External factors that influence the airline industry

Transcription

1 Overview: External factors that influence the airline industry By Teresa Cederholm S ep 03, :03 PM Must-know: External factors that influence the airline industry External factors that influence the airline industry The airline industry has contributed to the globalization of the world economy. It connects buyers and sellers. It also transports goods across nations. It breaks the barrier of distance and time. The U.S. travel growth forecast is provided in the following table. The industry s future looks bright. Travel expenditure in the U.S. is expected to grow by 4.3% in 2014 and 5.1% in The number of business and leisure trips is expected to increase. This is supported by economic growth. Like any other business, the airline industry is impacted by changes in its external environment. In this series we ll use the P olitical, Economic, Social, Technological, Environmental, and Legal (or P ESTEL) framework to analyze the airline industry. We ll also look at how the framework s factors influence the airline industry s fundamentals. Most industries are very sensitive to changes in the P ESTEL factors. However, the factors aren t controlled directly by the companies in the industry. C ompanies are forced to alter their business models, pricing, revenue, and cost structures to suit their customers changing needs in different economic conditions. As a result, knowledge of the trends and the economic life cycle can help predict external opportunities. It can also predict risk factors of investing in the industry.

2 The major players in the U.S. airline industry including Delta Air Lines (DAL), United C ontinental (UAL), American Airlines (AAL), Southwest Airlines (LUV,) and JetBlue Airways (JBLU) have contributed significantly to the growth in air travel. The companies have added customized services and capacity expansion to cater to the industry s demands. Exposure to airlines can be gained through funds such as the Fidelity Select Air Transportation P ortfolio. PESTEL framework analyzes the industry's external environment PESTEL Framework for analyzing external environment of the industry The P olitical, Economic, Social, Technological, Environmental, and Legal (or P ESTEL) framework covers the six external factors that impact the airline industry. The framework provides a broad perspective on opportunities and threats that surround the industry. The factors can t be controlled by the industry. Political and legal factors P olitical and legal factors include government intervention on economic operations or a particular industry. Airlines operate in a political environment that s very regulated and restricted. Government intervention can be necessary to protect the passengers interests and airline operations safety measures. You can read more on this in Part 3 and Part 4. Economic factors A healthy economy acts as a catalyst for industrial growth. Economic health is also measured by various economic indicators. Examples of economic indicators include growth in gross domestic product (or GDP), per capital income, disposable income, industrial production, level of business, and consumer confidence. Fluctuation in oil prices is another major factor that impacts airlines

3 profitability. We ll also see how economic indicators, like industrial output and business confidence, directly influence growth in airline passenger and cargo traffic in P art 5. Social and demographic factors The demand for air travel has increased significantly over the years. This indicates changing travel preferences among the latest generation. Demographic factors play an important role in forecasting demand and future travel preferences. For example, the future of U.S. travel and tourism will be defined by the growth in the millennial generation. This generation includes year olds. Retiring baby boomers people who were born between 1946 and 1964 spending on travel is expected to decrease. We ll discuss this more in Part 6 and Part 7. Technological and environmental factors To survive the intense competition in the airline industry, companies must adopt the latest technology. The use of advanced aircraft technology results in lower fuel consumption. This improves efficiency and the cost of airline operations. Technology is also one of the four pillars under the International Airline Transport Association s (or IATA) strategy to address climate change. All companies including legacy carriers like Delta (DAL), United (UAL), American (AAL), and low-cost carriers like Southwest (LUV) and JetBlue (JBLU) have been replacing their old aircraft with new fuel efficient ones. We ll discuss this more in Part 8 and Part 9. Why political and legal factors impact the airline industry Political and legal factors that impact the airline industry The airline industry is widely impacted by regulations and restrictions related to international trade, tax policy, and competition. It s also impacted by issues like war, terrorism, and the outbreak of diseases such as Ebola. These issues are political. As a result, they require government intervention. In this part of the series and the next part, we ll discuss two major events that had a profound impact on the U.S. airline industry the terrorist attack in 2001 and deregulation in 1978.

4 Financial impact of September 11, 2001, on the airline industry All companies in the airline industry including the top U.S. companies like Delta (DAL), United (UAL), American (AAL), Southwest (LUV) and JetBlue (JBLU) were negatively impacted by the 2001 terror attack. According to the International Air Transport Association (or IATA), the financial impact on the global and U.S. industry are as follows: It took three years for the global airline industry to recover the 6% decline in revenue between 2000 and It took the global airline industry five years to report its first net profit after the September 11, 2001 terror attack. Revenue declined by $22 billion to $307 billion in 2001 from $329 billion in In 2001, the global airline industry recorded losses of $13 billion. It reported its first profit of $5 billion in 2006 after four consecutive years of losses. Financially weak carriers even went into bankruptcy during the period. The U.S. airline industry revenue decreased to $107.1 billion in 2002 from $130.2 billion in P assenger traffic decreased by 5.9% year-over-year (or YoY) in 2001 and 1.4% in To match the reduced demand, airlines were forced to cut capacity by 2.8% in 2001 and 3.9% in Changes in the US airline industry's competitive landscape Deregulation in the U.S. airline industry The Airline Deregulation Act of 1978 removed all regulations governing the airline routes, airfares, entry, and exit of commercial airlines. Earlier, this was controlled by the C ivil Aeronautics Board (or C AB). Airfares and all other factors would be determined by demand and supply market forces. After the deregulation, passengers benefited from additional routes through the hub and spoke model. C ompetition also increased. This lowered airfares. The entry of low-cost carriers brought airfares down even more. Airlines offered no frills services to bring down the cost of operations. For more details on reducing airfares in U.S. airline industry refer to Why low cost

5 carriers influence the industry with low air fares. Laws and regulations preventing anti-competitive environment The recent consolidation in the U.S. airline industry had already reduced the number of top players. U.S. Airways merged with American West, Northwest with Delta (DAL), United (UAL) with C ontinental, AirTrans with Southwest (LUV), and American (AAL) with U.S. Airways. These carriers, along with JetBlue (JBLU) and Alaska (or ALK), account for more than 90% of the U.S. market share by available seat miles (or ASMs). With consolidation, competition reduced, fares increased, and passengers bargaining power decreased. However, the U.S. Department of Transportation (or DOT) has kept a close watch on the competitive landscape in the airline industry. The government wants to protect consumer interest and prevent monopoly. In August 2013, the Antitrust Division s civil enforcement program that protects and promotes competition along with seven state attorney generals and the District of C olumbia filed a civil antitrust suit to prevent the merger between U.S. Airways and AMR C orp. There were concerns that the merger would disrupt competition in the industry. The merger depended on the sale of slots and gates to low-cost carriers at some major airports. For more details on the conditions posed by the department for the merger refer to Why the American-US Airways merger was conditional. Why economic factors support airline industry growth Economic factors support industry growth Like most industries, the airline industry is impacted by the economic cycle s peaks and troughs.

6 The current growth in developed economies like U.S. that s driven by the loosening monetary policy has resulted in a rise in business confidence, industrial production, and international trade. All of these results act as catalysts for airline industry. According to the Bureau of Economic Analysis (or BEA), the real gross domestic product (or GDP) increased 4% annually in 2Q14 after decreasing 2.1% in 1Q14. With economic and industrial growth, employment rates have increased. This has led to higher real disposable income. In 2014, the U.S. real disposable personal income increased by 3.5% in the first quarter. It increased by 3.8% in the second quarter. The changes in real disposable income have strong relationship with the level of consumer spending on goods and services. Higher income consumers will likely spend more on leisure travel. Business and industry growth will have a positive impact on the demand for business travel and freight transportation. A irline industry growth and economic growth Airline performance is related to economic growth. Economic indicator trends can be matched with airline passenger and freight volumes. Revenue passenger kilometers (or RP K) measure the volume of passengers carried by an airline. It s calculated by multiplying the number of revenue passengers by the distance traveled. Freight Tonne Kilometers (or FTK) measure freight traffic. One FTK is one metric tonne of revenue load carried one kilometer. The FTK is closely related to business confidence that s driven by strong demand for goods. During periods of weak demand, businesses choose cheaper means of transport. The transport is substituted to reduce costs and maintain margins. This leads to reduced volumes. As a result, it bring down the FTKs and RPKs. In 2013, a healthy U.S. economy supported the growth in revenue of all major U.S. airlines including Delta (DAL), United (UAL), American (AAL), Southwest (LUV) and JetBlue (JBLU). Why social and demographic factors influence air travel demand

7 Social and demographic factors C ategorizing generations in the U.S. according to the year of birth provides insight into the changing trends in the travel and tourism industry. The demand for air travel has increased significantly over the years. This indicates changing travel preferences among the latest generation. The U.S. population is categorized as follows: Baby boom generation Born between Generation X Born between Generation Y or Millennial generation Born between Generation Z Born after 2000 Demographic factors also play an important role in forecasting demand. The factors match customer expectations in regard to value-add service offerings. For example, in the U.S. the future of travel and tourism will be defined by the growth in the millennial generation. The millennial generation includes year olds. Retiring baby boomers people who were born between 1946 and 1964 spending on travel is supposed to decrease. Travel spending forecast by generation According to Boston C onsulting Group s (or BC G) research, the millennial generation is the future of the travel and tourism industry. C urrently, the travel industry is driven by baby boomers travel needs. In the next five to ten years the millennial generation will enter their peak earning, spending, and traveling years. Their spending on business travel is expected to grow by 50% of the total by It s expected to remain strong for the next 15 years after that. C urrently, the baby boomers are the active customers. Their business travel spending is expected

8 to decline to 16% by It will decline to 11% by The high customer satisfaction scores of major U.S. airlines like Delta (DAL), United (UAL), American (AAL), Southwest (LUV), and JetBlue (JBLU) reflect their increased focus on satisfying the changing customer travel preferences in order to remain successful. In the next part of the series, we ll discuss how travel preferences differ between the millennial generation versus non-millennials. Travel preferences for millennials versus non-millennials Travel preferences In this part f the series, we ll summarize the Boston Consulting Group s (or BCG) findings. The BC G researched the millennial generation s travel preferences in the business and leisure segment. This will provide a better understanding of how social and demographic factors influence air travel. It will also show how the factors influence company strategies to adopt to the changing trends. According to the report, millennials spend 13% more than non-millennials per airline ticket. This is on average for business travel. They re 60% more likely to upgrade for seats with extra leg room and head room. They re more willing to pay for amenities such as Wi-Fi and in-flight entertainment. They buy more refundable tickets. They also buy more tickets that can t be upgraded. They tend to make more itinerary changes per trip than non-millennials. They re more interested in discounts, airline packages, and low-cost carriers like JetBlue (JBLU) and Southwest (LUV).

9 They re more likely to book tickets through online travel agencies. They re also more likely to use the mobile and travel applications of traditional carriers like Delta (DAL), United (UAL), and American (AAL). Knowledge of different groups travel preferences can help companies plan their target segments. It allows them to study which segment can bring higher returns on investment and increase profitability. It allows them to determine and plan future service improvements. The companies are able to satisfy growing consumer expectations in the long term. Must-know: The role of technology in the airline industry The role of technology Technological advancement has been the driving factor for improving airlines operational efficiency. Airlines have been able to reduce costs and improve operations by using advanced aircraft engine technology, IT solutions, and mobile technology. The technology has created better connectivity and enhanced passengers travel experience. Use of technology to reduce fuel cost Fuel is an airline s largest cost component. C urrently, it accounts for more than 30% of total operating expenses. According to Boeing, one of the largest aircraft manufacturers, advanced aircraft technology provides the following benefits: New aircraft like the Boeing-787, 747-8, 737 MAX reduce fuel consumption by doubledigit percentages compared to older ones. Aircraft performance also improves by using advanced technology winglets. You can learn more about winglets in Why winglets reduce aircraft drag and improve fuel efficiency.

10 Some of the technologies used for fuel efficiency reduce noise by as much as 30%. They also improve range distance that the aircraft can travel with a given amount of fuel and payload carrying capacity of an aircraft measured by weight. Increasing the range allows the airline to expand its connectivity and network. P ayload improvements increase revenue and profitability. Some of the new aircraft designs, like the ER, provide the flexibility to add ten economy class seats. This increases the payload. Other airline operations like maintenance and engineering and in-flight operations have also improved considerably by using innovative technology solutions. Among the top U.S. airlines, Delta (DAL) has been the most efficient in reducing fuel cost to $2.93 per gallon. This is the lowest cost among its peers including Southwest (LUV) at $3.02, American (AAL) at $3.03, and United (UAL) and JetBlue (JBLU) at $3.09 per gallon in 2Q14. Must-know: Environmental awareness in the airline industry Environmental awareness in the airline industry The global aviation industry consumes over 200 million tons of fuel per year. The rising demand for air transport and the rising crude oil prices could impact the industry s carbon emissions. The environmental impact could also influence sustainability. According to the Air Transport Action Group (or ATAG), the airline industry s impact on the environment is as follows: The global aviation industry processes 2% of all human-induced carbon dioxide (or C O2) emissions. Air travel is responsible for 12% of the total emissions from the transportation industry. Alternative fuels, like sustainable biofuels, are expected to reduce the aviation carbon footprint of fuel by 80%. 80% of the CO2 emissions are from flights that are longer than 1,500 kilometers. There s no alternative mode of transport.

11 The goal of the IATA s Carbon Neutral Growth (or CNG) 2020 is to put a cap on the increase in net aviation C O2 emissions from The association s success depends on several factors. The factors include the adoption of a C O2 emission standard for new aircraft by the International C ivil Aviation Organization (or IC AO). It also includes the growth in biofuel production and improvement in air traffic management. It also intends to achieve an average improvement in fuel efficiency of 1.5% per year until All major companies in the U.S. airline industry including Delta (DAL), United (UAL), American (AAL), JetBlue (JBLU), and Southwest (LUV) have contributed to achieving this goal through using advanced technology. Recent developments in alternative fuel options Sustainable aviation fuels are processed from a variety of feedstock. The feedstock includes industrial waste and biomass wheat, corn, and oil. It also includes oil plants jatropha and camelina. Feedstock are renewable sources of energy that can be blended with fossil fuels. They can reduce C O2 emissions significantly. The two alternative jet fuels that were approved earlier include Hydroprocessed Esters and Fatty Acids (or HEFA) conversion of triacylglycerides from plant oils and animal processing waste and the Fischer-Tropsch (or FT) process conversion of biomass and fossil fuel feedstock. The American Society for Testing Materials (or ASTM) International the largest standards development organization in the world has now approved the use of a new fuel called Synthesized Iso P araffinic (or SIP). It s produced from hydroprocessed fermented sugars. SIP fuel can be blended at up to 10% by volume to conventional jet fuel.