Five Ways Latin American Airlines Can Strengthen Through Bankruptcy
Two of the largest airlines in Latin America, Avianca and Latam, along with Mexico’s AeroMexico, have filed for bankruptcy protection following the coronavirus outbreak. In the period from 2008-2012, most of the US airline capacity went through bankruptcy and the result was a few big mergers followed by years of record profitability for the industry. It also meant that many retired employees lost lucrative defined benefit pension plans and the consolidation produced efficiencies by eliminating excess capacity and reducing total industry headcount. Will Latin America see the same financial results from this current crisis?
The situation is obviously quite different. Worldwide airline demand has dropped to low levels, and the return of that traffic is uncertain both in terms of its timing and whether or not all traffic will even return at all. Latin American aviation has seen growth with low cost airlines, like the US and Europe, with carriers like Volaris in Mexico, Sky Airline in Chile, Azul in Brazil, and Viva Colombia. But as American, United, Delta, Northwest, Continental, and US Airways consolidated into three carriers and became financially much stronger, will the traditional players in Latin America be able to do the same and have success against the upstarts?
The answers to these two questions is uncertain, but if these carriers are aggressive the results should ultimately result in a stronger Latin American aviation sector. The five key things to do are:
Significantly Reduce Production Costs
Production cost is an airline’s weight, and you can’t win a race when you’re overweight. Lower unit costs come from high productivity in all labor groups and physical assets, simplifying the operation, re-thinking distribution, and being realistic about the service to offer customers based on length of flight. Product features that can result in revenue premiums, because some customers will pay a higher ticket price, have to be made in proportion and should be evaluated as to whether offering such features is margin accretive. The growth of low cost carriers, just like in the rest of the world, shows that many customers want a low price over anything else. Larger, higher service airlines need to be able to offer low prices to those customers while still attracting higher paying passengers. The best way to thread this needle is with lower unit costs.
Fix the Fleet
Every airline in the world is re-thinking their fleet plan given the dramatic change in demand and the recalibration of asset pricing in the OEM and aircraft lessor sectors. An airline’s fleet determines not only where it can fly, but also how complicated its pilot training, maintenance, and support services will be. More complications always means higher costs for an airline. Using the flexibility that bankruptcy offers means that Latin carriers should be aggressive in re-structuring and simplifying their flown and ordered aircraft.
Diversify the Revenue Stream
Ancillary revenue has become a critical component of airline revenue. Airlines have learned that by lowering base fares and charging separately for products that some choose but others avoid results in higher average unit revenue. Traditionally higher-service airlines don’t need to go as far as airlines like RyanAir or Spirit but can create better pricing flexibility and attract a larger customer base when their revenue stream is more diversified. The realities of the coronavirus and the flexibility of bankruptcy restructuring gives Latin carriers a unique opportunity to change not only their unit costs, but also the robustness of their revenue engine.
Make Money On All Customers
Traditional airlines charge high fares to less price elastic business passengers and use low fares, and discretionary traffic, to fill seats still available. More successful airlines have figured out how to make money on every customer, including those paying the lowest fares. I don’t mean this in a true accounting sense, meaning comparing those fares to the marginal cost of an empty seat on a flight already scheduled. I mean that they actively recruit passengers of all price elastic bands, because they know that however the plane is filled, it will be profitable. This comes from low unit costs and aggressive ancillary revenue production.
Keep An Eye On M&A
In both the US and Europe, difficult environments resulted in airline restructuring that included mergers. Airline mergers are complicated, distracting, and don’t always work. But consolidation also has produced stronger companies and better controlled industry capacity. Latin America can benefit from this idea also, and this means that while these airlines in bankruptcy need to focus on items one through four on this list first, they should also try to position themselves to take advantage of tactical merger opportunities as they emerge from their own restructuring.
Bankruptcy is often seen as a sign of failure and mismanagement. But external events, like the massive demand destruction caused by the coronavirus, can also quickly change the financial position of airlines that may not have been perfect, but were viable before this. In these cases, bankruptcy can be an opportunity to fix core issues that will result in a stronger company with more growth opportunity. The relative strength of carriers like Delta, United, and American in the years prior to Covid-19 is in part due to the changes and initiatives made possible by bankruptcy and consolidation. Traditional Latin American carriers can do this same thing, and in the process became more competitive with low cost carriers and other countries’ carriers, and provide more stable employment and better customer service. But only if they use the toolbox that bankruptcy offers them!