The countdown to full European deregulation has begun, so where's the rush to the starting post? When the final hurdle to full deregulation is swept away on 1 April all airlines in the European Economic Area gain access to cabotage rights, enabling them to fly between any two domestic points within the 17 EEA states. Yet while some carriers are already gearing up at the starting blocks, most airlines will be onlookers in the race to use full cabotage rights, while others smugly claim that they have already completed part of the course.
'It's a load of old hype by journalists,' exclaims Sir Michael Bishop, chairman of British Midland, when questioned about the final stage of deregulation. Bishop is adamant that British Midland will not take up full cabotage rights. 'Freedom acquired by deregulation means freedom to make money, not to burn money. We're concentrating on further developing crossborder services instead.'
Frank Wade of consultants SH&E shares Bishop's pessimism over cabotage. 'We're not going to see airlines trying to make the market. Southern European airlines haven't got the capacity, while North European carriers are simply too smart.'
If British Midland, which considers itself a pioneer of deregulation, is so pessimistic about cabotage, has any other carrier marked 1 April in its diary? Some European majors, such as Lufthansa and British Airways, are eagerly eyeing the opportunities available, while smaller players such as Debonair also intend to take advantage of full cabotage rights.
Still, many airlines see enthusiasm over cabotage rights as misplaced, and view the date as largely symbolic. 'Nothing is going to happen because in a certain sense it already has happened . . . the real pioneering work of deregulation occurred in 1993 with crossborder flying,' says Bishop. Kees Veenstra, general manager aeropolitical affairs at the Association of European Airlines, agrees. 'Real liberalisation already happened when the Third Package was introduced in 1993 - these are just the finishing touches.'
Airlines point out that under the Third Package they are already able to use fifth freedom rights and operate consecutive cabotage services as extensions to inbound international flights, albeit with a 50 per cent capacity restriction. Yet few airlines have taken advantage of these rights and those who have, have largely failed.
'You've only got to look at British Airways with Deutsche BA and TAT - their startup costs have been enormous. If the major players can't break into a market and make any money, we're certainly not going to try,' pronounces Bishop. One source says Deutsche BA has lost DM300 million (US$184 million) since BA acquired it in 1992.
Lufthansa and Debonair have also trialled cabotage operations. Although Lufthansa started flying consecutive cabotage from Marseilles to Bordeaux and on to Munich at the start of 1997, previous attempts to fly on Frankfurt-Rome-Bari were 'commercially not viable due to insufficient demand', says Lufthansa's vice-president international relations Ulrich Schulte-Strathaus.
Debonair, set up in mid-1996, claims to be the first EU carrier to use ninth freedom rights with daily flights between Düsseldorf Express and Munich and between Madrid and Barcelona, although the services, in practice, remain linked to the carrier's London/Luton base. In contrast to its bold claims of speeding up the deregulation process, Debonair is reticent when it comes to revealing financial and traffic results on the routes, though claims they are 'meeting our expectations'. One source voices common scepticism about the routes' profitability. 'If Debonair sticks to 50 per cent cabotage on routes it would be impossible for them to make a profit - it would be too difficult to generate enough traffic.' Debonair's vice president marketing and sales Barry Zorn sees current operations as a stepping stone: 'There is a good possibility that we'll look at full cabotage rights.'
While some airlines cite aborted attempts to consecutive cabotage as a sufficient deterrent from taking up full cabotage rights, other airlines point to the barrage of structural impediments they believe will block their way once legal barriers fall down.Prime complaints include the cost of setting up an overseas operation, dominance of the national and local carriers in other European countries, and the lack of slot availability at overseas airports.
Sheer economics are enough to deter many carriers. A senior Commission official expects little cabotage activity after 1 April as 'it costs money to station an aircraft, crews and special maintenance teams abroad'. AEA's Veenstra agrees 'it is not economic for an airline to operate outside its own base'.
SAS director of European affairs, Hans Ollongren, claims that SAS 'won't be taking advantage of cabotage as we don't think we can make money on it . . . you have to export the whole company to another country.'
A major hindrance for carriers seeking to encroach into another airline's domestic market is the lack of under-served prime routes.
Despite the supposed global nature of the airline business, carriers foresee problems in dismantling cultural differences and they expect to suffer from passenger loyalty to the local or national carrier when operating in a neighbouring carrier's back-yard. 'I couldn't possibly see another carrier operating from the UK - they don't stand a chance as they don't know the market and have a different nationality and language,' says Stelios Haji-Ioannau, chairman of EasyJet.
'We have no special plans to operate in other European markets - local people have a better idea of market demand,' agrees Arturo Benito, director of corporate strategy at Iberia. 'Normal difficulties will be magnified when airlines face unfamiliar regulators and markets,' says Keith McMullan of consultants Avmark.
In time, however, commercial realities may overtake consumers' psychological preference towards a native carrier. Richard Bond of consultants Arthur D Little maintains that while passengers' 'knee-jerk reaction' will be to opt for their local carrier, 'it won't take much for a high quality airline, such as BA, to establish a position via its well known name and frequent flyer programme'. McMullan says: 'Large parts of Europe are very price-conscious whereas others are more loyalty conscious'.
Jonathan Ornstein, chief executive of Virgin Express, predicts that growing public awareness of a lower price option will stimulate change. 'It's a question of educating the public - their tiredness of paying outrageous prices will open up the arteries of competitive travel.'
Some carriers cite travel agent loyalty towards national carriers as a further hindrance to operating domestic cabotage. Wade considers, however, that changing passenger loyalty will also sway travel agents' preference towards carriers. 'Travel agents are only loyal to the national carrier if the market is loyal to that carrier. Distribution channel promotions are directed at the individual'. The growth of alternative electronic ticketing options will diminish travel agents' influence, says Wade.
Even if psychological barriers can be knocked down, non-native carriers view physical restrictions towards cabotage operations as tougher to push aside. Although Virgin Express wants to fly between domestic city-pairs, 'all good efforts at the Commission will go for naught if restrictions such as slots and airport facility costs are still in place,' says Ornstein.
Andreas Diederich of consultants R&C Airline Industry urges carriers to look at available capacity at the German airports other than Düsseldorf and Frankfurt. Diederich further encourages airlines to take advantage of the marketing, maintenance and financial assistance that airports offer.
McMullan considers that after deregulation carriers will move rapidly towards setting up offshore hubs to take advantage of available capacity elsewhere. An obvious choice for BA would be Paris/Orly, particularly were it to combine its subsidiary TAT with newly acquired Air Liberté, both based at Orly. An offshore hub would offer BA an alternative European point from which to develop long-haul operations - particularly valuable if the carrier were forced to relinquish slots at Heathrow following approval of its proposed alliance with American Airlines, says McMullan. However, such moves would run into bilateral difficulties.
Debonair is already setting up mini-hub operations at Munich, Barcelona and Rome. Debonair's Barry Zorn maintains that these hubs will not prove expensive as 'Debonair is flowing all aircraft through Europe and then returning them to their home base at Luton that day or the next.'
Some airlines have too many problems on their own doorstep to divert their attention to flying cabotage routes. 'I would advise still fragile Air France, for example, to bolster its own position in the French domestic market before attempting to fly in Germany,' says Bond.
Yet despite widespread doubts and worries associated with cabotage operations, some European majors with stronger balance sheets and more time to focus on new opportunities are eagerly awaiting 1 April. 'We're going to take advantage of full cabotage rights this year,' asserts Lufthansa's Schulte-Strathaus.
Lewis Scard, general manager franchises and alliances at British Airways, confirms that BA is keen to pursue cabotage activities already underway with Deutsche BA and TAT; BA now owns all of TAT and manages DBA, although the latter remains majority owned by German financial partners. 'BA sees opportunities for expansion in other countries in Europe. These could be undertaken by itself or, more likely, by alliances or franchisees.'
While some startups, such as Debonair, have been careful to position themselves before 1 April 1997, the onset of full deregulation is likely to entice another surge of more new entrants into the fold, in addition to the influx of 34 new carriers in 1996. Low-cost entrants are able to take advantage of available capacity at secondary airports and are in a better position to generate more traffic from an increasingly price-conscious travelling public and react more quickly to changing market conditions.
Wade of SH&E predicts that a combination of new carriers and increased capacity from existing airlines will result in falling yields. 'As capacity increases and bilateral pricing agreements disintegrate, ticket prices, on average, will drop for all but the most restricted fares. Promotion and predatory pricing will increase and will be difficult to distinguish from each other in all but the most extreme cases.'
Not all startups plan to pursue cabotage operations, however. Italian startup Air One is deterred by the 'enormous expense of positioning an aircraft in another country and all the additional costs involved,' as well as the lack of synergies cabotage operations would have with its current route network and the difficulty of having to establish an identity in another country, says a spokeman. Air One sees far more potential in introducing new routes radiating from its Milan base, where the carrier could 'use the same advertising message to target the same clients'. Emerging startups that are spurred on by full deregulation do not face an easy passage. British Airways' director Europe and Middle East, David Scowsill, points out that 'opportunities for startups are more limited on the continent than in the UK, as it's expensive operating in and out of airports and many major cities, such as Paris, do not have secondary airports.' British Midland's Bishop warns that 'the soft belly that new entrants rely to start on isn't there any more. Startups have served to make the majors tougher and more efficient - startups will have to learn the hard way how to compete against the majors.'
Even limited action in cabotage markets will place incumbent airlines under greater pressure. 'The whole deregulation process is rather testing for the majors - they've gone from a cosy situation with sometimes monopoly routes to a more flexible market with tougher market conditions,' says one consultant.
According to a Commission official, these increasing pressures will force major carriers to 'scramble to reorganise their activities or leave their routes to new entrants'. Consultant Andy Hofton says 'the more sensible carriers will get out of those markets where they are not making money, allowing startups or franchisees to fill the gap'.
Matthew Stainer, analyst at Morgan Stanley in London, also predicts that majors with credible intercontinental networks will be forced to focus on their long haul strategy, leaving unprofitable regional routes to startups, but safeguarding regional feed via low-cost regional subsidiaries or codesharing alliances.
Franchising is emerging as a particularly appropriate alternative. 'Full deregulation on 1 April gives European airlines full flexibility to franchise . . . as to who franchises and where, a lot depends on the strength of the carrier's brand and its existing market presence in the country where it wants to franchise,' says BA's Scard. Lufthansa's Schulte-Strathaus confirms that 'franchising is something we're looking at in the future to complement our route network'. A memo to staff from Lufthansa chairman Jürgen Weber indicates that Lufthansa is eyeing British Midland as a potential franchise partner. In the memo Weber reveals that Lufthansa is 'conducting talks on an alliance with British Midland with the aim of setting foot in Britain. A presence at London's Heathrow is highly important for our future expansion in the European market. Should this alliance come about, some of our UK services will be flown by British Midland.'
Franchising appeals to startups as well as majors. EasyJet's Haji-Ioannou says: 'If we wanted to fly domestically in another country, the best way to do it is to find a local company to franchise the operations and let local skills and management take over.' He sees EasyJet as having a 'nationality neutral' image, making it easier to export than, for example, British Airways' brand.
Many carriers are likely to consider crossborder acquisition as a means of avoiding the pitfalls associated with setting up from scratch in other countries. Airlines will buy a carrier in another member state to fly in that state and from there on to other countries, a Commission source predicts, though he warns of potential problems with the nationality clause in bilaterals. 'If for example, TAT, owned by BA, wanted to fly from France to the Ukraine, the Ukraine is able to refuse entry to an airline not controlled and owned by French citizens according to the nationality clause in bilateral agreements between the two countries.'
Now that internal deregulation is complete the focus will be directed to external negotiations. 'Antitrust and immunity type issues will become more important and the world outside the EU will move European carriers more rapidly forward than liberalisation,' says Hofton.
The European Regions Airline Association believes deregulation will increase activity among regional carriers. 'Regional airlines are looking outside their own national boundaries to expand,' says a spokesman, who expects more takeovers among regional carriers along the lines of the recent purchase of Deutsche BA's turboprop operations by Regional Airlines of France.
Full deregulation will blur Europe's national boundaries, leading airlines to seek increased crossborder sourcing of the cheapest pilots, maintenance, equipment and supplies, predicts Wade. He also anticipates greater cooperation among unions, as they recognise that a common set of problems should lead to a common set of demands. The result could be a levelling of costs and benefits, presenting a danger to carriers based in lower cost countries such as the UK.
While sceptics say that 1 April is only of symbolic importance, the impending completion of Europe's single aviation market is leading to increased activity within airlines' strategy departments. Alliances and franchising are emerging as the favourite responses, as cross-border acquisitions remain limited by bilateral restrictions with third countries.
Source: Airline Business
