Fire-sale pricing vs. airline demand stimulation and profitability.

Going forward and as airlines are adding capacity quickly, would airline massively discount tickets to generate cash and fill airplanes up? They might, however this time it is different as the industry is navigating through very fragile airline liquidity and economic times. 

To incentivize demand, airlines are using different promotional strategies. For example in China, most airlines have offered considerable discounts on many domestic routes. Deals have included from 10% to up to 90% discount, buy-one-get-one-free promotions, package deals allowing a family of three to five members to travel 12 times in a year, among others. In addition and in a bid to encourage travelers to take advantage of public holidays, airlines have slashed domestic fares. For example, seats for a 2-hr. flight were selling for as low as US$ 22. Moreover, a number of airlines continue selling very cheap tickets for flights that are later cancelled in a drastic attempt to improve liquidity and cash flow. A number of those flights were canceled due to low demand and rescheduled for another date at the same price point (or not) to optimize loads. 

Meanwhile, Lufthansa CEO has said that tickets for 9.99 EUR are ecologically and economically irresponsible. On the other hand, United Airlines commented that other US majors are flying a bigger July 2020 schedule than they are by selling extremely low-priced tickets, wasting money and destroying profitability. Are we getting into another vicious cycle of excess capacity?

To be able to offer low fares and still make a route contribution, many were counting on fuel prices to stay at historically low levels as we have observed in the past months. However, they are rising and as we know there is a high correlation on ticket prices and oil prices. Last week, fuel prices continue edging up from historically low levels last week and highest spike were felt in Asia/Middle East/Africa while the lowest in Latin America. Therefore, discounting fares to stimulate demand while fuel prices continue edging up might not be globally sustainable as originally thought.

Meanwhile, new capacity is being added quickly in a number of markets. As of week 27th, 2020 and based on OAG schedules vs. last year, Wizz Air capacity is at +1% already and its CEO expects a demand recovery to pre-coronavirus volumes in one year. Furthermore, Ryanair is only at 23% capacity as of week 27th but has improved 16% when compared to week 26th. Besides, it is planning to bring capacity faster in the next weeks and months. In fact, its CEO expects to see a very rapid return to normal volumes because of its lower price stimulation strategy and plans to reach pre-crisis demand level like Wizz Air by next summer. Wow!

Comparing capacity added for a selected group of 9 global ULCC (3 from the US, 2 European, 1 Latin American, 1 Indian, 1 Middle Easter and 1 Chinese), they were at -19% already vs. a year ago. In fact, capacity leaders are Spring Airlines +15%, Vivaaerobus +5% and Air Arabia +2%. Besides, other selected group of global FSC are at -59% while Qatar Airways, China Southern and China Eastern lead this capacity push. However as we all know, capacity is one metric but to get a full picture of how sustainable it is we will have to look at cancellations, LF, yields, route and network profitability.

While on a % change basis from a year ago, avg. domestic airline fares in the US show a -29% in May 2020 (5% down from April) showing a weak fare environment. This downward trend might continue as American Airlines is restoring the most capacity among the top 3 US majors in July or 55% of its domestic seat capacity. Meanwhile, fares in Europe show an improvement but with new capacity added and still under a lackluster demand environment they might trend down soon benefiting only the lowest costs operators. Besides, fares in Asia seem to be edging up and Latin America shows deeper domestic discounting than the US.

Despite the intention to restore air services, demand may not necessarily follow as rapidly as some expect even if stimulated by extra-low fares which could be a major problem. To improve their chances, it is critical that airlines continue working on building confidence in air travel again. However, if the economic downturn is severe and prolonged as expected (IMF Global growth projected at -5% in 2020 and recovery projected to be more gradual than previously forecast in 2021 to +5%), the negative impact on disposable income (leisure travel segment) and corporate travel budget cuts might be larger than expected. Therefore, cheaper pricing may be airlines’ only hope of filling their seats specially to lure back price-sensitive/bargain hunter traffic.

But by adding capacity too quickly and diluting yields could be as disastrous for airlines as it was to ground their fleet. Especially, as airlines are in a weak financial position where cash preservation and properly managing working capital and cash flow are key as reducing costs and rightsizing are. It is true that in these times, we all need a splash of optimism but it is paramount to be realistic. Carefully matching capacity with demand has perhaps never been more strategic than today in this fragile economic environment if one wants to rebuild profitability.

Therefore, it seems prudent to be conservative, put in place strong capacity disciple, grow gradually than being sorry. Perhaps, flying less and maintaining yields while rebuilding profitability is a better recovery strategy these days. A conservative fleet planning, capacity and fewer flights strategy will maintain prices up. However and unfortunately, it seems most likely it won’t happen as players and competitors try to generate cash with their fleets as soon as allowed and we might end up into a another vicious capacity/fare dumping environment which only lowest CASK operator will survive...