Europe's regionals continue to face tough questions as they face up to the low-cost challenge
Is there a future for the traditional regional airline industry in Europe? This rather stark question was the underlying theme behind the European Regional Airlines (ERA) conference in Barcleona in March.
The prime reason for this navel-gazing was the low-cost sector, which has expanded into markets that up until the last couple of years or so, most delegates would have regarded as their own. Ten years ago, many of those attending the conference would have been arriving in Barcelona on regional airlines. Today, the picture is more mixed, and Spain's second city has grown into a large destination for low-cost travel.
At the start of this decade, the usual mantra from regional carriers when asked about the low-cost sector was that the two sectors were chasing different markets. Regionals were focused on business traffic, while budget carriers were chasing the leisure passenger.
Back in 2001, Jim French was among the doubters, suggesting that the low-cost model was unproven in regional markets. Then he was speaking as chief executive of British European, a typical UK independent regional with a feeder role for Air France. A couple of years later and how things have changed. British European has transformed itself into a low-cost regional under the flybe name, operating Bombardier Dash 8 turboprops and BAE Systems 146 jets but with plans to add either the Boeing 737 or Airbus A320s. And just two weeks before the ERA conference, flybe announced that it was leaving the association to become, instead, a member of the fledgling European Low Fares Airline Association (ELFAA), alongside the likes of Ryanair.
Flybe is not alone in following a low-fare, leisure-based business plan. Norwegian Air Shuttle, now known as plain Norwegian, operates 737s, having ditched its Fokker 50 turboprops. Former KLM Exel boss and ERA stalwart Robert Stinga has also headed over the Dutch border into Germany and is running low-cost operator V-Bird out of Niederrhein near Düsseldorf.
Flybe and Norwegian had one thing in common - independence. Even when French was questioning whether the low-cost model could be extended to regional routes, he still made it clear that the fact that the carrier was not owned by one of the majors meant that it was possible to react quickly to changing market conditions - and few have reacted as swiftly as flybe.
Mainline influence
Although relatively few European regionals still retain their independence, all are increasingly coming up against low-cost competition on their point-to-point services. "Shouldn't Ryanair be a member of the ERA?" airline consultant Rigas Doganis asked those regional airline chiefs in the audience somewhat mischievously. "They are doing what you are doing."
On the face of it, Europe's regional carriers continue to produce robust growth. Analysis of the latest Top 100 Regional Airline Ranking shows Europe's carriers posting nearly 9%growth in passenger numbers and 15% in revenue traffic last year. Yet the low-cost carriers are growing even faster and have clearly managed to cream off cost-sensitive business as well as a whole swathe of the leisure traffic on which regionals relied to supplement their core business travellers. In a low-margin business, the loss of even the most marginal business can matter.
In response, the traditional regionals have been tackling costs, and continue to do so. But have they done enough? Doganis believes that "all the evidence is that they have not". In a climate where pricing power lies firmly with consumers, he warns, "the model is broken".
Despite this challenging environment, he believes that the more robust regional carriers, at least, will perhaps still have a role to play if they can adapt to changing market conditions. In part, he argues, they may be able to benefit from a pending shake-out in both the mainline and low-cost sectors.
In particular, he highlights the risks that lie ahead for Europe's second-tier national carriers. "They are too small to dominate, too large to be a niche player." He expects to see the European market consolidate around three to five mainline carriers and suggests that this will "perhaps" offer opportunities for regional airlines as the majors cut back on shorter, uneconomic routes and new gaps open up in the market.
While there may be opportunities for feeding mainline hubs, Doganis argues that the future of regionals on point-to-point routes is less certain. "As niche players, can they sustain any competitive advantage vis-à-vis the low-cost sector?" he asks. "If not, the economics of consolidation are really going to hit the regional market."
In the meantime, much of the focus is on cost. Lufthansais in the midst of a programme to pull together its five regional partners into a single group and along the way is looking for cost savings of €100 million ($120 million) over the next two years. Others too are looking to strip cost out of the business.
KLM Cityhopper's managing director Elfrieke van Galen points out that there is still plenty that regionals can do to reduce their cost base. She questions one of the fundamental orthodoxies of the hub-and-spoke system - banks of aircraft arriving to create connecting services. "Why not have aircraft arriving constantly rather than in waves," she asks. The concept of a rolling hub has already been pioneered by American Airlines to ease congestion at Chicago O'Hare and Dallas Fort Worth, and is also now raising interest in Europe.
Breaking the bank system
Van Galen argues that regionals will have to break out of the bank system if they are to have any chance of matching the utilisation levels of low-cost competitors. "In between waves, crews are idle," she complains.
Van Galen also believes that self-service transfer would be an opportunity to save costs. However, in common with most observers she warns against regionals trying to match the cost-per-seat of low-fare carriers. "Trying to win the game on productivity is not the game to play," she says. Instead, she believes regionals should focus on customisation. "They should adjust spend to the needs of large corporations," she says, adding that KLM Cityhopper is in discussions with one key corporate client about adjusting the airline's schedule to suit the customer's needs. She also argues that regionals are in a better position than low-cost carriers to provide ad hoc services.
As they battle to keep costs down and to stay flexibile, the relationship of regionals and the partents continues to surface as an issue. With Iberia as a notable exception, Euorpe's major mainline carriers have been busy buying up their regional partners to create captive groupings. Based on figures from the Top 100 ranking, some 60% of regional passengers in Europe are now flown by operators which are captive to mainline owners or part-owners. In the USA, independent affiliates still make up close to half the market.
Lufthansa, which has emerged with Europe's largest regional grouping, is among the latest to restructure its growing team of affiliates. It has formed a new layer of management to oversee the grouping which now includes Air Dolomiti, Augsburg Airlines, Contact Air and Eurowings, as well as Lufthansa Cityline. It has already acquired control of Air Dolomiti and is planning to raise its stake in Eurowings from 25.9% to 49%.
Indeed, the ERA conference provided a platform for Lufthansa to explain the thinking behind its decision to put its five regional affiliates under one umbrella. "In the past, we had various kinds of relationships," says Lufthansa vice-president regional, Werner Knorr. "This set-up was not easy to manage, and to the customer, the appearance was not coherent."
He explains that there will be clear areas of accountability between Lufthansa and the five regional carriers, . "The commercial side is the responsibility of Lufthansa, the operations are the responsinility of the partners." He says Lufthansa is moving towards a common brand for its regional partners, and all the carriers other than Italy's Air Dolomiti are repainting their aircraft in Lufthansa Regional colours.
Other mainline carriers provide a similar rationale for taking control of regional affiliates - to ensure that the strategies of the regionals and mother carrier dovetail and to present a common brand to the consumer. In many cases, there is also a greater emphasis on feeding the hubs of the mainline carrier. With low-cost carriers increasingly powerful on point-to-point services, some are asking whether Europe will move more towards the US model where regionals concentrate almost exclusively on feeder activities.
Knorr sees a key component of his job as striking a balance. "We will be as decentralised as possible, and as centralised as necessary," he says. The relationship has a further twist with Eurowings also effectively providing low-cost competition through its germanwings subsidiary.
KLM Cityhopper's van Galen picked up the issue of mainline ownership - a familiar theme at any ERA gathering. She is dismissive of the suggestion from some within KLM that Cityhopper should take over the 737 short-haul operations of the mainline carrier in the belief that the regional could carry out such operations more efficiently.
Of course, van Galen now has to look at strategy beyond just KLM. With Air France taking over the Dutch flag carrier, there are questions over whether Amsterdam Schiphol will be able to retain hubbing operations on today's scale. There is a five-year grace period when the two hubs will operate side-by-side, but van Galen is confident that KLM Cityhopper will hold its own in the new arrangement. "There is one holding company, two airlines, three business segments - passenger, catering and maintenance - I would add a fourth - regionals," she says, predicting that Cityhopper may form part of a regional team along the same lines as Lufthansa. "If Paris is the hub, then there will be a need for smaller feeders. I see only positive aspects of this deal."
Competing against the 737s with high utilisation rates clearly has its downsides, but there still seems to be a feeling among regional airlines that the sub-100 seat aircraft can hold its own. "As long as the trip costs are lower, we will use sub-100 seat aircraft for the sub-100 seat market," says van Galen. Anton Simigdales, chief executive of independent Greek carrier Aegean Airlines, is quick to stress that regional carriers have always been forced to be cost conscious - albeit it never more so than today.
Low-cost threat
The ERA itself is facing a potential low-cost threat of its own, highlighted by the drift of former members such as flybe to the new ELFAA low-fares association. ERA director general Mike Ambrose dismisses the likelihood that the new association will become a major threat. The ERA offers "a considerable amount more", he argues, adding that "quite frankly, the low-fares association does not have the expertise". Certainly, the ERA is prepared to fight its corner and is hopeful that the 10 new states joining the European Union in May will provide it with additional members.
Ambrose stresses that the two associations have pretty similar agendas. "There are very few interests where we diverge," he says. "We both want more capacity, freedom to grow. Where they are prepared to join in, we will co-operate in a constructive fashion - maybe."
One area that continues to be a major concern for both camps is the passenger rights proposals from the European Commission, which will see airlines paying far stiffer penalties for involuntary denied boarding, delays and cancellations. The ERA has indicated that a joint effort with other airline organisations is the most cost-effective way forward, and is supporting an IATA-led initiative to challenge the proposals through the UK courts. This will provide an early test of the ability of the ERA and ELFAA to co-operate.
In the meantime, survival continues to be the name of the game as the European regional sector emerges from the worst recession in the history of aviation, only to find itself facing the full force of low-cost competition. As Doganis notes, the challenge for many is to get through the next 24 months.
Kjell Friedheim, who has a long history working within the SAS regional affiliates and now has his own Friedheim International consultancy, points out that during his time as chief executive of Air Baltic in Latvia, the cabin attendants also issued tickets and helped with accounting, while the pilots helped load the baggage. "We have a long way to go for regionals in Europe to do that," he says. But, speaking a day after the SAS unions had agreed a ground-breaking restructuring deal to prevent a massive downsizing at the Scandinavian carrier, he believes that "the unions are beginning to see the writing on the wall."
The next couple of years will be a testing time for the regional sector, and although pilots loading baggage may seem extreme, even if regionals do not decide to join the likes of Flybe, they may well have to copy at least some aspects of the low-cost culture or risk extinction. As Anton Simigdales of Aegean Airlines, puts it: "We have a lot of thinking on strategy and philosophy ahead of us."
REPORT BY COLIN BAKER IN BARCELONA
Source: Airline Business
