It has been 46 days since I last posted a piece on swelblog.com. That is not to say that I have not been writing. I have - just not here. To be truthful, I am bored with most things U.S. I cannot read anymore rehashes of the American Airlines case; or labor forever trying to create leverage where there is none; or who will be AA’s exit partner if there is one; or the United pilots thinking that it is totally incumbent on management to reach a deal amidst union in-fighting and an ignorance about competitive realities.
But a topic that always has my interest is happenings in the Middle East region when it comes to aviation. I was asked by the Emirates Airline Public Affairs group for an interview that was included in their February 2012 Open Sky journal release. It is included below.
Doug Cameron, writing in today’s Wall Street Journal, talks of Emirates intentions to enter a 7th U.S. point in the immediate future with more to come. There is no better time for this inevitable next phase of competition to begin as SkyTeam’s European partners report weakening financial results; STAR carrier Lufthansa reports results are down but being buoyed by non-airline assets all the while partner Air Canada finds itself trying to simply hang on and remain relevant; and oneworld’s US partner American Airlines flounders in bankruptcy making it an opportune time for the Middle East juggernaut to begin the process of adding more of North America to its global route portfolio before the third global alliance is a more meaningful competitor.
I am excited to see new competition for the aligned U.S. and European competitors begin in earnest as it seems that employees and other stakeholders just do not take the threat of this obvious evolution as serious. It is. The U.S. carriers reported a paltry .3 point earnings margin in 2011 and that is before the new competition begins and ever increasing fuel prices are used to describe 2012. The work is far from done.
1. Generally, what do you see as the major themes playing out next year in the airline industry?
The health of the global economy generally, and Europe specifically, will continue to dominate headlines in 2012.
The industry can’t just be viable; it must continue to recreate its business model into one that can be profitable on a sustainable basis. The industry as a whole must find a way to earn at least its cost of capital in order that it can reinvest in itself.
Today’s dysfunctional governments, particularly across the Eurozone and the U.S., must find a way to function. When it comes to aviation, policy makers must begin to think clearly about what laws, regulations, taxes and fees are necessary for the business to achieve overarching economic and social goals. Too many current governmental decisions claiming to be in the best interest of the consumer are fraught with unintended consequences.
The growth of the Middle East carriers (Emirates, Ethiad and Qatar) will remain a topic of conversation around the world. Not surprisingly, the response to the Middle East carriers from some parts of the world has been protectionist. First the world wanted to open the skies. Now that the skies are largely open for some/most, the talk has turned to restricting access to markets from new, innovative and vibrant competition. I agree the new competition should not be allowed access to cheap capital that is not available to all. But to limit market access because of presumed subsidy, cheap fuel, little or no airport costs and whatever other excuse to limit the growth of Middle East carriers is just plain wrong.
Of course, the rhetoric over the EU Emissions Trading Scheme (ETS) and the proper policy to ensure that the industry is environmentally sustainable will be a news item throughout 2012 and beyond.
The price and volatility in the price of oil remains an important theme, albeit much less so in 2012 than in 2008. [here I may be wrong] Commodity industries abhor volatile input prices.
Consolidation will remain an important part of the global airline industry’s vernacular in 2012. It’s proving to be a healthy tonic for improved profitability in North America, but there are not many logical combinations left in the U.S. unless we begin the process of considering cross-border financial transactions among airline companies.
2. What effect is the Eurozone crisis having on protectionism vs. liberal aviation policies in Europe?
I think it is less the Eurozone crisis and more the fear of new competition from Middle East domiciled carriers that’s triggered increasing calls for protectionism in many parts of the world. From my perspective, short-term aviation protectionism stands in the way of a country’s long-term global relevance. Moreover, it seems like a high price for governments to pay in order to coddle a nation’s flag carrier.
There has been considerable consolidation among Europe’s flag carriers over the past five years. With the obvious buyers of remaining carriers, or stakes in those carriers, struggling financially, I expect fewer future intra-Europe financial transactions. As a result, the financial resolve of the remaining carriers in Europe will be significantly challenged, especially without hope of a government bailout. Those governments will be hard pressed to protect struggling flag carriers over the medium term.
Either way, I see Europe as a more protected zone in the coming years rather than embracing liberal policies promoting competition. The contemporary Europe will likely be anti-airline, except where the industry is viewed as a tax revenue generator and deficit reducing business sector. The consumer will lose, economies will lose and countries may even likely lose their coveted flag airlines. Ultimately, the market will win, but not before artificial protectionist barriers are erected. The good news for Middle East-based carriers is other opportunities for carrier growth are present in emerging markets in Africa, Southeast Asia, China and even mature markets like North America.
In many ways, the European market is going through a similar transition that the U.S industry has been painfully undergoing since the mid-1980s. That shakeout triggered massive change and until the Darwinian process fully plays out in Europe, liberal aviation policy thinking will probably not resume either.
3. Do you foresee any fallout, aero-politically, from the AMR bankruptcy filing?
I do not see any aero-political fallout from the AMR bankruptcy filing. Rather, I see it as necessary for the Fort Worth, Texas airline to obviate its competitive weaknesses relative to other U.S. network carriers that used U.S. law to restructure their mature operations.
Internationally, American Airlines is oneworld’s one and only link in accessing the world’s largest aviation marketplace – the United States. A loss of American weakens competition among the three global alliances in a significant way both across the Atlantic and the Pacific. In my mind, a loss of American would be another reason for politicians to restore the protectionist chorus that would point to the dominant positions held by the remaining two global alliances – STAR and SkyTeam - all the while ignoring the new competition emerging in the Middle East.
Rather than fallout from AMR’s restructuring, I believe oneworld carriers British Airways and Iberia – through their immunized joint ventures with American - will be an important aspect of any plan of reorganization. That plan could very well renew the call for changing foreign ownership rules. In fact, the continued growth and the competitive threat posed by the Middle East carriers for traffic flows that were once the sole domain of the global alliances is also a triggering event for change in the ownership laws.
4. What effect do you see from the EU ETS on EU-US relations or otherwise? What will be the knock-on effect?
While this story is in its infancy, there is no question that the global industry must address environmental issues and be a leader in creating a sustainable business. How to go about establishing the proper policy will be debated for years to come. It seems odd that the EU would institute potentially billions of dollars of new fees on airlines when finances of the global airline industry and economies around the globe are in such a fragile state. Less profitable airlines have less capital to invest in technology that will prove to be the best prescription for reducing the carbon footprint over the longer term.
I expect we will see business as usual “under protest” in the immediate term. Will ICAO act? Initially, US-EU relations will certainly be strained, but airlines attached at the hip through joint ventures will have to maintain the current course of business. What is ironic is the European airlines are high-cost producers and just became higher cost producers. If I was a lower-cost producer, I would be trying to figure out how to use this to my advantage and appeal to the customer through lower fares. This knock-on effect may finally open the eyes of the EU and other governments that you cannot tax and fee the industry into oblivion.
5. What is happening in the world of alliances and anti-trust immunities?
I am beginning to fundamentally question whether STAR and SkyTeam are growing/have grown too big in terms of number of carriers under the respective alliance umbrella. After all, it is the top 5 carriers within each alliance that realize a significantly disproportionate share of the synergy benefits generated. It is no coincidence these carriers enjoy an immunized relationship. Moreover, if the primary synergies of an immunized alliance are revenue only, we must be nearing an end to the alliance lifeline where marginal revenues generated by a new member exceed the marginal cost of inclusion of that new member.
Aviation networks have evolved from linear systems to hubs and spokes with a focus on building regional dominance; to connecting regional hubs creating national/continental networks; and then establishing connections between alliance partner gateways. The evolution of competition has been from city-pair to hub to gateway to network. Each of these evolutionary steps has led to increased traffic through the stimulation of new local and connecting traffic.
Alliances were originally built to accomplish what no one airline could do itself – create ubiquitous networks ferrying passengers from one point in one world region to another point in another world region. But are alliances truly ubiquitous?
Emirates is able to combine the use of new technology (the A380), with low labor costs, government policies designed to promote aviation and a unique geography allowing it to compete with global alliances. Should we really concern ourselves with flag carriers to the same extent today that we did 20 years ago or even 10 years ago? Alliances have already caused borders to blur and the colors in some flags to cloud. Emirates, Ethiad and Qatar are simply doing what the oneworld, Star and SkyTeam alliances have already done.
Just like low-cost airlines, the Gulf carriers will place enormous pressure on network incumbents to match prices. That will be a problem for some of those incumbents, whose high cost structures – particularly in Europe - make it difficult to reduce fares even when faced with new competition. Even if some of the carriers within the global alliances or the independents were to fail, the market has demonstrated time and again that, where competition is vulnerable, a new entrant will exploit that vulnerability. Where there are market opportunities, there will be a carrier to leverage that opportunity. And where there is insufficient capacity, capacity will find the insufficiency. Networks evolve because of competition.
I believe the next phase of evolution will do some of the same. The challenge from the three Gulf carriers to the three global alliances will accelerate the discussion about global mergers because the networks being built by Emirates, Ethiad and Qatar are truly ubiquitous. The Gulf airlines are each one carrier, while the alliances are a patchwork architecture designed to circumvent archaic bilateral rules. Organic growth will again prove to be the right tonic for airline systems to be financially sustainable – because the benefits of cost synergies are not being realized today and must be realized if the full financial potential of carrier combinations is to be appreciated and the resulting benefits are enjoyed by the consumer.