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. commonsenseless says:

    What?! So, the fact the prices are going down and competetion has increased leads to losses? That’s absurd economics. Just look at the smartphone industry for gods sakes!

    It is the goverment subsidies and regulations(yes it exists in the airline industry…FAA etc) that favor big airlines that is leading to the losses. Sort of like how government helped GM sustain despite its losses by bailing GM out and passing many regualations in GM’s favor (the Toyota Witch Trials for example). If anything we should be happy LCC’s exist and helping make sure prices are relatively low.

    Also, the only reason why LCC’s are a threat to the big airlines is becasue they are not tied by the damn Unions. Southwest airlines, for example, is profitable because the pilots are not part of any Unions!

    Hot debate. What do you think? Thumb up 8 Thumb down 12
    • flyergirl says:

      The pilots are part of a very strong union…SWAPA

      Thumb up 4 Thumb down 1
      • commonsenseless says:

        Yes but SWAPA is based in Dallas where unions are very weak! (Texas is a right to work state)

        Right to work laws are also the reason why southern state have a considerable leg up when it comes to manufacturing too. Most of the auto companies have factories in the South because Unions are relatively weak (They shouldn’t have even that small amount of power if you ask me)

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    • Alan says:

      Southwest is the most heavily unionized of all the carriers. The least-unionized airline is Delta.

      Thumb up 3 Thumb down 0
  2. TTFK says:

    This article does not take into account segments of cargo revenue, specifically US Mail.

    Just a rough example: In 1995, the mid-sized USAir cargo facility I worked at was overnight-processing upwards of 60,000-70,000lbs of mail per night, six nights a week. This does not include the mail tendered to the airline during the day directly from the BMC.

    Inside of a decade, USPS contracted out most all of it’s 1st class mail movements to Emery, then Fedex. The airlines went from receiving upwards of 5,000lbs of mail per flight to 500lbs. The mail they DID receive was all fluffy packages that Emery didn’t want to handle because of bulk. They kept all the poundage for themselves and gave airlines the fluff.

    As a result, the airlines were now making 10% of what they were just a few years earlier, despite the cargo taking up the same amount of space, prohibiting them from making up the shortfall elsewhere.

    This is a simplistic explanation, but should give you the general idea.

    Well-loved. Like or Dislike: Thumb up 9 Thumb down 0
  3. toni says:

    I stopped flying because the TSA has just become too intrusive. I drive now, even if it takes longer. I don’t like paying to be treated like a criminal.

    Well-loved. Like or Dislike: Thumb up 11 Thumb down 1
  4. Slackdammit says:

    Of course, the difference between the legacy and LCC carriers is union labor at the legacys. Until the labor playing field is leveled, the industry will be a ragged patchwork of profit and loss. You do not seem to have the cohones to say that.

    Thumb up 7 Thumb down 5
  5. Sydney says:

    I have seen this position taken on fuel in previous discussion groups. The tax argument is harder to make – with 1/3 the price of a ticket being taxes if they were seriously reduced demand would increase significantly which would allow core revenue to increase and profits increase – the low cost guys would be more profitable still. One misnomer on the low cost guys is that Southwest made most of its money in the 2000s on fuel hedging, not their airline ops. They were really an oil hedging company that happened to own an airline for much of the last decade.

    The article would be more interesting if they had stated Southwest has the highest labor costs for pilots, flight attendants, maintenance personnel and ground crews…but is the most profitable airline. How can this be. It is in the utilization of their aircraft. They average two more turns per day per air frame than the rest of the industry driving down their unit costs. Legacy airlines run the hub-n-spoke systems allowing for massive connections but also meaning aircraft have to sit and wait for everyone to arrive at a hub and then depart. This productivity gap is the primary reason for the difference in costs between the airlines. Not the wages, fuel or infrastructure expenses.

    Well-loved. Like or Dislike: Thumb up 9 Thumb down 2
  6. mfw13 says:

    I think one of the keys in understanding the problem is to look at the differences between profitable and unprofitable carriers. Since Southwest is the only carrier that has been consistetly profitable, I will use them as an example.

    1) Southwest only operates one type of plane, the 737 (although I think this is changing due to the Airtran acquisition), which has saved them huge amounts of money on training and maintainance.

    2) Southwest has an easy to use website with transparent pricing and allows you to build your trip one leg at a time in whatever fashion you desire…1-way, RT, 3-legged, 4-legged, etc. No hidden fees, ridiculous pricing schemes, etc.

    3) Southwest does not pre-assign seats and therefore saves money dealing with seat related issues.

    4) Southwest’s service is pleasant, their planes are comfortable, and most importantly, they deliver exactly what they promise.

    5) Southwest flies into smaller, less popular, airports, where gate fees are much lower.

    Now ask yourself how many of these statements are true for any other airline?

    Well-loved. Like or Dislike: Thumb up 13 Thumb down 0
  7. The Regular Joe says:

    maybe it is because they treat us like animals?
    http://theregjoe.blogspot.com/2011/05/flight-nightmare.html

    Thumb up 4 Thumb down 1
  8. Jim Ammerman says:

    Do the airlines still get government subsidies? Is that a hidden tax? Is that chosing winers and losers? Are our Airlines “too big to fail”? Are the carriers cutting back on maintenance to squeeze profits? Capitalism dictates profit. No matter what the reason if the airlines predominately lose money, seems like a poor business model and makes me want to drive home,since our rail system does not offer another option where I live.

    Thumb up 1 Thumb down 1