How to save distressed state airlines

Professor Rigas Doganis considers how government-owned or -controlled carriers can turn their fortunes around

Higher operating expenses mean Air India’s unit costs are around 20% above its Indian competitors’
Higher operating expenses mean Air India’s unit costs are around 20% above its Indian competitors’

Shutterstock

The past decade has been the most profitable ever for the world’s aviation industry. Yet most state-owned or state-­controlled airlines have not shared in this prosperity. ­Surprisingly, they represent up to one-third of all international full-service carriers.

While a few larger ones, such as Air China, Ethiopian and Singapore Airlines, have been profitable, the vast majority have been loss making or have generated only marginal returns well below the cost of capital.

Airlines that have suffered extended loss-making periods include Gulf Air, Kenya Airways, Pakistan International Airlines, South African Airways (SAA), Saudia, Thai Airways and numerous others.

Most state-owned or state-controlled airlines fail to prosper, even in good times, because they are in a distressed condition. This is a condition which, unless treated, can destroy state-owned airlines from inside. In most cases, the symptoms are clear.

DEBT BURDEN

A symptom common to most is that they are chronic loss-makers. While they may produce small profits in odd years, they have suffered losses in most years during the past decade. Their substantial losses have generally been financed by loans from government banks or agencies, so they have to service large accumulated debts. Air India, for example, in 2019 had an accumulated debt mountain of $8.1 billion. A key feature of this condition is that such airlines are often grossly under-capitalised. Their losses and expansion have been financed by debt rather than equity.

Servicing mounting debts means large annual interest payments. These often erode any operating profits and push the airline into further losses. Air India chairman and managing director Ashwani Lohani identified this problem when he said in 2019 that the carrier “is poised to make operating profits this year” but will record net losses as a result of “debt servicing charges”.

Writing off airline debts requires a strong political will on the part of the government owner

A second common feature of distressed state airlines is that they are over-politicised, in the sense that their government owners interfere frequently in managerial decisions. In return for providing direct or indirect support, such as guarantees for loans to buy aircraft or to cover annual deficits, governments and taxpayers expect to be able to influence the airline’s management and to impose numerous obligations on the carrier. Governments may require the airline to operate uneconomic routes in pursuit of social or political objectives, or may influence decisions on employment policy or labour relations.

To achieve their own internal and often changing goals, governments frequently replace their airline’s chairs and chief executives. In the past 10 years, Air India, Garuda Indonesia, Malaysia Airlines and SAA have each had six chief executives. Frequent changes at the top create uncertainty and indecision at all levels of management.

Many, but not all, distressed state airlines are characterised by a politically powerful workforce and/or strong unions. The union leaders have traditionally used the threat of strike action to influence or to thwart management decisions at every level.

Union leaders change less frequently than the senior management, and are likely to be better informed and more knowledgeable than any new chairs or chief executives, particularly those who come from outside the airline industry. Moreover, the union leaders frequently bypass their management and take their grievances or demands directly to the relevant minister or even to the prime minister. This has happened at Alitalia, LOT, Thai and elsewhere.

One direct consequence of being both over-politicised and over-unionised is that distressed state airlines are also overstaffed. The unions have used their power over many years to negotiate working practices that drastically reduce labour productivity and require additional staff.

Overstaffing leads to higher unit costs in all areas. In many distressed state airlines this disadvantage is compounded by higher aircraft operating costs. They often operate mixed fleets with small numbers of several aircraft types. Such fleets are inherently more costly to operate, especially if they include older-generation aircraft or a high proportion of leased aircraft. In the case of the Air India, for example, its CASK is around 20% higher than that of its Indian competitors.

Distressed state airlines suffer from having no clear and coherent development strategy. This is not surprising, given the lack of management continuity and frequent turnaround plans produced by successive consultants. Government interference may further confuse the management by imposing constraints on the airline. Governments often use their airline to pursue various social, economic or political objectives, some of which may be mutually inconsistent.

Political interference has stymied carriers including Kenya Airways
Political interference has stymied carriers including Kenya Airways

Shutterstock

bureaucratic muddle

Overstaffing, frequent management changes and constant political interference breed a bureaucratic management ­culture in which senior and middle managers are afraid to take decisions and bureaucracy stifles initiative. Memos requesting authorisation for a particular decision are passed slowly up the pyramid, gathering signatures on the way. Decision ­making becomes increasingly slow and concentrated at the top of a sharply pyramidal management structure.

The major symptoms of the condition, as described above, will manifest themselves to varying degrees at different airlines. Any airline that is suffering badly from several of these symptoms is in danger of being permanently on the sick list and perhaps eventually expiring.

There are several crucial steps towards a successful turnaround. The first and most urgent requirement for distressed state airlines is financial restructuring through debt write-off and/or the injection of substantial fresh equity capital. The debt write-off is ­crucial to relieve the airline from high annual debt servicing charges. New capital is also required in the form of equity, and not as a loan, to pay for the costs of putting the airline on a sustainable financial basis.

Writing off airline debts requires a strong political will on the part of the government owner, since such debts are often owed to government banks or agencies, or have been guaranteed by government.

The second and immediate step for the airline’s management must be to focus on reducing costs in all areas. Staff costs are likely to be the largest cost item apart from fuel, so reducing staff numbers and improving labour productivity must be an urgent priority.

The network needs to be ­optimised to remove loss-making services and perhaps launch new ones. This in turn will require fleet rationalisation and possibly renewal.

Some functions traditionally done within the airline, such as aircraft maintenance or ground handling, may need to be outsourced to reduce costs.

The airline will also need to ensure that its products and services are competitive and must improve its marketing with a focus on e-commerce. These measures may be costly, hence the need to inject some new capital.

Thirdly, the senior airline executives need to develop a coherent long-term strategy for the growth and development of the airline. This should be ­discussed with and agreed to by all key stakeholders, including government. It is crucial to ensure that the workforce, as a major stakeholder, buys into the airline’s long-term strategy from an early stage. The government too must agree to and own the strategy.

Fourthly, once the long-term strategy has been agreed to by the stakeholders, then the airline’s executives must be allowed to implement it without interference from their governments. This requires a change of attitude and thinking by many government owners. They need to think of themselves as pure equity shareholders.

The final step is to have stable and professional senior executives, who are not changed every two years and who have clearly defined business aims free from any form of political interference.

FALSE FRIENDS?

Some state airline chairs see equity alliances as a panacea. They believe that weak state airlines can save themselves by entering into an equity alliance with a larger financially strong airline. But alliances are not an end in themselves. They can reinforce a competitive ­advantage, if one already exists, but they are rarely the means of creating it. The recent experience of the Alitalia-Etihad equity alliance is ample ­evidence of this.

Partial or full privatisation is also seen by some governments as a solution. But again this will only succeed if the symptoms of the condition have first been eradicated.

The government owners or controllers of distressed state airlines must face up to reality and embrace the remedies and policies suggested above. This is not an easy decision. Governments need to absorb the cost of writing off their airline’s accumulated debts as well as the cost of injecting any new equity capital needed. Yet at the same time they are required to distance themselves from the management of the airline.

In the 1990s several European governments faced up to this contradiction and successfully salvaged their state-owned airlines as a first step to privatisation.

The remedies recommended will not ensure state airline ­profitability in all cases but they can make it more achievable. Unless the recommended actions are adopted by their governments, distressed state airlines will remain chronically unstable, regularly haemorrhaging capital and on the verge of collapse.

Professor Rigas Doganis is chairman of the Airline Management Group and author of Flying Off Course: Airline Economics and Marketing, the fifth edition of which is available to purchase from publisher Routledge and through Amazon