Much of the focus for this column over the last few months has been on the importance of the industry achieving a new and sustainable relationship between supply and demand. The search for this point of equilibrium has been painful, but it appears that it is close at hand. Regular readers will recall that expectations for the all-important rate of fundamental traffic growth began to exceed that for capacity earlier this year and the news continues to improve.
This optimism comes with cautions. The impact of this more favourable balance is not instantaneous. The industry cannot painlessly flick a switch and expect the upturn to show through - if it did, then airline profit profiles would be quite different. Yet there are now clear signs that a fundamentally better environment is at hand.
To trace the recovery however requires a step back a couple of years to the crisis in Asia. As economies went into freefall, so did traffic and carriers began to move capacity out of the market. Clearly, the capacity that was shifted out of Asia had to appear elsewhere and it duly did, turning up chiefly on the North Atlantic. Thus the pain last summer as capacity far outstripped demand and yields tumbled.
Even with if transatlantic yields suffered as a result, they remained substantially higher than those on Asian routes, as latest available figures from the International Air Transport Association (IATA) demonstrate. In 1998 yields on the North Atlantic were down at ¢6.8 yields per revenue passenger kilometre (RPK) - or ¢11 per mile. By contrast, yields on the Pacific were already lower at ¢5.4 per RPK and falling fast.
Furthermore, the shift out of Asia was not the only significant capacity switch. Latin America had become tough as capacity poured in from north of the border and it is now also pouring out again.
Of course, it takes time for the effects of an adjustment in capacity to feed through into yields. Take the transpacific experience of United Airlines as an example. In 1998 it dropped capacity dropped by 9% but its yields plummeted by 13%. By contrast, in 1999 capacity was again down sharply by 12%, but yields recovered from their low point by a full three percentage points. And looking at the first quarter of this year, yields were up 12% on a 3% fall in capacity.
What, then, of the current outlook around the world? The key measure here is the "gap" which exists between the actual levels of seat capacity going into the market and the underlying passenger demand, as driven by the rate of general economic growth. So long as capacity growth is lower than underlying demand, then yields should improve. If the gap goes negative as it did across the world last year then yields will be under pressure to fall (see table right).
At an aggregate level, our forecast is now for an increase in underlying traffic of 8.6% for the long-haul routes of the European majors and 7.6% for the international routes of the North American airlines.
Using July as the peak capacity month, then so far, so good. On the key routes, there is a positive gap, with underlying growth rates running at between 0.6 and 4.3 percentage points ahead of the rise in capacity In particular, capacity on the Europe-South-East Asia route is running some four percentage points behind demand, turning around a three point deficit last summer. The transpacific routes, which had recovered earlier, are also still four points ahead.
On the North Atlantic too the gap is now a positive 1.8 points again. That compares with the experience of last summer when, on the basis of our demand model, the degree of excess capacity was just over 4 points, resulting in catastrophic yield.
Latest comments by the airlines themselves tend to back up the view demonstrated by the model that yields and traffic mix have generally recovered this year.
Looking to the future, we remain comfortable as regards growth in capacity for the rest of this year and into next. Certainly, the experience to date underlines the view that as far as the relationship between capacity and the development of yields is concerned, less is more. That comes with the caveat that the this latest outbreak of rational behaviour may not last forever if airlines let capacity back off the leash.
But if, as looks increasingly likely, the balanced environment persists, then the underlying operating environment should only continue to improve. Attention can then turn to the question of how to raise the profits that this traffic yields through fundamental structural improvements on cost. What is clear is that volume and market share on their own are not enough. The need is for an appropriate cost base.
Source: Airline Business
