Late last year, Montie Brewer, a former Air Canada president and ceo, gave a presentation entitled ‘Five Reasons Why the Airline Industry Will Never be Profitable” at MIT. Here are the five reasons:

1.  It’s a capacity-led business model (which causes constant overcapacity)
The deregulation and subsequent commoditisation of airlines means the only way for an airline to grow is to add capacity. Airlines need to show more capacity on GDSs in order to grow revenue – this addition happens in tranches of hundreds of seats at a time, rather than the addition of tens, which might more naturally match demand. While adding capacity leads to lower operating costs, eventually total capacity grows too big to be sustainable.  Low cost carriers are less commoditised and better differentiated, not relying on GDS distribution, but distributing direct to consumer. They could ultimately prove to be hardier and more resistant to peaks and troughs than their legacy carrier cousins, who, according to Brewer, typically enjoy 10-20 profitable days in the year.

2.   Airplanes don’t go away (they just become more efficient)

It might seem reasonable to assume that consolidation in the airline industry through mergers, acquisitions and liquidations would lead to a natural reduction in overall capacity (fewer aircraft = fewer seats). But Brewer says that history shows a carrier’s capacity (both efficient and inefficient) never goes away. “The problem is aircraft do not go away, and aircraft do not make their way from an inefficient operator to a more efficient operator; aircraft CAN fly forever; even when an airline tries to retire aircraft, they come back like a bad spaghetti sauce (remember ValuJet using Delta’s DC-9s to compete directly with them in Atlanta); and, when carriers grow they realize great efficiencies.”

A three percent growth in capacity results in only a one percent increase in total operating costs.  But this works in reverse when carriers reduce capacity. The cost savings achieved aren’t commensurate with the reduction.   

3.   Labour Leverage

Brewer says labour organizations are not structured to manage the responsibility they possess.  He says labor has tremendous leverage over the industry, but because they are simple political organizations, they have a short-term view. He notes that politicians too (who often support labour for their own ends) have a short term aim – to stay in their elected position.  “Given the high fixed costs of the industry, airlines can rarely afford a strike or intermittent work stoppages.  According to Brewer, the working assumption is management will not allow labor to take too much, but in reality, labor can take all it wants – but then both parties will have to live with the outcome.

4. Revenue Cycle and Cost Cycle are Out of Sync  A low margin business with volatile input costs is a toxic mix. Even in the best of years, the airline industry is a low margin business where it is not uncommon for any number of input costs to increase at least 20%. The oil price increases during 2008 are the perfect example. Passengers flying on any date could be using a ticket bought when oil was $50 per barrel cheaper. Is the relationship between volatile costs and revenue impossible to manage?  No, but it would require companies to maintain outsized cash balances – which look good to labour during contract negotiations and also to financial raiders seeking to buy a company to harvest that cash. 5.  Nobody Really Wants It to Be Fixed

Happy consumers are enjoying below-cost flights. And airport service providers (often monopolies), and their retail outlets which passengers have no way of avoiding are also happy. Not to mention airline catering, aircraft lessors, ground handling, aircraft manufacturers, distribution systems, fuel providers, maintenance and repair organisations and freight operations. And travel agents. Each of these industry sectors in the airline industry value chain earn a higher return on invested capital than the airline companies that keep them in business. 

If Brewer is to be believed, the future for the airline industry is unremittingly grim. All around, existing airlines are hanging on by their fingernails waiting for the coming upturn, but this will be followed by a downturn. It does make you wonder… with the prospect of 10 - 20 profitable days a year why are new entrants into this fragile industry starting up at all?