Types of Inherent Risk In Aviation Industry

Airlines are most likely to face four types of risk, namely operational, financial and hazard risks. These types of risks can arise from both the business environment’s internal and external factors.

Operational Risk

These types of risk arise from the tactical aspects of operating the aircraft and this is one of the important concern of aircraft safety management. Through process re-engineering, contingency planning or improved communications operation risk can be reshaped to reduces risk. The following categories can be used to break down operational risk for airlines and similar service providers:

1) Loss of Control in Flight (LOC-1)

Loss of control in flights is a rare case as compared to other aircraft related things in safety management programs. The accidents records from 2012-2016 only 8 percent of the risk was only related to these types of accident. Unfortunately, loss on control is often an extreme risk as it usually leads to ridiculously a bad damage. This caused the death of 90 percent of LOC-1 crashes. Not only the total number of aircraft crashes be reduced by LOC-1 events but the overall flight crisis death can be decreased. As LOC-1 events are already fairly low chances, the best type of risk checking should focus a bit more on reducing damage.

2) Runway Safety

In airline industry runway safety is the most occurring event and this may also effect the airlines as well as the airport. Some of the problem occurs in the runway are the invasion and the trips, runway overshoot, hard handling and tail strike. For example, runway trips represented a whopping 19 percent of sudden crashes in the year (2016), the most common type of crash so far. However, in the 2012-2016 period, only 6 percent of these resulted in death.

3) Control flight into terrain

For the airline service providers CFIT is probably the most severe type of operational risk. This is due to extremely high rate of fatality and hull lose rates when these incidents occur.

4) Fatigue risk management

Flight and cabin crew fatigue is considered as a threat that will impact the general safety functions. The general safety function means that the human ability to practice safety behavior and the responds to safety incidents. This may result in mission focus, ability to communicate and energy to follow the procedures.

Financial Risk

Financial risk involves cash and capital management, including the outside factors effecting the predictability and variability of cashflow and revenue. The three-main financial risk that are effected by the airline industries are as follows;

Jet Fuel Price variations

Management of fuel process is critical since airline operating cost are substantial in terms of jet fuel costs. According to the statistical report, jet fuel costs comprises 13% pf operating costs for airlines, which makes the cost of fuel risk economically relevant for airlines. As crude oil is distilled from crude oil, unstable fuel price affect profitability for the airline industry and further reduction in other expense is sensitive.

Foreign Currency exchange

The risk exposure was defined as the sensitivity of the company’s market value to unexpected changes in the exchange rate and thus depends on its foreign exposure to the companies, which is based on its operating incomes, exposure to cost and the cash flow margins. Currency exchange influence on the aviation industry for many reasons and they are

• Impacts the airlines profitability since the majority of the expenses and revenue are spent in different currencies
• Foreign currency exchange risk and income are simultaneously affected by exchange levels and local competition.
• Since borrowing cost can be stated in various currencies so that the airlines liabilities can change with the equity.

Change in interest rate

In the airline industry, this is an important risk factor, as most aircraft are bought on loans, operating leases and financial leases. As the interest rate increases the cost of borrowing also increases, it can also reduce income and also cause financial distress for the aviation industry.

Hazards risk

These risks can damage the environment, the human beings, property and the reputation of the company. These types of risk can be classified into 2 and they are tangible and intangible. The intangible hazards include political stability, regulatory changes, regional competition and the tangible hazards includes cold weathers, non- trained personnel and the chemical product on the workplace are tangible hazards. In comparison to intangible hazards, the tangible hazard is easier to control.

Business and Financial Risks of Low Budget Airlines (Middle East & Europe Comparison)

Low budget airlines, also known as Low Cost Carriers (LCC) are airlines that have lower cost of operations and does not provide certain traditional services and facilities for its passengers resulting in low transport fares. However, in order to cover for the low prices, these companies can initiate additional fees for certain services. According to Becker (2013), LCCs came into existence as a result of the deregulation of the world aviation industry. As a result, their emergence has affected the competitive environment of the airline sector in liberalized markets. A greater level percentage of this is seen in the world’s aviation market that was formerly dominated by the Full-Service Airlines (FSAs). Thus, there has been an increase in competition between FSAs and LCCs all over the world (O’Connell & Williams, 2005).

In terms of regions, “LCCs contribute to more than half of air passenger traffic growth in several European countries” (Sarker et al., 2012). In the Middle East, the entrance of LCCs has been basically due to some factors such as poor infrastructure and lack of railway systems that links the Middle East countries together, along with increasing demand by passengers for Pilgrimage and shopping (Riaz & Kapadia, 2007; Middle East Amadeus Report, 2010; WTO Report, 2012). Examples of LCCs in Europe include Ryanair, EasyJet, Wizzair, Blue Air and Eurowings, among others. The airlines in the Middle East include FlyDubai, Air Arabia, Jazeera Airways, Sama, Nas Air, and Bahrain Air.

In their daily operations, these low budget airlines come across lots of challenges that can pose and prove to be certain business risk indicators. This analysis will focus more on the business and financial risks faced by LCCs in Europe and the Middle East and how they mitigate such risks. Financial risks include market risk, credit risk, and liquidity risk. On the other hand, business risks include operational risk and legal risk. According to Zank et al. (2018), credit outlook for Europe’s aviation industry is negative. Risks faced include limiting passenger growth and pressurizing the credit quality for LCCs, fuel price volatility, rising wages, high competition, and an increasing gap between large and small airline carriers. Large carriers have more capacity to manage these rising costs and keep ticket prices low, leaving LCCs at a vulnerable position as competition is making it even difficult for them to generate ancillary income.

The case is not different for Low Cost Carriers in the Middle East where they lack online purchase of tickets and the use of credit cards is causing them to rely on travel agents. Also, they operate mostly in secondary airports which most times are very far away from the capital of each country. Unlike in Europe where there is economic development and the political situation is stable, in most of the Middle Eastern countries, there is a factor associated to unstable political systems and slow economic growth. In addition, most LLCs in the Middle East face government restrictions such as higher airport Charges or Taxes, monitoring the costs and the services rendered on-board of the other airlines on routes not operated by primary airports, restricted licenses, closing the operations of some routes in order to protect primary airports and providing fuel subsidies for the national FSAs.

Generally, LCCs in both Europe and Middle East face challenges such as lack of capital and overcapacity, inadequate airport facilities, political influence and lack of adequate knowledge about the LCC model, price sensitivity by passengers in the aviation industry, regulation expense, cost of supplies, airport cost and other unknown costs driving higher airline cost structure (Wensveen, 2007). Furthermore, these LCCs also face daunting challenges of not being able to reach out to passengers through the introduction of various distribution channels, increased prices of oil and fuel, high quality of services demanded by customers, possibility of a recession which can lead to dynamic changes in the economy, competition from rail in Europe by 2012 which reduced demand, overcrowding in routes bringing about congestion, competition with FSAs in international routes for airlines who operate in the long haul routes, and all these would most likely than not lead to the shutting down of some LCCs.

Risk management in the European aviation sector using EasyJet for instance shows that the company mitigates interest rate risk through the implementation of policies that allows it to maintain an equal balance between floating rate and fixed leases. Asides the US dollar, EasyJet manages its foreign currency risk through the process of linking payment and revenue in each respective currency. The company utilizes hedging instruments to keep this risk minimal. In terms of credit risk, EasyJet considers it insignificant because concentration of credits are limited to cash, commercial debtors and hedging relationships. Major banks hold the cash and market rated money funds while debtors in trade consist of a few well-established acquirers of credit cards. Hedging relationships are with partners with a credit rating of A. In the Middle East, in addition to the risk management strategies used by EasyJet, FlyDubai, in managing risks, keeps their costs low using different steps like hedging of fuel, rapid turnaround and point to point service.

However, several suggestions have been made on measures that LCCs can adopt to effectively mitigate these risks. Such measures include but are limited to excellent customer service through the implementation of various policies, competitive and penetrative pricing, performance on time and broader networks, implementing retention programmers, frequency increase, providing attractive deals and offerings, a focus on ancillary income such as hotels, car rentals, online ticket charges, on-board entertainment and ancillary revenue. Ancillary revenue accounts for majority of the airlines’ revenue and is expected to increase. As such, airlines are expected to continue to focus more attention on revenue growth. In fact, airlines need to identify new areas capable of generating additional or supplemental ancillary revenue (Sarker et al., 2012).

Conclusively, while it is true that LCCs are faced with a lot of business, financial and operational difficulties, research has shown that most of them are thriving even during these challenges. It is therefore highly recommended as an alternative to Full-Service Airlines.

Risk Mitigation Measures

The risk classification diagram in the development of risk mitigation measures and assign the relative mitigation measures relevant to the risk type. We will use risk severity and frequency to classify the risk. Severity of risk is divided into two low and high. This represent the level of impact associated with the risk frequency of risk represent the number of occurrence on low and high frequency.

1. Risk avoidance and controlled loss: it means that the risk is most likely not transferable in the risk class, where the frequency is high and the severity is also high, so the ideal response to this type of either to avoid loss in full or to construct a robust crisis management.
2. Risk transfer: as there is a low rate of risk in this class it is best to transfer the risk to third parties, to reduce the impact of accidents. For example, if an accident occurs the insurance can be covered partially and we can reduce the impact.
3. Reduction Risk: This risk contains low but fairly high frequency exposures. This can be mainly driven by human errors that are being developed with the objective of predicting, proactively evaluating and eliminating a safety management system and artificial intelligence system before taking place.
4. Ignored risk: Normally it can be handled with a dedicated organizational resource and ignored because the impact and very low frequency are insignificant.

Effectiveness of Risk Mitigation Measures

Unless companies establish a mechanism to ensure the effective of the subject measures, they will not be able to take advantage of any risk management measures. It must be part of a comprehensive ERM framework which ensures sustainable review and monitoring.

• Crisis management: in the first place, the countermeasure is supported by a risk conscious culture in the policies and procedures within the organization, which clearly define the process of escalation and review of an incident. Top management needs to set the tone in the organization and develop an effective transparent mechanism and clear guideline on how disruption to the operation can be handled at different levels.
• Ignored risk: The key elements in this measure is to create a tend-checking mechanism and highlights any upheaval trends and the joint work of the company to identify any potential threats. Different technique could include loss analytics, self-evaluation, workshop on risk identification and a questionnaire on risk.
• Reduction Risk: in order to make the it infrastructure effective this is mainly controlled by advanced software and Al techniques, as explained earlier, in order to ensure maximum protection from all recent cyber-attacks.

Conclusion

In conclusion, operational, financial and hazard risks can be damaging and detrimental to the profitability and growth of the airline. For low cost airlines, financial risks are of most detriment due to the volatility and the unpredictable nature of markets. Interest rates, foreign exchange and oil prices move at high speeds, and airlines must be able to manage these risks to thrive. This is where risk mitigation comes in: It includes risk avoidance, where robust crisis management is required. It includes risk transferring, where third parties can manage things like currency exchange, etc. It includes risk reduction, where human error is reduced through training and preventability. Finally introduced is ignored risk, where insignificant issues are ignored so time and money are saved. The implementation of these risk reduction techniques will help low cost airlines to run at an effective and profitable level.