Perhaps you’ve noticed prices for flights have risen from 2020 when the demand was next to nothing, and fares were incredibly low. As recovery begins with two million passengers going through TSA screenings daily—compared to last year’s 750,000 around the same time—the current surge is outpacing aviation’s efforts to restore aircraft, pilots, and crew, and with it, the strain of accumulating costs.
Over the course of the COVID-19 pandemic, the airline industry accrued more than $1 trillion in debt globally. Many airlines borrowed huge sums of money to stay afloat and cope with high cash burn rates, according to industry consultants at McKinsey & Co. Summer demand and recouping this debt could, according to estimates, amount to a rise in ticket prices of about 3%, assuming a ten-year repayment window for the additional debt taken on.
Aside from the debt, crude oil is currently around $75 a barrel, a 50% increase from this time last year. For a major airline, fuel makes up about one-third of all costs. “With profit margins naturally low, that’s enough to make them unprofitable, even if they were profitable before, which they probably weren’t because of the pandemic,” says Geoff Heal, professor of economics at Columbia Business School. Labor costs have also increased after companies laid off about 90,000 employees because of the pandemic. Rehiring at higher salaries adds to the burden.
Additionally, the loss of business travel, which decreased around 70% from 2019, created a massive revenue gap. High-end business class fares haven’t changed much, but they’re also not being purchased, impacting some low-fare categories. “If we think about who historically—before COVID—paid more to fly or stay in hotels, it typically used to be business travelers,” says Vik Krishnan, McKinsey partner and travel industry expert, also stating that category customers also purchase tickets at a whim and close to departure dates when fares are typically at their highest.
The challenge is that business travel is slowly returning, whereas leisure is making up most of the current passengers. Consequently, airlines cannot capture the business revenue significant to all sectors of hospitality. “Having to rely primarily on leisure travelers who genuinely tend to be a little bit more price sensitive has meant that the airlines, hotels, and other players in the ecosystem do not have unlimited freedom to charge whatever they want,” says Krishnan.
With variants on the rise, it’s also difficult for airlines to predict trends. In the past, they used very sophisticated demand optimization and forecasting systems that use historic trends to determine what future demand might be. “The reality is that, as is no surprise, the COVID-19 crisis has taken all of those models and essentially thrown them out the window,” Krishnan explains. And so, airlines have had to come up with relatively new ways of deploying capacity as well as price in this environment. Right now, they’re looking at localized hotspots where travel is currently strong. This is seen domestically, specifically to national parks and nature-focused destinations.
“You should expect to pay pretty high prices to be able to go these places,” says Krishnan, adding those prices are asymmetric by destination. “For instance, air traffic recovery in San Francisco is nowhere near as robust as it’s been in Bozeman, Montana, where during certain times of the day it’s hard to find parking at gates to accommodate all the airplanes that want to go there.”
People who typically consider a vacation in Europe or other international locations are instead focusing on the domestic market because, in part, of the uncertainty from the Delta variant. In a May report from International Air Transport Association (IATA), the unpredictable nature of this ultimately places a restraint on future demand and overall recovery. Prices domestically are up, whereas internationally they are lower due to closed borders and less accessibility. Hence, less demand. However, in a similar report, it shows travelers remain optimistic and eager, but with caution based on COVID’s impact.
Regardless, consumers are traveling and want to travel. “Every airline CFO we’ve spoken to is extremely excited by the fact that consumer sentiment hasn’t depressed. In other words, people still want to travel,” says Krishnan. “The more sobering reflection, however, is we have taken on a significant amount of financial burden during this pandemic that we’re going to have to repay for years. Potentially well into 2030 and beyond.”
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