Building a Hedge Against Headwinds

Embry-Riddle professors are researching a revolutionary risk management solution that could help the airlines weather economic storms

The airline industry is suffering unprecedented losses as a result of the recent COVID-19 pandemic. The International Civil Aviation Organization estimated in August that the world’s airlines collectively could lose more than $355 billion by the end of 2020, compared to pre-COVID revenue projections. Additionally, more than 80,000 airline workers are facing (or have now been) furloughed.

It’s a devastating scenario, but it’s not the end of the story: Working with Embry-Riddle, the industry is responding with energy and innovation.

Enter Skytra, a wholly owned subsidiary of Airbus. In partnership with Embry-Riddle’s Worldwide College of Business, the company is exploring groundbreaking risk management and market-based solutions that could transform the airline industry and help protect it from future economic downturns. Skytra has created a new set of regulated benchmarks, the Skytra Price Indices, which will permit the aviation industry to hedge volatile ticket prices using financial derivatives. These indices measure the USD/RPK (U.S. Dollar per Revenue Passenger Kilometer) in a given geography and are produced on a daily basis.

Maneesh Sharma, professor and dean of the Embry-Riddle Worldwide Campus’ College of Business. Photo by Daryl LaBello.

Maneesh Sharma, professor and dean of the Embry-Riddle Worldwide Campus’ College of Business, says he and Embry-Riddle professors Sunder Raghavan, Alfonso Canella and Ron Mau recently demonstrated that Skytra’s proposed Europe-North America (EU-NA) Skytra Price Index could offer future revenue protection of close to 90% — even in the face of a COVID-19-type collapse in yields.

“We see tremendous potential,” Sharma says. “We think Skytra’s products will enable and lead to revenue protection which will transform the industry.”

A ‘Learning’ Proposition

The research partnership with Embry-Riddle is all about “learning,” says Matthew Tringham, Skytra’s co-founder and chief strategy and product officer. The agreement allows Skytra to tap into the financial expertise at Embry-Riddle and apply that expertise to a real-world problem.

Matthew Tringham, Skytra co-founder and chief strategy and product officer

It was Embry-Riddle’s Airline Financial Risk Management course — offered in partnership with the International Air Transport Association (IATA) — that first attracted Skytra to working with the university. Sharma recalls the initial contact from Skytra representatives: “They said, ‘We saw your course. We have a proposition; would you put this in your course?’ I said, ‘I will need to research it.’” And the partnership began.

Sharma says Skytra’s index revolves around hedging or buying insurance against “uncontrollable” revenue losses. Until now, the airlines did not have the tools or the market infrastructure to hedge revenue. But that’s all about to change, he adds.

Airlines have traditionally managed risk by hedging costs, such as fuel prices, interest rates and currency values. However, it is the inability to exercise significant control over revenues that makes the aviation business riskier and more volatile than other service-centric businesses, such as retail and consulting, Sharma explains. “Effective risk management should consider both the revenue and cost of an airline.”

Post-It Note Vision

According to Tringham and Elise Weber, Skytra co-founder and chief sales and marketing officer, Skytra began as an idea on a single Post-it note, which grew to become a wall of notes. Three years later, in 2019, Skytra was born. The company was established specifically to create the financial infrastructure necessary for the air travel industry to help risk-manage its revenue volatility. Based in London, the company is awaiting approval from the Financial Conduct Authority in the U.K. to operate as a benchmark administrator.

Elise Weber, Skytra co-founder and chief sales and marketing officer

“We want to give the industry, our customers, tools to better manage their risks — not only hedging costs, but complementing that with the possibility of hedging their yields measured in USD/RPK,” Weber says.

Tringham adds, “We’re doing this because we believe it could contribute to the financial health and stability of the overall industry.”

Weber says educating people about the new market infrastructure (Skytra Price Indices) for a more comprehensive risk management will be key to their success. “It’s extremely important for the industry to understand how to use these new tools to help them achieve their strategic objectives,” she says.

As part of the education equation, Sharma plans to eventually integrate the Skytra Price Indices and the various ways of using financial derivatives for risk management purposes into his coursework for future Embry-Riddle and IATA students.

Tool for the Future

Sharma says Skytra’s revenue hedging concepts could also be leveraged to benefit the greater travel, lodging and tourism industries.

Weber agrees.

“We started off with risk management because this is where the whole idea was born, but there will be many new value propositions, far beyond risk management. There will be new products coming out such as hedging corporate travel budgets and around flexible ticketing for individual travelers,” she says. “In terms of research topics moving forward, we have an endless list that we could dig into with a partner like Embry-Riddle.”