Europe's aviation landscape is changing. As the economic tide turns to reveal tougher times ahead, consolidation is rife and alliance leaders seem set to tighten their strongholds, seizing every acquisition opportunity that emerges from the shakedown. But, as members of the European Regions Airline Association (ERA) prepare to meet in Manchester, it is unclear how the tie-up trend will affect the regional sector.
Opinions on the impact of major carrier consolidation on regionals vary widely among the airline executives preparing to travel to Manchester. As Jacques Bankir, chief executive of independent Swiss carrier Baboo, summarises succinctly: "Very complex question. No simple answer."
The industry is in a state of flux. A set of put and call options between UK Star Alliance carrier BMI and Lufthansa mean that BMI Regional may be destined for new ownership by June 2009. Their alliance partner, Austrian Airlines Group, is about to be further privatised: will its new owners see a continued role for the Austrian Arrows brand?
Within Oneworld, British Airways and Iberia are joining forces - a move that could affect Iberia's independently owned regional partner Air Nostrum - while relaunch efforts at SkyTeam member Alitalia could cause a ripple effect across the Italian regional market.
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UK regional Flybe has already benefited from the industry consolidation, snapping up British Airways' regional arm |
Beyond this, Air France-KLM is waiting on its acquisition of Belgian regional VLM Airlines to be cleared and Lufthansa is taking a sizeable stake in Brussels Airlines' parent company. Both giants have also been linked with Alitalia and Austrian. Change is afoot.
UK regional Flybe has already benefited first-hand from the industry shake-up. British Airways made the bold move of selling its BA Connect regional operation after the carrier failed to meet its target of becoming profitable within two years of its March 2006 launch.
ERA director for air transport policy Andrew Clarke does not believe that regional carrier consolidation will naturally follow. He says: "Consolidation of major airlines does not imply consolidation of regional airlines, which are usually operating in a local or niche market. There have been only a few examples of mergers or acquisitions among regional airlines. However, I would expect to see an increase in strategic co-operative agreements."
Illustrating his point, Clarke uses the example of Air France-KLM's regional airlines - Brit Air, Regional and KLM Cityhopper - which are distinct entities, but co-operate in areas such as aircraft purchasing.
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He adds that the majors' regional strategies have been varied, contrasting BA's disposal of BA Connect to Flybe, with TAP Portugal's acquisition of Portugalia and Air France-KLM's planned takeover of VLM. "This conflict in strategies has been the case ever since I have been involved in the European regional sector. Many times over the past 20 years, one major has been disposing of its regional operation at the same time as another major has been acquiring a regional airline. I see no new trend emerging, except that now these strategic decisions seem to be reversed only rarely."
CRUNCH MOMENT
Air Nostrum chief executive Carlos Bertomeu has a different view. He says: "We foresee that the consolidation process will affect the regionals, so we anticipate that smaller regional airlines will fall within larger regionals, linked to major airlines, and some will disappear."
However, Flybe chief commercial officer Mike Rutter disagrees about the future relationship between majors and regionals. He says: "This is a crunch moment. There is a massive rationalisation of big carriers that will force the rationalisation of the carriers that rely on the megabrands. Rationalisation is going to be driven because the megabrands and franchises will have different priorities going forward. Regional activity will not fit with the new ownership of those airlines."
Rutter's view is not shared by the megabrands' regional offspring. Jean-Yves Grosse, who heads Air France subsidiary Regional, says: "An important share of the regional market is already operated by subsidiaries of the major European carriers or within an alliance. That trend will be further strengthened."
While views from the regional carrier boardrooms tend to be aligned with their business models, regional aircraft manufacturers share a more unanimous outlook. ATR head of sales John Moore says: "The process of airline consolidation, in Europe and elsewhere, has been ongoing for some time now and we can expect it to continue. The overall effect on regional carriers has mainly been towards causing a similar consolidation of regional carriers. Over time there are less independent, small regional carriers and a fewer number of larger regionals."
Embraer market intelligence vice-president Luiz Sergio Chiessi agrees: "I think there is a trend for more consolidation [among regional airlines] in the never-ending quest to achieve lower operating costs. One of the paths [for improved cost control] is via regional carriers getting more specialised in their operations."
CONSOLIDATION BENEFITS
Chiessi believes consolidation in general will lead to larger catchment areas, stronger international gateways and streamlined operations, giving benefits to both mainline and regional carriers.
Bombardier regional vice-president for markets and airline analysis Barry MacKinnon adds: "Regional carriers have continued to grow and order new regional aircraft. It demonstrates that even in an industry consolidation scenario, regional carriers provide an ongoing, important role in linking Europe's regions to the large carrier hubs."
But what does this mean for the manufacturers? Moore says: "The effect on demand for regional aircraft is less clear. Overall the trend is towards larger capacity aircraft, moving from 50 seats more into 70 seats for the turboprop, but this is not necessarily due only to airline consolidation.
"The other trend which may be, at least in part, related to airline consolidation is that some routes are being passed from the major airlines to the regional airlines to better match capacity with demand and cost with yield."
Major carriers are delaying aircraft deliveries, cutting capacity and pulling off thinner routes as they become unsustainable, so flying appropriately sized aircraft is a clear area where the regional manufacturers stand to benefit. As Lufthansa's head of regional partner management Jurgen Hild says: "The big get bigger, but niches get bigger as well."
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The Lufthansa executive believes the drive towards cost efficiency will pull larger carriers away from markets that need to be served by high unit-cost aircraft. "Big carriers will leave the 50-seat segment, thus giving regionals a bigger niche market."
The ERA's Clarke agrees that the downturn could be beneficial to the regional sector: "Many more opportunities will open for regional airlines as their smaller aircraft become the right size for operations that can no longer be sustained by Boeing 737 or Airbus A320 family aircraft. Consequently, regional airlines are less likely to park aircraft in economic downturns than majors and low-cost carriers."
This phenomenon is boosting the regional manufacturing industry by spurring aircraft orders, says Embraer's Chiessi: "Regional carriers are modernising their fleets to explore market opportunities resulting from major airlines' network and fleet optimisations."
On the flip side, consolidated carriers have increased purchasing power, giving them leverage to pursue manufacturers for more concessions, but all three manufacturers agree that the advantages outweigh the disadvantages.
Moore says: "Certainly the larger carriers that have a larger fleet size can achieve certain economies of scale and efficiencies that are unattainable for a small regional carrier. Overall the effect is positive for manufacturers as well because it can lead to larger scope for business and co-operation between the airline and the manufacturer than can be possible with a very small fleet."
Consolidation also brings greater financial strength and stability. Bombardier's MacKinnon says: "Regional carrier consolidation usually results in better earnings, a healthy balance sheet, a solid business plan and stronger growth prospects. This is definitely a positive development for aircraft manufacturers as the consolidated carrier is more readily able to purchase and finance new regional aircraft to renew their fleets."
FUEL COSTS
Although the regional carriers have not been left unscathed by the brutal increase in fuel prices, Regional's Grosse says: "One should nevertheless keep in mind that fuel represents a lower share of total costs in the regional market than in any other segment of the airline business."
Despite this proportional gain, fuel prices are affecting the regional sector. MacKinnon says: "Undoubtedly, the recent very high price of jet fuel has created challenges for all airlines. Bombardier is definitely seeing greater interest in its models with the greatest fuel efficiency per seat, notably the Q400 turboprop and the CRJ900 regional jet."
As costs increase, Hild identifies two trends. He says carriers will opt for larger aircraft with lower unit costs but at the same time highly efficient turboprops are emerging as favourites. Turboprops have certainly grown in popularity over recent years. Tyrolean Airways managing director Manfred Helldoppler says: "Tyrolean always believed in turboprops, but in times of high fuel prices and discussions about emissions, turboprops are even more important."
Moore says: "This evolution, which has lead to a significant increase in ATR sales over the past several years, is being pursued with greater urgency than before given the significant economic consequences at stake."
But at a time when even high-profile banks are collapsing, the manufacturers are seeing relatively little impact on regional carriers' ability to acquire and finance new aircraft.
MacKinnon believes Europe's regional carriers are well positioned to deal with current market conditions: "Many have modern fleets of turboprops and regional jets that are highly efficient and well adapted to serving lower density markets. Many have good fuel hedging positions. The strong euro puts them in a good position when they acquire new aircraft.
"While it is true that commercial bank credit capacity has tightened for lower-grade airline credits, financing has remained available to good quality regional airlines. As many of Bombardier's European airline customers are good quality credits, we have not been adversely affected to date."
Embraer's experiences have been similar. Chiessi says: "The market is under pressure given the economic slowdown in general, oil price and - very importantly - the crisis in the financial markets, especially in the banking market. However, we have been able to finance all deliveries of the E-Jets family. It is possible to get finance from European banks with the right structure, a good asset, a good airline and the right pricing."
From ATR's perspective, Moore says the financial climate has affected the timing of fleet renewal and acquisition decisions: "In the midst of this urgency to develop alternatives to cope with the challenges in the market, the timeframe for decisions on fleets have, for some carriers, been overtaken by more pressing concerns. Nonetheless, given the compelling advantages that ATR aircraft offer for long-term solutions to reduce costs, the market prospects remain quite buoyant for our products and we expect these fleet replacement projects to move forward."
RECIPE FOR SUCCESS
Despite their diverging views on the wider impact of consolidation, the regional airline executives seem to share a common vision about the recipe for success.
Bankir says: "As in all crises, airlines will be affected not because they are big or small, low-cost or high-yield niche carriers, but because they have the right product, good management and strong financial resources or backing. It will be more and more difficult to make money with 19- to 50-seat aircraft but, as always, there are exceptions such as Eastern Airways and TwinJet.
"More than ever, flexibility, strong management, the right choice of routes, the right type of aircraft, the ability to build on opportunities - for instance routes abandoned by either strong or vulnerable airlines - will be needed."
Like Bankir, Rutter believes the secret to running a successful regional airline is a clear business model and stringent capacity management. He says: "This is not the time to blame macro-economic conditions. You have to be agile enough to take on the small and big opportunities that will come out of rationalisation. Some regional airlines will emerge from this stronger. Only those that can be leader in their sections will survive. It is about finding, dominating and being ruthless about pursuing a niche."
During the opening of a new regional terminal at Paris Charles de Gaulle airport, French economy, industry and employment minister Christine Lagarde shared an analogy about the economic climate, saying: "When the tide goes out, you can tell the difference between those who are wearing their swimming trunks and those who aren't."
As the tide turns to reveal a streamlined industry structure, it seems likely that a new set of key players will emerge from Europe's array of regional carriers .
Source: Flight International
