Major carriers appear to be signalling their intent to rein back on excess capacity. Chris Tarry at Commerzbank looks at the signs and the possible influence of alliances in the equation.

It does not take a degree in rocket science to realise just how testing this year has already been for the European airlines, as capacity rises and yields fall. But senior management finally appear to be giving the first longer term signs of some more rational behaviour.

Although the increases in capacity have been global phenomena, it is the Europeans that have suffered most. That has been demonstrated with the round of financial results coming out for the June quarter. Lufthansa, which had pushed up seat capacity by an aggressive 12%, was rewarded with a 12.3% fall in passenger yields fall for the quarter. British Airways and KLM, which had been more restrained, still showed yield declines in the 5-6% mark.

The downgrades have already begun as financial markets look again at full-year profits forecasts. But while the planned capacity cuts are seen as an acknowledgement by the airlines of the severity of the current position, they are also seen by the markets as positive action. It is these actions rather than the downgraded near-term financial expectations that are seen as the key influence on sentiment and as a result the share prices.

The signs from management so far include:

British Airways planning an additional 12% reduction in capacity over the next three years. Lufthansa cutting its rate of capacity growth from 15% back to 5-6%. That is lower than its 8% before the hike. United, across the other side of the Atlantic, indicating that it is planning to cut capacity - although it is not yet clear where or by how much on individual international route sectors.

There is another less obvious factor that could be adding to the gross imbalance in supply and demand across the Atlantic this summer. Two of the most significant providers of additional capacity have been Lufthansa and United. As the OAG figures have shown, Lufthansa's capacity will have increased by close to 20% over the summer period (July-September) and United's by nearly 18%. While both have introduced new routes there is perhaps another factor driving this capacity hike - one that centres on alliances.

Alliance developments. at least across the Atlantic, seem close to entering the final straight with tighter ties in the offing. The relationship between United and Lufthansa is a case in point. Although this association already has a considerable market position, it has not yet realised the full potential that could be brought by moving further towards a full revenue-sharing partnership. Within any alliance, the ultimate goal must be to move in the direction of a true joint venture, opening the door to a true sharing of benefits.

One element missing in the current Lufthansa/United association is revenue sharing. At present each airline only benefits financially from the passengers that it flies on its own services, and not from the "alliance" traffic generated for a partner. To realise the full benefits from an alliance revenues must be pooled and shared on the basis of a pre-determined mechanism. KLM already has such transparency with Northwest Airlines and plans the same with Alitalia from the winter timetable. BA and Qantas do likewise.

Lufthansa and United have the necessary anti-trust immunity to follow suit. So, at the risk of asking an obvious question, what has been stopping them from taking this next important step? While there may be other managerial issues, one of the key missing pieces is a mechanism through which to share the benefit of the joint operation. Taking this back a stage, the fundamental question is perhaps is the basis on which to share the benefit. Market presence is often seen as a good starting point, and in simple terms the greater the market presence the larger the share of the pie.

Taking the three main summer months (July-September)as a whole, this year the division would go in favour of Lufthansa, with a 51.3% share of transatlantic capacity compared with United. That is little different from the 51:49 split which prevailed a year ago. One interpretation that could be put on this is that, where United led, Lufthansa was bound, or at least prompted, to follow in order to maintain its relative share. In particular, perhaps consequences of United's capacity shifts from the Pacific meant that Lufthansa had to respond to maintain the perceived balance.

As a further and important development, although it has not been given a particularly high profile, Lufthansa and United have announced their first joint venture route between Düsseldorf and Chicago - although there are no details about the basis of sharing the benefit.

This "posturing for position" is yet another factor in the relationship between capacity, traffic and yield. As suggested in on these pages last month, the point has been reached in some markets where lower fares are no longer stimulating new demand - just redistributing it for lower yields. This relationship between traffic and capacity and the rate of underlying economic growth underpins our analysis of yield trends.

Source: Airline Business