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Wednesday, 17 January, 2001, 19:08 GMT
Flying the global skies

Growth figures in the airline industry
The airline industry is set for another buffeting if the global economy takes fright. Positive forecasts from the end of last year already look out of date.

The key drivers for the airline industry are really quite simple, namely economic growth and the amount of seat capacity on major routes.

If the economy experiences a downturn, so do the airlines, particularly the main carriers operating the transatlantic route.

About 20-30% of traffic for the major airlines takes this route between North America and Europe, says Martin Borghetto, transport analyst at Morgan Stanley Dean Witter.

So if there is a US recession, it won't bode well for the airlines, he warns.

The rapid consolidation of the airline industry in the United States and Europe, and the rise of international alliances, is one attempt by the airlines to limit capacity and deal with the coming downturn.

Global forecasts

IATA, the International Air Transport Association, predicts that the Annual Average Growth Rate for total scheduled international traffic will be 5.6% for 2000-2004.

Airline growth forecasts
2000-2004: 5.6%
1999-2003: 5%
1998-2002: 5.5%
Source: IATA

This is up 0.6% from last year's forecast and up 0.1% on the 1998-2002 forecast.

These figures were compiled last October by surveying airlines, airports and civil aviation authorities.

An IATA spokesman said the figures may be revised in view of the US slowdown, but he adds it is still "a wait and see situation".

As the figures suggest, 2000 was good year as euphoria and numerous initial public offerings kept business executives shuttling between the US and London.

(It is worth pointing out that business travellers are considered a lot more lucrative for the major airlines, such as British Airways or American Airlines, than the average punter off on vacation.)

Capacity glut

The second driver - capacity - governs the delicate balance of supply and passenger demand in the industry. It is also closely linked to economic cycles.

After the Asian crisis of 1997-98, major airlines switched many of their planes to the North America route. The glut of supply that this created was not met by passenger demand.

Inevitably, overcapacity led to an industry downturn, as the graph above shows.

The oil price is also an important factor - the industry spends more than 10% of its operating costs on fuel - and can dent sentiment in the sector.

Airlines use different means to counter rises in the oil price, such as hedging and charging higher airfares.

During 2000, analysts were appeased after several airlines raised the cost of airfares to counter a high oil price during the summer and early autumn, says Mr Borghetto.

Shareholder value

This demonstrates only too well how the industry is under pressure to improve returns for its shareholders.

Consolidation is a necessary and wished for event for the industry

Martin Borghetto, Morgan Stanley Dean Witter

Such thinking likely lies behind the burst of merger activity in the US.

"Consolidation is a necessary and wished for event for the industry from a shareholder perspective," says Mr Borghetto.

From the consumer point of view, however, consolidation may mean higher fares.

Recently, both American Airlines and United Airlines have caught the headlines with blockbuster mergers in the US.

American Airlines is buying Trans World Airlines in a $500m deal as well as some of the assets of US Airways, while United is purchasing the rest of US Airways for $4.3bn.

Perhaps galvanised into action by the US activity, British Airways is reported to be wooing American Airlines again, after a previous attempt to forge an alliance collapsed in 1999.

The two US deals have also focused attention on other domestic carriers, Delta, Continental and Northwest.

Industry observers are waiting to see whether Delta, the third largest carrier in the US, will make a move to merge with one of its rivals.

Gridlocked traffic

While intra-US mergers are coming thick and fast, international mergers are inhibited by regulatory problems and complex bilateral agreements between different countries, governing traffic rights.

For example, under the current aviation agreement known as Bermuda II, only four carriers have access to the London Heathrow-New York route.

British Airways' attempt last year to merge with the Dutch carrier, KLM, was partly scuppered by KLM's reluctance to give up traffic rights to meet regulatory requirements.

Meanwhile, attempts to negotiate an Open Skies policy that will allow other airlines to compete for traffic rights on the North American route are hampered by a shortage of slots at key airports, such as London Heathrow.

Global alliances

In the absence of easy mergers, the industry has embraced whole-heartedly the concept of strategic alliances.

Airline alliances
Northwest and KLM
Star Alliance
Virgin and Continental

MSDW's Mr Borghetto sees alliances as a solution for the lack of merger and acquisition activity. They are also growing out of geographic necessity, he adds.

The deals usually involve marketing and scheduling agreements, as well as access to airport facilities and perks, such as frequent-flier miles.

The oldest joint venture, launched in the early 1990s, is between Northwest and KLM.

Another major tie-up is the global Star Alliance between United, Germany's Lufthansa, SAS of Scandinavia, Singapore Airlines and nine other airlines.

oneworld alliance
The industry has embraced alliances to increase geographic reach

The alliances bring mutual benefits, including the integration of IT systems and working processes.

For example, Lufthansa now handles marketing for SAS in Germany, while SAS holds the fort in Scandinavia.

The other large alliance is oneworld, involving American Airlines, British Airways, Cathay Pacific Airways, Qantas and four other airlines.

Virgin and Continental also co-operate, while Air France and Delta have partnered with two other airlines to create the SkyTeam Alliance.

Deregulation in Europe

Alliances aside, the European skyscape has also witnessed a proliferation of start-ups.

These airlines, such as EasyJet and Ryanair, have taken advantage of the new market created by the European Union three years ago.

Within this market, there is no issue of traffic rights and inevitably the start-ups are putting major airlines under pressure.

Although some of these smaller airlines, particularly Ryanair, are stimulating their own traffic by targeting new passengers with low fares, they are still perceived as a threat.

"They are changing the competitive landscape in Europe ... and prices are up for comparison," says Mr Borghetto.

Established airlines are responding by defending key routes, especially routes to long-haul hubs.

Overall, the outlook for the airline industry remains unclear while the US economy hangs in the balance.

IATA's official forecast is grounded in an optimism that already looks dated.

Signs of a recovery in Asia and South America - as highlighted by IATA's October report - are unlikely to soften the blow if the US economy stutters.

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