CTAIRA Chris Tarry Aviation Industry Research and Advisory Is sustainable profit an unrealisable dream? Chris Tarry Stockholm 19 th November 2003

Chris TarryAviation Industry Research and Advisory

CTAIRA

Is sustainable profit an unrealisable dream?

Chris TarryStockholm

19th November 2003


CTAIRA

Agenda

Industry background issues

Structural changes and consequences

Managing the responses

Conclusions

Final thoughts


CTAIRA

General Strategic Objectives

Survive

Compete

Prosper

BUT:

How does the industry match up


CTAIRA

Global airline industry: Performance

Industry operating profit and margin 1980 - 2002

-15000

-10000

-5000

0

5000

10000

15000

20000

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

$ m

illi

on

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

% m

arg

in

Operating result Operating margin

Source: ICAO


CTAIRA

Airline traffic and capacity trends

Passenger traffic and capacity index 1972-2002

0

100

200

300

400

500

600

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Ind

ex 1

972=

100

Passenger traffic Passenger capacity

Source: ICAO


CTAIRA

Passenger load factor trends

Industry passenger load factor 1970-2000

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

%


CTAIRA

Break even load factor trendsBreak even load factor trends (passenger)

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

%

Break even load factor = ((op cost x traffic)/(op rev x capacity))


CTAIRA

Long term industry trends

Load factors and margins 1970-2000

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

op

erat

ing

mar

gin

35.00

45.00

55.00

65.00

75.00

% l

oad

fac

tor

Operating margin Load factor est BE load factor

Source: ICAO/CTAIRA research


CTAIRA

International operating economics

Data: IATA

Break even load factor and cost per ASM AETF airlines 1991-2001

0

2

4

6

8

10

12

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

US

c

40

45

50

55

60

65

70

75

80

%

Cost per ASM Break even load factor


CTAIRA

The source of profit

Data: IATA

Break even gap AETF airlines 1991- 2001

-30

-25

-20

-15

-10

-5

0

5

10

1519

91

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Gap

fro

m b

reak

eve

n

First Intermediate Low Total


CTAIRA

Long term US yield trends in a mature market

US Domestic yields

0

2

4

6

8

10

12

14

16

18

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

US

c

Nominal Real (1978 cents) Linear (Real (1978 cents)) Linear (Nominal)

Source: ATA


CTAIRA

European Airlines Trends: Europe

Source: AEA

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00Ja

n-02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-0

2

Aug

-02

Sep

-02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

May

-03

Jun-

03

Jul-0

3

Aug

-03

Sep

-03

% c

han

ge

Traff ic vs 2 years Capacity vs 2 years Traff ic vs 1 year Capacity vs 1 year


CTAIRA

European Airlines Trends: North Atlantic

Source: AEA

-30.00

-20.00

-10.00

0.00

10.00

20.00

30.00

40.00Ja

n-02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-0

2

Aug

-02

Sep

-02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

May

-03

Jun-

03

Jul-0

3

Aug

-03

Sep

-03

% c

han

ge

vs 2

yea

rs

Traffic vs 2 years Capacity vs 2 years Traffic vs 1 year Capacity vs 1 year


CTAIRA

European Airlines Trends: Far East

Source: AEA

-40.00

-30.00

-20.00

-10.00

0.00

10.00

20.00

30.00Ja

n-02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-0

2

Aug

-02

Sep

-02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

May

-03

Jun-

03

Jul-0

3

Aug

-03

% c

han

ge

Traff ic vs 2 years Capacity vs 2 years Traff ic vs 1 year Capacity vs 1 year


CTAIRA

Forecasting issues – traffic and real GDP

Data: IMF, ICAO

Capacity and traffic ratios with GDP

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

tim

es

RPK/GDP ASK/GDP


CTAIRA

Nominal GDP and airline revenue

Nominal GDP multiplier for Airline Industry revenue

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

X

Multiplier Absolute average Average excluding extremes

Both traffic and GDP negative

Source: IMF/ICAO


CTAIRA

The search for a turning point: USAUS Consumer Expectations and Domestic Air Travel

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

Jun-

97

Sep

-97

Dec

-97

Mar

-98

Jun-

98

Sep

-98

Dec

-98

Mar

-99

Jun-

99

Sep

-99

Dec

-99

Mar

-00

Jun-

00

Sep

-00

Dec

-00

Mar

-01

Jun-

01

Sep

-01

Dec

-01

Mar

-02

Jun-

02

Sep

-02

Dec

-02

Mar

-03

Jun-

03

Sep

-03

Exp

ecta

tio

ns

ind

ex 1

995=

100

-40.00

-30.00

-20.00

-10.00

0.00

10.00

20.00

30.00

40.00

Tra

ffic

ch

ang

e %

vs

pre

vio

us

year

Expectations Traffic

Source: Pollingreport.com/ATA


CTAIRA

Industry Outlook

Still an exceptionally tough environment

Unsupported profit may not be possible before 2005/06

Airlines still need to achieve structural cost reduction


CTAIRA

Structural changes and consequences


CTAIRA

Terminology

Low cost airlineLow fare airlineNew model airline (NMA)TravellerCustomer Business travellerTravel policyComplianceProductCommodityMarketplace Value for moneyROI


CTAIRA

Product issues

What constitutes the product offer?• The flight?• Flexibility?• Timing?• Frequency?• Airport attractiveness?• On board service?• On ground service

It depends – • Each of us (and our employer) will value and price the

attributes differently


CTAIRA

Market segmentation - The UK example

Mainline British Airways Virgin bmi British Midland

Lower Cost easyJet

Low costRyanairCharter airlines

More widely, segmentation is also possible between geographic region, maturity of market and market type


CTAIRA

Market segmentation - International

Regional: limited long haul network (Finnair)

Supra-regional: extensive long haul network (Lufthansa)

Intra-regional: cross- border but not long haul (easyJet)

Global hub and spoke: global reach (Singapore, Emirates)


CTAIRA

Industry life cycles

What happens ?

Slowing growth rate

Changing consumer behaviour in maturing markets

Decline unless there is change and re-invention


CTAIRA

What are the constraints to change?

Management?

Labour?

Capital?

Infrastructure?

Regulation?

In reality a combination


CTAIRA

Airline industry life cycles Is maturity and decline the only option?

Does structural rigidity mean an inability to change?

Has the managerial prerogative at some airlines been ceded?

Is the fundamental and necessary change impossible?

Are the costs of change too high?

Will there be further exits?

Opportunities for segmental new entrants


CTAIRA

If traffic alone is not the route to profit, what is?

A need for:

The “right cost base”

The best revenue stream

The appropriate level of assets

There is not a “one size fits all” template


CTAIRA

Mainline airlines - what needs to be done? Reduction of structural excess supply

Differentiation of increasingly commoditised products

Addressing the gap between “customer and the traveller”

Reacting to changing market structures

Structural reduction of cost

Improvement of shareholder returns

Also important to keep a sense of perspective


CTAIRA

British Airways: Productivity measures

British Airways: Productivity measures compared (1993=100)

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Ind

ex F

Y 1

993=

100

ATKs per employee Employee multiplier

Source: Company reports


CTAIRA

British Airways: Total measurement

Data:: British Airways

British Airways: Total performance measurement

60.00

70.00

80.00

90.00

100.00

110.00

120.00

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Ind

ex 1

993

= 1

00

Traff ic revenue per ATK Revenue per f lying hour Net operating cost per f lying hour


CTAIRA

New entrant airlines


CTAIRA

Changing markets - The “new entrant” formula

Supply led growth

High utilisation

High density seating

Low distribution costs

Simple fare structure


CTAIRA

The London area experience

Source: CAA

Passenger numbers: EC scheduled traffic London Area airports

0.00

5.00

10.00

15.00

20.00

25.00

30.00

1997 1998 1999 2000 2001 2002

Mil

lio

n p

asse

ng

ers

LGW LHR LCY LTN STN


CTAIRA

London and the Southeast

Main focus of NMAs

Rich travel market and incumbents initially pressured

Significant fight back by incumbents

Signs of market maturity


CTAIRA

The Mainline “fight back”

With a focus on:– Price discriminators– Quality discriminators

Now able to offer “more options”– Business to Full fare Economy– Full Fare Economy to Restricted Economy

Fundamentally changed “rules of engagement”


CTAIRA

Mainline fight back (2)

Fare structure simplification

Easier internet booking process

Raising awareness of value proposition

Exportation of new fare structures


CTAIRA

Fare trends – 2002

Source: American Express

Intra - Western Europe economy class fares: 2002vs2001

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

Au

stri

a

Bel

giu

m

Den

mar

k

Fin

lan

d

Fra

nce

Ger

man

y

Gre

ece

Irel

and

Ital

y

Net

her

lan

ds

No

rway

Po

rtu

gal

Sp

ain

Sw

eden

Sw

itze

rlan

d UK

% c

han

ge

vs p

revi

ou

s ye

ar


CTAIRA

The UK in an intra-European context

Source: American Express

Intra Europe Economy fares vs Average Q4 2002

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

180.00A

ustr

ia

Bel

gium

Den

mar

k

Fin

land

Fra

nce

Ger

man

y

Gre

ece

Irel

and

Ital

y

Net

herla

nds

Spa

in

Sw

eden

Sw

itzer

land UK

% o

f av

erag

e

Economy Leisure Economy


CTAIRA

A snapshot of marketplace changes (1)

Source: British Airways

British Airways Premium traffic trends index 1996=100

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00A

pril

May

June

July

Aug

ust

Sep

tem

ber

Oct

ober

Nov

embe

r

Dec

embe

r

Janu

ary

Feb

ruar

y

Mar

ch

Ind

ex 1

996

= 1

00

FY2001 FY2002 FY 2003 FY 2004


CTAIRA

A snapshot of marketplace changes (2)

Source: British Airways

British Airways non-Premium traffic index 1996 = 100

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

Apr

il

May

June

July

Aug

ust

Sep

tem

ber

Oct

ober

Nov

embe

r

Dec

embe

r

Janu

ary

Feb

ruar

y

Mar

ch

1996

= 1

00

FY2001 FY2002 FY 2003 FY 2004


CTAIRA

Potential effects on the NMAs

From the mainline airlines’ response:

Fall in average fare

Rise in break even load factor

Pressure on earnings growth

Stock market reaction when “go-go” stocks go “ex”


CTAIRA

Limits to growth exist – even for NMAs

Markets are not infinite

Risk of over-dependence on journey price elasticity

Need for a reason to travel even if the ticket is free

Increasing importance of other “trip determinants”

Relationship between income and travel


CTAIRA

UK Maturing markets? (1)

Source: CAA

Luton: Domestic passenger trends (June)

0

200

400

600

800

1000

1200

1400

1600

ABZ BFS EDI GLA INV IOM JER

Pax

per

day

Jun-00 Jun-01 Jun-02 Jun-03


CTAIRA

UK Maturing markets? (2)

Luton: International passenger trends (June)

0

200

400

600

800

1000

1200

1400

1600

NC

E

CD

G

GIB

AT

H

DU

B

WA

T

AM

S

FA

O

AL

C

BC

N

MA

D

MA

H

AG

P

PM

I

TF

S

GV

A

ZR

H

Pa

x p

er

da

y


Source: CAA


CTAIRA

UK Regional traffic trends (1)

East Midlands: Domestic passenger trends (June)

0

200

400

600

800

1000

BFS EDI GLA CGI JER

Pax

per

day


Source: CAA


CTAIRA

UK Regional traffic trends (2)

East Midlands: International passenger trends (June)

0

100

200

300

400

500

600

AGP ALC BCN PRG DUB CDG AMS FAO BRU NCE PMI

Pax

per

day


Source: CAA


CTAIRA

Industry Consolidation


CTAIRA

Consolidation issues

“The degree of concentration in an industry reflects the extent and nature of competition”

based on Douglas Needham “The Economics of Industrial Structure” 1970

Competition and market maturity are not evenly spread

So – is consolidation the answer to the industry’s problems?


CTAIRA

Putting it in context

What are the problems of the mature and maturing airlines?Too much capacityToo much costNot enough profit even in the best times

Will these be solved by consolidation?Not in the absence of other actions

Is the industry capable of managing the necessary change?Not a good track record in this area


CTAIRA

ConclusionsPermanent change in the operating environment

New business models needed

Without continuing change the industry will not:– Achieve adequate profitability– Attract new capital

Key challenge remains the management of change


CTAIRA

Two final thoughts

“Progress is a nice word but change is its motivator and change has its enemies”

Robert Kennedy

“More of the same is not an option”

Chris Tarry


CTAIRA

This report has been prepared and issued by Chris Tarry Aviation Industry Research and Advisory Limited a business that is not registered to give investment advice.

This report is for information purposes only and should not be construed as giving investment advice. Chris Tarry Aviation Industry Research and Advisory Limited accepts no responsibility or liability whatsoever for any expense, loss or damage arising out of or in any way connected with the use of all or any part of this report.

No part of this report may be reproduced or distributed in any manner without permission of Chris Tarry Aviation Industry Research and Advisory Limited.

Chris Tarry Aviation Industry Research and Advisory Limited [email protected] +44 1892 506993

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CTAIRA Chris Tarry Aviation Industry Research and Advisory Is sustainable profit an unrealisable dream? Chris Tarry Stockholm 19 th November 2003