Trends & Predictions for 2010: Part II

As promised, here is the second part of Airline Bulletin's discussion of trends and predictions to examine in the coming year.

Prediction #1: Industry Consolidation, Especially Abroad
While U.S. carriers have made efforts to reduce their capacity and form strategic partnerships with other carriers, it does not appear likely that we will see a full-fledged merger or buyout in the U.S. in the coming year. This is not to say that such consolidation is impossible, rather that it's simply unlikely. There aren't a lot of perennially weak airlines left to consolidate. Frontier (which has recently showed signs of strength) and Midwest have been combined, Sun Country, to my amazement, seems to be hanging on, and small LCCs like Spirit and Allegiant that have defined business models and solid market niches don't appear to be losing buckets of money either. That being said, anyone is a possible takeover target or buyer. Even Southwest, which has historically avoided growth by acquisition (with a few exceptions), has signaled of late that it is open to potential mergers.

US Airways Deals?
One carrier that still mystifies me is US Airways. The airline has been very aggressive in implementing ancillary revenue-generating programs and cutting costs/capacity. CEO Doug Parker seems to know what he's doing in this regard. But, US Airways may not be very poised for future business travel growth. It operates by far the smallest international route network of any of the 5 legacy carriers in the States, and has actually cut some of its European routes recently due to poor loads. Growth in Asia has taken something of a hiatus, as US Airways let its Philadelphia-Beijing route authority expire after the airline wanted to avoid opening the route due to the recession. And the carrier's position in Star Alliance has been weakened due to Continental's recent entry, and due to the announcement of a strengthening of reciprocity between United and Continental frequent flyer programs. The conventional wisdom has been that American would make a bid for US Airways, since American has avoided much of the consolidation activity within the past 7-8 years, and as a result, has watched its market share decline, while US Airways needs an available suitor. But American and US Airways have almost no fleet compatibility--American is mostly Boeing, US Airways is mostly Airbus. And another merger would only further complicate the labor troubles that have hampered US Airways recently, particularly with its pilots union having trouble integrating seniority between old US Airways pilots and former America West pilots. On the plus side, the route networks of American and US Airways would align somewhat, with US Airways having hubs in the Southwest, Southeast, and Northeast, all regions where American lacks hubs (American's Miami hub, mostly geared towards traffic to/from Florida or Latin America notwithstanding). However, both carriers are relatively weak in Asia and the Middle East, areas where they will need to ramp up capacity if they hope to compete in these increasingly important business markets.

What seems to be a more plausible idea, actually, is a buyout of Spirit by US Airways. US Airways as noted above has been very aggressive, perhaps the most aggressive of any legacy carrier in seeking out new ancillary revenue opportunities, and transforming itself into an LCC which can effectively compete against the likes of Southwest, JetBlue, and AirTran on the ultra-competitive routes along the eastern seaboard. A buyout of Spirit would have very strong fleet complementarities--both carriers fly A319 and A321 aircraft, as well as strong route network complementarities. US Airways tried a few years ago to open a mini-hub in Fort Lauderdale--Spirit's biggest base, with routes to Caribbean destinations, but was fended off in part due to Spirit's competition. There is clearly money to be made on these routes, but US Airways lacked the cost structure several years back to adequately compete. Now the carrier has realigned its costs, and a buyout of Spirit would make accessing such routes much easier.

It would also do something else which is pretty important. The two slot swap deals announced earlier this year, which (if approved) will strengthen legacy carriers at slot congested airports while helping to keep out low-cost competitors. US Airways, even though they are starting to act like a low-cost carrier, is not a low-fare carrier, unless it is forced to be through competition. US Airways would rather stifle demand with higher fares (and higher profits) than lower fares which stimulates demand but reduces yields, which is what Southwest tends to do. Keeping slots in the legacy carrier "family" prevents potential low-cost competition at slot-congested airports (see also Prediction #2). Spirit is one of the few LCCs to have slots at both LaGuardia and Washington National (even though it has relatively few slots in both). A buyout of Spirit would help diminish low-fare competition at these airports, and allow legacies to charge higher fares to business customers. However, I still think that this deal is somewhat improbable, only because Spirit is presumably a money-making carrier with a good market niche, while US Airways is a money-losing carrier with lots of problems that could make a merger tricky. It could be an easy buyout, or it could just be an obstacle to US Airways doing what it needs to do to revamp itself to compete against LCCs while expanding its international network.

European Consolidation
In Europe, the picture is much simpler. I don't anticipate many state carriers to go out of business, however I do imagine that governments will work even harder in the next year to privatize or revamp the following state carriers, named yesterday in Part I:
CSA Czech Airlines
Croatia Airlines
LOT Polish Airways
MALEV Hungarian Airlines
TAROM Romanian Airlines

After additional research, I also want to add the following carriers' names to this watch list:
Aer Lingus¹
Air Malta²
Bulgaria Air

Given the obligation of these governments to maintain positive images, it appears extremely unlikely that they will suddenly pull the plug on these carriers' operations, stranding passengers (voters) and angering the public, a la the recent FlyGlobespan fiasco. However, such airlines are definitely at risk of being purchased by larger airline conglomerates or of being privatized. 

Notes:
1. Aer Lingus may be at risk for another Ryanair takeover attempt in the new year. The carrier has struggled to compete against Ryanair, and has gotten push-back from its unions as management tries to contain costs. Efforts have been made to diversify the carrier away from Ireland, opening new routes from London Gatwick. While the carrier may avoid a Ryanair takeover, serious reforms are needed to make the company profitable once again, and these do not appear forthcoming.
2. Air Malta may also be in need of further reform due to the recent arrival of LCCs in Malta after the airport lowered passenger charges. Air Malta had effectively been protected from LCC competition due to these high charges, but this is no longer the case. As a result, the carrier must find ways to diversify and compete. But since the vast majority of Malta traffic is holiday-oriented, and thus, price-sensitive, it appears unlikely that unless Air Malta can turn itself into a bare-bones LCC, the carrier could face extinction. Another possibility would be a buyout, perhaps by another LCC like easyJet, which would reform the carrier, much as it did with GB Airways, while maintaining most of the its routes.

In terms of LCCs, there are simply too many out there, and too few of them have such well-defended market niches that they can't be attacked by market leaders easyJet, Ryanair, Wizz Air, and Norwegian. I believe that the following carriers are in trouble, and are at risk of potential sudden shutdown. As a traveler, I would do some research before booking with them, and then only with a credit card:
bmiBaby_³
Cimber Sterling⁴
Niki
SmartWings
Vueling⁵
Windjet⁶

3. bmiBaby is unlikely to engage in a sudden shutdown, now that the carrier is owned by Lufthansa. If bmiBaby is closed, it will likely be in a controlled fashion, or if it is sudden, passengers should anticipate far fewer inconveniences than when FlyGlobespan shut down (ie. Lufthansa will likely offer alternate flights, etc.). However, bmiBaby is under heavy competition from easyJet and Ryanair. And while the carrier is growing--it recently expanded at East Midlands which easyJet vacated due to poor yields--it is unclear whether the airline, with relatively old, inefficient planes and infrequent service on many of its international routes, will thrive in the coming years. Lufthansa may use its recent acquisition of British Midland mostly for its aircraft and slots at Heathrow, taking the airline's good routes and using British Midland to help feed into Lufthansa's long-haul routes, while scrapping much of the rest of the company. As British Midland's low-cost subsidiary, bmiBaby doesn't have very much to offer Lufthansa, and a sale or suspension of services appears likely.
4. Who knows what's going on with Cimber Sterling? The carrier seems bereft of a coherent strategy, flying both business and leisure routes with a bizarre mixture of aircraft. Most of Sterling's core routes were taken over by Norwegian and Transavia immediately after that carrier's demise, and Sterling's new namesake has been left with relatively thin routes and little room to grow. I see Cimber as extremely vulnerable to shutdown.
5. Vueling is probably not going to shut down immediately, but will be increasingly vulnerable to competition from easyJet and Ryanair in Barcelona and Madrid. It is unclear whether the combination of Vueling and Clickair has really made the company more financially stable, and due to this lack of information, I am concerned about the carrier's future. However, Vueling has potential to thrive and grow within the coming years. It has a large fleet, a relatively low cost structure, and by operating from primary airports, including Heathrow, can attract higher-yielding business travelers. Thus, it is less vulnerable than most of the other carriers named on this list, but is vulnerable nevertheless.
6. Same issue as with Cimber. It's hard to know what's going on with this carrier. It's privately owned, not discussed much in the press, and it seems hard to believe that they have a real competitive advantage in the marketplace. Now maybe they're like Spirit Air in the U.S., and have a relatively undisturbed market niche on thin routes to/from Sicily. And given Ryanair's recent announcement that it may close domestic routes within Italy, WindJet may benefit through expansion of services. But without clear evidence that WindJet is a profitable LCC with competent management, I have to place them in the same category as Cimber--extremely vulnerable to shutdown.

Prediction #2: Continued LCC Growth
As the economy continues to suffer, expect more businesses to shop around for travel, and send employees on LCCs when necessary. LCCs will try to respond to this growing demand. In the U.S. in particular, LCCs will likely make more efforts to enter or expand services at airports that are dominated by legacy carriers and which are the few remaining bastions of high fares in the U.S. While virtually every large metro area in the U.S. has low-fare airline service, many large, primary airports in these metro areas lack much low-fare service. Examples include Dallas Fort-Worth, Miami, Chicago O'Hare, Newark, Washington National, Cincinnati, Charlotte, Houston Intercontinental, and Atlanta (obviously, AirTran has a large hub here, which keeps fares lower than they otherwise would be, nevertheless, the lack of Southwest, JetBlue, or other LCCs in the Atlanta area at all is problematic and allows a Delta/AirTran duopoly to set prices). Although some of these airports are more congested and delay-prone, they are often preferable for business travelers, as they are easier to access, are located closer to where companies are situated, have better facilities and connections to other airlines, etc. In the coming year, expect expanded service from AirTran, Southwest, and JetBlue to the airports above. While new leisure-focused service will be added, particularly to/from the Caribbean, don't count out future expansions at these key airports for business travelers. Leisure demand has actually held up better than business demand, and so while LCCs will do well in leisure markets, because they are already strong in California, Florida, and the Caribbean, less of the growth in their operations is likely to be concentrated in those regions, since little added LCC capacity is needed to handle this traffic.

In Europe, while it may seem like business routes would also see expansions in service, this does not seem to be the case. Ryanair has announced minimal service of late that will be attractive to business travelers, mostly because it is concentrated in very distant and inconvenient airports. EasyJet, which has aimed to take business customers away from BA and other full-service carriers, has instead recently announced that it will add new service to a host of leisure destinations next summer, mostly in Turkey. Such moves seem to place easyJet and Ryanair in closer competition with European charter carriers such as Monarch than legacy carriers like BA. It will be interesting to see whether carriers like Wizz Air, Norwegian, and Air Berlin follow suit and concentrate growth mostly on leisure routes, but that would be somewhat counterintuitive, given the growing demand of businesses to trim travel costs.

Prediction #3: Increasing Focus on the Environment
While there are other interesting predictions to be discussed, it's getting a bit late and I need to get this out. So I'll conclude with my third prediction, which is something that will be of increasing importance not just in 2010 but in the coming decade. Expect more airlines to highlight their "green" credentials whenever possible, through marketing campaigns, press releases highlighting environmental initiatives (such as this recent announcement highlighting airline participation in a jet biofuel scheme), and programs to offset emissions. Such efforts will be reinforced as Boeing delivers the fuel-efficient 787 Dreamliner to its first customers next year, and as the U.S. Senate debates a cap-and-trade bill to combat climate change. Although we're in a recession and customers are price-sensitive, more and more consumers are going to make what they perceive to be environmentally-friendly choices, given growing awareness of environmental concerns. While airline efforts to address the issue are mostly greenwashing, since the benefits of getting customers to recycle soda cans on the plane or powering one engine with 50% biofuels aren't diddly squat compared to the effects of contrails fully-loaded commercial jets spew out at high altitudes, such efforts will likely succeed at winning customers over since most people don't know any better. What we won't see, however, are serious efforts to make the industry more environmentally-friendly through new technologies. V-shaped aircraft ("flying wings") or better yet, high-altitude airships would radically alter the airline industry as we know it, but they would also make a substantial dent in the industry's pollution levels. But because such technologies aren't compatible with current air transport infrastructure, are not seen by consumers or regulators as safe, and in some cases are slower than conventional aircraft, don't expect Boeing to announce production of such aircraft anytime in the near future. This is not to say that such technology won't be commercialized, but significant steps aren't likely to be taken within the next year due to the recent air travel slowdown and manufacturers' focus on the latest generation of fuel-efficient planes.

In 2010, as the airline industry globally continues to struggle, it will likely once again continue to make headlines as it tends to do, and Airline Bulletin will be here, whenever possible, to offer commentary on these events. Until then, have a wonderful new year!

Trends & Predictions for 2010: Part I

After the recent hiatus which was a bit longer than anticipated, Airline Bulletin is back, albeit briefly. Believe it or not, I have a life outside of Airline Bulletin, and it has prevented me from doing much on the blog of late. I will be doing some traveling over the next few months to Africa, and so once again, posting may be a bit spotty. My apologies in advance. I am using this post and the following one to highlight some trends and make predictions regarding air travel in the coming year. Part I focuses on some of the trends shaping the industry, and discusses some of the potential problems facing airlines in the coming year. Part II will make more specific predictions regarding industry consolidation, expansion, and other significant changes.

Trend #1: Continued Economic Weakness
The economy is not poised to make a significant rebound next year, and the unemployment rate may not fall below 7-8% for several years. This means that air travel demand will be commensurately affected, perhaps even more so since travel is one of the first things businesses have cut back on during this recession. However, airlines are aware of this, and have taken proactive steps to cut capacity. U.S. carriers appear to be doing better now that they've taken these steps, and are likely to fare better in the coming year. That being said, expect profits to remain relatively low, and if oil creeps up (see Trend #3), then airlines could once again wind up with buckets of red ink.

It should be noted that this crisis is hitting the traditional developed economies hardest. Europe in general is facing a severe economic situation, and the continent's demographics do not bode well for future economic recovery. The U.S. and Japan will also continue to suffer, but possibly to a lesser degree than Europe. But carriers who serve China and the Middle East are still finding relatively robust air travel demand, especially from business travelers (Dubai's debt crisis notwithstanding). These new developing markets will be increasingly important for the airline industry globally, including for U.S. carriers, and airlines like Emirates stand to benefit from relatively strong economic growth in many newly industrializing countries. Carriers that concentrate service in these markets may be a bright spot during another difficult year.

Trend #2: Capacity Cuts, Especially in Small Markets
To go along with Trend #1, airlines will continue to make capacity reductions where they appear appropriate. These reductions are likely to hit small communities in the United States the hardest, because they rely on high ASM-cost regional aircraft, which are not very attractive for carriers at $80 oil. Airlines, particularly in the U.S. will continue to press for reductions in their regional jet capacity, and especially with 50 or fewer seat planes. In Europe, small airports that rely on the business of low-cost carriers such as Ryanair will be increasingly pressured for subsidies. While these airports face a different dilemma than their counterparts in the U.S., because they can be served with mainline jets, they will be increasingly played off each other, as Ryanair and other LCCs vie for lower landing fees. 

Another concern for small airports in the U.S. is how they will address the increasing penetration of low-cost carriers into small markets, a la Ryanair. Allegiant has successfully entered many small cities and siphoned off many leisure passengers who formerly flew regional jets on legacy carriers or drove to larger cities for low-fare service, in addition to creating new demand for vacation travel. While Allegiant has been a boon for many small communities, the airline's ability to offer much lower fares than legacy carriers has put pressure on legacies that use regional jets to serve these airports. Small airports will need to work hard to keep both kinds of service, because both offer travelers in their communities a range of travel options. However, make no mistake that Allegiant is hurting legacy carriers, and by siphoning off passengers, it reduces load factors on the very 50-seat jets that need to be kept full if airlines want to avoid junking that capacity.

But there is another issue to consider here. How does the introduction of low-fare carrier service into one small regional airport affect legacy service to others? One case to examine next year: Southwest's recent announcement that it will serve the Northwest Florida International Airport starting next May, albeit with subsidies from the St. Joe Company. Such service is likely to bring lower fares to one of the nation's most expensive air travel regions. How will the airlines and airports serving Pensacola, Tallahassee, Fort Walton Beach, and Dothan respond? This remains to be seen. New low-fare service in one airport has the potential to drive away traffic in others, or it could stimulate traffic, by forcing legacy carriers to reduce fares. As U.S. low-cost carriers look for room to expand domestically, entering small markets may become increasingly attractive, but this likely means picking and choosing certain small airports in a given region to stage their operations, since LCCs need larger catchment areas to fill mainline planes as compared to legacies that need smaller catchment areas to fill 50-seat regional jets. However, if regional jets are increasingly cost-ineffective for some small markets against larger LCC aircraft, legacies could be forced to offer fewer frequencies on larger planes, or to exit these markets, which is not a desirable outcome, given that a key competitive advantage of legacies over LCCs is their wide range of destinations. LCCs have the potential to spur competition, or to squelch it, and I worry it could be the latter.

Trend #3: Problematic, But Not Devastating Oil Prices
For airlines which are relatively unhedged, the challenge of high, volatile oil prices could be a challenge in 2010. However, (and I knock on wood when I say this), I doubt that there will be major oil price spikes or falls within the next year (however, such events are quite likely to occur in future years). Here is why: oil prices are tightly connected to overall economic strength since our economy runs on oil. We are currently dependent on it for most economic activities. As the economy grows, so does demand for petroleum products. But supply is being constrained, mainly because we're running out of oil (or at least the stuff that's easy and inexpensive to access). Thus, when the economy is doing poorly, we don't use as much oil, and it isn't as expensive. But as soon as the economy starts to show signs of life, then the oil price could go much higher, because the lack of new supply is likely to result in little new oil in the market, but lots of new demand. But if there isn't oil to supply this demand, then the demand goes away and economic contraction results. Since the economy isn't showing many signs of life right now, this won't be a concern. But in the future, when the economy does rebound, then all industries, including the airline industry, will have to learn to live with less oil if economic growth will occur. And airlines will have to contend with price spikes that affect how they do business because the economy is likely to go through fits and starts. Oil prices will be something to keep an eye on, but given weak demand, it won't be as significant problem for 2010 as it was in 2008.

Trend #4: In Europe, Serious Short-haul Weakness
European LCCs are kicking butt. They are rapidly taking market share away from legacy carriers. This has resulted in a hyper-competitive intra-EU market where legacies are at a distinct disadvantage. While European carriers are looking to mergers and consolidation in order to adapt, they will nevertheless encounter resistance to doing so (see for instance, British Airways' recent difficulties with their cabin crew who nearly went on strike over Christmas due to proposed wage and personnel reductions). But unlike Ryanair and easyJet, British Airways has a long-haul operation, and when the economy picks up, this is likely to make them lots of money, since there is less competition, and such routes can command high yields in premium classes. But not all European legacy carriers have such operations--a point missed by many analysts of this market. Legacy carriers without significant long-haul operations will be strained by more efficient, cheaper, and oftentimes, more comfortable LCCs. While some of these carriers are still owned by state governments, as these companies lose money, there will be increasing pressure to privatize and get taxpayers out of this loss-making business. Whether such privatizations will be successful or not, given the competitive disadvantage of these carriers, remains to be seen. Some of these carriers could get bought out by bigger legacy carriers, and become part of European Airline conglomerates, such as Austrian Airways, which got bought out by Lufthansa. However, without such deals, carriers such as LOT, CSA Czech Airlines, Croatia Airlines, Malev, and TAROM, are likely to suffer from the likes of Wizz Air and Ryanair, the latter of which has recently signaled its intent to open new bases in Eastern Europe. All legacy European carriers will encounter problems as they battle LCCs, but those without long-haul operations that bring less competition, higher yields, and opportunities to support feeder flights to other cities will be in serious trouble.

Trend #5: Pressure for Foreign Integration
As the recent battle between American and Delta for a partnership with struggling Japanese carrier JAL illustrates, U.S. carriers will increasingly look abroad to find ways to boost their route networks. While U.S. carriers are unlikely to become owners of many carriers abroad, they may continue to deepen their partnerships with alliance partners. As business travel increasingly entails international flights to countries poorly served by American carriers, such as China, India, or Gulf states, U.S. carriers can capitalize on the route networks of their partners. Additional deals such as the loans proposed to JAL from potential U.S. suitors are likely to occur as foreign carriers, especially those in Europe and Japan, struggle with weak economies and strong competition from LCCs.

But integration will also come in other forms. U.S. carriers already have the privilege of serving intra-EU routes, and come 2010, Open Skies II should take effect, such that EU carriers can serve intra-U.S. routes. While it remains to be seen whether this provision of the treaty will be enacted by U.S. authorities (failure to do so could result in the initial phase of the deal being nullified), it will be a boon to European carriers who could enter and cooperate with their alliance partners on U.S. routes, siphoning business travelers off from carriers like JetBlue and Virgin America with the perks many foreign carriers offer, and which U.S. carriers have removed.

Finally, integration could take place through foreign carriers purchasing controlling stakes in U.S. carriers. Right now, foreign entities are prohibited from owning more than 25% of U.S. carriers. Some, such as airline consultant Mike Boyd seem to think this is a grand idea and that such restrictions ought to be maintained. As he notes in his Dec 21 "Hot Flash", "Regardless of what the deals may represent to shareholders, foreign control of US airlines means foreign strategic planning." He then proceeds to spew out some jingoistic nonsense about how such foreign ownership is anti-constitutional, and how Democrats don't give a damn about U.S. independence from dangerous dictators. Please. Foreign ownership is not necessarily a bad thing (the key word here being necessarily). It's one thing to have Richard Branson's Virgin Group take a controlling stake in Virgin America, or for Lufthansa to increase its stake in JetBlue to 51%. These companies run profitable, world-class airlines, and would bring new capital and new insights into one of the world's most dynamic aviation markets. Such connections would also help support the expansion of carriers like Lufthansa, which with its evil, anti-American strategic planning, could better time JetBlue flights at JFK to coincide with arrivals from Europe, offering Lufthansa's European passengers a convenient option when they travel to the States. A controlling stake would lead to more complete integration, and likely provide customers with a more seamless travel experience, while preventing the conflicts that sometimes occur between alliance partners. While many of the benefits of ownership can be obtained in alliances, the different interests of shareholders and managers of the partners can result in conflicts between the companies and hassles for passengers if flights aren't adequately timed and ticketing/baggage systems properly integrated. Common ownership is likely to over time alleviate such problems, increasing efficiencies and minimizing the conflicts passengers encounter when they travel between carriers.

What Boyd worries about, and rightly so, is a scenario where a Chinese conglomerate turns Delta Air Lines into The Pearl River Delta Air Line, which would not only result in minimal alliance benefits for customers (since Delta's most Western hub is in Salt Lake City which isn't really convenient for many trans-Pacific connections), but would place America's largest carrier in the hands of a country we don't really trust. Ownership rules are ostensibly in place to provide aircraft for the military in the event of a national emergency. It's implausible to me that Richard Branson would suddenly divert Virgin America's planes to help Hugo Chavez, but Chinese control of hundreds of U.S. commercial planes could leave the U.S. in a difficult situation if there ever were such a crisis. The days of restrictions on foreign ownership of U.S. carriers should not end. But their days may be numbered. Such policies need to be changed not with a bang but a whimper. Steps should be implemented to allow investors from nations trusted by the U.S. (eg. the EU, Canada, Japan, Australia, etc) to control U.S. carriers. This may require changes to bilateral or regional trade agreements that have restrictions on foreign investment, but the process should be started. Integration will result in some "foreign strategic planning", but in a world where business is increasingly global, one where airlines need to be able to transport passengers seamlessly between distant markets, big and small, such common ownership may be increasingly important to building strong, dependable transport networks.

2010 will most certainly be an interesting year for the industry, and I'll offer some more specific predictions of all the interesting things we'll see in my follow-up post.