Rebuilding SAA will be mission impossible

Passengers board a South African Airways (SAA) plane at the Port Elizabeth International Airport in the Eastern Cape. Picture: Siphiwe Sibeko/Reuters
Passengers board a South African Airways (SAA) plane at the Port Elizabeth International Airport in the Eastern Cape. Picture: Siphiwe Sibeko/Reuters

Building a new airline out of the ashes of SAA may prove more daunting than government thinks.

SAA went into business rescue just as the Covid-19 pandemic was hitting China.

By then, Covid-19 hadn’t been declared a pandemic by the World Health Organisation.

That would come in January.

A few weeks later countries began shutting down their borders, effectively shutting air travel.

If the business rescue process hadn’t already done so, the national lockdown in March sealed SAA’s fate.

Now, government and the business rescue practitioners are working together to rebuild SAA from its ashes.

A version of a rescue plan for the airline detailing the proposed structure under which it can be created was leaked by the DA.

The document provides no details on how the new airline will be better than the old.

Read: After the aviation nightmare, get ready for SAA 2.0

These plans, however, have a ringing endorsement from President Cyril Ramaphosa who told editors last weekend that he saw “a good future for [new] SAA”.

But if keeping the old SAA afloat was a mission impossible, rebuilding it in this very tough economic environment is going to be mission impossible four.

Here’s why.

Success in the airline business is the tricky balancing act of getting as many bums on the seats as is possible but also ensuring that those bums have, on average, paid fares that make it possible for the airline company to make money.

An airline that has successfully kept its operating costs very low but does not have enough bums on its seats is on autopilot to financial failure.
Hlengani Mathebula

Covid-19 has meant that there are simply no bums available that any airline can attract in significant numbers.

What’s worse, the International Air Transport Association, which represents airlines globally which account for more than 80% of passenger traffic, paints a rather gloomy picture for the industry.

It expects global air passenger volumes to decline by 50% this year against a projected decline of 5% in global economic growth.

In addition to economic growth, the airline industry’s performance also tracks closely global trade which affects demand for cargo services.

Global growth is expected to rebound next year to its level last year. The airline industry’s rebound, however, will lag economic growth by about two years.

The biggest decline (60%) will be on international travel, with domestic travel falling off by some 40%.

However, the return of air passenger volume growth to last year’s levels will only happen in 2023, two years later than global economic growth.

The main reason for this is that passenger confidence, which is a key determinant of whether airlines get bums on their seats, may take longer to be restored, even after governments relax travel bans and open their borders.

Rebuilding an airline from its ashes in that environment is difficult, assuming that government succeeds in getting private sector investors to buy into its plans for the airline.

Read: You will keep paying for SAA

Airlines, as businesses, have a big chunk of their costs fixed. Hotels are another.

This contrasts with variable costs – those costs that rise or fall based on the volume of business activity being conducted.

This means that an aircraft with a capacity to carry 250 passengers, but flying to a destination with 100 passengers will on average still have a big chunk of its operating costs fixed – the same as one carrying 200 passengers.

Both will have the same number of pilots, will burn fuel and will have the same minimum flight crew.

Their handling and airport fees at both ends of the journey won’t be dependent on how many passengers they carry.

All of these costs aren’t dependent on how many passengers the flight has.

Yes, there will on the margin be differences of how much on average the fares were discounted by.

A flight carrying a full load of passengers, the majority of whom paid next to nothing for their seats, will prove more costly for the airline than one carrying half the number of passengers who paid a full fare.

Similarly, an airline that has successfully kept its operating costs very low but does not have enough bums on its seats is on autopilot to financial failure.

In short, airlines need as many passengers, paying on average a good price for those seats, as possible.

It’s the combination of those two factors that largely determine financial success.

Airlines have three broad options for maximising profit:

  • Stimulate demand (more bums on the seats);
  • Increase revenues; and
  • Reduce operational costs.

Of course, each of these three options come with their own risks.

Let’s start with stimulating demand. There are three ways in which an airline can try to stimulate demand. One is cutting fares or yields.

First, for this strategy to generate the desired benefit, reduced fares or yields must generate an increase in the number of bums on the seats that is disproportionate to the cut in fares or yields.

If an airline cuts its fares but gets disproportionately fewer passengers, its demand stimulating strategy is doomed.

Second, an airline can increase the number of flights on specific routes.

On the surface, the more frequent flights an airline has on a particular route, the more attractive it becomes to travellers, specifically business travellers who don’t spend time idling around waiting for the next flight.

That’s why, for example, travellers would fly to Europe to get a connecting flight to a destination in Africa.

This is because direct flights to that African destination are so infrequent that business travellers will have to lay low for days waiting for a flight.

However, the more flights an airline runs, the higher its operating costs. It requires a larger fleet, which means more pilots and flight crews.

Third, an airline can stimulate demand through improvements in the quality of services to passengers.

The risk with this strategy too is increased operational costs without attracting sufficient passenger volumes to cover the higher costs.

It is doubtful that the new airline will take off without SAA’s historical baggage.
Hlengani Mathebula

Then there’s the strategy of reducing operating costs. This can be achieved in two ways.

The first is by reducing the number of flights, on particular routes or across the board.

The risk of this strategy is that a reduction in the frequency of flights sees travellers, especially business travellers, migrating to airlines that offer more frequent flights per day.

The second involves cutting back on passenger service quality. Again, too deep a cut though can send passengers to competitors.

Lastly, airline companies also try to increase revenues. This is done through increases in fares or yields.

This, too, can backfire, leading passengers to seek better deals elsewhere.

Now, Covid-19 has meant that none of these strategies can be employed by any airline with any measure of success.

An airline can cut its fares to the bone, for example, but there simply aren’t that many travellers going anywhere anytime soon.

Yes, South Africa has now allowed some business travelling within the country, but this is likely to be limited for some time because of the health risks involved.

Since travelling by air is limited because of the coronavirus, making more flights available wouldn’t make sense.

Increasing fares would most likely make most business travellers keep travel to the most essential.

On the other hand, launching an airline now would appear to be well-timed for three reasons. Fuel prices are low – the price of oil has collapsed.

Secondly, since the airline industry is in the doldrums, an airline company with the necessary financial resources can pick up aircraft on the cheap.

Some airlines would have been forced to cancel their orders from aircraft manufacturers who are desperate to keep their manufacturing lines going.

Then, in the specific case of SAA, there could be a golden opportunity for the airline owners to start off on a clean slate without historical baggage.

This baggage includes what has been described as very generous packages for pilots. SAA also has more workers per aircraft, for example, than most comparable airline.

However, it is doubtful that the new airline will take off without SAA’s historical baggage.

The unions will not agree to their members taking a big cut in their salaries and benefits, or to a large scale ditching of excess employees.

Nor is government inclined to want a fight with organised labour.

All depends, however, on having enough bums on the seats.

Otherwise launching an airline in this environment could prove to be a very costly exercise.

Mathebula is the managing and senior advisor at Cornerstone Capital Partners

Twitter:@hlengane


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