As consolidation takes hold among the European network carriers, the effect on the regionals that knit together Europe's thinner routes has yet to be determined
As Europe's regional carriers prepare for their annual meeting in the northern British city of Manchester, dubbed Cottonopolis owing to its textile manufacturing and cotton spinning heritage, the fabric of the industry is changing. Europe's airline megabrands are jostling to swell their empires, but the long-term impact on the regional market remains unclear.
While regional airline executives commonly accept that there is a consolidation trend among the larger players, there is little consensus on how this bodes for their sector. As Jacques Bankir, chief executive of independent Swiss carrier Baboo, says: "Very complex question. No simple answer."
The industry is in a state of flux. A set of put and call options between UK Star Alliance carriers bmi and Lufthansa means that bmi Regional may be destined for new ownership by June 2009. Their alliance partner, Austrian Airlines Group, is to be further privatised: will its new owners see a continued role for the Austrian Arrows regional brand?
Within oneworld, British Airways and Iberia are joining forces - a move which could affect Iberia's independently-owned regional partner Air Nostrum - while relaunch efforts at SkyTeam member Alitalia could cause a ripple effect across Italy's regional market.
Beyond this, Air France-KLM is in the process of acquiring Belgian regional VLM Airlines and Lufthansa has negotiated the acquisition of a sizeable stake in the parent company of Brussels Airlines. Both giants have also been linked with Alitalia and Austrian. The landscape is changing.
UK regional flybe has already benefited first-hand from the industry shake-up. British Airways made the significant move of selling its BA Connect regional operation to flybe, after it failed to meet its target of becoming profitable within two years of its March 2006 launch. BA says: "Point-to-point regional operations are no longer a strategic part of our business and such activities are better undertaken by a regional low-cost airline."
But European Regional Airline Association director for air transport policy Andrew Clarke does not believe this is the shape of things to come. "Consolidation of major airlines does not imply consolidation of regional airlines, which are usually operating in a local or niche market. There have been only a few examples of mergers or acquisitions among regional airlines. However, I would expect to see an increase in strategic co-operative agreements," he says. Illustrating his point, Clarke uses the example of Air France-KLM's regional airlines - Brit Air, Regional and KLM Cityhopper - which are distinct entities, but co-operate in areas such as aircraft purchasing.
He adds that the regional strategies of the majors have been varied, acknowledging BA's disposal of BA Connect to flybe, but contrasting this with TAP Portugal's acquisition of Portugalia and Air France-KLM's planned takeover of VLM. "This conflict in strategies has been the case ever since I have been involved in the European regional sector," says Clarke. "Many times over the last 20 years, one major has been disposing of its regional operation at the same time as another major has been acquiring a regional airline. I see no new trend emerging, except that now these strategic decisions seem to be reversed only rarely."
However, Air Nostrum chief executive Carlos Bertomeu holds a different view. He says: "We foresee that the consolidation process will affect the regionals, so we anticipate that smaller regional airlines will fall within larger regionals, linked to major airlines, and some will disappear."
Bertomeu believes that consolidation, driven by the main European players within the Star Alliance, SkyTeam and oneworld, will lead to the emergence of several key European hubs. "This scenario is likely to lead to a consolidation in the regional market, with only one or two large and efficient regional airlines working closely with each major airline."
He argues that a regional carrier's size and its major airline ties will be important factors in its economic and operational efficiency. "In this new consolidated pan-European environment it will be more difficult for very small-sized regional airlines to compete effectively," he explains.
Flybe chief commercial officer Mike Rutter, speaking from the perspective of an independently-owned carrier, has an opposing view about the future relationship between majors and regionals. "This is a crunch moment," he says. "There is a massive rationalisation of big carriers that will force the rationalisation of the carriers which rely on the megabrands. Rationalisation is going to be driven because the megabrands and franchises will have different priorities going forward. Regional activity will not fit with the new ownership of those airlines."
But Rutter's view is not shared by the megabrands' regional offspring. Jean-Yves Grosse, who heads up Air France subsidiary Regional, says: "An important share of the regional market is already operated by subsidiaries of the major European carriers or within an alliance. That trend will be further strengthened." He argues that capacity constraints at London Heathrow left BA with "limited choice" over the future of BA Connect, leading to the sell-off and strategic focus on point-to-point markets from London.
"They don't have the opportunity to feed their hub with small aircraft on secondary routes. That is specific to London Heathrow. Air France-KLM has clearly chosen a double hub strategy with Amsterdam and Paris Charles de Gaulle. The different regional carriers of the group act as feeders of those two hubs," says Grosse.
Austrian, too, sees clear value in its Austrian Arrows regional brand, which is operated by Tyrolean Airways. The regional subsidiary's managing director Manfred Helldoppler says his carrier is well-positioned within Austrian Airlines Group and "plays a clear role" in its parent's strategy. He adds: "Austrian Airlines Group is very satisfied with the performance and development of Tyrolean Airways."
Helldoppler agrees with Grosse, saying that BA's strategy is "the exception in Europe" as other major airlines have opted to keep or expand their regional operations. "There is consolidation going on with the major airlines, but the main hubs in Europe will stay, therefore the regional airlines are needed. Besides Air France-KLM, Lufthansa also kept and needs its different regional operators. Even Swiss founded a regional subsidiary again," he says.
Lufthansa head of regional partner management Jurgen Hild says the Star Alliance carrier has followed a different model to many of its European competitors. "Our five regional partners - Air Dolomiti, Augsburg Airways, Contact Air, Eurowings and Lufthansa Cityline - are fully integrated into the Lufthansa network, ie sales and marketing et cetera, so it's not really regional in the way that most others work." He adds that the German carrier plans to stick with its Lufthansa Regional Group model: "Lower-cost production at the highest flexibility is the main driver to go ahead."
Business models among Europe's regional carriers vary quite considerably. At one end of the spectrum are the privately-owned independents, such as flybe and Baboo. The middle ground is occupied by carriers such as Air Nostrum, which is perceived to be part of Iberia, but is independently-owned, sharing a close, long-term working relationship with the Spanish carrier. At the other end of the scale, Air France is pursuing a franchise strategy and Lufthansa's regionals are integrated into its network system.
Flybe itself used to be an Air France franchise carrier, but Rutter says the inflexibility of this arrangement made it difficult to make money and blocked it from responding to competitive and cost challenges. "If you are part of a megabrand, it is very difficult to have the freedom and agility to deal with the challenges to survival," he says. "Most of them, over the last few years, have been on a fairly negative downhill spiral. It's very unlikely you can make money working as a franchisee."
Grosse disagrees: "Air France operates a franchise system. The profit and loss responsibility rests entirely with the regional carriers. All Air France carriers are very motivated to be profitable, and are profitable. Commercial decisions also rest entirely with the regional carriers. We were profitable last year and the year before, and we are hoping to be profitable this year, although it won't be easy. You should never underestimate your competitor. We don't."
The Consolidation Challenge
Bankir has seen the regional airline market from both sides of the megabrand fence. He is currently chief executive of Swiss independent Baboo, but is also a former chief executive of Irish regional carrier CityJet and Air France's Regional, where he led the merger of Regional Airlines, Proteus and Flandre Air. Bankir says: "Major consolidation can go both ways. Large groups that tend to centralise and over-control their regional activity take all the motivation out of their regional partners, while burdening them with major airline costs and constraints. That has been the case recently with European airlines that have seen the profitability of their regional partners evaporate very quickly. Other groups have respected the independence and dynamism of their regional partners with franchise or other business models that have kept them flexible and efficient."
"We foresee that the consolidation process will affect the regionals...some will disappear"
Air Nostrum is likely to feel the ripple effects of industry consolidation as Iberia and BA join forces, but the Air Nostrum chief says he views the merger as a "very positive" move, adding: "Air Nostrum, as long-term partner of Iberia, can only win out of this situation. It is always positive to work with a partner that becomes stronger and it opens a whole new scenario of opportunities for Air Nostrum to grow and enhance our business throughout Europe with the new group."
Whether or not the regional airlines join in the consolidation game, Lufthansa's Hild believes it is a positive development for the regional market, saying: "The big get bigger, but niches get bigger as well." There is also a general consensus that the regional sector may benefit in the face of wider industry adversity. Major carriers are delaying aircraft deliveries and cutting capacity, pulling off thinner routes as they become unsustainable.
ERA's Clarke says: "Many more opportunities will open up for regional airlines as their smaller aircraft become the right size for operations that can no longer be sustained by Boeing 737 or Airbus A320 family aircraft. Consequently, regional airlines are less likely to park aircraft in economic downturns than majors and low-cost carriers."
Although the regional carriers have not been left unscathed by the brutal increase in fuel prices, Grosse says: "One should nevertheless keep in mind that fuel represents a lower share of total costs in the regional market than in any other segment of the airline business."
Despite their diverging views on the wider impact of consolidation, regional airline executives seem to share a common vision about the recipe for success. Bankir says: "As in all crises, airlines will be affected not because they are big or small, low-cost or high-yield niche carriers, but because they have the right product, good management and strong financial resources or backing. More than ever, flexibility, strong management, the right choice of routes, the right type of aircraft, the ability to build on opportunities - for instance routes abandoned by either strong or vulnerable airlines - will be needed."
Like Bankir, Rutter believes the secret behind running a successful regional airline is a clear business model and stringent capacity management. "This is not the time to blame macroeconomic conditions," he says. "You have to be agile enough to take on the small and big opportunities which will come out of rationalisation. Some regional airlines will come out of this stronger. Only those that can be leader in their sections will survive. It is about finding, dominating and being ruthless about pursuing a niche."
During the opening of a new regional terminal at Paris Charles de Gaulle Airport in early September, French economy, industry and employment minister Christine Lagarde shared an analogy about the economic climate, saying: "When the tide goes out, you can tell the difference between those who are wearing their swimming trunks and those who aren't."
Likewise, as the tide turns to reveal a more streamlined industry structure, it seems likely that a new set of key players will emerge from Europe's colourful patchwork of regional carriers.