Economic forecasts may be better for the year ahead, but the airline industry must still adjust to structural shifts in demand, says Chris Tarry at CTAIRA

These are perilous times to be making traffic forecasts. Nevertheless, for an industry desperately in search of improved financial results, a correct reading of likely traffic growth over the coming year could be crucial.

One of the key guiding principles in the approach to traffic forecasting developed together with Airline Business, has been to try to identify the "underlying" level of demand for air travel generated by economic fundamentals rather than stimulated by price. In other words, it translates into the rate at which traffic can grow if yields remain constant.

If seat capacity grows broadly in line with this underlying "yield neutral" rate of growth, then the industry is in some form of balance. If seats are added faster, there would tend to be a decline in yields per seat flown. If capacity grows more slowly, then the industry should see a welcome rise in revenues.

This underlying rate of traffic growth is a function of the state of the economy, although with the caution that it can be heavily influenced in the near term by the level of business and consumer confidence.

By tradition the industry has used a rule of thumb that passenger traffic grows at roughly twice the level of economic growth. And on the face of it, this multiplier appears to fit. However, that does not take into account the extent to which pricing is used to stimulate demand in order to fill excess capacity. A more realistic multiplier is in the region of 1.6 times economic growth, although that too will vary depending upon the maturity of the market in question.

On that basis, the industry should be in for a better year in 2003. There is little doubt that the forecast economic outlook in all areas of the world is better than 12 months ago. Latest economic forecasts from the International Monetary Fund suggest that real GDP for the group of "advanced economies" will be some 2.5% in 2003 compared with 1.7% last year and only 0.8% in 2001. Within those figures the USA is due to run slightly higher at 2.6%and the European Union slightly lower at 2.3%. For "newly Industrialising" Asia, growth of 4.9% is forecast, up marginally from 4.7%last year and 0.8% in 2001.

All other things being equal, the rate of underlying traffic growth could range from 3.5% to 7.5% depending upon the region. However, in the real world, everything is not in fact equal. There is clearly the risk that factors ranging from war in the Gulf to high oil prices or a collapse in business confidence could yet dent hopes of a recovery.

More fundamentally for the airline traffic model are the changes which have been taking place within the industry, in terms of a marked downward shift in fare structure and a restructuring of networks, at least within the more mature European and the North American markets. If, as looks likely, these represent a response to a structural shift in the market, then the demand model needs to be rebased at a lower point. Whether the industry has indeed now reached such a new point of balance still remains to be seen.

As suggested a year ago, the underlying rate of traffic growth for 2002 should have been in the order of 2-3% based on the demand model. But the problem was to identify the new base point from which that growth would take place. In short, how much excess capacity needed to disappear before the link with economic growth was re-established. In reality, international traffic in 2002 is likely to have shown little or no growth against 2001 and will be heavily down against a 2000 benchmark.

There are of course marked differences across the regions. For the US majors, 2002 traffic was down 2.6% overall against 2001 and 8.7% against 2000. In fact, you have to go back to 1998 to find a lower number. The same is true on capacity, down 8.1% against the high of 2000.

Latest results from Europe paint a similar picture, with current capacity and traffic figures running somewhere near their totals back in 1999 or earlier. The less mature Asian market is clearly more buoyant, although the transpacific has suffered and Japan is still wrestling with deflation.

Consequently, the starting point for the re-establishment of underlying growth is perhaps some-where around the levels of 1998/1999 depending on who and where you are. Another issue remains that of excess supply, which we estimated by the end of 2000 had grown to represent 20-30% of the installed capacity. Surplus aircraft are a real concern, particularly if you own one and it is not earning money. it is worth noting that between the end of 1997 and the start of 2002, the active world jet fleet grew by more than 3,000 units to peak at over 16,000 aircraft.

The real adjustment process has yet to start, against a background of a structural downward shift in demand and revenues, at least for the network majors. What is certain in 2003, the industry cannot afford any let up on cost.

Source: Airline Business