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.


Randall Hoven

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.

Jim

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.

Chris

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

Enter your name

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?

Sbard

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.

Adam

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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JPL

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.

HH

"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.

Ian M

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.

Scott from Ohio

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.

Brian Smith

I think one large reason for this is that flying is honestly a miserable experience. Ever increasing TSA restrictions only make it more so. Most people will only fly now if it's time sensitive or its cross country. Medium distance travel has been taken over by cars and now thing like the Megabus. Not only that, but most legacy carriers are constantly trying to squeeze every dime they can, which only discourages customers. $25/bag, $5/headphones, seats less comfortable than those at the dmv. Not only that, but as they keep trying to squeeze more and more seats in the plain, I cannot fit anymore. My shoulders are literally wider than the seat. Rather than looking at the costs analysis, I think looking at various factors that have decreased demand should be the focus.

Erik Ducker

I wonder what effect the development of video chat has had on the airline industry. A lot of person to person business can now be done over the internet as opposed to flying out for the same meeting.

Mark

What about the addition of the internet and travel websites and the much inability of the airlines to recoup from having pricing transparency?

Mack

It would help me understand all this if I could get answers to two questions.

1) Do people own airline stocks?

2) Why?

RS

Airlines are a commodity business, made worse by being sexy.

Most commodity business face such profit pressures, because there is little for them to differentiate against competition, other than price. Over time, as the weaker players fade and the economy fluctuates commodity businesses are prone to cycles and consolidation.

What compounds the situation for the airline businesses, is that unlike cement or sugar, the business has had a great image premium for entrepreneurs and investors. This results in a continuous supply of new capital into the business, increasing supply and in the long-run, leading to further price competition and perpetual losses.

Mike B

I'm surprised that the industry doesn't push for re-regulation to bring back some stability and restore flying to the experience that it once was. Some may claim that since de-regulation the consumer has benefited with lower fares, but seriously, does anybody enjoy flying anymore? At least back in the regulated period people would pay for steak and get steak. Today they pay for ground beef and get something more like spam.

LCCs are little more than a scam that tempt people with flashy low fares at the top of their Expedia search, but then extract the profits with hidden fees and abysmal service. Also don't forget that as LCC cherry pick the flush routes that can sustain their model of operations, the types of destinations and flights that were cross subsidized under the old model will no longer be sustainable. Today if you don't live near a major airport you'd better be content with either one or two flights a day or using the bus.

Oh well I can't stand air travel so the more it implodes the better. Having fun wading through security. I'll be enjoying a lice liquid beverage while taking the train.

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Anakritis

Can the fact that flying has become an ever increasing unpleasant experience on the whole be ignored?
Over the past 15 years the experience has become so painful, uncomfortable, costly, and unpleasant as to be confused as something out of a Saturday night live skit.

mpod

correction: Berk*e*ley

commonsenseless

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!