Airlines vs the tech giants: the battle of the future?

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With European airlines facing strong headwinds, digital technologies present a huge opportunity but do they have what it takes? Sally White takes a look

Winter is coming!  Not a quote from The Game of Thrones, but a seasonal warning from international consultants McKinsey that European airlines are flying into trouble.  Nor is McKinsey the only one saying that Europeans airlines had but a brief moment in the sun last year. Brokers Jefferies heads its latest aerospace report with a question: ‘August - Where did everyone go?’ With every penny counting as OPEC pushes up oil prices again, the airlines’ online marketing battle to drive passengers to book flights direct is going to hot up.

Jolts, as McKinsey points out, have been coming all summer first with Brexit, then profit warnings from IAG, Lufthansa and Air France-KLM. The latest Jefferies Air Traffic global survey indicates that a rise of only 3.5 - 4% was seen in August, against 5.9% in July and 6% for the year to date.

With every penny counting as OPEC pushes up oil prices again, the airlines’ online marketing battle to drive passengers to book flights direct is going to hot up.

In Europe, however, the last figures from Jefferies, a major international broker, showed that in early September traffic was down 1.3% and had increased by only 0.1% over the past four weeks, 0.5% in the last ten. Lufthansa traffic was down 6.5% in August, although IAG’s rose by 7.9%.

The prevailing winds of the past decade - the rise of low-cost carriers (LCCs) and the ‘Gulf Plus’ airlines (Emirates, Etihad, Qatar and Turkish Airlines), says McKinsey, have wreaked havoc in Europe and are “going to continue to reshape the sector”. The LCCs have contributed to a 40% fall in intra-Europe flight yields, as they doubled their seat capacity within Europe over the past decade and pushing up their share of seats from 27% to 40%. The ‘Gulf Plus’ airlines have doubled the number of European airports they serve and have quadrupled the number of outbound European seats. As a result, European flag carriers have lost one-third of their market and their average yields have fallen by 22%.

The good run of profits from 2015 to 2016 was mainly the result of the fall in jet fuel prices. (Since 1985, says McKinsey, aviation has averaged €13 billion of losses.) Now prices are on the up again, it seems.  

In recent months, another major broker, Goldman Sachs, warns: “European airlines have increased capacity above underlying demand, lowering prices to support volume.” It expects European air capacity growth of 6-8% in Q4 2016 and 5-6% to 2018 while demand growth is running at around 3%.

Latest news, it says, confirms the view that traffic trends continue to deteriorate for the flag-carriers, volumes turning negative “for both Lufthansa and AirFrance-KLM (c.1.5-2.0 per cent y-on-y). IAG’s performance has been more resilient (with 2.7% growth in August, albeit the load factors declined by 100 bp.)”

An exception in this gloom, says Goldman Sachs, is easyJet. “A compelling structural growth opportunity,” continues in the short-haul European market, it says, expected low-cost-carrier penetration to rise 2-4%, to reach 47% by 2019. easyJet is in its view the most attractive way to get exposure to this theme.

What now?  The competition is getting even tougher. The ‘Gulf Plus’ airlines order books are of similar size to their current fleets: Emirates with a fleet of 244 has 298 on order and between 199 and 340 are on order for each of the other airlines, says McKinsey. The ‘Gulf Plus’ airports are planning multi-billion investments to accommodate increased traffic.

Among the LCCs, Ryanair is keeping up the relentless fare price pressure, saying it expects prices to fall by 10-12% over the next six months. In August, Ryanair and easyJet increased enplanements by 11% and 6.4% respectively, Jefferies notes.

So what should happen next? Cost cutting is key, say all three commentators quoted above, to enable the majors to compete on price. It can be done: Aer Lingus achieved a 46% unit-cost restructuring from 2001-2004, TAP achieved 17% over eight years and Iberia 16% in three years. Jefferies begrudgingly concedes that the traditional carriers are making “some efforts” to change their cost structure, including the establishment of low cost subsidiaries.

Business-model convergence is another idea. McKinsey suggests following the LCCs with denser seat configuration, fares with unbundled fees for luggage, meals and early boarding and schedules designed for peak passengers rather than bank structures. More use of loyalty programmes and sales through global distribution systems to premium customers is another McKinsey recommendation.

If other companies can offer a customised experience, why cannot .....an airline

The strategy followed by Lufthansa comes into criticism from Goldman Sachs, as it continues to pursue capacity growth to reduce unit costs. This is “adding risk to already deteriorating unit revenue trends,” comments the influential broker.

HSBC banking group’s analysts are very gloomy about 2016/17, as the European industry “is in an old-fashioned cyclical downturn”. They see consolidation as the only way, Europe having seen relatively little so far compared to other regions.

A solution from top international tech consultants, The Boston Consulting Group (BGC), as it asks in a latest report, is: “If other companies can offer a customised experience, why cannot .....an airline?”  It adds that airlines have “an enormous opportunity - digital technologies having increased the quality and quantity of their available data - to increase revenues by building strong customer loyalty rooted in personal experience”. This could lead to price premiums, cross-selling and brand loyalty and advocacy.

If airlines fail to act, deep-pocketed tech giants - which already have established footholds in travel - or well-funded start-ups may do so instead!

Problem is that traditional airline models do not share data from frequent-flyer programmes, booking or sources such as social media, across functions. The data is in silos, limiting its usefulness, with different functions using different IT systems. Of course, as well as learning new business cultures, BGC concedes, the IT changes would be expensive and airlines also have challenges in data security and privacy.

But BGC gives a warning: “If airlines fail to act, deep-pocketed tech giants - which already have established footholds in travel - or well-funded start-ups may do so instead!”

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