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Risks and Their Management in the Airline Industry: An Essay
Every organization has number of risks and its crucial to assess and evaluate the risk through risk management system. Risk management system refers to the process of identifying, assessing, and controlling the challenges or threats that face the capital and earnings of an organization. These risks could be natural calamities, data breach related risk or financial uncertainties.
The aircraft industry deals with enormous risks on regular basis, from a swing in the currency exchange rate and the cost of fuel to huge capital expenses, instability in travel demand, and rivalry from carriers operating in a small zone. And many airlines have gone through bankruptcy or been acquired by larger organizations (Gong, 2007). There are many risk management strategies approached by airline industry such as leasing, hedging, capacity management, and revenue management. Market leaders in the industry explore various option for mergers and acquisitions and their less travelled path are subcontracted to regional airlines. At operational level, based on demand frequency of flights and aircraft sizes are varied (Wei and Hansen, 2006). Fuel cost is a primary concern for airline industry, ranking first in operational cost. According to airlines fuel cost account for 10-45% of total expenditures from 2003 to 2013 (Ryerson and Kim, 2014). And relevantly mergers have been a good solution in decreased fuel consumption.
Risks of the Airline Industry
Currency Exchange Rate
Airlines have many operational costs such as pay for labor, fuel and other costs in multiple currencies and are exposed to fluctuation in exchange rates. Sometimes these fluctuations are beneficial for the company when the expenses are in other currency (weaker) and earning are in dollars. In some cases, companys operational procedures can reduce the risk of exchange fluctuations. Many organizations actively manage currency exposure by swapping between multiple currencies based on weakening of that currency in that week. In 2009, Emirates exchanged between several currencies, paying expenses in euros, Australian dollars, New Zealand dollars, Japanese yen. The airlines reported the AUD receipts were fully hedged and other currencies were hedged at 56%, 29%, 38% respectively (Ren, 2017).
Fuel Costs Fluctuations
Airlines experience huge risks due to fluctuation in cost of crude oil. A sharp increase in crude oil prices leads to great recession. Once prices were increased from $20 barrel to almost $140 before falling to $40 in a short period and again recovered to $110 and fell back to $30 (Sibdari, Mohammadian and Pyke, 2018). In such instances airlines makes a contract policy with the providers. For example, Southwest Airlines Cost per gallon was $50 per barrel, while the market price was $100 (till 2008). These huge differences bring high profitability to the airlines as compared to their competitors. And then there was recession in fuel prices and airlines experienced huge losses due to hedging contract. In 2016, Cathay pacific posted a net loss of $74.01 million due to bad fuel hedges. Singapore airlines were analyzing long term and short-term fuel hedges and their maturity and came up with figures for different quarters these showed up a loss of S$365 million till December 2016 (Park, 2017).
Many airlines stopped hedging in 2014. On the other hand, Alaska Airlines approached different strategy to counter this. Rather than buying future on crude oil, these airlines purchased insurance which would come into picture only when prices rise over a matured cap. With this Alaska saved around $300 million with cheaper fuel prices (Gosai, 2017).
Capital Expenditure
Business expansion for airlines includes expanding flights and routes they operate. As airlines expand, the order for new aircrafts is surging (Kamihsni-Morrow, 2017). The risk arises how the airlines would deal with huge capital costs to serve in new routes. It is very rare that airlines funds for the aircraft at once. Rather they lease aircraft from leasing company (Russell, 2017). Even if they purchase aircrafts, they will sell it to a leasing company and lease it back from them.
Capacity and Revenue Management
As airline industry faces challenges with rise in fuel prices or travel demand and swing in economy, they make decision about capacity of aircrafts and operating routes and frequency of flights. It only takes few months to re-assign flights to a new route while it takes years of time for delivery of a new flight (Cryderman, 2016). Another approach is re-fleeting through which airlines can accommodate passengers on other flights of same time schedule, since airlines pay penalties for re-fleeting unless all tickets are booked this approach is not frequently used. And other method used is upgauging where seats are added to existing flights based on demand (Carey & Nicas, 2015). Like some airlines switch to smaller versions from 747s to 737s based on travel demand on these routes.
Conclusion
Airline industry manages risk from various sources. The way airlines address them through various strategies, i.e., currency hedging, fuel hedging contracts, leasing contracts, insurance and other revenue management techniques has mixed outcomes some are positive and some are painful.
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