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Giving Thought to the Export – Import Bank Issue; Not to Protectionism

Below is an article I penned for the current bi-monthly edition of Routes News Magazine.  It questions whether the government of Canada should be protecting Air Canada from new competition originating out of the United Arab Emirates.

It would by hypocritical of me to suggest anything protectionist.  But when thinking about new competition from the capital rich Gulf State region, a question arises:  Do countries other than the United States (home to Boeing); and France, Germany, Britain and Spain (countries home to Airbus) realize a competitive advantage in the way they buy airplanes because they receive export credit?  [Canada (Bombardier) and Brazil (Embraer) have similar programs in place]  Export credit consists of loans or loan guarantees extended by a government to foreign buyers of the country's products and services.  Countries home to Boeing and Airbus are not eligible to receive the same below market financing.

We will explore at the end of the article.  

Article in Routes News Magazine – “Stand and Protect”

Depending on who you listen to, expanding bilateral rights between Canada and United Arab Emirates is good for Canada. Or it isn’t. But is it really about bilateral rights or more about short-term protectionism versus the long-term worldview? The issue is about whether Canada confines itself to its own borders or allows one or more of its cities to become global gateways that are relevant on tomorrow’s airline map. Similar decisions face governments in France, Germany, South Korea and the United Kingdom.

Emirates says allowing it to fly more services between the UAE and Canada would be a boon to the Canadian economy – but Air Canada vehemently disagrees. You’ll hear the same type rhetoric whether you’re in Germany, France, the UK or South Korea, just with different airlines like Etihad, Qatar and Emirates.

Emirates currently offers three weekly services between Toronto and Dubai operating a 489-seat A380 aircraft. What Emirates wants is a twice-daily Toronto service as well as to add Calgary and Vancouver to its Canadian flight offering.

Of course, Dubai is not a large local market, but it connects traffic all over the world, including the Middle East, South East Asia, South Pacific and the India subcontinent. In order to continue to build that mega-network, Emirates must continually add new destinations to its rapidly growing route map and these new market opportunities must be negotiated through the bilateral process.

Emirates s targeting Canada as it is a growth market. Or, is Emirates’ growth into the Canadian market really targeting a weakened Air Canada? 

Air Canada’s CEO, Calin Rovinescu, says, "What Emirates wants to do is flood the Canadian market with capacity. Its strategy is to scoop up travelers going elsewhere in the world and funnel them through Dubai, further strengthening Dubai as a global hub."  He also says Emirates' strategy will “constrain the growth of Canadian airports by turning them from hubs into stubs at the end of a spoke that leads only to Emirates' hub in Dubai". Just in case he didn’t make his point, Rovinescu added, "Sure, you will still be able to get to anywhere from Vancouver. But you will have to get there through Dubai."

Isn’t Emirates, along with the other Gulf carriers with global aspirations, really creating an airlines to compete with the big three global alliances? 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.

Emirates is able to combine the use of new technology (the A380), with low labor costs, government policies that are designed to promote aviation and a unique geography that allows 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 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 make it difficult to reduce fares even when faced with cut-throat 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.

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 to establishing connections between alliance partner gateways. Each of these evolutionary steps led to increased traffic through the stimulation of local and connecting traffic. 

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 seamless. The Gulf airlines are each one carrier, while the alliances are a patchwork architecture designed to circumvent archaic bilateral rules.

Emirates argues it will be a catalyst for new traffic growth that, according to a study commissioned by Emirates, will generate $480 million in economic activity. Air Canada claims all Emirates will do is take today’s traffic and redirect it to Dubai. The truth lies somewhere in the middle. There will be a stimulation of new demand producing new economic activity and Air Canada will be challenged to hold onto all of its traffic flying from its gateways today.

Mature markets like North America should embrace the competition brought by Emirates and others as these new carriers have networks designed to access both developed and developing economies. By any growth metric, it is the developing economies that are providing global airline industry growth and they are the industry’s future source of growth.

In the short-term, a loss of Air Canada would outweigh any economic benefit brought by Emirates to Toronto, Calgary or Vancouver. Over the long-term, Ottawa’s protectionist stance will only hinder the chances of at least one Canadian city emerging as one of the more important gateways in the world. The current regime will mean that there will be relatively few points on the map where the world can be accessed with one-stop and that will prove vital in determining tomorrow’s commercial flows.

Short-term protectionism standing in the way of long-term global relevance seems like a high price to pay to coddle the nation’s flag carrier. 

The Export – Import Bank Dilemma

Let’s focus on the United States for a minute.  In 2008 -2009, 11 wide-body aircraft were delivered to U.S. export – import bank eligible country competitors serving the U.S. for each one wide-body aircraft delivered to a U.S. carrier.  So, in essence, the U.S. government is giving foreign competitors a price break its own country’s airlines don’t get. It’s a distinct and often hefty – financing can be upwards of $4 - 5 million per plane – competitive advantage.

Competition is one thing. That’s why the U.S. has championed “Open Skies” agreements around the world.   Since 1995, the U.S. has negotiated 99 such agreements while other world governments combined have approved just 20.

The U.S. government creating an unlevel playing field is something entirely different.  The financing advantage enjoyed by recipients of Export Credit Agency (ECA) loans facilitates events that are neither good for airline employees, U.S. tax coffers or the prospects for the U.S. airline industry returning to profitability.

Small costs differences have added up to big change in the U.S. domestic airline market, triggering tectonic shifts in the makeup of competition. When cost differences between network airlines and the low cost carriers approached two cents per available seat mile, low cost carriers grew at the expense of the networks.  The same type of outcome could occur in the international arena - only it might not be U.S. flagged carriers replacing capacity lost by another U.S. carrier. 

ECA programs offering financing 4-5 percentage points less on a $260 million wide-body aircraft is not small change. Foreign carriers can save millions funding a fleet at a level and rate U.S. airlines can’t possibly match in the commercial markets.

ECA backed funding first came available in the United States and Europe in 2000.  U.S. competitors Emirates Airlines (UAE), Korean Air (Korea) and WestJet (Canada) have the distinction of not only being among the largest recipients of U.S. financing, but they are also the three airlines that have added the most capacity against competing U.S. carriers since 2002.

At a time when the U.S. government is imposing cost and regulation on top of the industry responsible for enabling more than one trillion dollars in economic activity, this would seem to be an easily resolved issue. Eliminate ECA funding and the ability it gives foreign airlines to use U.S. taxpayer dollars to simply swamp U.S. carriers with uneconomic capacity.  Again, I am all for competition...  Just not competition on an uneven plane that gives someone a significant advantage by subsidizing a cost center.

This is a slightly different virtuous circle than those we have referenced in the past – and one that can be stopped:  U.S. government backs loans to foreign competition; foreign competitor costs decline as a result; lower cost foreign competition accelerates growth; opportunity cost to U.S. airline industry equal opportunities lost because of cost disadvantage; fewer U.S. employees to bolster the tax rolls.

So why is the ECA case different from the challenge the Gulf airlines pose in Canada? That’s about access to the marketplace. The U.S. provides access.  ECA gives non-U.S. airlines a cash advantage to spend as they wish in that marketplace – whether by offering non-compensatory fares or to simply buy more airplanes to add new and marginal service to that marketplace that results in more non-compensatory fares.

You know how it goes from there.