Middle East airlines immune to merger bug

DOHA, Qatar – Margins are low; competition is intense; business is tough; the big become stronger; the weak fall by the wayside. And if you can’t beat them, join them!

DOHA, Qatar – Margins are low; competition is intense; business is tough; the big become stronger; the weak fall by the wayside. And if you can’t beat them, join them!

A business environment that today applies to virtually all industries – from retail and manufacturing to telecommunications and travel. Companies seek new business models or freshen existing ones in their pursuit to stay ahead of the pack.The airline sector is no different.

Fuel prices, the economy and over capacity of aircraft seats flying around the world remain key concerns of airlines in the quest for survival, let alone profitability. With fuel accounting for anything between 30 and 40% of total operating costs and an unpredictable economic outlook, there is nervousness within the airline fraternity about the future.

Some raised eyebrows here no doubt especially when one frequently reads stories of mega aircraft orders running into tens of billions of dollars and aggressive route launches with seat capacity being pumped into many air corridors. Airlines in the Middle East and Asia are largely responsible for making such headlines.

As any business person will tell you, keeping money locked up will not generate the cash flow needed to grow the business. It needs to be invested. So the shrewdest of those at the helm at some airlines have been smartly investing to keep at the forefront of their industry.

It is this investment in new planes, new onboard products and new services that has helped the region’s carriers woo customers fed up of flying in age-old aircraft and paying a fortune for poor inflight service on other airlines.

Airlines worldwide have generally managed to make adjustments to forces out of their control by passing costs onto the consumer or revisiting expansion plans. Job cuts, freezing pay, route closures and reduction of service levels are measures taken purely to improve financial performance at the expense of profitability. This is more rife in certain parts of the world than others, namely Europe and North America.

The general unease is what brings out the best of leaders charged with taking the reins and tackling the challenges head on rather than hiding behind a veil and buckling up at the thought of taking painful decisions for the benefit of the business.

Many carriers hedge fuel – pay a certain fixed price for a given length of time to protect themselves against fluctuations in the market. This is one way to achieve the corporate goal of improving the financial balance sheet and keep debt levels as low as possible.

In the United States, the doyen of the global aviation industry that sets trends for others around the world to follow, all of the scenarios set at the outset of this column have been experienced over the years with a mirror effect in other selected parts of the world.

The US is a market with low margins, intense competition in a tough business environment with the big becoming stronger and the weak trying to cling on.

Consolidation has been widespread over the years across the US airline industry, partially spearheaded by the proliferation of low-cost carriers eating into the short-haul operations of the big boys.

Last year saw two of the US giants – American Airlines and US Airways – finally winning approval to merge their businesses, inevitable after fierce rivals United Airlines had consolidated operations with Continental while Northwest Airlines tied up with Delta.

The level of economies of scale achievable was the biggest factor in deciding to align their businesses, though reduced competition meant fewer players had greater pricing control by being able to increase fares and avoid the bitter fare wars of the pre-consolidation era. The airlines argue consolidation provides consumers with improved choice and better service. Consolidation, however, has the painful price to pay – job losses.

Only a handful of big players now control the US domestic and international skies. It’s the battle of the three mega consolidated giants that will shape the US industry over the next few years. Their previous business models of cut-throat pricing on their own accord, especially on US domestic routes, was deeply impacted by the rise of low-cost carriers which ripped into their bottom line.

Consolidation has been rife in Europe over the past decade, but struggling economies across the region and the onslaught of low-cost players has yet to have a significant positive impact on the financial results of airlines caught in this business model.

German carrier Lufthansa, Europe’s largest by sales volume, has been the most active in the consolidation arena on the continent over the years, shopping for airlines such as British carrier bmi, Swiss, Belgium’s Sabena and Austrian Airlines. It still faces the challenge of overcoming economic downturns in many of its “home” markets to see a significant impact on its financial performance.

Spanish carrier Iberia and British Airways face the same dilemma. From a logistics point of view, the ability to jointly procure products and services such as aircraft has created purchasing power and economies of scale, but operationally the two which form the International Airlines Group (IAG) face huge economic challenges in their home markets.

Air France and Dutch giant KLM, the world’s largest airline when they joined forces 10 years ago, saw firsthand last October how consolidation can affect theirbottom line. They wrote off a 25% strategic investment in ailing Italian flag carrier Alitalia that was operating in a weak domestic economy and questioned the viability of pumping more funds into the struggling airline.

Across Europe there still remains a plethora of regional airlines not swallowed up by any of the big three. Time will only tell whether there is an appetite for further consolidation, or whether the smaller regional players can survive the competitive threat of both the low-cost boys and big boys.

In Asia, none of the established carriers have gone out of their way to pound on huge strategic investments within the region. Instead, they have focused on running their full-service network airlines alongside burgeoning low-cost models which are driving huge passenger growth in the region. To be part of the bigger picture, the established large airlines have successfully ventured into the low-cost arena by setting up budget subsidiaries or affiliating with existing operators.

In the Middle East, seen as the jewel of the global aviation industry, consolidation has been much talked about, but remains theoretical rather than practical.

Each of the big three Middle East carriers – Emirates, Qatar Airways and Etihad – continue to forge ahead with their own growth strategies organically. Etihad, however, has adopted an additional route by taking strategic investments in airlines across the world to penetrate markets and gain market share.

The thought of any of the three aligning their businesses remains just a thought and though nothing can be ruled out, there is no reason for any to join forces and be part of the consolidation bandwagon.

Many argue the three airline hubs in their respective markets of Dubai, Doha and Abu Dhabi are too close together to survive chasing the same business. But these are not the key markets of the three. They are all competing for a slice of the global market – business around the world that they serve to and from their hubs.

Not reliant on any single market on a particular continent, they can easily adjust their capacity according to demand in different parts of the world. But the power of the big three has had an impact on some of the region’s other carriers, both low-cost and full-service.

Since 2011, three regional airlines have collapsed –Kuwait’s Wataniya, Bahrain Air and, only last week, RAK Airways, the national airline of Ras Al Khaimah, which ceased operations for the second time in five years.

With only a handful of routes to a handful of destinations and insufficient frequency to give travellers the choice of departures they seek, coupled with general economic conditions, high operating costs and the impact of regional political instability, this sounded their death knell. Of course the might of the big boys operating in and out of their home markets providing wider global access didn’t help their cause. Only time will tell whether RAK Airways can plot a third incarnation.

There has however been a success story with the UAE’s low-cost carriers flydubai and Air Arabia able to sit comfortably alongside the region’s global players. Carving out a niche to and from their Dubai and Sharjah hubs, they have exploited the low-cost model on routes extending to as far as eastern Europe, with China set to follow in 2014.

They have shown sustainability in a vibrant market in the decade they have been around and for sure look to continue to grow their business models and take advantage of a diverse mix of cost-conscious travellers and the rapidly developing regional marketplace.

A recent report by the International Air Transport Association (IATA) showed that the Middle East and Asia would be the main drivers of international air passenger demand over the next four years.

By 2017, IATA projects the world’s airlines to see a combined 31% increase in passenger numbers to 3.9bn – a rise of 93mnpassengers over the 2.98bn carried in 2012.

IATA’s forecast is based on system-wide growth globally with carriers in the Middle East – essentially the Gulf – seeing the strongest growth of 6.3% ahead of the 5.7% rise expected by airlines across Asia Pacific. And the strongest growth of traffic will be on routes linking the Middle East and Asia Pacific.Africa and Latin America follow at 5.3% and 4% respectively, with Europe and North America expected to record the slowest growths of just 3.9% and 3.6% respectively.

IATA, which represents the interests of over 80% of the world’s scheduled passenger and cargo airlines, anticipates 227mn (24% ) of the additional passengers forecast will fly to and from China during the four-year period and taking the lion’s share of the overall growth.

“The fact that the Asia Pacific region – led by China – and the Middle East will deliver the strongest growth over the forecast period is not surprising,” said IATA chief executive Tony Tyler.

“Governments in both areas recognise the value of the connectivity provided by aviation to drive global trade and development.”

The forecasts come just weeks after the Dubai Air Show broke records for aircraft deals with orders worth over $200bn – the vast majority snapped up by Gulf carriers.

IATA said 2012 showed the Middle East carriers had the strongest year-on-year growth of any global region with passenger traffic up almost 12%. The region’s airlines have pumped in seat capacity as part of their robust expansion strategies to prise market share from competitors elsewhere in the world.

The body stressed that the developing economies in Africa and Latin America could easily share the same level of growth opportunities as the Middle East and Asia Pacific, but would need to secure government assistance to show the determination to succeed. Consolidation is far from a reality in these markets until the airlines get their own house in order.

“To reap the benefits, governments in those regions will need to change their view of aviation from a luxury cash cow to a utilitarian powerful draft horse to pull the economy forward,” explained Tyler.

The IATA chief cites the Gulf in particular as a model of industry and government co-operation that has created an effective regulatory regime of high global standards.

With forecasts for air travel showing growth at unprecedented levels, it makes one wonder why there is so much of a positive outlook when the airline industry faces pressure of rising costs, namely fuel and volatility of economies affecting consumer spend.

The reality is airlines continue to play with their revenue streams, trying to get the highest yield possible by pampering consumers at higher prices or charging add on costs for selected services.

Consolidation may well be the way forward to help some in a difficult industry, but in the Middle East, there are no signs of anyone pursuing such a strategy. There is enough business for the key players.

For the foreseeable future, the region’s familiar airline brand names are here to stay.

About the author

Avatar of Linda Hohnholz

Linda Hohnholz

Editor in chief for eTurboNews based in the eTN HQ.

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