EUROPE

RETHINKS

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AT A GLANCE

  • Low oil prices have been driving the unprecedented profitability of the industry. The time is perfect to promote necessary changes, mainly regarding capacity discipline.
  • Political uncertainty raises questions on Europe’s freedom of airline operation, freedom of people movement and the United Kingdom’s economy.
  • Recent airlines’ failures drives the market for consolidation.
  • The increasing participation of Low Cost Carriers will drive more business model alternatives.
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EUROPEAN WINDFALL

As with many other companies around the world, European flag-carrier airlines are crossing a period of unprecedented profitability – which has to be celebrated, but should also be seen as a window of opportunity to implement necessary changes.

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The current level of profitability is due – mainly – to the windfall from low fuel prices. While a focus on short-term thinking is understandable, a long-term approach is critical. The industry structure has not changed, and the pressure on yields and market-share gains are likely to continue unabated.

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Industrial unrest across both the major FSCs and now LCCs too is a trend that will require close monitoring and will require compromise from airline executives and unions alike. This issue is closely linked to that of crew shortage (not only pilots but cabin crew also) in Europe, and will require successful resolution for crew not to be seduced by more attractive opportunities in the Middle East and Asia-Pacific.

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OIL PRICES VS.
AIRLINE PROFITS

Source: IATA, Embraer – June 2018
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POLITICAL UNCERTAINTY

Exactly what the United Kingdom’s exit from the European Union means in reality may not be clear for a number of years, but it could involve changes to:

  • Freedom of operation: EU and UK airlines are free to set their own capacity, frequency, and pricing across borders. These freedoms under the European Union may just be continued, should the United Kingdom join Norway and others in the European Common Aviation Area;
  • Freedom of movement: for passengers traveling across Europe to work, visit friends and family, and take vacations.
  • UK economy: IATA suggests that British GDP could be 2.5 to 3.5 percent lower in 2020 than it would have been had they remained within the EU, reducing total UK passenger demand by 3.0 to 5.0 percent.
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AIRLINE INSOLVENCY & THE CONSOLIDATION PROCESS

A glut in capacity prompted by the low oil price compels carriers to slash fares in a battle for market share. The collapse of Darwin Airline highlights just how cut-throat competition in the European short-haul market has become. Airberlin and Monarch are other meaningful examples of the same issue.

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In this scenario, will the smaller carriers fade away or soldier on? The intra-region capacity share of the top three carriers (or carrier groups) is 75% in US, and 31% in Europe. However, that statistic in itself underscores the differences between the two regions and how the consolidation that is occurring in the former may take much longer to take root in the latter – if at all. Indeed, for all the airline failures Europe has seen, certain governments seem undeterred in the sponsoring of new “flag carriers”, or the resurrecting of old ones.

It should also be born in mind that in addition to regulatory approval for further consolidation, unions will also play an important role in the outcome.

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LCCS’ RAPID MARKET SHARE CONSUMPTION

Against this background, nearly every major airline has undertaken major structural reforms in order to adapt to the new landscape, resulting in the convergence of the two business models. Not that long ago, it would have been unthinkable for FSCs to be charging for on-board meals and drinks or checked luggage, though they have followed the LCC model of commercial aviation.

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While such Legacy Carrier strategies have served to delay the advancement of the LCCs, it has not been enough to stop such momentum. Especially over the past two decades, low-cost airlines have aggressively focused on cheap fares, resulting in a rapid growth of market share, changing the landscape of air transportation in the region.

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EUROPEAN MARKET SHARE
BY BUSINESS MODEL

Source: Source: OAG, Embraer – December 2017
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INTRA-EU EVOLVING BUSINESS MODELS

LCC and FSC business models are progressively displaying a set of similar strategies. At one end of the spectrum, some FSCs now have a lower-cost subsidiary operating for the mainline, while others have a supranational dedicated LCC division; Conversely, the LCC sector is becoming more mainstream and experimenting with FSC strategies, such as multi-fleet type, loyalty programs and sales through global distribution systems to premium customers.

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One of the last great taboos between FSCs and LCCs may be challenged in the near future: co-operation between the two, in the form of code-sharing, feeding each other’s networks, mutually improving each other’s connectivity. Though, before that can become a reality, some questions like “how viable are NB as hub feeders?” and “how can airlines harmonize a long-haul business product with an LCC on the regional level?” need to be answered.

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In the meantime, the regional business model is also going through a diversification from the traditional hub feeding operation with a growing role in high-yield business markets, where high frequency is extremely important to strengthen airline presence. A significant portion of the flights offered in shuttle markets are performed by Regional Carriers, where right-sized aircraft guarantee adequate service-level to maintain market share and capture premium passengers.

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ACMI LEASING MODEL

Europe is an ACMI powerhouse, responsible for roughly 40% of all ACMI companies and fleets installed today. From the lessee standpoint, ACMI brings a lot of value, since it allows the carrier to capture high season peak demand, avoid longterm asset commitments when launching a new operation, cope with AOGs, and even mitigate impacts of planned maintenance events that would disrupt the schedule. The “bmi regional”, for example, ensures it can launch a white tail aircraft within 2 hours of confirmation.

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Over the last 5 years, European ACMI business has grown 11% annually in terms of fleet leased, and there is room for further growth. Several of opportunities for outsourcing low-density routes to regional operators with lower cost base are sprouting, allowing both majors and low cost carriers to bring-in a more efficient airplane to serve thin routes without adding complexity to their narrowbody operation.

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The ACMI market in Europe will however need to evolve. There are at least 40 independent ACMI operators in 20 countries throughout the region (the UK and Spain standing out as having the most), yet there is a high degree of fragmentation and fragility. This sector too will undoubtedly experience a degree of consolidation in the years ahead.

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