Poor tactical decision making was the cause of SAA’s downfall

For much of 2020, there was a lot of industry focus on the business rescue of South African Airways (SAA). It is no secret that South African State-Owned Entities (SOEs) are underperforming organisations and face a lot of pressure in periods of normal disruption.

The reason why there was such a significant focus on the SAA business rescue was because, being the first SOE that was placed into business rescue, it could be seen as a test case for future SOEs that could face the same fate. In addition, it was the first time that the state (and by extension, taxpayers) were the funders of the rescue.

The state and the public want, and deserve, answers as to the events that led to SAA’s distress. I have done a case study where I present my thoughts on the matter. This is the first in a series of article that unpacks this.

Root cause
From 2009 to 2021 there were nine CEO’s and the government replaced the board six times. This was done in an effort to turn the airline around, to no avail.  The frequent changes also meant that there was no continuity and direction. As a result, the airline was placed into business rescue (bankruptcy protection) in December 2019 just before the Covid-19 virus was identified for the first time.

During the 2019 calendar year, only eight routes were profitable. There included one international route and seven regional routes. None of the local routes were profitable.

When SAA was put into business rescue there were 48 aircrafts in SAA’s inventory:

• seventeen (35%) smaller single-aisle (narrow-body) aircraft for domestic and regional routes;
• twenty-nine (60%) bigger twin-aisle (wide-body) aircrafts for non-stop, long-distance, international flights; and
• two (4%) freighter aircraft.

(Note – the sub-total in the Business Rescue Plan does not include the four A350-900 aircrafts due to a formula error).

Qty	Model	Engines	Narrow / Wide Body	Range (Km)	Passengers
7	A319-100	2 Engines	Narrow-Body	6,800	120-150
10	A320-200	2 Engines	Narrow-Body	5,700	150-180
6	A330-200	2 Engines	Wide-Body	13,450	210-250
5	A330-300	2 Engines	Wide-Body	11,750	250-290
7	A340-300	4 Engines	Wide-Body	13,500	250-290
7	A340-600	4 Engines	Wide-Body	14,450	320-370
4	A350-900	2 Engines	Wide-Body	15,000	300-350
2	B737-Freigher	2 Engines	Narrow-Body	3,700	22.7 Tonnes
48

There was no profitable core because none of these markets were profitable. The major portion of SAA’s business focused on international flights even though only one of the international Routes was profitable.  It contributed 57% to the overall sales, which is in line with the number of aircrafts, but resulted in an R3.0 billion loss (72% of the R4.2 billion loss).

Because the routes are all non-stop flights, bigger, long-range, aircrafts were used. These aircrafts are difficult to fill to make the flights profitable. As a result, these flights were running at a loss. 

With the downturn in passenger figures post-Covid, and the slow return of international travel, this situation deteriorated significantly.  As a result, there is a move to smaller aircrafts to achieve the necessary break-even passenger load factors to make flights profitable. This is a shift in the way that the industry operates that will require a change in strategy.

SAA competes head-on with its subsidiary Mango on local routes. This means that it is competing against itself in the form of a full-service airline (SAA) vs low-cost airline (Mango).  SAA could not operate any of these routes profitably which shows that there is not sufficient demand for a second full-service airline (British Airways and SAA).  It is therefore just reducing (cannibalizing) Mango sales.

The new airline that is proposed in the business turnaround plan will be smaller by almost half (26 aircrafts vs the previous 48 aircrafts). This resulted in retrenchments. However, benchmarks showed that the salary cost was excessive due to many years of increases that were far above inflation figures. The BRPs decided to reduce the number of staff even further and to renegotiate their terms and conditions of employment. In the case of the pilots, this amounts to a salary cut of roughly 50% (the pilot that was paid the least earned R3,6m per year)

Financial analysis (finding the profitable core)
During the 2019 calendar year, only eight routes were profitable (net profit). This included one international and seven regional routes. None of the local domestic Routes were profitable.

During a turnaround, all loss-making branches / business units are closed down so that only the profitable core business remains.

The business rescue plan that was prepared in June 2020 was based on a 10% reduction in turnover and a 25% reduction in cost as part of its financial modelling to determine which routes could be profitable in future.  The 10% reduction in sales is simply not realistic in terms of the current forecasts.  Domestic markets are slowly returning to normal but international routes will take a long time to recover based on the effectiveness of vaccination in different countries. The 25% cost reduction is quite drastic and would have to be managed carefully.

Fuel is a big expense. Moving away from its four engine A340 wide-body aircraft (variants of the two engine A330 wide-body aircraft) will reduce the fuel consumption for these aircrafts by roughly 9% (not 50%).

According to the Airbus Website, the A320neo Family with Airbus’ Sharklet wingtip devices and two new engine choices delivered per seat fuel improvements of 20% by 2020 which equates to an additional range of up to 500 nautical miles/900 km or two tonnes of extra payload. Newer aircrafts like the Boeing 787 Dreamliner, Airbus A350, and Bombardier C-Series, are also 20% more fuel-efficient per passenger-kilometre than previous generation aircrafts.

A 20% saving in fuel would therefore be possible provided that SAA will be able to source the latest generation of aircrafts. However, other expenses such as salaries will also have to be brought line as a percentage of turnover.  Salaries were above industry benchmarks by a significant margin.

Lessons learned
The root cause of SAA can be brought down to years of mismanagement and then years of Government interference where they tried to get the right management structure in place to give the airline the guidance it needed. Governments valiant efforts effectively dug a grave for the airline.

Why was SAA so focused on growing its international routs rather than concentrating on local routes. Common sense says that more passengers travel locally in a year than internationally or regionally. SAA also competed with its own subsidiary thereby eroding its market share. Another poor tactical decision by the airline.

Based on the basic assumptions presented above, we have a clear vision of what the future looks like for SAA from a profit perspective. None of the domestic flights will be profitable; therefore, it will not be feasible to compete in the domestic market.  Mango should therefore be allowed to compete in this market as a low-cost airline without SAA eroding their market by competing with a full-service offering.

Profitable routes can be increased from seven to fourteen of the eighteen regional routes and from one to five of the eight international routes. This is where the focus should be.