Initial Thoughts on Airline Economics.
A while back I read somewhere that the combined profits of all airlines since the inception of flying is close to $0. I am currently flying from New York to Seoul, and so I have a good 14 hours to kill, and I wanted to start to think more deeply about why this is the case.
In some ways, this feel strange. After all, flying is a useful, necessary, and even magical thing. Billions of trips are taken each year, and many of us enjoy experiencing other cultures; airlines are a key enabler of that.
And yet, something, somewhere, went wrong with the airline economics. They have to work out ways to keep squeezing more and more passengers into larger planes, and the experience at most airports leaves a lot to be desired.
But perhaps it is not surprising that most airlines make little profit, after all, it is a difficult business to differentiate oneself in. Most airlines buy their aircraft from either Boeing or Airbus and save some cabin customizations; there is no practical way for an airline to differentiate itself based on its planes.
And so, it all comes down to service, scale, price, and finding the right mix. It is also necessary to have a management team that can execute operations tightly because this is an industry where mistakes can be costly. A delayed flight can cost a huge amount of money, let alone a bigger mistake which leads to a loss of life.
Malaysian airlines couldn’t survive two aircraft accidents in a year, with MH370 that disappeared and MH17 that was shot down over Ukraine. In a capitalist system, it is quite good when there is alignment between safety and profits because you can be sure that there will be enormous pressure across the entire organization to ensure every facet of maintaining and operating these incredibly complex machines is looked at.
I heard that for one airline, they even start each board meeting with an announcement of where the emergency exits are in the building that they are meeting in, so much is their focus on safety.
Ryanair, the airline in Europe that everyone loves to hate, and that sparked the low-cost carrier revolution, has never had a fatality on any of their flights in decades of operation.
And yet, the cumulative profits are $0. Perhaps the lack of a true differentiation between airlines is the reason, and so it becomes a race to the bottom with regards to pricing to ensure that aeroplanes are full before leaving.
This is because, for airlines, a seat is the equivalent of a product sitting in a warehouse for a retail business. Even more specifically, it is like a piece of fresh fruit that will go off at a very specific date, after which it can no longer be sold.
A seat on an airliner has a certain amount of value, right until a few hours before the plane will take off, after which it can no longer be sold, and then it is worth $0 to the airline. They don’t want to miss out on filling the seat because they already have huge operating costs, and adding an extra passenger on a plane does not significantly alter the cost profile of operating that specific flight. So, the contribution margins are very high for those last seats.
And this leads me on to discuss about the strange, and what appears rather archaic, pricing across the airline industry. You see different pricing on different websites for the same flight, and you can use pricing algorithms that optimize the total value of all the seats on the plane. Then you have business class, which I have heard is where the real money is often made on a flight.
While this may work for the airline, it does not really work out for the traveler. Why has the market not settled on a standard price to fly from London to New York, from Singapore to Sydney, and from Bejing to Dubai?
All aeroplanes would always be full if each seat only costs $1. If every seat were $10,000 — very few would be.
I want to dig deeper and understand why pricing is so erratic for aeroplane seats, and how this is linked to the historical low profitability of airlines.
I have often wondered what a vertically integrated airline could be like — one that has its own model of aeroplanes operates its own airports, and fully control the customer experience end-to-end.
