Why cheap flights are NOT going away, despite what you may read

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Is social distancing on aircraft going to mean the end of cheap air travel?  If you believe certain travel and media figures in recent days, the answer is undoubtedly yes.

We shouldn’t necessary expect travel or indeed newspaper professionals to have a strong grounding in economics.  However, some recent thinking has shown that even concepts such as supply and demand seem to have passed them by.

This applies even at the top.  Welcome Alexandre de Juniac, CEO of airline body the International Air Transport Association (IATA).

If social distancing is imposed, cheap travel is over. Voila” he announced in a well publicised media briefing on Monday.

He bases this on two factors:

  • the need to ‘neutralise’ a third of seats on short and medium haul aircraft
  • a break-even level of 70-72% seats sold

Let’s ignore the most obvious point here.  If break-even at current fare levels is 70-72% and for a couple of years you can only sell 66% of seats, you’re nearly there already.

Break-even isn’t the same as making huge profits, of course, but I think most airlines will settle for a couple of years of break-even.

Let’s also ignore the fact that keeping the middle seat empty isn’t going to make much difference, based on the SARS case I wrote about yesterday that led to five deaths from a single flight.  Michael O’Leary of Ryanair agrees on this point.

Why cheap flights are not going away despite coronavirus

There is a fundamental failure to understand airline economics

The following example is how most people are thinking about the airline industry.  These numbers are roughly accurate – the average easyJet one way fare is £50 plus ancilliary revenue:

‘easyJet sells 171 seats per flight (92% load factor) at an average of £75 each including baggage and seat fees, for a total of £12,825.  If it cannot sell the middle seat, revenue will fall to £9,300 (124 seats x £75) and this is not profitable.  Fares will therefore rise to (£12,825 / 124) £103 to compensate.’

This is how the world of selling a ‘one price’ product works, and even then it only applies when selling something which people must buy and cannot substitute for a cheaper alternative.

In the real world, there are very few products like this.  It certainly isn’t how airline seats work.

In reality, easyJet would sell its flights like this, assuming 180 seats sold:

  • 30 seats sold at £35
  • 30 seats sold at £45
  • 30 seats sold at £60
  • 30 seats sold at £75
  • 30 seats sold at £105
  • 30 seats sold at £130

…. for an average fare of £75.

With 60 seats removed from sale, it is the cheapest 60 seats which disappear.  easyJet will start selling the flight at £60 including ancilliaries and not at £35.  The 60 people who are not prepared to pay £60 will no longer be flying.

Let’s look at the revenue again.

With all 180 seats sold using the distribution above, revenue is £13,500.

If you don’t sell the 30 seats @ £35 and the 30 seats @ £45, to keep occupancy to 120 seats, your revenue is still £11,100.

You have emptied 33% of your seats but only sacrificed 18% of your revenue.

Cheap flights are not going away despite coronavirus

Supply and demand works both ways

As you can see above, you can empty 1/3rd of your seats without losing 1/3rd of your revenue.  You also are not putting up prices for anyone except the 60 people who previously expected to pay £35 or £45 all-in and will now choose not to fly.

For 2/3rd of passengers, fares have not gone up.

Let’s look at another reason why fares won’t go up.

Aircraft are a fixed cost.  You are paying the lease, or the loan, irrespective of whether it flies or not.

Irrespective of your fixed costs, you operate the asset as long as your marginal costs are covered.  Let’s assume the apportioned lease cost for an aircraft for a flight is 100 units and the marginal costs of crew, fuel, airport charges etc are 35 units.

You might think at first that is isn’t worth flying unless you get 135 units in fare revenue.  Not true.  Because you are paying 100 units for the aircraft regardless of whether it flies or not, airlines will operate aircraft as long as the fare revenue is higher than 35 units.

As long as enough tickets are sold to pay for the VARIABLE costs of fuel (Brent Crude is now $20 vs $65 for most of last year), crew etc, then it makes sense to put more aircraft in the air.  The flight is at least making a small contribution to the 100 units fixed costs of the aircraft, and so reducing losses.  This means that airlines will put as many aircraft back in the skies as quickly as they can, and the more aircraft that are in the air, the lower fares will be.

We will, of course, see some airlines scrapping older aircraft such as Virgin’s A340s and BA’s Boeing 747s.  This is only a small percentage of their fleets, however, and these aircraft are already depreciated.  The aircraft that remain are newer, far more likely to have leases or debt attached to them, and so need to be in the air.

In the medium term, planes will come to the end of their leases and more capacity could be taken out of the market.  By this point, however, we should be back to 2019 levels of travel and it won’t be necessary.

Is ‘cheap’ travel over?

Not when you look at the numbers like this.

Of course, if by ‘cheap’ you mean the £5 Ryanair flight I took to Porto in February then, yes, that’s over.  Ryanair won’t be selling £5 seats now to guarantee that it fills every seat because – despite the Michael O’Leary quote above – it won’t want to.  It is more likely that Ryanair adds an option to guarantee an empty seat next to you, for an additional fee of course.

Similarly, those £35 and £45 easyJet seats in our example above are gone.

This isn’t ‘cheap’ travel though.  This is just seat-filling promotional activity.

If it turns out that easyJet won’t be selling any seats for less than £60 one-way in the future, I don’t call that the end of ‘cheap’ travel.  £125 return to fly to Europe – on a $42 million aircraft, which is what easyJet is paying for its next batch of deliveries – is not, by any stretch of the imagination, expensive.

When I was growing up, even flying to Paris was outside the dreams of my parents.  For a family of four, very much on the average British wage, it simply wasn’t even a consideration in the late 1970s and early 1980s, pre easyJet.

It’s worth remember that it has always cost £2,000 for four economy seats to a European ski resort over February half term, and anyone who has flown to European beach resorts in August will know that you were paying similar silly prices.  This wasn’t ‘cheap’ travel in the first place and I don’t see those prices getting much higher.

If we end up back at a point where a family of four has to pay £2,000 to fly to Berlin for a weekend break in rainy November then I will happily admit that we are at the end of ‘cheap’ air travel.  I don’t see that happening, however, and I think the economists would agree with me.

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Comments

  1. It’s an interesting article and I hope the result is air travel continues to be accessible and well priced. But I do think the analysis is overly simplistic and drawing conclusions from looking at only a single facet of, what is, a very hard to model problem. My instinct is that the cost of flights will increase on an absolute basis, and more markedly relative to disposable income for most.

    Ultimately every business has to cover its longterm operating costs to be viable. Regardless of the fixed vs marginal costs of indiviidual flights, assets will ultimately need to be sold and routes paired back if they are not profitable. On the supply side, there will likely be a shake out of the aviation industry causing some airlines to collapse, and reduced competition.

    The cost to the economy is and will be truly enormous, both for individuals and for many companies (there are only a few segments that benefit). Taxes will have to rise to pay. The ability to pay for travel will be squeezed at both ends due to less disposable income. Businesses will in general need to cut costs.

    For those who can afford it, there is likely to be less propensity to travel. More work will be done remotely – we’re collapsing years worth of societal change into months here. Fear of infection, quarantine, worries about health care availability in some countries, potential loss of reciprocal care with Brexit, potential invalidity or higher price of insurance for Covid-19 will all act to severely dampen demand. Remaining demand will be more concentrated towards people who are less price sensitive and those who simply have to travel.

    Any broad easing of flight restrictions in the short term is likely to see a rush of cheap tickets on the market to desparately kickstart some cashflow. But over the medium term I think the combination of these factors – the reduction in choice of supply and the need to spread operating costs over over a vastly reduced demand, concentrated on the less price sensitive population – will result in increased prices.

    • Peter K says:

      But you are making a large assumption that those at the lower end of the market will be thinking about medical costs etc on holiday. A large number do not buy holiday insurance, even when going to non-EU countries. A lot I know are just interested in the base cost.

      • I suspect that changes once the first cases of Covid-19 deaths or huge medical bills hit the news.

  2. Bagoly says:

    Let’s assume we get comfortable with some form of looser lockdown (masks, temperature checks, no-under-60s etc)
    And cases and deaths carrying on at the current rate in Europe.
    The aspect that I see dissuading me from travelling is the risk of getting trapped when away, whether ill or not.
    We now know that governments will close borders/suspend flights whenever cases spike.
    So you only want to be somewhere where the health care is good and well-resourced even in a crisis, and one is insured; and the hotels are cheap enough if one has to be there for months – I am struggling to identify candidates.
    Absent vaccination or cure, that looks like being a problem for several years.
    What do any non-state-owned airlines look like if the current situation persists for two years?
    I guess all state-owned, or perhaps the aircraft-leasing companies swap debt for equity?

    • TGLoyalty says:

      Not many borders were actually closed to non residents returning home or residents re entering.

      I would be wary of going to anywhere that did like India.

  3. Great article and makes total sense… a lot more than the scaremongering from travel bodies and other “travel experts”

  4. What about business class ?

    My feeling is that prices will rise overall and on “my route” of LHR-BKK I have gotten used to sub £2000 and often circa £1500 prices on the likes of Etihad.

    If that route went to £2000+ and there were no options for positioning to OSL, ARN etc. to pick up a €1000 business return (often via LHR !!!) then I may fly less and I would possibly fly the family less.

    Paying £5k for 3 to travel is a slug of cash but paying £8k or £10k for the same travel is much harder to stomach.

    • I don’t know your personal situation but we all may find that things we thought were affordable quickly evaporate for a variety of reasons.

      In a world where many have relied on house price increases outpacing their disposable income and zero interest rates to be able to afford the record levels of debts we hold we might find that things like going on holiday in business class come very low down on the list of priorities.

      I hope I’m wrong but right now I think covid might be the straw that breaks the mortgage our kids future / interest rates can never be a thing again mentality

  5. I like your analysis… It is however based on an assumption: Airlines have fixed costs which equals to airlines having to pay for aircrafts. Currently that appears to be the case. Airlines do everything to stay in business. Governments help them to stay in business by either easing the rules for refunds or providing loans.

    That doesn’t have to be the future, though. What if countries around the world decide to found new airlines instead of saving the old ones. Give everyone working for an airline in your country a guarantee that they are employed by the new national airline if they wish so. The existing airlines goes bankrupt. Who is paying now?

    The biggest losses would be with aircraft manufactures (Boeing, Airbus, etc.) and every company financing aircrafts (Who would that be?). Countries benefiting from aircraft manufacturing and financing would probably be tempted to implement a world wide policy of supporting existing airlines. Countries that would not be severely affected by losses in aircraft construction or financing would benefit by letting existing airlines go bankrupt and founding new national airlines to save jobs.

    Which country is in which group? My guess is that the UK, Spain (both IAG) and Germany (Lufthansa) actually gain quite a bit through selling aircrafts as they are either shareholders in Airbus or are the home to investment funds.

    But what about the likes of Wizz Air? Hungary doesn’t make money in these areas, but the airline has 121 aircrafts in use and ordered even more than that for a total of 268. Lead investor is a US company, but Wizz Air uses Airbus and is of no interest to the US government. It would be more efficient to found a new company, let the old one go bankrupt and buy the few needed aircrafts from leasing companies or the old Wizz Air airline at a drastically reduced price.

    The question is which group is larger and which group sustains for a longer period? To me that doesn’t look as easy to answer.

    • No lockdown for moi says:

      You could call ‘new Wizz Air’ some sexy name like Molev

    • Yes I’ve thought pretty much the same as you on that.
      Couple of issues:
      1. Owner of the debt effectively owns the aircraft, you may find them unwilling to sell them back at a cut price cost or find a higher bidder. Then you have an airline with no aircraft
      2. If you do default on the debt and buy the plans back at a lower price you’ll lose all confidence and possibly find you can’t get finance on new aircraft or a bunch of other things for your country if it appears your risk is high.

      In reality no one knows where the ground beneath our feet is right now.

  6. One thing I’ve not seen mentioned is the average Joe is unlikely to have as much disposable income in the future.

    Businesses on the brink.

    Employment insecurity.

    Debts.

    Appetite for needlessly spending money that they cannot afford?

    • mr_jetlag says:

      the average joe never accounted for the bulk of flying anyway. 10% of flyers accounted for half of international flights in 2018. I bet a good deal of that 10% are HfP & FT regulars too.

      • Correct, which is why I suspect there are so many replies to this post suggestive of confirmation bias, from individuals reluctant to accept an inflection point in international air travel.We’re at the start of an economic shock bigger than the last world war, but don’t worry full schedules and cheap seats will be back soon :rolleyes

  7. Nick G says:

    I was looking at flights from HEL to BKK for just under £1k on Qatar in biz class for October the other day.

    I was really tempted but just wanted to see how it pans out first.

    I’ve looked at other flights in Europe as well and as far as I can see it seems like prices are still attractive.

    Won’t hear that in the media though!

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