ANALYSIS: Europe’s legacy airlines fight for short-haul share

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CTAIRA analyst Chris Tarry examines the convergence playing out within Europe’s short-haul market

Regular readers of Airline Business’s Market Outlook will recall our interest in some aspects of behavioural theory and how perceptions and, in particular, the changes in those perceptions impact upon business outcomes.

In the past, we have focused on the extent to which the expectations of consumers and business leaders in respect of their economic environment provide an adequate leading indicator for the actual outcomes. Unsurprisingly, negative sentiment or perception reinforces a downturn and positive sentiment or perception reinforces an upturn or recovery.

At a company level, perception and, in particular, the extent to which a product or service meets the needs or wants of the buyer are key elements of consumer choice and, as a result, demand. It is worth considering how and why perceptions in the short-haul airline segment have changed and with what consequences, particularly in Europe.

In simple terms, making the decision to buy an airline ticket is no different from any other purchase, since the choice reflects the extent to which that ticket’s conditions meet the buyer’s requirements at a price considered to be good or the best value. Essentially, customers select a flight that goes to where they want to go and, depending upon their sensitivity to time or price, at a time that suits them and at an acceptable price.

On the supply side, there should be no doubt over the extent of the market convergence among short-haul airlines, particularly, but not only in Europe over the past four to five years. Convergence has been the outcome of a process of market adjustment that has comprised a number of phases. The first phase was characterised by the new entrant “low-cost carriers” offering markedly lower fares, targeting not only “legacy” carriers but also charter airlines, where, over time, what are best described as the “attraction fares” offered by the legacy carriers moved closer to those of the then new entrants. The second but more prolonged phase has brought a convergence in the offerings from the airlines in each of these groups.

To this end, the legacy carriers have moved their economy offer closer to that of the low-cost airlines by unbundling the attributes embodied in their product, whether charging for checked bags, food or seat assignments. At the same time, the LCCs have moved the available attributes that comprise their offer closer to those of the legacy airlines, especially in the areas of frequency and timing of services to key destinations from common or overlapping catchment areas.

There are also instances where the LCC offer is considered to be better than that of the economy product of a legacy airline. This tends to highlight why attempting to pigeonhole airlines is decreasingly relevant.

On the demand side, in the short-haul segment, business travel buyers behaviour has changed markedly, resulting in a structural reduction in the number of premium travellers and an accompanying increase in the number of business passengers travelling in economy or standard class. While this represents a challenge for the legacy airlines, it has provided a significant opportunity for the so-called low-cost airlines. For some, business passengers account for upwards of 20% of total traffic.

Even the most cursory look at the aircraft orders in place and delivery schedules shows which airlines will deliver the growth in the short-haul segment in Europe. It also brings into sharp relief the issues facing management in the legacy airlines in that region and what they should and might be able to do with their short-haul operations. While lack of prosperity in the short-haul networks at a number of Europe’s legacy airlines may also reflect revenue allocation decisions in respect of transfer traffic through “pro-rates”, rather than the “sum of sectors” approach which those LCCs offering interlining adopt, this is only one of the issues and although such traffic may bring an overall network benefit at best, it represents a suboptimal outcome.

In reality, the issues are little different from a generation or so ago, but the changes in the competitive environment and consequently in revenue have reinforced the need for a structural reduction in costs and although this is widely recognised, few managements have been able to achieve it.

To a greater, rather than lesser, extent, the short-haul businesses of these airlines represent a significant amount of underperforming capital, which almost inevitably leads to the question of why some European airlines continue to operate their own short-haul activities. Again, this is not a new question but one that still needs to be asked. Clearly, for the legacy carriers this is not the best outcome, but it is by no means clear that it is the least bad outcome, either.

The issue is whether managements are able make the transition in the existing business – including, if necessary, using lower-cost “airlines within airlines” or external capacity providers – or whether they should engage in a managed exit. These are not new issues and over the years, various approaches have been tried. However, while the fundamental constraint would appear to remain the cost associated with management implementing its decisions, there is also the issue of selecting an appropriate payback period against which any actions are evaluated, given the structural nature of the change in the market environment.

Further and inevitable market convergence will only exacerbate challenges on short-haul point-to-point routes. At the same time, increasing competition in key traffic flows and the introduction of new aircraft offering a favourable combination of long range and low operating costs will have an impact upon the catchment areas for the European demand aggregators, at the very least, increasing pricing pressure here, too.

While there may well be some improvement in the economic environment for airlines in Europe, the structural pressures are unlikely to abate for most and it is still not clear that their change programmes will produce sufficient structural and sustainable improvements in performance. In this respect, the issue is the gap between the perceptions of the outcomes of the individual programmes and the reality. The size of that gap will have inevitable consequences for the share prices of the quoted airlines.