Recent trends are leading to profit erosion in the industry
Key trends observed in the industry include the following:
Trend #1: Overcapacity i.e. massive additions to capacity by 2009.
Airlines, with their optimism fuelled by the strong profits currently being generated in Asia, are competing with
one another by placing large aircraft orders. The demand for new aircraft has been so good that Airbus and
Boeing are seeing record orders. Emirates alone will take delivery of their huge order of the A380s and most of
these planes will be deployed on the important Kangaroo route i.e. Australia – Europe. Any order made for an
aircraft today will generally see delivery beyond 2012.
Trend #2: Low-cost competition is on the rise
In nearly every market, we see low-cost (or at least low-fare) competitors dumping large numbers of very low
priced seats in core markets in the hope of stimulating demand. These airlines are attempting to generate new
pools of discretionary traffic. Even though these airlines do not explicitly target the business passengers from
which full service carriers make their living, they create a devastating residual effect.
When LCCs drop leisure fares, they also typically remove restrictions such as advance purchase requirements
or minimum stay. Because of this, full service carriers are faced with a choice: to either match these fares and
conditions and lose valuable premiums from business passengers, who now have access to these lower fares,
or to continue to take premium fares from business passengers and risk losing significant market share in the
leisure segment. Research shows that following the entry of a LCC on a route, the profits of the incumbent
carriers on that route decline by an average of 31%.
As for the Asian market, the threat from growing LCCs will mean a loss of market share for the traditional full
service carrier. Projections show that LCCs in the Asia Pacific region will increase their presence, resulting in
an increase of capacity share from less than 10% to 25% of the available seats. Furthermore, LCCs are
aggressively expanding beyond the traditional short-haul routes to medium-and long-haul markets. The few
that have started include Oasis from Hong Kong to London, and from the Kuala Lumpur hub, 2 other airlines
i.e. JetStar and AirAsiaX have started flying to Australia.
Trend #3: Rising factor costs — particularly fuel
Between January 2005 and December 2007, the crude oil price increased from USD38 per barrel to USD90
per barrel which is a massive jump of 135%. In January 2008, it touched USD100 per barrel. This is the highest
oil price that mankind has ever known. The increase in fuel prices alone has added nearly USD88 billion to the
industry cost structure, bringing the industry total fuel bill to USD149 billion. So severe was the impact of the
increased oil price that United Airlines announced in early November 2007 that it was contemplating grounding
100 planes within its fleet. Giovanni Bisignani, IATA’s Director-General and CEO, when asked to forecast the
outlook for the aviation industry, warned that the escalating price of jet fuel would seriously dent airline profit
margins, erode the yields and even cripple a number of airlines.
Trend #4: Increased public scrutiny on environmental issues
Based on data from the United Nations, aviation is responsible for only 2% of global carbon emissions – a small
quantum compared to ground transport and power plants that burn fossil fuels. IATA estimated that this figure
will grow to, at most, 3% by 2050.
With global warming and climate change being key topics of debate at world forums, attention is drawn towards
aviation’s role and its stand on the issue. Governments in various parts of the world are in unison in supporting
the global strategy i.e. to curb the increase of greenhouse gas emission. However, there is a lack of globally
accepted standards and solutions to the issue. There are governments or economic regions which are taking a
unilateral approach to address the issue. For example, EU is forging ahead unilaterally to design a legislation on
emissions trading - which is not in tandem with developments in other parts of the world e.g. Asia, Middle East,
South America, etc. Once this law is passed in EU, it will affect a lot of non-EU airlines which are unprepared,
causing these airlines to suffer financial losses as they will need to stop flying the European sectors overnight.
IATA is currently advocating a 4-pillar strategy: invest in new technology, operate efficient infrastructure, fly planes
efficiently, and introduce economic measures (tax credits for re-fleeting, offset programmes and emissions trading).
It has also made public its interim fuel efficiency target i.e. 25% improvement in fuel efficiency by 2020.
Many international airlines are rallying behind IATA’s strategy because it offers more structured and palatable
solutions to the environmental issues. In fact, IATA’s strategy has shown positive results to date: 15 million
tonnes of CO2 savings in 2006 and a further 10 million tonnes in 2007.
IATA is now working with the International Civil Aviation Organisation (ICAO - an international body representing
governmental representatives from various nations) to map out the options to achieving carbon neutral growth
and to develop a strategy to guide the efforts of governments, airlines and manufacturers. Most airlines,
including MAS, continue to be guided by IATA’s direction.
Trend #5: Possibility of slower global macroeconomic growth
While the Asia Pacific economy in 2007 remained positive, there are early indications of turmoil ahead. The
volatility of oil prices and the uncertainty of US economic growth due to a weakening housing sector may spill
over and impact Asia’s economic growth. This could amplify the negative impact on developments in the
aviation industry over the next couple of years.
There are also rising concerns among economists with regards to the possibility of “global shocks” due to the
continuous unrest in the Middle East and Africa, and an economic downturn in China post-Olympic 2008.
Historical events such as September 11, the SARS outbreak and the Gulf War have proven to have devastating
effects on the aviation industry, with short-term changes in demand in some regions exceeding 30%. While it is
arguable whether such global shocks are increasing in frequency, it is clear that when they do happen, these
events will have a greater impact on our industry. Today, as much as 70% of travel is purely discretionary.
