Reference no: EM132141722

How Much of Your $355 Ticket Is Profit for Airlines?

Airlines are healthierthan everinancially—and that’s why they add more fees and more seats

Next time you board a flight, just imagine you’re putting a $20 bill in the airline’s tip jar. Profit per passenger at the seven largest U.S. airlines averaged $19.65 over the past four years— record-setting profitable years for airlines. In 2017, it stood at $17.75, based on airline earnings reports. In truth, airlines now cover their costs with tickets and get their profits from baggage fees, seat fees, reservation-change fees and just about all the other nickel-and-diming that aggravates customers. You might also call those extra 12 to 15 passengers now crammed onto each flight “Andrew Jackson” for the profit they bring. It takes a lot to earn a little moving people. U.S. airlines experienced plenty of years of steep losses, when creditors were subsidizing tickets for travelers. But now, profit margins—about 9% in 2017—are healthy. Keeping $20 from every passenger is about twice the profit airlines in the rest of the world get, according to data from the International Air Transport Association. “It’s certainly high by airline historic standards. But it’s not high if you look across other companies in the U.S. economy. It’s average,” says Brian Pearce, IATA’s chief economist. U.S. airlines were on pace to take in more than $4 billion in baggage fees and $3 billion in reservation-change and cancellation penalties in 2017, according to Transportation Department data. (The full year hasn’t been tallied yet.) Most of that drops straight to the bottom line. The two categories add up to about more than half of the net profits airlines posted last year. Airline earnings are further boosted by other fees for things like seats assignments, extra legroom, early boarding and pets, plus sales of frequent flier miles to banks for credit-card rewards. Given the $20-per-passenger haul ($40 round-trip), it’s easy to see why airlines are so intent on cramming in more seats, even when they know travelers hate the lack of space and complain bitterly about shrunken bathrooms, slim seat padding and skinny rows. Last year, the average round-trip fare on the seven largest U.S. carriers— American , Delta , United, Southwest , Alaska , JetBlue and Spirit —was $355, based on their financial reports, up from $351 in 2016. Getting an extra two rows of seats on a plane can mean the difference between profit and loss. Of course, some passengers are far more profitable than others. First-class and businessclass travelers are more valuable when they pay for their tickets; less when they get a free upgrade. But even then, road warriors are often upgraded from high-dollar, last-minute coach tickets. Frequent travelers account for a large percentage of airline revenue—and profit. Low-fare passengers shoehorned into the back of the plane may not even be covering what it costs to transport them. But they scored a low fare because the airline was concerned it might not fill all the seats on a particular flight, and some fare is better than no fare. IATA’s Mr. Pearce says airline profits last year were squeezed by higher fuel and labor costs, and that trend is continuing in 2018. Jet fuel prices were up 26% last year compared with 2016, and prices are expected to be about 10% higher this year. Airline fuel efficiency has improved significantly world-wide as newer planes go into service, and older gasguzzlers are retired. But higher fuel prices have driven airline costs higher. At the same time, expanding competition from low-fare carriers has kept fare increases small. Big airlines are building up in competitive markets like Seattle, Boston and Los Angeles. Even some cities that saw dramatic air-service cuts are getting more flights now; Delta recently announced an expansion in Cincinnati, for example. With more empty seats to sell, airlines are finding it even harder to raise ticket prices. “Fares are too low for oil prices this high,” American Airlines Chief Executive Doug Parker said on an earnings call with analysts last month. “Over time you’ll see it adjust.” American spent $1.3 billion more on fuel in 2017 than the previous year, a 22% increase. The carrier also spent nearly $1 billion more on labor, a 9% increase. The airline grew only about 1% last year, so rising costs meant earnings were down $757 million. Thus Mr. Parker is pushing for higher fares. Among the big U.S. airlines, Southwest had the largest net profit margin last year, at 16.5%. Southwest continues to defy conventional airline wisdom. It doesn’t charge baggage fees; instead, it believes it attracts more passengers to each flight because many want to avoid the baggage fees charged by competitors. Alaska, JetBlue and Spirit all had higher profit margins than American, Delta and United. American had the lowest profit margin among the top carriers, at 4.5% in 2017. Airlines’ average profit margin of 9% is about average for a U.S. business. Last year McDonald’s posted a net profit margin of 23%; FedEx , 5%. But that average is a leap for an industry that had cumulative losses from 1979 to 2014 of $35 billion and suffered six major bankruptcies in the 2000s.

Questions.

1. How profitable are airlines today in comparison to historical performance? In comparison to other industries?

2. What does the author mean when he states that airlines get their profits from fees rather than ticket sales? Is this based on the fact that there is no cost of goods sold as there is for ticket sales? Explain your answer.

3. What earnings metric is used to compare profits across airlines of different sizes?

4. Consider the note to the graphic entitled "Flight Change." How much difference exists in determining this metric across airlines? Do you think the differences hurt this comparison? Explain.