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The airline industry has the lowest return on invested capital of any industry: http://centreforaviation.com/images/stories/2013/jul/05/ROIC4.PNG http://centref

by squidi 13y ago

The airline industry has the lowest return on invested capital of any industry: http://centreforaviation.com/images/stories/2013/jul/05/ROIC4.PNG http://centreforaviation.com/images/stories/2013/jul/05/ROIC... This analysis from McKinsey is worth a read: http://www.iata.org/whatwedo/Documents/economics/Profitability-and-the-air-transport-value-chain-final.pdf http://www.iata.org/whatwedo/Documents/economics/Profitabili...

leokun 13y ago
It's very strange given how necessary air travel is. It still surprises me how need and margins are inversely related (luxury goods have high margins, commodities low), but it makes sense. It's the price. The price of travel is so high for most consumers that they're going to optimize on price at the sacrifice of everything else. The cost of flying and operating an airline is so expensive that airlines also optimize on costs and prices. Virgin stands out as trying to change, that, but otherwise for everything economy class it's a race to the bottom. Looking at prices you'd think we value things we need lower than things we want.
- iand 13y ago
  Goods in high demand attract new suppliers who compete on price and so margins fall.
- jusben1369 13y ago
  Actually it's commoditization. There is very little differentiation in airline flying - particularly domestic in the US. So they get stuck competing on price. Imagine you're flying from NY or BOS to SFO. You have two choices. Pay around $500 per ticket with some price shopping. Have a horrible experience of cattle herding, no food choices, small seats. Or spend $2500 or something insane for slightly larger seats. Weird how there isn't an option for $500, $800, $1500 just like there's a Corolla, Camry, Avalon or Lexus. Now, the airlines will tell you that's because people just care about price and only price and that's why soon you'll need to drop quarters in to use the bathroom. But that's just opportunity to me. There are about 800 places you can improve the flying experience from the minute you hit the curb to bundled in Uber to and from to wide seats (vs just extra legroom) to food to entertainment to dedicated standing areas to "kids focused flights" (parents embrace business travelers avoid) to baggage rules........
  - bulte-rs 13y ago
    Problem with this is that airplane configurations are not easily changed; and accomodating 3 different sizes of seats with the risk of having to sell bigger seats for lower prices.... is not worth taking for most airlines (especially low-cost carriers)
    - lallysingh 13y ago
      Looks like a market opportunity for quickly-reconfigurable seats.
      - ChrisBland 13y ago
        A lot of people think that, there are a ton of FAA regs related to seats. Everything has to be tested in crashes. That also why it takes airlines so long to change seats to the new entertainment ones with power and everything. Your seat is your number one safety in the event of a crash. You are actually supposed to use the seat in front of you to brace yourself. It has a certain give to it so you don't run in to a brick wall when you land hard. If seats were easily configurable, every possible combination would need to be tested. Also whenever you do any work on a plane, you must have all of the supporting documentation, just think how long that would take to turn around. Document each bolt that was removed, when it was replaced, where it was..etc.. a lot of hassle.
      - saryant 13y ago
        It's actually pretty easy for (e.g.) United to add or remove rows of their Economy Plus seating. They can make that change overnight. When United and Continental merged and began adding E+ to the Continental fleet, most aircraft were completed pretty quickly since that change can be made during overnight maintenance at the hubs.
      - bulte-rs 13y ago
        If you are able to design one that passes all FAA/EASA/CAA/<aeronautical regulatory body here> certifications, I think ALL airplane builders will hail you as their saviour. Not to mention the airlines ;-)
- k-mcgrady 13y ago
  >> "It's very strange given how necessary air travel is" I haven't given this much thought but a lot of it isn't necessary at all. 1. Vacations abroad - vacation in your own country or take a boat 2. Business - a lot of business can now be conducted online which previously required air travel I'm sure those two things alone make up a vast portion of the consumer air travel market.
  - GFischer 13y ago
    On point 2), humans are still very much "social animals", and time and time again I see that business works a lot better face to face, and trust is much more easily gained. That has been repeatedly established, and there are very strong reasons why people with very limited time still travel a lot of hours to conduct their business. Not everyone is the same, but it is the norm rather than the exception. http://www.iacconline.org/content/files/WhyFace-to-FaceBusinessMeetingsMatter.pdf http://www.iacconline.org/content/files/WhyFace-to-FaceBusin... From the paper: "From a psychological perspective there are a number of positive features about faceto-face meetings that cannot always be achieved as well via other forms of communication. Face-to-face meetings allow members to engage in and observe verbal and nonverbal behavioral styles not captured in most computer mediated communication devises. There are nuances associated with hand gestures, voice quality and volume, facial expressions, and so forth that are simply not captured in email discussion, chat rooms, and the like. Even videoconferencing does not capture all of the dynamics of group members (e.g. the expression of others while one member is talking, etc.). A further advantage of face-to-face meetings is that they occur in “real time” as opposed to non-synchronized time. Computer mediated communications often are delayed because of a variety of reasons, not always received, and sometimes disrupted because of technical problems. Another feature is simply the fact that face-to-face business meetings provide human contact among members. Human contact is a primitive need among human beings. We are social creatures and isolation is harmful. A recent article in the New Yorker magazine8 discussed the impact of social isolation and concluded that “simply to exist as a normal human being requires interaction with other people” (p. 36). There is much psychological research affirming this proposition—that individuals need personal contact with others to satisfy deep primitive psychological needs. Face-toface business meetings help meet these needs. Emailing and even teleconferences are not as likely to meet these needs, notwithstanding the enormous popularity of Facebook which basically provides electronic connections between social “friends”. However, the popularity of this website suggests that people might be even hungrier for social friends than can be satisfied in their present day-to-day work and personal lives. Similarly, business meetings allow participants opportunities to develop important exchange relationships among themselves. These exchanges can be in the form of business negotiations, personal favors, promises, understandings, etc. that cannot often be achieved via other forms of communication because of their personal and informal nature. One psychological theory that emphasizes this notion is “social exchange theory” where human relations are viewed as an exchange of rewards among individuals or achieving equity between “what you put in” compared to “what you get out” of relationships." http://www.forbes.com/forbesinsights/Business_Meetings_FaceToFace/ http://www.forbes.com/forbesinsights/Business_Meetings_FaceT... http://online.wsj.com/ad/article/globaltravel-face http://online.wsj.com/ad/article/globaltravel-face
- sudomal 13y ago
  Aiming towards the higher end makes you vulnerable when recessions hit. You also have to compete with carriers that are run by government related entities, who operate for the prestige rather than the profits.
- frenchman_in_ny 13y ago
  Virgin [America] has been trying to change that, but financially it's still fairly questionable if they've been successful. [1] [1] http://www.nytimes.com/2013/09/08/business/at-virgin-america-a-fine-line-between-pizazz-and-profit.html?pagewanted=all http://www.nytimes.com/2013/09/08/business/at-virgin-america...
- squidi 13y ago
  I think it's hard for airlines to innovate much as many factors that determine the quality of service are outside their control. For example they don't own the airports (like Apple owns their own stores) and that affects a lot of the overall experience. Further to that, their profits are always being affected by fuel prices. If you read an airline's annual financial report it will talk about buying fuel futures to minimise the risk but they are still vulerable: http://www.transtats.bts.gov/fuel.asp?pn=0&display=chart1 http://www.transtats.bts.gov/fuel.asp?pn=0&display=chart1
- philwelch 13y ago
  Not strange at all if you know a little economics--actually it's encouraging. In an efficient market with perfect competition, economic profit (i.e. profit after opportunity cost) will be 0.
  - notahacker 13y ago
    The reality is though that virtually no airline routes are "perfectly competitive" (monopolies and duopolies are far more common; many routes are "natural monopolies") and airlines set (and constantly vary and test) their prices at levels they think will maximise yield, not at parity with some "market level" that everyone else charges for comparable routes. The difficulties in achieving profitability are all to do with high fixed costs and limited flexibility, and profits average close to zero largely because bailouts keep the airlines that are losing money in the sky as long as those which are highly profitable.
- rayiner 13y ago
  Food is also necessary, but the margins on staple foods are razor thin. It's Econ 101: profits in competitive industries tend towards zero. The only way to make consistent economic profits is to focus on industries where there is (relatively) little competition. One way to do that is ride the wave of a new industry before the competitors have time to pile in. Another is to enter industries where product differentiation plays a major role. E.g. wheat is wheat, but an iPhone and an Android phone aren't totally fungible. Just look at the posted chart: http://centreforaviation.com/images/stories/2013/jul/05/ROIC4.PNG http://centreforaviation.com/images/stories/2013/jul/05/ROIC.... What's at the bottom? Airlines, electrical utilities, paper, metals, construction materials, and trucking. These are all products that are highly standardized and fungible. You're never going to sell trucking services for 10x cost by making it a "lifestyle brand" the way Ralph Lauren sells jeans for huge margins.
  - smacktoward 13y ago
    > wheat is wheat, but an iPhone and an Android phone aren't totally fungible. You can also use branding-slash-marketing to make your fungible product seem less fungible. Witness, for instance, how cattle ranchers used marketing campaigns to turn "Angus beef" into a premium, name-brand product (http://bbq.about.com/od/beef/a/Angus-Beef.htm http://bbq.about.com/od/beef/a/Angus-Beef.htm) that customers don't believe is directly substitutable with unbranded beef.
  - randomdata 13y ago
    > wheat is wheat Except when it is not. Soft red, soft white, hard red, etc. Grading, protein content, etc. All can change who is willing to buy the product, and more importantly, how much they are willing to pay.
  - yuhong 13y ago
    I wonder what would happen if "profit margin fixing" was allowed.
- marcosdumay 13y ago
  lots people love the air transportation industry. They wouldn't think about working anywherer else... And on the economic sectors that this happen, salaries and ROI tend to be lower than the ones where it does not happen.
patmcguire 13y ago
Those are some baffling infographics.
- twistedpair 13y ago
  Clearly the McKinsey infographic guys never took geometry. I'm surprised at the elementary mistakes like scaling bubble charts by radius rather than by area. Makes the Asia airmarket growth look like 37000% rather than the actual 600%.
mseebach 13y ago
The McKinsey reports is summed up in the joke: "How do you make a small fortune in the airline business? You start with a large one."
twistedpair 13y ago
Now Exxon just needs to buy Boeing and then start and airline bringing the full powers of vertical integration to bear. That's probably the only way to make a dime consistently.
- joonix 13y ago
  Well, Delta did buy a refinery last year. It was a crazy move but I haven't heard much about how it's going since then.
  - twistedpair 13y ago
    True. The real winner is Emirates. They refuel when at the hub in the UAE where they get fuel for next to nothing. That is awesome given fuel is the driving cost of most airlines. When Boeing invents a flying fuel barge, expect them to dominate US routes.
    - joonix 13y ago
      It's a government subsidy just like any other. It's a huge one, and many carriers are complaining about it. They argue Emirates should be charged extra fees for their US service because of unfair competition. I think that argument has merit given US carriers have to pay market price plus taxes on their jet fuel. Emirates gets huge subsidies because its a goal of Dubai to become a world air hub. It certainly makes sense for them given their geographical position but I don't see how US carriers are supposed to compete with that.
      - FireBeyond 13y ago
        The US Government pays huge subsidies to US airlines that aren't extended to foreign airlines. It also has rules in place that do not allow foreign airlines to fly domestic routes in the US. Perhaps the UAE(/European/applicable foreign) governments should start charging US carriers an extra fee to combat the subsidies when they land abroad. I'm sure no-one would complain about that or attempt to use the US government's muscle to fight it...

by squidi 13y ago

leokun 13y ago

It's very strange given how necessary air travel is. It still surprises me how need and margins are inversely related (luxury goods have high margins, commodities low), but it makes sense. It's the price. The price of travel is so high for most consumers that they're going to optimize on price at the sacrifice of everything else. The cost of flying and operating an airline is so expensive that airlines also optimize on costs and prices. Virgin stands out as trying to change, that, but otherwise for everything economy class it's a race to the bottom. Looking at prices you'd think we value things we need lower than things we want.

iand 13y ago
Goods in high demand attract new suppliers who compete on price and so margins fall.
jusben1369 13y ago
Actually it's commoditization. There is very little differentiation in airline flying - particularly domestic in the US. So they get stuck competing on price. Imagine you're flying from NY or BOS to SFO. You have two choices. Pay around $500 per ticket with some price shopping. Have a horrible experience of cattle herding, no food choices, small seats. Or spend $2500 or something insane for slightly larger seats. Weird how there isn't an option for $500, $800, $1500 just like there's a Corolla, Camry, Avalon or Lexus. Now, the airlines will tell you that's because people just care about price and only price and that's why soon you'll need to drop quarters in to use the bathroom. But that's just opportunity to me. There are about 800 places you can improve the flying experience from the minute you hit the curb to bundled in Uber to and from to wide seats (vs just extra legroom) to food to entertainment to dedicated standing areas to "kids focused flights" (parents embrace business travelers avoid) to baggage rules........
- bulte-rs 13y ago
  Problem with this is that airplane configurations are not easily changed; and accomodating 3 different sizes of seats with the risk of having to sell bigger seats for lower prices.... is not worth taking for most airlines (especially low-cost carriers)
  - lallysingh 13y ago
    Looks like a market opportunity for quickly-reconfigurable seats.
    - ChrisBland 13y ago
      A lot of people think that, there are a ton of FAA regs related to seats. Everything has to be tested in crashes. That also why it takes airlines so long to change seats to the new entertainment ones with power and everything. Your seat is your number one safety in the event of a crash. You are actually supposed to use the seat in front of you to brace yourself. It has a certain give to it so you don't run in to a brick wall when you land hard. If seats were easily configurable, every possible combination would need to be tested. Also whenever you do any work on a plane, you must have all of the supporting documentation, just think how long that would take to turn around. Document each bolt that was removed, when it was replaced, where it was..etc.. a lot of hassle.
    - saryant 13y ago
      It's actually pretty easy for (e.g.) United to add or remove rows of their Economy Plus seating. They can make that change overnight. When United and Continental merged and began adding E+ to the Continental fleet, most aircraft were completed pretty quickly since that change can be made during overnight maintenance at the hubs.
    - bulte-rs 13y ago
      If you are able to design one that passes all FAA/EASA/CAA/<aeronautical regulatory body here> certifications, I think ALL airplane builders will hail you as their saviour. Not to mention the airlines ;-)
k-mcgrady 13y ago
>> "It's very strange given how necessary air travel is" I haven't given this much thought but a lot of it isn't necessary at all. 1. Vacations abroad - vacation in your own country or take a boat 2. Business - a lot of business can now be conducted online which previously required air travel I'm sure those two things alone make up a vast portion of the consumer air travel market.
- GFischer 13y ago
  On point 2), humans are still very much "social animals", and time and time again I see that business works a lot better face to face, and trust is much more easily gained. That has been repeatedly established, and there are very strong reasons why people with very limited time still travel a lot of hours to conduct their business. Not everyone is the same, but it is the norm rather than the exception. http://www.iacconline.org/content/files/WhyFace-to-FaceBusinessMeetingsMatter.pdf http://www.iacconline.org/content/files/WhyFace-to-FaceBusin... From the paper: "From a psychological perspective there are a number of positive features about faceto-face meetings that cannot always be achieved as well via other forms of communication. Face-to-face meetings allow members to engage in and observe verbal and nonverbal behavioral styles not captured in most computer mediated communication devises. There are nuances associated with hand gestures, voice quality and volume, facial expressions, and so forth that are simply not captured in email discussion, chat rooms, and the like. Even videoconferencing does not capture all of the dynamics of group members (e.g. the expression of others while one member is talking, etc.). A further advantage of face-to-face meetings is that they occur in “real time” as opposed to non-synchronized time. Computer mediated communications often are delayed because of a variety of reasons, not always received, and sometimes disrupted because of technical problems. Another feature is simply the fact that face-to-face business meetings provide human contact among members. Human contact is a primitive need among human beings. We are social creatures and isolation is harmful. A recent article in the New Yorker magazine8 discussed the impact of social isolation and concluded that “simply to exist as a normal human being requires interaction with other people” (p. 36). There is much psychological research affirming this proposition—that individuals need personal contact with others to satisfy deep primitive psychological needs. Face-toface business meetings help meet these needs. Emailing and even teleconferences are not as likely to meet these needs, notwithstanding the enormous popularity of Facebook which basically provides electronic connections between social “friends”. However, the popularity of this website suggests that people might be even hungrier for social friends than can be satisfied in their present day-to-day work and personal lives. Similarly, business meetings allow participants opportunities to develop important exchange relationships among themselves. These exchanges can be in the form of business negotiations, personal favors, promises, understandings, etc. that cannot often be achieved via other forms of communication because of their personal and informal nature. One psychological theory that emphasizes this notion is “social exchange theory” where human relations are viewed as an exchange of rewards among individuals or achieving equity between “what you put in” compared to “what you get out” of relationships." http://www.forbes.com/forbesinsights/Business_Meetings_FaceToFace/ http://www.forbes.com/forbesinsights/Business_Meetings_FaceT... http://online.wsj.com/ad/article/globaltravel-face http://online.wsj.com/ad/article/globaltravel-face
sudomal 13y ago
Aiming towards the higher end makes you vulnerable when recessions hit. You also have to compete with carriers that are run by government related entities, who operate for the prestige rather than the profits.
frenchman_in_ny 13y ago
Virgin [America] has been trying to change that, but financially it's still fairly questionable if they've been successful. [1] [1] http://www.nytimes.com/2013/09/08/business/at-virgin-america-a-fine-line-between-pizazz-and-profit.html?pagewanted=all http://www.nytimes.com/2013/09/08/business/at-virgin-america...
squidi 13y ago
I think it's hard for airlines to innovate much as many factors that determine the quality of service are outside their control. For example they don't own the airports (like Apple owns their own stores) and that affects a lot of the overall experience. Further to that, their profits are always being affected by fuel prices. If you read an airline's annual financial report it will talk about buying fuel futures to minimise the risk but they are still vulerable: http://www.transtats.bts.gov/fuel.asp?pn=0&display=chart1 http://www.transtats.bts.gov/fuel.asp?pn=0&display=chart1
philwelch 13y ago
Not strange at all if you know a little economics--actually it's encouraging. In an efficient market with perfect competition, economic profit (i.e. profit after opportunity cost) will be 0.
- notahacker 13y ago
  The reality is though that virtually no airline routes are "perfectly competitive" (monopolies and duopolies are far more common; many routes are "natural monopolies") and airlines set (and constantly vary and test) their prices at levels they think will maximise yield, not at parity with some "market level" that everyone else charges for comparable routes. The difficulties in achieving profitability are all to do with high fixed costs and limited flexibility, and profits average close to zero largely because bailouts keep the airlines that are losing money in the sky as long as those which are highly profitable.
rayiner 13y ago
Food is also necessary, but the margins on staple foods are razor thin. It's Econ 101: profits in competitive industries tend towards zero. The only way to make consistent economic profits is to focus on industries where there is (relatively) little competition. One way to do that is ride the wave of a new industry before the competitors have time to pile in. Another is to enter industries where product differentiation plays a major role. E.g. wheat is wheat, but an iPhone and an Android phone aren't totally fungible. Just look at the posted chart: http://centreforaviation.com/images/stories/2013/jul/05/ROIC4.PNG http://centreforaviation.com/images/stories/2013/jul/05/ROIC.... What's at the bottom? Airlines, electrical utilities, paper, metals, construction materials, and trucking. These are all products that are highly standardized and fungible. You're never going to sell trucking services for 10x cost by making it a "lifestyle brand" the way Ralph Lauren sells jeans for huge margins.
- smacktoward 13y ago
  > wheat is wheat, but an iPhone and an Android phone aren't totally fungible. You can also use branding-slash-marketing to make your fungible product seem less fungible. Witness, for instance, how cattle ranchers used marketing campaigns to turn "Angus beef" into a premium, name-brand product (http://bbq.about.com/od/beef/a/Angus-Beef.htm http://bbq.about.com/od/beef/a/Angus-Beef.htm) that customers don't believe is directly substitutable with unbranded beef.
- randomdata 13y ago
  > wheat is wheat Except when it is not. Soft red, soft white, hard red, etc. Grading, protein content, etc. All can change who is willing to buy the product, and more importantly, how much they are willing to pay.
- yuhong 13y ago
  I wonder what would happen if "profit margin fixing" was allowed.
marcosdumay 13y ago
lots people love the air transportation industry. They wouldn't think about working anywherer else... And on the economic sectors that this happen, salaries and ROI tend to be lower than the ones where it does not happen.

patmcguire 13y ago

Those are some baffling infographics.

twistedpair 13y ago
Clearly the McKinsey infographic guys never took geometry. I'm surprised at the elementary mistakes like scaling bubble charts by radius rather than by area. Makes the Asia airmarket growth look like 37000% rather than the actual 600%.

mseebach 13y ago

The McKinsey reports is summed up in the joke: "How do you make a small fortune in the airline business? You start with a large one."

twistedpair 13y ago

Now Exxon just needs to buy Boeing and then start and airline bringing the full powers of vertical integration to bear. That's probably the only way to make a dime consistently.

joonix 13y ago
Well, Delta did buy a refinery last year. It was a crazy move but I haven't heard much about how it's going since then.
- twistedpair 13y ago
  True. The real winner is Emirates. They refuel when at the hub in the UAE where they get fuel for next to nothing. That is awesome given fuel is the driving cost of most airlines. When Boeing invents a flying fuel barge, expect them to dominate US routes.
  - joonix 13y ago
    It's a government subsidy just like any other. It's a huge one, and many carriers are complaining about it. They argue Emirates should be charged extra fees for their US service because of unfair competition. I think that argument has merit given US carriers have to pay market price plus taxes on their jet fuel. Emirates gets huge subsidies because its a goal of Dubai to become a world air hub. It certainly makes sense for them given their geographical position but I don't see how US carriers are supposed to compete with that.
    - FireBeyond 13y ago
      The US Government pays huge subsidies to US airlines that aren't extended to foreign airlines. It also has rules in place that do not allow foreign airlines to fly domestic routes in the US. Perhaps the UAE(/European/applicable foreign) governments should start charging US carriers an extra fee to combat the subsidies when they land abroad. I'm sure no-one would complain about that or attempt to use the US government's muscle to fight it...