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Air travel is back… with an asterisk.
In 2019, 79,332,046 people passed through TSA checkpoints in the month of July.
In 2021, 63,118,017 did—representing an 80% demand recovery.
This blows away most expert forecasts from 2020, and is a remarkable number considering
international travel, and certainly international tourism, is still nearly nonexistent.
In Europe, air traffic has recovered to around 70% of 2019 levels.
In China, the number of scheduled seats has already surpassed 2019 numbers—they’re
beyond 100% recovery.
So, the US, Europe, and China—the world’s three largest aviation markets—have experienced
recoveries beyond the most bullish expectations.
But now, the asterisk.
In the second financial quarter of 2019, United Airlines earned $11,402,000,000 in operating
revenue.
In the same quarter of 2021, however, just $5,471,000,000—about 48% of the 2019 number.
Meanwhile, American and Delta’s second quarter 2021 revenues were 62.5% and 56.8%, respectively,
compared to 2019.
Context does not make these numbers better, because in the second quarter of 2021, about
67% as many travelers passed through TSA checkpoints as 2019.
Simply put, revenue recovery is lagging behind demand recovery.
A culprit is easily identifiable.
In the second quarter of 2019, United earned 14.32 cents per seat, per mile flown—“available
seat mile” as its called in the industry.
In 2021, they’re earning just 11.02 cents per ASM—76.95% of that of 2019.
Meanwhile, American’s revenue per ASM is at about 78.84% of 2019, while Delta’s is
69.45%.
While overall revenue should be considered entirely within the context of overall demand,
revenue per ASM should not be.
Airlines decide how many seat miles to make available, they decide how many flights to
fly, so the fact that airlines are earning some 20-30% less per seat stamps a massive
asterisk on the triumphant calls of travel’s return.
Travelers may be back, but they’re not the same.
In the US’ summer 2021, the entire country seemingly went on vacation.
Hilton’s in Hawaii were going for Four Seasons prices, rental cars in Alaska were a luxury
afforded to only the most foresighted travelers, and Ubers in Vegas were as elusive as a royal
flush.
The US’ tourism infrastructure was at absolute peak capacity in summer 2021, but then there’s
this: Midtown Manhattan, DC’s K Street, Chicago’s Loop—America’s major business
districts still sit abandoned.
Despite the resurgence in life in the US, many of the country’s largest office-based
employers, including Google, Microsoft, Apple, Facebook, Deloitte, Cisco, and McKinsey, have
yet to return to the office in any meaningful way.
When companies of this nature travel, they’re doing so to visit other companies so, without
open offices, there are no companies to visit.
Therefore, the fact these these companies, which include the top corporate travel spenders
in the country, have yet to return to the office explains why business travel has yet
to return meaningfully.
For United, American, Delta, British Airways, Air France, Cathay Pacific, Singapore Airlines,
Qantas—all the old, storied international airlines that you’ve heard of—this represents
a disproportionately dramatic problem.
These airlines—full-service network carriers, as they’re called—are essentially designed
to cater to the needs of business travelers.
Take, for example, the difference between Southwest, a leisure-focused airline, and
United, a business-focused airline.
If, for example, someone from Phoenix was travelling to Bozeman, Montana to visit Yellowstone
National Park, they could choose to fly on Southwest.
During the summer season, this airline operates a nonstop flight on the route each Saturday
and Sunday morning.
The same traveller could also choose to fly on United Airlines, through either Denver
or Los Angeles, leaving at 6:10, 9:40, 11:48, 1:55, or 3:41 pm each day.
Leisure travelers, however, disproportionately value the convenience of a nonstop flight
and they wouldn’t mind organizing their trip around the two days per week when a flight
operates.
Business travelers, however, are different.
Let’s say a sales rep from Phoenix needed to travel to a client meeting in Memphis,
taking place from 2:00 to 6:00 pm on a Tuesday.
Southwest does have a nonstop flight between the cities, but in order to make that meeting,
the traveller would have to take the Monday flight, leaving at 12:25 pm, arriving at 5:20
pm.
They’d then have to sit around in Memphis for 21 hours until the meeting, then wait
another 23 hours after for the 4:00 pm Wednesday flight back.
On United, however, the same traveller could leave at 6:00 am on Tuesday, connect through
Denver, arrive at 1:00 pm, make the 2:00 pm meeting, then take a 7:00 am flight back through
Houston the following morning and arrive at the office by noon, ready for the rest of
the day’s work.
Faced with the prospect of waiting around in Memphis for almost a day more, they’ll
almost always pick United.
In all, business travelers value not only the day of travel, but the time of day of
travel.
Therefore, it’s all a compromise—do you want flights going exactly where you want
them to, or flights leaving exactly when you want them to?
Disproportionately, leisure travelers value the former, business travelers the latter.
This is why nearly every United, Delta, and American flight routes through one of their
hubs—by consolidating travelers onto more regular flights to fewer destinations, they
can offer far more choices of flight itineraries.
The optimization for business travel extends beyond this to full service network carriers’
focus on premium cabins, frequent flyer programs, airport services, and more, but fundamentally,
there are stark differences between airlines made for leisure travelers and those for business
travelers, and many of the world’s largest airlines fall into that second category.
Historically, however, it’s been worth it.
Business travelers are on the road year round, rather than when the weather is good or school
is out, meaning they represent a more reliable client base for airlines.
In addition, they’re more price inelastic—that’s to say, when a consultant needs to travel,
they truly need to travel, and will book a ticket regardless of the price.
While leisure travelers will make decisions on price, businesses will pay whatever it
takes to get their staff where they need to go to make them money.
Only about 20% of domestic trips are taken by those on business, but they account for
far more than 20% of revenue.
That’s because of what’s referred to as price discrimination.
It works off of a simple truth: leisure travelers overwhelmingly make their plans and book trips
months in advance, while business travelers book weeks or days in advance.
Based on their own financial disclosures, we know that the average United flight length
is currently 1,460 miles or 2,350 kilometers, and that their average cost to operate a flight
of that length, per passenger, is $199.58.
We also know that, two months before, United is selling tickets for eight of these twelve
roughly 1,460 mile flights for below what it costs to operate on a per-passenger basis.
In fact, the overall average fare for these twelve flights sits below their operating
cost two months before departure.
While the sale of ancillaries such as extra legroom seats, checked luggage, wifi, food
and beverage, and more would likely push them above break-even, it’s clear that United
would not turn a significant profit on the prices most of us pay for tickets, but that’s
by design.
To fill planes, they need to sell cheap tickets, at least at first.
In the weeks leading up to a flight, however, fares rise dramatically, so by the day before
departure, the average fare for those twelve flights more than doubles to $413.83—these
are the fares businesses are paying for their typically last-minute travel.
Now, on that average 1,460 mile flight, imagine for the sake of simplicity that it was operated
by an all-economy, 179 seat 737-900.
We’d know based on United’s company-wide load factor that 150 of its seats should be
filled.
In this case, their operating cost would total $29,937.
Their total revenue from that flight, however, would be $36,245.
That means the operating profit margin is $6,308.
Imagining again for the sake of simplicity that United sold this hypothetical, perfectly
average flight for either that $199.58 or $413.83 price point, that would mean, to attain
their average $36,245 in revenue, they would need to sell 120 of the cheaper tickets, largely
to just leisure travelers, and a mere 30 at the higher price point.
That’s just 20% of the overall tickets sold on this flight but 20% happens to represent
another important statistic: the average proportion of domestic air travel in the US completed
by business travelers.
It’s not surprising that these numbers work together so perfectly, because this is the
exact equation United and other business-oriented airlines have been using for decades.
In the case of this hypothetical flight, its the final 15 passengers, half of the business
travelers, that make up the entirety of the airline’s profit.
Now, however, in the COVID era, they’re gone.
Southwest Airlines averaged 10.22 cents in operating costs per available seat mile in
2021’s second quarter, while United averaged 14.49 cents—a dramatical difference, simply
explained by the fact that Southwest is a low-cost airline, meaning its operating costs
are low, and United is not.
In a business environment now devoid of the majority of price inelastic business travelers,
airlines like United have and will have a lot harder time keeping up with the recovery.
While United, Delta, and American’s revenue recovery all fell behind demand recovery in
the second quarter, Southwest’s was on-track.
67% overall demand recovery was, in their case, accompanied by 67.83% revenue recovery.
And now, as August turns into September, recovery is only going to get tougher.
Summer 2021 was one of the busiest on record for many American and European tourist destinations,
but that’s coming to an end.
In a normal year, after a summer lull counterbalanced by the busiest leisure travel season, business
travel starts picking up come early September and stays above average through the end of
the year.
This helps stabilize demand during a season when few travel for leisure purposes, but
this year, that’s not going to be there in its full extent.
This abnormally one-sided transition is already happening.
Travel demand in the US dropped 2.8% between the week of July 25th and August 1st, then
another 3% the week of August 8th.
It’s a small drop, but there are some initial indications that it’s happening faster than
in 2019, when the first eighteen days of August saw 4.2% fewer travelers than the last eighteen
days of July.
This year, the difference between those two sets of days is 5.5%.
In absolute terms that might not seem like a dramatic difference, but in relative terms
it means the demand drop is happening 30% faster, and these weeks represent only the
very first of leisure travel’s end of summer retreat.
This trend will likely continue, and, more importantly, accelerate as leisure travel
continues to drop, and business travel fails to rise.
In the US, the next strong leisure travel period doesn’t come until Thanksgiving,
in November, and in Europe, it’s Christmas.
And of course, the Delta variant’s spread surely will not help, as businesses will play
it safe with office openings and corporate travel—now realizing that the path out of
the pandemic is not linear in nature.
For airlines, there’s not a whole lot that can be done at this point.
What the world lacks right now is confidence.
In the US, the University of Michigan’s consumer sentiment index, tracking confidence
in the overall state in the economy, recorded one of its largest drops in history between
July and August 2021.
It reached a level of 70.2, which is lower than any point in the pandemic so far, and
its lowest level since the great recession.
This is reflective of the amount of uncertainty the Delta variant and its rise in a post-vaccine
era has caused, despite the fact that in the US, Europe, the UK, and other places where
vaccines are now widely available, hospitalizations and deaths are still far from where they were
when consumer sentiment was higher.
Without the certainty of whether the pandemic will worsen or improve in the coming months,
however, businesses will not make the big decisions that will bring business travel
back.
Summer will have likely marked the first profitable period of the pandemic for European and American
airlines, but it seems increasingly unlikely that the recovery will continue its upward
trend in fall without strong business travel.
There’s also the question of whether business travel will ever fully recover—most experts
believe doomsday predictions of Zoom killing business travel to be overblown, however,
there is a realistic possibility that 2019 could serve as the historical high-water mark
for corporate travel as the world of big business moves increasingly digital, and concerns about
the environmental impact of flying to lunch in another city mount.
If this proves true, subtle changes will occur in the coming years that make United and Lufthansa
look more like Southwest and EasyJet.
COVID should have taught airlines just how important flexibility and adaptability is.
It’s hard to fault airlines for failing to turn a profit during the depths of a crisis,
but now, as much of the developed world plots a slow, bumpy path out of the pandemic, there
is opportunity for profitability.
Therefore, this is when the test truly begins.
This is what airlines were waiting for so now, with cash reserves wained and investor
goodwill gone, the coming months are truly make or break for airlines.
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