Why are Margins so low in the Airline Industry?
As of recent times, the airline industry has taken a hit as far as profitability. With multiple avenues directed towards increasing cost for the industry, along with specialized circumstances of the present create a unique environment for lower profit margins. Rising fuel prices, pilot shortages, and stricter safety regulations have made cost of operation soar while profitability remains low as travel limitations stay in place. It is necessary to recognize the ways in which this time is more challenging for the airline industry and what can be done to pave the way for a better financial future.
- Cost of operations have soared as airlines are highly regulated from a safety standpoint. All operations must run from the highest level of safety based on the FAA regulations, and past experiences with safety precautions. These increased safety measures means that airlines are paying more to keep up with guidelines.
- Travel restrictions are still in place for many parts of the world, each part with their own set of safety standards and regulations. These restrictions make it entirely more difficult for airlines to accommodate passengers and meet their needs according to their standards.
- Less travelers leads to an increase in price for the ones that do travel. Flight tickets have also increased which puts some people out of the economic ability to travel by flight. Many businesses have gone remote, at least temporarily, and are without need for traveling business ventures anymore, another big cut to revenue.
- U.S. airlines spent most of their free cash flow buying their own shares. With corporations authorizing record stock repurchases. Airlines spend a lot of that free cash flow buying their own stocks, which has come back to negatively impact the industry today as they are now needing government assistance to stay afloat.
Obstacles airlines face, and how that affects margins
- Cost of Safety: Over the years Airlines are having to tackle the increased cost of safety and added procedures related to safety. Then came the pandemic, the world and especially airlines were still trying to figure out exactly how they can keep their employees and passengers safe. Airlines have spent a lot of money on a myriad of tactics to curb the added precautions for travelers, including decreased flight capacities, social distancing measures, and increased sanitary crew members to keep up with added measures. These costs for the added safety of the industry have had no small toll, and account for many of the new costs for the airlines.
- Cost of Pilot Training and Salaries: U.S airlines are seeing a challenge in getting and maintaining pilots. The current pilot shortage has caused catastrophic damages to scheduling, flight delays and cancellations, and new wage demands. Signing bonuses and financial incentives are one of the only things keeping pilots on board for commercial airlines, which is costing the industry millions of dollars to maintain. With this is also the added hurdle of pilot training having its own obstacles in this current environment. There is also the fact that many of the pilots that were flying before the pandemic have either retired early or ceased working for the industry altogether. All around, the cost of training new pilots, keeping reliable ones, and signing new ones onto a company have greatly driven the decrease in profit margins as the cost of pilot training, the pilot shortage, and increased wages for that demand are putting pressure on airlines. The cost of training pilots is further exacerbated by the fact that some airlines are now starting up their own basic pilot training institutions. Which cost money to do so. Without the commensurate benefit already known in advance.
For more about this see our previous article: ‘Airlines And Pilot Training Academies”
- Decreased Revenue: Travel restrictions are making it more difficult to travel and for airlines to operate within those restricted areas. Every place has their own set of restrictions and regulations, it is difficult for airlines to be fully accommodating to those areas while meeting their passengers standards, this is also coupled with the changing environment of these restrictions and guidelines. These restrictions create a less willingness to travel for commercial and business passengers. Fewer people are willing to fly by air or are willing to leave home at all. Fewer people on flights also leads to the price of those flights to increase for airlines to try and mitigate the cost on them, the increase air-fare puts some passengers out of the economic possibility of air travel, which further drives the lessened income from people not flying or traveling as much since the pandemic.
- Political Pressure/Government Restrictions: Governments have tried to impose their own standards of safety and regulations for travel. It is unfortunate that there are debates as to what is necessary and what is not to the extent of placing restrictions on airlines. Airlines are at the forefront of debate as they struggle with keeping the airlines free of political bias while maintaining safety. For instance, the mask requirement for most airlines creates a problem as some passengers do not agree with the requirements for political reasons. Other restrictions that are placed by the government are often difficult to maintain without putting a part of the operational cost into the equation.
For more on the effects of government response to a challenge in the airlines, see our previous article: ‘The Pilot Shortage — Getting “Help” From The FAA…’
- Buying back stocks: Another major factor for airlines seeing low margins in this environment is because they have spent a good portion of their money over the last couple of years buying back their own stocks. This was a way to increase stock price and the value of the companies. However, U.S. airlines, due to economic uncertainties that came from the pandemic, have asked Congress for billions in aid and loan requests to keep the industry in business as travel demand sinks while operation prices soar. U.S. airlines spent 96% of free cash flow last decade on buying back their own shares, as stated by Bloomberg. This along with the fact that corporations have authorized record-breaking stock repurchases, at a never-before-seen pace, as reported by Goldman Sachs, further drives the impact. This essentially means that, when airlines are making money, they also spend a lot of that free cash flow buying their own stocks, which has come back to negatively impact the industry in this day and age as they are now needing bail-outs to help mitigate the negative impacts of this turn-around, causing stress on profit margins and revenue as a whole.
What this means, and what’s to come
The current environment of the world has created a unique set of circumstances for the airline industry to hurdle over. With cost of operation already high before the pandemic, it is no surprise that the added pressures that arose with the global spread of the virus also drove that operating cost even higher. Multiple avenues are working together to make the challenges that are being faced today even more difficult, specifically on the industry’s financial prosperity. Margins and profit expenditures are low at the time and may continue to be such as the world shifts back to whatever normal now means. As the industry tries to regulate itself and finds new ways to be innovative in these methods, we will see a slow and gradual change into the future, with hopes that it will bring back the big business in airline industries, as travel picks-up and the pandemic becomes less of a pressing concern.
- Profit margins will remain low: As the industry reels under the weight of the coronavirus outbreak corporations are looking to federal assistance to ease the burden. Airlines will still likely use most of their free cash flow to try and drive their value up with stock purchasing. However, it will be a slow and gradual process for the industry to see the potentially positive impact that government assistance may provide. It may even be a slower and longer process for airlines industries to curb the over obstacles they are faced with.
- Pilot shortages will remain and may even increase: Travel Daily Media reports that there will be a shortage of 34,000 commercial pilots (10% of the entire workforce) by 2025. And even still, this gap is based on a hopeful recovery scenario. This shortage might increase to 50,000 if the economy stays stagnant.
- Airlines merge or close: As of now, there is no clear solution to the big problem that is the pilot shortage and rising cost. Smaller airlines that work for larger carriers may be forced to combine or cancel destinations altogether, with the potentiality of these smaller companies merging with each other or becoming a part of a bigger airline. With the profit margins remaining low, some companies may need to work together to reach a solution, or may be out of business altogether.
- Boom for flight schools: As airlines are poised with the pilot shortage they are turning to the flight schools to potentially save them in this time. The airline industries are struggling to maintain their staff and are needing to increase their pay rates for many pilots, and give new financial incentives and signing bonuses. New pilots are becoming more interested in joining the industry with these added incentives, so there will likely become a boom in the pilot training segment because of this.
For more about this see our previous article: ‘The Pilot Shortage — A Challenge for Airlines, Possible Boom for Flight Schools.’
- Increased need for efficiency: While one of the most simple solutions may be to be as efficient as possible, in order to keep costs low. There will need to be an emphasis on efficiency with the operation of the industry. Airlines and pilot training institutions will have to start looking to new technology and software in order to conduct business easier, and faster in order to maintain the other aspects of the hurdle we are facing. Software and training programs will need to be faster, more concise, more reliable, easy to understand, and easy to maintain, while still keeping up with safety and other standards. Other measures of efficiency could be used in operational cost dealing with overall operations of a particular aviation business.
Getting through Today
As a myriad of obstacles listed above, the airline industry is facing a unique set of challenges when it comes to getting profit margins back to a position where the industry may flourish. Cost of safety with newly added precautions, the pilot shortage, pandemic challenges, and a decreased demand for travel, have all added up to increased headwind for the airline industry. While all of these factors do drive the price for operation up, the revenues of the airline industry remain low. One of the main tactics used by airlines to help increase their value is to buy-back their own stocks, unfortunately this has not had a good outcome with the obstacles of today, and many organizations are seeking government funding to help them stay in business.
Here are some things to look out for as the industry paves its way into a better future.
- Industry Mergers: Airline industries have already, and will continue to merge operations in order to keep costs lower and try to aid in profit margin increases. Smaller companies will likely have to merge or sell their assets to bigger companies in order to stay in business or not go bankrupt. At the same rate, larger companies may try to buy-out smaller companies for the same reasons.
For more about this see our previous article: ‘Airline Mergers: A Solution To The Pilot Shortage?’
- More flight schools/Instructors: With an increased demand for pilots, there will need to be schools and instructors that will get new pilots flying! More flight schools may start to appear to help meet this demand of pilots, and instructors will likely start to become more apparent as previous pilots will likely try to cash out from this environment as well. School and instructors will become even more necessary as time continues and the industry attempts to bounce-back.
For more about this see our previous article: ‘Discrepancies: Pilot Training vs Professional Pilot Careers’
- Less flights available, increased flight cost: Airlines have already had problems with increased cancellations and delays. With the pilot shortage not seeing a clear solution, airlines will likely have to lessen the flights they have available or cancel some destinations altogether. With airlines already struggling with revenue, less available flights would mean they would have to charge more for these tickets. It would not at all be surprising to see that there decreased flight traffic, and increased fares.
- Pilot incentives: The pilot shortage is one of the biggest problems of today. With airlines trying to get new pilots in and keep the ones they already have, signing bonuses and other financial incentives are being used. Wages for pilots during this shortage will likely remain on the higher-end with room for growth depending how the circumstances changes over-time
- Programming/Software that’s more efficient: Aviation businesses will need to do everything they can to save on the cost they can while not cutting any short cuts as far as safety and other standards. There will need to be an increase in efficiency in the software and programming, to consolidate programs and tasks. For example, a pilot training institution may use 3 or 4 different software programs to get a number of different tasks done such as scheduling, training, and communication. It would be likely for these companies to get updated or new software that would give them the ability to do all of these different tasks within one program.
There is no telling what the future is to bring. Whether that means the environment of today is changing or remaining stagnant, it does entail a challenging future for profits and revenue. Recent times and events have created such a unique circumstance for airline industries to operate under. Many of the circumstances that we are faced with today have not ever been seen before in the history of this industry. It is no surprise that this created a shock for airlines as they struggle to find the right solutions. Pilot shortages, rising costs, and decreasing revenue are just some of the reasons that margins are low, and there is still a lot of work to be done for these conditions to change. It’s increasingly important to be aware of what this means and what to expect for the future of the airline industry.
Thank you for reading this week’s On Aviation™ full article. Do you think that margins will remain low? If so, what are you expecting as the industry recovers? Please share your thoughts in the comments below.
Orlando — On Aviation™