Making money in the aviation business and the impact of the 737 Max fiasco

Aviation is having one of it’s best decades in a long time, with the traditionally wafer thin margins improving a little bit as per IATA’s 2018 data.

IATA Airline data 2018

So, the question is, why are so many airlines still losing money? And why are budget airlines, in particular, often on the brink (or over the brink) of shutting down and stranding their passengers?

As a recreational pilot who runs businesses for a living, there were 3 times in my life when I contemplated starting an aviation related business. First, I explored starting a flying school in China about 15 years ago. Then, I considered a private charter service between Singapore and key South East Asian destinations that were important for specific industries but not well served by airlines (Balikpapan in Indonesia, for instance). Finally, at one point I had an invitation to invest in a FBO (Fixed Based Operator) business in Senai Airport, Malaysia.

On all 3 occasions, I decided against taking the plunge because, to summarize rather summarily, there were too many factors outside my control which could impact cost – thus making it very hard to assess the viability of running such a business.

The most fundamental cost in aviation is the cost of the airplane. When I owned a plane, it cost me a fixed amount of money. Whether I flew it or not, I paid insurance and hangarage and had to pay engineers to do an annual inspection. I’d worked out a dry operating cost per hour on the assumption that I’d fly about 100 hours a year and realized at that time that if I rented it out and got it to fly 200 or more hours a year, my cost per hour would come down drastically.

The same is true of the airlines. Apart from the plane, airlines have other fixed costs as well that look better when amortized over more hours. Pilots get a base wage, so a pilot who flies to the legal maximum every month delivers more value than one who does less hours.

For airlines, one of the things that helps them get the most out of their planes and pilots is standardizing things as much as possible. Successful budget airlines try and fly just one aircraft type. They’ll pick it for maximum efficiency and profitability on a small number of routes and steadfastly avoid other routes that don’t make sense for this plane. This is why when budget airlines start trying to fly long-haul, they get themselves into trouble – because then they have to buy longer range aircraft and impair the efficiency of their model.

Everyone thinks budget airlines make money by charging you for sandwiches, water and checked in bags – while that helps recognize the real costs of these services it’s not usually a revenue earner. The core of profitability in budget airlines is getting the most out of fixed cost assets like pilots and planes (pilots are kind of a fixed cost asset in the sense that once you have one, you need to use them for the maximum legally allowed flying hours per month and year).

So, here’s the question – is that something that only budget airlines can do? Clearly not – there are enough airlines that attempt to limit the diversity of their fleet, are very choiceful about routes, avoid unnecessary costs and maximize their flying hours per aircraft and pilot. In fact, surprisingly, a look at the world’s most profitable airlines shows very few of the budget persuasion. (Data is from a Forbes report for 2017)

Airline business

What’s interesting there is the low margins for most companies – Southwest being the only one in double digits. From an investor’s point of view that’s a pretty low ROI.

Separately, all kinds of things can affect an airline’s ability to maximize the annual hours for each of it’s aircraft. Take the impact of the 737 Max crashes that have led to the entire fleet being grounded worldwide – we can expect every airline that flies these planes to have some problems this year. Planes sitting on the ground cost money – hangarage, maintenance contracts, bank loan repayments and so on. Pilots trained on these planes will have less to do but will still make their base salaries. It’s certainly possible for the airlines to make up a lot of the missed flights using the rest of their fleet but that’s not the optimal arrangement so the impact on P&Ls may be larger than the overall flight cancellations indicate. It may be that the airlines are able to recover some of these costs from Boeing or their insurance companies but unlikely that they will recover all of them.

Overall, this is a hard business to make money in even when everything is in your control, which clearly is not the case.. Between aircraft problems, weather and government control over airspace, there are many unpredictable factors that might make it a challenging business to be in, even for those who appear to be succeeding at it.