Revival of a sick airline by nuhman10


									                        “Revival of a Sick Airline”
Wild fluctuations in fuel costs, tightening corporate travel budgets and anxious consumers
have created shockwaves through the airline industry. In the current environment, any
activity that doesn‘t directly contribute to filling and operating flights safely and efficiently is
under the microscope as carriers scramble to find ways to stem the tide of red ink.
However, quality service and a positive customer experience is more important than ever for
attracting and retaining passengers, especially for the most profitable customers: business
travellers. Finding creative ways to improve service without adding costs—or better yet,
reducing costs—should be a top priority for every airline.
"Questions of control and viability" analyses the causes for the sickness of airlines and
suggests remedies. Winds of change are blowing with liberalisation and globalization, but
these airlines have learnt nothing. Their top-heavy managements have failed to anticipate
problems and suggest timely remedies or are it possible that the political bosses have shot
down all suggestions for the revival of the airline? While some public sector undertakings,
such as   the other companies, have proved profitable and able to stand on their own feet,
HIND        AIRLINE       has     been     in     the    red     and     limping      for     years.
It is the time civil aviation management, which is no fountain head of airline management
expertise, took its hand off the airline. There is no alternative to disinvestment and
participation of private parties who can provide the management skills to run the airline. As a
temporary     measure, international airline management           consultants can be hired. The
government can provide long-term loans to help the airline tide over the financial crunch and
phase out the ageing aircraft and purchase state of the art ones.
Research on the performance of major airlines suggests that there is a positive correlation
between on-time performance and operating profit. This is a similar phenomenon to that
found in manufacturing industry—where the cleanest factories tend to be those with the
highest productivity.

Poor On time performance
Punctuality is a key leadership challenge throughout the organization and should rank high on
the management agenda—from strategy and planning all the way to front-line operations. In
rising to this challenge airlines need to take a strategic perspective and apply a
comprehensive framework that addresses the three main levers for punctuality improvement
that are within their reach:
— Network planning and control
— Aircraft availability
— Ground operations and departure process
Our research shows that major airlines with above average punctuality rates have been more
profitable than those with lower than average punctuality performance. On top of the negative
impact on customer satisfaction, delays are expensive. Direct and indirect delay costs
typically range from 0.6% to 2.9% of revenue, depending on the size and type of operation
and the method of calculation. This combination of significant revenue and cost-side effects
is why punctuality should rank high on top-management‘s agenda. However, punctual
airlines appear to be more profitable. Research shows that major airlines with above average
punctuality rates have been more profitable than those with lower than average punctuality
Tools such as simulations, statistical sampling, process monitoring and key performance
indicators build the foundation to drill down to the root causes of delays. The key success
factor is to merge quantitative analytical rigor with the rich qualitative information from front
line observations, know-how and staff experience.

Two major trades-offs:
Punctuality vs. cost and equipment utilization
One of the most obvious and easy measures to increase punctuality is to remove bottlenecks
and add capacity (e.g. the number of aircraft, longer block times, and more ground staff and
equipment). Without a solid quantitative business case, based on analysing potential savings
from avoided delay costs, it is unlikely that a controller will support such ideas, especially as
most of the savings are variable while the capacity increase builds up fixed costs.
Punctuality vs. turnover and yield
Short-term revenue considerations such as display visibility in the global distribution
systems (GDS) do in most cases work against punctuality. Maintaining slots at peak times
during the day, short connecting times and tight block times are valid sales-based arguments.
However, they may ultimately result in poor operational performance, and may therefore
become counter-productive to revenue maximization in the long run.
Identifying the „Real‟ Delay Root Causes
There are three basic approaches to identify the ‗real‘ root causes of delays and to define
improvement levers
— “Conventional” methods
— Process monitoring and sampling
— Simulation
Conventional Root Cause Analysis
This category covers the conventional methods of analysis used in most airlines, for example,
delay code frequency, fishbone diagrams and correlation analyses. In the initial stages, these
methods can help identify the broad picture and provide a first cut understanding of the major
problem areas.
These methods also work well to generate agreement in cross-functional discussions and
workshops, as they are easy to understand and based on the immediate experience of staff.
Many airline executives distrust the delay codes reported by the front line. Nevertheless, they
are helpful to highlight major problem areas. A pragmatic interpretation is that systematic
failures in delay code allocation are at least consistent over time. Therefore, they can provide
data on delay patterns that highlights short- and long-term trends in certain ―delay areas‖.
To identify and understand the root causes it is necessary to leverage the knowledge of the
staff. The people working every day in the key processes do know many of the root causes
but this information is often not reported. Listening to them one by one may be frustrating,
but their individual statements are like pieces in a jigsaw puzzle that reveal the true picture
when put together. One thing that is often forgotten is to analyze the good days. There is an
untapped resource of information, often neglected by solely focussing on a problem-oriented
approach. Our experience is that it is important to study the perfect days on a regular basis to
better understand the causes of delays.

Process Monitoring and Sampling
Process Monitoring and Sampling‖ establishes a database to evaluate process performance in
the overall departure process, supplier processes, and the activities in problem areas. Process
monitoring requires that key milestones in the departure process are defined and measured.
Some airlines conduct spot checks on such milestones, taking samples from a number of
flights on a regular basis; others go as far as using automated electronic time-stamps that feed
into online monitoring systems. Although such systems can require significant investment,
the increase in operational transparency will pay off Data from process monitoring allows the
dissection of the departure process, identifies the origins of delays and the impact on the
overall airline delay rate.
The key success factors are analytic rigor and the use of a systematic top-down approach that
continuously asks the question ―So what‘s the ‗real‘ root cause behind that apparent root
cause that we need to remedy?‖

The Monte Carlo simulation of the rotation plan is a very powerful tool for evaluating and
optimizing the schedule. Simulations are also useful to plan certain ground activities such as
gate allocation. The expected outcomes of Monte Carlo simulations are:
— The effect on punctuality of variations in isolated parameters such as block hours, slack
distribution, etc.
— The impact of external factors such as ATC delays
— The identification of the critical lines of flight in the rotation plan—those lines that are
most sensitive to poor execution Simulations will not tell how to solve executional problems,
but they will put an end to some of the company‘s myths such as ―we cannot do anything to
improve punctuality because all the problems are due to ATC‖.
Solving the Delay Problems
As soon as the root causes are visible and agreed on, the path to remedying them is usually
clear and the different improvement options can be evaluated. These options typically fall
into two categories— internal measures and supplier related measures
Internal measures include:
      Resources, capacity and infrastructure. These refer to measures such as using
       dedicated resources for critical processes, reserve aircraft, or investments in system
      Process design and optimization aiming at doing things in innovative new ways,
       which have not been thought of or attempted before.
      Empowerment, motivation and discipline. These factors include incentives, new
       policies, clear roles and responsibilities for the staff involved.
Supplier related measures include:
      Service level agreements, which address not only what to deliver but also when to
       deliver it.
      Operational planning and interface design, integrating the activities and processes of
       each supplier within the entire network of operations.
      Continuous monitoring and feedback as well as incentives and penalties which close
       the feedback loop in the supplier relationship and which assign clear ―consequences‖
       to good or bad performance levels.
Many attempts to improve on-time performance have focused on one area at a time, such as
adding more slack to the schedule, decreasing turn-times, and not waiting for delayed
connecting passengers. Unfortunately, an improvement in one area often creates pressure on
another—like squeezing a balloon, the problem pops up elsewhere. Mercer has found that
effectively improving on-time performance over the long-term requires a holistic approach
that takes into consideration four key levers: planning, execution, recovery, and feedback
In building route structures and aircraft rotations, airlines seek to optimize the use of their
expensive aircraft. They create schedules designed to maximize profit, based on forecasted
demand. However, schedules are too infrequently checked for robustness, leave little slack
for recovery in case of irregularities, and can build in impossibilities. Planning for superior
on-time performance means building a flight schedule that is both reliable and robust enough
to handle the unexpected. Maintenance and operations planning must be developed hand-in-
hand with the flight schedule.
A reliable schedule accurately reflects the environment likely to be faced on the day of
operations. To build such a schedule, an airline needs to evaluate the fundamental elements of
the schedule (block times and turn-times) and the impact of operational constraints that might
be encountered during schedule execution. Frequently, airlines will use broad averages to
forecast the time required for each flight. This ignores the large variations that can occur
depending on the time of day, day of the week, other airlines‘ flight schedules, etc. For
example, one airline found that airborne delays had significant peaks on Monday mornings
and Thursday afternoons. Rather than increasing block times across the board, the airline was
able to tweak the times for the affected flights and improve on-time performance while
minimizing the revenue impact. While each airline‘s operational environment is unique, all
systems have constraints on the amount of activity they can support. An airline can
accidentally schedule its way into congestion and delays by scheduling more movements than
the infrastructure can support. A quick way to identify this problem is to compare scheduled
arrivals/departures to actual at a major hub, controlling for the effects of large-scale
disruptions A hub‘s economic success is linked to its ability to generate numerous connection
possibilities during a relatively short time frame, generally 60 minutes or less. When an
airline cannot deliver on peak arrivals and departures, flights slip out of the connection zone
and marginal revenue is lost, without a corresponding decrease in costs. Indeed, Mercer has
found that costs increase. Thus, rather than operate late, an airline may need to reduce the
number of movements while working to identify and eliminate the bottlenecks that limit its
Managing schedule execution is one of the greatest challenges in the business. Thousands of
activities must come together seamlessly to keep a flight on time. To stay on schedule with
such a complex operation, an airline must ensure superior management of the ―critical path,‖
i.e., that set of core activities which determines the actual length of the flight. An extra
minute in any one of the critical path activities means an extra minute overall.
The critical path of an airline flight has three segments: on the ground, in flight, and
overnight. When the aircraft is on the ground, the critical path is the cabin. The time for
passengers to disembark, for the cabin to be prepared, and for the next set of passengers to
embark determines the amount of time the aircraft will be on the ground ―Under the wing‖
activities, such as fuelling, inspections, and loading baggage, are generally not considered to
be part of the critical path, as these can be conducted in parallel, while the cabin activities are
In spite of good planning and execution, delays will occur. Once this happens, the airline
must go into recovery mode, not only to limit the impact on on-time performance, but more
importantly, to limit the impact on the customer.
Large-scale disruptions are the result of an important reduction in an airline‘s capacity. The
most frequent cause is ATC authorities reducing the number of movements at a hub airport
due to poor weather. The airline then has the choice of reducing the schedule to match the
new capacity or delaying successive flights for the rest of the day (and then is often forced to
cancel at the end of the day anyway because of curfews or crew service time violations). At
large carriers, these knock-on effects can show up as increased delays over a period of several
In most airlines, the biggest cause of delays after weather is the previous flight being delayed.
With airlines under pressure to better utilize their aircraft, scheduled turn-times often do not
leave slack to absorb late arriving aircraft. As a result, delays do not go away by themselves
and must be attacked with an appropriate recovery solution. Operations managers, in
cooperation with the other divisions, can reallocate resources to stop delays from building up,
taking advantage of the recovery opportunities that have been built in during the planning
process. The types of reallocation options—swapping aircraft, crew, or gates—are limited,
but the process can still be very complex, given the large number of resources (as well as
regulatory constraints) that must be taken into consideration.
A holistic approach to on-time performance is not complete when the day‘s operations are
finished. At most airlines, what actually happens on a given day can end up being quite
different from what was planned. This isn‘t necessarily bad, but an airline can only improve
its on-time performance by feeding information about schedule variances back into schedule
development and operational planning. Otherwise, the airline will simply be doomed to
experiencing the same schedule problems over and over again.
Capturing information on delays and proposing solutions is only half the challenge, however.
Where most airlines fall short is in applying an objective, rigorous analysis to proposed
solutions. This requires a cross-functional team armed with appropriate techniques to develop
a quantitative assessment. If a proposed solution cannot be summarized quantitatively and
supported by a business case, an airline cannot determine the impacts of changing the
planning process versus the potential gain in on-time performance. Without an objective and
strong process owner, feedback turns into nothing more than anecdotal comments during
schedule development meetings.

Aging Fleet and Low Profitability

Passenger-To-Freighter (P to F) Conversions and Aging Aircraft

In October 1996 the FAA completed a Freighter Conversion STC Review of a cargo
operator. This review revealed that the company involved was not completing the conversion
to FAA satisfaction and that some of the engineering was drawn and described after work had
started or even been completed. The review further revealed a significant lack of quality
control. Several beams were unsupported or simply butted up and not fastened at all. It is
commendable that this incomplete and dangerous work was discovered, while at the same
time, it begs the question of what other shoddy effort has not been discovered but has been
certified as complete and airworthy. Inspections of these modification facilities need to be
more rigorous and at an increased schedule.
In 1998 the FAA found that numerous B-727 converted aircraft were not in compliance with
their STC. Sufficient engineering had not been completed to allow the higher weights to be
carried in most positions on these aircraft. While it is good that the FAA discovered this
problem and took action to bring these aircraft into compliance, it points out a potential
weakness in the system that the situation developed in the first place, and that these aircraft
flew for several years and were not airworthy. Floor strength is a major concern with a
converted passenger-to-freighter (P to F) aircraft. The increased loads throughout the cabin
are substantially higher with cargo then when passengers are carried. The weight in a zone or
pallet position can be more than doubled based upon 18 passengers with seats of 22-inch
pitch and carry-on baggage to be approximately 4,000 lbs. This same position on a cargo
aircraft could be certified to carry more than 8,000 lbs. Aircraft have been found to have fuel
tanks supported by the same floor beams that are carrying the main deck cargo load. In a
FAA-published case, the combined floor weight and suspended fuel tanks with fuel would
have exceeded the certified weight by 100% or twice the allowable weight. Due to structural
modifications that add weight, freighter aircraft are usually operated at higher zero fuel and
take-off weights than passenger aircraft of the same type. These increased weights result in
increased speeds and air loads. Operating at these higher weights increases loads on the
landing gear, flight controls, spars, brakes and engines. The higher reference speeds also
result in more frequent operation near the flap and gear limiting airspeeds, thus the
assumptions made during initial certification about exposure rates to high loads may not be
valid. There is an on-going FAA Certification Process Study (CPS) to feed operational data
back into the certification process. This effort and resultant recommendations may help to
minimize this problem. These increased air loads have been responsible for several flap
failures that have been close to loss-of-control events.
With the quick expansion of the express cargo airlines in the late 1970s and through the
1980s, aircraft modification facilities expanded their business to include conversions of
passenger planes into cargo aircraft. One of the major modifications was the addition of the
main deck cargo door. It is widely known in the cargo industry that the best cargo door is the
door that was incorporated in the manufacturing process, in other words, an original part of a
new aircraft. Second best is usually an aircraft modified by the original manufacturer of the
aircraft and third best is the after-market modification facilities. Some modification centre
doors even have and continue to use the actual cut out piece of the fuselage itself as the new
door, and do not use a jig or any additional structural support during the modification.
Not only do these aircraft age, wear out and suffer the effects of time but so, as well, do the
avionics and other components that make up a fully assembled, flyable aircraft. For many
years replacements parts were produced for these older aircraft. But during the 1990s
manufacturing switched to greater use of the more reliable computer chip. This change has
meant older aircraft parts have often become hard to find, and many of those parts still in
service have been repaired numerous times and are worn out.

Increasingly being faced with tough competition
It is now 25 years since the world‘s first frequent flyer program was launched. Today all most
every airline, even a low cost carrier has a Frequent Flyer Program (FFP). The airline
industry collectively earns $10 billion by selling AOMPS (Add On Mileage Points) and
airline FFP memberships are growing at 13% per year, much faster than growth of airline
industry. However, over the years, air travel in most parts of world has become a commodity,
due to increased competition. FFPs have drifted away as main drivers for CRM strategy, their
original purpose of ―promoting loyalty‖ to being‖ independent profit centres‖.
   Brand Positioning of the Airline with product and service differentiation
   Product differentiation and brand positioning of the airlines‘ premium classes,(F/J), have
   necessarily to be linked to airline‘ product vis-a-vis competition on each major route. The
   differentiation of products fulfils consumer promise nut needs to be at a competitive
   price. The value benefit of airline product has to be highlighted clearly by targeting
   promotional campaigns aimed at specific markets segments.
   Price versus product/service differentiation of the airline with its competitors is a crucial
   benchmark for building the brand equity of an airlines‘ loyalty program overtime.
Transition from “frequent flyers” to frequent buyer”: In the dynamic market place of 21st
century air travel, airline FFPs have tied up alliances with partners from credit cards
companies, mortgage lenders, finance companies, fuel companies to corner grocery shops.
Airline normally sells their miles for 1-2 cents per miles to such partners, as co-branding
strategy. As a result, the majority of airline frequent fliers miles are now earned outside an
airplane, by frequent buyers that frequent flyers.
FFP Management from competitive scenario
        Ensure seats are protected in RBD for redemption
        Action on feedback from FFP members
        Keep track of FFP of other airlines
        Keep update on accrual/redemption ratios, etc.
        Keep update on blogs, websites like that give ratings for FFPs.

   Key success criteria
   From airline‟s point of view
        Integrate its FFP with alliance members and other airlines as well as, non-air
       partners‘ systems facilitating redemption and accrual across members
        Reduce liability of MPTs by expiring them, promoting the sale of expiring MPTs.
        Increase the frequency of and/or influence the customers‘ purchase
        Improve the service provided to members based on value
         Provide a mechanism to influence the behaviour and improve the profitability of the
        entire membership base.
Direct marketing resources for optimal return on investment Enable FFP platform and
processes to be performed at a competitive cost
         Create and enable partnership agreements, joint credit card promotions etc that earn
        additional revenue.
         Provide an additional promotional and payment channel to facilitate sale of in-flight
    From customer‟s point of view
         Success in getting award travel
         Personalized service by airline in the following functions
                  Accessing airlines‘ website
                  Recognition by airline, e.g. a birthday gift like a bottle of wine on board
                    aircraft, if travel date coincides with birthday
                  Special assistance during irregular operations, delayed flights, etc.
             Web enabling key internal business processes
             Integration with alliance partner airlines‘ FFPs, giving wider options to

Inadequate Cash Flow
An airline‘s profits depend on its revenue and its costs. Revenue depends on what a carrier is
able to charge for its flights and the number of passengers it carries. Costs depend on, among
other factors, the price of fuel and the wages and salaries of employees.
Number of passengers
The good news is that, traffic (revenue passenger miles) in 2004 exceeded its previous peak
in 2000. Negative traffic growth is a relatively rare occurrence in the airline industry—the
last downturn is only the fifth occurrence of a negative year over year traffic growth since
record keeping began in 1930. However, what is unprecedented about this drop in traffic is
that it took four years for traffic to rebound.
The recent downturn in traffic began in February 2001, one month before the recession that
began in March 2001 (and ended in November 2001). The downturn was exacerbated by the
aftermath of the September 11, 2001 terrorist attacks. Traffic growth has subsequently
returned, but why? One reason is that GDP is growing. Since its trough in 2001:3, real GDP
has been growing by more than 3 percent per year. Another reason is more travellers are
feeling that flying is safe enough for them to travel by air. Still another important reason is
that the airlines responded to the initial drop in traffic by reducing fares to induce people to
Fares fell by 25 percent from 2000 to 2004 after adjusting for inflation. This substantial
decline in fares has occurred only one other time in the United States, namely after capacity
restrictions were eased following the end of World War II. Because of the dramatic decline in
air fares, the rebound in traffic masks underlying changes in passengers‘ demand for air
travel. Our ―back-of-the-envelope‖ calculations indicate that, under reasonable assumptions
about the sensitivity of air travel to fare changes, in 2004 prevailing fares generated 17
percent less traffic than those fares would have generated in 2000 (with a plausible range
between 6 and 25 percent).
What has caused the change in passengers‘ underlying willingness to pay for air travel?
Plausible reasons are that the airline ―product‖ has changed. Increased security leads to
earlier arrival at airports and longer trip times; fuller planes—over 75 percent full on average,
the highest since right after World War II—make travelling more unpleasant. And
alternatives to air travel, teleconferencing and rail travel—at least in the Northeast Corridor—
have become more attractive options.
Consider as an illustration the effect on air travel of required earlier arrival at airports. If
passengers must now arrive at their origin airport one-half hour earlier than previously, then,
under plausible assumptions of relevant parameters, travel could decline 7 percent (a
plausible range is 3 percent to 11 percent). In addition to these considerations, the travelling
public, especially the (formerly) lucrative business travellers, are less willing to pay fares
many times higher than their fellow leisure travellers.
Labor represents the biggest single category of airline costs, currently about 28%. ―Legacy‖
airlines, by definition, are those that existed during the period when airlines were regulated
(through 1978). In that environment, there was so-called ―rent sharing,‖ as unionized workers
sought, and received, a share of the ―rents‖ (profits) that the regulated firms earned. Low-cost
carriers emerged with the advent of deregulation in 1978 and adopted a more
entrepreneurial/cooperative style of labor relations that resulted in lower pay and/or higher
worker productivity than legacy carriers were able to achieve with their work force. The
expansion of low-cost carriers has put increasing pressure on legacy carriers to lower their
labor and other costs. Since 2000 food and beverage costs per revenue passenger mile have
fallen by 35 percent and travel agent commissions (per available seat mile) have fallen by 69
percent. But since labor is the largest category of airline costs, it too has been the target of
cost cutting (and enhanced productivity) by legacy carriers, through negotiation as well as in
bankruptcy, as they seek to reduce their costs to compete with low-cost carriers.
In addition to unanticipated reductions in travel demand, the industry is vulnerable to
unanticipated increases in costs. Jet fuel, a necessary input into the production of air
transportation, accounts for between 10 and 30 percent of airlines‘ costs, and its price can
fluctuate widely from year to year. Fuel price increases can be a significant drain on airline
profits. Relative to the (nominal) price of jet fuel that prevailed in 2000—the last ―good‖
financial year for the airline industry (and one in which the price of fuel was relatively high
by previous historical standards.

What Can Be Done to Improve the Industry‟s Financial Performance?
It may be surprising to some that the financial problem that the industry is currently
encountering is broadly associated with the industry‘s long-term adjustment to airline
deregulation. Airline deregulation was based on the correct belief that enhanced and
unfettered market competition and enlightened public policy would benefit the travelling
public. But it is now clear that the airline industry has needed and still needs time to adjust to
its deregulatory freedoms by ridding itself of remaining cost inefficiencies, doing a better job
of matching capacity with demand, and anticipating and responding to changes in traveller
Both the market and enlightened public policy can enhance industry financial viability. But
we believe that policymakers should rely on the market to do the bulk of the work. The
fundamental problem is that there is excess high-cost capacity in the industry. Competition
among air carriers will reduce such capacity and no doubt may lead at least one if not more
carriers to contract, undergo liquidation, or be absorbed by another carrier. But successful
carriers—that is, those that are cost efficient and responsive to passenger preferences—will
be poised to pick up any slack. Indeed, travellers will gain if legacy carriers make the
required changes to be effective competitors in the new environment or are replaced by lower
cost carriers.
Airline competition is working in the sense that those carriers that enhance traveller welfare
are rewarded with higher profits. This is an important finding because it indicates that
policymakers should not intervene in the competitive process.

A substantial rise in yields has been the other element driving improved airline financial
performance. As capacity lagged the rebound in traffic, supply-demand conditions tightened
and yields improved as a result. This was most notable in US markets as the industry in
this region made the most significant cuts in capacity. Now capacity is returning to markets
and load factors have peaked. As a result yields appear to be levelling off. As traffic slows
further through 2011, supply-demand conditions may ease further. Yields look reasonably
well supported at current levels but further improvements look unlikely in 2011.
Margins look set to be squeezed to some extent in 2011 by stable yields on the one side and
rising fuel prices on the other side. We had previously expected oil prices to remain stable at
US$79 a barrel. However, central bank liquidity and capital flows are threatening to generate
asset and commodity price bubbles, helped by improved economic sentiment outside of
Europe. We have revised up our forecast for oil prices to an average of US$84 a barrel in
2011. Higher oil prices, stable yields and weak traffic volumes originating from the
developed economies cause some slippage in airline profits next year. Geographic differences
will remain. Stronger growth in the emerging markets will support stronger performance
from airlines based in those regions. European airlines will continue to be hampered by weak
home markets.

Inadequate Cash Flow
We are upgrading our forecast for airline industry profits in response to a strong cyclical
upswing in revenues and much better utilization of capacity by airlines. Our forecast for net
post-tax profits in 2010 has been raised to US$15.1 billion, up from our previous forecast of
US$8.9 billion. Better economic conditions, despite the European crisis, have supported
stronger market growth and better aircraft utilization has driven a sharp upswing in
profitability in all regions. Operating margins are now expected to exceed 5% this year, not
as good as the late-1990s but better than the previous cycle peak in 2007.
Airline profit cycles usually last 7-10 years, from peak to peak, implying that there are 4-5
more years to go before this cycle peaks. Nonetheless next year, 2011, may see smooth
upward progression being interrupted as oil and jet fuel prices rise and some economies in
Europe look set to be driven back into recession by debt crises. Emerging markets such as
Asia-Pacific look set to continue to grow strongly but a weak Europe is expected to make the
business environment for airlines more challenging than it was in 2010. With a stronger 2010
the starting point for industry profits is higher than we expected in our previous forecast.
But we are still forecasting some slippage in net profits to US$9.1 billion in 2011.

There has been a stronger-than-expected cyclical rebound in airline profits, but that rebound
and the upgrades we are making to these forecasts need to be put into perspective. First, the
US$6.2 billion upgrade to raise forecast net profits in 2010 to US$15.1 billion is just 1.1% of
revenues. Because profits are so small, relatively minor improvements in revenues or costs
can generate large changes in profits. Second, and more important, the cyclical rise in profits
represents a rise to just over 4% in returns on invested capital. As the chart below shows this
is still very inadequate. It shows that the industry can pay its bills, renew its fleet and service
its debt. However, it still cannot offer any return to its owners and shareholders for the risk
they undertake. Despite the cyclical rebound in profits, the structural challenges that keep
profitability in the industry inadequate, remain.

During the first half of 2010 the recovery of operating cash flows had been concentrated in
Asia-Pacific and the Americas, but by the third quarter a widespread cyclical recovery in cash
flows was underway. Even the European airlines, hampered by weak home markets, saw their
cash flows rise sharply in Q3 to just below the previous peak of 2007.
A strong post-recession rebound in cargo and travel volumes had already driven the
improvement in cash flows for Asia-Pacific airlines in late 2009/early 2010. Capacity cuts in
late-2008 had more steadily improving performance for US airlines. The change that drove
further improvement in Q3 and produced the European upswing was a sharp improvement in
aircraft utilization. Airline operations are highly leveraged and improved asset utilization
generates significant financial improvement.
Asia-Pacific airlines‘ cash flow performance has closely followed the fluctuations in air
freight volumes, since this is such an important business segment in that region. After a very
fast rebound through 2009 and into 2010 air freight peaked and has slipped back in recent
months. The Q3 slippage in Asia-Pacific cash flow reflects this. The air freight cycle has
been shaped by the business inventories – as firms sought to rapidly restock using air freight
– but that cycle has now ended. This has caused the recent decline in air freight but continued
economic expansion outside Europe is expected to generate a further leg to the air freight
upswing, albeit at growth rates in single figures rather than the 20%+ growth of the
inventory-cycle phase.
During 2011 we expect Europe to generate the weakest flows of passenger traffic. Already
governments have swung from providing a large fiscal stimulus, to turn economies around
from recession to recovery, to implementing austerity budgets which will remove several
percentage points of GDP from spending over the next few years. In addition the bank and
sovereign debt crisis in Europe is forcing further measures that are expected to drive a
number of European economies back into recession. On top of this challenging economic
environment European governments are placing new or increased taxes on air travel. In the
UK, Germany and Austria these amounts to additional travel costs representing 3-5% of
ticket prices and so are likely to have a material adverse impact on travel demand.
European airlines will be able to take advantage of stronger long-haul markets but even so,
the weakness of home markets is expected to produce the weakest traffic growth in this
region. The US economy is looking in better shape but debt is still a problem and below-trend
growth is expected from this market. In non-Japan Asia, Latin America and other parts of the
so-called developing world, economic growth is much stronger and expected to stay that way.
Airline traffic growth is forecast to be much stronger outside Europe and North America as a
result during 2011.

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