Why airlines are getting together

It's no surprise that British Airways and American Airlines are cosying up to each other again.

The world's biggest airlines are facing enormous pressure to squeeze more value out of a business that has seen better days.

The worldwide economic downturn - at its most acute in the lucrative US and European markets - is predicted to hammer revenue from ticket sales.

So mergers and alliances are a vital way of cutting costs, notably by sharing capacity and spreading expenses such as fuel, which has rocketed in price in the last couple of years.

Shareholders, who have suffered a series of disappointing results from airlines in recent months, are getting impatient.

Economic threats

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.

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

Carriers will suffer most if, as seems to be already happening, business travellers are forced to rein in their travel budgets.

Over the last few months, most of the world's biggest airlines have made frantic attempts to stop free-spending business travellers from deserting to economy class, where airline profit margins are wafer-thin.

Growth predictions

Earlier this year IATA, the International Air Transport Association, predicted that the annual average growth rate for total scheduled international traffic will be 5.6% for 2000-2004.

But that growth figure, relatively modest in historic terms, will almost certainly be revised downwards in line with weakening economies.

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

That business has almost entirely disappeared, and will continue to dwindle as Wall Street and the City of London suffer from the decline in finance business.

Flights to and from emerging markets are still growing sharply, but would need to do so for many years to even begin to equal the value of routes such as London-New York.

Capacity glut

As the economy wanes, big airlines like BA seem to have plenty of fat to trim.

The key area here is capacity.

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.

Sharing important routes allows airlines to deal with this excess, either by shifting planes elsewhere, or by retiring unneeded aircraft more quickly.

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.

In theory at least, bigger airlines - or alliances between carriers - can become more efficient in their consumption of fuel, perhaps by negotiating tougher deals with suppliers.

Shareholder value

Time is extremely short.

Stock market investors are too impatient to wait for the economic cycle to turn back in the airlines' favour.

Shareholders are asking for action to reverse the decline in airline share prices.

Shares in AMR, American Airlines' parent company, have fallen by one-quarter so far this year, and BA's shares have dropped by a similar amount.

And the problem is that even if airlines are eventually able to meet the 5.6% annual traffic growth target, that figure won't be enough to impress shareholders used to double-digit returns in other sectors.

Alliances in fashion

Mergers are, however, a tricky business, especially in the airline industry, which is hedged about with international regulations and national sensitivities.

A string of proposed cross-border mergers have been blocked by competition authorities, especially in Europe, where governments are keen to protect local carriers.

This has encouraged many firms to set up looser alliances as a partial solution.

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

The biggest such alliance is Oneworld, in which both BA and American are members.

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

But while these deals bring some benefits, both to airlines and consumers, they are rarely capable of delivering the sort of cost-savings offered by a full-blown merger.