If airlines are such a bad business model then why do businessmen keep lining up to start them?

Businessmen keep lining up to start Airline business because:
  • It is a high profile romantic business: It tends to fulfill social and ego needs of some businessmen wanting to become famous at international level. Airline CEOs/owners get far more public attention than other businessmen.
  • It appears highly profitable to naive businessmen: Businessmen having no relevant aviation experience tend to believe that it is a profitable business and ignore the risks involved in it.
Airlines are a bad business because:
  • It is capital intensive:  The price of a new single aisle 150-180 seat aircraft is between US$ 70 to 80 million.  Start up airlines, therefore, tend to lease required number of aircraft. Even this arrangement requires substantial capital. The security deposit usually demanded by the lessor is upto US$ 2 million per aircraft for a period of 3-5 years. Hence a start-up airline would require between US$ 6-10 million to lease a fleet of 3-5 medium sized aircraft. Capital required to establish other related infrastructure such maintenance facilities etc may require as much additional capital.
  • It is labour Intensive: Airlines are labour intensive employing thousands of the professionals to run an airline. This however depends on the size of an airline. Technology has not been able to replace manpower requirements to run an airline i.e.pilots, cabin crew, engineers and technicians etc. Among a dozen of cost its component, labour cost ranks the highest in Europe and North America where it is about 35% followed by Asia where it is about 18% on the average. Unionized airlines end up paying far more compensation than other airlines squeezing already thin margins.
  • It has very high operating cost: A 1000 km (Karachi-Lahore) short round trip by a medium sized aircraft (A320/B737-800) would cost around Rs 2 million (US$ 20000) and it would cost twice as much on a 2000 km round trip (i.e Lahore – Dubai). Cost of operations on domestic routes would be slightly less in Pakistan due lower airport charges and no route navigation charges.
  • It has very high fixed cost: Operating an empty aircraft costs almost as much as passengers sitting in it because all major costs associated with its operations are fixed such as airport charges, air navigation charges, ground handling charges, variable portion of labour cost, maintenance, insurance, depreciation and cost of operating lease/per hour etc.
  • It is the riskiest business: Airline business is the riskiest because empty seats are perishable.  Diversion to other airports due to bad weather at destination airport may double the trip cost besides upsetting other operations planned for this particular aircraft. Holding in the air because of traffic sequencing costs between US$ 100 to 150 per minute. Breaking out of viral diseases such as SARs & Zika virus, adversely affect demand for air travel bringing seat factor for months in a particular market. War or warlike situation such as Gulf war also affect demand and cost of operations as insurance cost tends to go up. Unpredictable oil prices also affect the bottom line.
  • It has fierce Competition: Airline business is oligopolistic where 3 to 5 airlines compete each other for the same size of the traffic, forcing airlines to cut the prices to attract traffic away from competitors. This inevitably results operations around breakeven seat factor, which is around 80% now a days. Average profit margins are between 1-2% if any. This is because capacity of the aircraft comes in bulk (i.e. 150-300 seats) whereas the passengers come in ones and twos. The passengers are also notoriously price sensitive. They rather do window shopping and it becomes virtually impossible for the airline to fill the aircraft at desired price level because of stiff competition in the market. Hence Revenue Management system comes into play selling seats at different prices. This is a complex computer algorithm programme that takes into account the number of seats available and the time left to sell them. It may also take into account the competitors’ price level and keep changing own prices from day to day, hour to hour and even minute to minute. Their primary objective remains achieving breakeven and holding on to their market share.
  • It is Cyclical: what goes up must come down. Global airline industry’s financial results typically suffer from 8 years business cycle. Return on Invested Capital (ROIC) usually remains below Weight Average Cost of Capital (WACC).

Chart Source: IATA 

  • It has more business restrictions: Regulatory restrictions in airline business are far more severe than any other business. Access to international markets is strictly regulated by a system of bilateral Air Services Agreements between Governments. Passenger Safety, Security and Public interest are strictly regulated in line with International Conventions on ‘Public International Air Law’ i.e. 1944 and ‘Private International Air Law’ i.e. Warsaw Convention 1929,  Rome Convention 1952, and Montreal Convention 1999 etc. Entry / Exit barriers are therefore more severe than other business.