What’s Wrong with the Airline Industry? Diagnosis and Possible Cures

The Problem

From 2001 to 2004 the U.S. airline industry flew nearly 3 billion passengers. Unfortunately, it lost an average of $13 on each one generating more than $32 billion in losses. With losses continuing this year, it is no understatement to say that the industry has a serious financial problem.

To be sure, the airline industry has always exhibited cyclicality because travelers’ demand is sensitive to the performance of the macroeconomy yet airlines must predict this demand accurately because of the lead time required to acquire aircraft. When airlines over predict demand, which can happen for any number of reasons, they suffer losses.

Figure 1 shows the cyclical nature of the U.S. airline industry’s operating profit margin for the last 67 years. The huge losses since 2000 have resulted, in our view, because the long-standing challenge of aligning capacity with demand over the business cycle has been exacerbated by the confluence of several events that have significantly reduced the industry’s revenues and raised its costs.