Part one of Flight International's annual airline survey, covering air traffic, suggests stability has returned to the global air transport market. Part two, with financial rankings, will be published on 5 September.

Chris Jasper/LONDON

For decades the mantra that 'big is best' has held sway across the airline industry. In a sector that throughout most of its history has been highly regulated, the pursuit of raw market share has commonly been regarded as the only viable strategy.

With most airlines state-owned, and foreign services operated under bilateral treaties that divided markets between 'designated' flag- carriers, this was probably true.

The liberalisation process of the past two decades, first in the USA and then, more recently, in Europe, might have been expected to change all of that, yet in reality the received wisdom continued to reign unchallenged. Airlines piled on capacity when economies expanded, and then desperately fought to rein it in during intervening recessions.

Cyclicity continued to be regarded as an inevitable trait of the industry, with the boom-bust cycle of the world economy mirrored by the boom-bust of airline profits as demand for travel expanded and contracted. Now - at long last - evidence of a genuine sea change in strategic thinking is beginning to emerge. Airlines are appearing to move away from the expansionist policies of the past, and even demonstrate a willingness to surrender market share in order to chase improved and sustained profitability.

That evidence is seen throughout part one of the 2000 Top 50 Airlines survey, which details traffic-related trends for 1999, and has become more clearly discernible in figures for the current year, which show that several key airlines, particularly in Europe, are slowing capacity growth to a crawl as they attempt to improve load factors and yields.

Back in 1998, most airlines proceeded cautiously in the face of fears over a possible world recession in the wake of the East Asian crisis. Subsequent indications that the feared collapse would be no more than a slowdown were enough to overcome this restraint, however, and capacity increases were introduced as carriers renewed their competition for market share. The result was high industry overcapacity, and an inevitable decline in profitability.

While industry overcapacity had an impact on 1999 figures, a hard-learned lesson finally seems to have sunk in, and while projections from the International Civil Aviation Organisation (ICAO) and the International Air Transport Association (IATA) suggest that traffic is set to grow markedly over the next few years, airlines now appear commited to keeping the lid on capacity, and hence managing growth to produce profitability rather hitching capacity to the coattails of a possibly ephemeral global boom.

This 'grown-up' approach to running an airline has long been advocated by airline analyst Chris Tarry of Commerzbank, and though he accepts that false dawns have brightened the horizon in the past, he believes current thinking may reflect a true coming of age.

Slower Capacity Growth

"Capacity growth is definitely slowing," he says. "There has been eight percent traffic growth in Europe this year, but capacity growth has been somewhere in the three-to-four percent range, so that it's getting back into a better balance. The airlines are behaving in a very rational manner and are no longer chasing traffic either explicitly or implicitly."

Tarry believes that so long as airline chiefs maintain their resolve, the sector could be on the brink of attaining long-term stability. "This is a supply-side determined industry and if you control the supply side you control the industry," he says. "It's really a case of 'over to the airlines' now. We've seen the turning point, but a controlled supply side remains important, because if people get greedy all they are going to do is get hurt."

Tarry credits British Airways and KLM as pioneers in "taking that sort of control", with moves to limit capacity introduced last year, although back then, he says, "they were acting in splendid isolation".

BA's moves were prompted by the collapse of profits in its 1998-1999 financial year, the airline having ramped up capacity by 12% over the 12 months, producing a 10% decline in yields. Though BA's financial performance worsened further in 1999-2000, leading to the demise of chief executive Bob Ayling, strategic changes introduced during the year may have laid the foundations for a brighter future, with the airline seeing yields rise by 10% in the last quarter.

Some European carriers had seemed reluctant to follow the BA model, which has seen the UK flag-carrier trading down to smaller aircraft on some routes and abandoning others, and introducing a fourth class between business and economy, but even Lufthansa - which at one point last year was defending the pursuit of market share planning double digit capacity growth - seems to have fallen into line.

"The figures show that European airlines are controlling capacity in the present quarter," says Tarry. "BA was first to realise that not all traffic was good, and the others are following suit, although KLM is wavering in its commitment to the policy in its winter schedules".

Liberalisation should have led carriers to abandon market share-based strategies far earlier, Tarry argues. "In restrictive markets, capacity control is not so important, and market share may be a genuine measure of an airline's effectiveness," he says. "But as markets become open then the importance of maintaining market share diminishes.

"Airlines took a long time to realise this, but it seems now that they finally have. You have to have a core growth of capacity to be flexible, but you don't throw capacity at any market, other than in the cut price sector, where an airline like Ryanair can grow its costs down. We saw proof of that last year, when there was plenty of capacity, but it didn't create growth."

The temptation to return to old habits remains, although Tarry thinks recent losses hit hard enough to force the message home. "The airlines can still make a mess of it because they may say 'ok, it's going well, let's dump more capacity down here and try to grow'," he says.

"But then again, they may not. Very often, your forecast is conditioned by your most recent experience and after an outbreak of pain you tend to get restraint that lasts several years."

Capacity restraint, coupled with traffic growth, is already producing results. "Underlying yields are recovering, and there have been some dramatic improvements, although currency effects are still harming some airlines. But carriers like Air France are showing big gains, and even US regionals, which already had high yields, are up. We are getting controlled capacity against a better economic background, and as economies recover we get a big increase in business traffic, too."

When business traffic increases but capacity holds steady, the net effect is to raise seat sticker prices, or to reduce the need for widespread discounting, which has been the bane of carriers such as BA. Either way, airlines benefit as profitability improves. The bottom line is still threatened by high oil prices, although Tarry believes that, with capacity growth restrained, airlines may be in a position to act on this.

Fuel Surcharge

"There's always fuel, and that will cut profits, but a fuel surcharge may now be just around the corner, certainly as we move towards the winter timetables from September," he says. "Everyone could live with a level of, say, 4%."

The most recent market projections from ICAO and IATA suggest that global demand for air travel is once again poised to increase at pre-1998 levels, with the Asian shock firmly in the past. With capacity growth restrained, this upward curve should herald improved profitability for airlines, and is also good news for Boeing and Airbus Industrie, with anticipated traffic growth tallying well with their ramping up of delivery rates over the next few years.

If the projections are accurate, the airframers - and ultimately their airline customers - will have called the market correctly. Deliveries of large aircraft (in the 100-seat plus category) rose from 790 in 1998 to 915 in 1999, and though expected to dip slightly to 800 in the current year, when Boeing anticipates the delivery of 480 aircraft and Airbus of 320, an increase on this figure is now projected from next year, Boeing having dropped early projections of a fall in deliveries.

While rates cannot be forecast with great reliability much beyond this, a glance at the orderbook picture suggests that the acceleration in deliveries is likely to continue, with 1999's order tally of 870 due to filter through as deliveries from 2002 or so onwards. Looking further ahead, the recent Farnborough show's order surge took the tally for 2000 past 900 - including A3XX positions - with more to come before year-end, so that the picture from 2003 onwards seems certain to be one of continued expansion.

This upward trend in the delivery/order data would seem to suggest that capacity constraint will be short-lived, but Tarry suggests that the fleet growth picture is more conservative than it might at first appear, and that even with these additional aircraft factored in, airlines should still be able to retain control of the supply-side should they choose to do so.

Tarry says that even with an increase in orders, new orders will actually represent a smaller proportion of the in-service fleet than they have at some points in the past. This is essentially because a significant number of new aircraft will replace others, and do not represent fleet growth as they have in the past. Moreover, a large chunk of this year's orderbook has come from converted options rather than entirely new positions.

"Aircraft deliveries as a percentage of installed fleet will actually drop, while though the Farnborough orderbook - for example - may have looked huge, a lot of these were order conversions anyway," he says.

The 1999 traffic figures are dominated by the Asian recovery, with many of the carriers that were hit hard in 1998 recovering most, if not all, of the ground lost in their annus horibilis. Korean Air and its compatriot Asiana, which performed equally badly in 1998 with traffic dropping 19.7% - the worst performance among the top 100 carriers - saw increases of 13.6% and 21.4% respectively. Carriers including Thai, Malaysian and China Eastern also exhibited double digit growth, though others - including Garuda - still lag.

Asian yields generally improved, with the market's strong rebound soaking up available capacity, in contrast with Europe, where loads were largely static or falling (although from relative highs), and often-large traffic increases failed to offset the impact of rising capacity. In the more mature US market, the traffic picture was essentially static, although 1998's big casualties, Northwest and TWA, improved markedly in terms of traffic, loads and passenger numbers. In the cargo market, which suffered most severely during Asia's travails, the recovery was also most visible.

Statistics published by ICAO, covering industry-wide financial performance, suggest the airline sector's financial recovery is lagging some way behind the upturn in traffic (part two of the Top 50 Airlines Survey, focusing on financial performance, will appear on 5 September) - but continued capacity restraint, coupled with increased demand, would seem to provide a clear route towards respectable profits.

Source: Flight International