An analysis of the latest data from Europe's major carriers suggests that there was a structural shift downward in yields last year and that the trend is for further falls, writes Chris Tarry of CTAIRA

We have warned before that the airline industry is not immune from the law of diminishing returns. Publication by the Association of European Airlines (AEA) of their latest and commendably detailed yearbook, suggests that it is still alive and well. As applied to the airline sector, the law suggests that, as ever greater volumes of over-capacity are added into a market, so the unit revenues decline. In short, traffic rises but yields fall.

Just witness the experience of AEA airlines over the past decade in their key markets of geographic Europe; the North Atlantic; the Far East and Australasia; and overall long-haul services. Since the bottom of the last downturn in 1991 traffic in Europe has more than doubled, yet "real" underlying passenger revenues have risen by only 21% once adjusted for inflation and currency fluctuations. The result is that yields have dropped by 40% per passenger and by a third in terms of revenue per available seat km/mile. A glance across the other key markets for the 1991-2003 period suggests a similar picture.

So what, if anything, does such an historic analysis have to say about likely future trends? Here it is important to note that although the final outcome for each market is remarkably similar, their behaviour in arriving at the result has not been so uniform.

In the intra-European market there has been a seemingly inexorable downward trend followed by a step change in 2003 when traffic remained flat but real seat yield fell by 12%. While a single set of figures cannot be treated like a trend, it is reasonable to conclude that 2003 was a year in which a structural shift took place in the intra-European market, effectively re-basing the yield figures. The more important issue is whether the relationship between capacity and yield that has held sway over the past decade will simply continue to do so even after the downward shift last year. It is reasonable to assume it might. And if the pattern does continue, then that suggests that a 5% increase in capacity would tend to result in a 3% fall in real yield per seat.

All other things being equal (which, of course, they may not be), that suggests that the real unit yield will indeed fall by around another 3% this year for AEA members on the intra-European market.

In other market segments, although the trend in yield is downwards, its relationship with capacity change is not so clear cut. In statistical terms the relationship certainly looks much weaker than for intra-European routes, even if the broad trend is heading in the same direction. This suggests that there are other factors at work and the existence of a more complex relationship and need for a more complex model.

Behaviourally we would expect that after an external shock, whether economic or geopolitical, airline managements will seek to find the price at which customers are again prepared to travel and at the same time cut back capacity. That is, in fact, just what tends to happen. As fares are cut, the first outcome is an immediate fall in yield followed by a recovery as the crisis in question subsides and capacity comes under better control. The historical pattern appears to suggest that this is what has happened in both the North Atlantic and Far East market segments.

However, while in both cases it is possible to rationalise the fall in yield that occurred in 2003 as a result of fears over the Iraq war and SARS, last year's collapse in yield on the North Atlantic does look suspiciously like a structural shift. While capacity was almost 5% higher, the seat yield fell by over 10%. Anecdotal evidence suggests although there has been a recovery in premium traffic in this market all other traffic is exceptionally price sensitive and growth in the market is increasingly dependent upon out-bound traffic from Europe.

Within the Asian market segment, where capacity was down 0.4% and yield 13% lower, a number of factors have been evident both positive and negative. First 9/11 and then SARS interrupted the recovery path from the economic crisis of the mid/late 1990s. As a consequence it would be wrong to extrapolate the trend of the last few years, for although the European carriers on the routes will face increased direct and indirect competition it remains a growth market which will be enhanced by liberalisation over the short to medium term. Whether that ultimately brings strong revenue and yield growth too remains to be seen.

Source: Airline Business