The old adage, 'what goes up must come down' is frighteningly true most of the time, and whether the topic under discussion is the economy or the fortunes of the airline industry, there is no escaping its veracity.
As the industry enters 1998, many managers will be wondering if the buoyant traffic, high load factors and strong profits enjoyed by the majority will continue. Already there are signs that the canvas on which the rosy picture of prosperity is painted may be cracking.
The chief worries are of course in Asia-Pacific, where the return of Hong Kong to Chinese rule, severe economic downturn and currency turmoil have taken their toll on traffic and profits. Asian carriers are looking towards 1998 with few expectations of an easier ride, while their counterparts in the US and Europe worry over what the winds from the Far East might bring.
While the world's stock markets recovered reasonably quickly from the knock-on effect of the collapse in share prices in Tokyo and Hong Kong, carriers will be extremely cautious when planning privatisations or initial public offerings in 1998.
So far, however, Europe and the US continue to enjoy strong growth and relative economic prosperity. But already some US analysts are predicting a possible slowdown, or even a decline in traffic, in the coming year.
There are plenty of pressures coming from other quarters. The unprecedented surge in new aircraft orders this year saw Boeing interrupt two major production lines to enable its suppliers to catch up, as it ramped up production to record levels. This alarming increase in production conjures up the dangerous spectre of overcapacity and falling yields, at a time when Asian carriers may have to scale back their fleet expansion plans.
Undoubtedly the Asia-Pacific airline industry passed its peak in early 1997 and is now truly in a trough. The question is whether the rest of the world will follow.
Labour will be arguing that it won't. Unions in Europe and the US will put more pressure on management in 1998 to give them a greater share of industry profits after years of concessions. High employment levels and competition between sectors to attract quality workers will help their cause. Any signs of a slowdown will not.
This uncertainty has its advantages. Unlike in the 1980s, the need to continue cutting costs and boosting efficiency has been accepted long after the last recession. In 1998 airlines will continue to outsource non-core operations and press their unions for productivity increases.
They will also continue the downward pressure on travel agency commissions and seek further ticketless sales and internet bookings. The wider trend towards call centres, private phone networks and intranets will also take a firm hold on the industry, producing substantial savings.
The main counterweights to these moves will come from regulatory quarters.
The coming year will be make or break time for the low-cost startups. In the US the public will again get behind the low-costs as the Department of Transportation spotlights domestic fare levels and frees up slots at major airports. In Europe, the startups may seek regulatory action as carriers like British Airways seek to preempt a repetition of the success of carriers like Southwest Airlines, by creating their own low-cost subsidiaries before smaller rivals reach critical mass.
Regulation also threatens major carriers on the alliance front. Conditions could be imposed on existing transatlantic alliances as well as on the proposed American/BA linkup. The benefits of frequent flyer programmes could also be taxed more widely and the competitive advantage of tieups between major partners curtailed. Both measures would have a significant impact on global partnerships like Star Alliance, as they focus on increasing customer loyalty.
Government limits on aircraft movements at airports like Amsterdam/Schiphol and a rise in taxes such as the emissions charges at Swiss airports, also threaten the industry's development as it nears the new millennium.
Jackie Gallacher
EUROPE
What happened? A brave new world for European aviation was meant to dawn dramatically on 1 April, 1997 as all airlines in the European Economic Area gained access to cabotage rights. In the event, the sweeping away of the final hurdle to full deregulation barely raised a flicker of interest.
The new year is not likely to be any different. European airlines' lack of enthusiasm relates in part to the fact that real liberalisation happened in 1993, when the Third Package freed up third, fourth and fifth freedom rights and allowed consecutive cabotage as extensions to inbound international flights.
The failure to leap onto the cabotage bandwagon is also acknowledgement of the weakness of existing forays into overseas operations. British Airways' French and German subsidiaries, Air Liberté and Deutsche BA, are hoping to reach their target of breakeven in the next two years and are just one of the challenges facing BA.
In 1997, the airline had to resolve union unrest over proposed cabin crew savings. Then came the scrubbing of the British flag from BA's tails in favour of flamboyant, surreal designs and the news that this traditional hallmark of quality is setting up a no-frills airline codenamed 'Blue Sky'. However fear of deteriorating labour relations has led BA to allow the unionisation of Blue Sky.
Strategists have been scratching their heads. Why should BA downplay its British connections by painting over the Union Jack on its tails with global designs? Why provoke union discord with the introduction of tough new terms and conditions? And why risk cannibalising the airline's high-revenue business product with a low-fare alternative?
Yet BA's bold moves illustrate the three fundamental trends facing the European airline industry. First, the need to shake off a national image in favour of a global brand, as linkups with international partners continue. Second, the necessary belt tightening as competition intensifies. And third, the alarm bells set off by the spawning of a new generation of European startups.
Movement on the alliances front is expected in 1998 with a long-awaited decision on the BA/American Airlines alliance. Clearance of the alliance by the US and European Commission competition authorities, albeit with severe conditions attached, could provide a template for both future and existing transatlantic alliances. The Commission is examining the proposed BA/AA alliance, the Star Alliance and the KLM/ Northwest and Delta linkups. Its findings, due to be published in the first quarter of 1998, could force alliances to give up specific slots and ban or restrict frequent flyer programme links.
While Lufthansa and SAS became members of the Star Alliance in 1997, other European carriers were still busy consolidating their links. Alitalia was expected to join up with either Air France, KLM or Swissair at the end of the year. And Air France was aiming to develop its cooperation with Delta Air Lines and Continental into full partnerships.
European airlines need not only to firm up their global partnerships, but also to keep their unions happy as tough restructuring programmes continue. Air France, in particular, underwent a series of strikes in 1997 following the thorny merger of Air France and its mainly domestic arm Air France Europe, and the imposition of lower working conditions at the latter.
The French flag carrier now needs to keep a tight lid on costs after the French government ruled out selling a majority stake in Air France. Alitalia, meanwhile, was still on the lookout for private investment despite the approval of L2,750 billion (US$1.8 billion) in state aid.
The reaction of Europe's two leading majors to the latest batch of low-cost airlines illustrates how startups, once spurned by the old-timers as inconsequential, are increasingly wrestling market share away from the established players.'Blue Sky' is BA's response while Lufthansa is also considering a low-cost operation.
The latest generation of startups has wasted no time in positioning itself for expansion, as they tap the financial markets. Brussels-based Virgin Express was planning to raise about US$90 million with a dual listing on the Brussels and Nasdaq exchanges before the end of 1997, and Luton-based EasyJet is also considering a flotation. Ireland's Ryanair raised $157 million and UK startup Debonair raised $41.9 million in public flotations in 1997.
As startups increase in size and financial importance, they are becoming more vocal in using complaints to ward off predators. In 1997 there was a batch of official complaints by startups over alleged predatory pricing by majors, and the Commission narrowly avoided issuing its first interim measures when EasyJet withdrew its pricing complaint against KLM.
Other complaints included World Airlines against Air UK and Belgian regional VLM versus Cityflyer Express. Virgin Express also unofficially complained of predatory pricing by SAS. EasyJet is already threatening a legal challenge to BA's 'Blue Sky', which it claims aims to put it out of business.
European majors will need to continue to forge global linkups and ensure that their competitive response to the low-cost startups does not lead them into difficulties with the competition authorities or their customers.
Lois Jones
NORTH AMERICA
In the US, 1998 might just be the year that the low-cost carriers begin to fight back - with a little help from friends in high places. But not one inch of ground will be regained without a battle.
Towards the end of 1997, the Department of Transportation began ruffling the feathers of the major carriers. First came DOT's decision to issue a quarterly report on the average airline fares paid in the top 1,000 US domestic city pairs - some 70 per cent of the market - and make that report readily available to the public. While the fare reports have been welcomed by passengers, civic leaders and airport managers, they have been heavily criticised by many of the majors.
According to Patrick Murphy, the DOT's deputy assistant secretary for aviation and international affairs, the reaction by the large airlines has been 'interesting'. 'The shedding of light on some of their airline pricing practices has made some major airlines uncomfortable. They have complained that our data is a first step toward reregulation; that our data is misleading; that the airline industry has historically low average profits and, therefore, we should not be concerned about high prices; that we don't understand the intricacies of yield management; and that our data can be misleading to consumers.'
With so much about the report to dislike, the majors are likely to work hard in 1998 to have it scrapped or substantially changed.
The majors are also concerned about DOT's granting of slot exemptions to low-cost carriers so they can establish themselves at important high-density airports like Chicago/O'Hare.
But Senator John McCain's proposed Aviation Competition Enhancement Act, which seeks to withdraw slots at congested airports from major carriers and reallocate them to new entrants or limited incumbent carriers, could really rile the majors.
The other source of support for the low-costs could be the passenger. There is a growing perception among the travelling public that fares are climbing and bargains are becoming more difficult to find. While the American public remains nervous about the safety of the low-costs, much of this will dissolve in 1998 along with the ValuJet name, and the low-costs are entering the new year with revamped operations and upgraded images.
Meanwhile more of the majors now have their own low-cost, airline-within-an-airline operation. Joining that club this year will be US Airways, which has long aspired to a low-cost airline, but first needed to get its labour costs in order.
For US Airways 1997 finally brought to an end the protracted negotiations between management and pilots; this will be CEO Stephen Wolf's year of the clean sheet of paper. All the majors will be watching to see how Wolf's plans to grow US Airways take shape this year, particularly Southwest Airlines and Delta Air Lines, which both operate low-cost services along the east coast.
While 1997 was another record year for most of the majors in terms of profitability, profits in 1998 will again be good but not as good, says the Air Transport Association's chief economist, David Swierenga. He estimates that net profits will be down from about $4.5 billion in 1997 to between $3.3 and $3.5 billion for 1998. He is confident of continued growth in the US economy but points to an analysis by JP Morgan which predicts that the economy might slow down enough to reduce traffic by as much as 6 per cent. 'If traffic is as weak as JP Morgan says, then our margins will be squeezed a bit in 1998 and profitability will decline,' he warns.
The US open skies ball will keep on rolling through 1998. Chile, France, Italy, Peru and Romania could sign new US bilaterals by the middle of the year, although the focus will remain on Japan and the UK.
US-Canada open skies continues to bear fruit, while Air Canada should strengthen its competitive position vis à vis Canadian Airlines as a result of its membership of Star Alliance. Canadian should benefit from its association with the proposed American Airlines/British Airways alliance, however.
Open skies will have many repercussions. Boeing's project director for market requirements, Tim Meskill, points out that, at minimum, any bilateral with Japan is likely to give incumbency to a fourth carrier, All Nippon Airways, which will negate the need for a very large aircraft on US-Japan routes because ANA will be adding seats. That effect, believes Meskill, will be mirrored almost everywhere that open skies agreements are forged.
The last vital question mark of 1998 will hover over the American/BA alliance. The longer the approval process, the more scrutiny there is of both this and other alliances. The result could be the imposition, by the European Commission in particular, of substantial restrictions on both AA/BA and earlier transatlantic linkups.
Should the BA/AA alliance alone have restrictions imposed, its managers will remain perplexed as they watch United Airlines' Star Alliance blossom. 'It's very frustrating,' admits an AA lobbyist.'When it was clear everyone else was doing it, we jumped in. But by then it seems the gate was closed and our cow was still stuck in the barn.' Meanwhile others, like Delta and Continental, are implementing major transatlantic expansion.
The coming year may turn out to be the one when the cow turns into a raging bull.
Karen Walker
ASIA-PACIFIC
Economic downturn, plunging currencies and dwindling profitability, all mean the bullish confidence of Asian airlines has taken a battering over the past 12 months.
Indeed 1997 has seen the brakes applied to growth predictions. The aggregate operating profits of the 17 members of the Association of Asia Pacific Airlines dipped 25 per cent to US$2.4 billion in the year to 31 March 1997. Revenue rose only marginally, by 0.6 per cent to US$51.9 billion.
That, said AAPA director general Richard Stirland, was a sobering figure to contemplate, particularly when compared to the buoyant results and soaring profitability of the US airlines during the same period.
There are few signs 1998 will prove much better, with all the indicators pointing to a further easing in the spectacular growth enjoyed by the region's carriers recently.
Everywhere in the region arrivals are either flat or declining and analysts have revised their income projections downwards. They are also warning airlines to take cost reduction programmes to new heights, reconsider adding capacity, and dig in to confront the slow market.
Indeed, the comment of Japan Airlines president Akira Kondo that JAL expects 'severe business conditions will continue, influenced by increasingly severe competition', reflects the view of all its regional rivals.
The recent economic crisis across Asia, particularly in Thailand, Indonesia and South Korea, followed the persistent failure of the Japanese economy to drag itself out of slowdown. Korea in particular has been a driving force behind Asian traffic growth and, as its economy stumbles, the impact has helped put the brakes on rapidly rising passenger numbers. Asiana has talked about aircraft delivery deferrals.
Economics aren't the only problem. Uncontrolled forest fires in Indonesia have thrown a pall of smoke over southeast Asia and continue to disrupt flights.
At the same time Hong Kong has suffered a dramatic fall off in traffic in the wake of its handover to China: JAL, All Nippon Airways and Cathay Pacific have seen loads on Japan-Hong Kong flights plunge more than 50 per cent since July. Cathay chairman Peter Sutch concedes the carrier faces an uphill battle to break even this year; traffic is also down on key routes elsewhere in Asia and Europe. The result is special fare offers and delivery deferrals.
Japan's carriers, still unable to implement speedy cost reduction measures because of traditional labour practices, are experiencing patchy progress. ANA saw its net income dip 28.9 per cent to US$49.5 million in its latest six months to 30 September.
JAL had its best result in years during the same period, - a net profit of US$166 million. But $70 million of that came through changes in the way it depreciates its aircraft.
The region's most successful carrier financially, Singapore Airlines, saw its net income rise 12.9 per cent to US$355 million in the latest six months to the end of September. But that includes US$63 million from the sale of aircraft and spares, and SIA has been disappointed by its progress on profits. SIA believes prospects for passenger traffic remain 'uncertain'.
Thai International - whose local economy has been in meltdown - and Korean Air have been worst hit. Others face more difficult times. Salomon Brothers in Hong Kong has forecast a sharp drop in earnings for Malaysia Airlines in 1998 and projections for others may be downgraded.
According to Thai president Thamnoon Wanglee, the airline faces a 10 to 15 per cent slide in profits for fiscal 1997, with outbound passenger numbers dropping 30 per cent and inbound passengers by up to 15 per cent.
The depreciation of the baht alone caused losses of US$100 million in the July to September quarter. The government has ordered all state enterprises, including Thai, to cut expenses by 5 per cent, and has frozen fares.
In Australasia profit projections have also receded to more modest levels. Ansett Australia has failed to return to the black despite intensive restructuring and rationalisation over the past year.
Currency declines have had a mixed impact on carriers. The plunging values of local currencies can help boost tourism by encouraging inbound travel for visitors who benefit from cheaper holidays. But outbound travel tends to slow. Up to 50 per cent of expenses are in hard currency, causing rises in operating expenses. Asian carriers also have huge orders in place for new aircraft and the devaluation of local currencies will make them up to 25 per cent more expensive. Analysts also worry that these aircraft orders will lead to serious overcapacity (see feature, page 42).
Many airlines are already discounting fares or launching special offers in an effort to lift traffic and revenue, a move that is likely to cause serious yield problems. The effects will be magnified by a number of ambitious startups keen to carve their own niche in the markets of bigger established rivals.
Despite the opening of several new airports - including Hong Kong's Chek Lap Kok and Malaysia's Sepang - air traffic and airport infrastructure congestion, as well as rising airport charges, will also remain a problem.
Asia's airline industry is entering a period of slower growth and narrower profit margins which will demand a more cautious approach to expansion.
Tom Ballantyne
LATIN AMERICA
Alliance issues will shape events in Latin America in 1998 as Washington finally rules on American's controversial links with Aerolineas Argentinas, LanChile, Avianca, and the Taca Group.
Approval could trigger a series of lawsuits by US rivals and shift the political tug-of-war to the Latin American capitals which must also approve these pacts. If Washington rejects the deals, or attaches conditions so restrictive that American opts out, a frantic scramble will ensue between US and Latin carriers hoping to realign.
Whatever the outcome, alliance issues will not go away. As Avianca's CEO, Gustavo Lenis, puts it: 'We can't compete without an alliance. We have to be part of something.'
Open skies will also be high on the agenda. Central America, Aruba, and Chile - with major strings attached - agreed to open skies last year, and Brazil and Peru are Washington's next targets. With open skies will also come new battles over US anti-trust immunity for north-south alliances. US rivals fear American will try to immunise its Taca alliance, and American has said it will seek immunity for its LanChile partnership if Chile and the US finalise the preconditions to open skies. The prospect of immunity could bolster open skies negotiations throughout Latin America, although the US DOT insists immunity does not follow automatically from open skies.
Intra-regional liberalisation could also grow. Open skies agreed earlier between Andean Pact members, as well as between individual members and neighbouring countries outside the pact, could produce clearer results. Mercosur is becoming one of the world's fastest growing regions. As economies in nearby countries such as Peru also improve, new cross-pact aviation opportunities could multiply.
The coming year will also witness the first effects of liberalising Mercosur skies under the Fortaleza accord. Opening scores of new city pairs to point-to-point service could give some of the region's emerging young carriers a chance to expand. The results could lead to further liberalisation within Mercosur and some real movement towards integrating Mercosur and the Andean pact.
Meanwhile the trend towards newer and more owned aircraft could convince more of the continent's privately owned airlines to seek outside investors through public offerings. Aces Colombia and LanChile have started that trend already.
The main obstacle will continue to be the US Federal Aviation Administration's safety assessment programme. Eight Latin American and Caribbean airlines are still operating under Category 3 restrictions, five under Category 2. By barring operations to the US or freezing them at current levels, the FAA hands US carriers a huge advantage. In turn Latin incumbents are protected from local upstarts. Peru and two Caribbean nations became the first in the region to regain Category 1 status last year. Bolivia, Colombia, and perhaps Ecuador could do so in 1998, but the playing field is likely to remain unequal for at least another year.
Finally, under newly inked liberal US bilaterals, Asian carriers could, with Latin approval, test their newly acquired fifth freedoms during 1998.
David Knibb
AFRICA AND MIDDLE EAST
While traffic growth in Africa and the Middle East is forecast to hit 5 per cent in 1998, a good deal of potential remains untapped. Internal conflicts, and the twin pressures of replacing ageing aircraft to meet noise rules and global concerns over safety oversight, continue to make the headlines in both regions.
Many Middle Eastern carriers are looking to 1998 as the year in which the uncertainties over the future of Gulf Air could finally be swept aside, while in Africa South African Airways continues to extend its dominance.
The Middle East remains a paradox. There is intense competition on longhaul routes - due to the Gulf states' open skies policies - but the intra-Gulf market is rigid. 'The region needs to address the future of intra-regional air services in the light of international trends towards liberalisation,' says Mouna Moussi, head of external relations at the Arab Air Carriers Organisation (AACO).
The coming year could see the final breakdown of Gulf Air's monopoly in Bahrain and a shift to true regional services to feed expanding, long-haul capacity. The failure of Gulf Air's owner states to agree on deregulation has contributed to the carrier's slow slide and overambitious international expansion, while Emirates, Kuwait Airways and the restructured Qatar Airways have continued to make progress.
Many in the region expect there to be agreement for an independent regional carrier, supported by all the Gulf states, to work around the political sensitivity of exacerbating Gulf Air's malaise.
AACO's reform has enhanced cooperation in the region with progress continuing in technical affairs. A pan-Arab CRS and the extension of joint handling arrangements at London/Heathrow are also expected.
While Emirates, Kuwait Airways and Egyptair are well advanced in their fleet renewal - and Gulf Air continues to shrink - the largest unknown is the future of Saudi Arabian Airlines' 50-aircraft order. The deal has run into financing difficulties made worse by the absence of a coherent fleet plan. To its credit, Saudi has responded by opening up to overseas cooperation for the first time, receiving technical support and wetleasing a Boeing 747 from Qatar Airways.
Meanwhile 1998 could be a breakthrough year for the North African carriers.
Royal Air Maroc (RAM) and Tunisair are nearing the end of strategic plans which have improved productivity and transformed their fleets, with older aircraft retained for regional African routes. The judicious pruning of unprofitable long-haul routes has left them fit enough to exploit the opportunities of feeding traffic south to fill the gaps left by the struggling west African airlines. RAM is included in the Moroccan government's privatisation schedule, though internal opposition is likely to delay this until 1999 at the earliest.
African airlines are still in a holding pattern dictated by domestic financial constraints and the relatively small rewards they have to offer overseas partners. 'The most important issue is completing the restructuring process,' says Aberra Makonnen, head of industry affairs at the African Airlines Association.
Meanwhile the region's airlines are pressing ahead with cost cutting measures at the expense of cooperative attempts. 'In the commercial and marketing area there is absolutely nothing beyond conceptual agreements,' notes Makonnen. 'Most of the airlines that could take advantage are engaged in internal housekeeping.' The big exception, of course, is Kenya Airways with KLM.
The prospects for enhanced cooperation are further complicated by some negative reaction to the franchise agreements in South Africa. Comair's deal with British Airways, and South African Airways' links with SA Express and SA Airlink, have taken hold and increased the hegemony of South Africa as far north as Zambia, feeding international traffic back to Johannesburg. While franchising appears to offer an opportunity for other regional carriers to ally with European long-haul operators, African airlines are taking a defensive approach.
Meanwhile Alliance Air, the joint venture in which SAA has a 40 per cent stake, has abandoned attempts to merge with Air Tanzania and Uganda Airlines, and instead plans to set up Express carriers to feed its Entebbe hub (see feature p40).
The future of South Africa's dominance will be dictated by the long-awaited privatisation of SAA, scheduled for 1998 following its spin-off from holding company Transnet. A question mark remains over whether SAA will join the Star Alliance; it cooperates with Lufthansa, which is in Star, and American, which is not.
Elsewhere, privatisation has slipped from most government agendas. With the exception of LAM in Mozambique, Uganda Airlines and Air Tanzania, most governments have accepted that their airline assets are unfit for sale.
The focus on safety oversight, which has overshadowed Latin America over the past three years, is also likely to transfer to Africa in tandem with the US administration's policy of promoting US-Africa trade. Around 25 states have already been assessed by Icao's safety oversight programme but another eight are still classed as Category 3 - unfit for US operations - by the FAA.
Douglas Cameron
Source: Airline Business
