Planning for recession November 1998

The only certainties in life are death and taxes; in the aviation industry, the only certainty is that after the longest single upturn in recent history there will be a recession sooner or later. Economists and analysts are capable of arguing until the cows come home on when the next downturn in the industry will occur and how deep it will be, but no–one argues that the traditional cycle has disappeared (the closest to this viewpoint may be Julius Maldutis — see Aviation Strategy, April 1998).

In an industry where net margins of just 2% are seen as aspirational, a downturn can be catastrophic — witness the red ink that spread throughout the aviation world in the early 1990s. And in the late 1980s, before the recession hit, everyone knew that a downturn would come — but, with honourable exceptions, very few airlines had detailed strategic plans for what they would do when it did occur. A bit of fuel hedging here, the odd spot of cost–cutting there, was just about the sum total of most airlines’ recession planning.

In part this was due to a tendency for airlines to spend time firefighting rather than look at long–term strategic planning, but it was also due simply to poor management. At its extreme the attitude of some airlines was just to let recession occur, and then the carrier would initiate stringent cost–cutting as needed — or, in Europe and Asia, let governments bail them out.

Happily, at many airlines things are different today. The shock of the early- 1990s recession along with a significant improvement in the quality of airline managements throughout the world has now resulted in far more sophisticated long–range planning. For example, in October 1998 United Airlines revealed details of what it is already doing in preparation for the next recession. Its four–part plan includes:

• Route diversification. The more geographical spread an airline has, the better it will able to ride out a downturn in one or more regions.
• Capacity switching. With route diversification in place, United is prepared to switch capacity between regions at a moment’s notice (e.g. from Asia to the domestic US market).
• Cost-cutting. United, like British Airways, has identified what its core product and assets are. Everything else is, therefore, a candidate for cost–cutting or outsourcing — but before a recession hits, not during it.
• Yield management. United is introducing measures to keeping high–yield business passengers loyal to the airline.

An important part of United’s plans — and a measure that is increasingly being seen at other airlines — is a flexible fleet (also see page 4). United is keeping on 727s and 737s and will ditch them when recession hits (instead of ordering more narrowbodies, which would have to be cancelled or postponed during a slump). Switching a higher proportion of an airline’s fleet from outright ownership and finance leases to operating leases also achieves the same flexibility.

Perhaps the greatest lesson that airlines have learnt in the last few years (or are still learning) is that market share means nothing if it results in horrendous financial losses. As well as cutting capacity sharply in downturns, this also means that capacity should not be over–expanded in cycle peaks.

Add to these measures the trend towards global alliances (which will reduce the effect of a slump on an individual airline), and there is a strong argument that many airlines are better prepared than they ever have been for an upcoming recession. Of course some airlines will always be unprepared — and they are the ones that will suffer most from the next recession.