Sep.9th: Will They Follow? A Discussion on The Possibility for Chinese Domestic Airlines to Cancel Change Fees

Cover Photo: An Air China’s 777 pushing back to Shenzhen in a bright morning.

Introduction
On August 30, 2020, United Airlines announced an exemption on domestic ticket change fees, along with same-day free stand-by for frequent fliers. Delta Air Lines and American Airlines followed suit a day later, promulgated similar policies focusing on making re-schedule free-of-charge. There must be distinct benefit for three major carriers in United States to waived this major revenue source: as shown by Andrew J. Hawkins, $2.8 Billion was brought by change fees in 2019 for the air industry. So here comes the question: will Chinese domestic airlines follow the same trend? This article aims to discuss the content and effect of the policy, and compares American market to Chinese market, to show why the possibility of similar approaches are very small.

Early Morning Departure of Air China’s A330

Analysis on New Policy

The new policy waived change and cancellation fees for economy class (except basic economy) of domestic flights, while the details vary. United Airlines (UA) enable customers to reschedule as they wish, to flights both earlier and later disregarded the price difference. American Airlines (AA) waived the changing fees, but passengers still need to make up for the possible difference on air fare. Delta Air Lines (DL) proposed similar approaches to AA’s, and announced that it will lock the middle row on the aircrafts until January 2021, in order to “offer safer travel space.”

Obviously, this move can stimulate demand, as less restriction means more choices (rights to change, a less crowded cabin) with the same price. But why should airlines voluntarily benefit the customers, by throwing away a steady source of revenue? Take Delta Air Lines as an example. In 2019, DL gained 1.8% of total revenue and 17.4% of total profit from tickets refunding and changing commission, a total number of $830.2 million USD. And those are easy money, as airlines only need to do forecast management by using overbooking models. Illustrated by International Air Transportation Association’s Airline Revenue Management, such a model could easily deal with cancellation and protect from spoilage (An aircraft took off with empty seats while there is still demand) with involuntary denied boarding only 8 out of 1000 passengers, a failure on overbooking model of which customers could not board on the aircraft due to airline’s problem. 

The validity of this revenue source is demonstrated by airlines’ market power, and basic game theory. If one airline cancelled the fee, than customers would become frequent fliers of that airline. For other airlines, their dominant strategy is to appeal the customer back, by similar approaches or others, ultimately hurt the profitability. After another period, the market turned to another balance as all airlines now provide more service (or less restriction) with similar or lower air fare, while customers would be accustomed to and benefitted from such a friendly environment. As airlines are the price-maker and can forecast a solution only favored customers in the long run, maintaining high cancellation fees industry is the dominant strategy. 

In the context of Pandemic, there are ample grounds for airlines to throw this revenue source away . They are trying to save themselves by throwing pure gold ballast when the boat is sinking, sacrificing profitability for liquidity. Airlines are facing serious cash consumption since the start of Pandemic. In the report on March 24, the International Air Transport Association (IATA) pointed out that “Only by itself, the airline’s cash flow is difficult to last for two months.” 

Source: IATA Economics using the Airline Analyst

Although many airlines have received government subsidies, for example Emirates has received government assistance worth $2 billion USD, the situation for airlines in United States is not optimistic: The Coronavirus Aid, Relief and Economic Security Act (CARES Act) passed in March this year will expire at the end of September. If the CARES Act expired with no further aids, United Airlines and American Airlines will have to downsize 35,000 employees (CA DATA). The vacillation of US government aids has caused airlines to deal with the urgent need, an enormous cash burn on their own. There were previous attempts to solve the problem by advancing future revenue, when IATA tried to advocate Electronic Miscellaneous Document (EMD) as a buffer. But because EMD infringed on consumer rights, this short-lived strategy was banned by regulators in China, the United States and Europe. 

This theory is further backed up by US carriers’ attitude toward “refunding fee”, the commission for demanding cash return instantaneously. Take American Airlines as an example. If you want to enjoy the exemption, instead of cash refund, customers would receive a set of “numbers with value” for future re-scheduling. This string of numbers possesses all the attributes and abilities of IATA’s EMD except being officially granted: “collect previous payments” and resemble “value document goods”, use in “future travel plans.” The three major U.S. airlines obtain the legal use of EMD by losing their own profitability, to achieve the purpose of delaying payment and alleviating liquidity. Although the change fee is lost, changing the existing refund requirement (payment of cash) into an order on the future flight (expected) has achieved the problem of alleviating the consumption of cash flow.

For passengers, these “free voluntary changes” are essentially buying tickets for early 2021 in early 2020. There must be a price difference due to the advance booking period, which is not included when airlines return EMD in AA and DL’s way. Passengers’ cash will still be held in airlines’ hand, and will be delivered as a redeemed ticket.

In a nutshell, due to the uncertainty of government assistance and the continued downturn in the domestic market, UA, AA, and DL had to sacrifice profitability in exchange for liquidity, using the same logic as had been used via EMD in April to “hold up” cash flow and ease liquidity crisis as much as possible.


Analysis from Market perspective

DL and AA immediately followed UA up the next day, as what would always happen in American market. So, will Chinese carriers to adopt a similar strategy? According to current evidence, the chances are small.

Source: OAG Aviation. Seats Added/Removed by Airlines.

In addition to alleviating the liquidity crisis, this move by the three major US airlines will also stimulate demand in future recovery period. Although part of the passenger flow will not bring profit as they were advanced by “valuable numbers” as discussed in the previous part, the recovery on capacity will provide a basis for the recovery of air fate, and will also boost airlines’ ancillary revenue. According to data from OAG Aviation, the U.S. market has not yet bottomed out, and the number of seats is still showing a downward trend. In such a market, carriers held pessimistic outlook, DL even chooses to lock in the middle row to increase the comfort, in turns the demand, from customers. IATA calculated a similar “social distancing” selling method in May, and pointed out that this method would not be profitable.

In Chinese domestic market, however, increasing capacity by reducing air fare is no longer applicable. According to OAG’s data, Chinese domestic market showed an 8% year-on-year growth in capacity, and the growth trend is significant compared to previous quarter. Different from U.S market, Chinese’s airlines are trying to restore air fare and achieve profitability as capacity has restored, not further increasing capacity. While with a 48% year-on-year decrease, U.S market had to increase capacity urgently.

The exemption will no doubt reduce the airline’s profitability, which would let Chinese carriers lost a precious revenue stream. The abandonment of revenue sources obviously contradicts the main objective of domestic airlines, and the stimulation brought about in U.S market will not be obvious in Chinese market. Chinese airlines have survived the most difficult moment under the effective aid policy.

Heavies are back due to fast recovery on low-value demand

Summary

In sum, American carriers are facing problem of liquidity. They have to survive in a market of weak demand and fewer government stimulation plans. For their current goals, giving up long-run profitability for short-run cash could be a great move. Due to different stages of recovery, Chinese carriers’ primary goal is to gain profitability back as liquidity and demand recover fast. Attributed to different market structure, cancellation on changing fees is not suitable for Chinese domestic market.

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