ANALYSIS: Airlines seek redress in relationship with suppliers

London
Source:
This story is sourced from Pro
See more Pro news »

A redress of the airline/service supplier relationship may not lead to lower charges, but carriers might extract better value, writes CTAIRA analyst Chris Tarry

We have often reflected on the fact that the majority of an airline's costs lay outside the direct and immediate control of management. Generalisations are inevitably dangerous but the reality is that, although model-dependent, some 65-80% of costs are externally determined. These include fuel, navigation charges, landing charges or reflect past management decisions and actions, for example labour and aircraft costs.

Beyond this, for any flying season costs are, in effect, fixed and little can be done to change them significantly. We have also debated the time some structural cost-reduction programmes have taken or are expected to take, and questioned whether the outcome will be one where the airline is ahead of the competition or merely catching up.

The ultimate issue is whether cost savings from whichever source are retained in the form of improved profitability or competed away - which for us as passengers is good news, but less so if we are airline investors. But although related, this is a different issue.

The proposition that airlines are the necessary element in the civil aviation chain for almost all other participants to make what appear to the airlines to be attractive returns, has been long debated. As have the "necessary and sufficient" conditions for the airlines to strengthen their bargaining position with suppliers.

Of course there are some elements of cost where airlines will always be price takers, fuel for example, but not all of these will result from developments in global markets. There is a group of costs and charges, best described as "administered prices", such as charges at larger airports and most air navigation service providers (ANSPs) which are generally not market-determined.

This predominantly results in charges increasing in real terms against a background where the underlying assumption has been of a decline in real yields in the order of 1% a year for airlines. Of course there are exceptions and budget airlines in particular have been able to negotiate deals where their managements have promised particular traffic volumes. However, in a number of cases in Europe this has resulted in instability as the low-cost carriers have withdrawn wholly or partially when the deals came to an end.

At times there is clear evidence that ANSPs and airports appear to address some key issues in an almost diametrically opposed way to their customers. In particular, when an airline's traffic falls the immediate reaction is to cut fares. The prevailing view, if not the regulatory mechanism of at least some of the larger airports and many ANSPs, is that when traffic falls, charges should or must rise. This is just at the time when the ability of their customers to pay comes under pressure.

However, change may be on the horizon. A report published in April by the UK Civil Aviation Authority about setting charges for regulated airports in the southeast of the country for 2014-2019 marks a potentially significant change in the terms of engagement.

In the case of Heathrow, the proposal is that the cap on the increase in charges for the next five-year period is RPI-1.3%, compared with the current regime (2009-2014) where the cap on the allowable increase in charges is RPI+7.5%. Conversely, in its documents to the CAA in February, Heathrow's management suggested it should have a cap of RPI+5.9%.

Turning to ANSPs and focusing on Europe and their unit rates quoted in Eurocontrol. Similar to airports, the unit charge is among other things the outcome of the interrelationship between volume, cost recovery, airspace complexity, investment costs, staffing levels and associated wage costs. And, where allowable, a return on the investment. There is, however, a wide range of experience. The rate sheet provided by Eurocontrol shows unit charges quoted in euros. To avoid the impact of currency variation, we must focus on providers in the eurozone. While France and Spain show no change during the past year and the Netherlands remains broadly flat; charges in Germany - among the highest - are up 2.4% and Portugal (Lisbon) by 4.8%. Those for Belgium/Luxembourg have fallen by 11.6% and those for Ireland - among the lowest charges - by 6.2%.

As airlines continue to seek to reduce costs that are notionally under their control, attention will increasingly focus on the level of administered costs and the fairness or otherwise of an almost self-perpetuating upward trend in real terms for those providing services to airlines.

It appears this debate might have entered a new phase. Whether this is good or not depends on from which end of the telescope you might be looking. From the airline perspective enough is enough, and in this respect we expect airlines individually and as groups to get better value from their administered costs - if not lower charges.

It seems the rules of engagement are beginning to change in this respect, but it is also clear there may be important battles ahead.