The link between traffic and the rate of economic growth has been somewhat sidelined amid all the crises and upheavals of the recent past, but is it now reasserting itself? asks Chris Tarry of CTAIRA
In better days, it was a useful rule of thumb that passenger traffic would grow at roughly twice the rate of underlying economic growth. Such old certainties have admittedly been badly shaken during the turbulence of the past three years. But as the industry begins to right itself, it is worth exploring whether in fact the old relationship between economic and traffic growth may indeed have been restored. And if so, what messages does it hold for the likely future levels of demand?
It is clear enough that the demand for air travel has been heavily distorted by a series of momentous global events. At the same time, there has been a fundamental shift in the structure of the industry, led by the rise of the low-fare sector, but followed by the response of established airlines. European majors were quickest to react, but now the recent Simplifares initiative from Delta Air Lines looks likely to cause a step change in the US competitive landscape too. While there has undoubtedly been a step change in fare structure that does not mean that the economy will not reassert itself as a key driver of demand, albeit on the basis of lower revenues.
First, it is important to consider the wider effects of new low-cost entrants. Their initial advantage is simply to offer lower fares in existing markets, so pulling passengers away from the incumbent carrier. Their subsequent growth is likely to be driven by rapid route expansion rather than organic growth. It could be argued that as route openings become ever more important as a driver of growth, this changes the risk profile, effectively increasing the importance of each new opening.
The importance of price in any industry demand model has also increased significantly over the last decade or so. However it is also the case that beyond a particular point, a reduction in price is unlikely to result in new traffic, but rather simply to cause a re-distribution of what traffic there is away from the high-priced and towards the low-priced competitor. Against such a background, if the new entrant is considered to be a sufficiently close substitute to the incumbent then it is important to examine the redistribution effects on the total relevant market where the airlines compete.
In any case, consumers are ever better informed of available prices and generally able to make better-informed judgements regarding which prices represent the best value for them, rather than simply judge on headline advertised fares.
As a consequence of the reducing influence of fares on travel, growth in the industry again becomes more dependent upon the rate of economic expansion and the rate of new route openings to provide service where none existed. As a result, traffic growth is likely to trend back to a natural relationship with economic growth.
We are not yet back at this point, since for most airlines there was a recovery element for both traffic and revenue in the earlier parts of 2004 and more recently the effects of the new pricing environment in the US have to work through to revenue.
This rather takes us back to where we started and the question is how demand relates to economic growth. It is worth noting at the outset that there is no hard causal reason why air traffic should grow at twice GDP and it is easy enough to stimulate artificial growth through fares discounting. So it is worth also looking at the relationship between passenger revenues and headline GDP (unadjusted for inflation).
The US market is a case in point. There, the long-term multiplier between US traffic and real GDP is markedly less than two and the relationship between passenger revenues and headline GDP less than one.
The following analysis is based on quarterly airline financial data from the US Transportation Department and data on economic activity from the International Monetary Fund. It looks at figures for the latest available September quarter, compared with both the performance a year earlier and also on the basis of a rolling 12-month average. Given the time periods we have taken a weighted average of the GDP figures for 2003 and 2004. That stands at 4% for real GDP and 6.3% for headline growth.
The US major carriers posted a passenger traffic increase of 8.02% in the quarter and a slightly lower 7.77% on the basis of an annual rolling average. Over the same reference periods passenger revenues appear to have increased by 5.33% and 9.03%. Relating traffic volume to real GDP suggests that the relationship was indeed 1.94 times for the year through to September 2004. The relationship between passenger revenue and headline GDP, however, suggests that revenues grew at 1.4 times GDP
So are these relationships likely to prove useful for the future? Obviously the new US fare structures have yet to work through the system, so it is reasonable to conclude that the multipliers for 2005 are likely to be lower. And with the forecasts for real GDP of some 3.5% against a headline rate of 6.3%, it still looks like pretty tough going out there.
Source: Airline Business
