Bill Swelbar FAA 2011

8/7/2019 Bill Swelbar FAA 2011

1/40

The US Airline Industry &Herbert Steins Law William S. Swelbar

MIT International Center for Air Transportation36 th Annual FAA Aviation Forecast Conference

February 16, 2011

www.swelblog.com


2/40

HERBERT STEINS LAW

Herbert Stein (1916-1999) was chairman of the Council of Economic Advisers under Presidents Nixon and Ford

If something

cannot go on forever,

it will stop


3/40

US Airline Industry: The Last Three DecadesBarriers to entry for new and existing carriers were removed If one had a dollar, an airplane and a certificate: an airline was born Entry and growth of Low Cost Carriers a major driver of change

Barriers to exit for inefficient carriers were erected Bankruptcy, government, labor as an internal source of capital Inefficient providers remained in the market

Finally in the 2000s, cost reductions and efficiency improvements that wereexpected during the previous two decades began to happen

A market share mentality created an industry grew too big to be sustainable

The market share mentality giving way to a profit mentality?


4/40


5/40

LOOKING BACK


6/40

With Rare Exception, Capacity Growth

Exceeded the Growth in Real GDP

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

Real GDP Percent Change ASM Percent Change


7/40

The Market Share Mantra

Built An Industry Too Big

0

50

100

150

200

250

300

Real GDP Index ASM Index

1 9 7 8 =

1 0 0


8/40

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

Passenger Load Factor Percent RPMs Millions ASMs Millions

Filling Airplanes Not A Problem

As Evidenced by the Growth in Load Factors


9/40

Enabled by Decreasing Real Fares

I n f l a

t i o n

A d j u s

t e d C e n

t s p e r

R e v e n u e

P a s s e n g e r

M i l e

( 1 9 8 2 =

1 0 0 )

0

1

2

3

4

5

6

7

8

9

10

Domestic International System


10/40

As Real Fares Declined,

The Industry Was Paying the Middleman More

-15%

-10%

-5%

0%

5%

10%

15%

Commissions as % of Operating Expenses Real Yield Percent Change


11/40

A Classic Example of Competing Away the Efficiencies Got Rid of the Middleman, Gave $6B in Savings to the Consumer

T o t a l C o m m

i s s

i o n

C o s t

( m i l l i o n s

)

P e

r c e n

t o

f P a s s e n g e r

R e

v e n u e s

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Total Commission Cost (millions) Percent of Passenger Revenues


12/40

Unit Revenues Began to Drop Dramatically

During the Second Half of 2000

5

6

7

8

9

10

11

12

13

14

15

Passenger Revenue per ASM Total Operating Expenses per ASM

Pre-9/11 Average Difference:$0.73

Post-9/11 Average Difference:$2.61

C e n

t s


13/40

The Relationship of Revenue to GDP

As It Turns Out, That Change Was Structural

Source: MIT Airline Data Project

0.30%

0.40%

0.50%

0.60%

0.70%

0.80%

0.90%

1Q90 1Q91 1Q92 1Q93 1Q94 1Q95 1Q96 1Q97 1Q98 1Q99 1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09

$27B$36B


14/40

Through 2000, Unit Labor Costs on the Rise As

Productivity Remained Relatively Unchanged

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

0

500

1,000

1,500

2,000

2,500

3,000

ASMs per Employee Total Labor per ASM

A S M s

( 0 0 0 ) p e r

F T E

C e n

t s p e r

A S M


15/40

The Restructuring Increased Output, but

The Cost Per Unit of Output Going the Wrong Way

20

25

30

35

40

45

50

0

500

1,000

1,500

2,000

2,500

3,000

Total ASMs per Employee (thousands) Total ASMs per Labor Dollar

A S M s

( t h o u s a n d s

)

A S M s p e r

L a

b o r

D o l l a r


16/40

An Industry Built on $30 per Barrel In the Wing Oil5-Year Average* U.S. Price per Gallon of Jet Fuel

* 3-Year Average for 2007-2010

$0.88$0.78

$0.69$0.60 $0.57

$0.73

$1.51

$2.22

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

1978-1983 1983-1987 1987-1991 1991-1995 1995-1999 1999-2003 2003-2007 2007-YE3Q10


17/40

Fuel Surpasses Labor As Largest Cost Category

0

100

200

300

400

500

600

700

1 9 7 8 =

1 0 0

FuelIndex

PassengerYield

Consumer PriceIndex


18/40

200 of the roughly 450 mainland U.S. markets comprise97% of domestic demand

Yet the 250 airport markets comprising 3% of domesticdemand compete for the same pool of dollars Spending money in all of the wrong places?

The market share mentality created a system thatcompeted with itself. Airlines the culprit of fragmentingtheir own marketplace at home

What About the U.S. Airport System?


19/40

40 Percent of Mainland Airports Produce 97% of Demand

Top 200 Airports

Airports #201-450

3%

97%

Percent of Domestic Demand


20/40

Per Enplanement Profit and Loss

Passenger Revenue Only1980 - 1989 1990 - 1999 2000 - 2009 2010E

Passenger Revenue $105.16 $129.44 $135.91 $144.81

Labor $39.66 $47.33 $49.04 $45.56Fuel $24.94 $17.64 $34.21 $44.30Commissions $8.99 $12.91 $3.16 $1.99Landing Fees $2.03 $2.90 $3.46 $4.05Aircraft Ownership $7.36 $12.87 $14.19 $12.82All Other $30.98 $44.12 $48.26 $49.45

Total Op Expenses ex TR $113.96 $137.77 $152.33 $158.17

Passenger Revenue Less Expense ($8.80) ($8.32) ($16.42) ($13.35)

Interest $3.99 $3.16 $4.87 $6.11

Passenger Revenue Less Expense + Interest ($12.80) ($11.49) ($21.28) ($19.47)

Ancillary Fees $0.14 $8.70

Restated With Ancillary Fees ($12.80) ($11.49) ($21.14) ($10.76)


21/40

Producing Unacceptable Annual Net Profits

1978 2010

-30,000

-25,000

-20,000

-15,000

-10,000

-5,000

0

5,000

10,000

15,000

20,000

P r e

T a x

P r o

f i t ( b i l l i o n s

)


22/40

Or. A Cumulative Loss of Over $40 Billion Since 1978 1978 2010

-50,000

-40,000

-30,000

-20,000

-10,000

0

10,000

20,000

C u m u

l a t i v e

P r e - T a x

P r o

f i t ( b i l l i o n s

)


23/40

And Not a Chance in Hell that the Industry

Could Earn at Least Its Cost of Capital

Source: IATA

Return on Invested Capital in the Airline Industry v. the Cost of Capital

P e r c e n

t o

f I n v e s

t e d C a p i

t a l

Cost of Capital(WACC)

93

14.0

12.0

0.0

Return on Capital

(ROIC)

94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 11F

2.0

4.0

6.0

8.0

10.0

10F

Forecast


24/40

If something


it will stop


25/40

B a n

k r u p t c i e s

BANKRUPTCIES

CUMULATIVEBANKRUPTCIES SOME HIGHLIGHTED CARRIERS

19781979 2 2 New York Air

1980 4 61981 5 111982 10 21 Braniff 1983 5 26 Continental1984 17 43 Air Florida, Wien1985 10 53 PBA, Cascade1986 6 59 Frontier1987 9 68 Air Atlanta, Air South1988 11 79 Mid Pacific1989 7 86 Eastern, Presidential1990 6 92 Continental1991 16 108 Pan Am, Eastern, Bar Harbor, Midway, America West1992 5 113 TWA1993 3 116 Hawaiian1994 2 1181995 5 123 TWA1996 4 1271997 4 131 Air South, Western Pacific1998 2 1331999 4 1372000 7 144 Tower, Legend2001 2 146 TWA, Midway2002 4 150 Vanguard, United, US Airways2003 2 152 Hawaiian2004 6 158 US Airways, ATA, Polar2005 7 165 Delta, Northwest, Independence Air2006 1 1662007 2 168 Maxjet2008 5 173 Aloha, ATA, Skybus, Frontier, Air Midwest


26/40

Airline Industry Restructuring Along the Way

Labor was the bank of first resort throughout the 1980sand 1990s (Barrier to Exit) Temporary fixes Labor gives concessions and gets paid back and more time and again

Consolidation among regional competitors in the mid1980s proved key in building national networks Strong carriers buying strategic assets from weakcompetitors

Recession in the early 1990s serves as catalyst to firstround of hub closures

Poor attempts at building airlines within airlines tocombat low cost competition still in its infancy


27/40


Travel agent commission structure targeted by the industryNegotiation of Open Skies Agreements becomes goal of USaviation policy Alters carrier thinking regarding international flying

International alliances in formative yearsSignificant changes to US Bankruptcy Code

The over exuberant use of 50 -seat regional jet begins Begins process of replacing mainline domestic flying

Southwest crosses the MississippiIndustry enjoys most profitable period in its historyAt the peak of the cycle, the industry tries to buy labor peaceand overpays


28/40

Airline Industry Restructuring Along the WayFirst transatlantic alliances immunizedNetwork carrier cost structures exploited by the vigorousincursion of low cost carrier capacityInsurance costs skyrocket after 9/11

Five of the seven network carriers file for bankruptcyNearly $12 billion in labor savings won150,000 jobs shedMaintenance outsourcing becomes a more widespread practice

First round of meaningful capacity reductionsSignificant shift of domestic flying from network carriers totheir respective regional partners takes placeNetwork carriers shift capacity away from US domestic marketand redeploy aircraft to international markets


29/40

As fuel prices increase, various hedging strategies employed withmixed success

As fuel prices peak, industry employs a number of strategies togenerate ancillary revenue

As fuel prices peak, industry announces significant capacityreduction and puts a capacity discipline mantra to work

New round of consolidation not limited to network carriers

Industry seems intent on not implementing their patternbargaining sins of the past with labor

Pushing the envelope to find new ways to take cost out of theoperation Few magic bullets remain



30/40


31/40

A LOOK AT CERTAINAIRLINE COSTS


32/40

The Expense Portion of the Income Statement

Labor: Expectations far exceed industrys ability to pay Want a restoration of pay without commensurate productivity Hard to restore pay when benefit costs so high

Maintenance: Outsourcing has slowed as a practice

Commissions: Low hanging fruit has been picked but Americanbelieves the middleman still has too much influence in this area

Airport Costs: Along with employee benefits and GDS fees, thisarea promises to be a cost center scrutinized by airlines goingforward


33/40

Landing Fees

The Age Old Airline v. Airport Conflict

$-

$2

$4

$6

$8

$10

$12

$14

$16

$18

0

50

100

150

200

250

Capacity Tons Landed (millions) Cost per Capacity Ton Landed

C

a p a c

i t y

T o n s

L a n

d e d

( m i l l i o n s

)

C o s

t p e r

C a p a c

i t y

T o n

L a n

d e

d


34/40

Unit Costs that Grow in Real Terms

Have Been Addressed in the Past

100

150

200

250

300

350

400

1 9 7 8 =

1 0 0

Indexed Landing Fees Consumer Price Index


35/40


36/40

But the Cost of Benefits Are a Concern

0

100

200

300

400

500

600

0

100,000

200,000

300,000

400,000

500,000

600,000

Total Employee FTEs Benefits per FTE Index CPI 1978=100

T o

t a l E m p

l o y e e F

T E s

B e n e

f i t s / C P I


37/40


38/40

WHAT TO MAKE OF THE LAST

30 YEARS OF THE USCOMMERCIAL AIRLINE BUSINESS


39/40

What to Make of the Last 30 Years?Then: Barriers to entry for new and existing carriers were removed

Now: Interestingly, fuel costs/volatility proving to be a barrier to entry Fuel costs have limited the growth of the Low Cost sector in a significant way

Then: Barriers to exit for inefficient carriers were erectedNow: Unlikely that labor is a source of capital this time around Traditional external sources of capital not likely to fund inefficient operators

Then: Finally in the 2000s, cost reductions and efficiency improvements thatwere expected during the previous two decades began to happen

Now: Will the industry stand and not give in to destructive pattern bargaining? Will the industry stand and not give in to the urge to add capacity? Along those lines, will the industry stop competing with itself? Will the industry finish the work of removing the middleman where possible?


40/40

If something


it will stop

Documents

Bill Swelbar FAA 2011