The dawn of a Golden Age? April 1998

Airline strategists have plenty to worry about at the moment — calculating the impact of the Asian downturn, estimating the effect of rising oil prices and forecasting when the next aviation recession will begin, to name but a few. Yet there is a small but growing voice within the industry that claims that the world’s airlines are about to embark on a sustained 10–20 year period of rising demand and profits — in other words, we are about to enter a Golden Age for aviation.

It’s a scenario that most people in the industry would find implausible, but the leading “super–optimist” is the legendary Julius Maldutis, aviation guru at Salomon Smith Barney.

His claim is that airline shares are set to embark on a sustained bull run over the next couple of decades, and that 20 years or so from now we will all look back and kick ourselves for not investing in airline shares in 1998, when they were so cheap.

The key to Maldutis’s argument for a Golden Age is demand. He says that underlying demand for air travel will continue to rise well into the next century, and that traditional downturns in the aviation cycle will do little to alter that underlying trend.

So what, you may say — everybody knows that already. But super–optimists argue that airlines today are more able then they have ever been to take advantage of this rise in demand. Maldutis cites four underlying reasons why airlines will prosper as never before:

1. Airlines now employ very capable CEOs — many of them with no prior experience of the aviation industry. He says: "What this new breed of executive has done is very simple: they close loss–making routes. Unlike previous managements, they realise that earnings per share are more important than market share."
2. The next 10 to 20 years will see an aircraft supply shortage as manufacturers struggle to keep up with rising demand. The impact of noise legislation, carbon dioxide emission rules and concerns about the safety of ageing aircraft will mean demand will continue to exceed supply — and the effects will prove to be beneficial for airlines, it is claimed.
3. The printed airline ticket is obsolete. Maldutis believes the Internet will have a huge impact on the industry, eliminating the travel agent as an intermediary and allowing significant cost savings.
4. Related to this is the fact that the Internet, along with better yield management techniques, will allow airlines to sell more seats. Once airlines can predict with a high degree of accuracy how many seats are usually left unsold at any point in time before a flight departs, they can compare this with actual sales and price remaining tickets accordingly. And the Internet will allow the last few seats on any flight to be sold for a few dollars just hours before the aircraft departs. Historically, the industry has not sustained load factors above 70% for any length of time. Maldutis says: “We are the only industry in the world that consistently throws away at least 30% of our stock unused, but that will change.”

But just how valid are these arguments for the dawn of a Golden Age? The long term increase in demand for air travel is well documented. Even after the Asian shock, most forecasts see between a 4%-6% average annual growth in RPKs over the next 20 or so years, stimulated by world GDP growth, the growing interdependence of economies, fewer political barriers to travel, increasing leisure time etc. But does this necessarily translate into a 20–year boom for airlines?

Maldutis is undoubtedly correct in his assertion that a new breed of executive, with an emphasis on profit, not market share, is having a major impact. However, most examples of this are found in the US. Truly commercial — and ruthless — CEOs are few and far between in Europe and Asia, although this will change.

His point about an aircraft shortage is much more contentious, particularly as some analysts believe that airlines have already over–ordered (see Aviation Strategy March 1998, pages 4–5). Maldutis’s counter–argument is that worries about supply are behind the exclusive deals signed by some US majors with manufacturers — even though playing off one manufacturer against the other would appear to be a better option for airlines.

On the impact of the Internet, Aviation Strategy agrees with Maldutis that the Internet will make intermediaries obsolete, or at best peripheral. Already, business travel agents are trying desperately to add value to clients through a range of extra services — but still more and more corporations are setting up specialised travel departments and booking direct (which means they can capture FFP benefits as well).

However, whether airlines can raise load factors over 70% long–term remains to be seen. But the Internet will help. A hint of the potential is given by Southwest’s weekly Internet sale, which can offer seats on a Las Vegas–Seattle flight for just $57.

Overall, it is far too early to say whether Maldutis’s predictions will prove to be right or wrong. And for every Maldutis there is a correspondingly pessimistic analyst, such as Chris Avery of Paribas who claims that: “The Asian flu is contagious and will spread, with a weakening outlook for global aviation.”

But, if for argument’s sake we assume that Maldutis and the super–optimists are right, should airline strategists sit back and wait for the profits to roll in?

Of course not. The lesson from history is clear — size or current status is absolutely no guarantee of corporate longevity, as former investors in Pan Am, People Express, Dan- Air etc, know only too well. The table below shows that compared with just 10 years ago, there has been significant change in the world’s largest airlines by region (although interestingly the top three has stayed the same in all three regions).

What really matters is competitive advantage and, more importantly, the ability for an airline to adapt to new circumstances when required. What is certain is that when the table below is updated in 10 or 20 years’ time, some current household airline names — those who cannot gain new competitive advantages — will not be on it. Which ones they will be is, of course, unknown.