The challenge of a profit

The old saying is that if you want to make a million bucks in aviation, start with ten million. Or, along the same lines, I can tell you that there is a lot of money in aviation because I put it there. Why, in other words, is it so hard for the airlines to make a profit?

The airlines are probably one of the most regulated industries in the world. There are rules for everything from when pilots can eat to what kind of screw must be used to assemble the sink in the lav. Even the font on the checklist is regulated. The pilot seats on the Canadair regional jet are north of $27,000. Twenty-seven grand! For a chair! And it isn’t even a Lazy Boy! The cost of the parts reflects the design, development and certification costs incurred by all parties involved, so I sit in a chair that costs more than a new car, and look through a window that costs almost as much as my house.

In addition to the federal regulations are the local airport rules that often vary from state to state. Each airport may have slightly different procedures for single-engine operations, deicing operations, fuel spill procedures, etc. Prior to 9/11, security (passenger screening) was much less standard than it is now. Some cities have also adopted trash recycling requirements that the airlines must comply with, and like everything else, there is a cost to that compliance (not to mention the fines for non-compliance).

One of the biggest problems is that the airlines only have two real ways to produce revenue. The first is their website, which is where you will buy your ticket, possibly rent your car and reserve your hotel room, and maybe even pay your baggage fees up front. The second source of revenue is the plane itself. It has to actually fly to allow the airline to ultimately keep your money, and it can produce ancillary revenue from liquor sales and last minute ticket sales, bag fees and in-flight movie purchases. Everything else in the airlines’ arsenal is an expense: tugs, computers, baggage carts, fuel, employees, etc.  However, if those items are not available, or broken, they suddenly can produce stratospheric costs. When the Comair computer for schedule pilots failed several years ago, tens of millions of dollars were lost and/or spent re-accommodating passengers (including meal and hotel vouchers), shipping their luggage, or refunding fares, not to mention the black eye from all of the negative publicity. While some airlines produce revenue by taking on contract maintenance, this is not a standard practice, and is not a part of the normal business model.

Along the same lines, the most useless commodity to have is an empty seat on a plane, much like (but worse than) an empty seat in a movie theater or a stadium (you can come in late to a movie or a game). Once the plane pushes back from the gate, the empty seats can never be sold again. That means that if you have a 737 with 137 seats on it, and it pushes back with only 37 passengers, you have, in effect, an expensive 37 seat airplane. Those revenue opportunities will never present themselves again. This is why last minute deals are offered: something is better than nothing, and maybe the passenger that pays just enough to offset the cost of having him on board will buy a beer on board and generate a small profit….but maybe not.  Empty seats drive marketers and CEOs crazy for that very reason.

Considering that the cost of air travel is the same in real dollars as it was in the 1980’s, the airlines have done well to make it as far as they have. That probably won’t make you feel better when you have to buy a short-notice ticket for $1000, but it might. And if it doesn’t, then fork over $7 for a beer, and live well with the knowledge that you may have single-handedly made your flight a profitable one.

–Chip Wright

4 Responses to “The challenge of a profit”

  1. Kyle Garrett says:

    Chip, you make several excellent points, and I’d like to add that “fare wars”, in my opinion, are partly responsible for an artificial deflation of airline ticket prices over the past two decades.

    While you mention the incredibly overpriced cost of building, maintaining, and operating an airline, fares have, for the most part, continued to plummet due to increased competition for each seat. All this competition between carriers has “trained” the public that a seat on a short hop should only cost $99-$149 each way. Airline passengers have become so accustomed to seeing these types of prices that they just won’t pay much more than that. So while fuel and other operating costs skyrocket, fares stay put, and a simple calculation will tell you the business model can’t succeed in the long term.

    One irony I find in all of this is my perception that the general public want their cake and eat it too… they demand highly maintained aircraft, veteran pilots with thousands of flight hours each, beautiful indoor shopping mall terminals, but they want it all for $99 a ticket… it just doesn’t work that way. According to an article published on the Library of Economics and Liberty website (www.econlib.org/library/Enc/AirlineDeregulation.html), “Airfares, when adjusted for inflation, have fallen 25 percent since 1991″ while most other costs associated with running an airline have increased significantly. Is it any wonder that starting pilot pay is so low and the airlines struggle to make a profit?

    I believe we’ll see prices for airline seats creep up over the next few years, and hopefully the public will understand that the days of the $99 ticket may be coming to an end.

  2. Josh says:

    I certainly agree that the business model of $99 airline tickets won’t last, and that the flying public assumes that they are flying well-maintained aircraft flown by happy, well paid, and well rested crew. And, all in all, I believe the airlines are generally safe and flown by qualified, professional crews – if not always happy ones.
    I’d like to see the results of an employee job satisfaction survey posted next to the ticket prices on the major travel websites. I’d personally spend an extra $20 – $40 per ticket to have a happy, well paid crew – and I think the overall travel experience would be much, much better as well.

  3. K. Black says:

    How is it possible that Southwest Airlines has been making a profit with $49 fares? This article and the first comment do not explain that. It seems to me that fares can be cheap while the Airline makes a profit. It’s just that the other Airlines (besides SWA) have not figured out how.

  4. Chip Wright says:

    I’d like to address K. Black’s comments. Southwest does indeed have $49 fares, but they are the exception, and not the rule. Most of their fares are substantially higher. That being said, what SWA has done more than anything is master efficiency. They get more flights per day from each employee and from each piece of equipment than anyone else, and that goes back to the difficulty the company had in just getting off the ground (read the book “Nuts!” for the full explanation of that). The result is that they need fewer employees per plane than other carriers. Further, they do not carry any real debt to speak of–they pay cash for their planes. But most important, they have a totally different outlook on how to treat their people, which is to say that they treat their people so well that they will bend over backwards to return the favor. That is a lesson that EVERY company should learn, not just other airlines.

    They have carried that over to their customers. For years SWA concentrated a lot of its service at under-used airports. They have strategically gotten away from that to venture into the likes of LGA and EWR. Lately, they have become known as the only airline not to charge bag fees, food and drink fees, or any other fees, which has won them rave reviews, not to mention new customers. They also make getting a refund or a change in flight plans very painless and pleasant, which further allows them to win favor and attract new customers.

    So, yes, $49 fares (pre-tax) can be had at Southwest, but they are not common, and they are NOT the bread-and-butter of the company’s business model. But the efficiencies mentioned do make those fares possible.

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