Thu. Jun 1st, 2023

Make hay when the sun shines, says the old adage. For U.S. airlines, this typically means flying the most flights during the busy summer months. Some airlines even used to balance their heavy maintenance plans to ensure enough planes would be available for flying during the peak of peaks in such a seasonal business. Pilot and flight crew vacations were also sometimes limited in the summers, with plenty made available during the typically much softer demand months of September and October.

This year, many U.S. airlines have trimmed their summer flying plans, in favor of operating more reliably. This is a remarkably disciplined and pragmatic position. Burned by instances of high cancellations and lower-than-average on-time performance, many airlines have decided to sacrifice some summer flying opportunities in order to return confidence to the travelers and their employees that reliability is possible again. This reality has several important consequences for airlines and customers.

The Right Amount To Cut

When cutting capacity in a peak period, tough decisions have to made about what to keep and what to sacrifice. The most obvious would be a simple, objective financial measurement: cut the routes that would result in the lowest profitability. This makes sense, but has two practical problems. First is that many airlines’ profitability measurement system do not track truly incremental profitability. Say a report says a certain route loses $1. The airline better be sure that if it cancels the route, its profitability would actually increase by $1. But most measurement systems aren’t this precise. That’s because the measurement may include some allocation of aircraft expense, but if the airline doesn’t get rid of the aircraft the expenses don’t go away. Its costs may just get shifted onto other routes. There are other costs that could not be accounted for in a truly incremental way, and revenues may not be too clear as well if the airline flies multiple frequencies on a route or connects many passengers.

The second reason a straight financial measurement doesn’t necessarily make sense is that the airline wouldn’t want to lose important real estate, or a critical slot at a slot-controlled airport, for what they see as a short-term staffing shortfall. These strategic reasons may extend to not allowing a competitor to take up slack left behind. So if an airline can’t just cut based on numbers, how do they decide? In most cases this will be to ensure points of strength can stay that way, and flights cut could conceivably never be brought back without considerable strategic loss to the airline. The reason you see numbers like 5% to 15% for most cuts is because that’s what airlines can do in a typical network before they start cutting real muscle.

Higher Fares May Be Necessary

Less capacity in high demand periods results in higher prices for consumers. Even a normally low-price airline will use supply and demand configurations in their favor this way. The way most low-fare airlines think about pricing is “the highest fare that fills the airplane.” If the plane can be filled with higher fares, then that will be what happens. Constrained capacity is used by companies in many industries to keep prices high, including Harley Davidson and Boeing. Airlines may believe that trading off capacity for reliability couldn’t be done at a better time, given the strong rebound demand that seems to be in place.

Summer Reliability May Not Mean Fall Business Traffic

One reason to improve reliability after a relatively dismal last six months may be to be perceived as reliable by the time business traffic returns in the fall. But this may not happen with or without summer reliability. That doesn’t mean the airlines should over-schedule and then cancel when they don’t have staff. But, they should be judicious about aligning available capacity with available staff to make as much money as possible in the summer, and if business traffic returns in the fall, then great.

Business traffic has been slowly recovering, but the issues holding back a fully complete recovery are unrelated to current operating reliability of the airlines. They have much more to do with changes in where we work, how efficient technology has become, why flying less lets some companies report better ESG scores, and individuals who just don’t want to be road warriors any more. The best thing that airlines can do in deciding what to cut to improve reliability would be divorced from their hopes about the full return of business travel.

Wrestling With Cost Per ASM (CASM)

Arlines measure their cost efficiency on a “per ASM” basis. An ASM, or available seat mile, is simply defined as one seat flying one mile. This basic unit is how airlines define both costs and revenues on a unit basis. As capacity is reduced, the denominator (seats x miles) both go down because the airline is flying fewer flights. It almost all cases, the airline costs will not drop by this much, causing an increase in the unit costs. Many U.S. airlines have projected increases in their unit costs in part as result of this reduction in flying.

The higher the cost per seat mile, the higher the revenue per seat mile must be for the airline to be profitable. This is why the fares must go up, as previously discussed, but this too may not be possible or accepted by consumers to the extent that the ASMs reduce. If every airline saw the same increase in unit costs, that might not be terrible in the short term. But higher costs invite lower cost airlines to swoop in since they can make money at lower prices. Southwest Airlines used their lower costs to drive higher cost airlines out of markets for over 30 years. Today, their costs have risen due to more senior labor and older airplanes mostly, and this has created a growth opportunity for carriers like Spirit, JetBlue and Frontier.

Is This The Future For All Seasons?

The big question is if the cutback in summer capacity is just a harbinger of what’s to come for the next few years. That’s because the labor shortages the industry is facing will not be solved by the fall, and make take years to properly address. This means that fast airline growth, planned by several airlines including United (with 500 planes coming in five years, albeit some for replacement), brings with it extra risk because a disproportionate amount of any newly available labor will need to go to them. This means higher labor costs and ultimately higher ticket prices. In normal times, these prices would be met with reduction in demand. That may happen again following a summer when everyone seems to want to travel no matter the price. The bottom line is that as the world comes out of Covid, U.S. airlines are facing serious challenges around their costs and growth.

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