Air Canada/Canadian: consolidation prototype July 2000

The demise of Canadian has left Air Canada with a near–monopoly in its domestic market plus a dominant position on transborder routes where it has a immunised code–share agreement with its Star partner, United. As Air Canada merges Canadian’s operations into its own over the next year or so, it will have the opportunity of realising the economic benefits of industry consolidation, acting a sort of prototype for United/US Airways, American/Northwest, British Airways/KLM, etc.. At the same time consumer groups and government will be carefully scrutinising developments, suspecting that their fears about industry consolidation are also going to be realised.

Air Canada and Canadian have been consistently unprofitable since Air Canada was privatised and Canadian emerged from an amalgam of CP Air, Pacific Western and Ward Air in the late 80s. Last year the two airlines' combined net result was a miserable loss of C$9m.

However, according to Air Canada’s own predictions it will soon turn into one of the most profitable of the North American Majors with an average cost base but yields which are second only to those of US Airways. Its forecast for the period to 2005 is summarised below. An immediate profit recovery is envisaged for this year (unfortunately, these figures were revealed just before Air Canada’s pilots' union threatened strike action, which looks as if it will go ahead in July). Then the operating margin grows steadily form 3.6% in 1999 to 12% in 2005. Air Canada has also produced a "recession scenario " forecast for cynics who don’t believe in steadily increasing airline profits — the impact of that scenario is also summarised below.

What factors lie behind the Air Canada forecast? First, Air Canada now completely dominates the key domestic markets — transcontinental, "Rapidair" (Toronto–Montreal–Ottawa triangle) and intra–Ontario.

It has rationalised capacity in these market — seats offered by AC/CP will be down 18% in summer 2000 compared to last year, and overall market capacity will have been cut by 11%. Some solid fare increases have already been pushed through — up 12% on average last year.

The exception is intra–West where WestJet (see Briefing, March 2000) is expanding strongly. There Air Canada continues to lose money. WestJet has plans to move eastwards, establishing a base at Hamilton in Ontario, but Air Canada in its forecast assumes just "limited expansion" by WestJet.

Regulatory response

Second, Air Canada/United, no longer having to compete against American/ Canadian, has about 75% of the transborder market. Air Canada’s transborder revenues have increased by more than 150% and it is now the carrier’s highest margin business and largest source of earnings. However, Air Canada’s success on this route may provoke a regulatory response. The federal government has already responded to consumer complaints concerns by proposing legislation which will give a new Airline Commissioner powers to investigate fares and collusion, fine miscreants and generally re–regulate the Canadian market. Now it may be considering offering cabotage rights to US carriers in order to increase cross–border competition.

The catalyst for this regulatory change could be strike action by the pilots who are threatening to shut down the airline in July over pay claims and disputes about the division of work between the mainline airline and the regional subsidiaries. Resentment over the last Air Canada strike in the summer of 1998 still lingers.

Third, Air Canada aims to find some C$700m of synergies resulting from the merger of the two airlines' operations (see table above). Some C$250m of these synergies fall into a "quick fix " category and should show up in this year’s financial results.

Admittedly, the various category titles are not very illuminating, but it is interesting that Air Canada feels able to project this level of improvement — equating to about 7% of the combined airlines' 1999 revenues — without any substantial cut–backs in the workforce and no involuntary relocations of personnel.

The combined carrier will also be able to reduce the high finance costs and aircraft lease rates that Canadian was forced to pay because of its parlous financial state.

Air Canada’s management, despite the rumblings from its unions, is projecting a new, confident image, presenting itself as one of the leading US Majors rather than as a semi–European flag–carrier. But the only way in which its strategy can be effectively tested will be in a fully integrated North American market, and Air Canada will resist that development most vigorously.