oriensadvisors.com

What price European connectivity?

admin — Wed, 10 Oct 2012 07:35:09 +0000

Published in Executive and VIP Aviation International, June 2012.

Chris Cain and Tristan Crawford, from Oriens Advisors, argue that joined-up thinking on airport capacity is needed if Europe is to get back on its feet economically.

The current headlines in the aviation community in Europe concern the threat of a trade war over the EU’s inclusion of air transport in its Emissions Trading Scheme (ETS) on climate change grounds, and taxation of air transport as a means of raising revenues and tackling government deficits. Yet an ever-present debate behind these hot issues is the looming shortage of airport capacity. In an ever more globalised economy, where connectivity to the fastest growing markets is seen as fundamentally important to future competitiveness, congestion at Europe’s airports could significantly constrain long-term growth.

Perhaps the most pressing example of this problem is in the south-east of the UK, where London faces the prospect of being unable to meet a growing demand for flights to emerging economies. Frankfurt, Paris and Amsterdam, each with between three and five runways, look better placed to serve this requirement. A period of inertia in UK aviation policy is not helping. The economic downturn has coincided with the intervention of the courts to delay implementation of the UK’s 2003 Air Transport White Paper. The election of the new coalition government in 2010, with its high-profile “no new runways” pronouncement, has deepened the sense of a policy vacuum.

Various proposals to address a future capacity crisis have met with apparently contradictory statements over the direction the government may take. The industry is still awaiting the release of a new “sustainable aviation framework” (originally planned for the end of March but now delayed until June) to replace the 2003 document.

Whatever long-term policy ultimately emerges, there will be no new runway capacity in southeast England for at least 8-10 years. This puts an emphasis on maximising the use of existing capacity, not only at Heathrow and Gatwick, but also at other tier 1 and 2 airports in the London system – including currently under-utilised commercial facilities such as Southampton, Southend and Manston and specialist business aviation airports such as Biggin Hill and Farnborough. However, Oxford Economics – admittedly in work commissioned by the British Airports Authority – predicts that by 2021 the UK will lose around €10.2bn in GDP and over 140,000 jobs as a result of the inability of London Heathrow alone to increase aircraft movements in line with demand.

Even the airports serving the UK’s near neighbours will run short of runway capacity in 10-15 years, with Amsterdam Schiphol and Frankfurt in particular facing legal and environmental challenges. The long-term capacity position in Europe looks increasingly problematic at a time when competitor economies elsewhere are investing heavily in their airport infrastructure. Prompted by fears for Europe’s economic recovery, the European Union commissioned a study by Steer Davies Gleave in late 2011 to help amend Regulation 95/93, governing allocation of slots, to help open up aviation capacity.

The Draft Regulation that has emerged suggests that more control will be granted to an EU-level committee that could intervene at airport and state level to improve slot utilisation and adopt a market mechanism to withdraw historical slots and auction them off.

A rival study carried out by Mott Macdonald for the European Regions Airline Association (ERA) and the European Business Aviation Association (EBAA) argues that the EU proposals take no account of the overall impact of revising current slot regulation. It puts the likely increase in the number of passengers flying through all coordinated airports at just 2%, equivalent to one year’s normal annual growth. This could create 75,000 jobs, but with a net economic impact that is impossible to quantify. Mott Macdonald says the EU openly accepts that its proposals do not factor in the effect on regional and business aviation services of replacing certain flights with others that make “more economically efficient use of scarce capacity”.

In short, the ERA/EBAA study warns that in return for a modest increase in capacity, slots will be opened up to the highest (probably non-EU) bidder, with the consequence that regional and business aviation connectivity across the EU will decrease and local economies will suffer.

The data suggests this is already happening. According to Airports Council International, airport traffic grew more slowly inside the EU than outside in 2011, at 6.3% compared with 12.2%, and capacity share is being lost to non-EU operators. NATS figures appear to confirm the trend, showing that flights departing from western European regional airports fell by more than 11% between 2002 and 2011, while flights by non-EU airlines to non-EU destinations rose by more than 60%.

Stagnant regional economies, increasing fuel prices and additional regulatory burdens such as ETS and some countries’ passenger taxes are already eroding regional and short-haul operating margins, a situation that is likely to worsen if the European Directorate-General for Mobility and Transport (DG MOVE) withdraws slots from airlines randomly and sells them off to the highest bidder, imposes slot reservation fees and closes down grandfather rights to slots for regional or business aviation operations.

Regional air services from congested hub airports do not create the commercial value of most long-haul slots, but serve to underpin thousands of jobs associated with economic sectors located away from core markets (for example the energy and tourism sectors in the UK). Relying on “allocative efficiency” as the driver of capacity, rather than connectivity, excludes regional services that cannot pay the market rate for slots at key hubs. SMEs could potentially lose the connection to their customers and suppliers in the wider world.

A large part of business aviation’s raison d’être is that it enables business-critical employees to access, establish and support inward investment into less accessible or deprived regions, which ultimately may lead to the development of scheduled commercial services.

Figures from Pricewaterhouse Coopers (PwC) indicate that with a total of some 9.5 million flights within the EU, business aviation brought a total of €19.7bn in annual gross value added to the European economy in 2007, accounting for approximately 0.2% of the combined GDP of the EU countries plus Norway and Switzerland.

The induced impact, at €9.3bn, was the largest contributor to the economic impact of the sector. Considering business aviation’s direct, indirect and induced impact, this section of the aviation industry alone accounted for more than 164,000 jobs across the continent and generated combined annual salaries of around €5.7bn.

Critics will claim that the underlying economy has far more influence than narrow issues such as slot availability when determining the benefits of business aviation. The counter-argument is that business aviation is usually the first part of the industry to recover following a downturn, due to its role in providing first-mover advantage for investors seeking access to new opportunities and exposure to growth sectors.

PwC says that following the 2008 downturn, business aviation was the strongest aviation market in the EU, with growth at 5.5% in 2010. Aviation as a whole grew by 0.8% in 2009. Business aviation flights in 2011 totalled 658,000 across Europe, up 4.7% on the previous year. One factor is “super-connectivity”: the EBAA says business aviation serves three times more city pairs than commercial aviation.

Europe needs, arguably more than ever, to maintain the capacity, capability and investment activity required to meet the demands of faster growing economies elsewhere. What it does not need is ill-conceived regulatory interference that simply benefits non-EU interests, and which specifically penalises regional and business aviation relative to other sectors.

Ultimately, the ability of the EU’s member states to sell their knowledge, lifestyle, products and services to the wider world is one of the priorities for getting Europe back on its feet again and creating a more balanced and resilient long-term economic future. Commercial, regional and business aviation can all combine to help achieve that common objective if they are given the freedom to do so.

Chris Cain and Tristan Crawford are associates at Oriens Advisors Ltd, which provides commercial advice to the aviation value chain.

Airline strategy for sustained profitability in volatile times

admin — Thu, 29 Mar 2012 09:30:25 +0000

By: Michael Ricks, COO Oriens Advisors, Dec 2011

Despite air transport’s continued performance as one of the world’s fastest growing economic sectors, most Airlines have consistently failed to deliver satisfactory returns to their investors.
With over 1000 commercial airlines vying for passengers, an outstanding strategy is necessary to promise sustainable profits. Several airlines have been standouts over the years, each with different, but successful value propositions. Topical examples include Ryanair, Singapore Airlines, COPA and Emirates. This week we take a quick look at Southwest, often mentioned as a strategic success, but fighting to regain and retain its profit-making prowess.

Growing industry, shrinking profits

While year to year passenger volumes rides a cyclical roller coaster, the air transport sector has charted a clearly positive long-term trend. Over the past forty years, the volume of air travel has grown by a factor of 10, freight by a factor of 14. Thanks to airframe and engine improvements, a doubling of fuel efficiency was achieved. Processes optimisation and better asset utilisation have further reduced costs, with the unit cost of air travel being halved in four decades. Time to break out the champagne? More sobering news comes from IATA, namely that we can expect the industry to make only $4 billion this year on invested capital of over $500 billion. Ignoring rounding errors, that is a slim 0.8 percent return for investors. Over the past 40 years, the net-post tax profit for the industry has averaged a meager 0.1 percent of revenues.

A standout in the crowd: Southwest Airlines

Southwest Airlines is arguably North America’s most successful airline whether based upon profitability: 2010 was Southwest’s 38th consecutive year of profitability with a net income of $459 million, or passengers carried, 88 million. The strategy that let Southwest run ahead of the pack for a time: not trying to be everything to everyone, rather adhering to a simple value proposition for a select target market, positioning itself as a low-cost, high frequency, point-to-point provider of travel. Every decision must deliver that strategy (and profitability). A few examples are worth noting regarding operations, risk management and employees.

Cost conscious operations

Operations at Southwest are geared to cut cost while still delivering the core product. Taping the advantage of a homogenous fleet certainly contributed to their success, including exchangeability of aircraft, reduction of spare costs and AOG time, as well as savings in pilot, cabin crew and engineering training, plus a consistent customer experience. Flying to uncongested airports of small cities and less congested airports of large cities reduces taxi times, gate holds and in-air waiting time. Not offering inter-line connections and baggage transfer saves coordination of services with other airlines. Quicker turnaround times (2 out of three planes turned around in15 minutes vs. an industry average of 55 minutes) work expensive assets harder.

Managed risks

Business risks abound in the airline industry and represent both challenges and opportunities. In this competitive market, taking no risks would hamper growth and competitiveness. Taking calculated, managed risks can create value. The business risk turned loss-creating reality for many carriers has been (and remains) the rising cost of fuel. Ten years ago, industry wisdom held that $30 per barrel of oil was the highest price the industry could pay and still produce a profit. In the meantime, $100 a barrel is a reality that all must accept. Airlines paying spot prices for fuel had a hard time as prices went up. Southwest invested in creating capabilities in both fuel hedging and energy trading, initially a winning game. The airline has since taken some hits on its once profitable hedges, again last quarter. A conservative growth strategy, only moving into markets in which volume could be quickly increased, served Southwest well. Damned with th success of having reached the most attractive markets, recent expansion into less-dense city-pairs has been less profitable. Risk management practices musts be nimble and past results are not a guarantee of future results.

Employees are aligned with profitability and customer satisfaction

Southwest strives to treat employees as family, yet keep them working hard. The proof is in the pudding, 1,208 married couples work at Southwest. Jobs at Southwest are sought-after: Southwest received 143,143 resumes and hired 2,188 new Employees in 2010, atypically for the industry, largely based upon attitudes rather than skills. Southwest is heavily (82%) unionised. As the result of competitors succeeding in breaking union contracts as they went into insolvency, Southwest now has some the highest paid employees in the industry. Southwest’s solution is to maximise productivity, achieving what some competitors three times the staff. Southwest keeps employees on board who, in turn, please customers with warmth, friendliness, individual pride and company spirit. That has brought them in first in the American Customer Satisfaction Index 17 years running.

Can others win with this strategy?

Many have tried to emulate Southwest’s successes. Few have come close. The culprit: incremental and inconsequent change. Many competitors have implemented elements of the strategy, but retain high cost structures. Some have gotten the costs right, but have forgotten to love the customer. Over the past five years, volatile ones by any definition of the word, Southwest has delivered a post tax profit margin averaging 5.8%. One European carrier seems to have built on the low cost strategy, Ryanair, delivering an exceptional growth and profitability, but that is the subject of another week’s column.

‘Flexible Based Operations’