A Long-Term View of Industry Yields
| Airline Industry Yields - A Closer Look |
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Are falling yields, in real terms, a short-term problem for the industry, or continuation of a long-term trend? Can the industry adjust to a new lower yield environment without a significant increase in productivity? What will be the next source of productivity gains? Historically, airline yields have fallen in real terms consistently since the beginning of the industry. In the early years, the speed and size of aircraft increased dramatically, providing a significant decrease in per passenger costs, enabling lower fares. In the 40s and 50s, aircraft continued to become more reliable, faster and larger, as we moved from the slow DC-3 era to the Constellation and DC-7. The introduction of jets in the late 50s and early 60s brought a revolution in speed, dramatically increasing productivity per hour flown. Wide-body aircraft introduced in the 1970s provided lower seat mile costs as size and speed continued the increase in productivity. New engines and improved fuel economy helped productivity in the 1980s and early 1990s, when the average size and speed of aircraft continued to rise. But by the mid 1990s, aircraft technology provided only marginal improvements, but the internet enabled lower distribution costs and fares continued to fall. Today, cost reductions have been taken across the board, and few areas remain for productivity improvement except for labor costs. Low fare carriers are establishing market prices, and legacy carriers are using the only lever remaining to reduce costs, lower wages and work rules that enable higher productivity. The key question is where to we go from here? In the last six months, yields have risen for the first time since 2000. But are these simply the effect of fuel cost surcharges, or can no further productivity gains be obtained? The next few months will be indicative of an industry recovery, or continued commodity competition in a perishable environment. With United, Delta, American and Northwest reducing domestic capacity, and only Southwest, JetBlue and Continental increasing capacity, the combination of normal traffic growth and reduced overall capacity should increase domestic yields. The opposite may occur, however, on international routes, which United, Delta, Continental, American and Northwest are expanding. With capacity increases that may outpace traffic growth, yields will likely fall internationally in key markets, particularly in trans-Atlantic and Latin American markets. Will Southwest and other low fare carriers keep fares low enough to depress yields for legacy carriers in competitive markets, or take advantage of fuel hedging and lower costs to increase earnings? If Southwest's entry into Denver is an indicator, fares for both Frontier and United's low cost unit Ted have been cut to match the new competition. Southwest shows no indication of backing off its competitive strategy to price just at the point in which it can be profitable and its competitors lose money. As a result, can we really be as optimistic about increasing yields? How long can the trend towards lower yields continue without a breakthrough in technology or productivity? The 787 and A350 promise 20% lower operating costs than their predecessors. However, this is not a breakthrough of the magnitude of the introduction of jets or wide-body aircraft on seat mile costs. If the past is prologue, lower costs will be passed through to customers through lower fares, rather than provide additional profitability to airlines. In a deregulated perishable commodity environment, economic theory tells us that the low cost producer will set industry pricing, which others will need to match. It appears, domestically, that has become the case, which does not bode well for higher-cost carriers that cannot provide market differentiation. |
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