Can airlines sustain their profitability? The key is flexibility

August 22, 2017

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By Jonathan Kletzel, PwC

For the second year in a row, the airline industry showed record profit and operating margins, bolstered by strong ancillary revenue growth. But passenger and cargo yields declined for a fifth straight year, indications that demand is softening and capacity increasing. If this trend continues, with the supply of seats exceeding the demand for flights, it could undercut the ability of airlines to charge profitable fares. Our own research and analysis not only supports this idea, but shows an increased correlation between capacity and profits. It’s no wonder that some analysts have voiced concern that some airlines are losing their capacity discipline.

Airline profitability has been supported by low fuel costs. If prices rise – and we expect gradual price increases in the coming years – these increases will erode profits. In the meantime, we see other costs rising, especially labor costs as a result of newly negotiated employee contracts.

Inevitably, airlines will face a more difficult environment in the years ahead. So while times are good, airlines should take the time to re-assess their product offerings and ensure the financial sustainability of these offerings during a downturn. How can airlines evaluate their ancillary products and services for sustainability? A good place to start is by evaluating them against four components:

  1. Portfolio coherence – how a product fits within the greater product portfolio
  2. Revenue maximization – looking at whether a product reaches its revenue goals
  3. Valuation of free offerings – measuring non-financial benefits (e.g., customer loyalty)
  4. Product sustainability – evaluating the shelf life of a product

Based on these analyses, airlines should then build roadmaps at the product and portfolio levels and ensure they include flexibility in vendor contracts and scalability in technology changes.

This is particularly important because with technology and customer tastes evolving more and more rapidly, airlines have to be agile. Inflight wi-fi (IFC) is a good example of why this is so important. Although IFC on flights began a mere 10 years ago, it is now built into customer expectations, especially for US domestic flights. But now, not only is basic connectivity expected, but so increasingly is the “living room experience” – the ability to stream (in HD!) self-selected entertainment on a variety of portable devices. To meet these customer demands and maintain some chance of product profitability, airlines must seek to maintain control over pricing and service decisions when they negotiate new contracts with vendors.

The process I’ve described is itself an evolving one, as outlined in our Tailwinds – 2017 airline industry trends report. Today’s product roadmaps may need to be revised to fit new conditions. This means airlines need to periodically review vendor performance, product and pricing strategies, technology, and contracts, allowing them to make necessary mid-course corrections.

© 2017 PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.  This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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