Pressures faced by legacy carriers

Global air travel has immensely grown over the past decade and there are signs of continued expansion. The air connectivity was positively impacted by the increased growth of Middle East hub carriers. The International Air Transport Association (IATA) reported that revenues increased to the US $746 billion (2014) from the US $369 billion (2004). 

Thus, besides competition within premium airlines, the segment has come under immense pressure with the advent of LCCs offering competitive pricing to lure customers. Legacy carriers are combating the threat of LCCs by setting up separate low-cost brand subsidiaries (displayed through the infographic below). Furthermore, the full-service long-haul industry seems to be moving from the traditional code sharing arrangements and global alliances to quasi-consolidations such as joint ventures (JVs) and equity alliances.

The legacy airline industry experienced a wave of consolidations ensuing the economic recession of 2007-09, the M&A transactions in the past decade pertaining to few of the American full-service airlines is shown in the below table.

Moreover, the American Airlines is the world’s largest airline based on fleet size, revenue earned, destinations served and passenger-kilometres flown. The airline carried more passengers in 2015 than any other US carrier. The next in the line is Delta Air Lines, which follow a similar model. Furthermore, both Delta and American airlines dominate few cities, wherein they primarily drive connecting flights through their hubs. In comparison with American Airlines and with other legacy carriers, Delta maintains a much older fleet. However, Delta's previous emphasis on older but well-maintained planes is presently changing. For instance, Delta during the second quarter of 2016 placed orders for 75 C-series planes from Bombardier and 37 Airbus A321ceo aircraft costing nearly US$10 billion (offering benefits such as savings on fuel).

The United Airlines, another major US carrier, focus primarily on strategically important cities for business travellers. The United with its greater exposure on international routes and with smaller hubs rely more on origin-destination traffic. Though, origin-destination traffic enables United to charge a higher fare in comparison with connecting flight fares, it faces greater competition and is, therefore, more susceptible to pricing wars in order to fill empty seats.

Televisory found that American Airlines fleet is 1.13x that of Delta’s, translating into a higher ASM and RPM of 8.9% and 6.4% respectively. Delta’s payload factor at 85% is higher than American’s 82.4% signifying better capacity utilisation for Delta. Additionally, for United, while the ASM increased by 1.6% in 2015 over 2014, RSM increased by 1.5% with a payload factor of 83.4%. 

Significantly, PRASM is the measure of revenue earned by an airline for each available seat mile (ASM), whereas the cost per available seat mile (CASM) measures the cost of each seat. The difference between these two key statistics measures the profitability or the margin/efficiency of an airline with respect to its capacity since fuel is a major cost in the industry (~30%), the airlines were largely impacted by the fall in prices.

On an average, the price of Brent crude oil per barrel was approximately 47% lower in 2015 as compared to 2014. Although Delta and United suffered fuel hedge losses, American Airlines benefitted from the drop due to the absence of a hedging policy. In spite of this, all the three airlines, including American experienced a fall in their PRASM in 2015 due to decline in airfare by about 5%. One of the primary reasons attributable to declining airfares were the price wars in 2015, this impacted both the payload factors as well as passenger yields. Delta has a higher spread in comparison with American and United indicating better management of its expenses. American seems to have a higher CASM than Delta on account of higher expenses incurred on salaries, wages and benefits attributable to a higher number of employees.

Therefore, with price wars ensuing in this sub-sector, cost efficiencies will further play out as airlines battle to expand their market share. IATA stated that going forward, jet fuel prices are projected to increase to $64.90/bbl as of next year from about $52.10/bbl in the current year, this will likely further pressure margins. The operational efficiencies will define the survival and success in the industry as airlines compete to woo customers.

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