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Premium #181 - The New World Order of Airlines »
Commercial Aviation Analysts
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It is difficult for US and European legacy carriers to effectively compete internationally, and they are increasingly seeking governmental assistance to overcome what they perceive to be unfair competition. From a consumer standpoint, we are fortunate that such actions are unlikely to be successful and that new competitors will continue to erode market share from these carriers by providing better value.

There are two sets of competitors that are negatively impacting the legacy carriers.

The ME3

The first group is the Middle-East big three, which offer a geographic advantage in connecting services between North America and Europe to Africa and Asia. Because these countries have small domestic markets, they have focused on international routes through connecting hubs, and rely on modern new aircraft, excellent service for business travelers, and quite frankly better value than their legacy competition.

By offering services to smaller cities and aggregating demand through their connecting hubs, they are able to offer routes that do not make sense for their US or European counterparts. Of course this is true on the other end, where travelers from Columbus, Louisville and other US cities must connect through a major US hub to reach their destinations, providing a similar advantage to US carriers.

Air France/KLM recently requested that air travel be placed under WTO rules, which would impact both Middle Eastern and US carriers with respect to subsidies and open markets. While this is unlikely, it indicates the concern among European carriers, who fear that Western network carriers could go the same way as Pan Am, TWA, Swissair, Malev and Sabena. Of course, WTO rules would likely allow additional competition from international carriers within the US, something the US legacy carriers don’t want at any cost.

While it is true that the Middle East carriers have had government investment, the US carriers have equally benefited from Chapter 11 restructuring. Our position is that the net impact is a wash, and that competition is good for the market. We’d like to see US carriers step-up their game, order new aircraft, and compete head to head with the ME3.  But none fly the A380, most have slow fleet renewal programs, and the level of service remains well behind their competitors.

The target for the ME3 is international business class passengers, and they have done a superb job at creating first rate business class products. From advanced IFE systems to the most modern seats on the most modern aircraft, combined with first-rate meals and customer service, the ME3 outperform both US and European legacy carriers in rankings. Skytrax ratings released at the Paris Air Show had Qatar, Turkish, Emirates and Etihad among the top 6 airlines (along with Singapore and Cathay Pacific). The highest European legacy carriers came in in the 12-20 range, including Lufthansa, Austrian, and Swiss at 12-14, Air France at 15, and British Airways at 20. The highest ranking US legacy carriers was Delta at 45, with United at 60 and American at 79. Is it any wonder that business travelers are moving towards the carriers with strong service, and eroding the profitability of European and especially US legacy carriers? Just imaging if there were no frequent flyer programs to maintain loyalty?

The International LCCs

Norwegian is changing the nature of transatlantic travel, offering discounted fares from three US cities to London Gatwick and that will soon increase to five. The carrier is averaging 93% load factors on its routes, indicative of its popularity and the attractiveness of its low fares between the US and the UK, where it fights not only the US carriers but BA and Virgin as well. To date, their operations to Gatwick have been quite successful. This story on Anna.aero illustrates their recent success.

Of course, not is all rosy for Norwegian, which had a strike in the first quarter and is in a regulatory dispute with the US over flights using Ireland as a base under open skies agreements. (We side with Norwegian and competition on this issue)

While legacy carriers earn the most profit from their premium cabins, the back of the aircraft also needs to be filled to maintain profitability.   As we’ve seen time and again, premium class only airlines tend not to do well unless they are in very specialized niche markets, as business travel on is own often isn’t enough to fill an aircraft. With new competition for the economy class traveler, legacy carriers are forced to lower yields to fill their aircraft, further impacting route profitability.

LCCs recognize that for most travelers, air travel is a commodity, and the low price wins. Success then also requires being the lowest cost producer.   Norwegian is using Boeing 787s on its routes, leveraging the most cost-effective aircraft in a low cost operation. It would be exceptionally difficult for legacy carriers in the US to match their cost levels, and fares, for economy class service and remain profitable.

We foresee additional transatlantic competition in the near future. Rumblings about Ryanair entering the market continue, and other LCCs are examining the option of connecting with one another across the pond.

The Bottom Line

With increasing competition from the ME3 for long-haul business traffic, and increasing competition from LCCs for the economy cabin, the legacy carriers are under attack on all fronts. Without improving their product dramatically, they can’t compete with the ME3 on service or quality at the top end. Without continuing to lower costs, they will have a hard time in the economy cabin competing against Norwegian at the bottom end.

What the ME3 have done well is to create brands that are differentiated from traditional carriers. Emirates has leveraged the A380 and relative comfort to great advantage. Qatar and Etihad have each stepped up the game in customer service, with modern new airports and connecting hubs.   That’s in marked contrast to US and European legacy carriers.

Norwegian offers a reasonable quality service for a low price, typically exceeding expectations. That provides competitive differentiation.

But if you asked us what differentiates a US legacy carrier, we’d be hard pressed to give an answer. And therein lies their problem with competitive positioning.

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