CTAIRA analyst and AEA Aviation Leadership Summit speaker Chris Tarry examines the economic and strategic headaches that legacy airlines face amid faltering growth and market uncertainties

As the current year has progressed, concerns have increased over whether Europe is entering a prolonged deflationary period, characterised by low or no growth and falling prices.

Even if this worst case scenario is avoided, which is by no means certain, despite the actions of the European Central Bank, the inescapable fact is that the traditional economic cycle has been broken. For many businesses, and not just airlines, there is no upswing to ride and, to a far greater extent, financial improvement will depend on realising benefits from making structural changes. Such changes should occur within the business to improve performance (getting more for less), or by successfully adjusting to the external marketplace (being able to compete more effectively and profitably). The low-cost airlines account for some 45-50% of the short-haul market in Europe, and the continuing expansion of the Gulf carriers, not only in Europe but also in important origin and destination markets for transfer traffic, bring additional challenges.

For the management of any European legacy airline, getting the short-haul part of the business to a point of sustainable profitability, let alone earning an adequate return, has always been a particular challenge, and not only as a result of pro-rate allocation.

But the fact that there has been a structural downward shift in fares in the short-haul market brings this challenge into sharper focus. There should be little doubt that the low-cost carriers will both increase their presence in the marketplace and, given the continuing convergence, will take a greater share of the business travel segment. Even at the simplest level, the fleet plans of the principal low-cost carriers provide a very clear statement of intent.

In theory, there are two distinct reasons why so-called ‘airlines within airlines’ should be able to provide a lower cost of carriage than the existing short-haul operation, and not just at the time they are established.

The first is that routes are ­migrated to them from the current business, and the second is that the lower cost base enables them to profitably address more of the market.

So much for the theory, the real issue is successful implementation, as the recent experiences at Air France show. In this case the stated intention (at least in the first instance) was limited to addressing a wider market, both inside and outside France, and perhaps acting as a buffer to protect the current short-haul business from competition, rather than providing a lower cost solution to the core business. Similarly, although the new Wings concept at Lufthansa should create the opportunity to profitably address a wider market, there would appear to be a similar challenge with its core short-haul business.

At the same time, the nature of the catchment areas for those airlines in Europe where demand aggregation is a key component of their business model is also changing adversely. As with any change it only needs to be at the margin with the loss of a few higher value passengers to a competitor to have a disproportionate effect on profitability.

The increasing presence of the Gulf airlines in North America is already having such an impact, one which will be exacerbated as airlines on either side of Europe take delivery of the Boeing 787 and the Airbus A350.

More generally, sustaining the unsustainable is no longer an option and, in this respect, there is also a strong onus on a number of managements, following recent approvals of state aid, to deliver the turnaround plans that they and the European Commission signed off on.

The fact that restructuring is a regular, albeit not constant, feature of life for managements of European legacy airlines highlights the constraints that exist to making the necessary change sufficiently quickly.

Indeed, it is generally not a case of not knowing what the numbers ought to be – which is after all the easiest part in establishing the targets in any budget or plan – it is the constraints associated with implementing the plans aimed at delivering a profit that need to be overcome.

It is, however, important to be clear that there is a considerable difference between reaching or returning to profit and achieving a state of financial sustainability. For an increasing number of airlines in Europe, realising this goal will require yet more change of a structural nature.

Source: Flight Daily News