Facing competition

Gunter Endres ROME

Italy is finally embracing airline industry deregulation after years of high fares and poor service. New carriers and new alliances reveal a market in transition

Trailing behind most of Western Europe, the Italian Government has finally begun deregulating transport market. Since the long-delayed process started to kick in seriously last year, the skies over Italy have become crowded with newcomers scrabbling for a share of the potentially lucrative domestic market. Before then the situation was uncomplicated, with flag-carrier Alitalia enjoying a virtual monopoly, consolidated still further into smaller markets through a number of franchise partners.

The downside for the Italian consumer - already a more reluctant air traveller than other Europeans and still preferring rail travel despite the large distances between metropolitan areas - has been an environment of high fares, poor one-class service, next to no catering and insufficient frequency levels.

But the environment is changing. Air One, Meridiana and Air Europe/Volare are already battling with Alitalia for the domestic market, and another newcomer has thrown down the gauntlet in the shape of National Jets Italia, the British Airways franchisee. Its managing director Charles Phelps-Penry says that deregulation has been very much the motivating factor behind the carrier entering the market at this point. "We offer the full British Airways product of superior catering, Club Europe cabins, and airport lounges where possible," he points out. "We clearly see ourselves in the vanguard of bringing real competition to the Italian market."

Last year, just over 21 million passengers travelled by air within Italy. Current annual growth rates of 5-6% are expected to increase further in the years ahead. In the nine months it has been operating, National Jets Italia has seen real growth in the Sicilian market, in which it flies from Catania and Palermo to Rome. "A factor is that on these key routes, capacity did not meet demand. We bring competition to the market, but obviously competition to a degree means taking away share from existing players,"says Phelps-Penry. "We believe we are able to do that in an environment of growth, that ultimately benefits everybody, [especially] the customer."

Consumer dissatisfaction

A frequent complaint from consumers in Italy, he says, is that they pay high fares for poor value. Published fares still remain high, but in reality there is a wide range of discounts available. Alitalia, for instance, has been active in discounting and not just in response to new competition. National Jets Italia has been putting out promotional fares too, but as a new entrant it had little choice to do otherwise. However, this trend will not last forever, says Phelps-Penry. "We do not want to completely re-price the market. We believe, as we offer superior value, our mainstream fares are not out of kilter with the kind of fares currently available," he says.

The carrier took a big step in February by entering the busiest and most lucrative, but fiercely contested, Rome-Milan market. Until now this was the domain of Alitalia and Air One, the latter being the first to offer competition to the flag-carrier. There are currently 29 flights a day in each direction, carrying some 3.6 million passengers a year. National Jets Italia is flying twice a day, but is looking for more slots to improve frequency levels. Phelps-Penry is convinced that there are not enough seats on the route, and customers are not necessarily being offered good service. He has also identified good traffic flows beyond Rome from Milan, especially to Sicily, through which he suggests the National Jets Italia network will give customers greater choice. Other routes are also being evaluated.

But National Jets Italia, the British Airways connection, will have some catching up to do with Air One, which has won nearly 10% of national marketshare in a relatively short period, almost entirely on the Rome-Milan sector. "But last year," says Air One managing director Dr Marco Benincasa, "we tried to grow the company from a niche player (we were mostly associated with the Rome-Milan route) into a much more regional carrier." Air One did this by considerably expanding its network. Routes it has added include those from Rome to Turin and Venice, and from Naples to Milan and Bari. Benincasa says these additions have contributed to a 25% increase in revenue and added a central-south axis to the carrier's more prevalent north-south structure. "We wanted to build a quality network to meet the demands of our business and holiday customers, and to engender loyalty," he adds.

Rome-Milan, however, remains its most lucrative route, with its 14 daily round trips accounting for 55% of company revenues last year. In less than five years, Air One has reached the level on of 1 million passengers on this route, representing some 30% marketshare. However, the growth has come at a price. Only the strong financial resources of the airline have enabled it to maintain and sustain the challenge to Alitalia.

Benincasa recalls the contest with Italy's flag carrier as an uphill battle against a competitor which has used all available means, including aggressive pricing and its sway with the travel trade to see off the threat from the upstart on Italy's most profitable route. He feels, however, that Air One has prevailed. "The brand image has been firmly established in the mind of the consumer. We are no longer considered just a temporary player in the marketplace, although we are still in the growing phase. The tough times are now behind us."

Competition

Meridiana, Italy's second largest carrier, has no plans to enter the fray on the Milan-Rome sector. "We do not see an opportunity at present, given the fierce competition already existing between Air One and Alitalia," states Claudio Miorelli, Meridiana's commercial director. "It is certainly the most important market, but we do not consider it a priority within our current strategic plan, which looks towards continued growth in areas were we are already well established."

As the local airline, Meridiana has been particularly strong in the Sardinian market. Its routes from Cagliari and Olbia to Milan are still among the airline's most profitable, although the Sardinian market now accounts for less than half of its business. Meridiana has also expanded aggressively into Verona, Rome and Sicily, from where a number of routes are flown from Catania northwards. "The north-south routes are clearly an objective for us," he says, "as is an increasing emphasis on seasonal tourist routes from the north, again primarily to Sardinia and Sicily."

What does Alitalia make of its new operating environment? The figures reveal that its marketshare has dropped from over 80% to below 70% in the last five years (see graph). In terms of passenger numbers, however, it has actually benefited from a 40%-plus growth in the total market. This growth can be directly linked to the new competition, although Alitalia's own increase over the five years was at 17%. To achieve even that, the flag-carrier was forced to improve its service and now has to accept that competition is not only here to stay but will continue to make inroads into its business.

Foreign influence

The importance of the Italian market has been recognised for some time by other European airlines, but access had always proved highly restrictive. Lufthansa entered into an equity partnership with Air Dolomiti some years ago, with the aim of feeding its Munich hub from Northern Italy. This has proved to be an inspired move, with the regional airline now providing direct flights to Munich from nine cities along the length of the country, with other flights linking in to Frankfurt and Paris. In January 1999, Lufthansa protected its market through an equity investment in Air Dolomiti, giving it a 26% stake.

Air One, already backed by powerful interests, has also thrown its lot in with the German flag-carrier, leaving only Alitalia and Meridiana without strategic partners. However, Alitalia is once again talking to KLM and is also in discussions with Air France. For its part, Meridiana will go all out to attract an investor when the time is more propitious, having temporarily abandoned plans it announced last September to sell a majority stake.

Suggestions that Meridiana might link up with Alitalia are pure speculation, says Miorelli. He points out that Alitalia's 70% marketshare, combined with their own 15% would attract the attention of Italy's competition authorities. But, having had a good working relationship with Alitalia for more than 30 years, including code-shares on some routes, Miorelli suggests that still closer collaboration cannot be ruled out. Even though such a marriage would create a strong second-force airline, Air One has no intention of investing in or buying Meridiana, says Benincasa, who adds that the airline is now firmly focused on its new relationship with Lufthansa.

The Air One/Lufthansa tie-up is potentially the most interesting development, giving Lufthansa, already highly visible in the Italian market, a further bridgehead, and Air One access to a partnership with a leading airline. Benincasa strongly refutes suggestions that this might relegate Air One to a feeder role. "Our (partnership) is not a traditional feeder arrangement," he emphasises. "The main features are the code-shares on our domestic network, and on all flights operated by Lufthansa from Rome to Germany. Membership in the Miles-and-More frequent flyer programme and co-ordination of sales and marketing functions are other areas of benefit," says Dr Benincasa. "The next phase will be to develop jointly international routes from Italy from 200, with the present plan envisaging two or three new international routes per year."

The long overdue changes in the Italian market have been speedy and already relatively dramatic, but there is still more to come. High fuel prices, the strength of the US dollar against the Euro and greater competition, are thought to have plunged all the Italian carriers into the red last year. It was Meridiana's first loss, although the size will not be revealed until the accounts have been audited. In addition to the partnerships with foreign carriers, some internal consolidation will be inevitable and only the strong will survive.

"None of us can continue to sustain losses for any length of time. Some form of consolidation will have to happen," says Miorelli. He suggests the process has already begun with the link-up of Air Europe and Volare, which is expected to lead to a full merger. Both airlines are part of the Swissair-led Qualiflyer grouping, although its struggling parent SAirGroup is currently re-evaluating its whole strategy.

Some of the smaller niche carriers, he adds, are also likely to enter into co-operation and full franchise agreements, as evidenced already by Minerva and AZZURRAair, which are both operating under the Alitalia Express banner. Meridiana itself is using Italy First, leasing that carrier's two ATR42s for some minor routes, on which its own aircraft would be too large.

With the possibility of further inroads being made into Alitalia's dominant position, the Italian domestic scene could eventually settle down to three or four major players with a more equal market distribution. But the north-south routes favoured by the large carriers - both on the mainland and from Sardinia and Sicily - will leave scope for smaller niche players to take advantage of growth opportunities. All will have to improve service levels if Italians are to be coaxed out of their cars and trains.

Top 15 Italian domestic city - 2000
City 1	City 2	Passenger thousands	Alitalia share
Rome	Milan	2,435	68.2%
Rome	Catania	851	70.7%
Rome	Palermo	848	68.5%
Milan	Naples	754	73.4%
Rome	Cagliari	717	69.6%
Milan	Catania	633	65.6%
Rome	Turin	619	63.1%
Rome	Venice	536	65.0%
Rome	Bari	502	70.3%
Milan	Palermo	480	65.8%
Rome	Genoa	396	72.0%
Rome	Lamezia Terme	355	73.3%
Rome	Bologna	338	61.3%
Milan	Bari	317	68.0%
Rome	Brindisi	306	66.5%
Total domestic market		21.244	67.6%

Source: Airline Business