The virtuous trend towards capacity constraint with which the industry ended last year appear to be holding steady. Kevin O'Toole and Chris Tarry of Commerzbank look for early signs.

A couple of months into the new decade and it seems that the industry's resolve is holding. Towards the end of last year there were some encouraging signs that the delicate balance between demand and supply was starting to re-emerge after a summer of excess. And while it is still early days, the figures for January and February would appear to show a few more steps in the right direction.

A glance back across the figures for the past 18 months on the key North Atlantic market illustrates where the damage was done (see table bottom right). Already in the summer of 1998 growth was starting to pick up, with a rise in transatlantic seat capacity of 7.4%. That was led by British Airways and the resurgent US majors, but others were still cautious. Going into last summer the constraints were let off. Although a contrite BA had by then decided on prudence, the battle for market share and redirected capacity from Asia sent growth above 11%. More recently the growth has come back down, hovering around the 7.5%mark. If it holds, that would be broadly in line with the rate of underlying demand predicted by the Airline Business/ Commerzbank Traffic Defficiency Indicator (TDI)model (see Strategy in January).

Summer timetable test

A couple of winter months is hardly enough to form a clear judgement and the real test will not come until carriers start to roll out their summer 2000 timetables. Yet there are broader signs of what looks like developing into a more favourable underlying trend.

The strength of the traffic recovery in Asia is one clear theme. The real question, however, is whether capacity will flood back just as strongly and swamp the region. The TDI model suggests that underlying demand will run at around 5-8%this year on the main routes into the region. At a first glance the capacity seems to be running ahead on key routes. Between Europe and South-East Asia seat growth is at around 9%, against an estimated underlying rate of 7.7%. Some of the Asian carriers have indeed taken the chance to push through some significant increases in capacity, albeit from a low base. Yet around half of the principal carriers, led by the Europeans, are still holding back, with zero or minus capacity growth. On the transpacific routes capacity continues to rise at less than 2%, which even allowing for Japan's prolonged slump, looks like undercutting traffic demand by three or four percentage points. Progress will be worth watching closely as the year progresses.

Millennium effect

There is another reason to reserve judgement about the year-end figures and that is the millennium effect. The profit warning from United that resulted in a 13% fall in its share price on the same day, highlighted in a dramatic fashion one feature of the millennium about which the European airlines had cautioned for months - the lack of demand for travel during the festivities.

There are a number of reasons why people did not travel. Some wanted to be at home when the great day came. Others may have been warned off by the price of hotel accommodation. Stories abound about the premium prices being charged for accommodation over the millennium, and it appears to have been an issue in choking off demand. A timely reminder, not only about how price sensitive the leisure market remains, but also that air fares are not always the main determining factor in the "travel decision".

For British Airways the 35% fall that it reported in traffic in the week after Christmas (compared with the same week in 1998) provides evidence of something out of the ordinary. There will of course be a corresponding effect in the January traffic figures - if you do not carry passengers out in in December then they cannot fly back again in January.

The implications of expensive accommodation on air travel are not necessarily confined to the millennium. Price there could well set limits on the growth of the low fare segment, particularly in Europe, which lacks the large volumes of cross-border "visiting friends and relatives" traffic that stimulates business around the USA.

On the other side of this equation there are questions too for the mainline carriers in intra-regional markets where segmentation is accelerating and the threat of commoditisation looms. Which traffic should they keep, which should "migrate" to affiliates or low-cost subsidiaries and which should they just leave to the others? Meanwhile, in both Europe and North America the yields continue to edge down.

It will be interesting to watch and see how such trends continue to develop as 2000 begins to unfold.

Source: Airline Business