North America fails to join Europe’s airline recovery

Paris Air Show » 2005
December 12, 2006, 10:53 AM

For many of the world’s airlines, the long and tiresome road to recovery has taken them through dips and valleys, hairpin bends and in some cases complete U-turns. Today, after seemingly negotiating much of the most difficult terrain, European airlines have caught a glimpse of the promised land over the horizon. So why, you ask, have the biggest airlines in the U.S. and Canada sputtered while many of their counterparts across the Pond look to have turned the corner to revival?

North America’s airlines tend to blame forces outside their control for their inability to lift themselves from their quagmire. Of course, everyone must deal with runaway fuel prices, rising security costs and higher taxes and airport fees. But the fact that the European industry managed to turn a profit in 2004 for the first time in six years despite those negative influences has raised some doubt about the efficacy of the North American industry’s response to 9/11 and subsequent economic downturn.

One thing seems certain: if, as many maintain, overcapacity remains the root of all evil in the airline business, the industry hasn’t fully broken its pact with the devil. Europe, however, appears more willing to let airlines fail in the interest of the industry as a whole, allowing the survivors to reap some of the benefits of less competitive markets.

“Unlike in the U.S., where every loser carrier gets propped up, there’s been some meaningful destruction, Swiss being one of the best recent examples and Sabena certainly being a fine example,” said Richard Aboulafia, an analyst with Washington, D.C.-based consultancy Teal Group. “Probably the best single example, and it was underrated at first, is [the] Air France-KLM [merger]. They can [now] make route decisions, for example, international flights out of Paris or Schiphol purely on the basis of profitability as opposed to, ‘That’s our home base, we have to use it.’ Everything hasn’t been rung out of the system yet, but it’s heading in that direction.”

Although it hesitates to applaud the collapse of some of its members, the Association of European Airlines also points to consolidation as a necessary and indeed healthy development. In fact, the industry’s troubles appear to have helped encourage a process that for nearly 20 years the industry has unsuccessfully tried to stimulate. “The trend toward mergers started in 1987, when SAS and Sabena tried to get together,” explained AEA information manager David Henderson. “From that point on there were just constant attempts to form marriages, which, although none of them ever made it, each one got a little bit further than the one before. And it became quite evident that one day one of them was going to succeed, and that appeared to be the case with Air France-KLM.”

Lufthansa to the Rescue

More recently came Lufthansa’s $400 million buyout of Swiss International Airlines, a deal that finally put to an end three years of struggle for Switzerland’sflagcarrier. Swiss came into being as a result of regional airline Crossair’s takeover of bankrupt Swissair’s assets in 2002. Since then, however, the airline could not manage to lift itself out of the red no matter how far it contracted its fleet and employment roles.

Not only has the European industry shed some of its dead weight, namely unviable airlines, those that survive appear to have finally gathered the nerve to cast off resource-sapping and money-losing business segments. British Airways, for example, found that its low-yield transfer traffic accounted for most of its losses. Once it simply stopped trying to match every fare from the likes of Lufthansa and SAS through Heathrow, it could dedicate more of its energy to its point-to-point services and high-yield transfer traffic.

“Up until that point, [British Airways] said, ‘We have to maximize the Heathrow hub, and because Heathrow’s so crowded we can do it only with big airplanes,’” said Henderson. “Suddenly they got rid of all this transfer traffic and that opened up Heathrow to all kinds of operating strategies for smaller aircraft and so on, and suddenly their profits started to recover.”

Regionals Not a Panacea

Of course, airlines in the U.S. and Canada have also tried to “rightsize” with smaller equipment, recruiting regional affiliates, for example, to assume responsibility for domestic routes once flown by single-aisle mainline jets. Although the regional airlines have reaped huge rewards from such strategies, it certainly hasn’t done enough to reverse the legacy carriers’ fortunes.

In fact, according to Aboulafia, the rise of discount-fare carriers has made competing in domestic markets untenable for full-service airlines regardless of the number of regional jets they field. More reliant on international routes than their North American counterparts, European airlines can afford to leave bigger pieces of their less-profitable domestic markets to the low-fare carriers, he added.

“They’ve come to the realization that domestic routes are for losers; just let the low-cost guys have the commodity markets,” said Aboulafia. “People are still preoccupied with market share [in the U.S.]. The biggest carrier in terms of RPMs still is American; I mean, that has a certain magic to it regardless of how fundamentally awful…”

Yet another positive sign for Europe and indeed just about everywhere else except North America is an apparent stability of debt burden. While North American debt has almost doubled since 9/11, European airlines have actually used surplus cash from operations to pay down debt. Combined debt among North American carriers now exceeds $60 billion, while Europe’s stands at roughly half that level.

Of course, as companies take more loans to pay for cash shortfalls, operational losses mount. Meanwhile, as airlines such as US Airways pursue radical fleet restructuring plans, they can’t help but add to their debt burden. Often bankruptcy presents the only way to escape default, but once in Chapter 11, financing new aircraft becomes next to impossible, creating a sort of Catch-22.

No one answer exists to the question of why North American carriers have struggled so mightily with paying down debt but, according to Aboulafia, the fact that they’ve lived in a deregulated environment for so much longer than Europe’s airlines might at least help explain, if not excuse, their bloated debt positions before the industry downturn started in earnest in 2001.

“[European airlines] are relatively new to the private enterprise game,” said Aboulafia. “What does that mean? It means the way Europeans work with privatization, you sort of get a full canoe and you get a good firm shove as opposed to playing the horrible free-market game for decades and accumulating debt. These guys were privatized with almost no debt, new fleets…you know, they get out there, they burp after a full meal and say, ‘Why can’t everybody play this free market as well as we do?’”

FILED UNDER: 
Share this...

Please Register

In order to leave comments you will now need to be a registered user. This change in policy is to protect our site from an increased number of spam comments. Additionally, in the near future you will be able to better manage your AIN subscriptions via this registration system. If you already have an account, click here to log in. Otherwise, click here to register.

 
X