Why Do Airlines Always Lose Money? Hint: It’s Not Due to Taxes or Fuel Costs

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It’s been more than 30 years since the airline industry was deregulated in 1978. Since then it’s lost nearly $60 billion on U.S. operations, though most of the losses have come since 9/11. The airlines were already in trouble before the attacks happened. The plunge in demand and resulting liquidity crisis led to billions in government cash and loan guarantees– the first true bailout of the 21st century, and certainly a sign of things to come in the next decade.

In a paper published last month, (Abstract here; full version here) Berkeley economist and overall airline guru Severin Borenstein examines some of the most common explanations for the airline industry’s dismal performance, and why experts and deregulation advocates failed so badly to predict what would happen after deregulation 30 years ago. A few key stats:

  • Domestic passenger airline operations lost $10 billion from 1979 to 1989, made profits of $5 billion in the 1990s and lost $54 billion from 2000 to 2009. To put these numbers in context, at the end of 2009, the entire book value of U.S. passenger carriers’ assets was about $163 billion and the book value of shareholder equity was $10 billion. Even at the end of 2000, after six consecutive profitable years, their assets were $159 billion and shareholder equity was $40 billion.
  • From 1979 to 2001, the U.S. airline passenger fleet grew in every year, by an average of 4.9% per year measured by aircraft and 3.6% per year measured by aircraft-seats. From the end of 2001 to the end of 2008 (latest available date), aircraft and aircraft-seats declined by 1.7% and 1.4% per year respectively.
  • The domestic airline industry has reported negative net income in 23 of 31 years since deregulation and a strongly negative aggregate net present value of earnings.

The knee jerk explanation among many airline analysts has been to blame the industry’s poor performance on overly burdensome taxes and high fuel costs. But Borenstein argues they’ve had little to do with it:

Descriptive statistics suggest that high taxes have been at most a minor factor and fuel costs shocks played a role only in the last few years. Major drivers seem to be the severe demand downturn after 9/11 — demand remained much weaker in 2009 than it was in 2000 — and the large cost differential between legacy airlines and the low-cost carriers, which has persisted even as their price differentials have greatly declined.

Here’s his case against fuel costs as the main culprit:

Fuel costs increases have certainly been a significant component of losses in some years, most obviously in 2008. Over the deregulation era, however, oil costs were highest in the first 7 years and the most recent 5 years, over $40 per barrel in 2009 dollars, and much lower during the 19 intervening years. [F]rom 1986 to 2004 the average jet fuel price was below $1.40 per gallon — relatively stable and much lower than in the early period of deregulation. Yet, the industry still lost money in 13 of those 19 years and on net lost $31 billion in 2009 dollars.

While there have been several taxes added to the cost of flying (passenger facility charges in the early 1990s, the segment tax in 1997, and the September 11 security fee in early 2002), Borenstein argues that the problem seems not to be that taxes have risen, but that base fares have fallen and stayed so low. He attributes this to the rise of low-cost carriers (LCCs), and the inability of  the legacy players to adjust:

Adjusted for the average flight distance, legacy carrier costs have remained 30%-60% higher than the LCCs for nearly all of the deregulation era, averaging about 40% higher in the last decade.
While the cost differential between LCCs and non-LCCs has remained large, the average price differential has been shrinking. LCC fares have declined much less than those of legacy carriers in the 2000s, reflecting in part their lower burden of excess aircraft capacity. This is no doubt a large part of the reason that LCCs have suffered much milder losses in the 2000s.

Airline bottom lines improved in 2010 as the industry consolidated routes and took profits, but Borenstein sees no reason why the future will be any less dismal.

[T]here is little reason to think those disruptions will be less frequent in the future. Furthermore, after more than 30 years, it seems unlikely that airline losses are due entirely to a series of unfortunate exogenous events relative to what management and investors should have expected.

[T]he experience of the last decade suggests that until legacy carriers can either close the cost gap with LCCs or increase the price premium they maintain, they will likely have difficulty earning consistent profits through the typical cycles in the airline business environment.

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  1. Randall Hoven says:

    I don’t understand the dismay here, or the line “deregulation advocates failed so badly to predict.” So legacy, high-cost airlines lost money. Boo hoo. But now we consumers can fly cheaper, and “LCCs” like Southwest are profitable for making that happen. It seems like a market is working here, which is exactly what deregulation advocates predicted.

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    • Jim says:

      Problem is, the failure of the main-line carriers to make money has resulted in billions of dollars of cost to taxpayers. We haven’t let the market work- how many large carriers have been forced into liquidation? (none) Hence the dismay.

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      • Clancy says:

        What about Pan Am and TWA?

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      • Steve_0 says:

        Yeah. I didn’t see a peep in this article about the TSA as an obstacle, or much mention of the bailouts as an economic effect (merely that they happened).

        Well-loved. Like or Dislike: Thumb up 21 Thumb down 2
  2. Chris says:

    Pretty sure you mean $60 billion in that first paragraph, not $60 million.

    Thumb up 3 Thumb down 0
  3. Enter your name says:

    All I want to know about the airline industry is this:

    Why does it cost LESS to get on flight 1234, fly to a hub, then get on flight 2345, and fly to another destination, than it does to get on flight 1234 (same day, same time, same seats), fly to the same hub, and stop?

    Why do the airlines insist on paying me (usually $100) for the privilege of hauling me even further?

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    • Sbard says:

      Because the airline has less competition flying to the hub and can charge higher fares while presumably, there’s more competition flying to your ultimate destination because people can take different airlines and stopover at different hubs to get there.

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    • matthewglidden says:

      Many corporations that own airlines also operate hotels, rental cars, and other attractions in destination markets. Changing ticket costs is one way to encourage passengers to spend money at those higher-margin businesses by sacrificing profits on their low-margin flights.

      Hot debate. What do you think? Thumb up 13 Thumb down 17
    • James says:

      Along the same lines, why does it often cost less to fly to destination X and return, than to fly to destination X and stay there?

      Another irritation: why does it seem impossible (or at least it did a few years ago) to find flights leaving Europe for the US after noon?

      I don’t know why airlines lose money, but I’m guessing the above might provide a clue or two.

      Thumb up 8 Thumb down 5
      • pawnman says:

        Because you’re filling two seats for them instead of one, eliminating the transaction costs of finding another traveler to fill that seat on the return flight.

        Thumb up 7 Thumb down 10
      • James says:

        That doesn’t make any sense at all. It would make sense to discount the round trip below the cost of two one-ways, because of transaction costs, but below the cost of a SINGLE one-way? Worst case, they can’t sell the seat on the return, it stays empty, and they save a bit of fuel and a package of peanuts.

        That is, if a one-way fare to some destination was $500, it’d be understandable if the round-trip fare was $900, but instead it’s $400. I sure can’t see the (for want of a better word) reasoning there.

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      • scott says:

        If the cost of finding another passenger was a real factor, there would be a discount when I book flights for my family.

        I have been used to seeing the flight costs change as soon you inquire or are about to complete a transaction, but in the last year I have gotten the “the cost for this flight as changed…” message with changes as high as 120% in the last year.

        This does seem to be an issue of the free market not being able to operate, so some carriers are being kept alive that would likely have failed.

        When an airline can hand you a $400 voucher to wait 2 hours for the next flight because they intentionally overbooked, that too is an indicator that market share is more important than profitability.

        All in all, it’s a very weird looking industry to the outsider.

        Thumb up 2 Thumb down 1
    • Jack says:

      I feel like the triangle inequality should be pretty important for a business operating in Euclidean space.

      Well-loved. Like or Dislike: Thumb up 10 Thumb down 0
    • F Lorenzo says:

      Maybe because of “gentlemans” agreements in fares that were between the two carriers that flew non-stop between Atlanta and Dallas. That was one of the priciest markets.

      The very best question would be why can’t the IRS audit the carriers books?
      The fares are not based on rocket science, just using fare rules approved by the foxes in the hen house, that are un-auditable.
      The very fact that the overbooking results in “denied boarding coupons” that are written off at tax payer expense at almost the maximum coach fare, much, much more than what an average passenger pays for their ticket.
      Airlines are cash cows for the banks, preferred stock holders and the board members paid for by the U.S. taxpayer.

      Thumb up 1 Thumb down 0
  4. Adam says:

    One of the main reason’s I quit flying is the lack of time saving. Dallas is my most frequent destination from home, it’s about 11.5 hours from my door to my Brother-in-Law’s house by car. Gas is roughly $80-90 depending on variation in gas prices.

    Now for me to fly the cheapest way (I haven’t done this in several years so my reconstruction is hazy) when I pick my time and day to depart is around $300. But now my time investment:

    45 Minutes to the airport from my home
    Arrive 90 Minutes prior to departure
    1 Hour to Atlanta
    2 hour lay over in Atlanta (if you’re lucky)
    2 hour flight
    30 minutes to deplane
    30 mintues at rental car desk (another $200)
    45 minutes to drive from DFW to my destination
    Time Investment: 9 Hours.

    So to fly from my home in Florida to Dallas, assuming I can find someone to get me to and from the airport so I don’t have to pay for parking, I spend about $400 dollars to get there 2 hours earlier. Yes, I could shave some time off by paying the direct-flight premium, but then that is maybe 2 hours less, and another 75 dollars in fare? That’s still over $100 per hour of saving! That cost is still way above the marginal price of my time, and assumes I travel without my wife to see her brother(?).

    Most travel functions put transit time at ~ .5*wage and wait time ~ 2*wage. A rational consumer like me HAS to drive, even if I put a safety premium on flying, as my car insurance deductible still leaves me paying $50 for every hour saved of solo travel!

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  5. JPL says:

    So… “deregulation advocates failed to predict” disruptions in the affected industry post-deregulation, such as the entry of agile new competitors disruptive to the status quo? Exactly why were they “advocating deregulation” in the first place, then?

    Seems to me deregulation did exactly what it was intended to do… spawned the likes of Southwest, Airtran, etc.

    The fact that entrenched old-guard industry players are struggling to keep up is viewed by some as, well, progress.

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  6. HH says:

    “Since then it’s lost nearly $60 million on U.S. operations,”

    I assume this should be billions, or else it’s not a big deal.

    Thumb up 3 Thumb down 0
  7. Ian M says:

    I’m no economist but I’m pretty sure the airlines have lost a fair bit more than $60 million.

    What’s 3 orders of magnitude? Close enough.

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  8. Scott from Ohio says:

    In other words, old airlines lost a lot of money, and are only still around because of the first government bailout of the 21st century. Yeah, that’s totally a failure of deregulation, somehow.

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