There are worrying signs that demand is falling in some markets – and with higher costs baked in for many airlines, this could be a tough winter, argues Shakeel Adam
The past two-and-a-half years have been good for airlines around the world, and lately carriers from United to Etihad to Cathay Pacific have reported exceptional second-quarter results.
Airlines with significant capacity to East Asia continue to see excellent growth as much of Asia reopened later after Covid, and revenge travel is still not exhausted. Demand to Japan is also booming, with the currency devalued some 40% to its lowest level in 35 years.
Although passenger numbers and revenue reached record highs in some markets, this is not consistently translating to record profits for the sector. American, Southwest and Spirit in the US, Spicejet in India and Rex in Australia, amongst others, aren’t enjoying the party.
And looking ahead, the outlook across the sector is more tempered; United and Air Canada have been the most vocal about overcapacity.
There seem to be two reasons why some airlines are doing well, and others aren’t. First, demand quality is falling. The second reason is self-inflicted injury, with many leading airlines having structurally increased their cost base.
Demand normalisation
Major airlines including United, Delta, American, Southwest and Lufthansa have signalled the second half of 2024 will be challenging. Turkish Airlines, which has outpaced most airlines of late, reported a weaker second quarter.
It is not just that growth is slowing: demand is clearly falling. Executives talk of ‘normalisation’ to make ‘softening/falling demand’ sound more palatable.
By the end of 2023, many airlines remained defiant, claiming capacity constraints were limiting their ability to meet demand. But aircraft remain full, and demand appeared artificially robust due to constrained aircraft availability.
Yet with slight increases in capacity in 2024, airlines are finding it near impossible to sustain high fares or to fill additional seats, even with steep discounts. The Pratt & Whitney GTF-powered fleet grounding of some 600 aircraft is the best gift to airlines, forcing capacity discipline which has been lacking since the Covid era of governments backstopping losses.
Demand has been declining since early 2023 in Canada and the US, where fares fell double-digits most months. In November 2023 Canadian domestic fares dropped 17% and in January 2024 they fell 14%.
For Q2 2024, Delta reported that system-wide yields fell 2.6% while unit costs rose 2%. A major Japanese aircraft lessor confirmed, “Airlines aren’t fighting for new capacity as they were six months ago.”
Capacity discipline
Post-Covid revenge travellers have been far less price sensitive and shifted away from LCCs, forcing them to pivot and constrain capacity.
This will lead to higher fares for the majors in the short term, but the global consumer spending boom is simply not sustainable, and a fall in broader consumer demand is overdue. Customers do not fundamentally change their sensitivities in the long term, and leisure travellers are already demonstrating price sensitivity again.
Considering the travel boom was led by the premium leisure segment, an economic downturn will pressure both passenger numbers and fares going forward. Free markets dictate higher prices and capacity constraints will incentivise new entrants.
As households tighten their belts, price sensitivity will increase. A look at Europe’s largest market, Germany, shows Europeans are reining in spending as household savings are on the rise.
While reporting Q2 2024 results, Air Canada confirmed corporate travel remains 25-30% below 2019 levels – consistent with studies indicating corporate travel would structurally have a new base after Covid – some 30% lower overall, and up to 50% lower in the premium segments such as professional services.
Structurally higher costs
The second cause for profit weakness is one that I predicted early in 2023. Airlines rightly shared their windfall with staff.
Emirates and Singapore Airlines issued significant ad hoc profit share bonuses. In other markets, including the US and Europe, labour groups negotiated significant pay and benefits improvements.
Both approaches put more money in the pockets of employees. One rewarded all employees equally and the company maintains the flexibility to absorb economic downturns.
In contrast, collective agreements institutionalise a higher cost base for many years to come, erasing two decades of progress which increased the robustness and sustainability of airlines. Many airlines have returned to a harmful framework from the 1990s where labour groups look after their own short-term interests at the expense of the long-term sustainability of the company.
US carriers agreed to well out-of-market pay rises that have now structurally increased the cost base for these airlines and are being used by staff at other airlines to demand pay parity.
While US corporates can fall back on Chapter 11, such cost increases represent an existential threat for airlines in other jurisdictions.
Air Canada and its staff may come out the big winners. Negotiations with pilots have stalled. The delay now allows both sides to take into account the impact a downturn will have on the industry and Air Canada’s ability to compete.
While in the short term the most senior Air Canada pilots close to retirement lose out on cashing in one last major increase as their American counterparts did, taking the current economic conditions into account will probably save jobs in the medium term and is good for the overall sustainability of the pilot cadre jobs and the company’s long-term existence. It is too late for the US carriers, some of which may need to take a serious look at Chapter 11 (again) if the market deteriorates as predicted.
Rough skies ahead
Demand is falling off a cliff, both in numbers and yield quality. Concurrently, negotiated pay rises really started coming into full effect only in 2024. Therefore, unless something changes, the industry is facing some dark days. We could see 20-30 bankruptcies during this winter, rising to 50 by the end of 2025.
There are positive signs, though. As Europe’s strongest economy, Germany’s household debt to income ratio was trending down until the pandemic, reaching 82.23% in 2018, but rose to a record 106.63% in 2000 before falling to record lows of 81.91% in 2023 and holding steady in 2024.
In Asia and Africa, demand figures are providing some balance to the weaknesses in other regions, but the drops in those regions cannot be far behind.
Airlines must move to reduce their cost base now before the cost of capital rises further and before options are reduced.
Cathay Pacific is probably the furthest ahead in this manner, having used the pandemic to rethink its business, emerging conservatively and growing with discipline.
Lufthansa Group started a full-scale reorganisation of leadership in 2023, and albeit there is more to do, changes to its operating model are already showing signs of tempering the negative impacts of market softness.
Post 9/11, airlines showed they could be resilient. They faced challenges head on.
That leadership talent has largely retired, but those behaviours need to be brought back into airlines quickly. Neither AI nor new modes of planning will save airlines now.
And further government backstops represent illegal state aid.
Cost discipline and focussing on revenue quality are the way forward.
About the author
Shakeel Adam is the Managing Director of global aviation consultancy Aviado Partners in Germany and an expert in airline turnaround and restructuring.
shakeel.adam@aviadopartners.com / www.aviadopartners.com
