Alliances stymied in solving transatlantic riddle

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The alliance groups' much-sought joint ventures across the north Atlantic are up and running, but the challenge of achieving year-round profitability in the market remains

Sir Freddie Laker's wit and wisdom accumulated in the transatlantic market more than 30 years ago was resurrected recently by one of the biggest players over the Atlantic to capture the dismal performance displayed by the industry during the first quarter.

Hammered by analysts over Delta Air Lines' weak results, carrier head of network planning Glen Hauenstein simply deferred to the late British aviation pioneer, and channelled the Sir Freddie's famous quote: "Any idiot can make money in the transatlantic market during the summer, it's the winter months that count."

Delta did not exactly challenge Sir Freddie's philosophy during the first quarter. "We had little success as the industry capacity increase of 11% put significant pressure on yields," surmised Delta chief executive Richard Anderson. The result was that Delta took a hammering as roughly $150 million of the $200 million erosion in its first quarter pre-tax profits was attributable to weak transatlantic performance.

Delta led the industry's double-digit transatlantic capacity increase during the winter by pumping 16% more seats into the ­markets year over year, which is "way too high", says Craig Jenks of aviation consultancy Airline/Aircraft Projects, which carefully monitors transatlantic trends.

A portion of the capacity increase was the restoration of pull-downs by Delta during the 2008-09 season to combat sinking demand and soaring fuel prices.

Oneworld camp 

  • Members: British Airways, Iberia and American Airlines
  • Estimated revenues: $7-8 billion
  • Weekly flights: 1,222
  • Capacity share: 20.0%
  • Capacity plans: Will evaluate winter flying and anticipates making seasonal route and day of week adjustments to improve performance
Hauenstein admits that in hindsight: "There was excess capacity from the industry and from us." Part of the capacity dump could be attributed to the relatively young joint ventures created by the three large airline alliances in the Atlantic market and their acclimation to joint network planning.

Relative to the transatlantic joint venture partners in the SkyTeam tie-up - Delta, Air France and Alitalia - Hauenstin says: "I think this has been a learning process for us as we go through the first two years of our joint venture." Delta and its SkyTeam partners applied lessons learned and have moved to assure that the joint venture's collective transatlantic capacity, which entails routes between North America and Europe, is falling by 7-9%, or 15 points, during the winter season, versus previous growth projections of 7-8%.

Members of the Star Alliance camp transatlantic joint venture have followed suit, as United-Continental, Lufthansa and Air Canada plan a six-point capacity reduction during the fourth quarter, which should keep joint venture capacity flat against the last three months of 2010. Oneworld members are evaluating their transatlantic operations for the upcoming winter season, and "anticipate making seasonal route and day-of-week flying adjustments to early 2012 flying to improve our performance", says American Airlines chief executive Gerard Arpey. The adjustments in winter capacity by the three immunised groupings show alliances "have made no real difference to the transatlantic dilemma of how to be profitable in the winter as well as summer", says Jenks.

He says although some theorise that the capacity push during the winter was the result of a propensity for immunised alliances to boost capacity since those tie-ups allow for the spreading of risk across multiple carriers is not a philosophy guiding alliance strategy.

"We believe the 16% boost by Delta last winter was more of a special case, the tendency over time is for alliances to prioritise profitability over growth."

US carriers moderated their capacity growth in transatlantic markets in the second quarter, and strengthened demand helped bolster performance as the summer season got underway.

United-Continental saw its transatlantic yields jump 8.3% as overall transatlantic revenues of $1.6 billion represented 47% of the ­carrier's recorded $3.4 billion in international passenger revenues.

The carrier had to make a payment to its transatlantic joint venture partners due to its outperformance. But United-Continental chief revenue officer Jim Compton remains bullish on the value of the Star joint venture.

"Our partnership with Lufthansa to Germany is quite significant, and the amount of connections that are new to the network that were not there before. So, I think there is tremendous value coming from the JV," says Compton. Delta also rebounded from its dismal first quarter ­performance, growing its transatlantic yields 10% year over year in the second quarter, and recording a 16% rise in revenues in those ­markets to $1.57 billion.

American's performance was vastly different in the second quarter as its transatlantic yields plunged by 4.7% on a 9% capacity increase.

 SkyTeam camp

  • Members: Air France-KLM, Alitalia, Delta Air Lines
  • Estimated revenues: $11 billion
  • Weekly flights: 1,632
  • Capacity share: 28.7%
  • Capacity plans: Cutting capacity 7-9% in the fourth quarter in response to higher fuel prices and seasonal changes in demand

During the quarter, American introduced flights from its New York Kennedy and Chicago O'Hare "cornerstone" markets to Budapest and Helsinki, respectively, the hubs of Oneworld partners Malev and Finnair, which don't generate the traffic flows of some hub-to-hub markets covered under rival immunised joint ventures established by SkyTeam and Star.

American chief executive Arpey admits ­perhaps the carrier anticipated getting traction from joint sales with transatlantic joint venture partners British Airways and Iberia "a little too soon", after the 6 October launch of their partnership.

Carrier CFO Isabella Goren cautions that the full effect of American's antitrust immunity agreement with British Airways and Iberia "will not be in place until the end of next year because there is considerable coordination involved". She stresses that because of the cycle of contract renewals, "it will be some time before we see the full benefit of joint deals".

American has stated the bulk of an estimated $500 million annualised gain in revenue would stem from its transatlantic joint venture with British Airways and Iberia and the transpacific antitrust tie-up with Japan Airlines. Goren has previously stressed American expects to reach that revenue milestone at the end of 2012.

SUMMER VERSUS WINTER

While continuing to struggle with profitability in the winter, the summer is shaping up to be strong, as "all available evidence" of an estimated 5.5% Europe-USA capacity increase coupled with fare increases should compensate for higher fuel costs should and be "easily absorbed by demand", Jenks says.

He also concludes that while alliances are leading growth across the Atlantic, the point can be exaggerated. Of the net 18.5 daily flights being introduced, nine and a half are hub to hub or ­mini hub, while nine are hub to spoke or point to point.

The percentage of new routes this summer representing hub-to-hub or hub-to-mini-hub markets is just over half, says Jenks, compared with an average from 200311 of 32%.

Calculations by the Airline/Aircraft Projects consultancy show that the number of hub-to-hub markets is higher than usual, but "it is not a stampede", says Jenks. "In fact, looking at the historical data, hub to hub has tended to outperform in early upturn years." Spanish Oneworld carrier Iberia appears pleased with the performance of its new routes introduced in March from its Madrid hub to American's cornerstone market of Los Angeles, and from Barcelona to Miami. Overall, Iberia is increasing its US seat inventory by 13% this year, says carrier US country manager Jose Alvarado, with bookings during the peak summer months on the Airbus A340-300-operated flights running in the 70% load range earlier this year, with the hub-to-hub performance of Miami-Barcelona showing ­similar results.

BA appears equally satisfied with interest in the resumption of flights from its Heathrow hub to San Diego in June. Just prior to the launch, the carrier stated it was pleased with bookings on the route. The head of BA parent International Airlines Group Willie Walsh believes London's strength and the carrier's position in the market allows BA to be shielded from some of the cyclical transatlantic challenges faced by other carriers.

Star Alliance camp 

  • Members: Air Canada, United-Continental, Lufthansa, Austrian Airlines, Brussels Airlines, Swiss and LOT
  • Weekly flights: 2,095
  • Capacity share: 34.5%
  • Capacity plans: Will reduce planned transatlantic fourth-quarter capacity by six points, resulting in the JV capacity remaining flat over the same period in 2011
"What is clear to us at this stage is London is a stronger market, and I think that is true over the past number of years, so where we have heard a number of our competitors and our partners talk about some capacity and demand issues, I think that relates more to the wider European markets than to the specific markets we operate in," Walsh said during IAG's second quarter results call.

As all three major alliances bolster hub-to-hub markets, Jenks sees "an interesting trend this summer" of EU carriers with histories of shunning transatlantic service from secondary cities now introducing such service in conjunction with their US partners. Virgin Atlantic is adding Manchester while United-Continental is teaming with Lufthansa to introduce a New York Newark-Stuttgart flight. SAS is also re-entering the Oslo-Newark market.

The North American transatlantic market during the summer is also seeing a rise in average seat count, driven by Air France and Lufthansa expanding their US A380 operations, Jenks notes. Average aircraft size has risen from 252.4 seats in 2010 to 255.8, underpinned by the addition of a total of five new A380 frequencies introduced during the summer. Lufthansa has added A380 flights from Frankfurt to New York Kennedy, Miami and San Francisco while Air France expanded its Paris-Atlanta A380-operated service introduced last year with the addition of Paris-Washington DC and San Francisco. Despite the rise in seats, Jenks says that pending equipment orders do not suggest a large capacity expansion in the transatlantic market in the summer of 2012, and the alliances overall are attempting to reverse market overcapacity in the winter of 2011.

"As we pull out of the high demand season post Labour Day," says Hauenstein of Delta, "we are going to make with our partners those necessary adjustments, so that we do not return all the profits we make over the next several months in the winter months".

Notes: Flights based on Europe-USA Sep 2011; capacity based on ASKs for some criteria. Source: Innovata.