Wednesday, December 16, 2009

Airlines: A Tough Business

Airlines have had a fairly brutal half century or so. It has just been a difficult business to be in for a whole bunch of reasons. Here are just some of the many problems:
  • Capital intensiveness
  • High fixed costs resulting in excessive operating leverage
  • Unpredictable fuel expenses that airlines have little control over
  • Fuel expenses typically make up a substantial portion (~20-30%) of an airline's cost structure with potential spikes beyond that level
  • Minimal to no pricing power
  • Overcapacity
  • Excessive debt (financial leverage)
A business with both high operating leverage and financial leverage will have net income (in the case of airlines mostly net losses) that is highly volatile. Generally, if you are in an industry that has inherently high operating leverage (like an airline) use of debt should be kept to a minimum. With both types of leverage in place net income becomes very sensitive to even small changes in revenues. When revenues are going up it's great but when they reverse profitability disappears quickly. Add in the unpredictability of fuel costs and a lack of pricing power and you have just about everything you don't want in a business.

From an article in The Onion:

In its ongoing effort to cut transportation costs and boost profits, United Airlines announced Tuesday that it was exploring the feasibility of herding them into planes and stacking them like cordwood from floor to ceiling.

"After much trial and error, we've found the most efficient way to stack them is to start with a base of large ones, then put down a layer of medium ones, then fill up all the holes with the smaller ones," operations manager Gary Brown said. "The really tiny ones are great for cramming up in the corners."

That's, at the very least, a novel approach to solving a difficult problem.

Adam

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