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Airlines and the post-lockdown planning challenge

Airlines and the post-lockdown planning challenge
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By Satyendra Pandey  May 14, 2020 1:02:42 PM IST (Updated)

For airline planners, the challenge is to look at a broad set of parameters that do not necessarily correlate and discern trends.

The corona pandemic and ensuing lockdown have already grounded the airline industry. But as the lockdown is gradually lifted, airline planners are now faced with a new challenge. Specifically, the lack of an internal forecasting capability and the incorporation of behavioral changes that cannot be quantified. Without these, the anticipated demand is at best a wild guess which then means planning for profitability is akin to flying blind. Yet it is one that planners are being forced to take. Demand patterns at this time are at best a “guesstimate.” And with fragile balance sheets and liquidity positions at airlines that in some cases can’t cover more than two days of expenses, the situation is precarious.  As such planners are left with no easy answers.

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The challenge of recovering costs
Airlines are notorious for their high fixed costs. These costs ideally have to be recovered in a manner that provides for returns that at the very least cover the cost of capital. And with liquidity constraints driven by marketplace challenges, for India’s airlines, with EBITDA margins hovering at an average of 10 percent- 12 percent (consolidated at an industry level) financing structures became increasingly critical to success. Sale and leasebacks were a significant source of income but in the current market no airline will be inducting fresh capacity and thus the sale-and-leaseback stream can be discounted. Other revenue streams such as ancillary revenues will also be adversely impacted. And the core revenue stream of ticket prices will be severely depressed.
On the costs side, while declining fuel prices ( down by 64 percent since January) will most certainly help, at the same time the dollar has risen by 8 percent and airlines are carrying the cost of the excess fleet. Costs are now amortized over a lower spread which will make for lower returns against each asset. For airlines, this poses a challenge. Because if each time the aircraft takes off there is a net-cash-loss to the airline, then ceteris-paribus the rational decision is to continue to be grounded till demand picks up. A second or even last-mover advantage beats the first-mover advantage in this case.
Not all demand segments will return
While the Indian market over the last decade had shown compounded annual growth of approximately 8 percent over the last ten years, the truth was that growth was unequal across segments. While approximately 30 percent of bookings were coming in the last seven days, market dynamics didn’t allow for airlines to enhance pricing power which was then reflected in extremely high load factors. And varying yields from segments were a point of contention and competition. These segments included the leisure traveller, the business traveller, the weekend traveller, labour flows, first-time fliers (who were taking to air because of ticket prices), traders, SMEs and students who could now visit home more than once given the price and convenience of air travel. But as long as prices were competitive (read: extremely low), everyone took to the skies.
This will no longer be the case. With policies around social distancing, the cost of carrying the burden of the excess fleet and a general malaise regarding air travel, airlines are left with no choice but to raise prices. But that effectively means that some demand segments will disappear. Not to mention the drying up of ancillary revenues. As such revenue challenges are imminent.
The forecasts have too many agendas
Business planning, in general, involves accurate reading trends and forecasting how these may change. Most begin planning from broad macro-economic trends. This is fraught with challenges. Canadian economist John Kenneth Galbraith famously said, "we have two kinds of forecasters, those who don't know and those who don't know they don't know."  But the reality of airline planning is that forecasts are required and forecasts are prevalent. And this becomes even more complicated as every forecast has an agenda. Even now, the narrative across several quarters is that in the long term there will be a reversion to the mean. Unfortunately, this is at variance with the ground reality.
Forecasts have always had agendas. Aircraft manufacturers tend to forecast a robust market for aircraft; banks tend to forecast a robust market for lending; technology providers forecast technology disruptions and complete digitization.
The challenge is that the agendas often inform the forecasts — sometimes subtly and at other times very openly. And in the pandemic, this problem is exacerbated.
What cannot be measured is exactly what planners have to look at
The old management mantra of quantifying all things and “what cannot be managed cannot be measured” simply does not work in the current context. Because quantitative data does not account for behavioural changes. And more than anything else the pandemic impacts how we think about travel which then informs how we travel. After all, how does one model fear and apprehension in a business plan?
For airline planners the challenge is to look at a broad set of parameters that do not necessarily correlate and discern trends. The trends include quantitative and qualitative factors. And the qualitative factors cannot be gleamed at sitting at a desk. One has to be in the market, experience the market and look at other factors that are completely unrelated to understand what is happening. Because there is no formula for this, proposing such an approach often drives quantitatively driven folks crazy.
As far as travel is concerned there is likely to be segmentation into essential travel and non-essential travel. Considering all the risks, the safest mode of transport may change. Overall, the perception of air-travel is undergoing a change: from one of convenience to one of risk. For airlines, this means revisiting the entire network and fleet plans and adapting to the new reality.
Airline planners have to incorporate behavioral aspects
Consider this standard growth narrative that was used until recently to justify decisions. A standard set of parameters — usually demographics, GDP growth and propensity to spend are looked at as leading indicators of air travel. Next was highlighting the air travel penetration using a metric such as seats per capita and concluding that the only way to go is up. This was all well and good because it accounted for an overall behavior pattern that was driven by emotions of optimism, social-proof and a desire to explore. As such the plans could count on growth as a given leaving planners with the task of determining what the level of growth will be. But fear and despair are not as easy to understand. Because each segment responds very differently to these emotions.
Thus airline planners have to do their own hard work. And much of this involves interaction as opposed to data modeling. Indeed, no regression model or forecasting tool can beat sustained interactions across levels and integrating those inputs. With these, one can come up with an understanding of the key drivers and influencers on the metrics that matter. Understanding trends also help to understand a change in the competitive environment. This can affect entire business plans and several options should be evaluated against changes in the marketplace.
As of now, there are no easy answers. Aping the west and force-fitting frameworks that may have worked in the past simply does not hold in the current situation. And this is what constitutes airlines and the post-lockdown planning challenge.
-Satyendra Pandey is the former head of strategy at a fast-growing airline. Previously, he was with the Centre for Aviation (CAPA) where he led the advisory and research teams. Satyendra has been involved in restructuring, scaling and turnarounds.
Read his columns here.
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