Louise Cooper Finance economics markets retail business

Monarch, Air Berlin, Alitalia.. why the airline industry is so tough…

Monday, October 2nd, 2017

Monarch has been in trouble for some years – not large enough to have serious capital and with a mess of a strategy.  It flew long haul, short haul, with a rump of a holiday business.  At the same time it was competing against the low cost carriers, specialists in what they do.  Management didn’t know what it was and staff and customers suffered accordingly.

(FYI Monarch flew 5.5mn passengers in the whole of 2016, Ryanair flew 12.7mn in just August)

A friend was a stewardess at Monarch and left a couple of years ago.  Although poorly paid, she frequently flew to long haul destinations and then had almost a whole week there, receiving salary and having her hotel and food bills paid, while she waited for the return flight.  At the time I thought cost control was clearly not strong enough….

In the days and weeks leading up to the administration being announced this morning, the board and owners would have been trying to sell the airline to a larger better capitalised player.   But Monarch’s collapse comes after Alitalia and Air Berlin have already gone into administration this summer.  Any big carrier looking for a cheap deal would have already had the choice of two other airlines to buy.  What happened is that both airlines were left to fall into bankruptcy and then the larger profitable competitors are cherry picking the bits they want – planes, landing slots and staff.

Ryanair had bid for bits of Alitalia, although that bid was withdrawn as Michael O’Leary tries to grapple with its current staffing problems.  (The good news for O’Leary is that there will be pilots that were employed at Monarch that are now available.) 

So what is it about the airline industry which makes it so tough?

Firstly, it is an operationally leveraged business which means airlines can swing into large losses (or profits) with relatively modest changes to revenue.  And this is because it is a high fixed cost business.  Irrespective of whether a plane has one passenger or 300, it largely costs the same to rent the plane, pay airport charges, pay staff and pay for fuel.  High fixed costs businesses are inherently really risky.  It is a crappy industry for investors.   

In filings to Companies House Monarch Airlines Ltd reported a statutory loss of £291mn in the year to October 2016.  Few businesses can afford to lose a quarter of a billion pounds a year.  Far less one with revenue of only double that at around half a billion.  The loss was blamed on aircraft leasing contracts.. so who was asleep signing off that contract?  Frankly in an industry as tough as airlines, such mistakes can be deadly (as has been proved).

The second problem with the airline industry is that it is growing , more and more of us are flying.  From 2008 to 2016 according to European Commission data, passenger numbers grew 16% IN A GLOBAL FINANCIL CRISIS!

You would think a growing industry is a good thing..  which is what all airlines do and so all add capacity to routes.  And therein lies the disaster.  If all players add capacity to routes then the supply of seats is greater than the (albeit increased) demand.  And this is where it gets ugly.  When the industry sees that supply of seats is increasing faster than demand, they all cut prices because it is a high fixed cost industry.  So to get bums on seats and to cover high fixed costs, all slash prices and the bloodbath in red ink begins.

And so look at Monarch’s 2016 results.  Although Monarch had basically kept 2016 capacity at 2015 levels, the number of passengers fell 7% and the prices achieved also fell, so revenue was down 15%.  High fixed costs means that level of fall crushes profitability.

It is also not a well run airline.  It had a load factor of 78% in 2016.  Ryanair’s most recent load factor was 97%. To be profitable low cost airlines have to have high load factors (bums on seats).

Mistakes with contracts, poor strategy, poor day to day management, this is an industry that does not allow mistakes… 

It is also a reminder to us all to use our credit cards when we book flights.

It is also worth asking what about those who have booked to be away more than two weeks?  Will the CAA bring them home?  It didn’t sound like it when I interviewed the boss of the CAA this morning…


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