This past week was witness to multiple events that lead the staff at IFExpress to query the impact of aviation fuel prices and the economic slowdown in the USA on airlines and ultimately in-flight entertainment. This is our view and frankly, it does not look good for airlines, aircraft manufacturers, or IFE vendors.

The price rise for Jet Fuel over the past year has been dramatic. Last week, spot Jet fuel prices for Los Angeles delivery closed at $3.85 per gallon whereas the spot price airlines were paying one year earlier was $2.15 per gallon. This 79+% fuel price increase has forced airline management to re-think every aspect of their operations.

When deregulation began in the late 1970’s, the airlines expanded, functioning under the concept that “bigger is better”. Hub and spoke route methodology ruled the skies in the USA, more planes were purchased and, for a time, airline travel boomed to a large degree due to cheap fuel, which comprised only a modest fraction of an airline’s operating budget. With the advent of skyrocketing jet fuel prices and a national economic recession (After all, that is exactly what this nation is experiencing or on the precipice of entering today) many of our country’s largest carriers are being forced to downsize to remain, not only competitive, but in business.

Both Continental and United Airlines made such announcements this past week. Continental is grounding 67 aircraft and laying off 3,000 employees while United Airlines announced it would discontinue their low-cost service TED, ground all their B737s, reduce their mainline domestic capacity by 14%, and lay-off 1,400 - 1,600 people. Furthermore, industry sources indicate that over 200 other aircraft, everything from regional jets to B747s, have been grounded since March and fare prices have risen by 16% since the start of the year. Many carriers, Delta included, have implemented a fee ($25 in Delta’s case) for a second checked bag and it is reported that one American carrier is planning a $15 fee for the first bag for many passengers starting this month. This in conjunction with the economy and the hassle of airline travel has already led to a decrease in ticket sales for the nation’s carriers. As a point of reference, the Air Transport Association is predicting that approximately 2.7 million fewer travelers will take to the skies this summer than in 2007 certainly validating the laws of supply and demand - higher prices driving down demanded lift. Another feature of the dour economic situation will be the reduction of total system-wide passenger capacity. Fewer RPM's will also force less economic (read: fuel efficient) aircraft from the system compounding the loss of available service, in many cases in smaller markets.

More daunting news was reported by IATA at their Annual General Meeting in Istanbul. IATA stated that in 2002 fuel represented 13% of costs, in 2007 it was 29% of operating costs, and this year it is forecasted to be 34% of the operating costs for airlines. However, IATA hedged their bet by saying this was an optimistic forecast and that with every US$1 per barrel increase there is a US$1.6b addition to the forecasted loss this year of US$2.3b. One aviation consultancy stated that, if aviation fuel costs remain at the current levels or increase, the aviation industry as a whole could lose $7.2 billion this year, resulting in more bankruptcy filings, more inefficient planes parked in the desert, thinner schedules and consistently high load factors to cover ever increasing operating costs. And, you guessed it, less demand for any passenger feature that is not a revenue generator.

This begs the question of what will the impact be on In-Flight Entertainment? The last major fuel crisis the United States faced was in the early 1970’s when IFE was in it’s infancy and very far from the complex, expensive, heavy, imbedded aircraft systems of today. Therefore, the present circumstances are perhaps better emulated by the impact 9/11 had on the airlines. And, it is not a great stretch of the imagination to envision a repeat of this negative event. In late 2001 and the following three or so years, this industry saw a boom in transportation demands in Asia and Europe while the US carriers faced consolidation, fleet retirement, lay-offs, and few new aircraft purchases. Costly imbedded AVOD & connectivity systems, both in aircraft down time and dollars, were sold to “elite” carriers like Singapore, Cathay, Etihad, and Emirates. Some AVOD, Interactive IFE, and connectivity sales were also made to European and Asian carriers. US carriers were forced to lay-off personnel, reduce fleet size, and when it came to IFE, they did a lot of window-shopping or moved towards portable devices (Alaska Airlines was the first to offer portable IFE in 2002) that required virtually no down time for installation and could be “rented” by the passengers, weighed less and had little impact on fuel burn, and basically cost less overall. Low cost carriers (LCC's) and charter carriers (CC's), both in the USA and Europe, cozied up to the idea. The demographic of their traveler was such that they could charge for extras and passengers expected to be nickel-and-dimed because the fares were so low. Ryannair and many European Charter carriers are prime examples of this business model and myriad of the legacy carriers in the United States have migrated toward this offering for Premium and Business Class applications for many of the same reasons.

The LCC's and CC's have long been the bread-and-butter for many of the portable IFE vendors and are likely to remain so in the coming years. However, we expect see a surge of interest from the legacy carriers in the coming months – especially those based in the USA and “second tier” operators as well. The flexibility of product “installation”, relative rapid upgrades to next generation technology, and the hardware non-purchase model have great appeal to airlines who are now more bottom-line conscious than ever.

One Low Cost Carrier who was a front runner in the use of portable IFE is Ryannair who recently posted a huge quarterly profit and upped their stake in Aer Lingus to 29%+. These aggressive LCC's will continue to place pressure on the legacy carriers and as one IFE aficionado said, “I feel this is a harbinger for the future where LCC’s will be taking over the legacy carriers. Or if not taking over then substantially affecting certain business strategies the legacy carriers would employ. The result will not only be a drive for lower costs for the legacy carriers but also a route restructuring to the advantage of the LCC.” Due to the restraint of trade laws in the USA this could be complicated but it would be very achievable in Europe and Asia.

There will always be premier carriers who will opt for the status of imbedded systems because it is part of their corporate culture and brand identity. But many of the other legacy carriers, who are fighting tooth and nail to survive and to avoid bankruptcy, will be seeking viable IFE options and this is where the portable market will continue to come into play, placing added pressure within the IFE industry for further consolidation or wholesale rethinking of product strategy by the Big 3 IFE vendors.

The shattered US economy and the resultant weakening of the global economy may already be taking a toll within the IFE market niche. In the last ten days one of the major IFE vendors has let go 25 – 50 employees...including engineers.

Certainly, the new planes coming off the lines at Boeing and Airbus will help stem the tide of losses and their 700 to 1,200 yearly delivery numbers will be a short-term anchor. However, as new plane sales drop off, installed systems will suffer. Retrofit installations will evaporate as airlines find better use for their cash. If IFE cannot generate revenue, it will be hard to justify on shorter flights. Long-haul may survive but content will no doubt be reduced.

The coming in-flight connectivity market will have to change as well. Since it is expected to come on line as a pay-to-connect feature, it may have a better future than traditional IFE. While the passenger valuation of the service and their pay-for-play following will help this feature fall under the "revenue" category, new ways of reducing installation costs will need to be found by vendors. As passengers will still want Internet and telephony services, airlines may have to jack-up rates to get earlier payback for them too. Perhaps, entertainment features will have to be added to them to replace the standard movie fare. Games look to be of value here as well.

The advent of carry-on IFE will probably be a boon to the customers but airlines and vendors will have to find ways to pay for installed IFE supporting those passengers. Only a ruling from the FAA, FCC or the airlines forbidding onboard use of PEDs can help this scenario.

Out of control fuel prices and a weakening global economy may have created the perfect aviation storm for IFE – hold on for a rough ride through uncharted territory. Our $2 billion dollar industry could fall to half that in a couple of years and if new aircraft sales suffer, the outlook is even bleaker.