Thursday, September 28, 2023

Flying through the Turbulence Part 4: Costs and the Way Forward

Leonard Khafafa - Public Policy Analyst

A lie can travel halfway around the world while the truth is putting on its shoes-Mark Twain.

Flying through the Turbulence Part 4: Costs and the Way Forward: The Popular Culture dictionary describes cancel culture as “the popular practice of withdrawing support for (cancelling) public figures and companies after they have done or said something considered objectionable or offensive”

Kenya Airways (KQ) has been in the crosshairs of a vicious cancel culture for receiving bailouts. The board has been accused of incompetence. Kenyans have even called for the winding up of the airline.

It has been pointed out, and rightly so, that most KQ flights operate at full capacity. However, many do not understand how an airline operating at 70 per cent and above load factors can possibly suffer annual losses which for the most part is attributed to corporate malfeasance.

The difference between the top line, representing increasingly growing revenues, and the bottom line is costs. Simply put, income from all airline activities is less than the expenses incurred in the generation of that income. And therein lies the rub! This article examines this existential crisis and proposes a raft of possible solutions.

Flying Through the Turbulence Part 1

For a start, it must be appreciated that most of the costs contributing to annual losses are legacy costs. These are costs incurred by an organization in prior years under different leadership or when the entity’s priorities and resources were different.” Decisions resulting in legacy costs can be difficult, sometimes even impossible, to reverse.

The Boeing 777-300s, large wide-body aircraft for a relatively small airline like KQ, are exemplars of legacy costs.  For ease of understanding, wide-body aircrafts are planes with twin aisles. They have a fuselage that is wide enough to accommodate two-passenger aisles. These obtain rows of seven or more seats abreast.

Previous articles have explained how these aircrafts were intended as a stop-gap measure. Delays in the delivery of the fuel-efficient Boeing 787s, crucial for the airline’s Project Mawingu expansion strategy, left KQ without wide-body planes.

However, there were external demand shocks that impacted favourable loads for the 777-300s. First, there was an Ebola breakout in West Africa that precluded KQ from flying there. Then a civil war broke out in Central Africa.

Other issues like terrorist attacks in Nairobi decimated demand from the European market on which the expansion plans were predicated.  As a result, KQ got stuck with wide-body planes that could not be used optimally yet had to keep paying for them. This contributed significantly to the onerous cost burden.

But it is the 2020 Covid-19 pandemic that put a damper on KQ’s recovery efforts. It forced the airline to suspend all its passenger flights following the cessation of all international flights to and from Kenya.

Flying Through the Turbulence Part 2: The Kenya Airways Debt

Grounded aircrafts meant revenue sources were cut off. But while revenue was cut off, there were still costs to be met to keep the airline afloat. Some of these costs included staff salaries, albeit on pay cuts and aircraft ownership loan repayments.  Consequently, KQ’s net loss for the financial year ended December 2020 nearly tripled to Ksh.36.2 billion.

Currently, industry pundits estimate that Ksh.420 billion is needed for KQ to retire all legacy debts and to have adequate working capital. Various scenarios have been contemplated as a way forward for the airline. Many have suggested that KQ should be wound up and a new entity incorporated in its place.

But there are more cons than pros to this. First off, the bulk of KQ’s debt is guaranteed by the Kenya government. The guarantees would fall due with the winding up of the airline putting undue strain on the taxpayer. This is in contrast to the current more structured piecemeal payments by the airline that will eventually see KQ discharge its debt as it moves towards profitability.

South African Airways took the winding up path. It has not been easy for them to start a new entity. One of the conditions of winding up was that they had to find a financier for the new entity, a challenge they have yet to overcome. Should KQ be wound up, the Kenyan government would still have to pump in money to fund the new entity.

Flying Through the Turbulence Part 3: KALPA and the CBA

Second, the new entity would need to be designated afresh to all the destinations KQ travels. Resetting up would also require effort and resources to get the new entity off the ground and to recapture the market. It is at this stage that many airlines fizzle out of existence.

A second option on the table is to look for a strategic investor to buy a controlling stake in the airline. The advantage of this would be the injection of much-needed operational capital.  The investor would leverage KQ’s brand equity to grow the airline’s profitability. However, some disadvantages would obtain. For instance, a major investor would likely be an existing carrier from the Middle East or from Europe.

It is probable that such an investor would take over KQ’s most profitable routes and diminish the importance of Jomo Kenyatta International Airport (JKIA) as a hub. Should the investor insist on a change in management, and by extension strategy, there would be a risk of failure of such changes to align with the Government of Kenya’s strategy for the country.

The third option is the consolidation of all national aviation assets into a single entity. This presupposes that any loss-making arm of the group would be supported by more profitable arms. Airlines like Ethiopian Airlines, Turkish Air, Qatar, and Emirates have successfully used this model to profitability. The National Aviation Management Bill of 2020 had this in mind when it proposed a consolidation of Kenya Airways, Kenya Airports Authority, and the East African School of Aviation.

The current board and management of KQ have worked to reduce the cost of running the airline. Already, they have negotiated with lessors to bring down the cost of leasing aircraft by 19 per cent. A further 26 per cent reduction is contingent on the clearance of arrears accumulated during the Covid-19 pandemic when aircraft were idle.

Jalang’o enrolls in aviation school to achieve childhood pilot dream

Whichever option the airline takes going forward, the issue of pilot remuneration remains the elephant in the room. Despite their productivity being at a third of their potential, KQ pilots continue to draw inordinately high allowances.

For instance, they draw a guaranteed layover allowance for 10 nights per month in an outstation whether they are at work or not.  This allowance was paid in the year 2020 even as all aircraft were grounded on account of the Covid-19 pandemic.

It would be more beneficial to all to replace this allowance with a variable productivity-driven allowance based on achieved nights.  In 2019, the company paid in excess of $2.5 million for nights not achieved.

Despite the arduous challenges facing it, KQ has been on a recovery trajectory.  This is reflected in the reduction of year-on-year operating losses by 14 per cent in 2012 and 17 per cent in 2022. It needs the support of all patriotic Kenyans.

Airlines like Rwandair have yet to break even yet the Rwandan government has committed USD 2 billion in the development of the country’s aviation assets. Qatar turned a profit for the first time in 2021.

Ethiopian Airlines and Emirates are heavily subsidized by their governments. That KQ needs liquidity injections from the Kenya government is not unusual. Nor should the airline be seen as an interminable money pit but as an important strategic national asset that contributes immensely to the country’s GDP.

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