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Airline Bankruptcy Stories

Article · February 2017

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Aseem Pratap Subedi

Tribhuvan University
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Bankruptcy Stories of Airlines

Aviation industry is a tremendous industry, in terms of employment, capital investment,

innovation carried out, revenue generation … simply anything. The number of airlines in
the world comes in the count of thousands. There are many new airlines entering the
business every year. But it NOT a safe business ground to play in by any regards. Tens of
factors affect the overall functioning of this industry and airlines need to be constantly
aware of that. Many of those have long term affects while some need to be acted upon
immediately because millions of people are waiting to board their flight during any
boardroom discussion. There are sufficient examples in which those who couldn’t or
didn’t take the right decisions in time faced the butterfly effect and eventually got wiped
out.

From New York Airways in 1979 to Republic Airways in 2016, there are more than 100
examples of bankruptcies in US alone, some of them filing for bankruptcies twice
(Continental) or even thrice (TWA) before vanishing for good. Mexicana Airlines filed in
2010 following Japan Airlines the same year. These two were the biggest of their
respective countries and members of the Oneworld Alliance. American Airlines declared
bankruptcy in 2011, following in the footsteps of Delta, Northwest, United, US Airways
and Continental. Malaysian airlines has gone ‘technically bankrupt’ according to its CEO
in 2015 followed by Transaero, Russia’s biggest private airline. We can go on and on.
Airlines-Inform.com will give you a list of more 300 airlines across the world that are
now defunct. It sounds really bizarre why this happens so frequently. Why indeed
detective?

Well, each example can be a separate case study. But there are some common
explanations for some major bankruptcies. Airline industry is highly susceptible to
market fluctuations and economic difficulties. The fixed cost is huge. A single airbus
A320-200 used by AirAsia costs $100 million. Low capacity planes like ATR 72-500
with no auxiliary power unit for hilly countries like ours demand at least $15 million
(>100 Crore NPR) with the largest A380 going as high as $400m. Boeing 737-800
owned in large number by Ryanair and probably the world’s most popular aircraft
generally consumes 850 gallons of fuel per hour and costs $80m to buy. Maintenance
costs and hanger costs are not mentioned. The fleet also depreciates in value over time
as a single plane is to be run for 20 – 25 years (upto 40 years if it were Nepal!)

The other major share is consumed by labor costs. An established airline needs around
8000 employees including pilots, flight attendants, mechanics, baggage handlers,
reservation agents, gate agents, security personnel, cooks, cleaners, managers,
accountants, lawyers, etc. Labor costs per employee is among the highest in any
industry. Again, the profit margins are also very thin despite the enormous investment
capital as airlines have a margin of just over 1 percent of daily revenue, of which one
third goes to labor charges. Mexicana in its bankruptcy statement claimed it had to pay
its pilots and flight attendants 49% and 32% more than what even American major
airlines paid its employees due to union contracts. Republic Airways said that lack of
pilots caused many of its planes to be grounded, leading to cessation.

Due to such huge investments, airlines need to generate high positive cash flows. They
need to invest the generated revenue in new aircraft, new equipment, new employees
and contract new routes. They must strategize to generate maximum revenue from the
existing constraints. They can’t afford their planes to waste any second or opportunity to
extract money from potential customers. That is why they practice a strategy called Yield
Management which is a continuous process of reading, influencing and anticipating
consumer behavior and using all the data to vary prices with situations based on fixed
resources and time. That is why airfare changes so very often and sometimes in
seemingly meaningless ways. But it’s all part of the game. (But again, it’s a whole
different topic.) Just do whatever you can do to keep the cash flowing. If any
interruption occurs, the whole cash balance can be jeopardized. That can be a straight
ticket to bankruptcy.

There can be other common factors too. But the story of some bankruptcies are worth
learning from and unique.

Before the Airline Deregulation Act 0f 1978 was signed in US, the Civil Aviation Board
controlled all the fares and routes of its member airlines, which included PanAm,
Braniff, TWA, Northwest, Eastern Airlines, Continental, US Air among others. Though
intended to regulate fees, travel fare could be increased upon request by consensus if the
individual airlines said that ticket prices could not cover up their expenses. Hence, air
travel was only for the insanely wealthy. Legacy Airlines, as they were called used to
compete only in the quality and extravagant services they provided (some even included
piano bars). However various evidences proved that regulatory methods were a failure
since fewer planes were flying in the skies in the ‘70s than in 1938. For a world moving
more into free market, CAB’s regulations didn’t allow new airlines. But with the ADA,
newer airlines came into play which offered the tickets at $29 for a ticket which cost
$100 in legacy airlines then. Southwest, AirTran and JetBlue were the forerunners of
this revolution. Other airlines started to emerge. Legacy airlines were hit hard by this
since they had to drop prices much lower than what it cost them.

PanAm was hit the worst. It should be noted that it was a cultural icon of US, an
unofficial flag carrier and also founding member of IATA. Beatles famously stepped out
of PanAm plane during their first and most famous US tour. But being unable to
forecast where the world was moving into was a mistake. Being headstrong and further
expanding with National Airlines and growing aggressively during a period of intense
competition was a mistake. Since it previously was established as an international
carrier, it focused its innovation on more expensive but inefficient things (a leftover of
2nd old war) and not on feeder networks which supplied customer information and trend
data for competitive airlines. PanAm was too late to understand the system and
competitors started getting PanAm’s sales data from the reservation systems that they
owned. Other factors might include the 1973 oil crisis and Persian Gulf War of 1990-
1991 when fuel prices jumped to record high while PanAm was already having a bad
time. It ceased all operations in 1991.
 http://money.cnn.com/infographic/news/
companies/airline-merger/

Other legacy airlines tried hard to avoid liquidation and vigorous merging of airlines
occurred to at least stay in the game. Merging of legacy airlines continued till 2015 and
ended with US Air and American Airlines combination. It’s not that once an airline has
established itself in the industry it can cruise forever. Competing with younger rivals is
always hard because older airlines tend to have an older workforce. Higher salaries for
veteran employees and pension benefits for retirees are assured by union contracts,
which are based on a long history of labor-management negotiation. You cannot ask a
mechanic or pilot to work more than what the contract serves him. Higher cash drainage
from this side makes it hard for older carriers to compete on ticket prices. One easy ways
out of this is… say what, by declaring bankruptcy. Filing for Chapter 11 protections,
there is enough time for the company to put the chaos in quarantine and devise a new
business model and strategize how to pay its creditors. Work rules, vacation an
employee gets, pension, benefits, everything can be restructured in bankruptcy. Union
contracts don’t hold much significance anymore in front of the authority of a bankruptcy
judge, who can transfer pension obligations to the federal government and even waive
some debts off altogether. However, the judiciary scrutinizes every intentions. Also, an
airline bankruptcy procedure can cost more than a hundred million dollars. Many
companies, being unable to find enough cash to pay back loans and cover fees of legal
proceedings have faced liquidation.
That said, filing for bankruptcy doesn’t necessarily mean vanishing from the face of the
earth. 350 billion yen ($4.44 billion) was injected into Japan airlines by Enterprise
Turnaround Initiative Corporation of Japan, a state fund when it declared bankruptcy in
2010. After massive restructuring and cost cutting: shedding about a third of its
workforce to around 31,000, slashing pension payouts and retiring its old fleet of fuel-
gobbling jumbo jets, the airlines came back in 2010 and announced the 2nd largest
Initial Public Offering (IPO) of the year at $8.5 billion (after facebook). The state fund
sold its entire 96.5 percent stake in the IPO, which amounted to around $4 billion
national profit. The IPO valued JAL at $8.72 billion, its shares being traded in the grey
market 9.5% above the IPO price. Also, Japan Airlines' potential expense per available
seat kilometer dropped to 11.4 yen from 13.8 yen before bankruptcy.

Many airlines have participated in the frenzy of merging following 1978. Merging is a
strategy to decrease supply and share common expenses. There have been four major
mergers in US since 2005 starting from the amalgamation of AmericaWest and US
Airways. Interestingly, after the aggregate airline redid the routes, its stocks sky-
rocketed. Following the same suit, Delta bought Northwest in 2008, Southwest bought
AirTran two years later and United merged with Continental the same year. Delta and
United now dominate the airline industry in the country. They together form a huge
global network which is unsurprisingly appealing the big corporate customers, who are
undoubtedly the lifeblood of this industry. The consolidation provides the airlines more
pricing power because as the number of routes and flights comes down, supply
decreases. While demand hasn’t been allayed as much supply has, nowadays the planes
are more likely to be occupied than in a long time. When even the low-cost revolutionary
Southwest Airlines begins raising prices (as it did in 2010), one has to speculate that
aviation industry in America is probably moving towards oligopoly, the Nash
equilibrium condition of this game and we know that oligopolies are anticompetitive.

Many other exogenous factors can undesirably trigger bankruptcy. The infamous 1988
Lockerbie crash of Pan Am Flight 103 resulting from a terrorist bombing that resulted in
the deaths of all 243 passengers on board caused PanAm to be grounded permanently.
Flight 800 crash affected Trans World Air (TWA). A year after Malaysian Airlines’
MH370 aircraft disappeared with all its secrets, its CEO declared the airlines technically
bankrupt cutting 6000 jobs. Necon Air, Nepal’s first private air dwindled after two fatal
tragedies in Kathmandu and Jumla in 1999.

By March 2015, Transaero had accumulated around 1.1 billion euro of debt due to post-
sanction devaluation of ruble and the shrinking market of tourism. Outbreak of H1N1
virus got the tourism industry in Mexico dwindling down, possibly also affecting
Mexicana. Kingfisher, though, went out of business in a rather careless way due to
mismanagement. It was making good money in the beginning but it started buying more
planes than it needed. It started to cannibalize leased planes for parts, which you are not
allowed to do with leased planes. Not flying enough international flights while its rival
Jet Airways was fast pacing up might was also a mistake.

Fuel prices have tripled in the past decade. Great Recession occurred in 2008. Probably
there can be other interesting theories too. But nevertheless, bankruptcy can be an
 analgesic or carcinogen. With fewer airlines though, the market will not be fragmented
and remain stable, albeit there are possible unfair chances of collusion.

Photo Courtesy - Pinterest.com - Beatles getting off their PanAm flight

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