The price of oil has plummeted over the last two months. Your first task is to explain the effect that this is having on the airline industry currently. How are airlines reacting? What adjustments, if any, are they making to their strategies? Second, you should select an airline and discuss the issues that must be assessed in the event of a prolonged period of low fuel prices. You should consider issues such as competitive positioning, fleet renewal schedules and risk assessment, for example. You should refer to the airline�s stakeholders and consider their expectations as well.
You can use charts and graphs as needed.
Fuel price and its effect on airlines
Introduction
The recent attenuation in fuel prices is expected to trigger a shift in various facets across the airline industry; ranging from possible reduction in air fares and higher profit margins for companies, to a reduction in the demand for fuel efficient airplanes as the need to hedge against increasing fuel prices diminishes. Airlines are already reacting to the lower costs of fuel it will only be a matter of time before companies review their strategies to accommodate the new status quo. The low cost of fuel is not only expected to reduce the cost of operation but it could also mean higher levels of competition as customers seek low priced planes. This paper is a discussion on the impact of low fuel costs on the airline industry to establish the reaction from airlines and adjustments that are currently going on in response to these changes.
Discussion
Impact of low fuel prices on the airline industry
The major force behind the high operational costs felt by airlines can be attributed to the cost of fuel. Accordingly, the plummeting fuel prices have the impact of reducing operational costs and this is directly reflected in the company’s level of profitability. Schifter (2015) notes that when the price of an input falls, the likely result is an increased level of profitability as a reduction in expenditure is witnessed. In an industry where the costs of operation have mostly been embellished by the ever increasing fuel costs, this marks a period of relief and a chance to record higher profits from operations (Australia freight transport report, 2015). This means that in the event that airlines do not reduce their fares immediately, they are expected to gain immensely from the elevated profit levels (Choudhury, 2015). Paris (2015) however notes that this may be short-lived because airlines may soon succumb to market pressures to lower air fares.
A major impact that the low fuel prices is having on the airlines is the pressure to reduce air fares in response to the low prices. The pressure from customers as well as governments is very high as fuel prices continue to fall and it is expected that most airlines will soon reduce their fares in order to remain competitive (Paris, 2015). Töytäri et al (2011) notes that in a competitive environment, companies aim at attracting customers through providing the most attractive packages and offering low prices is one of the tactics that companies use to attract customers. Furthermore, customers are likely to be attracted to lower prices and airlines that do not reduce their prices once the trend begins may end up losing their customers. The pressure to revise air fares downwards is therefore high among airline companies and this is expected to reduce prices across the industry.
A projected impact of the low fuel prices is that customers may lose out on the high end tactics that airplanes employ in order to maintain a decent level of clientele. The law of demand and supply portrays that as prices fall, supply also falls. This maybe applicable in the airline industry because lower fares do not lead to significant profits and the enthusiasm to provide services may not be as high as when fares are high (Tucker, 2010). Australia freight transport report (2015) notes that as fuel prices go up, fare prices go up and this means higher profitability for airlines; which in turn invest more in quality services in order to attract more customers. Low fares on the other hand will reduce such proactive strategies because it will be easy to attract customers without the need to invest in extra efforts. Customer comfort is therefore at stake as less may be invested in delivery of quality and unique services. In the event that airline fares may fall as a result of the reduced fuel prices, airline enthusiasm to make sales may be affected. Furthermore, low prices mean that more people can now afford to fly and less effort is needed to attract customers (Choudhury, 2015).
The low fuel prices are considered a major throwback for manufacturers of fuel efficient aircraft like the A320ceos and B-737 Max among others. Such aircrafts were designed to counter the high fuel costs and thus improve profitability for airlines. With fuel being the major line of expenditure for airlines, most airlines had the purchase of fuel efficient aircraft in their future plans in a bid to reduce costs and thus promote profitability (Schifter, 2015). Falling fuel costs however mean that airlines have less urgency to purchase fuel-efficient airlines as the normal aircrafts will still serve cost effectively given the low fuel prices. As noted by Flottau (2015), the main argument for fuel efficient aircraft is to lower operational costs and when this becomes less important as fuel prices fall by almost half, the result is lower demand. This basically means that the demand for fuel efficient airplanes could be negatively affected by the low fuel prices as more aircrafts consider the use of old aircrafts. The low prices mean that airlines can effectively delay the expenditure on new fuel efficient aircrafts and thus invest in other activities aimed at promoting business.
The reduced demand for these aircrafts also pose a threat to manufacturers who have currently accumulated huge orders in that customers may start cancelling their orders. This as noted by Flottau (2015) has caused a panic among manufacturers who may now be forced to speed up their production processes to avoid losses in case airlines decide to cancel orders. However, some experts are confident that this scenario is unlikely and indicate that airlines will only withdraw their plans to purchase their fuel-efficient planes if they are assured that prices will remain low for many years. Boeing’s earnings for example are still expected to continue rising despite low fuel prices and cancellations have been minimal (Rich, 2015). While airlines may choose to use their older aircrafts for longer periods, the demand for fuel efficient aircraft may not be significantly affected because an increased number of people who can afford to fly will still call for the purchase of more aircrafts.
Experts in the airline industry suggest that the reduction in demand for fuel efficient aircraft may not be immediate or very evident at this particular point because airlines may not have adjusted their strategies to respond to the new prices (Rich, 2015). Furthermore, it would be difficult to judge whether the reduction in the number of aircrafts ordered is as a result of the low prices or as a result of saturated orders and backlogs held manufacturers which may force them to regulate orders. In the event that the fuel prices keep falling, a shift in the demand curve for the fuel efficient airplanes is likely to change as shown below.
| Q1 | Qo | ||||||
| Quantity | |||||||
Fig 1: Shift in the demand curve for fuel efficient aircrafts, with lesser quantities demanded at Q1.
Flottau (2015) refers to the strategy where airlines secured as many fuel efficient planes as possible as a form of hedging that is quite expensive. This followed an assumption that fuel prices will always be high as demonstrated by the global trends in the recent years; such that airlines sought to purchase the airplanes as a means of life insurance against skyrocketing prices and thus compete effectively. Until recently, the demand for the airplanes including the Boeing and Airbus have been high and order backlogs have been evident as airlines compete to own fuel-efficient planes; with manufacturers of these planes experiencing a boom. With the falling fuel prices, these manufacturers could see a fall in revenues as demand for the fuel efficient airplanes declines (Tucker, 2010). In the face of continued fall in the prices of fuel, reduced demand could see the supply curve shift to the left as indicated below. This denotes a change in the economic conditions which force the supply curve to shift as less quantities are supplied. At a similar price, p, a lower quantity of fuel efficient aircrafts will be supplied if fuel prices keep going down as indicated by q1 (Tucker, 2010).
| Price | ||||||||||
| P | ||||||||||
| Q1 | Q0 | |||||||||
| Quantity | ||||||||||
Fig 2: Shift in the supply curve of fuel efficient manufacturers
Reactions from industry players
The effects of reduced fuel prices on the airline industry are undeniable and it is expected that players from the industries will react to these changes by adopting various strategies. So how are the airlines reacting in the midst of the changes identified? Tucker (2010) notes that, whenever the price of an input goes down, organizations are often left with two choices; to reduce the price of their products, or to add onto their profitability by maintaining current prices. Either way, a company’s actions affect future profitability levels and airlines must therefore make strategic decisions to react to the price changes without affecting the demand for their services.
A majority of airlines are yet to adjust their fares to fully match the low costs of fuel; a factor that has been associated with risk aversion. Airlines are still assessing the economy to determine whether the fuel prices will remain low in the future in order to avoid situations in which they reduce fares only to hike them following changes in the fuel prices (Paris, 2015). However, various airlines including Virgin Atlantic, Emirates and Qantas have already started reducing their fares by a huge magnitude in response to the falling prices and their actions are likely to trigger similar actions throughout the industry as airlines seek to compete with their peers (Paris, 2015; Saleem, 2015).
As indicated in a discussion above, the urgency for fuel efficient airplanes is expected to reduce if fuel prices keep falling and this may be reflected by changes in company strategies. Airlines are now considering keeping their older aircraft models as opposed to purchasing fuel-efficient airplanes. It is apparent that companies are increasingly becoming comfortable with their older models and thus considering the diversion of funds intended for the purchase of fuel-efficient planes. The need for bank facilities to purchase such planes may also be suspended by such companies if fuel prices continue to fall.
Case study of British Airlines
British Airways (BA) remains one of the most influential airlines in the world and its reaction to the low fuel prices is an important industry pointer and could possibly represent the industry’s reaction. British Airways is responding slowly to the changes in fuel prices and little has been done in terms of bringing down air fares (Paris, 2015). This can be attributed to the volatile nature of fuel prices which is often unpredictable. British Airways may be reluctant on reducing air fares because there is a probability that price adjustments made may need to be revised once again when there is another change in the market. In addition, fuel prices cannot be directly translated into lower fares because the airline purchases fuel long in advance and hence the reduction in current prices cannot automatically translated into lower prices. The pressure is however high as other airlines start reducing their fares. The likelihood therefore is that British Airways may end up lowering its prices to match its peers in order to retain its market.
While lowering air fares would seem the obvious reaction by airlines following the low fuel prices, the airline should not be quick to lower their fares because the volatility of the economy may not sustain the prices for a long period. In essence, revising the company’s strategy and budget based on the current low prices may not be a valid action because there is no certainty that the prices will remain low. It is however apparent that the company must effectively study the trends in the economy and strategies that are being adopted by other airlines in order to compete effectively (Heerkens, 2004).
The low prices of fuel present a change in the business environment for British Airways and different airlines may respond in their own unique way. The most likely effect of low fuel prices would be lower fares as airlines respond to market pressures to reduce prices. BA must engage competitive positioning tactics that will ensure that despite the changes adopted by other companies in response to the low fuel prices, the company still retains its market share through the season. It is notable that due to the low fare prices, clients have a variety of airlines to choose from and it is only through creating attractive features and creating value for clients that BA will prevent the airline’s customer from going for lower prices elsewhere (Töytäri et al, 2011). In the event of a prolonged period of low fuel prices, British Airways needs to weigh the possibility of reducing air fares according to the industry standards and thus attain a competitive position in the market. Töytäri et al (2011) suggests that the quality of service must be top-notch for any company that seeks to maintain competitive positioning. He indicates that customers are not only attracted to low prices but the nature and quality of services received could make them prefer a highly priced product.
British Airways may need to re-evaluate its fleet renewal schedules as it adjusts to current economic conditions. British Airways which is known for a well maintained fleet and affinity for low-cost airplanes may use this opportunity as a chance to invest in other projects as opposed to replacing its current airplanes with the fuel efficient planes. It is notable that one of the main focus for the airline was to replace its older models with fuel efficient ones in order to promote profitability over time. The lower prices however may call for a revision of the company’s fleet renewal strategy to reduce the need for fuel efficient airplanes.
As British Airways makes strategy changes following the low fuel prices, it is imperative that the management takes into consideration the need for risk assessment (Yilmaz, 2015). Flottau (2015), notes that, as fuel prices fall, there is a likelihood of various business risks including the possibility of rising prices in the future. According to Rich (2015), fuel prices are highly volatile and an airline must be extremely careful to avoid making decisions that may place it on the wrong side of fuel prices in the future. In addition, extremely low prices may push air fares too low for the companies to make adequate profits; especially where the company has invested highly in other systems for quality assurance. Companies which have not invested highly on class and quality measures including excellent customer care, social amenities for customers and in-flight services may find it easier to drop their prices in response to low fuel prices because this is the major aspect of their expenditure. World class airlines like BA however may have a hard time matching such prices because their expenditure is beyond fuel prices only. This means that the company may end up losing its customers to other airlines and this risk must therefore be averted through risk assessment which will lead to the adoption of effective strategies. In response to such a risk, BA may invest in continued dedication to excellent customer service and advertise the airline as an airline of choice for customers who choose comfort.
Conclusion
The low fuel costs dictate a change in various aspects of the airline industry. This discussion establishes that as the prices of fuel reduce, airlines are expected to experience pressure from customers to reduce air fares; which calls for airlines to react through well designed adjustments to their strategies. In the event of continued fall in prices, the probability of a fall in demand for fuel-efficient aircraft is apparent as the urgency to save on fuel experienced during high prices diminishes. Companies like British Airways must adapt effective strategies that promise to meet the needs of customers for lower prices while maintaining decent profitability. Risk assessment is highly necessary to assure continued profitability in the face of reducing fuel prices.
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