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Why airline profits are flying high

  • Fri, 21 Apr 2017 13:44

HARI SREENIVASAN: The airline industry and its business model have been in the crosshairs of late, particularly since the United Airlines story captured worldwide attention.

Many travelers have been asking, how do airlines make money, and do those profits come at the expense of passenger comfort and convenience?

Our economics correspondent, Paul Solman, has been exploring the turbulent business of aviation.

It’s part of his weekly reporting on Making Sense of economic news.

WOMAN: Oh, my God!

WOMAN: Oh, my God.

PAUL SOLMAN: The whole world was watching, watching United Airlines last week, as its skies proved a lot less friendly than advertised.

But a flight we took recently had a much happier ending: No passenger was bloodied and dragged from the plane, which took off from tiny Windsor Locks, Connecticut, and landed barely five hours later in Dublin, Ireland, for an affordable $ 549 round-trip, including four-day hotel stay for some of the passengers.

There’s a larger theme of our story, however, that an industry notorious for losing money has been making it, hand over fist, at the expense of often helpless consumers, but that competition may be on the verge of rescuing us at long last.

STEPHEN KAVANAGH, CEO, Aer Lingus: The president was kind enough to put knots in this twine.

PAUL SOLMAN: Aer Lingus CEO Stephen Kavanagh keeps an old globe gifted to his predecessor in the 1960s by the president of Ireland.

STEPHEN KAVANAGH: The first knot being based in Ireland, and the second knot was the technical range of aircraft at the time. And his ambition was that Ireland would become a gateway point. And 50 years later, we believe we’re delivering on that ambition.

PAUL SOLMAN: Now, Aer Lingus wasn’t exactly a cash cow as a government service.

Aer Lingus was owned by the Irish government up until when?

STEPHEN KAVANAGH: 2006.

PAUL SOLMAN: And it lost money in all that time, right?

STEPHEN KAVANAGH: Yes. Well, most of the time, yes.

PAUL SOLMAN: When I told sophisticated business people that I was doing this story, they said, oh, airlines, an industry that always in the end loses money.

So, are you just in a up phase of what eventually is going to be a down industry?

STEPHEN KAVANAGH: There’s no doubt that the business is cyclical. And there’s no doubt that that industry over many years has had difficulty in returning its cost of capital to shareholders.

PAUL SOLMAN: By difficulty, you mean it hasn’t.

STEPHEN KAVANAGH: It hasn’t.

PAUL SOLMAN: But smaller, fuel-efficient planes can now reach well beyond the knot on that 1960s string. Indeed, these are boom times for airlines, and not just Aer Lingus.

What explains the turnaround? The answer demands a bit of ancient history and ancient footage as well. For decades, governments, including the U.S., strictly regulated fares and routes, if they didn’t own the carriers outright. Fares worldwide were high, routes plentiful, planes often half-empty. But profits were rare to nonexistent.

Then, in 1977, President Jimmy Carter anointed Cornell economist Alfred Kahn to deregulate.

ALFRED KAHN, Economist: It’s the greatest thing I ever did in my life, other than have children.

(LAUGHTER)

PAUL SOLMAN: Kahn thought market forces would bring air travel to all. He didn’t worry much about profits. When I visited him in Ithaca, New York, in 2003, he was proud of his legacy.

ALFRED KAHN: What I did has been extraordinarily beneficial to millions and millions and millions of people every year who couldn’t afford to travel, who now can visit their grandparents, which now strikes home to me, go home for vacation from college, who can travel and indeed can be tourists.

PAUL SOLMAN: But a key part of Kahn’s plan never materialized: antitrust enforcement. Thus, deregulation spurred a wave of mergers, speeded up when business was walloped by 9/11 and then the crash of ’08.

Bankruptcies abounded. Today, the U.S. fleet has shrunk to just four main carriers, which control 80 percent-plus of the U.S. market. No wonder passengers are at the mercy of the major airlines: flights jam-packed, routes slashed, service to smaller airports dumped.

Yes, fares have dipped, but costs have dipped more, thanks to new planes, cheap fuel, do-it-ourselves software, and union work outsourced to contract workers.

Meanwhile, fees have so metastasized here in the U.S., one low-cost airline now differentiates itself by mocking them.

ACTOR: Is this your first flight?

NARRATOR: On Southwest Airlines, we don’t charge fees for stuff that should be free.

PAUL SOLMAN: U.S. airlines alone made an estimated $ 20 billion last year. Fees accounted for an estimated $ 3.8 billion, itinerary change charges another $ 3 billion. Selling miles to credit card companies has been estimated to bring in upwards of $ 10 billion more. Hey, even Southwest is now under pressure to impose fees to increase profits.

In justifying the profits of Aer Lingus, which itself has merged with British Airways and Iberia, CEO Kavanagh might as well be speaking for the industry as a whole: It has achieved greater efficiency.

So, your story is: We finally figured out how to do it right.

Is that true?

STEPHEN KAVANAGH: We have figured out what you need to manage.

KEVIN DILLON, Executive Director, Connecticut Airport Authority: Airlines are extremely profitable at this juncture.

PAUL SOLMAN: Kevin Dillon runs Connecticut’s Airport Authority. With only four carriers dominating the domestic market, he has to pay to bring new business to his underserved airport.

KEVIN DILLON: Our passengers out of this catchment area for many, many years have driven down to New York or driven up to Logan.

PAUL SOLMAN: Connecticut offered $ 13 million dollars in cash and guarantees.

But they still had to bribe you to get you to do this.

DECLAN KEARNEY, Director of Communications, Aer Lingus: Well, but if what you’re referring to is that we’re getting support from the airport and from Connecticut, yes, it’s helpful, as was we put a lot of commercial risk into launching a route. The fact that they would share some of the risk, we think is totally fair.

PAUL SOLMAN: Aer Lingus spokesman Declan Kearney stressed that the company too is making an investment, $ 50 million in equipment, crew and fuel costs, promotion. But the bottom line is that the profits from overbooked flights, infuriating fees and cheaper costs are luring competitors once more.

We first reported this torrent of competition last year, when no-frills Norwegian Airlines began flying to the balmy isle of Guadeloupe from New York and Boston for $ 69. Norwegian is about to start flying to Scotland from Connecticut, as we flew affordably to Dublin.

As we enjoy a brief pub interlude, remember the advantages of competition on flights to Dublin or anywhere else: low fares, no fees, comfy planes from which no one is in danger of forcible removal, because of the profits that beckon. And one last time, why the profits?

Two main reasons, claims Aer Lingus CEO Kavanagh.

STEPHEN KAVANAGH: That there has been some level of consolidation in North America, where it’s possible for airlines as businesses to generate sustainable levels of profitability. And the other is, capital is more disciplined as to where it’s deployed.

PAUL SOLMAN: Investors are more disciplined, he means, in that they now demand immediate profits, or simply sell their airline stocks.

But maybe the discipline in North America is just consolidation, right? I mean, it may be that if there were more vigorous pursuit of antitrust in America, you would have more competitors competing on price, and then airlines wouldn’t be making any money again.

Kavanagh’s answer to this question may be the moral of this story.

STEPHEN KAVANAGH: That is undeniably true. If you have full freedom of access to a market, where capital is cheap, where there isn’t a discipline of a return, then that isn’t a stable market. And, in airlines, no business in that type of environment is capable of generating sustainable return.

PAUL SOLMAN: Which would suggest that, once competition hits full-throttle, consumers may then again be flying high, while the airline industry will be coming back down to earth.

For the PBS NewsHour, Paul Solman, reporting from Dublin, Ireland, and 15 miles north of Hartford, Connecticut.

The post Why airline profits are flying high appeared first on PBS NewsHour.

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