The recent IATA AGM gave plenty of food for thought. There was clear agreement with our view that we have now entered the third phase of the downturn, which we fear could inflict a pretty vicious squeeze on the industry as revenue continues to fall and the price of fuel rises. In this respect there is, as analysts say, "downside risk" to even the most recent IATA forecasts.
There was little disagreement the industry willemerge resized, reshapedand restructured.This is inevitable, but thefundamental question is how this will be achieved, considering planned deliveries will increase capacity 17% over the next three years. Anumber of airlines have slipped some deliveries but, if deliveries continue broadly unabated, thebalance between capacity, demand and pricing will be further upset, changingthe economics of the industry. Even fewer airlines will have a chance of producing an adequate, let alone satisfactory, return-even at the next peak of the cycle.
Although there are common challenges, the actual impact of the current and likely future environment varies by airline. And despite the breadth of the economic downturn, there are still a number of markets which offer structural growth; Chinese domestic traffic is again growing at a rate in excess of 20%, driven by 6% growth in first quarter GDP. But in a number the consequences of too much capacity on yields and financial performance are all too evident. Here India comes immediately to mind.
For a number of airlines, even allowing for cost cutting which is unlikely to offset the near-term fall in revenue, their future performance is entirely linked to the economic cycle. All cost reduction has a cost (mostly cash), as well as a price associated with it. The main source of structural cost reduction in recent years has come through a new approach to sales and distribution and introduction of the e-ticket.
Whilst programmes to cut cost are a necessary reaction there are a number of non-negotiable items which include: safety related expenditure; customer service; brand and the minimum sustainable network. Cost reduction must also have a focus on the future and in this respect cuts must not compromise the ability of the business to take advantage of the upswing, despite the nearer-term cash attractions.
All businesses need an operational plan as well as a clear and coherent view of where they aregoing and how to get there.
Another view that was prevalent in Kuala Lumpur was further consolidation is inevitable. Whilethe main focus of attention is on mergers and acquisitions, do these solve some of the industry problems, namely: too little revenue; too much cost and not enough profit.
Here the answer must be that it won't, unless there is considerable post-acquisition activity where revenues are grown, but with a significantly reduced cost base tothe situation before the two airlines came together.Achieving this is difficult and costly. Of course consolidation in a market can also happen through exit and, although there have been some 18 airlines that have failed so far this year, we fear that there will be more to come.
So against the background of one of the messages from the IATA AGM - an expectation that the "industry will transform itself and emerge stronger" - the reality is that a small number of airlines will achieve this and it will also be a reflection of earlier decisions, as well as ones taken in the current environment.
Unfortunately for many, the expected transformation and emergence as a stronger airline should not be assumed to necessarily be the case. Indeed in the near term we fear it is going to get more difficult before it gets easier and in this respect we share the view that the "facts fail to support the optimists".
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