State of the Industry – The Game Players
Keynote address to APG World Connect
Monte Carlo, October 25, 2012 >>
Ladies and gentlemen:
Every two years , Jean-Louis Baroux brings this Conference back to Monte Carlo, a place of opulence, perhaps in the hope that some of those characteristics will eventually rub off on our perennially troubled aviation industry.
Well, if we can believe the latest IATA forecast, the anticipated industry-wide – 0.6% net profit margin for 2012 – is not likely, once again, to cause everyone to pop champagne.
Not to take any chances, this conference continues to ensure that this magic liquid is amply present at every reception, to help either to celebrate our successes or to drown our sorrows, as the case may be.
Before I go on, let me remind you that the views expressed here are strictly my own and do not represent the views of IATA or any other corporation that I have been associated with over the years.
Our industry is accustomed to having to deal with numerous uncertain conditions, and this current year is no exception.
The Chinese economy, which has become a major engine of world economic growth, has been slowing down.
The Asia-Pacific international market was showing a 5.5% expansion. However, when one takes into consideration the impact last year of the Japanese earthquake and Tsunami, and the recovery this year of the Japanese market to its previous level, the real growth of the Asia-Pacific international market was, in fact, marginally negative.
India’s domestic traffic was essentially stagnant, partly as a result of the government’s disastrous aviation policies, bureaucratic nonsense and excessive taxation.
North American markets were essentially flat.
However, on the bright side, the other regions of the globe have continued thus far to show good growth, particularly the Middle East, Latin America and Africa.
The financial crisis has shaken public confidence in the banking system, revealing that unfortunately some banks – driven by greed – had total disregard for the basic rules of prudent investment.
To avoid a liquidity crisis which may have brought the entire economy to a halt, the government provided a huge “bail-out” fund to the banks – at the expense of the tax payers!.
Unfortunately the banks are not the only ones misbehaving.
Many governments are overly in debt, and the situation is particularly acute in Europe.
And unfortunately, unless the North American economy clearly recovers – and Europe fixed its problems – all regions will likely suffer.
Against this background of economic uncertainty and continued aggressive competition, the various major players have been re-evaluating their strategies, each in its own way.
Latin America has been one of the important battlegrounds.
The merger of two important airlines in the region, namely LAN and TAM – each belonging to different alliances – forced a re-examination of their respective affiliations.
The Chilean antitrust regulators told LATAM, the new combined entity, that its two operating airlines will have to be in the same alliance – and not in the same alliance as their primary Latin American rival, AVIANCA-TACA.
LAN is a founding member of “OneWorld”, and TAM became a member of STAR in 2010.
The dilemma should have been resolved this Spring, when AVIANCA-TACA was admitted into STAR.
One could have concluded that LATAM would be the South American member of “OneWorld”. However, LATAM has been keeping its options open.
Just to complete the picture, in Latin America we should remember that Aeromexico and Aerolineas Argentinas are the region’s members of Sky Team.
The European presence of “OneWorld” was somewhat weakened in Eastern Europe by the bankruptcy of MALEV.
However, that void will be partly compensated by Air Berlin and its affiliate Fly Niki, which joined the alliance in March of this year.
The bailout package provided to Portugal by the European Central Bank and the International Monetary Fund (IMF) imposed a requirement for the privatization of the national airline, T.A.P.
The relatively strong position of TAP in two key emerging markets – Latin America and Africa – has raised the interest of several groups including I.A.G. and the Lufthansa Group.
Among the other major alliance developments worthy of note is the expectation that Malaysian Airlines would join “OneWorld” this year.
And then, on the Indian sub-continent the largest Indian private airline, Jet Airways, has been invited to join STAR.
However, the government of India has requested that Air India, which had been previously rejected by STAR, be admitted at the same time as Jet Airways. This could complicate the situation.
As a natural expansion of the “Metal Neutral” Joint Venture between Lufthansa and All Nippon Airways , SWISS and Austrian were invited to join in.
Finally, Japan Airlines and I.A.G. have agreed plans for a Joint Venture business … on all services between Europe and Japan.
The European low fare airline scene has long been dominated by RyanAir and EasyJet.
For the first time – and perhaps as an indication that the market is reaching saturation – their growth rate has been coming down to a meager 4 to 5 percent per annum.
And for the first time also seasonality has become a factor. RyanAir, for instance, decided to ground a number of airplanes during the winter months.
This year, a newer and aggressive airline – “ Norwegian Air Shuttle” – has decided to challenge those leaders.
Norwegian Air Shuttle, last January, placed an order with Boeing and Airbus comprising of 374 aircraft, of which 222 are firm orders and some 150 are options to be exercised later.
One gets a good measure of this ambitious move when one compares the Norwegian Air Shuttle fleet plan with the size of RyanAir’s current fleet of 270 airplanes and EasyJet’s 204 airplanes.
Determined to stop the attack on their short-haul markets, the three major European airline groups have launched some substantial restructuring programs to reduce their operating costs.
Their objective is to achieve a more competitive presence in the European short-haul market.
Lufthansa, which recently announced a reduction of some 3,500 full-time administrative jobs worldwide, is considering shifting up to 90 jet aircraft to a division providing short-haul, low cost services outside of Frankfurt and Munich.
This would likely be combined with its low cost unit, “Germanwings”.
As part of its cost reduction effort, Austrian Airlines also decided to transfer the company’s fleet of 80 airplanes and its 2100 employees to its 100 percent-owned subsidiary, Tyrolean Airways.
The move was carried out to eliminate duplication and to achieve a new collective agreement.
The other member of the Lufthansa Group, Swiss, is looking at splitting off its short-haul operation – possibly to be based outside Switzerland – to achieve lower costs.
IAG – the International Airline Group – is disbanding the loss-making BMI Baby, redistributing its valuable airline airport slots to the more lucrative markets.
Thus far, the main focus of the Group has been in Spain. This will include short-term downsizing and network reshaping to address Iberia’s uncompetitive cost structure.
The Group will increase its low-cost presence in the Spanish market.
Iberia Express, a new subsidiary with services said to be almost identical to those of Iberia but with staff remunerated at low-cost competitive rates, became profitable in its second month of operation.
Thus far, Iberia Express and Vueling – also 46 percent owned by Iberia – are both growing successfully.
Finally, the last member of the European “ big three” – the Air France/KLM Group – centers its efforts on Air France, with a plan to increase productivity and efficiency by 20 percent.
Its regional restructuring is based on a three-prong effort:
First, giving Transavia – formally a KLM subsidiary – an increased role to operate a no-frills, leisure airline from Orly to Mediterranean and European destinations.
Transavia’s fleet will be increased from eight aircraft today to 22 by 2015-2016.
Second, the activities of AIRLINEAR, BRITAIR and REGIONAL will be regrouped with the objective of reducing costs by 15 percent.
Then, Air France is opening regional hubs in Marseille, Nice and Toulouse for services to various European and Mediterranean destinations.
Thus far, the results of those new liaisons have been somewhat mixed, suggesting some fine-tuning is still required.
The Gulf carriers had remained strongly focused on their plans to “Connect the World” through their respective hubs, maximizing 5th and 6th freedom opportunities.
But in the last few weeks we have seen a dramatic shift in their strategies which could position the Gulf carriers at the core of a new global order.
Emirates and Qantas have exchanged a major codeshare agreement which covers all major European destinations.
This could cause some serious strain on the “OneWorld” Alliance.
And then Qatar Airways, which had been cosying up to British Airways, and has now joined OneWorld.
The third member of the powerful Gulf “triumvirate”, Etihad, together with Air Berlin has now announced a wide-ranging commercial agreement with Air France/KLM.
Given this new development one wonders how long Air Berlin – 29% owned by Etihad – would remain in “One World”.
Clearly, the major strategic shift by the Gulf carriers has thrown the three alliances … into a state of flux!
A brief overview of the region would not be complete without mention of Turkish Airlines – fast growing and also ideally located between Europe, Asia and Africa.
Turkish Airlines, which today operates to five North American destinations plans in the short to medium term to add five more major destinations.
Turkish Airlines is also looking at investing in other airlines, and has been showing interest in LOT Polish Airlines as well as Portuguese TAP.
Finally, the growth of Air Arabia – the largest low-cost carrier in the Middle-East and Africa – is most impressive, and has established new hubs in Casablanca and Cairo in addition to its main base in Sharjah.
Regardless of who is involved, more consolidation will take place in the U.S.A.
American Airlines’ restructuring plan calls for a reduction of 13,000 employees, major concessions from each labor group, and termination of the defined benefit pension plan as well as closing the Fort Worth Maintenance Base.
The plan hopes to generate sufficient cash to renew the fleet over the next five years.
A strong American Airlines would marginalize U.S Airways, leaving it with little scope to grow. This is believed to be the reason for U.S. Airways to begin a potentially hostile take-over bid for American Airlines.
The U.S. Airways’ effort to gain control of American Airlines has generated much support from Wall Street and American Airlines’ own unions.
American Airlines, which had originally shown very little interest in merging with U.S. Airways, has since indicated that a merger should be considered.
Southwest Airlines, the model of the “low-cost” par excellence, has played a part as well in the consolidation process, having acquired AirTran. Southwest’s recent losses are, in part, related to the integration of AirTran in its operation
Return to its full profit potential is now targeted for 2014.
As part of its diversification activities, Delta Airlines has decided to invest 100 million dollars in GOL, the San Paolo-based airline, which has a 40 percent market share in Brazil, to leverage and consolidate further its long-term commercial agreement.
And then in Canada, in line with the trend to develop hybrid business models, Air Canada has announced its intention to create a NEW long-haul, low cost, wholly-owned subsidiary. This new airline will target trans-Atlantic leisure destinations as well as in the U.S.A. and the Caribbean.
Looking for more room to grow, WestJet announced this year the creation of a regional carrier division, with an order of some forty Dash8-400 airplanes.
WestJet was successful in negotiating with its current employees a lower wage rate for any new employees to join this new division.
And then, moving off the strictly no-frills product, WestJet is now introducing a premium product with more legroom and various amenities to appeal to the business travelers.
Hybrid business models are proliferating. Well, it’s a case of whatever will work for you!
Low-cost carriers are expanding rapidly in Asia/Pacific.
Malaysian low-cost carrier, Air Asia, continues to increase at 12% annually.
SCOOT became the third long-haul, low-cost carrier in Asia, joining JetStar and AirAsia X.
SCOOT is also the fourth brand in the SIA group’s portfolio, which already includes low-cost carrier Tiger Airways, partially owned by SIA, and the short-haul, full service carrier, SilkAir, in addition to the mainline Singapore Airlines’ full service brand
Seven years ago, there were no low cost airlines in the Singapore market. Today L.C.C.s account for 25% of passenger traffic at Singapore’s Changi Airport.
Yet Singapore Airlines has not shrunk. The market has simply grown.
Japan is fast becoming the new L.C.C. battleground in Asia-Pacific, with three new entrants this year namely:
JetStar – a Qantas /Japan Airlines’ joint venture;
PEACH – a subsidiary of ANA /All Nippon Airways; and
AirAsia – a joint venture between Malaysia Air Asia and All Nippon.
This flurry of new entrants has prompted Narita Airport to announce that it will build an L.C.C. dedicated terminal, due to open in 2015!
L.C.C.’s are projected to carry 20% of Japan’s domestic traffic by the end of 2012, and possibly as much as 50% by the end of the decade.
The L.C.C. Japan phenomenon is rapidly spilling over into neighboring countries.
The Qantas’ Group, which also follows a multi-airline portfolio strategy, has chosen to have its Asian expansion channeled through its low cost JetStar subsidiary.
JetStar, joining forces with “China Eastern Airlines”, will launch a new low cost subsidiary in 2013, based in Hong Kong.
China is the target market.
Another Chinese carrier, Hainan Airlines Group, plans to turn its affiliate – 45 percent owned “Hong Kong Express” – into a low cost operation.
Vietnam, Indonesia and the Philippines are seen as markets with great potential for low cost travel. Both are archipelagos with large numbers of overseas workers, and are increasingly popular tourist destinations.
Finally, Myanmar’s aviation market is poised to enter a major period of growth as the country begins to open up to world trade and tourism.
Despite a slowdown of work related to a delamination issue, Boeing plans to deliver – on schedule – forty-five B-787s to customers in 2012, and has a goal of meeting a rate of 10 aircraft per month by the end of 2013.
The first airplanes were powered by Rolls Royce Trent 1000. Earlier this year certification was completed for the B-787 powered by General Electric, GENX-1B.
Boeing’s network analysis group has forecast that a potential of up to 450 new city pairs could be opened as a result of the B-787-8s particular combination of size (250 passengers), range (14,000 kms) and operating economics.
Thin routes such as Boston-Tokyo, Mumbai-Mexico City or Frankfurt-Santiago (Chile) would be good candidates.
Meanwhile, Airbus has started the final assembly process of the A-350-900. Airbus still believes that it can begin customer delivery in 2014.
Redesign efforts have been on-going on the larger A-350-1000 model to reinforce its ability to compete successfully with the Boeing 777-300 ER and any further improvements to this model, which Boeing is already beginning to examine.
Not surprisingly, predictions vary widely between Airbus and Boeing on the performance of their re-engined, next generation, narrow bodies.
The A-320 NEO is due to begin commercial operation in three years, while the Boeing B-737 MAX debut is even further off – targeted for 2017.
Airbus indicates that the A-320 NEO is expected to produce an overall fuel-burn improvement of 15 percent compared to the current A-320 model.
Boeing is claiming that the B-737 MAX will have a 17 percent fuel burn advantage over the current A-320.
This could be a case of “apples and oranges”.
Boeing’s prediction for fuel burn per seat is based on a 162-seat configuration for the B-737 and a 150 seat arrangement for the A-320.
A huge order from SkyWest at Farnborough for 100 Mitsubishi regional jets – the 90-seat MRJ-90 – was a major signal that the Bombardier-Embraer duopoly may have ended.
SkyWest is a key player in the biggest regional jet market, the U.S.A.
But Mitsubishi is also studying a stretched 100 seat version for potential customers including Air Lease Co.
The MRJ is the second entrant in the larger regional jet arena, following the SUKHOI SuperJet 100 which entered service last year but has yet to gain full credibility with Western operators.
Meanwhile, Bombardier no longer insists that the first flight of the C-Series – the CS100 – will take place by the end of 2012, but still hopes to deliver a certified for 120 minutes E. T.O.P.S. at entry into service to a customer in 2013.
The plan also calls for the larger C.S.300 to be certified by 2014.
By allying its product with the Chinese COMAC C-919, Bombardier would be able to offer a hybrid family to the Chinese carriers.
COMAC C-919 is expected to fly in 2014, and start delivery in 2017. RyanAir has expressed an interest for the aircraft.
The objective of the Single European Sky initiative, launched in 2004, was to achieve a European airspace without borders.
Progress has been painfully slow.
Unable to see a way of overcoming, the complex political and bureaucratic obstacles required to achieve a Single European Sky, the Europeans have embarked on an intermediate step of forming Functional Airspace Blocks … (F.A.B.)
This would at least allow some consolidation of facilities and functions to reduce costs – and by extension, the fees paid by the airlines.
To illustrate the magnitude of the current European system’s inefficiencies, it may be sufficient to note that the United States’ A.T.C. delivers approximately twice the volume of all European ATCs – for the same price!
There are today, in Europe, some 27 air navigation authorities and a number of military air control centers.
And, at present, the European States are planning to regroup their ATCs into nine (9) multinational Air Space Blocks covering almost all of Europe.
But then, once the integration is completed within each of these Functional Blocks there will remain the task of ensuring that the nine will efficiently work together.
On the technical side progress is achieved more easily.
The Single European Sky ATM Research (S.E.S.A.R.) program was also launched in 2004 to provide Europe with “high performance air traffic infrastructure and technology” to meet the requirements of the future.
The 4-D Trajectory Management is on track, and is one of the more significant projects to deliver flight optimization.
This will require further coordination between airborne and ground systems.
The modernization of air traffic services is progressing in other regions.
In the U.S.A., as part of the NextGen air navigation improvement program, the F.A.A. has now awarded a contract to accelerate the development of satellite-based procedures.
These will allow aircraft to fly more directly to their destinations – and more efficient approaches into an airport.
In Asia, the concept for a seamless Asian Sky (S.A.S.) has achieved widespread, high level support.
S.A.S. does not mean one owner – but a need to agree that the airspace boundaries need to be transparent, or seamless.
Fortunately, Asian governments have progressive aviation policies. China, Japan and India will each provide valuable input, and will enable smaller countries … to find their place in the overall picture.
A decade or so ago, many airlines – particularly the low costs – began to offer their products directly through the web.
The advantages seemed obvious, and a number of experts were predicting the death of the travel agents.
But it is now clear that the travel agents are going to outlive those experts.
The role of the travel agent is not decreasing. More than 60 percent of all airline tickets are still being sold through travel agents.
G.D.S’s, which were also predicted to become obsolete, have evolved and today also operate direct sites for airlines.
The travel agents are being paid more money to use the G.D.S’s., which are probably their prime customers.
However, there is a need for the travel agents to develop a response to the rapidly increasing use of mobile devices.
The increasing importance of ancillary products to airline revenues is introducing a new dimension.
To what extent should travel agents and G.D.S.’s be involved in retailing ancillary products such as seat selection, food, entertainment etc. – in addition to those traditionally related to the trip, for example hotels, car rental, theatre tickets etc.?
The love-hate relationship between the airlines and the G.D.S.s is continuing, with strong opposition by all airline associations to a U.S. DoT proposed mandate requiring all airlines serving the U.S.A. to distribute all their content and services through Global Distribution Systems (G.D.S’s).
Meanwhile, Google is de facto becoming a distribution channel in its own right, with the additional capabilities of proposing more products and services on the basis of your purchase history and preferences.
Some eleven years ago, Ryanair C.E.O., Michael O’ Leary, boasted that eventually his airline would be making so much money from ancillary revenues that he would be able to afford to fly people for free -perhaps based on the expectation that gambling would be allowed on board, which of course has not happened.
Nevertheless, over time airlines have continued to come up with many more ways to boost their so-called “ancillary revenues”.
An annual study carried out by IDEA Works, sponsored by AMADEUS, has been tracking those revenues.
This year’s report shows that the total revenue collected by fifty carriers reporting ancillary revenues as a separate category was 22.6 billion US dollars in 2011 – up from the 13.5 billion dollars reported two years earlier.
Some observers believe that these revenues may be starting to top out, but there may still be some room by varying prices by flight based on demand, just as carriers have done with yields.
Meanwhile, Mr. O’ Leary is no longer talking about flying his customers for free!
Among other aspects being explored, airlines may be able to gain some additional revenues for connectivity on board.
By the end of 2011, 1,885 aircraft were equipped with Wi-Fi , and the current forecast is for 6,100 airplanes to be equipped by 2015.
Today, most Wi-Fi equipped airplanes fly in North America. All major U.S. airlines are – or plan to be – totally equipped.
The number of passengers who chose to pay for the Wi-Fi service increased to 7 percent by the end of 2011 from some 4 percent in 2010.
The growth is, in part, driven by the rapid penetration of smart phones and other communication devices such as tablets.
In-flight Wi-Fi revenues are expected to exceed 15 billion US dollars in 2015.
Connection services are provided by Chicago-based GoGo Inc., which covers all of Continental U.S.A., Canada and Alaska.
This represents only some 2 percent of the earth’s surface, but Geneva-based OnAir plans to offer near global coverage using INMARSAT satellite.
The price is not cheap, but the coming boom in air-to-ground and satellite broadband capacity should drive prices down.
Despite all those efforts of frequent cost restructuring, mergers, acquisitions, alliances, joint ventures, experimenting with different business models, hybrids and subsidiaries – the aviation industry as a whole continues to fail the profitability test!
With a few exceptions – far too few – the airline industry is not profitable, and does not consistently earn its cost of capital.
Many airports are also unprofitable – and overly constrained in their expansion.
Air Navigation Services are under pressure, and need to be encouraged to regroup.
For a few governments – and the Gulf States are a good example – commercial aviation is a strategic industry, and plays a major role in the development of their respective countries.
But unfortunately, for many governments – particularly in Europe and North America – commercial aviation and air travelers are regarded as the proverbial “milking cow”.
And the cow is getting thinner, and thinner!
And yet the socio-economic impact of air transport is simply huge on every country, region, and indeed the world.
A recent study carried out by Oxford Economics, clearly demonstrates the economic and social benefits of aviation at the national level.
This study involved over fifty countries, and concluded that when the air transport industry has been encouraged to grow efficiently in response to the demands of the expanding market, the economic impact has been very substantial.
The Oxford Economic study concluded that aviation is a key factor facilitating world trade, helping countries to participate in the global economy, and increasing their access to international markets.
While it may be a giant undertaking to convince all governments to be more supportive of our industry, we can make significant progress by working together better.
As partners of the broader travel, transportation and tourism world, we would all of course benefit from more enlightened government policies.
But we can also help each other to become more efficient and more profitable, and seek greater synergies to our mutual benefit.
This is an important dimension which we will begin to explore more thoroughly in the Friday afternoon session of this Conference.
In closing, ladies and gentlemen, I am reminded that having lost twenty thousand pounds in the South Sea bubble in 1720, Sir Isaac Newton has been quoted saying
“I can calculate the motion of heavenly bodies, but not the madness of people.”
If he had lived today – and invested in our industry – he may well have said the same thing about the way we manage airlines, which leads me to conclude that most of us must be in this industry for the romance and the fun – but certainly not for the money!
Yet we must be looking forward to a brighter tomorrow!