – Charges on carbon emissions from jet fuel, called “departure taxes”, are imposed by some jurisdictions like Sweden. More nations are considering such levies.
  • Emissions trading – Rules requiring airlines to buy carbon credits for a share of emitted carbon add to operating costs, like under the EU ETS scheme.
  • Low emissions zones – Cities are increasingly imposing emissions-based airport access charges on higher polluting aircraft. This encourages fleet upgrades.
  • Aircraft engine NOx limits – Tightening limits on nitrogen oxide emissions from jet engines requires airframe and engine OEMs to invest in designs meeting standards.
  • Noise limits – More stringent aircraft noise certification standards impose aircraft design constraints which compromise performance and efficiency.
  • Sustainable aviation fuel – Mandates requiring use of blended lower-emissions fuels will significantly increase fuel costs as supplies scale up.
  • Carbon reporting – Extensive emissions monitoring and carbon footprint reporting adds administrative overheads to track and demonstrate progress.

Though environmental sustainability is imperative, adapting airline fleets and operations to meet rapidly evolving regulations will take financial investment and raise operating costs as well.

Aircraft Manufacturer Delays

Airlines depend on aircraft manufacturers like Boeing and Airbus to deliver ordered planes on schedule to renew and expand fleets. Production delays force airlines to keep old jets flying longer at higher operating costs or constrain growth by retiring planes without replacements.

Some risks around manufacturer delays include:

  • Development issues – New aircraft models like Boeing’s 737 MAX and Airbus A220 faced multi-year delays due to design changes needed, forcing airlines to postpone retirement of old models.
  • Production problems – Manufacturing ramp-up issues, labor strikes, part shortages or supply chain instability slow output rates, delaying deliveries.
  • Test and certification delays – Program setbacks completing flight tests and obtaining safety certifications from regulators push first delivery timelines.
  • Order backlogs – Huge aircraft order backlogs mean priorities go to older orders first. New customers face long wait times before getting planes.
  • Staffing deficits – Insufficient engineers and mechanics at manufacturers to meet high production rates causes assembly bottlenecks.
  • Merger impacts – Mega-mergers like Boeing-McDonnell Douglas caused management distraction and production integration issues, delaying plane deliveries to airlines.
  • Quality issues – Manufacturing quality problems lead to reworking of completed aircraft, slowing deliveries to fill orders.
  • Economic volatility – In recessions, airlines cancel or defer orders which may disrupt manufacturing cadence and industrial planning.

Aircraft supply issues force airlines into extended use of outdated models with higher operating expenses. Network growth also stagnates absent new deliveries, impacting revenues.

Foreign Exchange Volatility

Currency volatility directly impacts airline earnings. Major cost inputs and sales revenues involve foreign currency exposure. Hedging mitigates some FX volatility but represents a cost.

Key foreign exchange risks include:

  • Fuel price swings – As most jet fuel is traded in U.S. dollars, a stronger dollar increases fuel costs for foreign carriers by amounts unmatched by higher fares.
  • Aircraft financing – Aircraft loans denominated in dollars create greater financing expense when the dollar is strong vs. local currencies.
  • International demand – A strong home currency depresses inbound travel by making it more expensive for foreign tourists. Outbound leisure demand rises though.
  • Foreign revenues – Local currency weakness reduces the value of foreign revenues for airlines when converted back to domestic currency.
  • Route profitability – Currency shifts alter the economics of international routes for airlines tied to partner hubs abroad.
  • Input costs – Imported aviation parts, airport services, and consumables become costlier when the local currency weakens against producer country currencies.
  • FX hedging – Hedging mitigates some FX volatility but has inherent costs and risks like potential margin calls. Most airlines only hedge 1-2 years out.

Managing FX risk is crucial for global airlines. Hedging and adjusting capacity and fares across currency zones helps minimize volatility. But large swings remain an earnings risk.

Airport Infrastructure Constraints

Limited airport capacity causes congestion, slot controls, delays, and operational headaches for airlines. Runway expansion projects are extremely costly and face political hurdles.

Airport infrastructure bottlenecks negatively impact airlines in many ways:

  • Congestion and delays – At capacity constrained airports, congestion leads to arrival and departure delays which increase fuel burn, staffing costs and passenger accommodation expenses.
  • Slot controls – Airports apply slot restrictions when congested, limiting airline schedules. This caps growth and competitiveness in major hubs.
  • Noise restrictions – Noise limits close to airports can prohibit adding runways or limit night flights, reducing schedule flexibility for airlines.
  • Curfews – Night flight bans to limit noise, like those in effect at major airports including Heathrow, Frankfurt and Sydney, restrict operations during certain hours impacting connections.
  • Gate shortages – Limited gates at cramped terminals prevent airlines from adding flights during peak periods or force use of costly hardstand positions.
  • Airspace constraints – Fragmented air traffic control systems and congested airspace corridors contribute to flight delays within regions.
  • Taxiway jams – Insufficient taxiways relative to runway capacity at some airports causes outbound taxi delays after landing, wasting fuel and time.

Though airports are slowly adding capacity, project costs and environmental concerns limit scope. This puts pressure on airline productivity and costs at major hubs.

Information Technology Disruptions

Airlines depend on vast global IT systems for ticketing, reservations, flight operations, maintenance, and administration. Outages or cyber attacks can severely disrupt operations and service.

Major IT related risks include:

  • Reservation system failures – Airline booking engines going down causes inability to sell or change tickets during outages, impacting revenues.
  • Check-in systems downtime – Check-in technology failures lead to long lines and passenger handling disruptions at airports around the network.
  • Flight plan system outages – Critical systems used to file flight plans and process weight & balance going down delays or grounds aircraft, forcing cancellations.
  • ATC technology faults – Air traffic control relies on complex systems to manage airspace safely. Radar, radio or automation system technical faults introduce airspace chaos.
  • Airport IT troubles – Failure of airport IT infrastructure like baggage systems, customs clearance etc. causes knock-on disruptions for airlines.
  • Maintenance IT – Digital systems for aircraft maintenance tracking, parts inventories, technical manuals etc. are indispensable. Failures compromise safety.
  • Cyber attacks – Airlines face growing cybersecurity threat from hackers disrupting operations or stealing customer data.

With airlines utterly technology dependent, even brief IT system outages cause major network disruption with big revenue and recovery cost impacts.

Geopolitical Conflicts

Wars, political unrest or diplomatic rifts between nations directly affect airline networks and overflight rights. Geopolitical conflicts cause volatile fuel prices and currency fluctuations also hitting profits.

Geopolitical risks include:

  • Airspace closures – Conflicts prompt authorities to close airspace like Ukraine’s after Russian invasion. This forces route diversions adding flight time and fuel costs.
  • Overflight permit limits – Countries deny overflights to airlines of nations they have diplomatic conflicts with, forcing inefficient alternative routings.
  • Flight suspensions – Airlines halt services to nations directly involved in conflicts due to safety concerns and lack of demand.
  • Aviation boycotts – Countries ban flights from their airspace in response to political events. This happened between Arab states and Qatar during recent rifts.
  • Tourism declines – Conflicts devastate leisure and business travel demand to impacted regions with severe revenue implications for airlines.
  • Fuel market volatility – Geopolitical instability disrupts oil production and supply chains, causing jet fuel price spikes.
  • Currency fluctuations – Conflicts stoke financial market uncertainty, leading to currency volatility which impacts airline costs and revenues.
  • Insurance premiums – Insurers raise premiums for airlines operating to regions with heightened geopolitical tensions and war risks.

Geopolitics have always influenced aviation’s global connectivity. Airlines must continually adapt networks for political realities while pursuing diplomacy to protect access.

Aircraft Lease Risks

Many airlines, especially low-cost carriers, lease a substantial portion of fleet to contain aircraft capital costs. But leasing carries financial risks as lease rates fluctuate.

Primary risks related to aircraft leasing include:

  • Rate volatility – Aircraft lease rates rise and fall based on market conditions. Rate spikes raise operating costs for airlines reliant on leased planes.
  • Residual value shifts – If actual aircraft residual values differ from assumed values in leases, costs are higher than projected over the lease term.
  • Early returns – Airlines sometimes opt to return leased planes early when unprofitable. But contracts may impose penalties for early returns.
  • Maintenance reserves – Lessees must contribute to lessor-controlled maintenance reserves to cover future maintenance events. hose reserves are lost if leases are ended early.
  • Redelivery conditions – Airlines must redeliver leased aircraft in a specified maintenance condition at lease-end, which may mean unplanned maintenance expenses.
  • Lease leverage – Operating leased planes increases balance sheet leverage compared to ownership. This worsens credit quality.
  • Inflexibility – Operating leases have fixed terms, reducing flexibility to adjust fleets compared to owned aircraft. Sale-leasebacks do allow flexibility however.
  • Lessor distress – If lessors experience financial problems, repossession of aircraft could force costly disruptions to airline schedules.

While leasing provides fleet flexibility, airlines lose some cost control. Careful lease management and own-vs-lease analysis is crucial to contain lease related risks and costs.

Distribution Channel Costs

The rising cost of selling tickets through channels like online travel agencies and global distribution systems eats into airline revenue. Distribution represents 5-10% of operating costs.

Distribution cost challenges include:

  • GDS fees – Booking through travel agents and online agencies relies on costly Global Distribution Systems run by Sabre, Amadeus, Travelport and others who charge substantial fees.
  • OTA commissions – Online travel agencies like Expedia and Booking.com receive commissions of 10-30% on bookings made through their sites, reducing airline yield.
  • Credit card fees – Airline ticket sales often use credit cards, resulting in merchant fees levied by card networks Visa, Mastercard, and Amex of 1-3% per transaction.
  • Travel agent incentives – Airlines provide quarterly incentives for travel agents who achieve booking targets, aiming to encourage sales through agencies.
  • Interline agreements – Agreements to book on partner airlines result in transaction fees paid to partners.
  • Travel management contracts – Large corporate deals involve upfront incentives and discounts paid to corporate travel departments to secure lucrative business.
  • Marketing costs – Advertising spending to promote fares and drive bookings through high cost channels adds to distribution spending.

Rising distribution costs make direct website and mobile app sales crucial to avoid third-party intermediary fees. But those channels require digital marketing investments to attract customers.

Fleet Impairment Charges

Airlines frequently take large one-time impairment charges on aircraft fleets before the normal end of useful life due to fuel prices, competitive dynamics, or crises. These non-cash charges result in major financial losses.

Typical triggers for fleet impairment include:

  • Fuel price spikes – High fuel costs make operating less fuel efficient older generation aircraft unprofitable. This leads to accelerated retirements and impairment.
  • Excess capacity – Weak demand amid competition may cause airlines to cut capacity by parking inefficient aircraft, resulting in impairment losses.
  • New technology – Airlines accelerate replacement of older planes when new aircraft with better fuel efficiency become available.
  • Bankruptcies – Restructuring in bankruptcy requires massive fleet cuts, driving large one-time impairment costs through bankruptcy financials.
  • Mergers – Airline mergers result in fleet optimization and reduction of duplicative planes, causing impairment charges.
  • Epidemics – Health crises decimate travel demand for years, forcing airlines to shrink fleets with large impairments.
  • Accidents – Major crashes cause specific aircraft models to be grounded indefinitely pending investigations, requiring impairment valuation hits.

While non-cash, fleet impairment charges indicate significant real economic losses for airlines driven by external factors that destroy aircraft value ahead of expectations.

New Accounting Standards

Regulators frequently introduce new accounting standards mandating substantial changes to financial statement presentation and impacting reported profitability.

Key risks from new standards include:

  • Lease capitalization – Rules requiring operating leases to be brought onto airline balance sheets increase reported debt levels and asset values.
  • Revenue recognition changes – Moving to recognize revenue when flights occur rather than on booking impacts revenue trends and timing of results.
  • Fuel hedge accounting – Marking some hedge instruments to market value creates income statement volatility as their value fluctuates.
  • Goodwill amortization – Having to amortize goodwill acquired in mergers over a fixed period depresses profits until the write-off period ends.
  • Loyalty accounting – Upcoming changes will require deferring of loyalty revenues over expected customer tenure instead of on mile issuance.
  • Credit loss provisions – Forward-looking expected loss provisions on receivables increase bad debt expenses reducing income.

While most changes aim to improve financial statement comparability, restating results to comply perplexes investors and puts airlines at a disadvantage vs. peers on transition timing.

Risks Specific to Long-Haul International Airlines

Long-haul international airlines face magnified risks from external events relative to domestic carriers given the mission-critical importance of global network integrity and hub connectivity for their business model.

International network risks include:

  • Government restrictions – Border closures or travel restrictions imposed by governments due to conflicts or epidemics halt traffic on vulnerable long-haul routes.
  • Hub competition – Competitor hubs in the same region dilute connecting traffic needed to support long-haul route economics.
  • Fuel costs – Super long routes are highly fuel intensive. Extended fuel price spikes can render ultra long-haul flights unprofitable.
  • Geopolitics – Diplomatic disruptions affect overflight rights while terrorism deter long-haul leisure demand. Both undercut hub connectivity.
  • Currency volatility – Flows of connecting traffic depend on stability of currencies like USD and EUR to avoid deterring either end of travel.
  • Alliances – Partnerships with foreign airlines are essential to feed long-haul flights. But disputes within or dissolution of alliances causes traffic losses.
  • Competition – Other airlines adding nonstop flights on routes previously served one-stop through a hub erodes transfer traffic critical to viability of the indirect service.

With highly interconnected networks optimized for sixth freedom flows, international airline profits are extremely vulnerable to external disruptions to travel patterns and hub connectivity.

Conclusion

  • Airfares are determined by supply and demand. Fares are adjusted frequently depending on competitive factors, fuel costs and overall capacity.
  • Ancillary fees have become an important profit center for airlines. Bag fees, seat assignments, on-board purchases etc. diversify revenue.
  • Business travelers typically book at the last minute and have less flexibility. This allows airlines to charge much higher last-minute fares.
  • When fuel prices rise, airlines institute fuel surcharges on international tickets to offset the increased costs.
  • Bankruptcies allow airlines to renegotiate high labor costs, debt costs, leases and other obligations to become solvent.
  • Airline consolidation through mergers improves economies of scale and pricing power but reduces competition.

Frequently Asked Questions

What are the main operating costs for airlines?

The largest operating costs for airlines are fuel, labor, aircraft maintenance, sales/distribution, and landing fees/rents. Fuel represents around 30% of costs while labor is typically 20-25% of costs. Maintenance, distribution fees, and rentals are each around 10% on average.

How do low-cost carriers keep prices so low?

LCCs keep fares low through very high aircraft utilization, point-to-point networks avoiding hubs, dense seating, and minimal included amenities. They also fly one or two aircraft types to maximize crew flexibility and maintenance synergies. Lean staffing, online sales, and secondary airports further reduce costs.

What factors do airlines consider when deciding which routes to fly?

Airlines evaluate potential origin-destination demand based on local population, propensity to travel, and competition when selecting potential routes. Profit potential depends on costs like landing fees for the airport pair and aircraft suitability for the route distance.

How does airline competition impact consumers?

Intense competition forces airlines to aggressively match rivals’ fares and services, which is beneficial to consumers. It limits the pricing power of airlines. Consolidation can reduce competition, enabling fare increases.

Which customer segment is most profitable for airlines?

Business travelers buying refundable last-minute tickets are the most profitable customers for network airlines. Economy leisure passengers buying advance discounted fares are the least profitable. Loyal frequent flyers fall in between.

How do airlines hedge against changing fuel prices?

Airlines mitigate fuel price risk using financial hedging instruments like call options, swaps, and futures contracts to lock in fuel costs in advance. However, hedges can be costly if fuel prices decline below the contract price levels.

What causes airfares to be higher during peak travel seasons?

Higher demand from holiday leisure travelers during peak summer and Christmas travel periods leads airlines to increase fares. Higher fares ration capacity to the customers with greatest willingness/ability to pay.

How does adverse weather impact airline operations?

Poor weather forces flight delays and cancellations which increases costs for airlines operationally. It requires expense reimbursements for disrupted passengers. Lost bookings also dent revenues when weather reduces demand for travel.

Why have airlines been retiring older aircraft models early?

Older generation aircraft like 747s and MD-80s are being phased out sooner by airlines due to high fuel consumption relative to new models. New aircraft feature lighter materials and more efficient engines.

How crucial are airline alliances for international carriers?

Alliances like Star Alliance allow members to coordinate schedules, share airport facilities, link frequent flyer programs and sell joint itineraries. This expands each member’s global reach, enabling long-haul international connectivity.

Why have airline bankruptcies accelerated in recent decades?

Intense competition, boom-bust demand cycles, periodic shocks to travel, high fixed costs and heavy debt levels make airlines prone to restructuring. Bankruptcy laws favoring reorganization have also promoted more filings vs. liquidation.