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THE PRESENT ENVIRONMENT 37 production capability in the United States with attendant adverse consequences for the military establishment as well. Other nations, with economic and social criteria that do not apply to private U.S. firms, can and may seek to take advantage of recent changes in this U.S. market environment. Foreign programs to launch new aircraft could damage the prospects for future U.S. industry recovery. This subject will be discussed in more detail below under ''Emergence of Foreign Competition." Monitoring this situation, and taking corrective action as need be, warrants the highest attention within industry and the government. This "worst case" scenario could not be regarded as probable at the present time. However, very undesirable and costly deterioration could occur before the problem is perceived and adequately addressed if it is not watched carefully. FINANCIAL STATUS OF THE AIRLINES Major Airlines For all major and for some of the smaller airlines, deregulation generated great uncertainty with respect to financial yield per seat-mile offered. It also produced an inappropriate match between the existing aircraft fleet and the evolving network of routes. For many of the major airlines the consequences of these events, combined with a deep recession, have been a suboptimal fleet mix for hub-and-spoke routes, reductions in market share, serious deterioration in financial performance, dramatically different and heightened competition, and an urgent need to control or reduce frequently intractable operating costs.4 Table 2-4 and Figures 2-3 to 2-5 reflect the decline from consistent profits to severe losses and the deterioration in debt/equity and working capital ratios, and breakeven points. Although these changes are obviously adversely affected by the recession, they began well before it and coincide with the onset of deregulation. Perhaps the most important and uncertain elements relate to planning route structures and fares, forecasting financial performance, and projecting capital and equipment requirements for procurement of new flight equipment. The changes noted above are very important to the future health of the suppliers of new transport aircraft. It has become more difficult to forecast market requirements, and the continuing ability of customers to accept and pay for new equipment is less certain. These changes have altered the investment climate and the prospects for adequate security and return on
THE PRESENT ENVIRONMENT 38 investment for the financial institutions that fund the purchase of new aircraft. In a regulated environment the route franchise was regarded as a valuable asset that provided security for loans. Historically, new aircraft were funded by internally generated cash and short-term and long-term credit from banks and institutional lenders. The sharp deterioration in financial performance has dried up the former, and the reduced stability brought about by deregulation, combined with poor profit prospects, has largely dried up the latter. It is interesting to note that representatives of the equity investment community are more optimistic over the financial prospects of the airlines than are bankers who supply credit and must be concerned with ability to repay loans on schedule.5 The financial results for 1983 have not been reassuring. TABLE 2â4 Operating Profit of U.S. Air Carriers on Domestic Operations, 1970â1983 Year Millions of Dollars 1970 (1)* 1971 257 1972 493 1973 494 1974 785 1975 117 1976 575 1977 657 1978 1018-Deregulation 1979 129 1980 (6) 1981 (264) 1982 (736) 1983 NA * Loss SOURCE: Aerospace Industries Association of America, Inc., Aerospace Facts and Figures, 1983/1984, pp. 88â89. Recently the industry has been successful in raising funds in the public market, but these funds have been used largely to cover losses. Due to the uncertain profit outlook this source of funds is no longer as readily available. The financial representatives on the panel indicated that the debt leverage permitted in the future will be scrutinized more carefully. New sources of funds and possibly the development of new financial instruments may be needed, but a return to consistent profitability is essential if carriers are to be able to purchase new, more efficient aircraft. As noted, the outlook for the domestic airlines to continue to
THE PRESENT ENVIRONMENT 39 serve as "launch customers" for new aircraft is clouded. An economic recovery with modest growth in air traffic has not yet resolved the problems of excess capacity, severe fare competition, and the need to reduce operating costs that continue to impair profitable operation. With respect to reducing operating costs, some airlines have taken drastic steps to avoid bankruptcy and have been able to achieve reductions in labor costs on a time scale that few familiar with the industry would have predicted at the beginning of the recession. A few are using bankruptcy reorganizations as a means to void labor contracts that have been a barrier to achieving cost-competitiveness. Other carriers will no doubt continue to experience liquidity problems that will inhibit their ability to finance new aircraft. The ready availability of low-cost used equipment will likely continue to make it easy for new entrants into even major hubs as long as noise regulations do not ground such equipment. It is also possible that carriers not experiencing significant financial problems will devote resources to protecting route structures by cutting fares to meet competi Figure 2-3 Domestic Operating Profit of the Major Airlines Before and After Deregulation Source: Civil Aeronautics Board.
THE PRESENT ENVIRONMENT 40 Figure 2-4 Composite Debt-to-Equity Ratio, U.S. Major Airlines Source: Presentation before U.S. Civil Aviation Manufacturing Industry Panel, July 7, 1983, by H.C. Munson, Boeing Company, Seattle, Washington. Figure 2-4a Working Capital Ratio, U.S. Major Airlines Source: Presentation before U.S. Civil Aviation Manufacturing Industry Panel, July 7, 1983, by H.C. Munson, Boeing Company, Seattle, Washington.
THE PRESENT ENVIRONMENT 41 tion rather than risk commitments to new generation aircraft that may not meet competitive needs by the time of delivery. Figure 2-5 Load Factors and Breakeven Points of Major Airlines Before and After Deregul ation Source: Derived from Civil Aeronautics Board data. The domestic airline industry may well continue to be unstable for some years. The failure of several additional major carriers is a possibility. It is likely that when the situation stabilizes the industry will continue to exhibit the characteristics now displayed, i.e., it will be made up of several financially strong carriers, such as American, Delta, and United, a number of marginal carriers, and a number of new entrants with varying financial strengths. The number of carriers comprising the latter group will probably vary with the economic cycles, with some failing and new ones entering. The financial health of the industry will be strongly affected by the success of airline managements and labor unions in achieving lower costs and higher productivity. The success of individual airlines will be strongly influenced by the marketing perception and nimbleness of their management in identifying and serving attractive market segments. They will operate in a much more volatile competitive environment. It is unlikely that many of the new airline entrants emphasizing low-cost operation, severe price competition, and great flexibility will readily take on the long-term capital commitments required to purchase new aircraft, much less to help launch a new aircraft.
