Thoughts for 1999 January 1999

Economic analysts are generally being miserable at the moment, worrying about a loss of consumer confidence in the West, the ripple effects of the Asian crisis, the stubborn recession in Japan, imminent melt–downs in Brazil and other developing economies, the impact of the euro, Y2K, etc, etc. Yet the actual GDP forecasts for 1999 are not all that bad, showing a slow–down in growth rather than stagnation or decline. The consensus would appear to be: the US, a real GDP increase of 2.3% in 1999, down from a 3.5% rise in 1998; the EU — a 2.1% rise, compared with 2.8% in 1998; Japan — a 1.0% rise, up from a 2.0% fall in 1998; Southeast Asia — up from negative figures that are too painful to calculate yet.

As usual the airline industry will act as a lead indicator of the global economic trends. But within the industry some new trends will emerge; this is our list of developments to look out for.

Capacity imbalance is becoming a major worry, especially as widebody aircraft are shifting from Asia to the Atlantic. Airlines operating from countries that have signed open skies agreements are potentially the most at risk, whereas BA’s decision to postpone its alliance with American and retain the protection of Bermuda 2 may prove to be the correct strategy in this phase of the cycle. One question that may be answered in 1999 is whether capacity as traditionally measured is now being overstated because code–sharing duplicates the services actually provided.
Buying minority stakes has again become a widely used tactic to assure an alliance partner’s loyalty. These investments tend to pay off when the investor airline also gains management control, and specifically joint inventory control on overlapping routes, as American has done with Canadian and as BA will do with Qantas. Cathay, undoubtedly wisely, pulled out of its 40% purchase of PAL when it became clear that its management authority would not be certain. On the other hand, Swissair has proceeded with minority stakes in flag–carriers, charters and regionals as part of a bold expansion; is this really the way to overcome Swissair’s geo–aero–political exclusion in Europe?
The US virtual mergers face strong opposition from the antitrust authorities, yet two of them — Northwest/Continental and American/US Airways — are still possible or even probable. But some questions are being raised about dis–economies of scope — specifically, FFP amalgamation. By combining major FFPs, airlines risk removing the one characteristic that stops air travel becoming a commodity, so they will have to revert to competing purely on price. Also, by merging FFPs frequent flyers will find themselves closer to critical redemption levels than they would be with separate FFPs — hence the cost to airlines of operating the FFPs will rise.
There are signs that the US will change its rules on foreign ownership to allow an increase in its limit to 49%, which might be enough to tempt Virgin Atlantic into making a bid for a domestic carrier (MidWest Express is a bit of wild speculation). At the same time the US authorities, faced with acceleration (continued on page 2) in the consolidation process, will move further from their traditional $1 attitude towards re–regulation in favour of consumer interests.
The Asian crisis bottomed out in August — in terms of traffic but not yield — and has been staging a tentative recovery since then. SIA will emerge as one of the main global players from the crisis, having established its regional empire with Ansett, ANZ and China Airlines, and its entry into Star will be as a co–equal to Lufthansa and United. Cathay, plus Dragonair, is attempting the same strategy within the now looser oneworld alliance.
Asian governments — in Malaysia, Indonesia, the Philippines and South Korea — are, like European governments earlier this decade, not going to allow their flag–carriers to disappear. The issue is whether Asian aid will prove to be more effective than European aid. If government funds are used to prop up existing networks, which are based on delusions about the role of flag carriers, this money will be wasted; if the funds are used to restructure, downsize and focus on regional markets, then the aid might just be justifiable.
It has been a long time since the last wave of airline bankruptcies. Many of the Asian airlines are in effect bankrupt but, as noted above, will be bailed out by their governments. A couple of the European flag carriers teeter on the edge — will their governments invent a Euro–Chapter 11? In the US TWA has to reverse its losses very rapidly in view of its capital expenditure commitments on A318s and 717s.
A second wave of European flag carrier privatisations is set to occur in 1999. On the blocks are Austrian and Air France (both postponements from 1998), Iberia, the second portion of Alitalia and possibly Aer Lingus. The question will be whether the industry cycle will be strong enough to support these privatisations and indeed whether there is still sufficient investor appetite. There will also be another wave of European regional carrier IPOs or private placements in order to raise the funds necessary to expand their Emb 145/135 and CRJ fleets.
European low–cost carriers are going to consolidate their position in the market if economic conditions deteriorate. Unlike the US in the mid–1980s, they will not be forced out because the cost gap between them and the Euro–majors is much wider than that between the US Majors and US start–ups, the leading low–cost carriers have very good quality management and the regulatory authorities are exercising a type of reverse discrimination. None of the continental Euromajors, constrained by their unions, has yet to develop an adequate response to the low cost threat beyond hopeful reliance on FFPs and slot shortages.
The low–cost carriers will also increasingly encroach on the territory of the traditional Euro–charters, exploiting a change in leisure travel patterns away from packages to shorter, more frequent, more specialised holidays spread throughout the year. Still, the prediction of Stelios Haji–Ianniou of easyJet that the charter sector will disappear completely within five years is a bit extreme.
Another type of airline may be just over the horizon — the long–haul start–up. There is now the realistic possibility of starting point to- point operations on very thin transatlantic routes, using the new 737ER configured to, say, 100 seats. The first airline to contemplate such a strategy, Swiss World, has collapsed but others, and some of the US majors, are starting to take the concept semi–seriously.
In the manufacturing industry, relations between Boeing and Airbus are going to deteriorate. Infuriated by loss of market share, which it attributes to unfair, government- subsidised competition, Boeing may persuade the US government to tear up the 1992 agreement on research and trade in large commercial aircraft.
Radical restructuring of the aircraft financing business will continue with more investment banks purchasing operating lessors in an attempt to boost their RoI. There is also a chance that GECC will sell or float GECAS.

Meanwhile — whether these predictions come true or not — Aviation Economics wishes all the readers of Aviation Strategy a prosperous New Year.