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. Tommy says:

    Guys, i know nothing about the airline business. So far what i’ve read is all disappointments about the Industry. Nevertheless i am aspiring to start an Airline Business. Turn around the flying business, bring back the Howard Hughe’s times. Trying to make Commercial flights as Taxi’s only these ones are Air Taxi’s . Affordable price with the best service. BTW am only 18 yrs old. So forgive me if i sound too business naive, or crazy has some have called my idea. But i know it will work.

    PS. Forgive me, if my spellings are wrong or my English because English is my 4th language. Am an African by birth, been in the states only 5 years. I would appreciate your comments about this industry and what do you think of such an idea. I know i don’t have much information on how i will transform it, but am working on that.

    If you can email me @tizzo009@gmail.com

    Thanks and y’all have a great day.

    Tommy

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  2. F Lorenzo says:

    Airlines, in my opinion, since deregulation, are the most corrupt industry in the U.S.
    The costs are going down, except for fuel and that is kept to a minimum by flight cancellations of less than full equipment and using “free trip coupons” which actually profit the carrier for not operating as scheduled.

    We are the chumps.

    They are working on reduction of crews since the aircraft are becoming more and more automated…..sort of like drones. Many departments of carriers have been reduced, outsourced and automated. There is a severe lack of competition, as a result of very badly handled deregulation. It should have stayed regulated. The greed factor started with the carriers for the 80′s, 90′s and until today.

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  3. Tom Lessing says:

    I have spent about 10 years of my life developing systems for airlines. If you ask me they don’t make money for a number of reasons, 3 to consider:

    1) They don’t know where they are really losing the money. Too complicated! I have seen the arguments the systems the irrationality of complex logic. It simply doesn’t make sense in the end.
    2) Due to their revenue management models they end up slicing the cake roughly the same every time. That is why the LCC’s caused so much trouble initially. They turned the revenue model upside down and stole customers by cutting out much of what made the airlines lose money.
    3) Things like lounges, frequent flyer programmes all quietely ends up wipping out the profit on the bottom line. There are more sins with hard to calculate costs. In fact it is virtually impossible to calculate the cost of cannablism of your own revenue models. It is just assumed that you have an advantage. Nothing worse than a perceived advantage costing money.

    The obvious factors are compensated for because it is easy to relate the expense to the income it simple to raise airport taxes … , so is higher fuel etc. The non obvious things that cost airlines dearly are those pesky arguments about things that really have nothing to do with flying or are hidden from view. So what does our Frequent flyer program really cost us? No one knows and don’t you dare question the wisdom behind that. The externalties are just too complex and hard to understand. In the end airlines seem to almost always fall for the narrative fallacy … The end result is all the problems are pinned on high fuel costs or airport taxes, the economy or whatever it is. No mention of the real reasons. Besides who can hold a CEO post by saying to investors … I don’t know why we lost money?

    As Warren Buffet said he is an airoholic and I think he also said the biggest problem with airlines is testostorone.

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  4. SiliconDoc says:

    Anyone else notice the liberal OP declares deregulation has done all the damage the last 30 years then spews out endless paragraphs without a single regulation lost as proof ?
    I certainly noticed.
    How can people write up such crap that contradicts their main thesis declared as fact then, refute themselves so easily, and still pretend it’s deregulation ?

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  5. don't fly says:

    It’s not a big f’n mystery!!!! IT’S THE TSA

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  6. Don says:

    Cost containment is the key, as the airline industry as a whole has reduced their product to a commodity. Gone are competition based upon services, as marketing over the last 30 years has trained passengers to consider only price in selecting an airline flight. I would also argue in part that the increase in numbers of people flying post deregulation has been due to lowered fares (often below the point of cost recovery, much less profit) encouraging those who would previously not considered flying to fly.

    I would also argue that the two key cost issues negatively affecting airline results are the high levels of debt accumulated by airlines post deregulation in order to expand and seize market share from competitors (much of this debt discharged by numerous airline bankruptcies through the 1990s and early 2000s), and the higher cost of operating a hub and spoke system. While hub and spoke allows maximum passenger choice in selecting flights and permits an airline to “control” passenger traffic and yields out of a given airport, it requires more personnel and equipment during traffic banks (which often sit idle during slack times) and results in greater delays at an airport.

    Everyone seems to address fuel, taxes, and personnel costs; no one seems to consider the effect of high debt levels incurred in trying to squeeze competitors out and the higher costs to operate a hub and spoke network.

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