Challenges and Prospects : The Future Shape of the European Airline Industry


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Challenges and Prospects The Future Shape of
the European Airline Industry
Aristotelean University of Thessaloniki

Professor Rigas Doganis Rigas Doganis and
Associates Visiting Professor Cranfield
University
8 May 2006
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2001-2004 A crisis too farEconomic downturn
Iraq War SARS and higher fuel prices
Total IATA net losses 1990-93 US 15 billion
..but. (11 billion state aid given European
carriers 1992-97) Total IATA net losses 2001 to
2005 US 37.4 billion (after 5 3 billion
aid to US carriers 2002-2003) Projected 2006
loss 4.0 billion Downturn is deeper/longer
than just another industry cycle
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A Cyclical Industry Profit/Loss ICAO Member
Airlines
Dr. P. Morrell
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A marginal Industry Net result as revenues of
ICAO airlines
Dr. P. Morrell
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Rising fuel prices deepen crisisand pessimism
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Average oil price in real and constant values
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AIRLINE CHALLENGES

• Surviving current crisis and impact of higher
  fuel prices
• Is fuel-hedging adequate
• Is cost-cutting deep enough
• Is route restructuring needed
• Are cash reserves sufficient
• Is state aid needed (US airlines receive c. 8
  billion)
• Is Chapter 11 another form of state aid

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US network carriers in deep crisis - face
structural instability
after exceptional items including US 5 billion
federal aid provisional
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Crisis for US Airlines Deepening

• ... Their weakened financial condition combined
  with significant financial obligations including
  delayed pension fund contributions makes
  recovery uncertain for US legacy airlines...
• US General Accountability Office
• August 2004
• US Court allows United to escape 9.8 billion
  pension liability (6.6 met by Governments
  Pension Benefits Guarantee Corporation)
• May 2005

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Crisis in Europe less severe
AF plus KLM in 2004
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Optimism because GDP Elasticity is 2-2.5
Annual Changes in GDP versus Changes in RPKs
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Annual Growth Rates (Pass-Kms) Worlds 12
Largest Markets 2004-2023
Source Airbus Global Market Forecast December
2004
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AIRLINE CHALLENGES

• Surviving current crisis and high fuel prices
• Trend to further liberalisation unstoppable
• European Court Decision 5 November 2002
• Regional Agreements e.g. Asean Nov 2004
• Asian bilaterals opening up e.g. 2005 India
  agrees increased flights on many bilaterals -
  UK/India from 21 to 80 per week
• EU - USA talks re-start June 2006
• Result more open deregulated markets
• more intense competition

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Key Turning PointEuropean Court Decision 5th
November 2002
Articles in bilaterals with US which limit
designation to airlines substantially owned and
effectively controlled by a states own
nationals infringe Article 43 of EC Treaty on
the right of establishment. So Bilateral
between EU and third countries must allow any EU
airline to be designated not just those owned by
nationals of the signatory state.
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Impact of European Court Decision

• Bilaterals with US must be amended.
• Other bilaterals must change too.
• European Commission given mandate June 2003 to
  negotiate
• (a) with USA begun June 04 no
  agreement yet
• (b) block agreements e.g. Chile Lebanon
  Australia New Zealand
• Nationality rule will slowly be abandoned
  elsewhere too more competition for BWIA and Air
  Jamaica

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AIRLINE CHALLENGES (Contd)

• Surviving current crisis and high fuel prices
• Impact of further liberalisation
• Consolidation/alliances to reduce costs and
  overcapacity
• Economic/commercial pressures for concentration
• Relaxing nationality will facilitate
  cross-border mergers
• Must reduce number of players esp. long-haul
• Alliances to plan/reduce capacity more
  effectively
• e.g. Air France/KLM (2004) Lufthansa/Swissair
  (2005)

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Drivers for AirlineConsolidation and
Concentration within Alliances

• Gain marketing benefits of large size and network
  spread
• Reduce costs
• Reduce competition on duopolistic routes e.g.
  SAS-Lufthansa alliance on Frankfurt
  Copenhagen Oslo Stockholm
• To bypass nationality rules

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Profile of the major global alliances in 2005
Key data is for the year 2003. Staff numbers in
some cases do not include staff in aviation
related separate subsidiaries e.g. in
maintenance companies
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AIRLINE CHALLENGES (Contd)

• Surviving current crisis and high fuel prices
• Impact of further liberalisation
• Consolidation/alliances to reduce
  costs/overcapacity
• 4. The low-cost revolution
• - has undermined short-haul scheduled markets
  and network airlines in US Europe and Australia
• - is spreading to South America Asia Africa

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Low-cost carriers in Asia/Pacific
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Unit Cost versus Sector Distance in
2003 Intra-European Services Selected Scheduled
Airlines
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of Total Scheduled Seats to Other EU States or
on Domestic Offered by Low Cost Carriers March
2006

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Southwest dominates its major markets

• Largest carrier in 90 of SWs top 100 OD markets
• 65 share of its top 100 OD markets (second
  largest American with 7)
• 77 share of intra-Texas traffic
• 71 share of intra-California traffic

WILL EUROPE AND Greece GO SAME WAY
Source Debbie Ackerman Geneva Aviation Forum
February 2004
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FUTURE CHALLENGES (contd)

• Surviving current crisis and high fuel prices
• Impact of further liberalisation
• Consolidation/alliances to reduce
  costs/overcapacity
• Low-Cost Revolution
• 5. How to reverse continued decline of yields
• - over-capacity
• - impact of IT
• - have airlines lost control

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Passenger Yields Association of European
Airlines1999 to 2004
Real adjusted for exchange rate and
inflation Source compiled from AEA data
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Average Fares in Real Values in Deregulated
Markets
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AIRLINE CHALLENGES (Contd)

• 1. Surviving current crisis and high fuel prices
• 2. Impact of further liberalisation
• 3. Consolidation/alliances to reduce
  costs/overcapacity
• 4. Low-Cost Revolution
• How to reverse continued decline of yields
• 6. Cost reduction as a long-term necessity
• - labour is the key (25-35 of total costs
  less in Caribbean)
• - distribution costs too high (12-17)
• - network and fleet rationalisation
• - outsourcing
• Key aim how to achieve fundamental shift in
  labour cost base e.g. more performance-related
  pay as in SIA

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AIRLINE CHALLENGES (Contd)

• 1. Surviving current crisis and high fuel prices
• 2. Impact of further liberalisation
• 3. Consolidation/alliances to reduce
  costs/overcapacity
• 4. Low-Cost Revolution
• How to reverse continued decline of yields
• Cost reduction as a long-term necessity
• 7. Developing an effective IT Strategy

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Developing an effective IT strategycrucial to
long-term survival

• 1. Strategic issues
• How much to out-source
• Reduce in-house silos/complexity
• 2. Business to customer
• Implement effective distribution
• Effective customer relations management
• Simplify passenger travel (SPT)
• 3. Business to business

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Philippine Airlines - A Confusion of IT Service
Providers

• 1. On-line reservations - by Planitgo (Amadeus)
• 2. E-ticketing - Sabre
• 3. Frequent Flyer Programme - Mercator
• 4. Revenue Accounting - Oracle
• 5. Revenue Management - Another Supplier

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AIRLINE CHALLENGES (Contd)

• 1. Surviving current crisis and high fuel prices
• 2. Impact of further liberalisation
• 3. Consolidation/alliances to reduce
  costs/overcapacity
• 4. Low-Cost Revolution
• How to reverse continued decline of yields
• Cost reduction as a long-term necessity
• Developing an effective IT Strategy
• 8. Environmental pressures
• eg emissions trading in Europe

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All challenges require effective long-term cost
management through

• Fuel minimisation/hedging
• Consolidation/alliances synergies
• Learning from low-cost sector
• Reduce labour costs (25-35 total costs)
• Cut distribution costs (12-17 of total)
• Maximising IT opportunities
• Network rationalisation
• Fleet planning and aircraft utilisation

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The conventional network airline model has been
battered by -

• Spread of deregulation over-capacity
• Growth of alliances aggravated over-capacity
• Low-cost carriers undermined conventional
  short-haul
• Internet selling shifted market power to
  consumers and fares collapse
• Is the model broken
• Large size/scope no guarantee of success
• Can it be mended or must it change

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Future shape of airline industry - in US Europe
and Asia too

• Long-haul network dominators (3 to 5)
• - reduced number through collapses and mergers
• But must
• Increase focus on long-haul
• Cut uneconomic shorter routes
• Use alliance partners/franchisees to feed
• Simplify fleet
• Re-engineer procedures
• Cut labour and distribution costs
• Consolidate and use alliances to reduce
  overcapacity
• i.e. new business model(s)
• e.g. are Virgin Atlantic Cathay SIA Emirates
  the models

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British Airways ResultsFinancial Year 2004-05by
area of destination
N.B. BA lost 1.2 billion on European routes
since 1997-98
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Future shape of the airline industry

• Long-haul network dominators (3 to 5)
• Low-cost no-frills (2 or 3 majors)
• Grow rapidly - over 25 p.a. in Europe/Asia
• Squeeze out or buy new-entrant LCCs
• Become dominant on most short-haul routes
• Attack smaller national carriers
• Control costs
• Risks for LCCs
• Too rapid growth
• Go for too long sectors
• Head-on competition between survivors
• Costs rise as size multiplies

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Future Shape of the Airline Industry

• Long-haul network dominators (3 to 5)
• Low-cost no-frills (2 or 3 majors)
• Low-cost charters (3 or 4 groups in Europe)
• Focus on -high-yield IT
• - Flexible Dynamic packaging
• - Seat only
• Further consolidation (eg Tui and Thomas Cook)
• Increased emphasis on densest short holiday
  routes and long-haul
• May set up low cost no frills (eg Thompsonfly)

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The losers in Europe Asia and elsewhere

• 20 MEDIUM/SMALLER NATIONAL CARRIERS
• Mostly government-owned or influenced
• Over-staffed
• Over-extended network (the Sabena Syndrome)
• Too many unprofitable routes
• So
• Too small to be network dominators
• Too large to be niche carriers
• Too high-cost to be low-cost

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Survival Strategies for Medium/Smaller National
Carriers

• Must down-size and cut costs to be regional
  niche carriers (e.g. Aer Lingus Air New
  Zealand).... and/or
• Become feeders or franchisees to network
  dominators or
• Merge to get benefits of size and network spread
• but should take care if
• Set up low-cost subsidiary (SASs Snowflake or
  Qantass Jetstar )or convert into low-cost (e.g.
  Independence Air America West and now USAir)
  but attempts show mixed results

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The Future of Network Carriers

• Lower fuel prices if any will only be
  short-term palliative
• Deep cost-cutting essential but not enough to
  ensure long-term viability
• A key to survival in age of growing low-cost
  dominance in short-haul markets and over-capacity
  in long-haul is
• - radical network restructuring
• - capacity reduction/rationalisation

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Future Shape of the Industry in Europe/US Will
this be the pattern elsewhere

• 3-5 Network Dominators
• Low-cost Service Providers
• - No Frills (2 to 3 majors)
• - Charters (3-4 in Europe only)
• Niche Carriers
• - Regional/National
• - Cargo and Integrators

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For these and other current issues see new Dec.
2005 revised edition of The Airline
Business by Rigas Doganis Publisher
Routledge.com and also available
throughwww.amazon.co.uk