Airlines face new challenges

THE real question is not whether the airlines would survive another recession so soon after the 2008/2009 global economic meltdown. In an industry dominated by national players whose fate goes beyond commercial considerations, willy-nilly the majority of them will pull through, perhaps struggle to stay afloat, and emerge badly bruised.

While experts generally do not foresee a trough as deep as the previous one, the signs aren’t all that encouraging with recent reports of the American economy still floundering, the debt of Greece widening, no letting up of the political unrest in the Middle East, the prospect of the China market contracting, Japan still reeling from the aftermath of natural disasters, stocks across the world plunging, and a sinking oil price that ironically should and yet not completely be good news for the airlines.

According to the International Air Transport Association (IATA), airlines are reporting better than expected passenger demand, but profitability has not kept pace. In a simple profit and loss equation, it can only mean higher costs or lower yield, and for some airlines, perhaps the growth of capacity outpacing the demand. In its latest forecast, IATA expects lower profit for 2012 in a very tough environment, projecting it to fall to US$4.9 billion from US$6.9 billion expected this year even as passenger demand grows by 4.6 per cent compared to 5.9 per cent for the current year.

But it is not all gloom and doom according to IATA Director General and CEO Tony Tyler, who said: “Relatively stronger economic growth will help Asia-Pacific airlines to maintain their 2012 profits close to 2011 levels at $2.3 billion. The rest of the industry will see declining profitability. And the worst hit is expected to be Europe where the economic crisis means the industry is only expected to return a combined profit of $300 million. A long slow struggle lies ahead.”

Indeed, it will be a long, rocky road to recovery for most, if not all, airlines, if the world economy continues to slow down, moving backward as it moves forward. The prolonged volatility of the global market only serves to confirm the lessons of the previous downturn – lest they have been forgotten – and to provide an opportune respite for the airlines to re-strategize, at least for those who have wised up to know that going forward, it cannot be business as usual.

Market shifts

The market has definitely sifted downward. It is worth reiterating how during the 2008/09 financial crisis, the demand for air travel fell and people who must fly were looking at cheaper fares, which explained the flourish of budget carriers and the misfortune of major carriers which thrived on the premium market particularly when corporations downgraded executive travel. We have witnessed how the aviation landscape quickly became dotted with budget upstarts, particularly in Asia-Pacific (understandably so since it is comparatively a new phenomenon here than in Europe and the United States), and more recently how full-service airlines themselves are setting up budget subsidiaries and joint ventures to protect their turf in light of the competition posed by independent carriers and be where the business is heading.

The most anticipated entry into this arena is probably Singapore Airlines (SIA)’s fully-owned yet-to-be-named budget subsidiary which is expected to commence operations in 2012. SIA has indicated that the new offshoot will not be used on routes below the 4-hour duration normally operated by the traditional budget model, as it is eyeing the more lucrative North Asian markets such as Korea. SIA is pushing the evolution of the budget model from a mere no-frills entity in a segregated market to a viable competitor in the total air travel business – something that has already happened in Europe and the US and preceded by budget long haul flights such as the operations of AirAsia under the AirAsia X banner from Kuala Lumpur to Paris and London.

Interestingly, India’s Kingfisher Airlines has decided to exit the budget market – closing down Kingfisher Red – and focus on full-service operations. In spite of India’s booming low-cost traffic which has increased to 50 per cent of the country’s total traffic from 39 per cent two years ago, Kingfisher CEO Sanjay Aggarwal’s decision not to “compete in the low-cost segment” may be a case of foresight of an impending saturation of the no-frills market. He said: “Capacity induction of the LCCs (low cost carriers) has outpaced the demand growth in the domestic market. The induction of so many aircraft in the low cost segment will potentially lead to substantial overcapacity and a price war with declining yields.” But the vacuum vacated by Kingfisher Red is likely to be quickly filled by rivals and new upstarts.

The corollary is one of opportunities offering better returns in a reviving albeit slowly reviving full-service market while others shift their focus away from it. Mr Aggarwal said: “While there are currently five airlines participating in the low-cost carrier segment, there are only three full-service carriers. We believe that competition will be far more intense in the low-fare space than in the full service space.” He was optimistic that full-service yields would far outweigh additional costs on things like global distribution and in-flight catering.

Yet, as the competition flattens across the broad aviation terrain, nomenclature will become less important, even redundant. The demarcation between budget and full-service is beginning to blur. The competition will be decided by the consumer’s perception of value, whether budget or full-service, and less so by image.

The future of premium travel

Just because the market has shifted downward, it would be wrong to assume that premium travel is heading for oblivion. Major airlines such as Singapore Airlines, Cathay Pacific Airways and British Airways (BA) have reported the numbers clawing back. The premium market will continue to constitute an important aspect of the business, considering that, as in the case of SIA, the revenue generated by class has traditionally been 40/60 premium/economy against 16/84 premium/economy by seats offered.

But as the competition becomes heightened by budget carriers shifting upwards, again flattening the playing field and putting pressure on the kind of margins that full-service airlines once enjoyed, full-service airlines face a new challenge of marketing not only intra-airline but also inter-airline class distinction, whatever the nomenclature. The rebranded Virgin Australia, going international, is eyeing the business market. Qantas’ subsidiary Jetstar has long introduced business class. EasyJet of the United Kingdom reported healthy bottom lines derived from the introduction of business class travel.

It may be back to the generic two-class configuration of upper (call it First, Business or whatever) and lower (economy or coach) as more airlines begin to downsize or eliminate First when it becomes more economically profitable to market Business (which could well be First in status) as the upper class difference. Some airlines have done away with First in their configuration, including SIA on certain sectors. Cathay in introducing Premium Economy is making the same move selectively. The in-between class which, as its name suggests is a better Economy package aimed at netting down-graders and luring borderline up-graders, has long been experimented by other airlines including early pioneer EVA Air in a limited way, Air Zealand with its Skycouch and BA with its World Traveller. It has yet to achieve shaker status, and Cathay faces the challenge of unravelling the magic that would make it so.

Geographical positioning

While the rest of the world churns in economic turmoil, Asia has emerged as aviation’s Holy Grail. In the words of Qantas chief Alan Joyce, the Australian flag carrier would “increase our focus on the world’s fastest growing aviation region” to avert an Australian “tragedy”. Qantas had earlier declared setting up a budget joint-venture with Japan Airlines (and Mitsubishi Corporation) and plans for an Asia wide-premium service to be based most likely in either Singapore or Kuala Lumpur. Not to be left out, Virgin Australia is also looking at opportunities in the region. SIA’s new budget subsidiary to reach Asian ports beyond the 4-hour flight time is perhaps also a correctional move to balance its exposure to markets in Europe and the US, which during the financial crisis until now have weighed down its profitability. It is understandable when Europe and the Americas generate 40 per cent of the revenue by routes.

Soothsayers are so overwhelmed by the huge potential of China and India that any possible contraction of the regional economy is unthinkable. But when it happens, it will be a different game. Sufficient to say that survival in aviation competition is a gold rush mentality.

Alliances in times of need

Especially in times of need, having friends helps indeed. Alliances help extend an airline’s reach and improve its visibility, provide transparent transfers between airlines and better flight meshing for the partners’ customers, strengthen the concerned airline’s competitive edge, and garner benefits for the partners in shared costs and opportunities. The recently announced SIA/Virgin Australia alliance would provide seamless transfers between SIA and Virgin flights and allows SIA access to Australian ports outside its network – a move that causes rival Qantas some concern, or, to quote Virgin Australia CEO John Borghetti, “a nightmare for Qantas international operations”. Virgin Australia has been busy shopping to ink strategic partnerships with airlines across the globe.

During the last financial crisis, many airlines were compelled to cut services and exit some routes. It made economic sense to co-operate to utilize excess capacity. Qantas is said to be working out possible extensive code-share arrangements with OneWorld partner BA to exit some stations served by both airlines. Some analysts think this would be a costly mistake for Qantas, which would lose visibility and control over the traffic it feeds into BA. The downside of alliances of this nature is that airlines soon begin to lose their individual distinctness and identity; weaker carriers may be advantaged by leaning on the good name of their more reputable partners, but the latter are less likely to relish the association.

That’s how the aviation landscape has changed consequent to the financial crisis. When you book on a preferred airline but end up flying on another, brand – and the loyalty that comes with it – no longer is an important consideration. Airlines will have to rethink the game as to what now has become more important to the discerning customer and how they can individually preserve their good name and retain customer loyalty.

The irony of a falling fuel price

During the 2008/2009 crisis, the soaring fuel price had often been cited as a key contributor to the woes befallen upon the airlines which until today still warn that this will continue to be a concern in light of the unabated political unrest in the Middle East. Ironically, the unanticipated fall in fuel prices following on the heel of the crisis caused many airlines million-dollar hedging losses. In its current five-year-plan, Qantas did not rule out more rounds of a fuel surcharge hike but recognized there was a limit to how much more an airline could resort to such a measure. The fuel price has fallen from the erstwhile high; by all indications, it should be good news, but if this is a sign of the worsening economic downturn, it does not forebode well for the industry.

Cost and the discerning customer

Most – if not all – airlines reacted to the last crisis by trimming costs. Looking back, rationalizing for consolation, we might attribute the setback to a period of forced correction whereby airlines became conscious of waste, unconscionable runaway costs, and frivolous and unnecessary expenses. At the same time, the customer became more discerning, discriminating and driven by a greater awareness of value relative to his or her needs and propensity for excesses as well as the availability of alternatives.

It was a stitch that might have come too late for the unfortunate few which did not have the strong books of SIA or a ready life-line from white knights. Going forward, the cut would be deeper if airlines forget the lessons learnt in the event of a recurrence of similar or worse circumstances. The new challenge is to seek out cost-savings that go beyond the elimination of an olive in a martini through more efficient equipment and methods of operation without sacrificing service standards, such benefits that will also favour the customer directly.

The pressure of environmental concerns

Whether or not the economic situation improves, there will be added challenges posed by developments in other world arenas. The pressure on airlines to go green will increase. Conscious of this, SIA recently announced its membership of the Sustainable Aviation Fuel Users Group (SAFUG) which pledges to accelerate the development and commercialization of sustainable aviation biofuels. But if airlines – which contribute about 3 per cent of the world’s total carbon dioxide emissions – choose not to heed the call to help the environment, the authorities may regulate to bring them in line.

The writing is on the wall. UK Energy and Climate Change Minister Greg Barker said: “The aviation industry, in the same way as other industries, needs to play its part in reducing emissions.”

The European Union (EU) has plans to include any airline landing or taking off on EU territory in its emission trading scheme, which is being challenged by North American airlines. In response to the American argument that this was a violation of the Open Skies Agreement, European Court of Justice Advocate General Juliane Kokott said: “The inclusion in the EU emissions trading scheme of flights of all airlines from and to European airports is compatible with the principle of fair and equal opportunity laid down in the Open Skies Agreement.” She added: “Indeed, it is precisely that inclusion that establishes equally of opportunity in competition, as airlines holding the nationality of a third country would otherwise obtain an unjustified competitive advantage over their European competitors if the EU legislature had excluded them from the EU emissions trading scheme.”

Australia is the latest country to pass a bill for the controversial carbon tax, to be paid by polluters for each tonne of carbon dioxide emission. Slated for implementation on July 1, 2012, the tax will evolve into an emissions trading scheme in three years like the one in Europe. Airlines then can expect to face the same fate.

Will the defaulted airlines willy-nilly pass on the “penalty” costs to their customers or will this force them to become more efficient? It is not that simple in a competitive environment. The discerning customer is not likely to want to pay a second fuel surcharge, this time for a carrier’s inefficiency.

The cry for innovation

Necessity is the mother of invention. New engines designed to reduce fuel use has been the driving force at aircraft manufacturing facilities, with Airbus and Boeing claiming to be leaders in the field as they rolled out the A380 and B787 Dreamliner respectively. Qantas has just placed a US$9.5 billion order for 110 Airbus aircraft – 32 A320s and 78 A329neos, no doubt to be expected following announcement of its Asian expansion plans. The next-generation A320 neo is said to be 15 per cent more fuel efficient than the original A320.

More than just innovation in the field of hardware, the industry is badly in need of new sparks ine way the business is executed. The problem with the nature of the industry is that ideas often take too long to be realized or implemented while the impact of external events can happen in a flash.

Foggy skies ahead

All said, it’s still foggy skies ahead. Between SIA and Kingfisher as representative of the initiatives across the aviation landscape, it may even be said many of us are far more clueless than we claim to be about what the future holds as we await the next revised forecast by IATA.

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About David Leo
David Leo has more than 30 years of aviation experience, having served in senior management in one of the world's best airlines and airports. He continues to maintain a keen interest in the business, writes freelance and provides consultancy services in the field.

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