Last stop for the airline gravy train?

Flying sky high, for now

It's been quite a stretch for an industry that never really became profitable on a yearly basis since, well, the very beginning of its existence. Airlines have made some real bank in the last several years, an amazing bounce-back from the brink of collapse a mere decade ago. But that jetstream of profits is starting to shift and there could be some strong headwinds coming.

Thanks to the introduction of ancillary fees for baggage, food and other services, airlines have been raking in profits like never before. Ideaworks Company, an industry consulting firm, co-sponsored a study in 2017 that projected ancillary revenue for airlines worldwide to reach US$82.2 billion in 2017. That staggering figure included the revenue generated from selling frequent flyer miles to credit card and other companies as part of their loyalty benefits, but there was no denying that, in many cases, the added fees were contributing more to the airlines' bottom lines than actual airfares.

The financial crisis that hit airlines hard in 2008 and 2009 made companies rethink their pricing strategies. Baggage fees were introduced, fuel surcharges added significantly to the cost of international tickets, and airlines scrambled to find ways to charge more without raising airfares sharply, which they feared would crush demand. Airlines also began to consolidate with competitors to expand their reach and, though not admittedly, mitigate profit-damaging fare wars. Some carriers declared bankruptcy to clear their ledgers of debt and other costs and emerge leaner. They also became better at managing their available airline seats so that fewer of them would go empty. An era of capacity discipline took hold, rightsizing aircraft and routes and keeping everyone's flights very, very full.

Once some of the dust settled and global economies began to get back on track, airlines stuck to their survival strategies and adjusted their approach to fees. Fares that became unbundled into separate, chargeable components – like baggage and seat assignments – were re-bundled into fee-based groups of ancillary services based on passenger preferences. From early boarding to seat assignments to in-flight Wi-Fi, airlines were finding ways to gain revenue without having to raise fares too much and the ancillary fee strategy shifted from preservation and survival to a genuine, workable business model. Once passengers were resolved to the fact that fees weren't going away, airlines put their focus on creature comforts and perks that passengers actually didn't mind paying for. The outrage that began with baggage fees changed to a begrudging whimper and eventually settled into a quiet acceptance as more "useful" fee-based services were introduced. Having found the "Goldilocks zone" of fee-based pricing, airlines put their revenue gains on auto-pilot and sat back for a relatively easy cruise to profitability.

But I said we'd talk about headwinds. So, let's talk headwinds.

Last December, the International Air Transport Association (IATA), the trade group representing over 280 airlines around the world, said that airlines were set to reap over US$38 billion in profits in 2018. The December report by IATA based the numbers on fuel prices of $60 per barrel. By early June, oil prices spiked to over $70 per barrel which caused IATA and other industry analysts to promise an adjusted profit forecasts for 2018, likely downward.

Demand for travel worldwide has remained strong, but international travel to the U.S. declined in 2017 from the previous year. Some of this had to do with stringent and sometimes confusing immigration and visa policies set by the U.S. administration as well as temporary bans on electronic items on flights from certain countries. In addition, a revisited U.S.-Cuba policy put a damper on bourgeoning travel by Americans to the island nation by bringing back some travel restrictions eased in 2014 and 2015. A weakening U.S. Dollar could ease any impending slump by making it more attractive to visit the U.S. but uncertainty rules in the current geo-political landscape and policy fluctuations from trade disputes to threats of conflict add to the mix. Will there be oil price hikes? Will trade wars affect aircraft manufacturers and airlines, or a consumer's desire to splurge on air travel? There are lots of moving parts and no one really knows how many unintended consequences could emerge.

The U.K.'s departure from the EU could add to some significant changes to aviation agreements between the U.K. and other countries, affecting joint ventures and other partnerships between airline alliance partners. Some airlines based in the U.K. might decide to move elsewhere. New treaties might have to be forged if flying privileges enjoyed as a member of the EU no longer apply after the U.K's departure. This might not seem significant to the average passenger, but to the airlines, it could wind up costing them if codeshare flights and revenue sharing pacts are adversely affected.

Labor unions also want a piece of the profits. For many years, many labor groups have had to either give back salaries or go without raises due to poor financial results by their airline employers. The stretch of unprecedented profitability could be pitting airlines looking to upgrade aircraft and add new services against some aggrieved employees looking to gain back what they feel was denied them for many years. Some groups have been working without a new contract and could leverage these good times as a means to get the best deal. Fuel and labor are the two highest costs for an airline. With fuel prices already going up to levels not seen in years, pressure from labor could force concessions that further erode profits.

And then there's the weather.

You show me a superstorm that knocks out air travel over a significant region and I'll raise you a plume of volcanic ash that cripples aviation for an entire continent.

Storms are brewing for airlines. Are they ready?

Weather is unpredictable, cyclical and unavoidable. Airlines have always had to deal with it and sure, aircraft can scamper around thunderstorms with their sophisticated instruments, but we're talking about a climate that's producing stronger storms and unusual weather in places not normally known to have such phenomena. The schedule disruptions are costly and the more frequently they happen, the more airlines are going to have to dip into their coffers to get things back in order. Guess what? They're happening more frequently.

Aviation is a significant contributor to greenhouse gasses and, over the last several years, industries and governments have been hashing out policies and goals to reduce emissions through efficiency, alternative fuels, and the creation of a taxation scheme as an incentive to cut down on carbon emissions. Efforts in the U.S. to roll back environmental and other regulatory mandates might provide temporary financial relief to an industry that contributes more than 11% of all carbon emissions in the U.S., according to the Environmental Protection Agency (EPA), but if you believe in cycles, you know there will eventually be a price to pay once the political pendulum swings in the other direction. Changes in weather patterns will continue to wreak havoc on an air traffic control system bursting at the seams, especially in older aviation markets like North America where infrastructure improvements will require an enormous expense that the aviation industry will have to contribute greatly to.

To navigate those stormy skies, airlines are also going to need pilots in the coming years – lots of them. Through retirement, growth in regions like Asia, and rules that require more flying hours for entry-level pilots, airlines are going to find it more difficult to fill those flight deck chairs. In fact, Boeing recently predicted that over the next 20 years, about 637,000 new pilots will be needed to cover demand. Regional airlines are losing their best qualified pilots to larger carriers who need pilots with more qualifying hours, and backfilling those positions is a costly proposition. For these new pilots, the high cost of training is best offset by a good entry-level salary and that's costing the industry more in higher starting wages and incentives.

Finally, for now, there will be continued pressure against increasing airfares, which is an airline's best way to buffer against rising costs. It's just not a popular thing to do, and airlines usually wait to see who else gets onboard the price-hike flight before the increase either takes off or crashes back to the ground. A spike in prices hurts demand, and that has repercussions for the entire travel sector (car rentals, hotels, tourist destinations, airport lounge operators and retailers). Lowering prices to react to competitors also hurts profits. There is a very small margin between pricing a seat to stay competitive and pricing one to make a buck without losing money or turning off passengers. Airlines are in a good place to cushion any bumps right now, even without raising fares, but they might have to go there eventually if economic pressures put a tighter a squeeze on profits.

If you've been around the airline industry long enough, you know that no period of triumph or tribulation lasts forever. Airlines have had to learn to fly through many storms, from terrorism and pandemic scares to volcanic eruptions and bad press, even self-inflicted bad press. Having invested in new aircraft, food, seats and services, airlines are finally getting to do some of the things that they've had to put aside due to lack of capital. But there's no denying that the music at this multi-year party is starting a slow fade, or at least mixing a different tune.

If fuel prices rise sharply; political decisions change the global economic landscape; trade disputes increase the price of goods around the world; and competition from budget airlines on longer international routes increases, many airlines might just find a familiar nemesis making a return. There's nothing to suggest that a sudden downturn is imminent. In fact, things seem to keep rolling along even with some signs of change. IATA's forecasts for industry profits, though ticking downward, are still in positive territory and the economy in the U.S., still the world's largest aviation market, remains strong.

It might not be as dramatic or come as quickly, but the winds are shifting, and eventually could get strong enough to clear the dust off of some those old cliches about "all good things" and "what goes up." Let's hope that if and when things do turn, airlines are well prepared this time around.