Over the last ten years, the airport sector has seen ongoing and continuous growth, with the only exception being the years of global crisis, which however were rapidly recovered upon.
At global level, future projections are also positive, both according to institutional research institutes and sector representatives: the International Civil Aviation Organisation (ICAO) forecasts 4.7% annual growth between 2010 and 2030, with Airbus Industry expecting 4.8% between 2010 and 2029 and Boeing forecasting a doubling by 2030 of global passenger traffic.
This development however will be uneven across the various regions, with much relating to the Chinese market and the other expanding regions (India, the Middle East and part of Latin America), which overall comprise (OECD figures) 68% of global traffic, while the advanced economies (Europe and North America) expect growth rates of slightly under the global average at approx. 3.7% annually for the 2010-2029 period.
At European level, a range of factors may impact on the growth estimates: the continued economic crisis, financial difficulties within the airlines – due to high oil costs and unfavourable Euro-USD exchange rate movements - but also weak performances by the air transport sector in Europe. In terms of cargo traffic, expectations are also strong - related principally to international trade with the emerging economies. Over a twenty-year period, Airbus expects 5.9% growth annually. Within this however, Italy holds a marginal role compared to the other European countries, with a market share of 6% (compared to 10% for France and 30% for Germany) and with only 2% of total air cargo transported.
Uncertainty has become the new norm in the air transport industry and risk reduction has become of prime importance for the airlines within a re-stagnating European economy and a US economy which struggles to take off. The air sector, maybe more than others, is extensively impacted by general economic developments and must undertake challenges over which it has little power to control or intervene. The price of fuel is the most important variable, comprising 40% of total airline costs presently, while also being one of the least predictable and manageable. In addition, a series of factors impacting quickly developing markets must also be considered, which are re-modelling the way in which the business is operated by the airlines - with these factors also being outside the control of managers – highlighting the reason why many airlines need to work very hard to generate decent profit margins, or even any profit at all. These challenging outside factors are pushing airlines into improvised partnerships, necessary but still managed closely due to excess regulation in a number of countries.
The turbulence of a quickly changing market5
With regards to the majority of operating variables outside of their control, air support operators have little room to manoeuvre in terms of improving operating efficacy and efficiency. The principal factors continue to be personnel cost reduction and increased productivity. However, the idea of reducing costs in this manner is strongly challenged by the fact that fuel costs account for nearly half of total costs.
The price of fuel has become an important variable for new aircraft demand. High oil prices have fed demand for more modern and efficient aircraft. Before 2004, personnel costs were the greatest cost factor for airlines. Since then the price of jet fuel has more than tripled and today comprises nearly one-third of overall costs.
The increase in the price of oil has fundamentally changed the air transport sector. Consequently, the airlines have removed from their fleets older aircraft and seek to replace them with more efficient models.
Producers have gained from this opportunity, opting to take a low risk strategy: instead of designing completely new models of aircraft, preferring to concentrate on existing aircraft, with the use of new motors and other improvements. More than 1,500 aircraft were delivered to commercial airlines in 2013: at global level these numbers are without precedent.
An additional worrying factor for various airlines, capable of making cost reduction a marginal issue, is the manner in which the sector competition model is changing. The low cost airlines have re-modelled the short range connection network throughout the world. Long haul low cost flights are becoming increasingly extensive in the Asian region (as soon will be the case in the North Atlantic region); the Gulf airlines are re-defining many of the competitive dynamics of the hubs and of the long haul connections operated by the traditional airlines. Partnerships have increasingly become a last resort for airlines in difficulty. Amidst these difficulties and due to this extensive pressure both on the short and long range market, both the network airlines and the point to point airlines have begun to consider agreements and compromises which a year or two ago would have been absolutely unthinkable.
Global alliances have fulfilled a very important need and continue to provide a very effective support for many airlines, although heightened competition requires the need to adopt new and more specific partnership models. Only the major US airlines have not been impacted by these developments. Comfortably organised in the largest protected domestic market in the world, further strengthened through mergers which have created large and dominant players, almost unprecedented profits are being delivered on the domestic market. Internationally, in the key North Atlantic market, the “big three” (American Airlines, United Airlines and Delta Airlines) are also enjoying the protection of the Anti-trust authorities, which block the development of alliances by their European competitors. This combination has undoubtedly created a favourable environment, at least in the short-term. In 2014, discussions around the traditional air industry framework, which has remained virtually unchanged for approx. 70 years, will most likely intensify. Over the last two years, the sector has reached a tipping point. Technology and social pressures have moved the focal point. The key commercial features of the industry are:
- access to the market, in a wider sense, in part hindered by bilateral agreements;
- sale and distribution, dominated by intermediaries, with a minority share of direct sales.
Sooner or later a revolution will occur, which has already begun to take shape at the edges of the market. Although amid rising oil prices, long-haul traffic growth is picking up, both thanks to new aircraft models and liberalisation, joint ventures, alliances and partnerships.
This new aspect concerns not only the Gulf airlines, but also the Chinese airlines which are becoming increasingly central to point to point traffic and sixth freedom operations. In fact, the Chinese airlines will become the driver of the future partnership system. Although they may not pursue international expansion directly, the attraction of the Chinese market for foreign players is driving them to court the few Chinese airlines still available.
Low cost long haul flights, up to now a feature of South-East Asia, are becoming of interest in the North Atlantic. This model, initially underestimated, of low cost long haul flights, requires the adoption of a series of new measures, such as for example a more efficient management of crew, in addition to the use of aircraft such as the 787, together with the typical low cost model mindset. The first airlines to embrace this philosophy were Norwegian, Air Canada and WestJet and the arrival of this Asian phenomenon in the North Atlantic is without doubt the beginning of something much larger.
This market development will increase pressure on long haul global alliances, particularly if fuel prices continue to fall. The impact will not be limited to the North Atlantic or to global alliances alone. All airlines operating long haul flights will be impacted. This hybridisation process will speed up and both the low cost airlines and the traditional airlines will evolve towards a low cost model with a full service profile. This double-sided model has become standard also for the European airlines, although the major traditional airlines must still focus on operational restructuring in order to contain costs and increase efficiencies. The low cost airlines are expanding particularly in Asia, with South-East Asia representing 60% of intra-regional seats. China has however announced that it will permit the creation of two new domestic low cost airlines and the Northern Asian markets (China, Japan, Korean and Taiwan) are becoming increasingly interconnected.
In 2014, the result, in terms of traffic volumes, of these new developments will not shake the foundations of the air transport industry, but surely will lay the basis for a new wave of low cost global growth and, consequently, a cycle of further liberalisations.
In Europe, the major low cost airlines such as easyJet and Ryanair are highly profitable, despite the economic stagnation which has afflicted the continent. Mexico is a lively and turbulent market, with 61% of domestic traffic handled by low cost carriers. India (72%) and the Philippines (92%) are dominated by low cost airlines. The platform for future market development has been built and the related processes have been put in train.
The competitive strategies of the airports6
Competitive pressures on airports today stem from the hybridisation of the aeronautic industry, which is fundamentally changing. The low cost airlines are developing their offer to attract the medium/high-end of the market, while on the other hand the “full service” airlines are restructuring and simplifying their offer and - as is the case for the low cost airlines - are basing their development on margins rather than volumes. These changes impact upon airports, which must deal with companies which have adopted a range of business models. This has required airports to develop greater flexibility and responsiveness, in order to ensure stronger negotiating positions.
In this environment, the opportunities for airports to increase their offer of routes has become increasingly restricted: while in 2010, 1,141 new routes were opened in Europe, in 2013 only 251 were opened.
Pressures on aeronautic revenues have driven airports to intensify the development of alternative profits sources, in particular retail and food & beverage, but also property, advertising and parking. Attention is therefore not only being focused on passengers, but also on other visitors to the airport. However, these goals have been significantly restricted by the drop in consumer spending and the intensification of offsite services competition, both in terms of retail and parking. In addition, we must consider the hand baggage restrictions and the regulatory restrictions on the sale of certain products.
Top 10 Western European airports
Source: CAPA - week starting 03-feb-2014
We cannot ignore the fact that airlines and passengers benefit from significant subsidies, resulting in the payment of much lower prices than the real cost of airport infrastructure and services. Fees paid by the airlines in 2013 represented only 14% of total airport revenues, with a total contraction of 21% from 2008. Also considering the charges paid by passengers for the use of terminals, the European airport industry highlights a shortfall in operating costs of Euro 4 billion. For this reason, the generation of alternative commercial revenues to aeronautic revenues has become such an important issue.
The ACI Europe report also measured the impact of the 2008-2009 crises on European air continent connectivity. Since 2008 the connectivity of EU airports has improved slightly, although direct connectivity reduced 7%.
This is in stark contrast to non-EU airports, in particular those in Turkey, which increased direct connectivity 34%.
The report indicates in addition that although the European hubs were more resistant than the small regional airports in terms of direct connectivity, significant competition has been felt from the hubs located in Turkey, in the Gulf and to a lesser extent in Russia. Since 2004, the European hubs have lost 10% of their indirect outside Europe connections market to the Gulf hubs. In 2004 the level of intercontinental connectivity offered by the three leading Gulf hubs (Dubai, Abu Dhabi and Doha) was well below that of the three major European hubs (London Heathrow, Frankfurt and Paris Charles de Gaulle). Today the situation has entirely turned around with the three major Gulf hubs enjoying market leadership, capable of providing double the level of intercontinental connectivity of the three European hubs.
Significantly, the intercontinental connectivity of Dubai airport alone is equivalent to the combined intercontinental connectivity offered by London Heathrow, Frankfurt and Paris Charles de Gaulle.
The competitive strategies of airlines7
The IATA (the International Air Transport Association) forecast for 2013 total profits by associated airlines of approx. USD 12.9 billion, with a net margin of 1.8%.
Top 10 Western European airlines
Source: CAPA - week starting 03-feb-2014
While the airlines of North America, the Middle and Far East achieved a net margin of 4%, the European airlines reported weaker performances. The AEA (Association of European Airlines) estimated that the net margin of the European airlines for 2013 would be approx. 1%. In particular, the AEA calculated that despite the fact that air transport contributes approx. Euro 365 billion per year to European gross domestic product, the average profit of the European airlines was approx. Euro 1 per passenger.
The change in the breakdown in the type of traffic reported by European airlines was also significant. In fact, the AEA calculated, taking as a base figure 100 in 2007 for the index of passengers traveling in business and economy class, in 2013 those traveling in economy class increased to 107, while passengers in business class fell to 67.
In addition, the European airlines are losing traffic to non-European airlines. In fact, in the 2007-2013 period the European airlines reported an overall increase in seats offered of 22%, while the non-European airlines increased seat numbers by 35%. One of the reasons for the declining performances of the European airlines continues to be fragmentation. In fact, the number of airlines in Europe is 450, while in the United States and Canada, which have a similar amount of passenger traffic, 190 airlines operate. A further element of weakness of European air transport was confirmed by market share: while in North America the 5 principal airlines occupy 69% of the market, in Europe the leading 5 airlines cover only 45% of the market.
The global aviation sector in 2013 reported record new aircraft orders.
Forecast delivery times of European aircraft
Source: CAPA - week starting 03-feb-2014
Europe played its part in making 2013 a record year. Ryanair ordered 175 new Boeing 737-800 and easyJet 135 Airbus A320. Lufthansa opted for 100 aircraft from the A320 and 59 widebody family (34 Boeing 777-9Xs and 24 Airbus A350-900s). Also IAG, up to recently reticent to extending its fleet, ordered 98 aircraft (30 A320 and 32 A320 neos for Vueling, 19 converted Boeing 787 and 18 A350 for British Airways).
For a low margin sector, the challenge of financing all these orders remains significant. For decades capital expenditure has almost always exceeded the operating cash flow generated by airlines throughout the world. The industry has had to rely on increasingly imaginative forms of external financing.
The competition between Boeing and Airbus has put the American producer at a slight advantage: 648 aircraft delivered in 2013 and 1,355 orders for 2014. Airbus however announced the delivery of 626 aircraft in 2013, with 1,503 orders for the subsequent year.
In relation to the low cost airlines, Ryanair in 2014 delivered significant innovations: the first delivery of a Boeing, the introduction of allocated seating, a new user-friendly website, a less penalising approach towards passengers, new distribution channels (including a mobile application) and increased presence at the major airports.
For Norwegian, 2014 will be the first complete year of experimentation with long haul operations, verifying whether this business model may be further consolidated.
The three major flag carrying groups will seek to develop the offer of their low cost airlines.
Principal European Union regulatory actions
In terms of Civil Aviation, the EU in 2013 focused on the following programmes:
- Airport Package – The European Commission package of proposals concerns the review of the Regulation on slot allocations, of the airport noise regulation and the ground handling and airport fee directives. Apart from the new Airport noise regulation which has recently been adopted, the other matters are currently being discussed within the European Union. The new Airport noise regulation introduces on the one hand more restrictive measures, while on the other hand creating decision-making mechanisms to establish restrictive measures which take into consideration both the interests of persons living close to airports as well as those involved in the air transport sector.
- Air Passenger rights – The new EU Regulation on passenger rights introduces a series of innovations to Regulation (EC) No. 261/2004, based on 10 years of applicative experience. The final text should be adopted in 2014.
- Single Sky and SESAR – While the package of EU regulations concerning the Single Sky have experienced various applicative difficulties, in particular in relation to the full implementation of the Air Space Functional Blocks, the SESAR programme – i.e. the technological modernisation of the European ATM system - began to be rolled out in 2013. Between 2013 and 2014 the first 6 pilot projects to be implemented from 2015 were identified.
- Occurrence Reporting – The Regulation concerning Occurrence Reporting, which concerns the transfer to a single “European database” of every accident or dangerous event, was finalised in 2013 and published in April 2014. This substitutes Directive 2003/42, introducing a number of innovations. The new Regulation proposes to make a significant contribution to safety through the creation of a common database, fed by all member states, which will provide useful information to prevent accidents.
- ETS (Emission Trading Scheme) – The EU Directive concerning CO2 emissions was strongly opposed by the major non-European States (in particular the United States, China and India), whose airlines would have been subject to the ETS. While awaiting an ICAO decision, the European Union decided to suspend implementation (“stop of the clock”) outside of EU airspace.
(4) Sources: Transport Regulation Authority, First Report to Parliament 2014; CAPA Yearbook 2014
(5) Source: CAPA, Yearbook 2014
(6) Source: ACI Europe, Press releases of 14/06/2014 and 17/6/2014
(7) Source: CAPA, Yearbook 2014