Good afternoon and thank you for that introduction. It is a pleasure to be back at the Wings Club. When I spoke here a few years ago, it was as the CEO of a major Asia-Pacific airline. Today I’m excited to be here on behalf of the International Air Transport Association (IATA). The Wings Club and IATA each have a long history of serving aviation. Yours is the senior organization by a few years, having turned 71 this year.
In a little more than three months, we will recognize another important milestone for aviation: A century of scheduled commercial airline service, which began on 1 January, 1914 when Tony Jannus operated the first recorded airline flight--a 23-minute jaunt between St. Petersburg and Tampa, Florida with a single paying passenger. It was an inauspicious beginning for an industry that quickly would transform the world. Even by 1942, the year of the Wings Club’s founding, commercial aviation was playing a vital role in the nation’s economy, having transported 4.1 million passengers the year before. Aviation’s importance was quickly recognized by the US Government, which effectively requisitioned the industry for war time use.
Today, airlines are the transit system for the global economy; and they have transformed commerce every bit as thoroughly as the automobile transformed America. Consider that this year, we expect airlines to carry more than 3 billion passengers—equivalent to around 44% of the Earth’s population and we make possible $2.2 trillion worth of economic activity. By value, over 35% of the goods traded internationally are transported by air. Within the United States, aviation contributes some $670 billion of gross value added (GVA) annually, equivalent to 4.9% of GDP, and supports 9.3 million jobs.
The industry’s remarkable safety performance has made this transition possible. In less than a lifetime, air transport went from being a high risk activity to a routine part of daily life. For example, last year the Western-built jet hull loss rate was just 0.20 per million flights, or an average of one major accident for every 5 million flights. At that rate, if you took a flight every day, odds are you could go 13,500 years without an accident. Of course there is always room for improvement in safety, as we have been tragically reminded by the recent accidents in San Francisco and Alabama.
But for all its success in revolutionizing the way we live, work and spend our leisure time, there is one thing that has not changed very much down the decades: aviation remains an enormously capital and labor intensive business that is extremely challenging across the business cycle and highly vulnerable to external events. And, partly owing to these factors, throughout its history, airlines in all parts of the globe have struggled to generate a satisfactory return. Last year, the industry delivered earnings of $7.6 billion. I know that sounds like a lot, but on revenues of $680 billion, that equates to a net profit margin of just 1.1%, or around $2.50 per passenger. That won’t go very far in Manhattan—that’s for sure!
I do not mean to downplay the industry’s recent achievements. If we look at our history, it’s surprising that airlines are in the black at all in current conditions. And it bears witness to the enormous business transformation that airlines are successfully continuing through internal restructuring as well as consolidation. It has allowed us to be profitable despite the fact that the price of fuel—our largest cost item—has increased 55% since 2006, while airfares are one third lower--in real terms--than 20 years ago.
What holds true globally is also true locally. In fact, the US airline industry could be said to be showing the industry the way forward in terms of how to stay in the black during challenging times. Earnings last year, excluding special items, were around $2.1 billion. And air travel in the US is an amazing bargain. In constant dollars, the average domestic round trip ticket, including bag and reservation change fees, has fallen by 10.4% since 2000. Meantime, the average price of Gulf Coast jet fuel has risen 260% since 2000 according to our friends at Airlines for America (A4A).
So, to sum up, airlines are making money, with lower fares in real terms than a decade ago, in the face of much higher cost inputs. Yet, if you were to look at our financial performance the way lenders and investors look at it, the airline industry still has a way to go before it is generating the kind of returns on invested capital that would make it attractive, compared to other industries, or even compared to our suppliers and business partners.
Unfortunately, our ability to continue our transformative journey--which is necessary to attract the investment to enable us to meet growing demand for connectivity--is at risk. The threat, however, does not come from market forces.
No, our biggest challenge comes from governments that are engaging in what I would broadly describe as regulatory backtracking. What do I mean by that? Simply this: Having deregulated airlines beginning more than 30 years ago, it seems that they no longer trust the invisible hand of the marketplace to maintain a vibrant, competitive industry—despite overwhelming evidence that the market is working.
As a result, regulators have and are continuing to pursue policies that are preventing airlines from partaking fully of the global economic revolution they themselves have done so much to facilitate. The net result is not just bad for airlines, but for air travelers and the economy.
Here are just a few examples of what I mean:
- Airlines must conform to a thickening web of overlapping rules intruding on their commercial practices and customer relations
- While market concentration has been accepted in other sectors of the economy as a necessary step to maturity and economic sustainability, governments hold airlines to a different standard
- Too many governments continue to behave as if air travel was a luxury item for a select few, and stifle it with punishing taxes and charges that often go well beyond the contribution that airlines might reasonably be expected to make toward infrastructure
This is a global challenge, but it is particularly distressing to find that the United States, where this industry was born and which led the world in liberalizing domestic and international air transport seems to be moving forward into the past.
I will take each in turn.
The airline industry may be deregulated to the extent that in most jurisdictions carriers are permitted to set their fares according to demand and in many also to serve destinations at will. But regulators around the globe aim to design the details of competition in a manner that is wholly at odds with how other industries are treated and with the workings of the free market.
In particular, they appear determined to hold commercial aviation to a different business standard than any other form of transportation—or consumer facing activities. It is a strange paradox: We are a service industry that operates in a hyper-competitive environment. Yet governments actually prevent airlines from competing with each other in terms of the way they deal with their customers.
It is totally appropriate that governments set some simple minimum customer service standards. But that’s not what’s happening. Regulators are micro-managing our businesses, telling us how we may advertise our services, how long we must hold a reservation that has not been paid for, and how we compensate and care for passengers when there are disruptions, even in situations where airlines are not responsible for the disruption.
These regulations impose a huge penalty on the economy and ultimately raise the cost of air travel for all consumers.
For example, the tarmac delay rule in the US that creates an artificial deadline by which time a flight must either depart or return to the gate was introduced with the admirable goal of protecting consumers from extended ground delays. Without a doubt the rule has virtually eliminated extended delays, but the cost to passengers and carriers alike has been enormous. Why? Because it has resulted in thousands of flights being canceled that would have otherwise have taken off – simply because airlines might have faced enormous fines if they had attempted to operate the flight and then been subjected to an extended delay. And it did not begin to solve the underlying factors that resulted in these delays.
In a study conducted not long after the rule took effect, the US Government Accountability Office estimated that the number of flight cancellations increased by more than 5,000 over similar time periods before the passenger rights rule went into effect. And in an analysis released this past June, researchers at the Massachusetts Institute of Technology concluded that the rule “is an ineffective mechanism for reducing passenger delay, and overall, can lead to significant increases in delays for passengers.” The analysis also estimated that the total cost of delays in terms of lost time to passengers is around $9 billion per year. So the tarmac delay regulation addressed a very small but highly visible problem by imposing a very large but unseen cost on the overall economy.
Airlines are committed to ensuring the safety and comfort of passengers and recognize the need for passengers to have access to basic protections during their journey. To that end, IATA members recently affirmed a set of core principles on consumer protection that aim to strike a balance between protecting passengers while maintaining industry competitiveness and recognizing the power of the marketplace.
Regardless of where one comes down on the tarmac delay rule, there is a broader issue at play, which is that the airline industry was deregulated in 1978. However, it is beginning to look as though the confidence in market forces that motivated deregulation has seriously eroded. The continued micro-managing of competition has the real potential to harm consumers by raising airline costs and causing reductions in service.
Another area where governments appear to think they can do a better job than the market is in the area of distribution. The threat of a new regulation that would mandate how and where airline ancillary products are displayed continues to overhang the industry. But the market is already moving to give consumers a more transparent air travel shopping experience through an IATA initiative called the New Distribution Capability (NDC).
Developing NDC is a priority for IATA, as set by our Board of Governors, so I would like to spend some time on it. NDC is about bringing the same level of capability to display and sell products and services through the travel agent channel that already exists on airline websites. That’s not the case today. On an airline website, you may have access to a wide range of add-ons and fare packages.
On the travel agent website by contrast, all you usually see is the fare and schedule.
There is a long explanation for why this gap exists. But the short version is that distribution via travel agents is built on pre-Internet messaging standards. These don’t have the same capabilities as XML—the lingua franca of modern Internet-based commerce. This is changing: The global distribution system (GDS) companies are working towards making it possible for airlines to merchandize their products better. But each is working on its own proprietary solution.
IATA’s raison d'être is to set global industry standards to enable harmonization and greater efficiency across the entire industry. Standards enable innovation and make it possible for incumbents and new entrants to work from the same blueprint. We believe an NDC standard will enhance the air travel shopping experience for passengers. But standards are a hard thing to visualize, so I would like to show you a short video of the shopping experience that the NDC standard could enable.
I hope that you will agree with me that the potential for NDC is exciting and could deliver enormous value to consumers and create new opportunities across the travel value chain.
Creating the NDC standard will unleash innovation—and that will mean change. But, let me assure you of a few things. NDC will operate within the same privacy laws that govern every other business. That is no change from today. But, by giving travel agents more information, there will be greater transparency. As you saw in the video, the NDC standard will enable much richer comparison shopping for travel products, not just the base fare, but the entire spectrum of offerings – including those ancillary fees and services that regulators have been cogitating about for so long. It’s another example of the market doing it so that regulators don’t have to.
I should also be clear that IATA’s role is to set the standard—which we are doing collaboratively with a broad cross-section of industry players. What you saw in the video is what might be developed when other companies use the standard. Pilot projects are underway and more are in the pipeline.
Furthermore, we have created two new groups—the Agents-Airline Forum and the Passenger Distribution Group Advisory Forum, to ensure alignment with our business partners across the stakeholder chain including travel agents, GDSs and other technology providers.
Another thing that is not in keeping with the workings or spirit of the free market is governments’ approach to airline consolidation. Putting aside the matter of archaic ownership and control rules both here and abroad that impede airlines’ access to the global capital marketplace and prevent the emergence of a truly globalized industry, the fact is that airlines face higher hurdles than other businesses when it comes to mergers and acquisition.
We recently were reminded of this when the US Department of Justice (DOJ) announced it would sue to prevent the merger of American Airlines and US Airways, a step that stunned the industry as well as Wall Street.
I am not an expert on US antitrust policy, but I do know something about the airline industry and I have to agree with those in the investment community and elsewhere who have found DOJ’s arguments to be unpersuasive. I can easily point to several examples of faulty reasoning.
- The first is that DOJ claims that if the merger goes through, competition from low fare carriers will be ineffective in preventing the three major network airlines from raising prices because “LCCs have different business models, in particular most do not have hub and spoke networks.” In response, I have to agree with Brett Snyder, AKA the Cranky Flyer, who found it “pretty amusing that Southwest isn’t considered a legitimate competitor even though it’s the largest domestic US airline.”
- In the lawsuit DOJ takes special aim at ancillary fees, which it states have become “very profitable. In 2012 alone, airlines generated over $6 billion in fees for checked bags and flight changes.” In reality, IATA data show that ancillaries may be the difference between profit and loss for some airlines. Without the additional revenue from these ancillary products, industry revenues would have been $10 below cost on a per passenger basis in 2012. Including ancillary products revenue per passenger exceeded cost by $2. I don’t know about Washington, but where I come from we call that being barely above breakeven.
- While lamenting the consolidation it earlier approved, DOJ ignores the factors that spurred consolidation. One Wall Street analyst noted that the lawsuit “fails to mention that the past round of airline consolidation coincided with an almost 400% rise in the price of jet fuel.” Indeed, as far as the lawsuit is concerned the 2008 fuel bubble—which nearly drove the global industry to its knees and caused the failure of several small US airlines—never happened. But for those in Washington who need a reminder—in 2008, US airlines lost close to $23.7 billion, according to DOT data.
- DOJ also seems to believe that a larger number of unhealthy airlines is better than a smaller number of healthy ones. “In 2005, there were nine major airlines. If the merger were approved, there would be only four.” Left unsaid is the fact in 2005, four of those airlines either entered bankruptcy or were already undergoing a Chapter 11 reorganization.
Despite DOJ’s claims, the fact is that consolidation has resulted in a healthier, more profitable industry and that is good news for travelers as well, because it means airlines have the financial wherewithal to invest in their products and services--as US airlines are doing, to the tune of $1 billion per month according to A4A. And government data show that service is improving on the things that matter most to customers: punctuality, baggage delivery and so on.
Governments’ reluctance to allow aviation to operate like other businesses extends into the realm of fees and taxes, where aviation is taxed at levels far exceeding those of most other activities, in order to bolster national treasuries. Meanwhile aviation infrastructure is starved of much needed investment.
Ironically that investment would go a long way to addressing the underlying factors contributing to the operational issues governments seek to regulate out of existence.
Uncle Sam has plenty of company in this regard. The UK collects around GBP2.9 billion annually through its infamous air passenger duty. But Washington also has its hands in your pockets. Fees and taxes represent around 20% of the average domestic ticket and totaled $18.9 billion last year, according to A4A. And the Obama Administration’s budget proposal for the 2014 fiscal year includes a slew of tax increases and new fees adding further billions to the cost of air travel. Let’s recall the $2.50 per passenger profit that airlines earned last year. With that paltry figure in mind, it is not hard to understand why even a small increase in passenger taxes can have big consequences for the bottom line.
The volume of fees and taxes levied on air travel suggests that many decision makers still view it as a luxury item, not as the glue that holds the global economy together. That is a misguided view, as we saw last spring, when aviation became a pawn in a partisan budget battle. The flight delays and cancellations inflicted on air travelers to, from and within the US owing to sequestration-related budget cuts had the potential to inflict real damage to the economy if they had been permitted to continue. Fortunately, just a few days of disruption were enough to persuade both sides of aviation’s importance and find a way around the impasse. But we need to work together to make sure all governments have that understanding all the time and not just in times of crisis.
The problems discussed above are hardly unsolvable. Indeed, public and private stakeholders have a strong tradition of working together to address major challenges in critical areas such as safety and security. We also have had great success in reducing aviation’s environmental impact and it is in this area that we are presented with our next big opportunity. In less than a week, the 38th Assembly of the International Civil Aviation Organization (ICAO) will meet in Montreal. High on the agenda for the 191 member state delegations will be aviation’s CO2 emissions. The aviation industry is committed to addressing its climate change impact. The industry has committed to a three-stage plan, comprising:
- A 1.5% annual improvement in fuel efficiency through 2020
- Carbon-neutral growth from 2020 (CNG 2020)
- A 50% reduction in net CO2 emissions by 2050 compared to 2005.
In June, IATA’s 240 airline members approved a milestone resolution calling on governments to reach a global agreement on a market-based measure (MBM) as a key tool to manage aviation’s carbon footprint and meet our CNG2020 target. Specifically, our members support a mandatory carbon-offset program as the simplest, most transparent and most efficient method.
The aviation industry wants a deal. But the ball is out of our hands. It is time for governments to step up at ICAO and reach agreement on an MBM. In order to do so, they will have to move beyond the narrow concerns of national and regional measures to embrace a global solution—because aviation is a global industry. We are the only industry to achieve consensus on a plan to address its climate change impacts. Governments have a golden opportunity to keep aviation on the pathway towards sustainability.
At the beginning of my remarks I noted that the airline industry will soon celebrate its 100th anniversary. I am convinced that aviation is a powerful force for good, connecting people to markets, bringing commercial opportunities to the developing world and enabling greater understanding among cultures. It is a conviction that was shared by the founders of this organization, and I am sure by all in this room. And we must take this simple message to governments: Let us make the second century of air transport even more remarkable than the first.