The Airline Industry’s Rising Crisis

The airline sector is facing unprecedented turbulence. According to analysts, airlines could suffer losses of US$9 billion this year. As recently as March, the red ink was estimated at US$4.7 billion for 2009, according to the International Air Transport Association (IATA). IATA has also adjusted its estimates for losses in 2008, from US$8.5 billion to US$10.4 billion. Giovanni Bisignani, director general of IATA, painted a gloomy picture for the industry at the association’s latest annual meeting in Kuala Lumpur, Malaysia, affirming that “there is no modern precedent for today’s economic meltdown. We are witnessing a cataclysm. Our industry is trembling.”

According to IATA, airline cargo revenues will drop 17%. Carriers will transport 33.3 million tons, in comparison with 40.1 million tons in 2008. Similarly, demand by passengers could drop 8% to 2.06 million travelers, in comparison with 2.24 million in 2008. Add to that reductions in profits of 11% for cargo and 7% for passengers. Overall, IATA estimates that revenues will drop by 15%, from US$528 billion in 2008 to US$448 billion in 2009 – numbers that are unprecedented.

According to Antonio López de Avila, director of the IE Business School’s master’s program in tourism management, the sector has not experienced such a crisis since the terrorist attacks of September 11, 2001. “September 11 was a scare — a little pause to see what was happening. Above all, it was the U.S. airlines that suffered a lot. [After] 9-11, people weren’t flying because they couldn’t fly. Now, it’s because they don’t want to fly.”

IATA’s Bisignani noted in Malaysia that after 9-11, revenues fell by 7%, but “almost immediately, we returned to growth that was fueled by strong economies.” Now, the scenario is one of global recession.

Demand, Petroleum and Returns

Experts note that the epicenter of this earthquake is the collapse in demand that resulted from the economic crisis. According to López de Avila, as a result, “companies have been obliged to reduce capacity, reduce frequency and make very significant economic adjustments.” According to IATA, “this dramatic fall in demand can lead to a rise in unit costs that are not related to fuel, and which cannot be cut proportionally.”

Amid this flood of bad news, the good news is that fuel prices are lower than last year. The sector’s spending on fuel will drop by US$59 million to an estimated US$106 million this year. López de Avila says that such a strong drop in the price of fuel has enabled airlines to survive this year, mitigating the damage from the fall in revenues. Airlines have adjusted to a market in which there is very little demand by reducing supply. “The margins in the aviation sector are very small, about 1%, so the sector has to get by on volume. It has to squeeze a great deal of profitability out of each plane and each flight it makes. What has happened is that profitability has declined enormously, and this has led to a very significant drop in revenues, and in a very critical year.” Added to this are the extremely tough price wars the airlines are conducting against one another.

Last year, when petroleum rose above US$140 a barrel, many companies suffered a death blow. Those that survived the crisis, notes López de Avila, “made a tremendous adjustment in their costs by reducing their personnel and flight frequency. Now, they are trying to fill more seats on each flight in order to make it more profitable.” However, the trend in oil prices has become alarming again. Goldman Sachs has raised its forecasts for the end of the year to between US$65 and US$85 a barrel. López de Avila warns, “To the degree that it [oil] continues to rise from here through the end of the year, we are going to see some airlines close down because many airlines are overcoming the crisis as well as they can but they are running red ink.” In his view, “starting from US$70 to US$80 a barrel, airlines already have problems. They have already done all they can, especially because they have adjusted prices and demand has plummeted.” He notes, for example, that the business class segment has fallen by practically one-half, “and this is the class that makes airlines profitable.”

According to Josep Francesc Valls, professor of marketing at ESADE’s tourism management center, the airline sector has overcome the brutal increase in oil prices that happened last year, and now the price is about US$70 to US$80 per barrel so the sector is suffering less from this factor. Despite the fact that some airlines did not foresee these historic oil prices and were battered by difficulties, “today, there is no company that is counting on oil prices remaining at the levels we’re seeing today. Since the excessive [prices] of the past have ended, this factor is no longer critical. The problematical factor now is the fall in passenger seat sales, and there is a great opportunity to create new conglomerates with new market niches [that serve routes] between Europe and America,” he notes.

Valls notes that aviation is undergoing a very rapid globalization in its mindset. “The approval of the Open Skies Agreement last March means that companies in the U.S. and Europe, with some restrictions, can already make international flights between the U.S. and Europe — a great market that is very attractive. This, along with the process of mergers and alliances, and the creation of great Euro-American groups, led by Europe, presents an excellent opportunity for globalization.”

The creation of these conglomerates “will empower some traditional companies (Iberia/BA, where negotiations are making progress), and some low-cost airlines (Clickair/Vueling), as well as the American airlines, with which we were already associated,” says Valls, referring to the alliance in which Iberia participates. “But you can say the same thing about the alliance of Air France and KLM; and about the Lufthansa consortium. In this sense, we have a great opportunity, because this should permit a higher professionalization of airport services, and the remodeling of the great global airports, as well as a rapid process toward decentralization and privatization” which are an obstacle to modernization in the case of Spain.

On the other hand, Valls points out that nowadays you also have to take environmental costs into account. In order to save fuel and be cleaner in that regard, he says, airlines are using technology so they can lighten their equipment and have less environmental impact. “The global requirements for governmental measures are going to raise air travel-related production costs a bit. A factor that is going to mitigate this a little is the economic crisis.” In his view, this means that air travelers will pay more in order to fly, but on the other hand, societies everywhere around the world will benefit from the lower environmental impact.

LAN and Copa, the Exceptions

When it comes to regions, the airlines that are suffering most are the Asian, European, African and North American carriers. This year, IATA estimates that the companies of the Asia-Pacific region could record the greatest losses, since Japan, the largest market in the region, is immersed in a deep recession, while airlines in China and India accumulate great losses because of the slowdown in demand for those countries’ exports.

European airlines could lose some US$1.8 billion because of the collapse in demand for premium services in all of their major markets (intra-European, Europe-North Atlantic, and Europe-Asia). African airlines will lose some US$500 million, while Near Eastern airlines will suffer US$1.5 billion in losses. In the U.S., the losses will amount to US$1 billion, a better number than the US$5.1 billion in losses recorded in 2008. The explanation for this recovery, says IATA, is that “their inability to invest in covering their risks from fuel prices left the aviation sector in the U.S. at the mercy of a rising spiral in the price of fuel in 2008. This wound up being an advantage in 2009 because the same companies could take advantage of the better spot prices once the price of fuel began to drop.”

IATA estimates that Latin American airlines will lose some US$900 million because of the impact of the recession in the U.S., and the fact that Chinese demand for the region’s raw materials and products will weaken. But it’s not all bad news for the region. Amidst this bleak landscape, two Latin American airlines have managed to avoid recording red ink, says López de Ávila: “Chile’s LAN Airlines and Panama’s Copa Airlines. In 2008, LAN recorded a net profit of US$336 million, and it expects that figure to grow by 12% in 2009. Copa recorded a net profit of US$152 million last year”.

López de Avila notes that these two airlines have survived so far because the economy of the region in which they operate has not deteriorated as much as the rest of the world. “The economies of countries like Colombia, Argentina, Chile and Panama have not suffered so much from the crisis, and they have even managed to grow.” This fact becomes clear with LAN’s creation “of a ‘Premium Economy Class,’ a sort of business class that is nevertheless economy. LAN is still banking on its business class because demand for it has yet to drop,” he says.

In addition, both airlines have done very well when it comes to controlling costs and achieving operational profitability, “which is 12% in the case of LAN and 17% in the case of Copa,” notes López de Avila. “LAN and Copa are engaged in lean processes, which involve eliminating any waste that does not bring value to the customer, and which reduce corporate costs as a result. They are continually reviewing their operational business practices.” Valls believes that this progress didn’t come overnight in the case of LAN. “LAN depends on very good service policies. It has not moved toward a low cost structure, but it has lowered its costs below the levels of the flagship carriers. In addition, LAN has established alliances with other Latin American companies, in some cases through mergers; in other cases, it has done this simply through alliances, which have converted it into an airline that serves [all of the Americas].”

In contrast, low-cost Brazilian companies, such as Gol Linhas Aereas Inteligentes and TAM, whose country of origin was growing until recently, have been suffering. López de Avila explains that at TAM, “they are already tightening their costs, but not their capacity for 2009. They wanted to grow by 8% in the domestic market and by 20% in the international market, but they still need to do some homework. They estimate that part of their US$311 million in profits comes from the depreciation of both petroleum and the Brazilian currency, the Real. Last year, Gol lost 1.39 million reales, and its operational lost was 89 million reales (or US$45 million). They eliminated long distance flights in 2008 and they are trying to lower their costs in 2009, so they can try to improve their position.”

López de Avila stresses that IATA is seeing a stop in the decline of air cargo traffic. “This figure has remained steady … something that analysts consider a positive sign. Historically, once air cargo starts to recover, passenger traffic also begins to recover. There could be a light at the end of the tunnel, so long as the price of a barrel of oil does not rise above US$80.”

On the governmental level, initiatives are already taking place to restrain the impact of the crisis on the sector. In France, for example, air fares have already been reduced. In Spain, fare prices for 2010 have been frozen, and the rules for the sector have become more flexible. Thus, those air carriers in Spain that increase the number of passengers they carry during the second half of 2009 will be provided with a bonus worth 100% of the extra passenger fares that result from that growth in traffic. According to López de Avila, however, this measure is futile because “practically no company is going to improve its numbers from last year, which was a record year. In addition, we were starting from air traffic control tariffs that were the highest in Europe. If AENA (the Spanish state owned company that owns and manages all Spanish airports) records a deficit next year or the year after, despite the fact that it has sustained itself until now, the most important thing to do may be to cut costs [for carriers] so that companies do better — not to subsidize something.”

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