Last week we presented the main causes that led the Thomas Cook Group to bankruptcy. One of these main causes was the large pro-exposure of the company in the aviation industry with cheap tickets, where the competition is awesome.
In the last two years, several low-fare airlines have ceased to operate while some have been forced into bankruptcy. The French companies Aigle Azur (the second largest in France) and XL were the last victims of this terrible competition in this service industry.
by Thanos S. Chonthrogiannis
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Competition in air transport with cheap tickets in the EU
In the EU, the airline industry with cheap fares is characterized by specific building blocks that require participating companies in this industry to be overly cautious in their functional design because it is very easy with a change of business conditions to be brought to bankruptcy. More specifically,
Photo by Arpingstone, https://en.wikipedia.org/wiki/Public_domain
1. The main source of revenue for these companies is their ticket prices. Since competition exists exclusively in ticket prices it leads all industry participants to offer very cheap travel. As a result, both company revenues and their respective profit margins are compressed.
In order to respond to this continuing challenge, the companies should adjust their total operating costs in the course of their revenues and when their short-term and medium-term operating costs to industry companies are characterized as semi-fixed.
Ryanair-type companies, as an alternative and complementary source of revenue to their revenues from the cheap tickets, they charge everything on the fly. In this way, the cheap fare increases and substantially manage to partially increase their revenue.
2. Several companies in the industry in order to reduce their constant operating costs avoid flying to destinations that are expensive airports. At the same time, they avoid entering new markets such as transatlantic travel since entry into this market wants another air fleet and an offer average cost fare, while generally competition in these fields changes character.
3. The operating costs of these companies are semi-fixed, except for staff costs/labour costs. Another main expense in addition to the maintenance costs of their air fleet is fuel cost (kerosene), which the volatility of the price of fuel can significantly affect the company’s profitability in the industry.
One solution in this case to avoid volatility of fuel prices is the use of financial derivatives on behalf of companies. Specifically, futures and chain options where the underlying instrument in these derivative products is the aviation fuel (kerosene in tons).
With the use of these financial products the companies in the industry can achieve a price stability in their fuels and irrespective of the fluctuation of fuel prices. To make use of these financial products, the companies should have funds available and except the required rescue funds that they should have for emergencies.
In the coming years and up to 2025 the total annual operating costs of labour costs and aviation fuel will reach 48% of the total annual revenues for the companies in the industry.
Additional costs for these companies are the green taxes on pollutant emissions and any resulting passenger compensation.
4. The profitability or bankruptcy of an enterprise, apart from the necessary and optimum corporate design each time, depends on the forces of supply and demand prevailing each time in the market concerned. If demand is greater than supply, the profit margin of companies increases and can, depending on the amount of this, attract new companies to enter in the industry.
But when supply exceeds demand as is the case in the airline market with cheap fares in the EU the profit margins of companies are squeezed and companies operating near break-even point having also a high percentage of debts and without saving funds for difficult situations then it is very likely in a difficult time to be brought to bankruptcy.
The best solution for all these companies is by themselves to be driven into mergers between them in order to create economies of scale that will take out all these companies from the economic and competitive impasse.
In the coming years it is likely that a series of mergers between cheap ticket airlines will appear in the EU and the European market in this branch of services will end up consisting of four or five companies operating in economically viable business field.
