ANALYSIS: 24 November 2008

"It's pretty awful and it is going to get worse" - Chris Tarry

If any airline executives were entertaining feelings of hope or dreaming that things might improve in 2009, they clearly missed Chris Tarry's presentation at the executive forum of ACTE in London last Thursday (November 20).   

Armed with facts, figures, graphs and charts as well as his own deep knowledge of the economics of the aviation industry, Mr Tarry delivered some woeful warnings.

In a nutshell, he told the 100 delegates that things were "pretty awful" for airlines now but it is going to get worse.

Mr Tarry, who runs his own research company and is a leading airline analyst of the industry, described what sounded like a familiar sequence of events. When the going is good, airlines order new aircraft and increase capacity; when the going is hard, they can't take the extra capacity out quickly enough to retain their fare levels. The result is both falling demand and falling revenue.  

He pointed out that more aircraft were delivered to carriers this year than last. Delivery numbers are not due to fall until 2010. Something similar happened in 1992. Demand dropped because of the Gulf War but with too many aircraft on order, the industry took two years to recover and start making money again.

According to EC figures, economically and in terms of consumer confidence things were already now as bad as they were in 1992 and 2002 (the aftermath of 9/11).

But what made 2008 unprecedented, said Mr Tarry, was that the carriers had already been hit by high oil prices which put pressure on their costs. On top of this there was now pressure on their revenues because of the global economic slowdown.

While the worst might be over from high oil prices - it dropped to $48.50 a barrel last week from a June high of $147.50 - the slowdown was spreading and as a result, airline traffic and fares were falling. There was already too much capacity in most markets and for some airlines the key issue was now survival.

But if airlines are to keep their fares up, they have to cut capacity. This can not be done quickly and it also costs money to do so. Also if capacity is cut, they need to attract more customers to keep up their revenue. But this is a market in which demand is falling so as volume and load factors fall, the airlines are forced into cutting fares to attract business. 

In other more flexible and profitable markets, industries could adjust. But few would apply those two adjectives to aviation.

With figures from the International Air Transport Association (IATA), Mr Tarry said that despite carrying many more passengers in 2007 than in 1970, airline margins had barely changed, rising from 2.5% to 3.5%.

But now passenger numbers since September, especially in premium, were "falling off the cliff." Since June, premium traffic has dropped by 10%, according to IATA. This was partly because companies were banning or cutting travel and looking for alternatives. But it had an immediate affect on airlines. As premium traffic rose, Mr Tarry said, BA's profits rose. When it fell, so did the airline's profitability.

In this "exceptionally challenging environment", Mr Tarry said he expected IATA to revise downwards its prediction of airline losses for 2008. For many it really was a case of survival.

But there was one group who stood to gain from this story of decline: the buyer. In a downturn, Mr Tarry said, the traveller re-gains the upper hand. With less travel, buyers could get more value for their money and use their power to re-negotiate in a market with excess capacity. 

There is a possibility that legacy carriers can follow the LCCs and start unbundling their product and charge for baggage, food, headsets and pillows - something that Willie Walsh recently said BA would not do. But even imposing ancillary costs carried the risk of upsetting passengers and might not even cover the money lost through falling revenue.

It was a dispiriting picture of an industry locked into - for the time being at least - unstoppable decline.

There may be a few winners - airlines which seize the opportunity to adapt - but most will be losers and the consequences could be with us for a while.