Across the world, many a fortune has been lost on airlines—most of it consisting of taxpayers’ hard-earned money. Given the abysmal record of state-owned airlines the world over, consensus has finally emerged that governments have no business being in this business. Many countries have been exploring private sector ownership of their national airlines, and IFC Advisory Services in Public-Private Partnerships has worked on nearly a dozen such transactions. Some of these deals were successful; some failures; all were extremely difficult. The upside of IFC’s vast experience at the sharp end of airline reform is that we can share the lessons learned.
Lesson 1: Watch the bottom line (slip away)
The joke goes like this: How do you make a small fortune from airlines? You start with a large one. For a variety of deep-seated structural reasons, airlines have an amazing capacity to lose money. Some of the biggest problems include:
- High fixed costs: The vast bulk of airline costs—fuel, staffing, capital costs—are fixed in nature and largely beyond management’s control.
- Overregulation: Bilateral agreements between governments prevent competition from functioning normally.
- Leverage: National airlines invariably have excessive debt due to the exorbitant cost of purchasing aircraft plus years of unprofitable operations.
In 2004, 70 percent of Samoa’s budget deficit was due to losses at Polynesian Airlines. This served as a motivation for reform, but also a warning that success would not be easy.
Lesson 2: Use your political capital
Throughout the world, airlines are viewed as national treasures that deserve special prestige and a prime spot in a nation’s heart. Working at an airline is seen as an honor, and government-owned airlines invariably become over-staffed by political appointees. With their fleets of old and uneconomical aircraft, most national airlines share three common characteristics: they are unprofitable, unreliable, and unsafe.
In attempting to privatize under these circumstances, it is essential to have key champions within the government, and earn the confidence of the airline’s management.
Lesson 3: Cheap flights mean more travelers
Empirical evidence suggests that when a low-cost carrier (LCC) enters a market, prices fall by an average of 20 percent over the first four years, resulting in traffic increasing by about 50 percent over the same period. What does this mean for reforms?
First, if reform brings competition to the aviation market, tourism numbers should grow, creating a powerful incentive for government to complete the transaction. In Samoa, although several hundred jobs were lost in the restructuring of the airline, an estimated 2,000 new downstream jobs have been created by new tourist arrivals—in a country with a total population of only 180,000. In three years, this transaction has taken several percentage points off the national unemployment rate—a significant impact. Enlisting support from other players in the tourism sector (hotels, travel operators, and the like) is an important way of mobilizing support for reform.
The second lesson is that sometimes the most important consideration is not the price at which the national airline is sold, but to whom. The strategic airline partner must bring more to the table than just money—otherwise, the transaction may be completed, only to see the privatized airline go bankrupt a few years later.
Lesson 4: Competitive bidding may not always be possible
It is international best practice for governments to implement reforms through competitive tenders. However, in the aviation sector there may be justification for suspending this rule. In airlines, the key objective is often finding a strong airline partner that can provide access to global networks and a lower cost base. The detailed terms are often more significant than the price paid, and are too voluminous and complex to encapsulate within a competitive bidding structure. In such situations, the country’s interest may best be preserved by a process of “competitive negotiations” rather than by an outright bid.
Lesson 5: Don’t be afraid of failure
Given the inherent economic difficulties of the global airline sector, plus the irrational attachment people and politicians have toward airlines, it is not surprising that more than half of all attempted airline privatizations globally have ended in failure. This is due primarily to a lack of “acceptable” buyers. Inevitably IFC has had its fair share of failures, even after customarily going above and beyond the call of advisory duty. We all have failures; the important thing is to learn from them.
In Cameroon, IFC learned from its experience advising on the privatization of the chronically loss-making Camair. Against all the odds, IFC brokered a $15 million investment by SN Brussels to create a new national airline. The government ratified the deal; statements were released; everyone was happy. Well, not quite everyone: at the very end, the anti-reform faction within government played its trump card, cancelling the deal for a variety of trumped-up reasons. And so the cash cow Camair stumbled along, leaving a trail of missing millions under suspicious circumstances in its ever-widening wake. Lesson learned: without a home-grown desire for reform, and a strong political champion, don’t waste your time.