Flying Toward Change

Proactive transformations and transactions to avoid airline insolvency. Author: Scott Weatherhead

Airplane Landing

Airline insolvencies are high profile failures. Full service and cost carriers overburdened by an inflated cost base and niche carriers unable to find their place in the market leave behind disgruntled passengers, disillusioned investors and bad press. Airline executives can work to preserve operations by proactively identifying and executing measures to ensure sustainable profitability and to preserve strategic goals.

The pathways to insolvency are well documented and well known. For small carriers, the lack of market influence to set fares, to achieve favorable rates from suppliers and lessors, and to combat larger carriers, makes the game seem fixed before it is even played. For large carriers, complex systems and processes make agility and innovation difficult. Furthermore, labor unions pushing wage increases, on top of network and product propositions lagging behind market leaders, make the odds of success slim.

Ask the Right Questions
The first step in seeking sustainable profitability is to look inward. An astute executive should take a step back and ask fundamental questions: Is my business model working? Am I able to negotiate favorable lease terms, with the right aircraft for my needs? Is my network efficient enough to maximize block hours? Do I have the right agreements in place for maintenance and engineering? Do I have the right service proposition and am I achieving the right cost levels with my ground handling partners? Am I offering the right ancillaries to maximize non-air revenue? In what areas can I aspire to be best-in-class?

The answers to the above questions can help to focus on the right areas of change and the right strategic goals. With a focused transformation or optimization program an airline can adjust the course back onto the right path. However, the fallacy of many struggling carriers is the belief that internal actions will be enough to survive. Even with an internal focus to turn the ship around, most cannot afford the required investment to deliver required efficiencies and compete with more agile competitors.

The Digital Model
Widespread modernization and a wholehearted embrace of digital technologies can deliver a much needed boost to an airline’s competitiveness. Best-in-class digitalized airlines are using customer data to disintermediate the distribution environment and deliver personalized propositions directly to the customer at a lower cost of sale. Having the right fare available in the market is no longer limited by 26 RBDs (Reservation Booking Designators) but by the number of potential customers with whom an airline can have a direct conversation about their travel needs.

Radical change to an airline’s business model can appear attainable, but even with the best plan and the best team, the quantum of optimization can be insufficient to avoid insolvency. In some cases, it could arguably be best to proactively prepare for the end of operations in order to preserve any remaining investor value, and minimize long term damage. A concept seemingly unpalatable to executives and investors. Proactive executives can recognize the need for change and lead honest dialogue with boards and investors to forge a path to sustainable profitability and to identify and preserve core goals.

Jet airplanes on airport runway

Goal #1: Saving Face
In many cases preserving the brand and identity may be more important than owning or running the airline independently. In this case, there are several strategic options to help to assure preservation.

  • Back office non-core, and even some core processes can be outsourced to more efficient third parties or other carriers
  • Support businesses (catering, ground handling, cargo, engineering) can be sold to existing global providers, releasing cash and decreasing operating expense due to platforming efficiencies
  • The entire airline can be sold to a larger, non-competing carrier wherein the brand and identity are protected as part of the sale agreement

These options may have negative implications for the local workforce. But when compared to an insolvency may allow governments, investors and executives to save face, while allowing the airline to continue flying. In the case of the third option, smart and realistic executives can work to improve the eventual outcome by being proactive and preparing for a sale on their own terms.

In Switzerland the 2002 grounding of predecessor Swissair was still fresh in the national memory when, in 2005, Lufthansa took over the new Swiss International Air Lines. Today Swiss maintains its iconic brand, provides extensive service from Switzerland to the world, but has integrated many non-customer-facing processes into Lufthansa Group and its subsidiaries.

Goal #2: Building Scale
As a small carrier, operating in a niche environment limits the ability to achieve economies of scale and to compete against larger market players. For most, it is vital to achieve scale in operations to attain sustainable profitability. Inefficiencies across aircraft type, fleet size, and management overheads drive unit cost beyond achievable average fares. Executives can seek transactional or restructuring actions in order to improve the likelihood of profitability.

  • Raise additional capital to direct toward reinforcing and growing the source of competitive advantage. This may mean hard decisions to divest areas which do not contribute to core growth or to seek investment from other carriers or funds
  • Focus on peripheral, supporting businesses – ­growing scale by expanding across the value chain. In small or monopolistic environments, this can help to reduce pricing power of suppliers and entrench the airline into the operating fabric of a city or region, making the airline indispensable

These options may require a strong case for additional capital investment and aligning shareholders to an aggressive growth path. With quantifiable benefits and realistic timelines, the conversation can focus on growth plans rather than dramatic actions to avoid insolvency.

In Chile, the privatization of the national carrier in 1989 led to a strategy of regional expansion to build sufficient scale. After many years of organic growth LAN acquired an airline in Colombia and merged with TAM in Brazil. Today LATAM is the largest airline group in South America and is focused on network growth and modernizing their customer proposition.

Goal #3: Serving the Home Market
Traditionally, a national flag carrier could serve dual purposes: ensure domestic connectivity and access international markets, and also support domestic economic growth and national priorities. However, pressures to reduce governmental spending and competition controls have made direct subventions unfashionable, infeasible or even illegal. To maintain important network connections and sustain a national airline’s visible symbol of national pride, executives need to look to creative solutions.

  • Build the right partnerships to funnel demand for air transportation to domestic markets. Traditional global alliances often bring significant overhead and reduce flexibility, making membership unattainable. Instead, executives can seek innovative and flexible alliance solutions, such as self-connecting itineraries sold on shared platforms, to bring incremental traffic onto key routes
  • Leverage inter-industry partnerships, niche demand or other operational advantages to drive non-traditional traffic. For example, a regional or local government may have a strategic priority to increase tourism traffic. Partnering in this objective may open access to a new source of funding, or support for touristic charter business to support hotel traffic. Similarly, isolated industrial regions often require corporate air travel to reach their sites. Rather than stand up independent operations, corporations may look to invest in airline operations or enter into block space agreements to ensure continued access. Outbound traffic, such as annual religious pilgrimages, allow for incremental aircraft utilization, leveraging flexible airport operating hours, and delivering supplementary revenue streams.
  • In addition to the sell-and-protect option mentioned earlier, prepare for a sale on your own terms with the protection of key routes as a top priority

Owned by the Government of Algeria, Air Algérie has relied on capital injections to modernize fleet and systems, and has increased its focus on Cargo, recognizing the growing export market. However, significant opportunities remain untapped, with operations well below capacity and incremental business opportunities unrealized. For example, as national airline, Air Algérie should expect more than a small percentage of the market for annual pilgrimages to Mecca.

Make the right decisions
Avoiding insolvency in today’s market requires more than stop-gap options or solutions. Paramount to ensuring survival is a proactive and honest conversation about the competitive capabilities of a carrier. Executives can easily fall into a trap of financial and accounting instruments to preserve acceptable financial results. However, the right solutions require hard decisions and a sharp focus.

Similar to the fundamental questions posed earlier, fundamental profitability drivers should come front and center when evaluating these alternatives. Executives should first assess the impact on aircraft utilization, load factor, per-passenger unit price and cost impact on leases, before venturing into conversations on restructuring or transactions.

With a proactive eye on some of the aforementioned strategic options, executives can chart a course toward sustainable profitability before it is too late.

EY is a trusted and proven strategic partner throughout the transaction lifecycle. Our Operational Transaction Services team, numbering over 1,800 professionals worldwide can support executives to design and implement rapid and quantifiable improvements to strengthen the resilience of your operations. In the event of severe distress we stabilize your business through operational cash management and support you to enhance your cash flow. To support a sale strategy, we support executives to execute across the entire divestiture life cycle, including strategy, separation and stabilization upon deal closing.