Memorandum by Christopher N G Tarry (AT
THE AIR TRANSPORT INDUSTRY
I am an investment analyst and head the transport
sector equity research team at Commerzbank Securities. I have
been a follower of the airline industry since late 1986 at which
time British Airways was being prepared for privatisation. I am
a Fellow of the Royal Aeronautical Society and a Member of the
Chartered Institute of Logistics and Transport. I welcome this
opportunity to present my perspective to the Committee on a number
of the key issues that confront the airline industry at the present
time both in the UK and elsewhere.
2. AREAS OF
I will address the following in this submission:
The pre and post 11 September operating
environment for the airline industry.
The nature and consequences of the
fundamental changes in the UK market place.
The nature and consequences of the
fundamental changes in the international market place.
Issues of consolidation.
Constraints to the efficient functioning
of the air transport system.
3. THE CHANGED
3.1 The pre 11 September operating environment
3.1.1 In the period up and until the events
of 11 September 2001, the operating environment for the airline
industry was already showing very clear signs of a marked and
accelerating deterioration. The onset or at least the perception
of an economic slowdown was increasingly evident in underlying
demand and in particular in respect of business travellers in
a number of markets. Research that we had undertaken earlier in
the year indicated a breakdown in the traditionally accepted relationship
between GDP and airline traffic. There appeared to be for example
a stronger relationship between business and related confidence
indicators and traffic. This is in reality unsurprising but meant
that the slowdown in air travel occurred earlier than might have
been reasonably expected on the basis of traditional economic
models. Indeed the US market in particular was displaying the
key characteristics of a mature market and, even before the breakdown
in the traditional GDP based relationship that we identified,
was growing at a fraction rather than a multiple of GDP.
3.1.2 It is important to differentiate between
the cyclical effects that were in evidence and which had begun
earlier and appeared to have a greater intensity, and the ongoing
structural issues that have confronted the industry for some considerable
3.2 The post 11 September operating environment
3.2.1 The immediate and near-term consequences
and reactions to the attacks on the US on 11 September have been
well documented. Whilst some commentators have sought to draw
a parallel with the period of the Gulf War, perhaps the only similarity
is that a major external event resulted in the emergence of the
perception of a threat to travellers. The attacks on the US in
terms of the impact on air travel were orders of magnitude greater.
Whilst airline traffic has begun to recover from the lowest points,
this is largely a reflection of the significant marketing campaigns
that the airlines in the most affected regions, North America
and Europe, have pursued and the resulting price stimulation of
the market. The immediate need for the airline industry was one
of liquidity and the extent of support provided is also well documented.
Operationally the requirement was (and still is) to generate traffic
to produce cash.
3.2.2 The capacity reductions that have
been announced and implemented have been rapid and these to varying
degrees have been accompanied by workforce reductions, although
the pace of implementation has been dependent upon local labour
legislation and the nature of the method of reduction.
3.2.3 Over the next few months attention
will turn to the Summer booking period (generally February/March)
and final decisions over Summer capacity to be implemented in
the timetable from the final Sunday in March. Whilst a recovery
in business traffic is dependent on the emergence of a more positive
perspective for the world's principal economies, recent experience
has shown that at least some of the traffic can be recovered by
price stimulation. One significant unknown is the extent to which
this will result in a further re-calibration of consumers' expectations
regarding air fares, which will place even greater pressure on
costs. There remains a fundamental need for the industry to control
capacity and cut cost.
3.2.4 Over the medium term there is an opportunity
for the industry to emerge from this period of turmoil fundamentally
stronger and more profitable. A reluctance or inability to take
the necessary steps and follow these through will almost inevitably
result in large parts of the airline industry continuing to fail
to realise their potential. In large part future success will
be dependent on the ability to emerge with a more appropriate
cost base, an issue which was very clear even before the events
4.1 Changing market segmentation
The traditional segmentation of the marketplace
into the business traveller and the leisure traveller is far too
narrow. Whilst airlines will tend to report their traffic figures
on the basis of those travelling in economy or coach class and
those that travel in premium (First or Business Class), the reality
is that the segmentation in the market place is more complex.
It is also clear that there is not a "one size fits all"
template that is appropriate. Whilst there is much focus on the
so-called low-cost segmentthe reality for all airlines
is that they must have an appropriate cost base for the revenue
stream that they seek to pursue. The issue is not just one of
traffic but rather whether their cost base allows the traffic
to be profitable.
4.2 An important difference between the customer
and the traveller
At the same time there is an important and significant
difference that has increasingly emerged in the business market
between the traveller and the customer. It is the customer that
pays the cost of travel and it is also clear that corporate travel
policies are more rigorously enforced than in the past both in
respect of volume and class of travel. Minimising cost even in
more normal times is a principal focus area for the corporate
travel office. For the financial control department, travel is
an easy area to cut. This was borne out by the rapid fall in business
travel in the early part of 2001, particularly in the US as companies
became concerned about their own prospects and cut back on travel
budgets. This will also clearly impact the recovery in traffic
in the current environment.
4.3 Changes in the UK industry structure
4.3.1 The UK airline industry comprises
three major types of passenger carrier. The mainline airlines
which accounted for 59 per cent of the passengers carried by the
UK industry; the charter or scheduled leisure carriers which accounted
for 31 per cent; and the low-cost/no frills airlines which accounted
for 10 per cent of the industry's passengers in 2000. These shares
exclude the effect of Ryanair, which is a major participant in
the low-cost segment but is Irish registered. The business models
of the low-cost airlines are not the same, with a significant
difference in the approach of Ryanair when contrasted with both
Go and easyJet.
4.3.2 For the "new entrants" the
opportunities embrace both the development of new markets and
the potential of providing alternative/substitute services to
the established carriers. The ability of these airlines to perform
the second function depends largely on gaining access to the "appropriate"
catchment area. In this respect data from the CAA illustrates
quite clearly that business travellers will select an airport
closer to their home or place of work whereas leisure travellers
are prepared to travel a greater distance to an airport to take
their chosen flight. This is clearly a reflection of the difference
to each traveller of time and price.
4.3.3 In this respect the increased focus
on Gatwick by the low-cost carriers/no frills that is now evident
was to be expected. Firstly from the perspective of these airlines
getting closer to the main origin of higher yielding business
traffic compared with their traditional operating bases to the
North of London. Secondly the apparently high break even load
factors of Go and easyJet even in normal times suggest that there
is a need to enrich their traffic mix.
4.4 Changing International competition and
4.4.1 The most significant developments
in respect of changing international competition relate to the
formation of alliances and other partnership arrangements. Alliances
are not new neither is the perspective that the industry will
centre around three major groupings currently; Star, Skyteam and
4.4.2 There is also little doubt that the
greater the degree of integration, the greater the potential realisable
benefit. However in the current regulatory environment it has
clearly been shown that the commercial agreement between the partners
is significantly more important than any shareholding. A number
of commentators have suggested that the events of 11 September
will almost inevitably result in further consolidation. This is
however by no means certain and it is unlikely to be manifest
by "airline A acquiring airline B". Market exit, whether
partial or total, will also show through as market consolidation.
4.4.3 What is clear however is that international
competition is now to an increasing extent between the networks
of one airline group and its partners and the others, particularly
where there is no direct service between particular city pairs.
The US DOT in October 2000
highlighted the rapid growth in the so-called "behind and
beyond traffic" where passengers from one partner's network
are fed across the Atlantic and out through another partners network
in the other continent. The mainland European and US partners
in Skyteam and Star are able to benefit in this way.
4.4.4 In this respect it is reasonable to
conclude that the relevant reference market for assessing future
alliance developments should be Europe rather than a particular
individual market. However, it is also reasonable to be cautious
regarding the timing of the conclusion of a multilateral agreement
between the EC and the US, when the expected changes in jurisdiction
occur, given the potential for disagreement in a number of areas.
4.4.5 Whilst airline alliances offer the
potential for significant cost cutting much of this may remain
unrealised given the degree of integration and the ceding of control
that is needed to realise the benefit, even before consideration
is given to a merger/acquisition, which in itself will introduce
nationality issues. As a consequence the greater potential for
alliances is through extending the reach and feed of an airline.
The potential in this regard is well illustrated with the alliance
between Air France and Alitalia where the extensive network of
Air France is connected with the under-served Italian market.
The link between SAS and Lufthansa gives rise to similar opportunities
in the Scandinavian market.
4.5 Underlying of fundamental demand
4.5.1 Despite an almost universal view in
the airline industry that it is traffic alone that matters, it
is evident that in more normal times not all traffic is either
good or profitable. It is however clear that traffic that might
not be profitable for one airline can be profitable for another.
It is important to recognise the variation in market maturity,
which in some markets may be absolute, whereas in others they
are only mature at the prevailing price structure.
4.5.2 Analysis that we have undertaken at
an aggregate level in the past has focused on determining and
forecasting what is best described as fundamental demand for in
effect a given pricing environment. Our analysis recognises the
difference between reported passenger traffic and what we would
describe as fundamental demand, which is a reflection of underlying
activity and expectations over the economic outlook.
4.5.3 Reported passenger traffic reflects
the combination of this underlying element and the degree of excess
capacity that exists in the market place. The degree of excess
capacity that exists will in effect determine the pricing behaviour
in the short term given the inability of most airlines in normal
circumstances to adjust capacity rapidly. Excess capacity in the
industry is also cumulative in effect and it is possible that
over the period since 1980, globally, aggregate excess capacity
exceeds fundamental demand by some 30 per cent with the consequent
depressing effect on average revenues. The general underlying
assumption within the industry is one of an inexorable decline
in real yields and this is not misplaced. There is a need for
a structural reduction in both capacity and the industry's cost
base. Without it, the necessary returns for the wider industry
are likely to remain out of reach, with the consequences for funding
4.6 Financial returns
4.6.1 For the traditional airlines, once
beyond break-even some 80 to 85 per cent of any additional revenue
would flow through to profit. The margin performance of the traditional
airline segment suggests however that there has been a breakdown
between the pricing strategies and the cost of operation. The
airline industry provides clear evidence of supply side economics
at work and is also an industry that has suffered from the consequences
of considerable excess supply. The ability of an airline to stimulate
traffic in a market has never been in doubt if it is prepared
to reduce its fare levels to the market clearing price. The problem
has often been an incompatibility of the pricing strategy with
the cost of operations. This shows through in an average operating
margin since the start of the jet age of little over three per
cent and rates of return for the majority of the industry which
only exceed the cost of capital for short periods of time in the
upswing phase of the cycles.
HISTORIC RATES OF RETURN AND WEIGHTED AVERAGE
COST OF CAPITAL
ROCE (adjusted for operating leases)
|Year to March
|Air France||2.1 per cent
||2.8 per cent||6.5 per cent||4.8 per cent
||5.9 per cent||5.5 per cent
|11.7 per cent
||11.2 per cent||6.9 per cent
||5.7 per cent||2.7 per cent
||5.2 per cent|
|7.5 per cent
||4.3 per cent||8.0 per cent
||4.2 per cent||2.0 per cent||4.1 per cent
|7.0 per cent
||5.6 per cent||10.1 per cent
||12.2 per cent||5.1 per cent
||11.0 per cent|
||53.1 per cent||39.3 per cent
||25.6 per cent||15.7 per cent
||12.1 per cent|
|* Results to preceding December.
|Year to March||1996|
|Source: *Company Reports/Commerzbank Securities.
4.6.2 Generalisations are inevitably dangerous and the
experience of the "low-cost" segment in the UK shows
how with an appropriate cost base they are generally able to stimulate
and create a market by adding significant capacity, but profitably.
4.6.3 In particular these airlines have tended in the
first instance to enter markets offering service between particular
city pairs which have been unserved or under-served and which
by definition are not mature and furthermore which are profitable
at the average price levels offered.
4.6.4 It is important to note that transparency on pricing
is not absolute in the low-cost segment.
4.6.5 The reported returns from the airline industry,
where the traditional carriers only cover their cost of capital
in the good times and then make insufficient in this period to
offset the downswing, are increasingly unsustainable. The reality
of this is that unless these airlines are able to improve their
returns then investors will be unwilling to invest for anything
other than the short term.
4.7 Cost issues
4.7.1 There are significant differences in the cost structures
of the participants in the various segments of the airline industry,
not only between long haul and short haul but also as might be
expected between the established airlines and the new entrants.
In the latter case these reflect differences in the method of
operation as well as in the scope and scale of operations.
4.7.2 In the latter part of 2000 and the early part of
2001 labour costs, in the wake of a number of significant settlements
in the US, became an issue of concern in Europe and this was not
aided by the settlement reached with the pilots at Lufthansa,
4.7.3 For any airline not only are a large percentage
of costs determined externally but in any scheduling period they
are also almost 100 per cent fixed. Indeed as the actions post
11 September have shown it is necessary not only to take capacity
out of the market by grounding aircraft but it is also necessary
to remove the associated costs of operating that capacity.
4.7.4 For the new entrant airlines it is possible to
establish the business model from first principles. For the established
airlines the issues are of managing transition to be able to avail
themselves of the opportunities offered in a number of areas.
4.7.5 The use of the internet and other direct routes
to the market for advertising, sales and distribution has been
used perhaps close to its maximum by the new entrant airlines.
The benefits in financial terms are clearly evident through the
low levels of commission costs in particular.
PASSENGER RELATED CHARGES: SELECTED UK AIRLINES
|Passenger services (a) Fixed||11.83
| (b) Variable||0.00||4.32
|Passenger embarkation fees||2.58
|Advertising and promotion||11.20
|Total per passenger||52.79
|Source: CAA Airline Data Statistics 2000.
4.8.1 The traditional measures adopted by the industry
are misleading. The use of ATKs per employee as a key indicator
of productivity, where in effect capacity is divided by the number
of employees, reveals little about the fundamental performance
of the industry. In particular it gives little or no indication
of how changes in this figure translate into an improved operating
result. This particular statistic can of course be affected by
changes in size and route length. All other things equal, a structural
change in an airline's fleet over time will distort productivity
reported and measured in the traditional way.
4.8.2 Revenue and actual cost based measures of productivity
are more appropriate. In this respect measures that reflect for
example the cost per flying hour set against the revenue gained
per flying hour will provide a better basis for analysis and evaluation.
4.9 SLOTS AND
4.9.1 There was a certain inevitability that one of the
key issues once again in the regulatory deliberations concerning
the proposed alliance between British Airways and American Airlines
would be Heathrow slots. It would appear reasonable however, that
since the focal point for the relevant market is Europe to the
US, and that as competition in this market is between the airline
groupings, attention should focus on the scope for the existing
Heathrow operators to cede slots to their partners to gain access.
HEATHROW SLOT SHARES
|Of which BA||36.4
|Total of these||88.3||89.0
|Source: Commerzbank Securities from ACL data August 2001.
4.9.2 Of course it is easy to point to the share that
OneWorld grouping has, but in relative terms this is a smaller
share of slots than any of the European partners of the competing
alliances hold at their respective home bases. Indeed, BA's share
of slots at Heathrow is markedly lower than its European competitors
at their principal bases. (BA's slot share differs between these
tables as it reflects a different data source and the period used.)
ALLIANCE EUROPEAN PARTNERS' SLOT SHARES AT HOME AIRPORT
|Airport||Share of slots|
|Air France||Charles de Gaulle
Source: Commerzbank Securities/Airline Business.
4.10 Constraints on the efficient operation of the air
transport system in the UK
4.10.1 For any airline operating a high intensity operation
at a congested airport there are significant cost penalties that
are incurred. Whilst there are valid concerns regarding putting
too much store by the use of hours and minutes flown as a meaningful
measure of productivity, the data can provide a useful indication
of the differences in utilisation.
4.10.2 In 2000 British Airways and bmi British Midland,
both operating a substantial part of their system out of Heathrow,
reported utilisation of between 6.5 and 7.7 hours and 7.5 and
9.4 hours a day respectively for their short-haul fleets. This
compared with 9.1 hours for Go and 11.1 hours for easyJet. The
data for Q2 2001 is presented as Appendix 1 on a wider basis showing
actual utilisation as a percentage of the aircraft hours theoretically
4.10.3 Congestion and delay is a very real impediment
to the efficient operation of the airline industry in the UK and
indeed elsewhere. It is unlikely to be relieved either by Terminal
5 or the provision of incentives by the CAA for BAA to increase
slots at Heathrow to 480,000 a year which will require additional
delays to be borne by airlines and passengers. Indeed the CAA
itself recognises that the binding constraint at Heathrow is the
runway or in effect the absence of an additional runway capacity
and that it is unlikely to be relieved in the period to 2007.
As traffic recovers there is an inevitability that airlines and
passengers will have to endure additional delays both foreseen
and incorporated in the schedule and unforeseen in this regard.
4.10.4. British Airways also suggested that delays caused
by BAA at Heathrow cost them some £60-£70 million in
the previous calendar year before some £25 million of cost
4.10.5 At an aggregate level for 2000 the data collected
by Eurocontrol's Central Office for Delay Analysis (CODA) showed
significant delays at the key UK airports. These delays are however
not wholly unexpected and insofar as they are foreseen are included
as a buffer in the timetable. For many airlines, arriving close
to time ensures that the integrity of the network is maintained.
This is clearly much more of a pressing issue for the operator
of a high intensity short-haul network.
MINUTES OF DELAY 2000: DEPARTURE
|Minutes of delay
||% of flights delayed||Average delay|
|Source: Eurocontrol: CODA
MINUTES OF DELAY 2000: DESTINATION
|Minutes of Delay
||% of Flights Delayed||Average delay per delayed flight|
|Source: Eurocontrol: CODA
4.10.6 An analysis of an airline schedule over time will
give an indication of the extent to which the provison for delays
has increased over time. In this case analysing the British Airways
schedule shows increases of:
12 per cent on the HeathrowGlasgow route between Summer
1989 and Summer 2001
14 per cent on the HeathrowParis CDG route between Summer
1979 and Summer 2001
18 per cent on the HeathrowFrankfurt route between Summer
1979 and Summer 2001
33 per cent on the GatwickFrankfurt route between Summer
1979 and Summer 2001
4.10.7 Most recently, and again as might be reasonably
expected, the CODA data for November 2001 shows a marked reduction
in delays. In particular in November 2000 some 19 per cent of
Heathrow departing flights were delayed for an average of 19.1
minutes. Similarly 18 per cent of the flights arriving at Heathrow
were delayed for an average of 23.8 minutes. The corresponding
data for November 2001 does not include Heathrow in the departure
delay table and only 5 per cent of arriving flights were delayed
(but for an average of 28 minutes). Reduced delays however are
likely to prove to be a temporary phenomenon and the underlying
issue that remains to be resolved when traffic recovers to previous
levels is one of terminal area delays.
C N G Tarry
4.9 AIRCRAFT UTILISATION
|Aircraft type and airline|| Sector length|
| Passenger flights|
|BMI British Midland||674
|British Airways (Euro Ops Gatwick) ||759
|BMI British Midland||664
|British Airways (Euro Ops Gatwick) ||1,012
|Airtours International Airways Limited
|AIRBUS A320 100/200||
|Airtours International Airways||2,135
|BMI british midland||655
Memorandum by the British Airline
Pilots Association (AT 36)
AIR TRANSPORT INDUSTRY
In responding to the Select Committee invitation BALPA wishes
to bring the committee's attention to the effect of the recent
terrorist atrocities and their aftermath to the UK airline industry.
As the Trade Union and professional association representing around
8000 commercial pilots we are represented in most carriers in
every sector of the industry. We also have a unique perspective
on security issues as our members are directly in the front line.
We concentrate here on the economic and employment aspects of
the crisis, but we also look forward to measures, which can help
the UK sustain and improve its leadership in European commercial
The effect of September 11 has done more than exacerbate
a downward trend it has effected a catastrophic short term reduction
traffic, including the temporary closure of US airspace, and led
to a medium term depression in the airline industry. Even the
most optimistic forecasts do not foresee a full recovery before
the third quarter of next year and many see recovery being delayed
until the first quarter of 2003. In many ways the impact of the
current industry crisis has been worse than the Gulf war aftermath
the only comparable event. One respected airline economic consultancy
estimates the impact to be twice as bad as the Gulf War, with
long-term uncertainty for business travel as the most significant
If there was any doubt about the overall economic contribution
of the air transport sector they have surely been dispelled by
the events of September 11. According to a recent report by Oxford
Economic Forecasting air transport contributed £10.2 billion
to UK GDP (1.4 per cent of the total). Previous
rapid growth and projected growth meant aviation was growing four
times more quickly than the rest of the UK economy, and would
contribute two per cent to GNP by 2015. Moreover the growing sectors
of the UK economy such as information technology, biosciences,
telecommunications and tourism depend heavily on air transport.
The sector sustained directly 180,000 jobs or 0.8 per cent of
total jobs in the UK.
In addition aviation demonstrates considerable "multiplier
effects", sustaining up to three times the number of direct
jobs through the supply chain induced effects and jobs directly
relating to the tourism which air transport facilitates. In terms
of macroeconomic impact aviation was responsible for £6.6
billion of services, 11 per cent of UK service exports and three
per cent of total UK exports. The industry helped Britain's export
effort by transporting £35 billion of exports, amounting
to one fifth of all exports. The contribution to the exchequer
of this vital industry is conservatively estimated at £2.5
billion although the real contribution is thought to be far higher.
Aviation also provided about three per cent of UK business investment
As the lynchpin of the UK's rapidly growing tourism industry,
the sector sustains an estimated 200,000 jobs.
Given the economic, and social importance of the air transport
industry to Britain, we are deeply concerned about the industry
future in the light of current events. In our submission we wish
to make several key points.
1. To outline the extent of the crisis and its effects
on BALPA members and the airline within which they are employed.
2. To place the crisis in its correct context as a major
"discontinuity" in the industry's development.
3. To discuss the issue of government assistance both
here and abroad
4. To suggest some initiatives which might help alleviate
the current situation and facilitate long term restructuring.
5. To suggest some measures which might help the UK to
emerge from the current crisis in the best possible position.
2. THE CONTEXT
3. Since September 11 the UK airline industry has undergone
a well-documented period of severe financial and economic discomfort,
extending across all sectors. The entire industry has been affected,
from the largest intercontinental flag carrier to the smallest
training school, affected by the glut of commercial pilots.
4. THE IMPACT
1 FOR BREAKDOWN
5. It is important when assessing the impact of September
11 and its aftermath that we recognise the diversity of the airline
industry, addressing issues within particular sectors, rather
than viewing the industry as one entity. Throughout this difficult
time BALPA has worked constructively with the airlines concerned
to find a productive solution to the short-term problem. Whilst
ensuring that the resources for future growth were in place.
6. THE MAJOR
7. Before September 11. In truth the industry was on
the cusp of recession but was taking steps to manage that downturn.
Carriers had already taken reduced capacity, rightsizing their
workforces accordingly, and were exploring further changes. The
unions across the UK industry understood and supported this. Having
laid the foundations for recovery, the industry suffered the catastrophe
of September 11, which must be seen as a major shock and discontinuity
to the industry. There may well have been a recession but effectively
September 11 has not only exacerbated the situation it has worsened
the situation markedly. We would argue that whilst carriers may
have had plans to rationalise their operations, September 11 by
putting the industry into what is effectively a demand side depression
has made it necessary that many take action. Transatlantic yields,
which provide most of the revenue are down 60 per cent, the number
of passengers flying has fallen as uncertainty grips the US and
elsewhere. The difficulties in air transport have repercussions
for the rest of the economy.
8. The worst affected areas of the industry are those
with a direct exposure to the transatlantic market, where both
revenues and yields have plummeted. This has led to major problems
for the main scheduled carriers British Airways, Virgin Atlantic
and BMI British Midland. These carriers have varying degrees of
exposure to the transatlantic market, which is the most lucrative
premium market in the global airline industry.
9. BA has suffered from both the US shutdown and a prolonged
fall of in revenues. Their premium business class product, revamped
to great acclaim and attracting business from other carriers was
heavily dependent upon strong transatlantic traffic. Whilst yields
had started to fall of pre September 11 as the industry faced
a predicted downturn (see below), the terrorist actions have placed
revenues from this source to a degree greater than any cyclical
economic effect. Business travel has fallen off as companies curtail
travel for security and cost reasons. In total BA's latest yield
figures show that current yields are down 25 per cent on November
10. In effect these transatlantic revenues have cross-subsidised
other aspects of the BA operation, maintaining BA's position as
the UK network carrier in the European and global airline industry.
These issues have prompted both major redundancies as BA strips
out capacity, and adapts to a lower yield environment, and have
also led to the early withdrawal of older 747 fleets signalling
the demise of the flight engineer, and have also required staff
pay sacrifices in respect of a deferred pay claim and Christmas
bonus payment. The airline has also been forced to re-appraise
the future "size and shape" although detailed proposals
have yet to be advanced.
11. Virgin Atlantic also suffered from the loss in transatlantic
revenues where the effects were arguably more concentrated given
the carrier's exposure to long haul traffic, and to a US/Caribbean
focused leisure business. Virgin was also harmed by the fact that
its traffic mix is exclusively international save for some abandoned
feeder routes and as such has been affected in every international
market. As the UK's second Transatlantic carrier with a large
exposure in terms of both services and revenues Virgin was forced
to take immediate action. This meant that retirement of all remaining
older 747 classic aircraft which in addition to BA withdrawals
has effectively ended the requirement for flight engineers certainly
in the UK. These withdrawals also affected a large number of pilots,
many of whom were made redundant. The carrier also terminated
its A320 operation servicing the UK from Athens causing further
job losses. BALPA negotiated a restructuring package with the
company to facilitate fair redundancy but we were still left with
152 job losses. In addition to job losses the redundancy process
has brought reductions in pay through demotion for those losing
command positions. This is usually the case where compulsory redundancies
12. bmi British Midland was also affected by transatlantic
exposure, primarily because such services were the basis of planned
expansion. The carrier also suffered falling revenues and yields.
Overall the company put forward a business plan, which envisaged
a reduction in capacity of 16 per cent. The most immediate impact
was a withdrawal of aircraft used primarily to operate inclusive
tour routes for holiday companies; they were also affected by
the general downturn. Bmi has also curtailed its European route
network, as overall air transport has fallen in the short term.
109 confirmed job losses with further demotions have resulted,
although the company council and BALPA have negotiated ground-breaking
part time working deals. Some pilots have opted for 50 per cent
13. Other carriers have been less badly affected by the
direct problem of transatlantic losses. But these carriers and
others have suffered in any case from the general anxiety in consumer
confidence, and the general downturn in the economy, which though
evident before September 11, was being dealt with by carriers.
14. These are all worrying developments however we believe
that the overall demand for air travel remains strong, and that
with the reductions in capacity which have taken place, the industry
has taken steps to ensure that it can recover quickly. There is
encouraging news from festive forward bookings, which suggest
that the urge to fly again has returned. Leisure passengers are
also hugely important to the industry, and it is to this sector
we now turn.
15. THE LEISURE
16. The UK leisure carriers continued to fly throughout
September 11 primarily because bookings are committed in advance
and fearful flyers would have lost their deposits. However other
concerns particularly about domestic job losses could affect consumer
17. Nevertheless there has been a reduction in capacity
across the industry, and a wave of redundancies. Pay restructuring
has also been in evidence, as have been the suspension of working
agreements. In our view the sales outlook in the charter sector
is not as pessimistic as some operators originally claimed. Indeed
a recent survey commissioned for ABTA points to a 5 per cent reduction
in holiday bookings generally. Some two million fewer holidays
are being sold this time. Leading to a more sustainable market.
We expect that consumers will continue to travel, and that many
are waiting until the last minute to secure discounts. Many industry
analysts believe that the withdrawal of capacity is an opportunity
for carriers to firm up prices, before the January booking season.
In our view the airlines have by cutting capacity so precipitately,
exposed themselves to the problem of possible undercapacity when
the market recovers. We find it worrying that many carriers are
actively seeking to operate a "winter crewing" business
model, whereby they procure extra capacity from outwith the UK/EU.
We have written to DTLR and made clear our opposition to such
a strategy and discuss this further below.
18. THE LOST
19. The low cost operators seem to be proving that there
is a market for air transport, although many enjoy significant
cost advantages. Both Ryanair and easyjet have discounted fares
to grow the market and have been maintaining and improving their
market share, often at the expenses of major airlines. However
there has also been sustained discounting, and whilst this guarantees
cash flows it does reduce margins. Yet low cost airlines generally
with access to low cost airports, less congested airports can
achieve the required utilisation to profit from this business
model. Other low cost operators such as GO and Buzz the KLM subsidiary
have also expanded. The expansion of low cost carriers is something
we welcome, and their existence has absorbed at least some of
the surplus pilots ejected from the UK industry.
20. REGIONAL OPERATORS
21. The regional operators have also been affected to
varying degrees, Gill Air a regional carrier operating from Newcastle
on a network servicing Air France and operating its own point-to-point
services was, we feel, hastily liquidated in the immediate aftermath
of the attacks. Financial market nervousness is a factor in the
industry's problem, and those carriers with little or no access
to additional borrowing possessing saleable assets, are most at
risk. 93 pilots and additional other staff lost their jobs at
Gill Air, which may have had a viable financing as a result. We
have just learned that another UK operator British World which
strictly falls within the "supplementary/ad hoc" category
has also filed for bankruptcy. The carrier had earlier withdrawn
fleets, and demanded a 15 per cent pay cut from some staff, and
has clearly been affected by the tendency in recessions for carriers
to minimise wet leasing and chartering.
22. Other regional operators have been largely unaffected
although those who provide a feeder role to major carriers such
as BMI commuter, where there have been job losses and BA Citiexpress
where restructuring is underway have been affected. Other regional
operators have seen increased traffic as more people choose to
avoid the congestion of large hubs.
24. How can the industry be assisted to overcome the
effects of September 11? We outline briefly our views below. But
we wish to look forward and to look positively at the opportunities,
which will present themselves when the industry recovers. Many
of these issues will be short term but the best assistance government
can give is to recognise the industry as a pivotal sector of the
economy which needs clear policy and direction. We outline the
issues we wish to see addressed below:
25. GOVERNMENT AID
26. Whilst being hobbled by the crisis the industry has
also faced a continued drain on its resources. The requirement
to increase security has been a major cost burden for airlines,
as have increased insurance costs. Though we very much welcome
the government's support to the industry in the form of underwriting
guarantees, these costs are but one aspect of the increased industry
cost burden. US carriers have asked for and received substantial
state support in the form of compensation for losses, help with
security measures and structural aid. These amounted to $18 bn
in total. In Europe the Commission has re-iterated its view that
state aid should not be used to bail out stricken carriers, although
state bank guarantees and other actions cannot be so readily detected.
The commission in its report of October 2001 gave permission for
national governments to compensate carriers, and we wish to see
the UK government use this authority more widely.
27. Government has come forward with compensation for
estimated revenue losses on the shutdown days, however this support
whilst in our view welcome, goes only part of the way. Government
needs to do two things. Firstly it needs to recognise that UK
carriers are under medium and long-term threat from US carriers,
who have benefited from large-scale subsidy, and from a number
of government interventions, which are in our view akin to state
aid. It also needs to recognise that the industry is a strategic
one with wider impacts on the economy. Because of that impact
it is important the government works with the airlines, the tourism
and hospitality industry and other affected sectors to build the
necessary confidence and ensure that people have both the confidence
and the opportunity to fly on UK airlines.
28. CONFIDENCE BUILDING
29. Demand Side Measures
30. Government can provide the necessary framework by
facilitating general drives for tourism and commerce and by encouraging
people to fly in greater numbers and more frequently. This applies
as much to business as to leisure passengers. Whilst a tourism
tax credit of the type introduced within the US might be more
complex to administer in the UK, we still feel this is worthy
of consideration. We would still suggest that some immediate relief
could be given to the UK industry, which would ease the airlines
cash flow position. We re-iterate here our plea for an easing
of the costs burden through the withdrawal of Air Passenger Duty
as stimulus to the industry, and/or its hypothecation to the industry.
The removal of APD would act to stimulate the industry and make
fares more attractive.
31. Recent precedent for helping stricken industries
includes Government's £1.2 billion compensation to farmers
so far this year. Aviation worth 1.5 times farming industry in
GDP terms has at least the same right to crisis aid.
32. Government can afford to help the aviation industry
with at least eight billion in unallocated reserves and underspend
on this year's budget.
33. We would also suggest that government provide comprehensive
assistance with security costs, although in this submission we
do not wish to make specific recommendations on security per
34. However we need to invest in new aviation security
measures. This would be very easy to justify in political terms,
given the timbre of public opinion. Good security is quite costlyEl
Al spends two per cent of its revenues on security, compared to
a US/EU average of 0.25 per cent.
35. Supply Side Measures
36. There are a number of issues which we believe need
to be addressed in the context of the industry crisis, both to
guard against a temporary complacency which the current temporary
downturn may encourage, and to promote a longer term approach
to policy on air transport if these decisions are taken then the
industry which be able to benefit from the growth which is predicted.
37. The main point to make is that the industry globally
will recover. It may well recover on a different basis, and on
a more modest growth path than previously believed, however it
will recover. Longer term planning for growth needs to take place
now given the long lead times in the construction of airport infrastructure.
Even the mid range forecasts from ICAO suggests that air passenger
traffic could grow six fold between 1990 and 2050. The bulk of
this growth will come in the first three decades. The UK authorities
predict a doubling of air traffic on the mid range forecasts between
2003 and 2015. The events of September 11 may have a lasting impact
in changing the nature of air transport, but they will not threaten
its growth, as the growth of air transport is a constant in a
globalising economy with an increasing proportion of tradeable
services. When the industry does rebound, we need to ensure that
UK carriers are not put in a position where they are disadvantaged
either in the short or long term.
38. Firstly, whilst security is a specialist and sensitive
subject, and one, which we will not address specifically, government
needs to take account of the very real impact September 11 has
had on UK carriers in this regard. The government guarantee of
insurance cover is most welcome. However the UK with its high
level of aviation security has borne these costs without government
support for many years, whilst carriers in other nations and particularly
the US have had these subsidised by government. Aviation security
is an issue in which we would like to see government take an increasing
responsibility. Allowing our operators to preserve and extend
the high levels of security currently available in the UK.
39. Secondly in the short to medium term, we need to
ensure that current re-negotiations on Air Service Agreements
do not disadvantage UK carriers in relation to those in the US.
There is every sign that starved of growth in the US; many US
carriers will target Europe and particularly Heathrow as the major
transatlantic business hub. Existing market distortions particularly
the continued protectionism within the US market suggest to us
that we should not surrender the bilateral treaty Bermuda II at
this critical time. We are particularly concerned that such negotiations
are being linked to the granting of anti-trust immunity for certain
alliances. We re-iterate our concerns as voiced in the Aviation
Forum's evidence to the select committee on Air Service agreements
(HOC 2000). We agree with a re-negotiation on the basis of managed
regulation, but we feel regulation continues to be necessary.
40. Thirdly the UK government needs to take positive
action as it reviews aviation policy to address the problem of
infrastructure. The UK's major hubs and increasingly the secondary
hubs are operating up to and over capacity. Poor terminal facilities
and inadequate runway capacity, as well as a disproportionate
attention to environmental objections, and a cumbersome planning
process have delayed and frustrated growth in the UK. Whilst the
granting of permission to build Heathrow's fifth terminal has
been a ray of light in the planning process it was well overdue
and will now not be ready for many years. By the time T5 is ready
greater capacity will be needed if our airports are to compete.
The government needs to consider two issues.
41. Firstly we need to ensure that existing terminal
and runway capacity can be utilised effectively, within the constraints
of reasonable environmental objections. This means a more balanced
approach between the objections of those who have lobbied on for
example night flights from UK airports, or on changes in runway
use, and those who benefit in both jobs and access to air services.
42. Secondly we need to encourage long-term sustainable
growth in the industry, to allow the UK to compete as an aviation
hub with the rest of Europe. That means additional infrastructure
and airport development. The balance must be struck between the
economic and social benefits of continued aviation growth and
reasonable measures to protect the environment and communities.
However those communities, which stand to benefit, from jobs gained
and sustained in air transport must be listened to. The events
of September 11 have shown in graphic detail the employment multiplier
effects of our air transport industry. The cancellation of flights
has affected not just the airlines and the tourism and hospitality
sector but also a myriad of suppliers, providing everything from
food and drink to specialist computer equipment, training, transport
and a host of other services. All of these are dependent upon
air transport. Air transport is a key industry and needs to be
seen in that way.
For air transport to grow and recover it needs to have the
resource base to benefit. One worrying issue of current pilot
lay offs is that they may encourage airlines to believe that pilot
shortages are over for now. Indeed it is important that we use
the breathing space afforded to examine the whole issue of pilot
43. Pilot Availability:
44. The dynamics of the industry suggest that when traffic
recovers everyone will want to expand at the same time. Recovery
may be on the basis of lower yields as carriers discount, to build
cash flow, but in a network industry everybody is tempted to expand
at the same time and everyone searches for the same inputs. As
yields recover and profits grow then expansion will continue.
In that sense the issue of training and recruitment is more crucial
than ever because one issue, which will affect the airlines, is
their ability to recruit and retain skilled staff, including pilots.
These shortages could be the main constraint on expansion and
could severely limit the UK's ability to preserve its comparative
advantage on air transport. The continued growth of job opportunities
for pilots in the future means that we need a sustainable and
dynamic training effort; at the moment our training is ad hoc
and inconsistent. The route to airline pilot training is expensive
and unlike that in other countries does not benefit from favourable
tax treatment. VAT for example is levied on this vital element
of vocational training. This disadvantages the UK training industry,
which is a vital part of our air transport industry and creates
a distorted market favouring European competitors.
45. Assistance with training
46. Government can also assist by taking action to ease
the training of skilled staff into available jobs. Government
could for example offer through the DFW subsidised low interests
training loans, or could even underwrite the training cost under
EU restructuring criteria. This would help both cash strapped
airlines and unemployed qualified pilots. For example there are
many qualified A320/A340 pilots at both Captain but mainly FO
level. The transition training for these pilots to get them into
positions with the low cost carriers, where there are vacancies
on the 737 fleets would be minor but welcome to those involved.
Government could also assist the flight engineer community with
retraining costs, and help facilitate their absorption in alternative
47. Restrictions on Work Permit issues and wet leasing
48. One issue, which still threatens the employment of
UK pilots, is the continued use of work permits for non-EU nationals
and the one issue of wet leasing of capacity whereby aircraft
and crews are hired on a temporary basis to cover capacity shortfalls.
49. On the specific issue of work permits and the recruitment
of non-EEA pilots. We have written to the DTLR and the Overseas
Labour Service outlining our view that there should be no new
issue of permits, and no extension of existing ones whilst the
current crisis prevails. We have around 700-1000 redundant commercial
pilots, many of whom we expect will be unemployed for at least
a year. Those pilots in training who have contributed hugely to
their own training costs are also disadvantaged as work permits
are usually sought to employee fully "type rated" pilots.
This allows some carriers to minimise training, and should we
believe be discouraged if the UK is to develop a sustainable supply
50. We have also asked DTLR to refuse applications for
wet leasing when the UK currently has excess capacity. In our
view the rationale for either measure no longer applies when the
industry is suffering from excess capacity. The relevant legislation
(EU Regulation 2407/92) specifically states that such leasing
should be carried out only under exceptional circumstances. A
number of operators are actively committed to a business model
which uses wet leasing to develop new routes and services, and
who aim to maintain these arrangements long-term.
51. We are especially concerned that operators, who have
reduced capacity before any evidence of a sustained downturn,
are not encouraged to supplement that reduced capacity with wet
leasing. Wet leasing is appropriate where carriers come up against
immediate capacity restraints, and short-term emergencies. However
where it becomes a structured and planned business strategy; it
can only undermine UK carriers and UK pilots and crews. The UK
has a quality air transport industry with most of Europe's leading
leisure airlines. By allowing some sections of the industry to
source capacity on a wet lease basis we threaten that quality.
It is vital that we preserve the UK reputation as the leader in
quality and safety. We leasing especially at a time of unemployment
and overcapacity destabilises that quality, and we believe through
fragmentation and the use of varying operational standards can
also potentially threaten safety.
53. The UK industry has been and will continue to be
severely affected by the events of September 11. Our members have
suffered with other workers from the crisis, and continue to suffer
from the uncertainty, which has affected the industry. We have
suggested measures, which can alleviate the current situation,
but we have also suggested measures, which are more long term.
In our view, the industry still has a vibrant future and we need
to lift our sights beyond the current crisis and take positive
action to ensure that our air transport industry can benefit from
that growth albeit with the increased security and re-assurance
which passengers and flight crew alike demand.
Dr John McGurk,
Head of Research and Communication
OUTLINE OF JOB LOSSES AND PAY CONDITIONS REDUCTIONS UK
|Air 2000||17-72||Up to 30
|British European||40 proposed
||20||May re-assess given more favourable environment
|British World Airways||100
||Closure of carrier
|BMI British Midland||109
||55||Deferral and suspension of long haul pay
||Proposed deferral||Negotiations on alleviation to scheduling agreement
||Pay increase granted||Could suffer from loss of Hadj charters
||9 per cent pay cut||Loss of Swissair contracts
||Closure of carrier
||Pay freeze to cope with revenue and profits loss
||Proposed pay cuts of 15 per cent
||Possible job losses|
||May be mitigated by route expansion
||Mainly through natural wastage
||Company will review operations post Christmas to assess impact
Supplementary memorandum by the Civil
Aviation Authority (AT 07A)
OF 10 JANUARY
Q1. In the CAA's written evidence it states that "new
entrants put considerable pressure on any airline with poor products
and/or high cost structures". Given that that is the case,
to what extent is the current slot situation at Heathrow and Gatwick
"protecting" inefficient high cost carriers?
The administrative slot allocation system and the principle
of historic precedence that lies at its heart has allowed airlines
to retain slots at congested airports from one year to the next
provided they do not fall foul of the use-it-or-lose-it rules.
This has certainly constrained the ability of new entrants to
acquire slots at Heathrow and Gatwick. Consequently, the competitive
pressure that incumbents have faced from new entrants has often
been more muted than it might otherwise have been.
However, we are not able to quantify the extent to which
incumbent carriers are being protected, particularly given the
existence of a "grey" market in slots. Establishing
a properly functioning secondary market in slots should significantly
improve the position, in terms of both the competitive pressure
exerted through new entry and the efficient allocation of scarce
airport capacity. It would also confront the existing users of
slots with their true value, which should make it less likely
that slots are used inefficiently.
It should be added that the current slot situation is not
the only constraint which serves to protect incumbent carriers.
The artificial constraints imposed by the inter-governmental system
of bilateral air services agreements, with its restrictions on
numbers of airlines, routes, frequency and capacity and fares
and, most fundamentally, the nationality of the ownership and
control of airlines, have had a much greater effect.
Q2. To what extent is the continuing lack of slots at the
major London airports influencing what would otherwise be the
natural development of the UK airline market?
There is no doubt that the scarcity of slots at Heathrow
and Gatwick has had a profound influence on the development of
the UK airline market. If capacity at Heathrow had expanded to
meet the demand for slots, for example, it is likely that the
UK airline market would have developed rather differently from
the way it has. Precisely how it would have differed is, however,
difficult to say.
Having said that, scarcity is by no means unique to airport
slots. Many industries and markets develop in an environment in
which one or more factors of production are scarce. In order to
achieve an economically efficient outcome, the normal approach
would be to ration scarce resources by means of price. In the
CAA's view, the same principle should be applied to scarce airport
capacity through the establishment of a properly functioning market
Again, as noted above, the artificial constraints imposed
by the inter-governmental system of bilateral air services agreements
will also have influenced significantly the development of the
UK airline market.
Q3. Evidence from ACL indicates that the largest increase
in slot requests is at Gatwick, and that there has been a decline
in requests at Stansted. That evidence appears to be at odds with
the CAA evidence, which suggests that Gatwick is likely to be
more affected by the events of 11 September than Stansted. Does
the CAA accept ACL's analysis and what is the CAA's view of the
potential impact of those trends on the industry?
The CAA has no reason to dispute the evidence provided by
ACL. As the body responsible for the allocation of slots at Gatwick
and Stansted, ACL will have detailed first-hand knowledge of slot
requests and usage. The CAA's evidence on this point was based
in large part on BA's announcement that it would be reducing some
services at Gatwick and transferring others to Heathrow. There
were also reports of cut-backs by other Gatwick operators since
11 September, including the main charter carriers. On the other
hand there still appeared to be growth at Stansted with the latest
data then available, provisional statistics for October, showing
a 5 per cent increase in passengers there as compared with a 13
per cent decline at Gatwick. At that time it was unclear whether
any airlines would be looking to introduce new or expand existing
services at Gatwick. In the event, however, it appears that a
number of airlines, notably easyJet, have obtained slots at Gatwick
in order to operate new services. To the extent that the expansion
of low-cost carriers' services at Gatwick is likely to intensify
the competition faced by services operated on parallel routes
from Heathrow, this is to be welcomed.
Q4. Do you consider that now is the right time to be advocating
a change to the charging regime at regulated airports that will
inevitably increase airports' charges to airlines?
The CAA is required by the Airports Act to set price caps
on airport charges for the five years to March 2008, with these
not coming into force until April 2003. While some airlines are
currently suffering financial losses in the wake of the 11 September
attacks, the position may look very different in 15 months time
when the new price caps come into effect.
The Airports Act gives the CAA a number of statutory objectives,
including that of encouraging investment in new facilities at
airports in time to satisfy anticipated demands by users. The
CAA's priority in terms of the future economic regulation of BAA
is one of investment. Heathrow in particular continues to exhibit
substantial excess demand. In these circumstances the CAA believes
that price increases need to be permitted to secure greater investment
in capacity and service quality and to improve the efficient use
of existing capacity.
ON 9 JANUARY
Insurance and security costs
The CAA sees no case for the Government to compensate UK
airlines for increased costs associated with insurance and security.
To the extent that costs have increased, these might either be
absorbed by the airlines or passed on to consumers in the form
of higher fares. How much they can be passed on to consumers will
in practice depend on the level of competition in any given market.
In fact, many UK airlines have implemented fares surcharges to
cover the increased costs associated with security and insurance.
These surcharges have generally been set at £2.50 per one-way
sector. The CAA saw no reason to intervene to prevent these surcharges,
but has approved them only until the end of March 2002 in order
that the position can be kept under review.
North Atlantic fares
Since 11 September there have been a number of pricing initiatives
by US and UK airlines, as one would expect in any event at this
time of the year. Under the terms of the bilateral agreement,
US airlines file their fares with the CAA for approval and our
normal practice is to act on these filings upon receipt. However,
since 1 November and at the DTLR's request, where US airlines'
file fares which undercut UK airlines we have been delaying our
approval for 48 hours in order to give UK airlines an opportunity
to complain if they believe that particular fare levels are unjustified.
We have received no such complaints from UK airlines. Indeed,
there is no clear evidence that the US Government's assistance
has in fact affected fare levels in the marketplace.
British Airways slots at Gatwick
Responsibility for the allocation of slots at Gatwick rests
with ACL. We have confirmed with ACL that British Airways relinquished
180 slots per week at Gatwick for the current Winter season (2001-02)
that it no longer required for this season or for the future.
These slots were returned to the pool and reallocated by ACL to
other airlines with outstanding requests under the EC Regulation
on slot allocation (Council Regulation (EEC) No 95/93).
In addition approximately 200 British Airways slots are being
cancelled monthly (up to the end of February so far) as BA re-evaluates
the shape and size of its future Gatwick operations. We understand
from ACL that the airline intends to re-claim some of these slots
for Winter 2002-03 under the provision of the Regulation which
deals with "unforeseeable and irresistible cases outside
the air carrier's control". In practice, therefore, these
slots are available only for ad hoc flights.
In neither case is there any question of British Airways
being able to exert any influence over which airlines were allocated
the slots it had relinquished.
Transatlantic Deregulation; The Alliance Network Effect. US DOT
October 2000. Back
Heathrow, Gatwick, Stansted and Manchester Airports' Price Caps
2003-2008, CAA Preliminary Proposals-Consultation Paper-November
2001 paragraph 2.19 Back
Performance Reports of BAA London Airports and Manchester Airport:
August 2001 paragraph 7.31 Back
Source: BACK Aviation from OAG data Back
Oxford Economic Forecasting 2000 Back