Airlines: The Most Profitable Industry in the World! (Yes, you read correctly)

Managing Director of the Seabury Group consulting, Joe Schottland, explained to HBS students why he is placing big bets on the airline industry.

Few consider the airline industry to be an attractive investment, particularly given the recent wave of bankruptcies, high fuel prices, security risks and ongoing labor battles. On November 21, HBS welcomed Joe Schottland, managing director of Seabury Group consulting, who explained how the airline industry could be on the verge of becoming one of the most profitable in the world. Seabury Group is the leading boutique consulting and investment banking firm to the airline industry.

After ironically arriving on a delayed flight of a client airline, Mr. Schottland stuck to his guns pronouncing a bright outlook for this ever-turbulent industry. He opened up his talk, co-sponsored by the Hospitality & Travel Industry and Management Consulting clubs, by asking whether anyone in the audience actually believed that airlines could become the world’s most lucrative industry. To the skeptical crowd, he declared, “it will be…for a time.”

This hypothesis is based on research by MIT’s respected aviation center that projects the U.S. airline industry alone could generate up to $30B in net profits in 2009. Their analysis shows that since deregulation in 1978, industry profits have followed an oscillating sine wave curve with a growing standard deviation. It shows that there has been dramatic and predictable cyclicality in airline profitability which is set to become greater. One of the main driving forces behind this cyclicality is the three-to-four year lag of aircraft orders to delivery, with orders being placed in boom years arriving during downturns. The flip-side to this rosy profit scenario is the $18 billion loss that U.S. airlines could generate by 2012, according to MIT’s regression.

Another reason Schottland believes the airline industry is poised to become one of the most profitable in the world is the huge variability in performance that is possible. He cited airlines such as Southwest and Ryanair that are some of the most successful companies in the world. He noted the fact that Southwest Airlines was recently rated the all-time most successful investment by Fortune magazine.

Schottland also noted two unique challenges of the airline industry. Perfect competition exists to a large extent, since airlines are mandated to provide complete access to route operating and financial data. Airlines have historically served as substitutes for one another given the majority of customers select on price, use the same aircraft and airports, and the barriers to entry remain low.

Secondly, regulation contributes inefficiencies to the market. This is illustrated by Chapter 11 bankruptcy laws that protect weak performing carriers, limitations on M&A and foreign ownership, as well as ineffective and inefficient safety oversight.

Schottland addressed the herd mentality within the industry. He referenced the proliferation of low-cost startups and “single-syllable airlines within an airline” such as Ted, Song, Go, Jazz, Buzz and others whose business models have proven dubious at best.

Looking to the future, Schottland noted that consolidation has been a major force in streamlining capacity among major network carriers. Beginning with the Air France-KLM union and continuing with America West-US Airways, he sees merger activity as accelerating. That said, he thinks US Airways’ proposed hostile takeover of Delta is unlikely to pass antitrust review due to the significant overlap in route networks and competing hubs between the country’s fifth and third largest carriers.

Schottland also sees continuing segmentation in the industry, with single-class carriers covering all ends of the market, ranging from Southwest (simple coach) and jetBlue (premium coach) to MAXjet (business class) and Eos (first class). He cites new startup carrier Skybus, based in Columbus, OH as continuing this trend, offering ultra low cost fares like its model Ryanair, with a significantly lower cost base. Skybus is due to start flying in the spring -see above photo for an exclusive picture of a Skybus jet.

Schottland feels venture capital dollars will continue to flow to business plans such as Skybus, as investors chase dreams of building a better, more efficient mouse trap in what is considered a “sexy” industry. He also feels that Europe is particularly ripe for consolidation of its 274 airlines, and that national pride is the only real barrier to putting more European airlines together to generate economies of scale from larger fleets and route networks.

In response to a question from the audience, Schottland stated that he sees the new Airbus A380 super-jumbo as a niche product that will only be useful for connecting major international hubs. Production delays at Airbus aside, he credits Boeing with taking the upper hand by pinning its hopes on its lower-density, fuel-efficient 787 aircraft instead of trying to compete in the 500-800 passenger aircraft market. He further commented that the long-term future of business aviation may lie in “air taxis” or “Very Light Jets” that will seat 4-5 passengers and connect airports of all sizes around the world.

Schottland also made sure to let students know that Seabury Group is hiring, and that they welcome any airline enthusiasts to apply. Check out the Job Bank or their website for details on job opportunities that Seabury offers around the world.