There is an industry we’re all familiar with that is characterised by:
- a commoditized service differentiated mainly by customer experiences
- a high level of safety and reliability of the result
- a high barrier to entry for competitors
- a dependency on a relatively high load factor to reach break-even
- low marginal cost (every new customer after break-even cost little to serve)
- any excess capacity has zero-shelf-life (once it’s gone, it’s gone for good)
- high fixed costs, much of it spent on specialised labour
- high technological turnover
- close governmental regulation
You might imagine I’m talking about the cataract and refractive surgery business, and you’d be half-right. But in fact, I’m talking about the airline industry. Stay with me, you’ll see the connection.
About a month ago, IATA director general Alexandre de Juniac said: “The imposition of social-distancing measures on commercial flights would mean an end to “cheap travel” It is clear that if social distancing is imposed inside the aircraft, it will neutralise a huge proportion of seats – at least a third – for short- and mid-haul aircraft.”
Imagine that. An industry that operates on a 70% load factor is forced to curtail capacity by 33%. That’s an equation that won’t add up unless airlines raise prices – hence de Juniac’s remark regarding “an end to ‘cheap travel’”.
It’s the most basic equation in all of business:
Net profit = sales revenue − total costs.
Basic economic theory will tell you that when supply is low, prices increase; and when demand is low, prices decrease. The Coronavirus crisis, however, throws a spanner in the works of basic economic theory. Not only are we experiencing a demand-side crash, due to lockdown and the second-order effects of declining household incomes and residual fear around contracting the virus, we are also facing a supply-side contraction, due to regulations (i.e. social distancing) aimed at protecting the public.
Leisure travel, like refractive and private cataract surgery, is a discretionary expense. So, what’s going to happen to the travel industry?
Duncan Craig, Travel Editor for the Times and The Sunday Times, says:
Aviation will find a way to take off again, but in the short term, only the most fervent travellers will want to subject themselves to the thermal scanning, the disinfection tunnels, the intrusion, the hassle, the cost, the risk. We’re going to see a clear demographic demarcation of travellers, either self-imposed or driven by punitively priced or unobtainable insurance. Could flying become a young (and healthy) person’s game?
There will be positives: the eradication of ghost flights and phantom levels of protection; an end to entitled, pin-in-the-map, bottomless-prosecco-style binge travel. The trend will be towards fewer, longer and more meaningful holidays. The term “trip of a lifetime” may even be reclaimed from cliché.
Noel Josephides, Director of the Association of Independent Tour Operators (AITO) writes:
“There is an immense will to travel — and I don’t think there’s any country like the UK for the love of it — but it will be more expensive (author’s emphasis). I don’t see how it can’t be. If companies aren’t getting forward bookings, then sooner or later you have to start cutting your headcount, and the sheer uncertainty will lead to a much smaller sector. Prices will rocket because there will no longer be the advantage of mass travel on cheap flights. Initially, supply will be affected, and we’re not sure in which age group demand is going to come back. The 60 and 70-year-olds who have the money to travel may not feel so confident about a Greek island that has only two hospital beds, for example.
Unsurprisingly, Andrew Dunn, founder of Dunn luxury travel company, is by contrast optimistic: “It is extraordinary that from April 1 to 23 we had a surprisingly high number of inquiries — nothing like what it would have ordinarily been, but we thought that it could be zero. People have been inquiring about ski holidays, the Indian Ocean, Kenya, Tanzania, Costa Rica and the Caribbean.”
As I wrote back in March, luxuries are recession-proof.
Well, unlike refractive and private cataract surgery, economies consider public air transportation vital to keep commerce going. That’s why, when airlines get into trouble, national governments rush to their aid with billion-dollar bailouts.
Ergo, airlines continue to function and are able to raise prices while keeping them reasonably accessible to affluent leisure and business customers even when they literally have no business doing so.
Moving on from the travel industry, when’s the last time you heard of a refractive or cataract surgery clinic getting a bailout?
I’ll pause while you recover from laughing out loud.
When squeezed profit turns into massive losses
So, what is the refractive surgery clinic to do when faced with unyielding fixed costs while surgical volume tumbles? Profit turns into a loss.
I agree with ophthalmology business consultant, John Pinto, when he wrote in Healio, on April 7th:
… the accompanying table presents realistic expected case and adverse case models for ophthalmic gross charge production in the average U.S. practice through the balance of 2020. This is divided into general and retinal categories because of differences in non elective vs. elective components; glaucoma might be expected to fall somewhere in between. Elective plastics and LASIK cash flows will be much more deeply affected. (author’s emphasis)
Note: Figures shown in each cell are the percent of baseline gross professional fee charges expected, before factoring in the usual third-party payer adjustments and delays to yield net revenue received on average about 25 days down-calendar. This does not include fast-diminishing old accounts receivable from services rendered, earlier. While I believe that the “expected” and “adverse” estimates are approximately correct, it is important to understand that the U.S. and the world were heading for a recession and market correction already, and this, combined with jittery patients (who could be expected to delay routine care until well into 2021), may make the tabulated figures overly optimistic (author’s emphasis).
Ok. That’s pretty scary. Using Market Scope’s average reported (premium) LASIK price of $2142 per eye in Q4-2014 (the last figures I have), I’ve modelled Pinto’s figures using our 5-Steps Practice Growth System. I’ll share my model soon, but in the meantime, I see the need to significantly increase prices to break-even. Using the following assumptions
- Charging an average LASIK price per eye of $2142 per eye through the end of May
- A gross profit margin of 40%
2020 LASIK volume percentage of 2019 would be as follows:
Break-even at the expected case projection requires a LASIK price increase to $3120/eye (a 45.6% increase). Break-even at the adverse case scenario requires a price adjustment to a whopping LASIK price of $7150/eye (a 233.8% increase).
I, like all of you, hope to see the expected case (or better) scenario play out. Raising LASIK and cataract surgery prices to counter the adverse case will certainly lead to a shrunken market of financially suitable candidates. However, I’d recommend you prepare for the adverse case scenario, and get ready to see significant volume reductions and raise your prices accordingly. The alternative is massive losses that will most certainly lead to widespread insolvency. We’re already seeing 6% of ophthalmologists in the US ceasing to practice as a result of this crisis. That number will surely rise.
It goes without saying that my dire predictions above do not account for a second wave (and possible further lockdown), which experts predict is highly likely.