“We are talking about a potential global capacity reduction of 80 percent to 90 percent before the month is out,” says airline industry analyst Judson Rollins about the impact of the coronavirus pandemic.
[Editor's note: government restrictions and carrier schedule changes are, needless to say, unprecedentedly fluid at the moment. To put this article in context, the information below is based on an interview that took place on March 14, with an updated conversation on March 22nd.]
Airlines have been cutting schedules for two weeks as demand has plunged to depths not even seen after the terrorist attacks on 9/11.
But this existential moment for airlines, caused by the spread of the novel coronavirus pandemic (COVID-19), is like nothing the industry has experienced before.
While most airlines have not gone bust or laid off staff en masse, the severe reduction in capacity has altered and will continue to alter, the jobs of airlines’ network planners and revenue managers as teams seek to find a bottom for air travel demand and forecast how and when its return will happen.
Network planning at carriers directly impacts the role of the revenue management team. To get a sense of how professionals in those key roles are reacting to the painful contraction in demand, we checked in with Judson Rollins, founder of Auckland-based Propel Aviation Solutions, an airline consultancy.
Typically, Rollins noted, the network planning team, operating on marching orders from senior management, is told that the airline needs to cut “X percent of capacity.” In other cases, the carrier needs to target “X percent in hub or region A, Y percent in B, and Z percent in C.” Ultimately, optimizing schedules involves examining where the poor performing routes and poorest performing frequencies are by balancing historical models and real-time booking flow.
At least that’s how the job of identifying and cutting money losing routes is supposed to work when air travel is relatively normal.
‘Drop What You’re Doing’
We asked Rollins how network planners’ decisions being made now, and how route cancellations and capacity reductions were being managed.
“Let me give you a recent example,” Rollins said. “The network and scheduling teams at one airline I’ve worked with had been in the office all day last Saturday, reacting to plummeting demand across their network. At about 4:30 that afternoon, the country’s government announced a self-quarantine requirement for overseas arrivals, which would strangle travel demand. By 5:00 p.m., key members of the revenue management team were back in the office and worked until late Saturday night. Some members of both teams were back by 9:00 a.m. on Sunday morning and worked most of the day. Early Monday morning, the airline unveiled plans to reduce more than half of its total capacity.”
“You don't see such hours under normal circumstances. People normally do things Monday through Friday,” said Rollins, who has worked with nearly 20 airlines across four continents. “This time, people were told, ‘Drop what you're doing, get to the office, we need you.’ A crisis team was set up in a conference room on the executive floor. They decided on the high-level plan and sent emails to cascade that plan down to other departments.
That scenario has played out at airlines around the world this past weekend. Network planning, scheduling, and revenue management were all meeting throughout the weekend and were back at it on Monday.
“This particular airline had to slash and burn its schedule, and they’re now working from a ‘clean sheet’,” Rollins said. “Will the day-to-day jobs [of revenue managers and network planners] change permanently post-coronavirus? No, but because this is such an unprecedented decline, it's going to be really hard to predict the path to recovery.”
Airline Execs Split On Demand
Data histories that normally drive demand forecasting now mean nothing. Therefore, the revenue management team has to come up with an all-new demand forecast using “100 percent art, zero percent science,” said Rollins. “You're looking at real-time booking trends, you're looking to see what you think customers are going to do and how customers are going to react.”
At this early moment in the crisis, Rollins described a split in the schools of thought within the industry. That split was on display at last week’s JPMorgan Aviation, Transportation, Industrials Conference, which featured the CEOs of Delta, United, American Airlines, Southwest, Spirit, JetBlue, and Alaska.
“You've got some executives, like [American CEO] Doug Parker, who are saying we think price can still stimulate incremental demand,” said Rollins. “On the other side of the fence, you've got [Southwest CEO] Gary Kelly and [United president] Scott Kirby who say they don't think incremental demand can be stimulated at any price. They believe people are just too afraid to fly.”
Southwest’s Kelly pressed the latter case on CNBC, saying the only solution the airline has is to cut capacity.
“American has done some capacity cuts,” Rollins said. “They've been more incremental so far. I think the airline was cutting 30 percent [capacity] in its initial announcement. They've cut a lot more international flying since. For carriers that think they can stimulate demand, they're going to be slower to cut because they're just trying to cover the variable cost of flying each passenger — what we call ‘variable cost of carriage.’ They’re looking to generate enough revenue to cover the costs of dispatching the airplane: things like fuel, crew, airport handling costs. Just the bare minimum variable costs.”
For airlines that think they can't stimulate demand, Rollins argued, all they can do is reduce capacity and say, “What is the absolute minimum we need to operate essential public services? What routes have such high yields or enough volume that we can still operate one frequency a day?,” Rollins said. “For instance, you're never going to see New York to Los Angeles [service] go away, because even in this environment, there's still enough demand to fill some seats. Maybe instead of four dozen flights on a typical weekday, there's only enough demand to fill six or eight or 12 flights.
Another factor in the current environment is cargo demand. Rollins pointed out that air cargo yields have exploded across the Atlantic and Pacific, as well as within Asia, due to an ongoing capacity shortage. Cathay Pacific, Scoot, Delta, and American have all announced plans to operate their passenger aircraft as de facto freighters.
“It’s rare that a passenger airline can carry enough belly freight to cover variable operating costs, but we’re now seeing such pockets of demand because of the grounded aircraft,” said Rollins. “I understand Boeing is writing instructions to operators on how to secure cargo in the passenger cabin, either as boxes stacked on seats or smaller pallets where seats can be removed. I expect you’ll see more temporary conversions of passenger aircraft in the coming weeks.”
Making Demand Decisions
As of this writing, there has been no complete U.S. government restriction on flights. And in the past few days, news stories about insouciant millennials taking advantage of cheap flights has pointed to possible answers to questions about where demand will emerge once the crisis ebbs.
“Absent regulatory restrictions, you're looking for fares that on average that will cover the cost of operating the airplane,” Rollins said of the current cut-rate deals a small number of travelers are grabbing. “In theory, your business travel is near zero at this point, because almost every corporate account has banned travel for its employees. On top of that, you don't have any small-business demand.”
“You may have some leisure demand from people who, in theory, are still gutsy enough to travel [despite coronavirus], but that's a guess,” Rollins said. “I don't think anyone knows how big that market is in the present environment. You assume your business travel is probably five percent of what it was previously, and then all other demand is just leisure fares.”
Can an airline sell leisure fares and bump up the average fare enough to cover the cost of flying the airplane? In most markets, the answer's going to be no, Rollins said. Every airline now has to decide how badly it wants to defend its market share in the short term.
“If I'm United, do I want to keep flying to a smaller market like Panama City, Florida? Or do I want to suspend service for 60 days?” Rollins said. “Or if I'm Delta, do I need to fly to Valdosta, Georgia? It’s tiny and I don't have any competition. Do I really need to serve this market in the short term if it’s going to lose money? Does that make strategic sense?”
Where’s The Bottom?
In his JPMorgan presentation, United’s Kirby said the airline has been doing a lot of “stress test” scenario planning. United’s median scenario is a 12-month return to full demand and stress test scenario of 18 months.
Additionally, United’s stress-test scenario assumes a 70 percent system revenue drop over the next two months, then two more months down 60 percent, the following two months down 50 percent, and a gradual improvement through the rest of 2020.
“United is still down 20 percent at the end of this calendar year in its stress-test case. No one expects a massive pent-up surge in demand. It's going to be slow, as you've seen with most demand recessions over the past 40 years. It’s going to be a slow return while passengers start to kind of straggle back and companies start to loosen the purse strings on business travel.
The next couple of months will likely see the largest cuts. “We are talking about a potential global capacity reduction of 80 to 90 percent before the month is out,” Rollins said.
Unlike previous downturns, the drop in demand has been so rapid, it has affected business and leisure travel simultaneously. Most of the time, when the economy declines, business travel decreases first, followed by leisure travel. During a recovery, leisure travel typically comes back first and business travel last.
While there is no universal playbook for this downturn, when demand returns, previous trends of leisure demand leading business demand are likely to resemble past patterns.
“When people have more disposable income, and their employment is secure, they are more likely to book personal travel long before their employers decide to restore normal company travel policies.”
Still, will business policies emphasizing remote work change the need for business travel?
“Business bookings are obviously the highest yielding segment of travel demand,” Rollins said. “The revenue impact of a structural change in business travel would significantly outstrip the volume impact. That's a question people in the industry are already starting to ask: ‘How do we model for the return of business travel? Will it ever return to what it was in 2018 or 2019?’ We don't know. Airlines are counting on it being either an L-shaped recovery, or a very gentle upward slope. Either way, it looks like it’ll be a very slow climb back to normal.”