On a wing and a prayer

“The new airline should not be run by the government which will, despite all good intentions, inevitably interfere. If at all humanly possible, the airline should have a private majority ownership with the Government retaining a golden share.”

Former Prime Minister Lawrence Gonzi recently told The Malta Independent that he believes the new airline which will replace Air Malta “should not be to make a profit” but still be strong enough to aid the country’s economy move forward, without becoming “a bottomless money pit”.

Now, I know that most politicians are genetically made to be neither fish nor fowl, thus retaining the flexibility to be whatever they want, or they think the electorate wants, from time to time.  But Dr Gonzi takes the cherry for it. 

If there is anything that anybody should have learnt from AirMalta’s 49-year history, it is that when governments have intervened heavily in its operations, either commercially or by overloading it with workers, the airline invariably had to struggle to make money.  Its money-making ability was also severely constrained by excessive pressures from hoteliers to operate loss-making routes or routes on which it made thin margins.   

Financial viability

Gonzi was reported as saying that he thinks the new airline can be financially viable, but it has to be led on commercial and business lines.  Now, financial viability pivots on the degree to which a business generates sufficient income not just to meet operating payments and debt commitments, but also allow for growth.  So, running it on commercial lines is not enough. There have been numerous instances of airlines being run on commercial and business lines but still failing, the reason being that the airline industry is very fickle and operates on razor-thin margins anyway. Therefore, any financially viable airline can only survive if it builds sufficiently strong resources to withstand sudden external shocks.

According to the former premier, a national airline “is not interested in profits but in bringing investments and tourists to the country and in exporting.  We must depart from that point,” he declared.  Wrong, wrong, and wrong.  It is true that there is such a thing as a social enterprise.  This typically charts a distinct course from traditional businesses due to its unique characteristics and objectives. It must meticulously balance its social mission with financial viability, a factor that significantly shapes its strategy. While a social enterprise can be a non-profit one or one that is happy with just breaking even, an airline is not a non-profit business which could be considered successful even if it does not generate profits for the shareholders.  An airline must of necessity be a for-profit firm which is typically geared towards financial results.

This, of course, does not mean that the national airline cannot cater for certain social or strategic needs – medical cases, the development of the tourist industry, good communications with other countries, earning foreign exchange, and so on.  These other non-profit activities cannot be the main raison d’être of the airline but must be subject to the imperative of ensuring a sufficient margin on turnover.    

The intricacies of the airline business

The airline business is highly technological in nature and relies on very expensive equipment. Suffice to say that the capital cost of a fleet of six Airbus A321s, including spare parts, would now be at least €897 million.  How can any airline which does not generate good profits hope to sustain that cost?  Surely, it cannot borrow the whole amount.  Indeed, no commercial bank would be prepared to do so and, therefore, building cash reserves to finance the acquisition is essential.  Leasing would be less strenuous on the cash flow, but more expensive in the long run and would not provide equity-building in the aircraft.

Even if, somehow, a miracle would permit a not-for-profit airline to stay afloat, its future viability remains a huge question mark if it just marks time.  In today’s extremely competitive market and huge economies of scale, a six-aircraft airline is already a wonder.  It means that its considerable overheads – however lean the manpower is – must be amortised over a small fleet; its purchasing power with the various suppliers is hugely limited; its clout with the financial institutions that provide working capital or loans quite small; and its market presence hardly noticeable.  And this is not an exhaustive list of its disadvantages.

Dr Gonzi might be a good lawyer, but his command of the intricacies of the airline business is, well, very poor.  He would be unable to convince any shrewd investor to part with some of his money and put it in this not-for-profit airline, the more so if we really want to attract a strategic partner.

As I said before, the airline industry’s average net profit margin is very low, coming in at less than $6 per passenger, according to figures released by the International Air Transport Association and reported in the Wall Street Journal.  Well-known low-cost airlines like Allegiant Airlines and Frontier Airlines in the USA, where the low-cost concept was launched and developed, have reported operating margins of 11-18%, while Ryanair reported 15% last June.  Compare that to mainline airlines profit margins, such as Delta’s 14%, American’s 11%, and United’s 10%.

By keeping a common fleet and almost exclusively sticking to short-haul sectors in their key markets, costs are kept down and aircraft utilisation high. These airlines also tend to record extremely high load factors, meaning almost all seats are sold, no matter the price per ticket. While this comes with trade-offs like less legroom, no meals, and no changeability or refunds (with additional fees), it’s a model passengers love.

In fact, today many airlines make their profit not from the sale of passenger tickets, but on ancillaries such as carry-on or checked bags, meals, seat selection, priority boarding, and hotel and transport add-ons. In the last decade, ancillary revenues have ballooned. To understand the scale, in 2019, airlines clocked a massive $110 billion in ancillary services alone, according to CarTrawler’s yearbook.

Ryanair is a great example of this phenomenon. During the year ending 31st March 2022, the airline earned €2.15 billion in ancillary revenues out of a total of €4.8bn – just under 45% of the carrier’s total revenue.  CarTrawler reports that in 2019 WizzAir brought in 56% of its 2021 revenues through ancillary sales. American low-cost carriers Spirit and Allegiant earned 54.3% and 51.3% respectively.  By comparison, mainline United brought in less than 25% of its income from ancillary fees.

That elusive strategic partnership

By the way, it never ceases to amaze me how politicians latch on to some soundbite and keep repeating it until they come to believe in it.  The notion of finding a strategic partner for AirMalta has been around for donkey’s years, since 9/11 actually.  All efforts to find one have been unsuccessful and, according to me, are destined to remain so.  A strategic partnership presumes two or more companies which are contributing in a substantial manner to the partnership.

What does Air Malta have to offer?  It’s not its small, uncompetitive fleet.  It’s not a huge domestic market.  It is not considerable feeder traffic, nor is it some extraordinary deals it can secure from sub-contractors.  Certainly not a commanding presence in a market which is not open to the other partner.  Haven’t we learnt anything from the supposed partnership with Alitalia, which would have sunk AirMalta permanently hadn’t Louis Grech stopped the idea in its tracks?

I strongly believe that the new airline should not be run by the government which will, despite all good intentions, inevitably interfere.  In fact, If at all humanly possible, the airline should have a private majority ownership with the Government retaining a golden share.  This golden share would be like the veto in the EU, available but hardly ever used, ensuring that the Government can insist on certain overarching strategic objectives but be unable to impose uncommercial conditions. 

Faulty business model

Dr Gonzi might enjoy claiming that the deal his government had concluded with the EU Commission would have saved the airline had it not been for the incoming Labour government.  The reality is that, although some progress was made in the airline’s restructuring, it wasn’t enough by any stretch of the imagination to stem the hemorrhage.  Nor is it because of the government’s ability to convince the Commission.  The fact of the matter is that the airline’s business model was faulty.  To be honest, ex-Minister Konrad Mizzi’s misadventures inflicted the final coup de grâce.

Dr Gonzi is wrong on another count. The EU Commission has consented to the setting up of another airline not because, out of the kindness of its heart, it accepted that a national airline is essential for Malta.  It did so on condition that the new airline would be a for-profit one.  This also explains why the Commission has not approved a second aid package for Air Malta, something that in 2018 I had advised would not be accepted by the Commission.

What Dr Gonzi is floating is a ‘wing and a prayer’ airline.  Gone are the days for such wishful thinking, and that includes any lingering ideas that it can be a legacy airline and a low-cost one at the same time. The new airline needs to have a robust and credible business plan, a low-cost structure, good funding, the best in marketing and revenue management, and excellent management.  Whether this combination can be delivered or not is very much a moot question. 

Frankly. I don’t bet on it, though I wish the new airline well.

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