The Shape of the Aviation Industry in 10 Years’ Time

I was recently asked by a UK fund manager what factors might shape the industry in the next 10 years. Thinking back to what I might have said in 2007 if I had been asked that question then, and the developments that have taken place to the present day, I think I would have needed a much better crystal ball than the one I owned at the time. So fresh from a recent expensive purchase on e-bay, here are a few predictions that my new crystal ball is putting forward over the next 10 years.

 

There will probably be a global economic crisis

The first major development of the ten year period starting in 2007 was of course the impact of the Global Financial Crisis. Unlike a former British Prime Minister, I don’t believe we have yet reached an economic nirvana with the end of “boom and bust”.

In my mind it is almost unthinkable that over the next 10 years the global economy will not once again have to face some sort of recession. What will trigger it is beyond the capabilities of even my new upgrade crystal ball (an oil price hike, war, global pandemic, interest rate hike, stock market crash etc. all spring to mind) but the consequences are maybe easier to predict as we have the benefit of history to tell us.

Passenger and freight demand will fall, airlines will slash prices to shore up volumes and profitability will collapse. Some airlines will fail, and the strong will survive and get stronger once economic recovery gets underway. What may be different in the next decade versus previous decades is perhaps a number of new entrants on the OEM front (COMAC, Sukhoi, Bombardier and Embraer entry into the 100 seat plus jet market), who may be slow or reluctant to match production rates with a new economic reality resulting in a more prolonged period of overcapacity, consequently driving down fares and profitability.

No longer a commodity industry ?

The rise of the pure low cost carriers (LCCs) and the ultra-low cost carriers (ULCCs) has been based on the affordability of tickets. Ryanair is arguably the most successful of these LCCs. Ryanair proclaims itself as “the low fares airline” and on the home page of its website has the straplines “Find Cheap Flights to Europe” and “Find the lowest fares to over 200 destinations”.

Will it be all about price in the future ? Today, thanks to Skyscanner, TripAdvisor, Google Travel and a host of other websites, it takes just a couple of clicks to find the cheapest option to fly from A to B. If I go into a supermarket it is blatantly obvious which is the cheapest can of baked beans available, and it seems many passengers regard buying an airline ticket the same way.

So much so that of course many of the European full service carriers have their own in-house LCCs (Vueling, Eurowings, Transavia) and indeed long-haul LCCs (LEVEL and now JOON) in order to be competitive in the marketplace for the price sensitive traveller.

Does this change in the next 10 years ? Will consumer behaviour tire of the current LCC model, the ultimate expression of this perhaps being Michael O’Leary’s vision that he will give away tickets for free on Ryanair and earn all his revenue from the sale of ancillaries ?

Perhaps in 10 years’ time, there may be a reversal of the current trend of commoditisation. Flying on planes that are full (Ryanair average load factor for June 2017 was 97%), being charged £4.75 (US$6.20) for a beef and red onion chutney sandwich bloomer (British Airways), and charging for carry-on bags (Wizzair charge US$11.70 for a large carry-on bag) is making flying a tiresome experience for some.

Perhaps in 10 years’ time, the model will evolve to cater for passengers who are prepared to pay an all-in price for a seat with a comfortable amount of leg room and a free meal service. Thinking again of my supermarket analogy again, making a more discerning choice of selection of a bottle of red wine (and definitely not the cheapest bottle on the shelf). Perhaps this will be confined to some of the more mature and wealthier economies where consumers are happy to pay a premium for some products (BMW, Bosch, Apple and Chateaux Marguax). Flying just like it was originally.

Airline consolidation continues but at what pace?

Consolidation is certainly good for profitability in the airline industry as the US airlines have proven. The big three (American, Delta and United) have coupled capacity discipline and economic pragmatism to achieve record levels of profitability.

Elsewhere in the world, progress on consolidation remains sluggish as airlines struggle to achieve true multinational mergers because national or regional ownership controls restrict the ability of airlines to own airlines in another country. Minority investments, as a means of circumventing these ownership regulations have had a chequered history in providing acceptable returns to shareholders (in the deep past SAS buying stakes in Continental and British Midland, Swissair swapping equity with Delta and Delta with Singapore, British Airways buying into US Airways and so on). A more recent example is Etihad’s equity investment in Air Berlin and Alitalia (and others) which resulted in Etihad’s US$808 million write-down on exposure to its equity partners, a change in CEO and a reversal of strategy.

Will cross-national ownerships restrictions ease in the next 10 years? Probably not, but the recently announced news that Delta and its partners Air France-KLM and China Eastern have announced a new strategic focus on cross-shareholdings suggests the old model is not entirely dead. Most interesting is that, as well as focussing on a new joint venture (JV) to replace two overlapping JVs, Delta and Air France-KLM now have combined equity of 80% in Virgin Atlantic, with UK shareholder interest through Sir Richard Branson’s Virgin Group being only 20%. How this works from a regulatory stance post-Brexit, assuming the UK is no longer a member of the European Common Aviation Area is unclear.

Deal flow is likely to continue, with the richer airlines perhaps happy to continue to take minority stakes in airlines which they can provide a positive return even if there is little operational synergy. At least Qatar Airways is acquiring stakes in airlines in its own Oneworld strategic alliance, with a 20% stake in IAG and a 10% stake in the LATAM Airlines Group.

Will HNA Group be the precursor to airlines being acquired as part of larger conglomerates specialising in the industry as a whole? As well as stakes in airlines such as Azul, TAP and a number of domestic Chinese carriers, HNA has interests in aviation services companies such as Swissport and Gate Gourmet, an aircraft leasing company, Avalon, an 82.5% stake in Frankfurt-Hahn Airport, and hotel chains such as Hilton and Carlson / Radisson. With assets in excess of US$100bn, perhaps the next 10 years will see airlines being subsumed into wider travel and tourism conglomerates.

A factor in the pace of consolidation will be partly dependent on the attitudes of various governments towards protectionism. For example it would seem unlikely that under a Trump Administration there would be a relaxation of the regulations limiting foreign ownership of US airlines to 25%.

As far as Europe is concerned Ryanair’s Michael O’Leary has looked into his own crystal ball and suggested that there will be just five European airline groups in five years’ time – Ryanair, Lufthansa, Air France-KLM, IAG and easyJet. What progress these groups will make in mopping up the secondary flag carriers, smaller LCCs, and regionals will fascinating, and will perhaps depend on the outcome of the current dismantling of Air Berlin and Alitalia.

Long-haul low-cost

So far yet to deliver a consistently profitable concept, long-haul low cost carriers will certainly feature strongly as a business model in the short-to-medium term. What’s new to the business model in the future is that the routes can now be flown by narrowbody aircraft such as the A320neo LR which has a range of 7,400km, and a long-haul variant of the B737 MAX. These aircraft allow long-haul LCCS to avoid head-to-head competition with the full service carriers operating widebody aircraft on routes with high levels of demand and develop new markets that do not have direct services today.

One by-product of this is the impact on hub airports. Hubs which connect short-haul markets have been impacted by the rise of LCCs and their concentration in opening up new point-to-point routes which by-pass hubs. If the long-haul low cost model gains hold, then passengers living in the regional cities will no longer have to rely on reaching their final destination via a hub airport.

Technology

The crystal ball is most obscure when foreseeing where technological developments will impact the aviation industry. One hope is that the development of the biometric technologies including facial recognition might be integrated with smartphones and electronic ticketing to improve the check-in experience.

Improvements in security will also hopefully improve the passenger experience. Molecular scanners are expected to replace X-ray machines and will be able to tell the chemical composition of luggage and be able to recognise dangerous items 10 million times faster than now. In the near future, luggage will come with digital tags already built into the suitcase. If this comes to pass there are implications for airport planners and perhaps a reconfiguration of the split of space between landside and airside.

Perhaps not in the next 10 years, but certainly an area where investment will be made is on the possibility of pilotless aircraft. Analysts at UBS say this innovation could provide a material profit opportunity of more than US$35 billion per year for the aerospace and aviation industry.

Airports

The next decade will see the opening of several major new airports around the world which will impact travel patterns and shape the future of the airlines that serve them. There is the prospect of a new six runway airport, Beijing Daxing International Airport, to serve the Chinese capital. Next year, 2018, will see the opening of Istanbul New Airport with an initial two runways and a terminal capacity of 90 million passengers, with the scope to build a further four runways. The new airport serving Mexico City will open with three runways with the potential to expand to six runways.

Countries that actively promote aviation will continue to provide the infrastructure to support forecast levels of passenger and cargo growth. Airports under private ownership now seem a well-accepted model, it is after all 30 years since BAA was privatised. The institutional appetite for airports seems as strong as ever, and perhaps the next decade will see airports in the US and Canada join countries such as Saudi Arabia and Japan in embracing airport privatisation.

Hold on, what’s this, my crystal ball has gone all misty. Just for a moment I thought I might have seen work taking place on a third runway at Heathrow.

Note: RDC has worked on the new airports in Istanbul and in Mexico City.

PS I can’t actually remember the last time I bought a can of baked beans.

By Tim Coombs / Connect on LinkedIn Tim Coombs