These are the good times, but life for the average airline manager does not appear to be getting any easier. Many carriers might have enjoyed their best year ever in 1996, but as 1997 dawns the balance of factors which govern financial success remains precarious at best.
Buoyant demand is likely to keep load factors healthy in most parts of the world, but yields are under pressure everywhere as competition intensifies. As a result, there is a need to drive unit costs down further, yet many of the easy cost-cutting measures have already been taken.
Furthermore, all but the most profitable airlines are still not generating a high enough return on capital to satisfy the financial markets.
The result is pressure, and plenty of it. Sales and marketing departments are under ever more intense pressure not just to generate traffic, but to produce customers at higher average yields. And all departments are under increasing pressure to find further cost cuts.
Many of the more advanced carriers have realised that structural change is required if they are to produce meaningfully lower costs, and this is resulting in moves to outsource activities and convert internal departments into profit centres and subsidiaries. The airlines which have fallen behind in the race to cut costs face a tougher battle every day - often in the face of employee opposition - as the gap between the 'haves' and 'have-nots' widens.
Certain experiences in 1996 indicate that airlines are going to have to be very careful as they implement further major changes to the way they are organised. The aftermath of the ValuJet disaster revealed shortcomings in the carrier's outsourcing strategy, and America West's maintenance outsourcing resulted in an increase in costs. Careful planning, rigid control, and delicate handling of the employee issues are required.
Against this background, the twelve main points to look for in 1997 are:
1 While nothing dramatic is expected, the granting of full cabotage within Europe from April may provide a further boost to startup carriers and cross-border investment.
2 The outcome of the American Airlines/British Airways alliance proposal will have a profound effect.
3 The European Commission may achieve a mandate for negotiating traffic rights with the US, and the US will be looking to make more open skies progress with the Pacific rim nations.
4 Some experts predict a fall in fuel prices early in the year; this will take some of the cost pressure off carriers.
5 Hong Kong's transfer to Chinese rule from 1 July will make Cathay Pacific vulnerable to fresh competition.
6 The ValuJet bubble has burst, benefiting most US majors, but the startup phenomenon could return.
7 Startups are flourishing outside the US, but once the honeymoon is over there is likely to be a shakeout.
8 The alliance picture remains confused, and more steps need to be taken to produce a clearer picture that airlines, their employees and customers can understand. The key alliance-builders to watch are American Airlines (both with BA and in Latin America); most of the major carriers in Asia; Iberia; Alitalia; and Varig. Some of the recently signed agreements, such as those between Air France and both Continental and Delta, will have to prove themselves.
9 The major carriers most likely to be involved in consolidation are US Airways, TWA and Canadian Airlines.
10 Carriers should begin to find out whether the Internet really is the holy grail for airline marketeers.
11 Following the spate of aircraft accidents in 1996, carriers may face a backlash from consumers, the media and insurers.
12 It is possible we might see the early signs of the next recession.
Looking further ahead, airline moguls might like to ponder a few questions. Will the hundreds of new aircraft ordered by the US majors be used for capacity growth or to replace old aircraft? Will a European flag carrier ever be allowed to disappear or be taken over by a stronger competitor? Is there a route to long-term profitability?
Richard Whitaker
Europe
Theoretically, 1997 is the big year for European aviation with the final hurdle to full deregulation disappearing in April, after which any airline based in the European Economic area will have full domestic cabotage rights within the 17 member states.
But the general consensus is that little will change after the April watershed, much like the 1993 introduction of the third package, which swept away most restrictions to intra-EEA services but was slow to produce a significant competitive dynamic.
The main reason domestic cabotage rights will fail to catalyse startup activity is that those operators which were looking to take advantage of the final stage of deregulation are already in place. Europe saw a considerable amount of startups appear during late 1995 and 1996, including Virgin Express, EasyJet, Debonair, Alpi Eagles and Air One. They have had time to establish themselves while most of Europe's majors were still repairing their balance sheets.
Indeed, most of these new operators are exploiting easily identifiable niches in the market and the further deregulation in 1997 is unlikely to produce many new opportunities. The clearest trend that should emerge during this year is the move towards further consolidation in the industry, an area in which the new entrants are already playing a role: witness the codesharing deal between Alpi Eagles and Alitalia and the commercial alliance between Sabena and Virgin Express on the Brussels to London route.
Alliance building among airlines has until now proved to be a relatively fickle pursuit, but approval of the American Airlines-British Airways deal could change all this. The potential threat posed by such an alliance will push other European carriers into finding an alliance partner or strengthening existing links.
Furthermore, the complex regulatory solution that will be needed to seal the deal, which will involve US, UK and European Commission approval, should give a framework for future intra-European and transatlantic alliance building.
American and BA want to seal their pact using a legal formula to replace the need for cross-equity holdings. This agreement will include provisions for divorce penalties and stipulate each partner's role in the alliance precisely.
The Commission's role in approving this alliance is disputed by both carriers and Brussels is unlikely to do anything that would jeopardise US antitrust approval for the deal. This would leave it open to accusations of favouring the other US-Europe alliances, which already have antitrust immunity and have belatedly come under intense scrutiny from Brussels.
Indeed, Brussels' decision to scrutinise AA-BA has much to do with the Commission's desire to win external competence, both on antitrust matters as well as for wider air service negotiations with the US. This means the whole process is intrinsically linked.
If the US succeeds in prizing open skies out of London by linking antitrust immunity for AA-BA with full US-UK liberalisation, then the Commission may lose the UK as the most vociferous opponent to Brussels gaining a full external negotiating mandate.
Even if a 'hard' rights mandate is not forthcoming, expect further talks between the Commission and Washington over the issue of soft rights, following ground-breaking negotiations in late October 1996.
As a result of much backroom activity in Brussels last year, the second half of 1997 should see a whole ream of legislation approved by European transport ministers, including the revisions of the slot regulations and CRS regulations and a new regulation on airport charges, designed to bring transparency to the process. New guidelines for assessing state aid applications are also due to come into force.
During the first half of 1997, European transport ministers are likely to be preoccupied with safety and air traffic management issues. Early impetus will also be given to further development of an external negotiating mandate with central European countries.
Airlines' financial performance should pick up during the first quarter of 1997 with an expected drop in the fuel price and the seeming willingness of a number of European carriers - notably Finnair, Lufthansa and KLM - to concentrate on margins instead of growth.
But labour unrest will not be far from the surface with profitable carriers like BA, KLM and Lufthansa all attempting to squeeze more concessions out of employees in what is fast starting to mirror the US practice of 'whipsaw agreements', where management takes the deal at one carrier as a precedent for the minimum conditions it wants in its own agreement. Staff morale at Europe's more successful carriers is suffering as a result. SAS will have to join the search for more concessions after its poor performance in 1996.
At the remaining European majors playing catchup with the others - mainly the state-controlled carriers like Air France, Alitalia, Iberia and Sabena - management is also in for a rough ride. Employee resistance to the restructuring programmes could be further heightened by the general wave of labour unease spreading across the continent as those governments looking to join the first wave of European monetary union impose strict austerity measures.
Mark Odell
North America
It started with United Airlines, in August. The carrier's $3 billion fleet renewal order was soon followed by that of Continental Airlines. Then came USAir's more-than $4 billion order in early November, soon eclipsed by American Airlines' order for $6 billion worth of new Boeing aircraft two weeks later. Delta, it is expected, will soon follow suit.
Industry sages could easily be forgiven for resigning in frustration after years of warning against overexpansion provoking overcapacity. However, the orders occurred as US major carriers as a whole were turning in a second year of record profits, and most of them are to replace older aircraft rather than for growth - at least, that is what the airlines claim. Moody's Investor Service airline analyst Renee Shaker agrees: 'I don't have the concerns about too much growth yet. My concern is if this is all (the strong airline performance) there is. Two years is not much'.
As carriers try to keep profits rolling in as long as possible, their chief financial officers have a three-fold package of potential problems to deal with. First, as so many majors have paid down debt this year, some analysts believe that calling in public unsecured debt is becoming less viable (United especially will have little room here). Next comes the fact that large-scale airline capital expenditure is about to accelerate dramatically, having slowed to a trickle over the last three years.
A third factor to watch for is continued pressure from shareholders to initiate stock buyback plans. Continental and America West have done this already, while Delta, America and United are in various stages of planning repurchases.
Though significant, these trends are not troubling too many industry officials. Even with less ability to pay off debt in the near term, the large capital expenditures are for aircraft that will be brought into fleets over several years. All the orders also aim to increase fleet commonality and cut operating costs. Many stock repurchase plans - Delta's and American's in particular - are being considered as ways to fund options for pilots who are making wage and work-rule concessions to operate low-cost subsidiaries.
These rational executive-decisions represent a new facet of the US airline industry that leads some to suggest that the next general economic downturn - in 1997 or 1998 - will have less of an impact on major carries than the recession at the beginning of the decade.
One area where this can already be seen is the generally uncontrollable cost of fuel. Though prices have gone up, the consequential effect has tended to be managed well. Air Canada, for one, has been highly successful with hedging. At United, management is running on all cylinders, to the point that it was able to achieve third quarter 1996 net earnings of $340 million despite the fact that fuel prices had spiked 22 per cent.
Even without an economic slowdown, US carriers willexperience some wrenching changes in the coming year. The word consolidation is being heard more frequently as observers look at TWA and USAir (aka US Airways) as potential takeover targets, and as Canadian Airlines struggles for survival.
If USAir takes on TWA in a bid for global relevance, it will do so only to probable objections by the investment community. 'As we all know, airline mergers are unimaginably difficult', says Philip Baggaley from Standard & Poor's. 'USAir is, for instance, looking to simplify its fleet structure. This would not advance that cause'.
Stephen Wolf's strategy for USAir, guessed at for nearly a year, is now clear: reshape and repaint the fleet, establish an east coast low-cost unit akin to Shuttle by United, and bring the airline upmarket, emulating British Airways in all but accent. This transformation, Shaker says warily, is 'an almost-go-for-broke strategy. It is so daring, and so ambitious'.
'The programme will increase the company's financial burden and involves risks,' says Baggaley. But is there any other way to go?
All else will pale in 1997 if the US and UK grant American Airlines and BA the approval they seek for linking their systems with the benefit of antitrust immunity. Not only will this mark a momentous point in transatlantic aviation history, it will also have far-reaching repercussions for US carriers; besides starting a race for those US airlines without European partners, it will be the first commercial step to liberalising European airline access to the domestic US market.
It could be tough for carriers to improve on their performance in 1996, a vintage year for profitability. Even with the artificial profit stimulator of the 10 per cent ticket tax removal, as well as the fact that the majors were bolstered by the repercussions of the ValuJet crash, it was a year of great highs.
Northwest Airlines continued its marked turn to profitability, Delta turned in a year that CEO Ron Allen believed was its best yet, and Continental Airlines seemingly rose from the dead to become the poster child of a re-emerging industry. And, though the ticket tax holiday helped, 'one of the most impressive feats occurred when the tax was reinstated,' notes Baggaley. 'The industry was able to raise fares by 10 per cent - in some cases more - while traffic remained strong.
A rash of debt paydowns and preferred conversions helped clean up the industry's off kilter balance sheets than in almost any year in history.
Mead Jennings
Asia-Pacific
With zero net debt and the strongest balance sheet of any major listed global carrier, Singapore Airlines sounded a warning shot to the Asia-Pacific airline industry when it announced a 22.7 per cent plunge in operating profit to US$227 million for the six months to 30 September.
Despite an 11.3 per cent growth in traffic, revenue rose only 3.7 per cent to $2.3 billion as yield fell 6.7 per cent. In a research report in November, Salomon Brothers' Hong Kong airline analyst Peter Negline forecast SIA's earnings growth would be below the market average in both 1997 and 1998, rating the airline's foreign shares 'a Hold'.
This diagnosis might well be applied to most of the Asia Pacific's operators, as they continue their struggle to regain real profitability in the face of rising fuel costs, shrinking yields, spiralling competitive forces, and an unhelpful exchange rate.
The benefits of record traffic and rising revenue are being dulled by still soaring costs. The profit slowdown could not have come at a worse time, as the region's major flags take their first strides into new five-year business plans designed to maximise growth and expand operations for transition into the next century.
Rising levels of debt are of concern for the future among some airlines as they launch unprecedented fleet modernisation programmes. Carriers have ordered $40 billion worth of new jets during 1996 for delivery over the next 10 years and more big spending is expected, particularly on the new high capacity transports from Boeing and Airbus.
But 1997 is shaping up as another tough period as strenuous cost-cutting efforts fail to eliminate the slide in margins.
In the key Japanese market there are few signs that full recovery from economic slowdown is underway; Japan Airlines' profit slumped 77 per cent to $26.5 million in the six months to 30 September.
Korean Air suffered a $311 million loss in its first six months, hit by foreign exchange losses and rising costs.
In Australia, despite profitability, Qantas has been forced to lift its cost trimming target in the current year from a planned $180 million to $260 million because of anticipated lower revenue growth and a strong Australian dollar.
Although most airlines remain healthily in the black, the story is the same across the Asia-Pacific region, and there are other concerns for the next 12 months. Internal aviation liberalisation continues to add competitive pressures as local startups grow stronger and win rights to international routes.
While small in global terms, operators such as Sempati in Indonesia, and GrandAir and Cebu Pacific in the Philippines are ambitious, growing rapidly, and seeking new offshore destinations.
Both Thailand and Malaysia will see startups this year, though it may be 1998 before they are cleared to enter international routes and even then they are likely to be barred - at least initially - from competing directly with incumbent national flags.
Pressures from outside the region for freer Asian skies will also intensify as the US strengthens its campaign to outflank Japan and forge open skies agreements with other Asian nations. Washington's strategy in Asia is already showing signs of duplicating efforts in Europe, where a string of open skies agreements has left Britain and France in isolation.
Perhaps the most dramatic change will take place on 1 July, when Hong Kong will finally come under Chinese rule, ushering in a new and possibly uncertain era for one of the area's most successful carriers, Cathay Pacific.
Although there is no evidence to suggest that Beijing will alter the territory's aviation regime soon, it appears certain that Cathay will face new competition, possibly through mainland Chinese carriers being given rights to fly through Hong Kong to compete on some international routes.
Another longterm enigma in Asia - the lack of direct flights between Taiwan and China, could also be resolved in 1997. Many analysts believe the handover of Hong Kong will be the catalyst for cross-Straits services. Alliances remain critical for Asian airlines. Those not involved in major partnerships will be watching developments as the Qantas/British Airways/American Airlines and Thai/Lufthansa/United groupings fine-tune their links.
The new alliance of Air New Zealand and Ansett should begin to realise financial benefits for both operators and many analysts suggest they will eventually link up with the Thai alliance.
Growing contributions to the bottom line from such cooperation will tempt others. Japan Airlines, still trying to regain financial strength, could finally tie the knot with BA, for example.
Overall, Asia's airline industry continues to be the most profitable in the world. Yet carriers are realising that the enormous income levels of the 1980s have gone forever. Their ability to recapture strong profitability lies in their willingness to dismantle some of Asia's cultural norms - such as the principle of permanent guaranteed employment - to enable them to reduce costs further.
While short-term growth may be dented by rising fuel costs, Asian carriers will continue to be sustained by a rapidly expanding market. But the economic maturity which will deliver market growth also is bringing new competition and higher costs, particularly as salaries rise. Cost control will become more of an imperative.
Tom Ballantyne
Latin America
Latin America continues to be the most complex aviation market with the interplay of a web of alliances, lucrative traffic growth, and the invasive influence of the US majors offering a series of challenges to airline executives in the region.
At first sight, key developments are as likely to be played out in offices in Dallas, Washington DC and Madrid as they are in Sïo Paulo or Santiago, but in reality the balance of power is shifting slowly back to the region itself.
The irresistible rise of American Airlines as the dominant force in the region will continue to bear fruit if it succeeds in its pursuit of alliance partners. The Taca group should be the first to get antitrust immunity for a codeshare deal with American, which is continuing its overtures to LanChile and Aerolineas Argentinas.
Continental Airlines continues to expand southwards but will face a a tougher time than in Central America if it is to challenge the duopoly of American and United. However, its entry may push US carriers to offer equity as part of any marketing deal.
Iberia continues to cast a shadow over the region, retaining control of Viasa and, through its parent Teneo, stakes in Aerolineas Argentinas and Ladeco. Iberia's repurchase option on the latter pair runs to June 1998 and it has so far resisted LanChile's attempts to buy out the Ladeco stake and complicated Aerolineas' talks with US partners.
The sale of Venezuela's Aeropostale in September 1996 marked the final airline privatisation in the region and the existing alliances face a period of consolidation. The Vasp group has started to reequip Lloyd Aereo Boliviano and Ecuatoriana, but will find its management and financial resources stretched as result.
The final prize for the US carriers lies with Varig, which should emerge as highly profitable by 1998. It is likely to dump existing partner, Delta, and switch to American or Continental.
Privatisation and more commercial management have narrowed the competitive disadvantage between Latin carriers and those from Europe and the US. The principal gaps lie in marketing clout and finance costs.
The former is being addressed through prospective codeshares and initiatives such as the LatinPass frequent flyer programme. Stronger balance sheets and lower funding costs offer Latin carriers the opportunity to build on the consolidation of the last three years. LanChile, Rio-Sul and TAM head the airlines lining up to secure overseas funding next year. Varig may consider the IPO market, but wants the Ruben Berta employee foundation to retain control.
The US is scheduled to renegotiate two bilaterals during 1997, Chile and Brazil. The former has beenthe most contentious in recent years and, while observers expect further liberalisation, they do not forecast open skies. However, the US government may use any potential alliances with US majors as levers to secure more open markets.
The success of the open skies policy among the Andean Pact countries has yet to filter through to the Mercosur states in the southern cone, which failed to reach agreement on a similar policy during 1996.
Executives will continue to wrestle with the US Federal Aviation Administration's tough stance over safety oversight, an issue which has blighted bilateral relations with the US and cast a shadow in the region.
Doug Cameron
Africa
Airlines in sub-Saharan Africa face a crucial 12 months as the combination of domestic and international political pressure pushes them to continue on a more commercial path or face possible extinction.
The last three years have seen a transformation in government attitudes towards many airlines as, pressured by the World Bank and the International Monetary Fund, they have adopted a more hands-off approach.
This policy has brought dividends at a number of carriers such as Ghana Airways, Air Gabon, Air Tanzania and Uganda Airlines, which were on the verge of bankruptcy two years ago. These carriers have moved back to profitability as a result of radical cuts in their operations and staffing levels.
The goal for most governments remains privatisation, but while they will closely monitor the progress of the Kenya Airways/KLM alliance, the reality is that the domestic and international investor appetite is non-existent. Ghana, Tanzania and Uganda have all slated their carriers for partial sale.
The desire to emulate the Kenyan carrier has further slowed the fragile steps towards increased regional cooperation, despite healthy intra-Africa traffic growth of four per cent. When overseas suitors fail to emerge these airlines are likely to look again at links closer to home. 'When overseas investors don't show they will be pushed back together again,' comments Aberra Makonnen, director of corporate and industry affairs at the African Airlines' Association. 'And unless the commercialisation process started in 1992 is completed over the next 12 months some of them will go down.'
As many as three airlines in west Africa and four in the south remain on the verge of bankruptcy. The imposition of the new unlimited passenger liability regime will place a further stern test on carriers in the form of a doubling of premiums.
The South African market remains a benchmark for the region's development, with a final decision on the partial sale of South African Airways expected by June 1997. Zambia Express, the franchise run by the SAA subsidiary SA Express, remains the prototype for this form of operation in Africa and there are plans to extend into other frontline states. Likewise, Comair's franchise deal with British Airways will be monitored closely. This approach could spread through some of the region's smaller carriers, which remain economic even after restructuring.
Doug Cameron
Middle East
Privatisation, alliance building and consolidation may be the forces shaping the global airline business, but the Middle East has remained remarkably immune from them. There is little evidence that the highly charged political role of carriers in this region is set to diminish in the medium-term.
The most significant issue will be the resolution of Gulf Air's future as a multinational carrier. Management will either continue to be hampered by political tension among the airline's four owners or, more likely, regenerated by its transformation into the flag carrier of Abu Dhabi. The fragmentation of the industry in the Arabian Gulf has already seen the creation of separate carriers in Dubai, Oman and Qatar, a process likely to continue.
This fragmentation in the Gulf contrasts with renewed efforts to foster cooperation in the region, with the relaunch of the Arab Air Carriers' Association and the creation of the Arab Civil Aviation Conference bringing fresh impetus to the process. This is particularly strong among the north African carriers, which are keen to improve links through joint maintenance, training and marketing.
The proximity of the north African airlines to the European market has pushed them to take a more commercial approach in terms of fledgling alliance building and, in the case of Royal Air Maroc, the start of the road to privatisation.
The region is also starting to suffer the effects of congestion arising from outdated infrastructure - compounded by overflight traffic growing at 9 per cent a year - and Acac is leading efforts to harmonise ATC systems and fill gaps in coverage, notably in Saudi Arabia and Iran.
Traffic growth of 4.9 per cent a year is above the world average and lags behind only the Asia-Pacific region. This has promoted widespread fleet renewal in the region. The first of Saudi Arabian Airlines' US$7.5 billion order arrives in 1997, while Emirates' capacity will almost double by 2000.
The planned sale of El Al has again been shelved and its fortunes remain linked to the stuttering Middle East peace process, though progress so far has allowed Middle East Airlines to start its modernisation and brought Syrian Arab Airlines out of isolation.
Despite healthy overall traffic growth the benefits are unevenly distributed, with GDP growth ranging from double-digit in Dubai and Qatar to near-stagnancy in Saudi Arabia and Bahrain, with North African states hovering around four per cent. Yields are also under pressure from overcapacity created by Europe-Asia fifth freedom traffic, particularly to Asia-Pacific and the Indian subcontinent.
The outlook is for the Middle East to remain relatively isolated from the wider airline community and driven, with few exceptions like Emirates, by national political and economic goals. Carriers have resisted the development of alliances; the region remains the last home of the true flag carrier.
Source: Airline Business
