By David Knibb
Recent events suggest the pendulum is swinging in parts of Latin America away from private to state ownership in aviation. As Bolivia launched its new state-owned airlineBoliviana de Aviacion, Venezuela declared it will nationalise Aeropostal and centralise control over its airports. Now, Bolivia’s President Evo Morales plans to nationalise the country’s jet fuel supplier, Air BP.
While Venezuela and Bolivia have led the recent trend, they are not alone. Argentina’s nationalisation of Aerolineas and Austral remains subject only to funding, and it has also taken over the big aircraft facility in Cordoba. Earlier this year Uruguay completed a recapitalisation of Pluna that leaves it holding a fourth of the partly-privatised carrier. Other countries continue to support their military carriers, such as Ecuador’s TAME and Colombia’s Satena, and allow them to expand beyond missionary routes.
This trend is not universal. Peru’s government shut down its military-operated TANS amid private carrier complaints, while Mexico privatised Mexicana and Aeromexico.But Latin watchers still note the region’s tilt to the left, marked latterly by El Salvador’s election of Mauricio Funes.
Private ownership of airlines may be falling out of favour in parts of the region, but they are not giving up without a fight.In Bolivia private carriers tried to block the launch of BoA in late March, but did secure assurances in a decree against government favouritism for its new airline.AeroSur, Amazon, and Aerocon have formed an alliance in response to BoA to integrate their domestic networks under the brand UNA Bolivia. Aerosur’s regional vice-president Oscar Vargas says BoA’s launch on domestic trunk routes has already cost his airline almost a million dollars in lost revenue. To compensate for this, Vargas says Aerosur will boost its international network, especially in South America’s southern cone.
In Venezuela, the government’s rationale for nationalising Aeropostal has drawn fire from the country’s airline association. President Hugo Chavez justifies the conversion of Aeropostal into “social property” because it recently dropped some domestic routes, leaving domestic cities without air service. Yet, Humberto Figuera, association president, puts the blame on the government for keeping fares below costs and limiting foreign exchange. Starved of hard currency, Figuera argues that local airlines have no choice but to drop marginal routes. He claims Cadivi [the agency that controls foreign exchange]has held up airline conversion of the local bolivar into foreign currency for eight months, even though “70% to 80% of the expenses of the airlines are in dollars or euros”.
Figuera also says local airlines suffer at the hand of Venezuala’s other state-owned carrierConviasa. “When it was created we thought Conviasa would take care of the social routes, but rather it was dedicated to other routes that are productive,” he says. As a result, Conviasa now competeswith private players. With Aeropostal also under state control, Figuera wonders what markets the state carriers will serve.
The aircraft, which will be the airline’s fourth of the type, was due for delivery at the end of May, says Qantas.
“Airbus has advised us that, due to production issues, it will not be delivered until mid-July. It is now scheduled to enter service at the end of July,” it adds.
Qantas recently deferred its seventh to 10th A380 deliveries by up 10-12 months due to the economic downturn, but is still taking three aircraft this year.
“After number four in July, we will take another two by the end of the year,” it says.
Delay to delivery of the fourth A380 will mean “a short delay in offering additional A380 services and we have adjusted our schedules accordingly”, adds the airline.
“Defence equipment 2009”, a report of the House of Commons Defence Committee, had asked the government if there was “a real risk that the entire A400M project might be so delayed that abandonment would be preferable”.
In its response to the report, the government noted indications from Airbus Military that the A400M’s first flight would occur “no later than February 2010”. Given a slowing of Airbus’s production plans and the six-month lag between first delivery (to France) and first UK delivery, the Royal Air Force could not receive the military transport aircraft before 2013 or put it into service before 2014.
“We are currently considering all potential outcomes and are supporting actions within OCCAR and with partner nations that help inform our position,” says the government.
Among the contingency plans under consideration are an extension to the life of the Lockheed Martin C-130K fleet and the leasing or procurement of additional C-17 and C-130J capacity.
Airbus Military’s launch order committed it to deliver its first A400M to the French air force in October 2009, but in January EADS revised this target to around three years after MSN001’s flight debut.
“What we are waiting for is for the flight-test campaign to confirm – or not – what we have forecast,” Airbus Military managing director Domingo Ureña said on 4 May. “As soon as we get this we will be in a position to relaunch production.”
The hypersonic X-51A WaveRider has completed its first technical review in a process that will lead to a first flight of almost Mach 6.0 in the fourth quarter of this year, programme officials say.
“We’re on our way,” says Charles Brink, X-51A programme manager for the Air Force Research Laboratory (AFRL).
Including the AFRL, Boeing and Pratt & Whitney, the X-51A consortium has already submitted the flight-test plan to the Air Force Flight Test Center (AFFTC) at Edwards AFB, California. Brink says a “successful” meeting was held with the centre’s experts on 12 May, with this resulting in follow-up actions.
Boeing and P&W have also recently completed ground tests of a “flight-like” hypersonic engine, the first hydrocarbon-powered system to include a closed-loop heat transfer in the fuel system, says Joseph Vogel, Boeing’s X-51A programme manager.
The AFRL has funded the $250 million X-51A programme to demonstrate four test flights starting in late October or early November. Each 300s powered flight is expected to add volumes of data that could be used to design a wide variety of future hypersonic vehicles, such as long-range missiles and spaceships.
“When we finish flying this mission we’ll have probably flown on one mission more time on a hypersonic, hydrocarbon vehicle than all other hydrocarbon-type systems that have ever previously flown,” Vogel says.
The X-51A next faces a safety review board at the AFFTC in early June, Brink says. That will be followed about one month later by loading an X-51A on a USAF Boeing B-52H to ensure the electronic systems are compatible. Then, the B-52H will conduct captive carry tests with the X-51.
By around September, the programme plans to conduct a full-scale “dress rehearsal” of the event, including a picket line of aircraft – perhaps US Navy Lockheed P-3C Orions – to relay airborne telemetry data from the vehicle to the USN’s flight-test range facility at Point Magu, California.
The first of four flight tests should follow about a month later, Brink says. Each of the next three flight tests should occur in 30-day to 60-day intervals, unless an issue is discovered in flight tests.
When the economy catches a cold, airlines are in intensive care and airports are in an open ward,” says Airports Council International director general Angela Gittens. Airports operators may be at a lower risk of fatality than airlines, but their vital signs are not looking good. In 2007 just 13 of thetop 100 ranked airports posted traffic declines. In 2008 that number widened to 53.
As the two patients languish in their sick beds, airlines are fighting for survival while airports are preoccupied with life after the recovery. Gittens says: “It is hard to have a conversation when one party is sitting there, wondering if it will make it through the night, while the other is wondering whether it is going to be able to satisfy the customer it knows it is going to have in five years – and that might not be the person sitting across from them. Airport long-term planning is not based on individual air carriers.”
Airports are highly capital-intensive infrastructure businesses, with few variable costs and long development cycles. Traffic is dwindling, access to capital is limited, security requirements are tightening and, despite the downturn, there is a looming capacity crunch. Some projects can be postponed, others cannot. Airports are struggling to secure financing and, for those that do, it is very expensive.
Jean-Michel Vernhes, who represents ACI’s Francophone airports, says: “The challenge is we are not building for five to 10 years, we are building for 30 years. We are having to take decisions in a context which is not very well defined.”
While striving to adapt to lower revenues and an unrelenting fixed cost base, airports are under pressure to provide pain relief to their airline customers by reducing charges, but a shot in the arm now could jeopardise essential infrastructure projects – vital to future economic development. Airports are trying to ease their airline partners’ burden where possible, but ACI Latin America and Caribbean regional secretary Eduardo Flores argues: “Airport costs in isolation, not including air traffic fees, are very small in terms of the economic costs of an airline; they don’t have a dramatic impact. It is a matter of principle for airlines to say it is too much and that they must be reduced.”
The airport-airline dynamic is a strange one. TAV Airports chief executive Sani Sener summarises: “There has to be co-operation between airlines and airports, but in a way they compete. One side wants to reduce its costs, while the other wants to maximise its revenues. I call it ‘co-opetition’.”
Gittens adds: “You have two people, individuals or organisations who, to a certain extent, talk past each other; their outlook is so different. This is a key area of tension between airports and airlines.”
Airlines are understandably sick of being top of the critical list and are they now calling on their suppliers to share the pain. AirBaltic chief executive Bertolt Flick says: “It cannot carry on like this, where the one creating the value is the last in the profit chain.” Although weakened, airlines have bite.
Liberalisation means they can pick and choose their markets and threaten to pull services if they disagree with local taxes or charges. ACI North America president Greg Principato says: “An airline can take their asset and fly at 500mph away from the community. An airport can’t just roll a facility back up and put it in the closet.”
Gittens questions how the model will evolve, joking that soon airlines will want airports to pay them to land – an ominous suggestion. She continues: “Airports are stuck. They can’t go and find a more attractive market; they have to make their market more attractive – to airlines and to passengers.”
Consolidation has led to fewer and bigger airlines with greater negotiating strength. But airports feel they are suffering a hangover from their state-owned utility days, when airlines needed to be protected from a monopoly supplier. Airport charges must be fully transparent, unlike air fares. Airlines are merging, while BAA has been told to sell some of its facilities. Peel Airports deputy chief executive Neil Pakey argues: “People need to stop seeing airports as a monopoly and a cash cow.”
With the changing dynamic, airports have had to cut their reliance on aeronautical revenues, diversify into non-aeronautical streams and shift their customer perception.Manchester Airports Group chief executive Geoff Muirhead explains: “When we began think of passengers as our customers too, it had a radical impact on our airports in terms of terminal design, investment strategies, our approach to our business partners, colleague engagement and innovation. It is undoubtedly the key to our future success and that of our partners.”
But these commercial activities, which support airport modernisation and development, are now facing the worst trading conditions on record and the situation is being further exacerbated by liquids restrictions and new airline cabin baggage limitations. Developing commercial activities with falling passenger numbers is no small feat.
So, aside from lower costs, what areairlines looking for? Bmibaby commercial director Julian Carr says data is essentialfor new routes. He urges airports: “Give us the numbers. Understand the situation; we don’t want to miss opportunities, but we don’t want to take unnecessary risks.” Clickair chief executive Alex Cruz agrees with Carr: “We need tangible opportunities.”
Norwegian chief operating officer Daniel Skjeldam says that a single point of contact, marketing support and year-round route potential are more important than ever. He adds: “Dealing with private airport groups is something we like. Privatised companies are more eager to share risk because we are in the same boat. Too often state-owned companies are not willing to share any extra burden.”
Overnight a new challenge can emerge, threatening traffic flows. Swine flu is simply the latest example. Based on the experience of SARs in 2002-03, Malaysia Airports managing director Bashir Ahmad is fully aware of how devastating health issues can be to air traffic.
He believes industry partnership will be essential to overcoming the threat: “We realise the seriousness of the situation and the importance of good airport-airline relationship.” Just as every partnership is unique, no two airports are the same. Their challenges vary by business model and size. Each region is suffering in its own way.
Gittens summarises: “Everyone has a story. No one has been left unscathed.” European airports are facing an unprecedented fall in demand but, unlike their US and Asian counterparts, they have not benefitted from economic stimulus measures.
Despite this backdrop, ACI Europe director general Olivier Jankovec says 70% of Europe’s airports have decreased their charges or kept them stable: “We haven’t seen a massive increase in European airport costs, contrary to what airlines are saying. Airports have to be very careful about what they do with charges, based on the competitive situation.”
By 2030 European air traffic is forecast to double, growth which is expected to result in an airport capacity crunch. But the regulatory backdrop remains a major obstacle for European airports. Jankovec says getting the go-ahead for expansion is becoming increasingly difficult, noting thatthe region’s airports must “earn the licence to grow”.
European regulators are also pursuing a temporary suspension of the “use it or lose it”rule, which requires carriers to surrender slots which are used for less than 80% of the time. Although those constrained by the rule have welcomed this relief, Jankovec says airports have fiercely opposed the change: “In Europe we have several highly congested airports. Not withstanding the crisis, there is a waiting list of airlines which want slots.”
Regional airports are particularly concerned, fearing they will lose key air links. Muirhead says: “Capital city hub airports are better placed to weather the storm than regional airports, as airlines are more likely to reduce their networks into a hub and away from the sometimes marginal services operated from non-hub airports.”
At a country-level, Jankovec says Spain has been hardest hit by the downturn, suffering the hangover of an “overheated” economy. The UK comes in at number two, while France and Germany are weathering the crisis fairly well. Among the region’s airports, he says Milan Malpensa has been “hurt very badly” by Alitalia‘s downscaling, its traffic plummeting 32% in February. And, although airport staffing tends to be security-based and therefore inflexible, Milan Airports operator SEA has placed 900 of its 5,000 staff on reduced time. Elsewhere, Amsterdam Schiphol is looking at reductions of 10-25% because of the brutal market conditions.
Unlike their counterparts in other regions, Europe’s airports have to meet their own security costs. Prior to 9/11 these formed 5-7% of operating costs, but this has since swelled to 30%. Although the EU is working to eliminate liquids restrictions, Jankovec says new screening technology will add yet another burden to an already largeand inflexible cost base. He adds: “Public financing is urgently required if European air passengers are ever to see the benefits of such technology.” ACI North America’sPrincipato agrees that streamlining security processes, such as lifting the liquids rule and shoe screening restrictions, would help airports in the current climate.
He says: “We tend not to learn lessons; we keep doing what we’re doing and add things on top. The security systems from post 9/11 need revamping. We need to take account of the practical results from the last eight years. Now is a good time to take a blank piece of paper approach to security.”
The financial meltdown first hit in North America and its airports have suffered accordingly. Principato feels that the government has handled the situation well, providing stimulus measures where necessary, but he adds: “All the numbers seem to indicate that we haven’t reached the bottom yet. Nobody knows how long this is going to last.The problem, for both big and small airports, is it makes it hard to plan.”
A recent ACI NA survey conservatively estimates the region’s airports will need $94.4 billion in capital over the next five years, even after recent cuts. Principato says: “It is based on projects which already have, or will, achieve approval. This is not a wish list.”
US airports support their infrastructure costs via a passenger facility fee of up to $4.50 per person. Principato says this is not enough, but airport users are resisting a campaign to increase the fee to at least $7.50, itself lower than the $8.55 required for capital needs plus inflation. He says: “The money that we are collecting now is for old projects and projects which are already underway. There is nothing for new projects and many airports have their PFC pledged out over 20-40 years.”
The situation in Canada is more stable, but Principato says: “I think from a strategic point of view things are just less bad there. The big cloud darkening is Air Canada’s future. Air Canada’s financial situation is very tenuous.”
Further south, Latin America’s airports are also cutting costs, but their challenge is not so much dwindling traffic as accommodating rapid growth. ACI LAC’s Flores says: “The Latin American market is very defiant. Globally there may be a downturn, but the market is doing – not well – but fine in terms of operating revenues. Even though there is a crisis, airlines like LAN, Copa and Gol are asking for more aircraft and putting capacity on certain routes. We are a very dynamic region and we have more tools to respond to the situation.”
Mexico’s airports, with their geographical proximity to the USA, have suffered a greater impact from the downturn. And, as the originating site of the swine flu outbreak, its traffic is under threat of further erosion. Flores stresses that only certain areas of the country have been affected. He urges people to get wise to the real risks and take sensible precautions, adding: “If you stop all flights from Mexico back and forth to other countries, traffic flows will always find different ways to get from one place to another. Trying to put a barrier up would be to try to stop all transport.”
Asia was probably worst hit by the crisis in terms of timing, being in the midst of massive capital investment surge when the downturn hit. Sydney Airport Corporation chairman Max Moore-Wilton says fast growth and the emergence of major domestic markets in China and India are placing significant pressure on Asia Pacific airlines and airports.
ACI Asia-Pacific regional director Maggie Kwok says infrastructure projects, such as new terminals, runways, rail link and airport cities, are rife. In China alone there are plans for 97 new airports over the period 2006-20. Gittens stresses: “They absolutely have to continue with their investment in capacity. The recession is going to be over at some point. They will be in huge trouble if they don’t continue investing at a very rapid rate.”
The region’s airports are being proactive. Kwok says Hong Kong is offering a HK$450 million ($58.1 million) relief package, via lower fees and interest-free rent deferrals, while Malaysia has launched a similar initiative, offering all airlines a 50% landing charge discount. Malaysia Airports’ Ahmad says this may go further: “We are also currently considering rebates for passengers to further spur the travel industry.”
He adds that budget carrier growth has compensated for traditional carrier shrinkage, noting: “We foresee positive growth for our airports despite the grim outlook worldwide.”Meanwhile, Airports Authority of India chairman VP Agrawal says capacity across AAI airports will increase from 101.2 million to 178.3 million by 2010. He adds: “We are not slowing down in terms of airport infrastructure development, rather AAI is looking atthis as an opportunity to develop its infrastructure so we can cope with the surge in traffic as and when the economy revives.”
Regional challenges may vary, but Principato flags uncertainty as a common theme. Quite simply nobody knows when the downturn will end. Sydney Airport Corporation chairman Max Moore-Wilton adds: “Given the significant structural impacts on capital availability and consumer spending, it is likely to be some time before a generalised improvement in the situation will occur.”
But Malaysia Airports’ Ahmad is optimistic about the future: “We have recovered from the 1997 Asian financial crisis and we got through SARs in 2003; we are definitely rolling up our sleeves for a full economic recovery. We don’t know when this recovery will happen, but we firmly believe that maintaining a healthy relationship with our aviation partners is key to weathering this period of crisis.”
Airports have several strategic options to overcome the downturn. They can further diversify their revenue streams, cut costs, postpone capital projects and offer incentive schemes, but Gittens stresses that financial prudence is also key: “If you don’t have much revenue due to temporary circumstances, you can get into trouble really quickly if you don’t have the financial policies and practices which you need.”
Above all, innovation and flexibility will be needed. Gittens says: “There is increasing pressure to keep development and finances stable in what is essentially a non-stable business. I think we will see more and more experimentation with different models.”
Partnerships are growing. France’s Aeroports de Parisand the Netherlands’ Schiphol Group have teamed up, mirroring their incumbent carriers Air France and KLM. At a regional level, three small French airports – Bergerac, Limoges and Poitiers – have forged a co-operation pact and are looking for further partners to increase their chances of survival.
Youssef Sabeh, president of SNC Lavalin which owns and operates France’s Vatry Airport says: “Being part of a group you are better prepared to face this kind of challenge. Today what we are offering to airlines is more services for the same amount of money. It is more manageable to give more for the existing fee than reduce fees immediately.”
Small innovations also make a difference. Peel Airports’ Pakey says his group has boosted revenues by charging passengers a £3 ($4.54) fast-track security fee, an idea inspired by Euro Disney. As an additional benefit, thismove boosts passenger dwell time, maximising airside sales.
Airlines and airports may be on separate wards with different priorities, but they share the same ailment and economic recovery is the common cure. ACI NA’s Principato says:”Airport directors are among the best business people I know. As a group I am confident in their ability to manage these tough times.”
CASE STUDY: MILAN MALPENSA
Victoria Moores, London
Milan Malpensa Airport was dealt a staggering 19.5% traffic blow last year after restructuring national carrier Alitaliadownscaled itsoperations at the airport.
Giulio De Metrio, chief operating officer and deputy chief executive at Malpensa and Linate operator SEA, says the drop in traffic was unprecedented: “After Alitalia’s decision to leave Malpensa, Alitalia passengers fell by over 7.8 million and freight by over 83 million tons.” This marked a huge U-turn for SEA, which posted 36.7% passenger and 68% freight growth between 2002 and 2007.
De Metrio says:”This forced SEA to come up with a new industrial plan, aimed at restoring Malpensa’s strategic role among European airports and limiting the damage caused by the Alitalia withdrawal.”
Through a strong marketing push, Malpensa has attracted 15 new airlines. Together withnew frequencies from existing operators, it has now secured a total of 640 new weekly connections. This means that other airlines’ passenger numbers rose by a quarter, or 3.1 million, in 2008.
But the biggest breakthrough cited by De Metrio is the arrival of Lufthansa Italia, which launched operations in February and now links Malpensa with three domestic and eight European cities. More importantly, notes De Metrio, it gives Malpensa a role as part of Lufthansa’s multi-hub strategy.
Despite the turbulence of 2008-09, SEA is pressing ahead with its infrastructure investment. With a planned outlay of €1.4 billion ($1.9 billion) by 2016, it is upgrading its freight, runway and commercial facilities.
And, although traffic is still dwindling in many parts of the world, in April Malpensa posted 7.9% growth. De Metrio concludes: “The strategic actions that SEA is taking to face this difficult period are continuing to deliver good results and this makes us confident for the future of Malpensa.”
CASE STUDY: LAS VEGAS MCCARRAN
Megan Kuhn in Washington
Plummeting short-term demand is forcing Las Vegas McCarran International airport to shed costs and preserve lower landing fees as it presses ahead with new terminal construction to meet future demand.
The airport’s passenger traffic fell 14.1% during the first quarter, with average daily departures down among its biggest carriers: Southwest, US Airways, United, Delta and American Airlines.
McCarran is especially sensitive to fuel and other economic fluctuations because Las Vegas attracts discretionary leisure and convention-driven business, says Randall Walker, director of airport operator Clark County Department of Aviation.
To sustain traffic, McCarran is touting its low operating costs. Average cost per passenger is expected to be about $7 this fiscal year, compared with the US average of more than $10 in 2007.Landing fees have also been kept below the industry average to make the airport more competitive, says Walker.But diminished airline, concession, parking and jet fuel revenues have forced McCarrren to slash capital expenditure by $30 million this year, slicing around $360 million from its five-year plan, including a $215 millionrunway resurfacing.
After McCarren asked its employees to submit cost-cutting ideas, seven unused gates were closed and lesser-used restrooms have been shut during off-peak hours. A further $2-3 million has been trimmed by adjusting terminal heating and cooling by a few degrees. Walker says: “We’ve stressed to our employees that little things add up, in terms of savings as well as expenditures.”
With the upturn in mind, the airport is pushing ahead with its third terminal. Before the recession, in 2007, McCarren’s Terminal 1 handled roughly 43 million passengers, already exceeding its 42 million capacity.
While it will take time for service to return to past performance levels, Las Vegas often recovers from downturns more quickly than other markets and when it does, those 14 extra gates will be needed, says Walker.
CASE STUDY: BANGKOK SUVARNABHUMI
Siva Govindasamy in Singapore
Thousands camped out at Bangkok’s Suvarnabhumi Airport last November, but they were not the crowd that its operator wanted to welcome. Anti-government protestors took over the terminal building and control tower, forcing the cancellation of all flights for a week and making tourists scramble to neighbouring countries to get out of Thailand.
Suvarnabhumi, built as a rival regional hub to Singapore’s Changi Airport and Malaysia’s Kuala Lumpur International Airport, opened in September 2006. But just days earlier, Thailand’s military deposed the airport’s champion -prime minster Thaksin Shinawatra-in a coup. Soon after, repairs were required when cracks were founds on runways and taxiways, and there were complaints that the terminal was already nearing its design capacity due to poor planning.
But the biggest setback came when protestors took over during the peak tourist season. “The confidence of the passengers who wish to travel or conduct business in Thailand has weakened,” says Airports of Thailand. AOT says passenger traffic dropped 26% in November and 37% in December.
As the global economic slump bit, it posted a 14% drop in January, 17 % in February and 11% in March. Its revenues fell by 23% to 2.9 billion baht ($82.6 million) for the last three months of 2008, and it suffered a net loss of 1.65 billion baht versus a profit of 780.9 billion baht.
There have been attempts to solve the problem. In April, AOT introduced a relief package withextended payment terms for landing and parking fees until September and reduced concession fees, based on passenger throughput, until December. Thai Airways was also allowed to move domestic operations out of Don Meung, the old international airport, in March and combine them with its international operations at Suvarnabhumi.
However several challenges – mostly beyond its control – remain. AOT lacks direction after having had several presidents and boards, in line with government changes, over the last few years. The ministry of transport is still sitting on a proposed expansion that includes a third runway, an extension to the main terminal and the construction of a new satellite terminal to help increase annual capacity by a third to 60 million passengers. Finally, since the start of the year, several massive anti-government protests in Bangkok and other cities have continued to hit tourist arrivals.
Despite its turbulent start, Suvarnabhumi could still take its place as one of the region’s best airports in the future, but itfaces numerous hurdles before it can get there.
Last month we outlined how low-cost carriers are waking upto a new reality, facing many of the same troubles as their legacy competitors. In short, they are facing the growing pains of not being so young anymore. Their leaders are responding in three primary ways: by getting together, playing the waiting game or changing their model.
A natural response to threat is to adopt a strength in numbers approach, and that is precisely what many budget players have done.Although this has taken several forms,mergers and commercial alliances have emerged as a favourite. Canada’s WestJetand Mexico’s Volaris have established codeshare and marketing agreements with Southwest Airlines,allowing the latter to virtually expand geographically, something it has been loathto do directly. AirTranand Frontier Airlines have also established a broad-based marketing agreement to take advantage of geographically complementary networks.
On the acquisitions front, easyJet bought BA’s budget arm Go and GB Airways; FlyBe has absorbed BA Connect; Air Berlin purchased Deutsche BA and LTU in Germany; and Ryanair has made multiple attempts to buy Aer Lingus. Mergers are also rife, with Sterling and Maersk Air joining forces in Denmark, Air Deccan and Kingfisher coming together in India, JetStar Asia merging with ValuAir in Southeast Asia and, most recently, Clickair merging with Vueling in Spain.
The word on the street is that the next area to watch for consolidation activity is the over-served Mexican marketplace. Avolar and Almahave already failed and others – InterJet, VivaAerobus, and Volaris – are poised to combine in some shape or form.The Mexican ‑government, historically reluctantto see competition disappear, is now seriously contemplating allowing the merger of Aeromexico and Mexicana along with the latter’s budget subsidiary, Click Mexicana.
Whether such combinations are simply the low-cost extension of an otherwise consolidating airline industry, or the normal shakeout one would expect in an industry with too many participants, is not clear.Regardless, the effect is the same: fewer budget players – and those that remain looking and feeling more like larger carriers.
THE WAITING GAME
Several low-cost airline leaders have concluded that the safest response to the troubled times is to “hunker down”and stay out of the spotlight.Despite having recently added some new flights to Boston, Virgin America has curtailed network growth for the foreseeable future, preferring to be a survivor than another failed low-cost that suffered from over-expansion.JetBlue has deferred or cancelled aircraft deliveries, while Frontier has sold aircraft and returned leased examples early while in bankruptcy protection.Even the historically robust Ryanair has lightened up on the throttle, recognising that there may be a cliff at the end of the runway.
Though getting into a foxhole while bombs fly overhead could well be a sound business strategy and the one most likely to ensure survival, it goes against the grain of the low-cost model for several reasons.
Firstly, it means little or no growth, the fuel of the low-cost fire.But this somewhat mutes budget players’dynamic and entrepreneurial nature and with that comes the loss of certain cultural and organisational traits, which low-costs have historically leveraged.It also means investment horizons and liquidity timelines for founders and private equity investors are extended, often leading to frustration and impatience in the boardroom.
CHANGE THE MODEL
Certain budget carrier leaders have responded to deteriorating market conditions by adapting their business models.Faced with converging competition from both other budget players and more efficient legacy carriers, several have started introducing amenities and product differentiators.Others have resorted to more traditional business practices, such as third-party distribution or loyalty schemes.Butthese add-ons often cost money and serve, in the long-term, to erode profitability.
The evolution of traditional low-costs has perhaps spawned a new segment: “new world carriers”, such as JetBlue and Virgin Blue.The leadership of these carriers believe the answer lies not in the purist approach, but in offering differentiating product characteristics while holding true to doctrine on operational efficiency.It is quite conceivable, given the strong convergence trend, that most budget players will migrate into this new world space.Airline industry consultant and former Virgin Blue executive David Huttner believes that “over time, you’ll likely find very few carriers at either extreme end of the product spectrum.Staying true to the low-cost model requires an incredible amount of discipline to say ‘no’.”
THE DRIVE TO ZERO
Whereas the tendency among some budget carrier chiefs has been to go more mainstream, the purists have actually gone the other way.Recognising that the primary driver behind low-cost success is low fares and market stimulation, certain players have declared that “zero pricing”is their ultimate objective.
Foremost among them is Ryanair.Already known as the price leader in Europe (and perhaps the world), Ryanair has publicly declared its desire to get its fares consistently down to zero via cross-subsidy from other revenue streams and advertisers/sponsors.To make that model a success, leaders will not only need to hone their purist cost management and avoidance skills, they will also need to get equally effective at ancillary revenue generation and third-party sponsorships.
Allegiant Air, the relatively new Las Vegas-based low-cost has implemented a business model predicated on substantial ancillary revenue generation and it appears to be working well, allowing the airline to profitably link secondary US cities, with poor direct air services, to major leisure destinations. Garry Kingshott, chief executive advisor of Philippines budget carrier Cebu Pacific, sums it up nicely: “The next phase of low-cost development is to continue to play the price leadership game, to drive market stimulation, ultimately with zero fares and ancillary revenue.”
Perhaps unsurprisingly, alongside marketplace and business model convergence, we have witnessed a convergence of sorts in the area of leadership talent.Historically, low-cost carriers touted themselves as the “non-airline”airlines, preferring to employ leadership talent from outside the industry, unburdened with legacy thinking.
Virtually all the prominent low-cost carrier founders or drivers, with the exception of David Neeleman’s JetBlue, were newcomers to the industry: Clive Beddoe (WestJet), Tony Fernandes (AirAsia), Herb Kelleher (Southwest), Michael O’Leary (Ryanair) and Stelios Haji-Ioannou (easyJet), to name a few.But a close examination of the leadership teams of many of today’s players reveals a large number of big airline transplants.
Notable examples include ex-JetBlue Airways president Russ Chew (American Airlines),JetBlue Airways executive vice-president, commercial Robin Hayes (BA), Ben Baldanza (US Airways) as chief executive of Spirit Airlines and David Cush (American) as chief executive of Virgin America.Gol, the successful Brazilian low-cost is replete with airline executives from defunct Brazilian legacy carriers such as VASP.Even successful JetStar was nurtured under Alan Joyce, an Aer Lingus alumnus from the days prior to the Irish carrier’s low-cost transformation.
Such a tendency is not surprising.Whether they stay true to the pure play low-cost business model or not, budget carriers are, after all, airlines with many of the same operational, commercial and financial issues.As they grow, those issues become meaty and more complex, and proven industry experience is often required to manage them.
Virgin Blue chief commercial officer Stefan Pichler concurs:”In the beginning, a lot of low-costs had an entrepreneur as their leader.Those entrepreneurs had a clear vision and were good at building up a business.But as soon as a business starts growing rapidly, an entrepreneur must become a leader and many are now struggling with that.That’s because, at a certain stage, it is not about managing a vision but managing complexity.A lot of entrepreneurs can’t do that.”
TOP LINE FOCUS
The past half-decade has witnessed a low-cost functional excellence shift from operational to commercial.Historically, perhaps the most sought-after role was that of chief operating officer who was the “guru”of operational efficiency and likely the internal “cost czar”.The operations function at Ryanair, for example, has spawned many low-cost evangelists who have gone on to launch or manage other budget operations around the globe.
But with low costs becoming a staple not only among budget carriers, but also many legacy carriers, the battle ground has shifted to the top line: the commercial agenda.Recognising the diminishing returns on cost reduction, and also the substantial upside on ancillary revenues and improved revenue management, low-cost chief executives now place a big premium on top flight chief commercial officers.Securing creative and innovative commercial executives, and teams who can win in the guerrilla warfare of the low-cost battle ground will, in our view, become increasingly important in the years to come.
The change in leadership working its way through low-cost leadership ranks may have unintended secondary effects. Perhaps most important among them is culture.Beyond better fundamentals (cost, simplicity, newness), budget carriers have also historically enjoyed the benefits of their entrepreneurial and employee-centric cultures.Those cultures have normally been established and nurtured by visionary founders who appreciated that employee engagement and commitment is worth as much, if not more, as a 5% edge on unit costs.Southwest’s legendary efficiency and customer loyalty are both the clear product of a culture that works for all involved.
So, what happens to low-cost culture when the team at the top changes?Can “imports”be realistically expected to fully internalise and become advocates of a culture they did not help shape?Is it realistic considering they did not participate in the rapid growth start-up phase of the airline and its associated entrepreneurship and camaraderie?Likely not.
Conversely, can budget carrier owners, often private equity firms, plausibly expect the founders and teams that drove unbridled growth in a spirit of optimism and opportunity to now dispassionately address the harsh realities that their carriers face?Can they be as effective at reducing headcount as they were launching new routes?Likely not.
There appears to be an increasing level of impatience among private equity investors with their investment’s leadership teams.While they were willing to see through a few bumps in the road on the glorious upside, they now appear much less inclined to give management the benefit of doubt in more troubled times.This suggests a more fundamental question – is private equity the best vehicle to support the budget sector or is there a growing mismatch in investment horizons?
With the passage of time and major environmental changes, it is inevitable that low-cost leadership and culture evolve, drawing them nearer to the mainstream. But there are a few exceptions where the culture and its core benefits are jealously guarded and protected as sources of competitive advantage.David Huttner, says: “The cost culture of Ryanair is owned and advanced by the CEO who has been a constant at the carrier.Equally, WestJet has done a very good job of not losing its culture as it has grown to become a major player in the Canadian marketplace.To ensure that, leadership has to live the culture, from top to bottom, every day.”
Stefan Pichler agrees: “We at Virgin Blue still have our culture as it was from the first day.But this has a lot to do with the fact that our founding CEO is still on board, and he lives the same culture every day.When you change your CEO, you will often get a new culture as that person does tend to bring new senior management into the organisation.”
Low-cost mergers present additional cultural challenges.Alex Cruz, Clickair chief and future CEO of the merged Vueling-Clickair, shares the challenge in merging two different low-cost cultures:”It’s a big and difficult task.We appreciate that it shouldn’t be culture A or culture B that survives but instead that A+B = C and that we need to sell employees of the combined entity on a new culture, C.”History has proven that successfully managing an airline merger is a monumental task with uncertain outcome.Having to define and propagate a new culture as an effective blend of two others makes it even that more complicated.”
A NEED TO LEAD
The past few years have presented low-cost carriers with the challenges of a lifetime.Not only must they deal with a myriad of business issues, they must also tackle the hard reality of hitting full-fledged adolescence, if not adulthood.That life cycle transition comes with its share of aches and ills. Now the challenge for low-cost airline chiefs is to lead: to provide clear, unambiguous – and likely bold – direction to their organisations.If there is a time for creativity and innovation, it is now.
While the low-cost community is considered an off-beat and innovative bunch, adopting and implementing a low-cost cookie cutter model from abroad – be it Southwest, JetBlue, or Ryanair – is not true innovation.
The turbulence these leaders now face requires fresh thinking, the kind that brought the first low-cost carriers, and their first major derivatives, into existence in the first place.The executives who provide that, and find smooth cruising altitudes quickly, will undoubtedly reap the rewards.
About the authors:
Michael Bell, who previously spent six years with McKinsey, co-leads the global aviation practice of executive search specialist Spencer Stuart. Email: MBell@SpencerStuart.com
Thierry Lindenau is Brussels-based regional co-ordinator for Europe, Middle East and Africa at Spencer Stuart’s global aviation practice. Email: TLindenau@SpencerStuart.com