The State Airline Virus & How To Treat It.
Prof. Rigas Doganis AMG Chairman’s article in Airline Business April 2020
The past decade has been the most profitable ever for the world’s aviation industry. Yet most state-owned or state-controlled airlines have not shared in this prosperity. Surprisingly they represent up to one third of all international full service carriers . While a few larger ones, such as Air China, SIA or Ethiopian , have been profitable, the vast majority have been loss-making or generating only marginal returns. well below the cost of capital. Chronic loss-makers include LOT , Saudia, Thai Airways, PIA , SAA , Egyptair, Royal Air Maroc, Kenya Airways, Gulf Air and numerous others.
Most state-owned or controlled airlines fail to prosper, even in good times. because they suffer from what one might call the ‘Distressed State Airline Virus’. This is a virus which, unless treated can destroy state-owned airlines from inside. Like most viruses the symptoms are clear.
A symptom common to most distressed state airlines is that they are chronic loss makers. While they may produce small profits in odd years, they have suffered losses in most years during the past decade. Their substantial losses have generally been financed by loans from government banks or agencies. So they have to service large accumulated debts. Air India, for example, in 2019 had an accumulated debt mountain of US$8.1 billion. A key feature of this virus is that such airlines are often grossly under-capitalised. Their losses and expansion have been financed by debt rather than equity.
Servicing mounting debts which means large annual interest payments. These often erode any operating profits and push the airline into further losses. The Air India Chairman and MD, Ashwani Lohani, identified this problem when he said earlier in 2019 that Air India “is poised to make operating profits this year” but will record net losses due to ” debt servicing charges”
A second common feature of distressed state airlines is that they are over-politicised in the sense that their government owners interfere frequently in managerial decisions. In return for providing direct or indirect support, such as guarantees for loans to buy aircraft or to cover annual deficits, governments and taxpayers expect to be able both to influence the airline’s management and to impose numerous obligations on the airline. Governments may require the airline to operate uneconomic routes in pursuit of social or political objectives or may influence decisions on employment policy or labour relations.
To achieve their own internal and often changing goals governments frequently replace their airline’s chairmen and chief executives whom the government itself had previously appointed. In the last ten years, Air India, Garuda Indonesia, Malaysia Airlines and South African Airways have each had six different chief executives. Elsewhere the changes may be less frequent but the effect is the same. Frequent changes at the top create uncertainty and indecision at all levels of management.
Many, but not all, distressed state airlines are characterised by a politically powerful workforce and/or strong unions. Their power stems from the ability of almost every specialised group of workers no matter how small, to bring an airline to a halt. The union leaders have traditionally used the threat of strike action to influence or to thwart management decisions at every level.
Union leaders change less frequently than the senior management, and are likely to be better informed and more knowledgeable than any new chairmen or chief executives particularly those who come from outside the airline industry. Moreover, the union leaders frequently by-pass their CEO or chairman and take their grievances or demands directly to the relevant Minister or even to the Prime Minister. This has happened at Alitalia, LOT, Thai and elsewhere.
Even when drastic action is required to turnaround or save an airline, union leaders may oppose any action in the belief that the government will continue to support the airline financially come what may .
One direct consequence of being both over-politicised and over-unionised is that distressed state airlines are also over-staffed. The unions have used their power over many years to negotiate working practices which drastically reduce labour productivity and require additional staff.
Overstaffing leads to higher unit costs in all areas. In many distressed state airlines this disadvantage is compounded by higher aircraft operating costs. They often operate mixed fleets with small numbers of several different aircraft types. Such fleets are inherently more costly to operate especially if they include older generation aircraft or a high prortion of leased aircraft. Collectively these and other disadvantages mean that the CASK of most state airlines tends to be higher sometimes, much higher, than those of competitors. In the case of the Air India its CASK is around 20% higher than that of its Indian competitors.
Distressed state airlines suffer from having no clear and coherent development strategy. This is not surprising given the lack of management continuity and frequent turnaround plans produced by succesive consultants. Government interference may further confuse the management by imposing constraints on the airline. Governments often use their airline to pursue various social, economic or political objectives some of which may be mutually inconsistent.
Overstaffing, frequent management changes and constant political interference breed a bureaucratic management culture in which senior and middle managers are afraid to take decisions and bureaucracy stifles initiative. Memos, requesting authorisation for a particular decision, are passed slowly up the pyramid gathering signatures on the way. Decision-making becomes increasingly slow and concentrated at the top of a sharply pyramidical management structure.
The major symptoms of the virus, as described above, will manifest themselves to varying degrees at different airlines. Any airline which is suffering badly from several of these symptoms is in serious trouble. It is in danger of being permanently on the sick list and perhaps eventually expiring.
SYMPTOMS of DISTRESSED STATE AIRLINE VIRUS
There are several crucial steps to a successful turnaround. The first and most urgent requirement for distressed state airlines is financial restructuring through debt write-off and/or the injection of substantial fresh equity capital. The debt write-off is crucial to relieve the airline from high annual debt servicing charges. New capital is also required in the form of equity, and not as a loan, to pay for the costs of putting the airline on a sustainable financial basis .
Writing off airline debts requires a strong political will on the part of the government owner since such debts are often owed to government banks or agencies or have been guaranteed by government. Writing off debts immediately impacts adversely on the balance sheet of the government or its banks . So writing off airline debts requires a strong political will on the part of the government owner. Yet these debts are unlikely ever to be repaid.
The second and immediate step for the airline’s management must be to focus on reducing costs in all areas. Staff costs are likely to be the largest cost item apart from fuel , so reducing staff numbers and improving labour productivity must be an urgent priority. The network needs to be optimised to remove loss-making services and perhaps launch new ones. This in turn will require fleet rationalisation and possibly renewal . Some functions traditionally done within the airline, such as aircraft maintenance or ground handling, may need to be outsurced to reduce costs. The airline will also need to ensure that its product and services are competitive and must improve its marketing with a focus on e-commerce . These measures may be costly hence the need to inject some new capital into the airline .
Thirdly, the senior airline executives need to develop a coherent long-term strategy for the future growth and development of the airline. This should be discussed with and agreed to by all key stakeholders including government. Restructuring needs to be done with the support and co-operation of the workforce as many of the necessary actions may upset those employees who fail to grasp that change is the prerequisite for survival. So it is crucial to ensure that the workforce, as a major stakeholder, buy into the airline’s long-term strategy from an early stage. The government too must agree to and own the strategy.
Fourthly, once the long-term strategy has been agreed to by the stakeholders, then the airlines’ executives must be allowed to implement it without interference from their governments. This requires a change of attitude and thinking by many government owners.. They need to distance themselves from the day to day issues affecting their airline and think of themselves as pure equity shareholders. Governments and key Ministers should also avoid being pressurised by unions or the workforce behind the management’s back.
The final step is to have stable and professional senior executives, who are not changed every two years, and who have clearly defined business aims free from any form of political interference.
Some state airline Chairmen see equity alliances as a panacea. They believe that weak state airlines can save themselves by entering into an equity alliance with a larger financially strong airline. The latter can inject capital into its weaker partner as well as some management expertise. But alliances are not an end in themselves. They can reinforce a competitive advantage, if one already exists, but they are rarely the means of creating it. The recent experience of the Alitalia-Etihad equity alliance is ample evidence of this .
Partial or full privatisation is also seen by some governments as a solution . But again this will only suceed if the symptons of the virus have first been eradicated.
The government owners or controllers of distressed state airlines must face up to reality and embrace the remedies and policies suggested above . Not an easy decision. Governments need to absorb the cost of writing off their airline’s accumulated debts as well as the cost of injecting any new equity capital needed. Yet at the same time they are required to distance themselves from the management of the airline into which they have poured a great deal of money. This contradiction may be difficult to accept !
In the 1990s several European governments faced up to this contradiction and successfully salvaged their state-owned airlines as a first step to privatisation
The remedies recommended will not ensure state airline pfitability in all cases but they can make it more achievable . Unless the recommended actions are adopted by their governments, distressed state airlines infected by the virus will be chronically unstable, regularly haemorrhaging capital and on the verge of collapse.