Do recent traffic declines signal a fundamental shift in the link between GDP and airline growth asks Chris Tarry of Commerzbank?
A common theme among airline managements of late is not just how steeply the market has turned down but how quickly. In part that appears to have come from a change in consumer behaviour, as discussed last month. Businesses have cut travel budgets early, so that the bad news has hit early. The upturn may arrive earlier too than it did in the last cycle.But will the old certainties continue to apply in this changing environment?
There is evidence, certainly in the US market, that the relationship between airline demand and growth in general economic output (GDP) has shifted. That shift in the multiplying effect of GDP raises a key issue to the Traffic Demand Indicator (TDI)model established by Commerzbank and Airline Business. The model essentially estimates "underlying" traffic demand on the basis of forecasts of GDP. Given the changes that appear to have taken place in some of the basic traffic relationships, that raises the question again of whether the fundamentals still apply? At present there are not only a number of probable explanations but also a few possible answers.
Although economic growth has slowed sharply in the USA and dipped elsewhere, there are in fact few areas where the world's economies are technically in outright recession. However, traffic for the US and European airlines has nevertheless been under heavy pressure in the first half of the year. And overall the downward pressure on yields tends to suggest that despite only modest growth in capacity, carriers have been lowering fares to stimulate traffic and doing so more more aggressively than might have reasonably been expected at this stage. What is becoming clear in this new environment is perhaps just how little fundamental traffic there may be in some markets.
Of late, growth in US domestic air travel appears to have been correlating better with business confidence indicators than with the old GDP measures. However while such confidence indicators accurately reflect market sentiment, they are very short term in nature, often as an immediate reaction to changing conditions.
A new model?
So could this mean that we could see positive GDP growth but little or no airline traffic? That would mark a significant departure from form. When the US economy last went into outright recession last time traffic fell in line with the declining economy. This time, most recent data suggests that although the US economy is still growing - albeit slowly - traffic is actually falling. This outcome lies at the heart of the suggestion that there has been a behavioural shift.
There is also another marked difference from when recession struck a decade ago. Then there was a lot of capacity going into the market which inflated reported traffic and financial losses. Now capacity growth is modest in both absolute as well as relative terms.
For the point of view of traffic forecasting, however, GDP remains the key driver. The issue is over what judgements to make in determining the size of the multiplier and the lags between a change in GDP and traffic. In other words, how to anticipate the lag. Of late, US traffic would appear to have been three to six months ahead of the fall in GDP. To what extent that traffic has been lost to the system is another matter.
Against this current background a number of the traffic multipliers used in the TDI model have come under review. For example instead of using a multiplier of 1x for the US domestic market, a factor of between 0.85 and 0.9 appears more appropriate. But even then the shift in consumer behaviour means that the model is over-estimating traffic demand at least for the majors. On a GDP basis the model suggests fundamental traffic growth of 1.3-1.4%, whereas the year to date experience has been a slight fall. Even this has been achieved with a near permanent fare sale. Coach fares in the US fell by some 9.3% in July with a year to date fall reported to be 4.1%. However, it is worth noting that the low-cost sector has not necessarily experienced the same decline and could benefit from the change in consumer spending.
Similar figures are coming out of the Association of European Airlines (AEA). It reports the North Atlantic traffic was some 2.3% lower, in large part explainable by the British Airways strategy of cutting back on the transatlantic routes. However, for BA, passenger numbers have fallen faster than the cuts in capacity. In April alone BA carried 152,000 fewer passengers on its North American routes compared with an overall reduction in UK transatlantic traffic of just under 149,500. The net fall in traffic on all scheduled routes between London and North America was 110,000. Volume is not everything and BA reported a significant increase in yield across its network in its latest results for the June quarter.
To isolate the "BA effect" we have to make some reasonable assumptions. Last year BA accounted for some 25.7% of the transatlantic traffic carried by AEA members. So the cut in BA's capacity alone can be estimated, all other things equal, as equivalent to a reduction of some 3.0% in the market. Stripping this out, the TDI model suggests underlying growth on the North Atlantic of 3.6% for all other airlines. Taken together, the outcome is that there be a reported decline in the market of just less than 0.5%. In the event, the AEA airlines have reported a fall of 1.4% in North Atlantic passenger traffic over the first half of the year. If this is examined in terms of the fall in traffic experienced by BA rather than its deliberate capacity cuts (which suggest an impact closer to 3.5% on the total market) the outcome is a fall in the market overall of 0.8%.
For Asian airlines our model now suggests underlying growth of some 3.7% on international routes for 2001. This appears to be reasonably close to the experience for the year.
Such is the forecasters dilemma. In more steady times forecasting is more accurate but the results less revealing. However in times of change, there are more complications, but the results are a lot more interesting - in the current climate, change is the airline industry's only constant.
Source: Airline Business
