November 1998 Planning for Recession

Aviation Strategy Issue No: 13 November 1998 Planning for recession he only certainties in life are death and taxes; in the aviation industry, the Tonly certainty is that after the longest single upturn in recent history there will be a recession sooner or later. Economists and analysts are capable of Analysis arguing until the cows come home on when the next downturn in the industry will occur and how deep it will be, but no-one argues that the traditional cycle Planning for recession 1 has disappeared (the closest to this viewpoint may be Julius Maldutis - see Aviation Strategy, April 1998). Playing the In an industry where net margins of just 2% are seen as aspirational, a down- alliance end-game 2 turn can be catastrophic - witness the red ink that spread throughout the aviation world in the early 1990s. And in the late 1980s, before the recession hit, every- Why should banks want one knew that a downturn would come - but, with honourable exceptions, very to own operating few airlines had detailed strategic plans for what they would do when it did occur. lease companies? 3-4 A bit of fuel hedging here, the odd spot of cost-cutting there, was just about the sum total of most airlines’ recession planning. US industry over In part this was due to a tendency for airlines to spend time firefighting the peak, but still records rather than look at long-term strategic planning, but it was also due simply to strong results 5-6 poor management. At its extreme the attitude of some airlines was just to let recession occur, and then the carrier would initiate stringent cost-cutting as Pawns in the Asian needed - or, in Europe and Asia, let governments bail them out. alliance game 6-8 Happily, at many airlines things are different today. The shock of the early- 1990s recession along with a significant improvement in the quality of airline Briefing managements throughout the world has now resulted in far more sophisticat- ed long-range planning. For example, in October 1998 United Airlines revealed United and the spirit of details of what it is already doing in preparation for the next recession. Its four- employee-ownership 9-13 part plan includes: • Route diversification. The more geographical spread an airline has, the bet- British Airways - ter it will able to ride out a downturn in one or more regions. coherent strategy, • Capacity switching. With route diversification in place, United is prepared to tactical frustrations 14-17 switch capacity between regions at a moment’s notice (e.g. from Asia to the domestic US market). Management • Cost-cutting. United, like British Airways, has identified what its core prod- uct and assets are. Everything else is, therefore, a candidate for cost-cutting The benefits of or outsourcing - but before a recession hits, not during it. hub-and-spoke networks 18-19 • Yield management. United is introducing measures to keeping high-yield business passengers loyal to the airline. Macro-trends 20-21 An important part of United’s plans - and a measure that is increasingly being seen at other airlines - is a flexible fleet (also see page 4). United is keep- Micro-trends 22-23 ing on 727s and 737s and will ditch them when recession hits (instead of order- ing more narrowbodies, which would have to be cancelled or postponed during a slump). Switching a higher proportion of an airline’s fleet from outright ownership and finance leases to operating leases also achieves the same flexibility. Perhaps the greatest lesson that airlines have learnt in the last few years (or Aviation Economics are still learning) is that market share means nothing if it results in horrendous James House, LG, financial losses. As well as cutting capacity sharply in downturns, this also 22/24 Corsham Street means that capacity should not be overexpanded in cycle peaks. Add to these measures the trend towards global alliances (which will London N1 6DR reduce the effect of a slump on an individual airline), and there is a strong argu- Tel: +44 (0) 171 490 5215 ment that many airlines are better prepared than they ever have been for an Fax: +44 (0) 171 490 5218 upcoming recession. Of course some airlines will always be unprepared - and E-mail: [email protected] they are the ones that will suffer most from the next recession. Aviation Strategy Analysis Playing the alliance end-game he make-up of the handful of major alliance through their networks rather than on an individ- Aviation Tgroupings that will dominate the industry in the ual route-by-route basis. If, as seems likely, the Strategy first decade of the next century is now becoming US Airways and American deal is given the go- is published 12 clearer. But the construction of these groupings ahead, along with a perhaps modified times a year by lies not solely in the hands of the airlines them- Northwest/Continental deal, then there will be Aviation selves, but will also depend on the decisions of four Mega-majors (see table below). Economics on the first of the regulators, in particular the US Department of The final make-up of the US Mega-majors is each month Justice and the US Department of Transportation. pivotal in the shape of the global alliance group- The summer of 1998 saw what appeared to ings. No global alliance can be formed without a Editors: be the final stage of consolidation in the US air- strong US partner and if the US regulators deem Keith McMullan line industry, 21 years after deregulation, with a that the minimum number of Mega-majors it will Nick Moreno series of domestic codeshare agreements and permit is four then this will in turn determine the so-called virtual mergers proposed between number of global alliance groupings. Subscription American and US Airways, Northwest and Of these alliances, arguably the most enquiries: Nick Moreno Continental, and United and Delta. advanced in terms of branding is the Star Tel: +44 (0) 171 The United/Delta deal appears to have self- alliance, with United and Lufthansa as its core 490 5215 destructed because of the demands of the unions members. There is also a large amount of glue at Delta. In any case, most analysts believe that between oneworld partners British Airways and Copyright: the deal would not have received regulatory both American and latterly US Airways, which has Aviation Economics approval given that United ranks as the second now dropped its lawsuit against BA and is explor- All rights reserved largest passenger carrier by revenue in the US, ing ways to co-operate. and Delta the third. They were also in two sepa- The confusion lies with the other two global Aviation rate, competing transatlantic alliances that both groupings. KLM and Northwest have a strong Economics enjoy anti-trust immunity. There is more than a partnership, which is probably the most advanced Registered No: 2967706 (England) hint of suspicion that Delta and United were using of the alliances in extracting revenue benefits. a domestic codeshare deal as a bargaining chip Alitalia is easily accommodated but Continental Registered Office: to block the other domestic alliances. adds the complication that it also has a strong James House, LG The other two transactions remain alive but relationship with Air France. Whilst it would seem 22/24 Corsham St subject to scrutiny by the regulators. The DoJ is sensible for Continental’s management to wish to London N1 6DR VAT No: 701780947 particularly concerned by the clause in the keep the relationship with Air France intact in case Northwest/Continental agreement that will even- the Northwest deal fails to get regulatory approval, Printed by: Printflow tually allow Northwest to take a controlling stake if it is given the go-ahead then surely Continental ISSN 1463-9254 in Continental. will join the so-called Wings grouping? The opinions expressed in The importance for the rest of the world is that This will leave Delta and Air France, airlines that this publication do not nec- essarily reflect the opinions by determining which transactions to approve the already have a codeshare relationship, to extend of the editors, publisher or US regulators will, in effect, also determine the this agreement into a full blown strategic alliance. A contributors. Every effort is made to ensure that the number of global strategic alliances. The US reg- neat solution - but one that leaves Swissair uncom- information contained in this publication is accurate, but ulators have historically generally taken a very lib- fortably positioned. At present Swissair is a mem- no legal reponsibility is eral stance towards airline consolidation, accept- ber of the Atlantic Excellence grouping, which has accepted for any errors or omissions. ing the airline argument that airlines now compete not been marketed as aggressively as either Star or even the fledgling oneworld. Rumours persist that The contents of this publica- THE US MEGA-MAJORS tion, either in whole or in Swissair, and potentially its close partners, part, may not be copied, 1997 revenue stored or reproduced in any American + US Airways $27.1bn Austrian, Sabena and TAP, are considering other format, printed or electronic, without the written consent Northwest + Continental $17.4bn alliance options - in particular Wings and oneworld. of the publisher. United $17.4bn The Swiss more than anyone else await the deci- Delta $13.6bn sions of the US regulators with interest. November 1998 2 Aviation Strategy Analysis Why should banks want to own operating lease companies? he purchase by Deutsche Bank of the the margins seldom exceed 80 bips, such is Tmedium-size US leasing company, the competition among banks for airline Boullioun Services, from Sumitomo Trust, business.

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