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Bankruptcy & Overcapacity in the US Airline Industry Research Paper

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Updated: Aug 18th, 2021

Introduction

Invention of airplanes is one of the few inventions that have deeply changed how people live and experience the world. Since both the World War I and World War II, the demands for airplanes have improved the techniques for building and designing airplanes. Major airplanes routes have since been established and the industry has progressed to a critical point where life without air travel is unimaginable. Air travel has changed our distance concept, making it possible for us to conduct business in places that have been originally considered remote.

The airline industry can be classified into four categories, this is;

  • International Airline,-this includes all air planes with a capacity to handle over 130 passengers and take them anywhere in the world, annul revenue of companies in this categories stands at over US $1 billion.
  • National Airline; these seats between 100 and 150 passengers with a revenue base of between the US $100 million dollars and US $ 1 billion.
  • Regional; the companies operating in this category have a revenue base of less than the US $ 100 million dollars.
  • Cargo airlines, are airlines whose main function is goods transportation.

Some of the important factors affecting the airline industries are;

  • Fuel cost; this makes up to 15% of the airline operational cost
  • Labor- over 40 % of the airline expenses goes toward payment of Pilots’ salaries, baggage handlers, flight attendants, dispatchers and customer service. Another factor that also has major effects on the airline industry includes; route structure, lease cost of aircraft, airport capacity etc.

Industry Overview

The airline industry remains one of the largest and growing industries and it is very central to globalization taking place in almost all industries. It facilitates economic growth, international investments, world trade and tourism.

In the past decade prior to the terrorist attack that took place on September 11th 2001, air travel was growing at a steady rate of 7% annually. Travel for leisure and business has experienced strong growth. Over 1.5 billion passengers traveled by airline in 2000. Availability of large aircraft facilitated the growth of leisure travel as it became more affordable and convenient to travel by airline to popular tourist destinations all over the world.

The government in developing countries seized this opportunity and developed infrastructure and exotic resorts and hotels to lure tourists from developed nation like United States and Europe to visit their countries. This in turn has led to development of these countries and significant growth of economy.

The airline industry has also helped in growth of business as many businesses have been able to spread their wings to the international market through investments, customer reach, supply of goods and services and shifting of production base. In turn, the swift growth of direct international investment and world trade has also contributed to the growth of the airline industry due to increased business travel.

The International Air Transport Association IATA predicts that the airline industry will continue to grow at an impressive rate of 6.6 % despite the impacts of the September 11 terrorists attacks in the United States. The most dynamic growth is being experienced in the Asia /Pacific region where rapid international investment is shifting and fast-growing International Trade. China for example is promoting the growth of airline industry in this region due to the fact that it is the fastest-growing economy in the world.

Again India and China have become the most favorable production base due to availability of cheap labor and raw material hence major international companies like Coca-cola, Microsoft, and Sony etc are shifting their production base to the Asia region. Dubai has become a major hub for international business where international trade is bringing businessmen and women from all over the world to do business. The regions have since 1998 experienced an impressive 9% growth in air travel in terms of passenger handling and the general growth in airline sector.

Europe – North America route remains on top in terms of total passengers trips, whether the route can continue holding on the top is subject to the kind of adjustment the Airline industry in that region will make.

Effects of Economy on Airline Industry

The profitability of airline industry is closely linked to economic growth, trade and stability in a nation. History has shown that recession in the world makes the industry suffer a lot. For example, the gulf war in 1991 made international passenger travel drop by a big margin. Airline industry riding high on the 1980s air travel boom placed big orders for new aircraft form the aircraft manufacturers between 1990 and 1994, leading to considerable excess capacity in the airline market. This in turn led to unnecessary competition which saw many companies making losses worth over $20.4 billion in two years.

These events marked a good starting point as airlines were able to realize the mistake and in turn made radical changes to ensure prosperity and survival. Renewed economic growth has since made the industry recover and return to profitability. To reap maximum benefits and profits, the airline had to aggressively cut costs, increase the load factor, reduce debts and build reserves.

Most profitable players in the airline industry are those that are investing heavily in the provision of quality service both on the air and on the ground. These include more comfortable seating, interactive booking and entertainment, ticketless travel and personalized service to win most customers.

A number of factors have come into play making the airline’s industry more efficient. A good example is the European Union (EU) directive that governments in European countries should not subsidize those airlines that have continued to make losses. In other countries, state-owned airlines have been privatized in order to ensure that management is placed in the right hands away from political influence so as to turn the industry in profit-making. The shareholders become the watchdog in the management of the industry-leading to efficiency and competitiveness, thus turning the industry to profit-making.

Deregulation is also another factor that has contributed to the growth of the airline business, circumstances have forced Europe to follow the United States by allowing airlines from one state to operate in another state in terms of passenger and cargo handling. This is done through open skies agreement. In Unites States though, the impacts of the 9/11 have caused a nationalist attitude toward national carrier. The federal government has started implementing a recommendation requiring that all airlines operating in the United States be owned by US companies.

Despite this shortcoming, recent years have seen the airline industry proceed well in the path towards consolidation and globalization, as it is happening in other industries. There has been establishment of partnerships and alliances between airlines, which have since led to expanded operation network and customer access. Airlines all over the world have entered into alliances through; code sharing, marketing agreements, equity transfer and franchises.

International forecast shows that the number of passenger booking will have doubled by 2010 from the current number. The future holds numerous challenges and shortcomings for the airline industry. Only those airlines which will position themselves well to cut cost and improve their services will survive. This calls for concerted effort to secure strong market presence in the world’s major aviation markets.

The United States is the largest aviation market in the world accounting for over 31 % of scheduled passengers as at the end of 2007. This sector of the US economy has experienced a continued growth since 1978 when the congress passed the airline deregulation act. Major hitch occurred during the 1989 recession which led to loss of billions of dollars in the airline industry, nevertheless, the airline industry recovered soon after the period to considerable growth, this growth was halted in the 2001 by the terrorists attack.

Recent years have seen major improvement in the sector as airlines restructure to survive and return to profitability. Most US airlines have undergone cost restructuring and concessions and are now riding high on the low fare and low-cost environment. Cross-border alliances have also been applied by many airlines leading to improved profitability. United States Past leadership have recognized the impacts of the airline industry to the economy and have put recommendations to ensure that the industry remain competitive, efficient, superior industry with strong financial base and access to the global market.

The effects of the September 11th 2001 attack on Airline Industry

The events of 9/11 had major effects on the economy of the United States. The effects were even more apparent in that business closely related to the tragedy such as air travel.

In the first week of the terrorists attack, the airline industry lost over 1.5 billion dollars, six months after the attack, over 95,000 airline jobs have been cut and total loss was at 8 billion dollars. Major airlines like Delta airline had to increase their security measures cost by over 50 million dollars.

For a long time, many passengers believe that another terrorist attack will take place in the near future, making the number of bookings reduce significantly. The past few years have seen the availability of many airline facilities and few customers, both for business and leisure. The airline producer’s service supply outweighed by far the demand for the services. In return, the airline producers had to cut down on those services, leading to low labor consumption. The net effect was that many workers were laid off.

Those workers who were laid off reduced their spending significantly, leading to low demand in another non-related market as consumption went down. Those workers who were not laid off feared that they will be laid off in the near future and due to this uncertainty, they had to cut spending leading to reduced demand for goods and services from another non-related market.

As people watched the decline in the Airline industry, they perceived this as signs of failing economy. In effect the general public had to cut back their spending to cater for the future, in essence the spending power went down, The net effect was that all other industries and markets were affected by this cost cut back effects, the airline industry ignited spiral effects affecting almost all industries.

Within a few days after the terrorist attack, the United States Aviation industry canceled all third-party liability coverage of war risk for the airline industry. When the coverage was restored after the main player cried foul, it had undergone changes and with far-reaching limitations. This led to cost escalation as the airline had to absorb all these costs. Things were further complicated by the introduction of terrorism insurance coverage to the Aviation industry.

The effects of 9/11 left many people clamoring for increased security not only in the airline industry but in all other sectors of the economy. This security comes with a price, and a lot of money is being used in security-related issues while some sectors of the economy like health care, are being deprived of the much-needed cash

Security measures have been taken are driving passengers away, the time taken to undergo security checks has increased significantly due to stringent airport screening. Many passengers feel that they would use air travel frequently if the security measure is relaxed a bit as they perceive the security check to be very intimidating.

Major US airlines including US airways and united airlines have already filed for bankruptcy due to financial crisis accelerated by the terrorist attack.

Effects of Government policies

The federal government is the process of implementing a policy requirement that restricts foreign ownership of US-based airlines. Security concern is the major driving force in the introduction of this policy. The federal government feels that American will be more secure when the airlines are fully owned by United States companies.

Observer in the airline industry feels that the move is likely to have negative effects on the US economy as there are many private airlines that are owned by foreigners operating in the United States. Implement this policy will mean that these players will have to shift base to other countries. This will trigger chain reaction which will include loss of business revenue and the much-needed jobs. There is the general feeling that the policy should be changed to reflect a move toward limiting foreign capital investment rather than eliminating it.

Four more policies have been introduced and are being implemented by the United States Federal Government as a result of the 9/11, this includes;

  • Electronic communication surveillance.
  • Internet surveillance.
  • Video surveillance.
  • Telephone surveillance.

Other policies pertain to foreign student travel to United States for studies. New federal policy is likely to bar students from Canada and Mexico from seeking part-time education in United States. These measures are geared toward protection of United States citizens from a repeat attack like the one which took place in 2001.

Another policy proposal is the introduction of a radio frequency identification tagged passport to help in identification of the passport holder.

Wages Inequality

In the Airline Industry, no comprehensible formula has been developed in wage inequality calculation. Today, wage inequality is measured primarily by statistics analysis which shows a complete breakdown of how much airline industry employees are making. In the United States, the National range differs from one State to the other due to federal living wage regulations. Current statistics indicate that wage inequality exists and low wages are making the turnover to be very high.

In major airports like San Francisco International Airport, 78% of the total employees make less than 10 US dollars per hour. There have been many attempts to introduce legislation to guarantee that the lowest paid employee gets at least 14 dollars per hour. This is in bid to narrow the wage difference between the highest-paid managerial staff and the lowest staff. As the wage increase, the employees become efficient and are more dedicated to their jobs, this is of great benefits to the airlines.

Conclusion

The airline industry has major effects on the economy of any given nation. Successful airline industry in a nation contributes to major growth of the economy. Failure of the Airline industry has spiral effects on the overall economy as it affect almost all sectors of the economy. A stable economy on the other hand contributes to the success of the airline industry. Economy on recession will most likely cause the airline business to fail as the success of this industry largely depends on the stability of Economy.

Reference

Borenstein S. (1992) The Evolution of U.S. Airline Competition, Journal of Economic Perspectives, 6th Edition.

Brueckner, W.T. Whalen (2002), The price effects of International Airline Alliances, Journal of Law and Economics, 43rd Edition.

C.Syverson (2003) Aviation insurance and 911. Web.

David M. walker (2001) State of the U.S. commercial airline industry report to the International Aviation club of Washington, retrieved on 6th March 2008, available at US Government Accountability Office, GAO. Web.

Mayer C., T.Sinai (2003) Networks effects, Congestion Externalities and Air Traffic Delays; why all delays are not devil, American Economics Review, 93rd Edition.

Morrison S.A. (2001) Actual Adjacent and potential Competition; Estimating the Full Effects of Southwest Airlines, Journal of Transport Economics and Policy, 35th edition.

Seth Sandronsky (2004) Bankruptcy, overcapacity and the US Airline Industry. Web.

Zabin, C. (1999). Web.

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