Many of the world’s airlines experienced a dramatic improvement in financial results in 2010. In fact, a combination of factors worked to create what many called “a perfect storm” for carriers, prompting the International Air Traffic Association (IATA) to dramatically revise its initial forecast of airline net profitability for 2010 to $15.1 billion USD – a 70 percent increase over what IATA had predicted just three months earlier.

While some factors contributing to the airlines’ recent good fortune – such as lower fuel costs and increasing demand – have been out of their control, the carriers have been able to influence their profitability in a number of ways. A key example is the capacity airlines eliminated globally over the past several years by suspending service on low-demand routes and by reducing service frequencies and/or shifting to smaller aircraft on some city pairs.

This action was initially taken out of necessity, but as travel demand has improved, it has translated into stronger pricing power for the airlines. As a result, carriers are expected to be disciplined about adding back capacity in order to continue commanding higher rates. According to OAG (Official Airline Group), there are only 6 percent more scheduled airline seats in operation worldwide this month vs. January 2010, despite travel demand that is increasing by double digit percentages in many regions. Of course, the severity of the gap between demand and available capacity will continue to vary greatly by location and will remain highly dependent on market dynamics.

Why it matters

• Increased importance of advanced booking The continued expectation for increased demand and limited supply makes advanced booking as important as ever to ensure travelers can effectively reach their destination to conduct business. Organizations particularly challenged by this may consider increasing the advanced booking recommendation in their travel policy to ensure availability and manage costs.

• Potential impact to contracts In some instances, a preferred airline’s capacity reduction efforts may result in lack of availability or uncompetitive pricing in certain markets. If these factors force companies to frequently use airlines outside their program, they may become at risk of not meeting market share commitments, putting negotiated discounts in danger. Buyers who notice this happening should address it with their airline partners immediately.

What to look for in the future

• Higher prices Air fares will increase in 2011, due to reduced capacity and a variety of other factors. This, combined with additional price increases expected in other areas of travel, presents a real challenge for organizations trying to contain costs while maintaining travel as a way to achieve business goals. Travel managers should focus on making their program as effective and efficient as possible, including looking for incremental savings opportunities that likely exist in other areas.

• Continued airline caution Significant regional differences are anticipated in terms of economic growth and travel demand. In Europe, air travel taxes in Germany, Austria and the United Kingdom may reduce air demand in favor of rail where available. Additionally, the price of oil is slowly rising, with Brent crude approaching $100 USD per barrel. These factors will likely prompt airlines to remain cautious about adding back capacity. Meanwhile, airline systems for managing inventory and yield will continue to become more sophisticated, enabling them to respond to capacity fluctuations and other dynamics more quickly.