The world airline industry ended 1994 close to break-even, but cost of reduction is still top of the agenda.
At times, it seemed that it would never happen, but the world airline industry at last appears to have ended its record run of losses.
Preliminary results point to little more than break-even results for 1994, but even this modest performance ranks as a major cause for celebration in an industry which has netted losses of more than $20 billion since the beginning of the 1990s.
The recovery is still patchy, as illustrated by the Flight International ranking of the world's top 50 airlines (see P43), but, while there is still the odd patch of red ink around, the industry is now longer drowning in it.
Of the top 50 airline groups, which account for the bulk of the world industry, only around one-third turned in net losses for their latest financial year. That compares with more than half in 1993.
Perhaps more encouraging, is the fact that four out of five groups are now reporting profits at operating level, suggesting that the fundamentals are in place, for a full recovery. Where losses do persist, the trends are at least moving in the right direction.
The reasons for the turnaround are not too difficult to trace. Backed by more buoyancy from the world economy, traffic growth continued at a healthy 5.7% in 1994, helping to soak up some of the over-capacity which has dogged the industry for the past four years.
Europe's airlines report an exceptional rise in traffic, of more than 9%, virtually matching the boom market of Asia-pacific. A more mature US market also managed a respectable 4.6%. Most within the industry now believe that the capacity equation will come back into balance by 1997 as traffic growth and capacity constraint continue to fill up seats.
The effects are already evident in the operating performance and will begin to feed through directly to the bottom line over the next couple of years, even for the worst performers.
The cost side of the equation is also beginning to show signs of improvement, helped by better use of existing capacity, although the full force of restructuring efforts have yet to emerge in earnest. It is these efforts which will determine how carriers are able to turn recovery back into boom.
Even in an improving market, yields are due to continue their decline, albeit at a slowed rate of 1-2%. The winners will be those that can chase their costs down to match.
In the meantime, the industry can at least celebrate an end to the disastrous losses of the early 1990s. After a couple of false starts the International Air Transport Association (IATA) estimates that its members turned in a humble $100 million net profit in 1994, their first in half a decade.
Again, the biggest encouragement comes from a healthy growth in operating profits, which IATA estimates more than trebled, to reach $6.8 billion.
A similar view emerges from the International Civil Aviation Organisation (ICAO), which tentatively estimates that its broader base of airline members showed an operating profit of around $8 billion for 1994.
Estimates from both ICAO and IATA suggest an operating margin of around 3% - still poor, even for an industry which lives off the margin, but showing dramatic improvement.
ICAO is more cautious on predicting a net profit for its members, but expects at worst, the 1994 result will be "very marginally negative".
The US market provides a clear illustration of how the turnaround has begun to come about. Among the top ten carriers, capacity and costs remained virtually unchanged, despite continuing traffic growth.
If profits remained scarce, that was largely because of another series of hefty provisions as the industry put in place the final pieces of its long-running restructuring. It took the shine off what American Airlines group chairman Bob Crandall admits should have been a "truly outstanding" year.
The big three carriers, American, Delta and United, alone took charges of nearly $1 billion to cover the cost of restructuring, redundancies and, in United's case, the cost of its dramatic share-ownership scheme.
The most remarkable turnaround story of 1994, however, has to be credited to Northwest Airlines. Only a couple of years ago it was heading up the world's biggest loss-makers and came within a hair's breadth of filing for bankruptcy. In 1994 it emerged with the US industry's highest profits.
As president and chief executive John Dasburg is fond of pointing out, Northwest's success has been based around a deceptively simple strategy of concentrating on strengths and abandoning the pursuit of "ubiquity". Foregoing the allure of competing with emerging "low-cost" rivals on point-to-point routes, the airline retrenched its US network around its heartland in the mid-west. Dasburg has also been keen to exploit two other unique advantages, a hub in Tokyo and a virtually unfettered alliance with KLM. The reward has been an equally unique ability to raise yields in an otherwise declining US market.
Northwest may yet face low-cost challenges, in its mid-west fortress, however, especially if the intense competition between Southwest Airlines and United Shuttle on the West Coast begins to spread further east.
Down in Atlanta, Georgia, Delta is also cutting costs with religious zeal in pursuit of its goal of ¢7.5 per available seat mile (¢4.7 per available seat kilometre). Its restructuring may have come more slowly, but it is also thorough and unlikely to run into the union problems, which have beset its peers.
The smart money is backing Delta to be setting the pace on profits within the next couple of years, with other of the slimmed-down network carriers not too far behind. Analysts at SG Warburg are forecasting that Delta could be netting upwards of $700 million by 1997.
The very fact that financial analysts, are back in the business of picking winners, rather than potential bankrupts among the US majors, itself signals the extent of the turnaround.
Like Northwest, most of the network carriers now appear to be regaining their poise after the initial panic brought on by the onslaught of the low-cost start-ups. At the same time as the threat recedes, the majors are emerging with slicker and better focused operations of their own.
Even Continental Airlines and USAir appear to re-emerging from their baptisms of fire, which came close to crippling them both in the fight to transplant the fast-turnaround, low-cost concept to the east coast. Continental's unceremonious dumping of its Lite operation has eased the pressure on its competitors (even Southwest welcomed the move). It has also freed Continental to focus on the hub-and-spoke operations it knows best.
While the US recovery begins to take shape, Europe's airline industry certainly had a better year in 1994.
The Association of European Airlines (AEA), which represents all of the region's flag carriers, says that it is still too close to call whether the industry returned an operating profit. The final figure is hanging somewhere close to break-even. Whichever way it falls, the result represents a small triumph, given losses of $7.5 billion so far in the 1990s.
The AEA cautions, however, that it was exceptional traffic growth, rather than a more fundamental improvement in costs or productivity, which produced the turnaround.
As the passengers returned in droves, especially on routes within Europe, international traffic grew by a heady 9.3%, one of the best increases in more than two decades. At the same time, capacity rose by a more gentle 5.3%, with a net increase of around 66 new aircraft. The result was a three-point leap in load factors, to 68.8%, the highest figure ever recorded by the AEA.
The exceptional load factor was responsible, for around 80% of the profits improvement the AEA estimates. By contrast, the improvement in the cost: yield equation added a paltry $55 million to the bottom line.
The AEA sagely points out that, if the industry cannot turn a profit with aircraft fuller than they have ever been, then there is little option but to cut costs or raise yields.
Although yields did in fact recover by an encouraging 3% in 1994, helped by a pick-up on the North Atlantic, there is no pretence that the long-term holds anything other than a continued decline. So cost-cutting it is.
The industry needs look no further than British Airways to see the results. The airline has consistently achieved annual cost-saving targets of more than $200 million and sees no reason why it should not continue. "We're now confident that we have a culture in the company where managers are expected to improve their costs. I see no reason why we cannot go on targeting a reduction in output costs," says managing director Bob Ayling, answering the question of when the cost cutting will stop.
He points out that BA has shaved more than $1 billion from its cost base since 1991. Ayling adds that savings made the difference in 1994/5 of BA reporting record profits of $700 million (excluding the write-down on its USAir holding) instead of a loss of more than $400 million.
Competitors have already taken note. Lufthansa, now free of state control, has begun to forge ahead with an onslaught on costs, including the setting up of its low-cost Express service. Others, such as KLM, are also reaping the benefits from early action on driving up productivity and efficiency. Analysts are waiting for the profits to start rolling in.
Even the state-owned carriers of southern Europe are now tackling the issue head-on. The European Commission (EC) has anyway made such restructuring a condition for the latest round of state-aid flowing into the airlines.
Iberia, which is still awaiting an EC decision, has embarked on an aggressive three-year restructuring designed to return to profit, including the promise to slash the workforce by 14%. The Spanish carrier has already agreed a wage-freeze with its staff.
Olympic Airways in Greece, long ranked among the region's laggards, are also showing more earnest restructuring efforts under new chairman Rigas Doganis. The latest pronouncement out of Athens is that the airline is heading back towards its first profit in a decade, having slashed losses by nearly two-thirds in the first quarter of 1995.
Despite a new realism among airline management, European carriers continue to face an uphill struggle on cost containment. Efforts to improve the region's expensive and inefficient infrastructure are slow, while political and cultural hurdles remain in addressing staffing issues. Witness the recent embarrassing strikes at KLM and SAS, as well as the running battle still bogging down Alitalia.
ASIA TAKES HEED
Despite world-beating traffic growth and a traditionally low-cost base, the realities of the cost equation are also catching up with the carriers of the Asia-Pacific region.
The three big Japanese carriers have already been humbled by heavy losses, finding themselves overextended in the face of deeply depressed markets both at home and abroad. Restructuring measures are now in their third year and should put the industry back into profit for 1995/6.
Elsewhere, Singapore Airlines and Cathay Pacific, have led with warnings of falling yields and rising costs not helped by domestic currencies, which are steadily strengthening. An increase in international competition and strong capacity growth are common themes.
Malaysian Airlines and Thai Airways have managed to re-instate earnings over the last year, but only after an unnerving dip, while China Airlines has suffered this year, and may be casting an anxious eye over its shoulder at Taiwan's other rising stars.
Strong traffic demand and region's low-costs should help offset some of the concerns, but the carriers of Asia-Pacific might do well to learn the lessons of Europe and the USA, that battles for market share are no substitute for good housekeeping.
Source: Flight International