Sep 6, 2020

This storm has put airlines’ models in a tailspin

written by Lisa Eason

Certain businesses do not require external capital: they use customers’ money to fund their operations. Examples include tour operators and travel agents, insurance underwriters and brokers, construction companies and membership clubs.

These types of business models fall into two categories: one where the client pays in advance — for example, holidays and building projects; and one where the customer pays a regular subscription, which is, in effect, paying in advance by instalments, with renewal built in.

In some cases, customer funds are protected via segregated accounts, and supervised by industry regulators such as the Civil Aviation Authority and Abta for travel, and the Prudential Regulation Authority and Financial Conduct Authority for insurance. They can provide compensation for customers of failed companies who have lost deposits, or had claims unfairly denied.

Entrepreneurs such as Mike Gooley of Trailfinders think escrow and trust accounting — where funds are deposited with a third party as a repayment or deposit — should be mandatory for travel companies.

The nature of funding mechanisms has been laid bare by the crisis hitting the travel industry under lockdown. For example, airlines often receive money months ahead of the flights they are required to provide. Because a large proportion of holidays have been cancelled thanks to travel bans or quarantine measures, the services were never supplied.

Naturally, customers have sought refunds. However, these have been hard to obtain in thousands of cases — with credit vouchers often offered as a substitute. Governments have been reluctant to put pressure on airlines over refunds because they know the carriers are in dire financial straits.

The heart of the matter is that, historically, many airlines have been undercapitalised. It has always been something of a mystery to me as to why so many entrepreneurs would attempt start-ups in such a notoriously difficult industry. For example, the three largest US airlines, United, American and Delta, have all filed for bankruptcy in the past: I can think of no other sector where the leading operators have almost all had to seek protection from creditors or be bailed out by government owners.

New players have been able to launch thanks to aircraft leasing, advance monies for tickets from customers, and bank lending. However, they are still subject to the vicissitudes that beset the industry: fuel price volatility, intense competition, lack of brand loyalty, terrorist activity and endless external impacts, such as bad weather and strikes by air traffic controllers. Meanwhile, the business suffers from high fixed costs and low margins.

Overall, the global airline industry made money for 10 years until this year. In the preceding decade, 2000 to 2009, it generated net losses in seven years. Across 2020 and 2021, it is forecast to lose roughly $100bn (£75.4bn) — equivalent to the preceding three years’ profits. Consequently, airlines are unlikely to show much of a net profit for the entire period since 2000. Of course, some are better run and have lower cost models, and so deliver superior results.

There are efforts among many travel trade customers to change the system so that customers pay for their flights only as they check in. Credit-card details would be taken for a deposit, and the full price charged for no-shows. This model applies to the hotel trade.

However, in Germany, the government is likely to side with national carrier Lufthansa against such a proposal from the travel trade body VDR, since the airline has been handed a bailout from the state worth €9bn (£7.9bn).

This threat is probably not the biggest facing the airlines. The possible demise of business travel is what’s really keeping aviation bosses up at night. While business travellers represent only 10%-15% of passengers, they contribute 40% of revenues — or have in the past.

I speak to many executives who plan to reduce their flying for work significantly — perhaps permanently. While leisure flying volumes should resume in a year or two, experts are pessimistic about the recovery of business traffic.

The slump in air travel has hit the aerospace sector hard. The two big jet manufacturers — Boeing and Airbus — are both in crisis. The Chinese are no doubt happy at yet another disaster for the West, thanks to Covid-19: making airliners is one segment of manufacturing where we still dominate. Neither company will go under, but they are severely weakened.

The lockdown/pandemic has exposed customer vulnerabilities in certain industries, but given the difficulties the air travel sector faces, changing the model now will be a tall order.