The collapse of Iceland’s WOW Air, which abruptly ceased operations and stranded passengers last week, came as no surprise to experts who were watching the discount carrier’s operations and said it was on an unsustainable path.
An ambitious business model, rising oil prices and competitive pressure all contributed to WOW’s dramatic nosedive. The airline failed to raise enough money through corporate bonds and was banking on subsidies from Iceland’s government, but that help never came. After eight years in operation, WOW posted a notice on its website on March 28 that all flights were cancelled and advised ticketed passengers to look for “rescue fares” with other airlines.
“For the last six to 12 months, they were trying to play too big to fail. They were trying to be too big for the Icelandic state to ignore their demise,” said Thorolfur “Toti” Matthiasson, an economics professor at the University of Iceland. “They almost got lucky with that strategy. But in the end, the government was not willing to put their money on that.”
Matthiasson joined Kerry Tan, associate economics professor at Loyola University Maryland, and Mar Wolfgang Mixa, assistant business professor at Reykjavik University, to analyze the airline’s woes on the Knowledge at Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)
WOW Air launched in 2011 as a discount regional carrier that offered cheap, no-frills fares designed to undercut legacy players. Along the way, it decided to compete with the bigger airlines, specifically Icelandair, by offering transatlantic flights. That decision required WOW to upgrade its fleet with larger jets capable of making longer trips.
“I think WOW might have tried to grow a little bit too quickly,” Tan said. He compared WOW Air, which had about 10 planes servicing 30 destinations, to Texas-based Southwest Airlines, which has about 750 planes for 100 destinations. “With the small fleet size that WOW Air had, if there were any problems, mechanical issues or otherwise, it was really hard to bring in a new plane to service the flight. So, they might have grown a little too fast for safety.”
Rising Fuel Costs
Volatile oil prices were another factor in the airline’s ruination. While airline stocks benefited from falling oil prices last year, crude rebounded by more than 20% early this year, according to Barron’s. And prices are now rising faster than analysts predicted. In a statement, WOW Air said increasing fuel prices were partly to blame for a $33.7 million loss in the first three quarters of 2018.
“Competition is certainly one aspect of the issue, but it’s not the only one,” said Gerry Tsoukalas, a Wharton operations, information and decisions professor who studies the airline industry. “I think equally important is the fact that the business model is very sensitive to exogenous market shocks, and only the most well-funded and efficiently run budget airlines are able to survive. If oil prices continue to rise, it wouldn’t be surprising to see more budget carriers have to cease operations.”
Mixa agreed, saying WOW’s move toward transatlantic flights coincided with rising fuel costs to become the “nail in the coffin” for the airline.
“For the last six to 12 months, they were trying to play too big to fail. They were trying to be too big for the Icelandic state to ignore their demise.” –Thorolfur “Toti” Matthiasson
“They were simply going on a bookshelf that they didn’t belong on, so there was really no room for mistakes,” he said of the airline’s growth strategy. “To my best knowledge, WOW Air did not hedge themselves against those oil prices. Once the oil prices began going up, they were left vulnerable. Even though they would have been at full capacity, simply the changing oil prices would have put their business under pressure.”
A Lack of Equity
According to The New York Times, WOW sought an injection of cash through bonds and had reached a preliminary agreement with Indigo Partners, a private equity firm in Phoenix, Arizona. Those talks quickly fell apart, along with discussions about a potential acquisition by Icelandair.
“A big problem for WOW was a lack of equity,” Matthiasson said.
The Icelandic government was aware of the airline’s troubles but unwilling to step in with financial assistance, despite the country’s growing attraction as a tourist destination, the professor noted. Foreign visitors have increased from 459,000 in 2010 to 2.3 million in 2018, according to the Icelandic Tourist Board.
According to Tsoukalas, subsidies are often justified in the interest of the public good, but they create fairness issues for competition.
“The reality is, without [subsidies], some airlines would not be able to operate,” he said. “But again, such a business plan is not necessarily sustainable long term. What if the subsidies disappear?”
“In a sense, over time, some low-cost carriers start resembling legacy carriers more and more.” –Gerry Tsoukalas
WOW flights ferried 30% of visitors to the country last year, and some analysts have predicted a 16% drop in tourism as a result of the airline’s collapse, according to Reuters. But the professors said the effect is unclear because other airlines, including Icelandair, will likely step in to fill the void.
WOW joins a pantheon of hundreds of airlines that have shut down over the years, including US Airways, Aloha Air, Air Berlin, India’s Kingfisher Airlines, Britain’s Monarch Airways and Denmark’s Primera Air, which suddenly shuttered in October and left thousands of passengers with worthless tickets.
Because of all the variables involved – many of which companies like WOW cannot control – airlines are inherently risky ventures. “In the case of WOW, it’s likely a combination of multiple factors that created difficulties,” Tsoukalas noted. The company’s aggressive expansion “required a large capital investment and not only complicated its operations, but also made it more difficult to fill the extra seats. At the same time, the company had to deal with upward trending fuel prices … and likely increasing wages as its staff started become more senior. In a sense, over time, some low-cost carriers start resembling legacy carriers more and more.”