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. Julien Couvreur says:

    I’m not sure which part is a surprise to advocates of deregulation. In short, competition pushed airfares down (allowing more passengers to travel). The companies that adapted to the low cost constraints are doing well, but the legacy businesses that were used to the old model (and probably used to benefit from regulation and cartelization) are struggling.

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  2. AHodge says:

    let me say as an economist you are confusing these “companies” especially legacy
    with companies that care anything about their customers
    the airlines/ airports are legendary for neglectandabuse and foolish bureaucratic rules and possibly the absolute low o f customer satisfaction ever

    or their investors
    they invented prepackaged bankruptcy in the 80s and regularly stiff stock and bondholders since.
    Its all about their own employment and dollars including the pilot and other unions and the execs
    they live in a dream world of taking away all the coach class rights so first class looks more elite, like some 1980s country club.. a bunch o f old losers living the Catch Me If You Can dream

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  3. Nate W. says:

    “Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”

    — Warren Buffett, annual letter to Berkshire Hathaway shareholders, February 2008.

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  4. Dave says:

    Since capacity can be added in very small increments, there is very little opportunity for profit (economic rents). When a route allows a profit, a competitor can enter quickly and compete away the profit margin. Thus, only the lowest cost position can win.

    There are niche opportunities for the “full service” options such as FlexJet and NetJets. However, corporate travel policies now specify not only “economy” class but “lowest fare”, often requiring acceptance of one or more hops if lower cost than a direct, non-stop fare.

    Let’s hear it for video conferences!

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  5. Paul says:

    What I want to know is…why is Southwest Airlines now trying to become more like the legacy players and abandon its successful strategy as the premier low-cost carrier? They are now in virtually every airport (higher cost ones included), they now do more long-haul flying including destinations outside the continental 48 states (less efficient), made their frequent flyer program much less attractive and far more complex than in the past, and now have fares that are often no more attractive than the legacy carriers. I loved Southwest, and now they are just another airline. I can’t figure out their management’s strategy and positioning today…other than bags fly free and no exchange fees.

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  6. anon pilot says:

    For all those market purists out there, you are seeing market correction. The industry is consolidating to survive. In the future, expect to see two or three large “legacy” carriers offering international service and two or three LCC or “national” airlines such as southwest taking the domestiv market. Once this happens you will see a dramatic rise in airfares as competition is reduced. Airline passengers have been spoiled with stagnant ticket prices for the last 20 years. In order for the airlines (and air travel) to survive, a market correction is in order and that means paying more for a ticket. Those who don’t consolidate will go the way of Eastern, TWA and Midwest.

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  7. skyliner500 says:

    Here’s what regulation offers.
    1)Air travel is not a right, but it does improve the flow of the economy. Regulation to ensure price efficiency is pro-economy.
    2)It costs some “constant” amount — let’s say C– to fly from point A to point B (all variables taken into consideration) If you are an airline and you want to offer the service of flying passengers from point A to point B — then pro-economic regulation could say “you can charge the constant C time 2(or some other multiple) to fly a passenger from point A to point B. Then you can compete with other carriers for those passengers by, I don’t know, BEING NICE to your passengers. That would certainly when me over.

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  8. dw says:

    Isn’t the real problem chapter 11?

    If the old, inefficient carriers like United and American simply went out of business when they ran out of money then they would be replaced by more Southwests and JetBlues. Instead they continue like zombies, using up most of the landing slots at airports.

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