14
PRICE, PRODUCTIVITY AND FINANCIAL PERFORMANCE IN THE
TRANSPORTATION SECTOR
Air Transport Industry
Over the past two years, the Canadian air industry has undergone
a series of mergers and acquisitions aimed at improving productivity
and financial viability through restructuring.
In 1998 and early 1999, both Air Canada and Canadian Airlines
International restructured their regional affiliates. Air Canada
merged its two eastern regional carriers, Air Nova and Air
Alliance, while Canadian Airlines sold one of its regional affiliates,
Inter-Canadien, and legally amalgamated two others, Time Air and
Ontario Express,Note
5 into Canadian Regional.
As the financial viability of Canadian Airlines and its affiliates
became precarious in 1999, further restructuring was initiated.
On August 13, 1999, the federal government established
a special process to facilitate the orderly restructuring of the
airline industry. Further details are presented in Chapter
11, Structure of Transportation Industry.
This section does not analyze the performance of individual
carriers in detail, but instead looks at the industry's overall
performance. Because of limited data, the industry is taken to
be most of level I and II air carriersNote 6 for the purpose
of this section. This group accounts for 82 per cent of total
industry revenues. In 1998, these carriers generated total revenues
of $10 billion, an increase of 7.6 per cent from 1997. However,
falling productivity and significant increases in factor prices
resulted in a sharp decline in industry profitability.
Price and Output Indicators
In the first six months of 1999, output grew by 2.0 per cent
whereas prices increased by 4.9 per cent. In 1998, the aggregated
airline price and output levels were affected by a labour dispute
at Air Canada and by several external factors, including a severe
ice storm in eastern Canada, a weaker trans-Pacific market, stiffer
price competition in domestic and international markets, and the
replacement of the Air Transportation Tax (ATT) by NAV Canada
fees. Overall, in 1998, the industry had an average price increase
of 3.3 per cent and output increase of 6.1 per cent.
Part of the price increase was due to the implementation of
NAV Canada air navigation fees. Prior to the privatization of
air navigation services, navigation fees had been added to the
price of air tickets paid by consumers in the form of the Air
Transportation Tax, the proceeds of which funded those services.Note
7 Since March 1998, air navigation fees are no longer
secluded as a tax but are included in the operating expenses of
the carriers, and the carriers in turn recover them through the
prices they charge. Previously, the Air Transportation Tax was
not taken into account in the analysis of air prices. It is estimated
that the new air navigation fees explains most of the price increases
of the carriers. But, since these fees replaced the Air Transportation
Tax, the net price increase in 1998 was close to zero. Consumers
have benefited from the new system. Using 1997 traffic to simulate
the differences between the Air Transportation Tax and NAV Canada
fees, the air navigation fees, as revised in September 1999, would
produce approximately ten per cent less revenues than
the Air Transportation Tax.
Table 14-9 shows the effect of navigation fees on air carriers'
revenues by sector. On average, the new NAV Canada fees are
estimated to have increased carriers' prices by 2.6 per cent.
The largest impact was on domestic services, the prices of which
rose by as much as 3.6 per cent. The impact is larger
on domestic services, since distance on the Canadian territory,
a key parameter of the navigation fees, is shorter on international
flights.
![](/web/20060212045306im_/http://www.tc.gc.ca/pol/en/Report/anre1999/graphics/chap14/99t14e09.GIF)
From 1991 to 1998, output of the airline industry increased
by 51 per cent, while average prices increased by only 2.5
per cent. The prices of domestic passenger services rose by 3.4
per cent; once the effect of the NAV Canada fees is accounted
for, domestic passenger prices in 1998 were at about the same
nominal level as in 1991. This corresponds to an 11.5 per cent
decline in real terms and has stimulated domestic demand,
which increased by 28 per cent. Transborder is the only
market segment that experienced growth in both price and output
over this period, by 35 per cent and 98 per cent,
respectively. Since 1991, discount fares have largely contributed
to the 12 per cent decline of the price of international
services outside the US, and to significant demand increases.
Total airline revenues from freight activity have increased
between 1991 and 1998 by 14 per cent, while air cargo rates
declined by 5.6 per cent. The volume of air freight grew
by 21 per cent over the same period. Overall, if air transport
prices had grown at the rate of inflation during this period,
airline users would have spent $625 million more to
travel than they did in 1998, a net saving of seven
per cent. However, the inability of some air carriers to align
price changes to the evolution of their cost structure was
one of the major factors that rendered them unprofitable.
Cost Structure
The cost structure of the industry, in terms of the split between
variable and capital cost, is relatively stable, at 82 per
cent for variable and 18 per cent for capital. There were,
however, some major shifts within the variable cost group
during the eight-year period.
Labour costs represented about 24 per cent of total variable
cost in 1998, close to that of 1997, but was 3.4 percentage
points lower than in 1991. Fuel cost share was around 14 per cent
of total in the aviation sector from 1991 to 1997, but dropped
to 12 per cent in 1998. Other variable costs as a group (airport
and navigation fees, marketing, materials and other expenses)
represented a cost share of 46 per cent in 1998, significantly
higher than 40 per cent in 1991.
Capital costs as a share of total cost have not changed in
1998. There has been a shift from owned to leased assets. The
leasing component within capital costs went from one third
in 1991 to more than one half in 1998.
Productivity and Unit Cost Indicators
Between 1991 and 1998, total factor productivity of the airline
industry as a whole increased by 27 per cent, with most of the
gains achieved in 1996 and 1997. Since 1991, the unit cost of
the air industry has declined by nine per cent, half the
cost decline observed in the railway industry over the same period.
This cost performance was one of the factors that has, since 1991,
allowed the major air carriers to keep factor cost increases below
inflation and achieve cumulative annual cost savings. By
1998, these savings had reached $1.3 billion, or 14 per cent of
the cost base of the airline industry.
In 1998, the productivity of the airline industry dropped by
6.5 per cent, while unit cost increased by 5.1 per cent. This
performance explains the decline in profitability of the industry
during the year. For instance, after inflation, industry costs
increased by $348 million whereas revenues grew by $55 million.
The performance of individual carriers, however, varied significantly.
Air Canada's productivity was adversely affected by its pilots'
strike, while Canadian Airlines was subject to market competition
preventing it from passing its cost increases on to users.
With the exception of fuel, all major cost groups (including
labour, airport and navigation fees, aircraft rents and marketing
expenses) contributed to a 13 per cent increase in total cost
in 1998. The productivity decline meant higher unit costs,
but industry costs also rose because of exchange rate variations.
The devaluation of the Canadian dollar against the US dollar
had a significant impact on some large Canadian carriers, as part
of their expenses (such as aircraft rents, commissions and other
purchased services) were incurred in US dollars. It is estimated
that exchange rates had the effect of raising input prices
by about two per cent.
Financial Performance
The net cost reduction, after price reductions, between 1991
and 1998 reached $676 million. They were not, however, sufficient
to offset the cumulative economic lossesNote 8 of close to $3.3
billion accumulated by the industry over the same period. Such
losses, sustained over several years, resulted in the structural
changes experienced by the industry in 1999. Figure 14-2
shows cumulative financial losses and cost reductions in the airline
industry from 1992 to 1998.
![](/web/20060212045306im_/http://www.tc.gc.ca/pol/en/Report/anre1999/graphics/chap14/99f14e02.GIF)
Canadian Airlines accumulated financial losses in 1998 and
1999 of $360 million. These consecutive losses have compromised
the viability of the carrier. In December 1999, the majority of
the shareholders of Canadian Airlines accepted Air Canada's purchase
offer. The performance of Canadian Airlines' regional airlines,
for the most part, was also not robust.
Air Canada's profitability was adversely affected in 1997 and
1998 by a labour dispute and several external factors. There was
significant improvement in 1999. However, its operating income
rose to $503 million, from $144 million in 1998, and its
net income reached $213 million, compared with a $16 million loss
in the previous year.
In 1998, the total combined revenues of Air Canada and Canadian
Airlines, including their affiliates, amounted to just over $9
billion, an increase of six per cent from 1997. Total cost, however,
increased by nine per cent. As a result, their average
operating ratio deteriorated to 98.7 per cent from 94.6 per cent.
Table 14-10 summarizes the financial results for the airline industry.
![](/web/20060212045306im_/http://www.tc.gc.ca/pol/en/Report/anre1999/graphics/chap14/99t14e10.GIF)
Lower productivity performance and rising costs were major
factors in the sharp decline of the air industry's profitability
as a whole in 1998. Furthermore, relatively high debt costs added
to net losses for some carriers.
In 1999, total combined operating revenues of Air Canada
and Canadian Airlines climbed to $9.8 billion, an increase of
seven per cent from 1997. Total cost, however, increased by five
per cent. As a result, their average operating ratio improved
to 95.3 per cent. Fourth quarter results of Canadian Airlines
are estimated.
In 1998, the independent carriersNote 9 as a group also showed
a deterioration, with their average operating ratio climbing 3.6
percentage points to 97.6 per cent.
Air Transport Industry
NOTES:
5
Ontario Express operated under the name "Canadian Partners."
6
Air Canada, Canadian Airlines, Air Nova, Air Atlantic, Air Alliance,
Inter-Canadien, Air Ontario, Ontario Express, Time Air, Air BC,
Air Transat, Canada 3000, Royal Air and WestJet. The last four
carriers are not included in the productivity and cost analyses.
7
The Air Transportation Tax was reduced by approximately one half
in March 1998, and subsequently eliminated in November 1998. Correspondingly,
the new fees introduced by NAV Canada were set at 50 per cent
of fees required to achieve the recovery of the services.
8
The economic loss is the difference between the operating margin
of the firms and the capital cost that ensures their financial
viability.
9
Air Transat, Canada 3000, Royal Air and WestJet.
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