current trends in aviation

Trends in transport

Current trends in aviation

Stephen Wheatcroft

This article predicts that world air trafftc could grow at an average annual rate of 67% in the 1990s. Improvements in aircraft technology and airline service standards, and continuing economic growth in the major traftic-generating markets support this optimistic forecast. The move towards deregulation will stimulate competition and promote mergers and takesvers. The introduction of the Single Euro- pean Market in 1992 will accelerate the trend towards multinational ownership. Shortage of skilled personnel, airspace congestion and inability to attract capital investment threaten the realization of these predictions.

The average annual growth rate of air traffic could be 6-7% in the 1990s producing a doubling of traffic by 2000. Within this growth of the total market, the fastest rate of expansion will be in the long-haul travel market. Travel from Europe to other continents could well grow at an average rate of lO-11% each year. This represents an optimistic view of air traffic prospects and is equally applicable to the growth prospects for international tourism. Tourism and air transport are indivisibly linked, particularly in the long-haul markets in which alternative forms of transport have virtually disappeared.

The first objective of this article is to justify the optimism of these forecasts for future traffic growth. The second is to give some views about the structural changes in the world airline industry which will accompany this growth in the 1990s. These optimistic forecasts must then be tem- pered by an examination of the threats to growth which

could prevent the realization of the potential. Threats to

the growth of air transport are equally problems for the international tourism industry.

Stephen Wheatcroft is Director of Aviation and Tourism Interna- tional, 33 Park Walk, London SW10 OAJ, UK.

Justification for trafIic forecasts

Optimism about the continuing high potential growth rate for air travel rests upon a number of vital assumptions about the future. The most important of these are:

that the total demand for travel-business. recreational and personal - will grow at a faster rate than rising national incomes; that the price of oil will not increase dramatically in the next decade; that airline operating costs, and hence fare levels, will continue to be reduced, in real terms, by improvements in aircraft technology and operating efficiency; and that airline service, in the air and on the ground, will be improved to meet the higher standards demanded by business and holiday travellers, and to beat the competitive challenges of higher speed surface transport.

These assumptions require some further examination.

Economic growth factors

Forecasts of a continuing 6-7% a year air travel growth rest heavily on the assumption that people spend a higher proportion of their incomes on travel as they get richer. It is commonly assumed that the income elasticity coefficient for air travel is at least 1.5. Although this conventional wisdom still has a general validity for forecasting in most parts of the world, it is important to note that it is no longer true in the US travel market. In the years from 1973 to 1987 the percentage of US consumer expenditure on travel has remained remarkably constant - the income elasticity coefficient has been 1.0 and travel expenditure has grown at only the same rate as all other expenditure. This may change in the next decade. Medical expenditure

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was the main growth sector over the past 14 years. This may reach a peak (in percentage terms) and recreational and travel activities may again increase their share of consumer spending. In any event it seems unlikely that the US spending pattern will be repeated in the UK and the rest of Europe in the decade ahead.

There are, however, other downside risks to travel growth which must be mentioned. Business travel is less than 20% of total European air traffic but, because of the higher average fares paid by business travellers, it produces a much higher share of revenue. Sir Cohn Marshall recently reported that business travellers provide about 50% of British Airways passenger revenue. It is possible that the growth of this market sector will be challenged by developments in electronic communications. Facsimile trasmissions and video-conference facilities put offices across the world next door to each other.

In the holiday travel market an analagous risk to growth may arise from the further development of climate con- trolled resort areas close to major cities. Many people who were forced by delayed flights last summer to spend miserable hours or days in airport waiting rooms must have questioned the pleasures of travel. The repetition of such experiences would make them a ready market for a holiday in a simulated Mediterranean or Caribbean beach resort a short car journey away from their homes.

There are, of course, many aspects of travel in which the reality of the experience cannot be simulated. And past experience with improvements in communications suggests that these tend to increase the demands for travel rather than replace them. Nevertheless, air traveller fore- casters would be wise to keep a close watch on developments which could have adverse effects on their optimistic predictions.

Fuel prices

The dramatic rise from $14 to $34 per barrel in oil price in 1979-1980 was a key factor in triggering the world economic recession from 1980 to 1983. As a result of the recession the demand for air travel was static in this period and airline profitability also suffered from the formidable increase in operating costs caused by a two-and-a-half-fold rise in the price of aviation fuel.

The optimistic growth prospects for air travel in the decade ahead assume that this history will not be repeated. This seems to be a reasonable assumption but the consequ- ences of it being wrong are clearly enormous.

Aircraft technology and airline efficiency

Throughout the history of air transport, airline operating costs have been progressively reduced by technical improvements in aircraft design. Sometimes these improvements have come in large steps - as with the introduction of the B707 and DC8 jet aircraft in the 1960s and the B747 in the 1970s - but more often the downward trend of costs has been a slow process. And this downward trend will continue in the 1990s - there is no technological plateau in aircraft operating costs.

Three aspects of improvement in aircraft efficiency are

p titularly important. First is the increase in non-stop r ige of aircraft used for intercontinental flights. The r .tern of world air routes is being transformed as a result 1 the development of more fuel efficient engines which

educe economical operations for flight stages one-third L the way around the world. The second development arises from proven standards

Engine reliability which make it possible for twin- engined aircraft to be certified to fly long trans-oceanic sectors. This development is extremely important because, for the first time since B747s were introduced, it is now

possible for smaller aircraft, with 200 to 250 seats, to offer the low level of seat-mile operating costs which were only possible previously on flights which justify a 4.50 seat aircraft.

The third development to be expected during the 1990s is the introduction of new-style turbo prop aircraft (un- ducted fans) on short- and medium-haul routes. This new technology may reduce fuel consumption by 25% or more on routes of 1500 miles.

Other improvements in aircraft technology may be expected from the increased use of lighter weight mate- rials, from more sophisticated aerodynamics and from the computerization of flight systems. These and other improvements in aircraft design will ensure the continuation of the historic downward trend in aircraft operating costs.

Other aspects of airline operating costs will be reduced by technological developments, particularly by the increased use of computers. There are few aspects of airline costs which will not be touched in one way or another by computerization and the overall effects of these innova- tions will be measured mainly by improvements in personnel productivity. But in addition to increasing output per employee, a major contribution of computerization has been to increase revenue by more effective yield control. This has been a by-product of the data made available from computer reservations systems (CRS) which has enabled the airline to offer discounted fares only in those markets and on those flights which would not otherwise have attracted higher fares.

The prospects of continuing reductions in airline operating costs is one of the best reasons for optimism about the future. Lower costs can be directed towards lower fares in those markets where they will produce the biggest in- creases in traffic.

Airline service standards

The satisfaction of customer needs is an essential require- ment for the achievement of the full potential of air traffic growth. A poll undertaken by the International Founda- tion of Airline Passengers Associations in 1987, covering 28 000 frequent passengers, concluded that traveller priorities were - choice, value for money, and improved quality of service. The survey indicated that airline passengers, particularly businessmen, are looking more and more for good schedules, punctuality, reasonable leg room and better in-flight service. And, on long non-stop stages, seat comfort, washroom facilities and other cabin facilities become even higher priorities.

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Increased airline competition has already played a part in improving service standards of this kind. The new business class standards on long-haul routes which British Airways now provides in Club World class, are an excel- lent example of this improvement. With slumberseat, extra leg room, improved catering, express check-in, etc. these standards are almost those of first class 10 years ago.

Not so much has yet been done to improve the standards of economy class travel. It is to be expected however that the increasingly competitive environment of the industry in the 1990s will ensure that there will be wider price/ quality options in the future. Some passengers will continue to want the lowest possible fare levels and will accept the discomforts which go with them. But there will be scope for more choice and there will be airlines willing to use their lower costs to improve standards rather than reduce fares.

Intra-European air services will face a marked increase in competition from surface transport in the 1990s particularly from high speed trains. A network of TGV services will provide 300km per hour train services in Western Europe and, connected to London by the Channel Tunnel, will offer highly competitive journey times against air services. This may prove to be a blessing in disguise for the UK air transport system. If traffic is diverted from short- haul air services this may provide a short-term alleviation of the critical pressures on airport capacity in SE England.

The biggest problem of service standards will, however, be largely outside the direct control of airlines. Regularity and punctuality depend upon the adequacy and efficiency of the infrastructure and the way that scarce resources are allocated. It must be repeated that getting the act together will be a determining factor for the validity of optimistic assumptions about a high rate of traffic growth.

Impact of regulatory changes

Much of what has been said above about the potential growth of air travel in the next decade, rests on the assumption that there will be radical changes in the way that the airline industry is regulated. The deregulation of airline activities in the USA since 1978 has had profound effects on the regulation of the industry in many other parts of the world. In Europe the process of liberalization has been slow but, nevertheless, a significant step was taken in December 1987 when the EC Council of Ministers agreed a package of measures which reduces the degree of governmental controls over fares and capacity. Further liberalization is envisaged as part of the 1992 programme for the creation of a single European market. It is unlikely that Europe will adopt the US approach to total deregulation of airline operations but it is certain that there will be more freedom of entry and more direct competition between airlines in price and service standards. It may well be that the future European airline system will be more competitive than that of the USA.

There are disturbing signs in the USA that deregulation cannot necessarily be equated with more competition. The US deregulated industry has become highly concentrated -

in 1987 eight airlines carried 94% of all domestic traffic. Even more disturbing, from the point of view of competition, has been the movement towards monopolistic control of traffic at major hub airports. There are now 15 major hubs at which the dominant airline carries more than 60% of the traffic through that hub.

It is true that there is competition between hubs. But the control of hubs by a single airline is a new and unexpected feature of the airline system which is worrying those advocates of deregulation who believed that it would produce a more competitive system.

Industry concentration does seem to be an inevitable outcome of less regulation. Although there are few econo- mies of scale which have a significant effect on operating costs, US experience in the past few years has shown that large airline size produces enormously increased strength in marketing. It is these marketing advantages which explain the mergers and takeovers which have characte- rized US airline industry concentration. And it is the pursuit of these marketing advantages which explains airline policies in the UK and other parts of the world.

The most relevant example of this trend in Europe is the takeover of British Caledonian by British Airways at the end of 1987. It brought to an end the ‘second force’ airline policy inaugurated by the Edwards Committee in 1969. The takeover reinforced the dominant role of British Airways in UK scheduled operations and, following the US pattern of industry concentration, gave British Air- ways effective control of the Gatwick hub as well as Heathrow. The Monopolies and Mergers Commission gave its approval to the take-over largely on the grounds of the strengthening of the competitive position of British Airways in the face of increasing competition from US mega-carriers. This is a powerful argument, particularly in the light of US experience demonstrating the marketing power of giant airlines. It therefore seems clear that unregulated market forces will lead increasingly to an international airline industry which is dominated by a small number of mega-carriers and that small airlines will only survive if they are successful in exploiting a market niche. But this may not be a more competitive airline industry.

Europe may be able to create a more competitive airline system if it re-examines the issues of industry structure on a regional rather than a national basis. This process may be assisted by the moves towards privatization which are evident, not just in the UK, but in many other European countries. Whatever the original reasons for the national ownership of airlines, state ownership has been closely associated with nationalistic aviation policies. Privatiza- tion ought, therefore, to lead to a reduction in aviation nationalism. This is not a universally accepted syllogism as was evident in much of the opposition in Britain to an SAS proposal to take a substantial shareholding in British Caledonian as an alternative to the British Airways takeover. Nationalism does not immediately die with privatization. But, in the longer term, privatization should help to make possible a multinational approach to the structure of the airline industry.

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Multinational mergers could, or course. be yet another step towards oligopolistic concentration in the airline industry. It is therefore essential for the future of competition that the European Commission should have effective powers to regulate such mergers and to perform the function on a regional basis which the Monopolies and Mergers Commission (MMC) is expected to undertake in the UK. There are good and bad merger proposals. The commission should be empowered to decide which proposals are likely to have adverse effects on competition.

A major question mark over the future structure of the European airline industry is whether the operation of inclusive tours (IT) charter services is a ‘niche’ sector of the market which will survive in a future dominated by mega-carriers. This is an important issue in Europe because these non-scheduled IT charter services now carry substantially more than half of total air traffic. In the UK the IT industry continues to become more concentrated as recently evidenced by the take-over of Horizon Travel by Thomson Holidays. The liberalization of aviation regulation may well have the effect of reducing, or even eliminat- ing, the past dichotomy between scheduled and IT charter operations in Europe. Some of the stronger charter airlines will be tempted to move into scheduled operations. And the sheduled airlines will be able to compete more effectively in the packaged holiday market by offering part-charters on regular services. As a result it seems highly likely that the whole structure of European airline operations will change greatly in the 1990s.

Threats to trafic growth

Set against these exciting prospects for airline development and traffic growth in the 1990s. we must come back to the problems which will face the industry in their realization. The two major challenges will be:

l financing the future; and 0 infrastructure congestion.

The solutions to the first of these problems are, at least partially, in the hands of the airline industry itself. The second problem is, however, one which calls for a coordinated approach by sections of the air transport industry and requires large investments which the airlines cannot, by themselves, undertake.

The problem of structural unprofitability

It has long been a persistent characteristic of the airline industry that its average level of profitability is remarkably low. Since the beginning of this decade the airlines mem- bers of the International Air Transport Association have in aggregate, reported losses after interest in five of the eight years and the best results, in 19&1, showed a margin of only 6% of operating revenue over operating expenditure. .A margin of at least 10% is generally regarded as necessary to make adequate provision for the remunera- tion of capital and to provide part of the funds needed for future aircraft. These aggregate industry results obscure

wide variations in profitability. A few airlines are highly profitable, others make large losses, but, overall, the airline industry has fallen far short of an adequate level of profitability.

A potential growth of 67% a year in world air traffic. as envisaged in this article, calls for huge new aircraft investments in the decade ahead. There are currently about 7500 jet aircraft in airline service and about 11 000 will be required to meet the traffic forecast for 2000. About 2500 aircraft will be retired from service between now and 2000 and so the industry will need about 6000 new aircraft in the 1990s. It has been estimated that this will involve a capital investment in the order of 6250 X 10’ (US billion),

Logically it seems improbable that the airline industry could attract such a huge new investment unless it dramatically improved its profit performance. It is possible that this will happen. The leverage of the three key economic factors in airline financial results-operating costs per seat km, yield per passenger km and load factor - is so large that only quite small improvements are required to con- vert from losses to adequate profits. And even if profit margins are not improved, past experience of the industry suggests that financial logic has not prevented airlines from getting the aircraft needed to meet traffic growth. At the beginning of this decade they had many more aircraft than they needed.

There is, moreover, a new development in the financial world which will help the industry to finance its future aircraft needs. The new factor is the emergence of a new breed of lease companies willing to accept the risks of providing aircraft to airlines whose profit records and credit ratings would not previously have been an accept- able basis for financing. The two new features which have transformed the aircraft leasing business are operating leases and asset based financing. An operating lease is one in which the lessee does not contract to cover the full cost of the asset and where the residual value risk (or reward) remains with the lessor. The leasing company takes on this risk in the belief that an aircraft can readily be transferred from one airline to another during the course of its life. An aircraft may therefore be operated by three or four different airlines in quite different markets over its fife. The leasing company raises finance for these transactions on the basis of the market value of the aircraft and is, therefore, not dependent on the credit rating of the lessor airline.

So far this has been a highly successful innovation in aircraft financing and it appeals to prosperous airlines as well as to those with low credit ratings. Sean Donolon, executive vice president of the GPA Group, recently forecast that about 20% of the !NOO jet aircraft in service in 1991 would be on operating leases.

The implications of this development are quite profound, most particularly in its effects on the relationship between airlines and aircraft manufacturers. Only the large airlines will be able to maintain a traditional relationship with the manufacturers and the ability to specify precisely what they want. For the smaller airlines the leasing company deals with the manufacturer and takes

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Current trends in uviurion

is inadequate to meet demands, as in the London area. the congestion problem is inevitably thrown back upon the ATC system. More aircraft are held in stacks waiting their turns to land. The ATC authorities may try to alleviate their own problems by introducing flow management’, which means rationing operations in the air space and keeping aircraft on the ground until there is a slot for them in the sky.

It has become increasingly evident that the problems of congestion in the European air transport system cannot be resolved by any country acting alone. A regional solution is required and, even though the European Commission may be better organized to tackle the problems, the wider area of the European Civil Aviation Conference, embrac- ing all 22 European countries, is the most appropriate scale for action. The best hope lies in the EC taking the initiative and putting forward proposals, including the regeneration of Eurocontrol, which can be adopted on a Europe-wide basis.

The problems of providing more runway capacity will remain. These involve massive new investments and the political will to overcome powerful opposition.

over the long-term corporate planning functions by mak-

ing global market assessments of aircraft requirements and subsequently deciding the performance characteristics required.

The new leasing companies are taking on large risks in making these market assessments and these are not dimi- nished by the change in financing, even though they may be more widely spread. The real test of the success of operating lease/asset based financing arrangements will come when there is a downturn in market growth.

In the first instance the airlines will be cushioned from the effects of such a downturn - they will have the flexibility to reduce their fleets by returning aircraft to the leasing companies. But if this were to happen on a worldwide scale the leasing companies would find themselves in serious financial difficulties and the airlines would be back again to the problems of justifying aircraft financing on the basis of projected earnings.

Problems of inadequate infrastructure

Few people in the UK can have any doubt, after reading front page newspaper reports every day in summer 1988, that airspace congestion could be a major barrier to air traffic growth in the years ahead. The reasons for aircraft delays in summer 1988 were complex. Industrial relations disputes in several countries, with demands for higher pay, were a significant factor. This is a problem which will have to be tackled and solved if we are to avoid an annual round of hostage holding strikes at peak holiday periods. But even without the problems of industrial disputes the European air traffic control (ATC) system is overloaded and badly coordinated. Better communications between air traffic control centres would provide a short-term improvement but the longer-term problems are more deep rooted.

One basic problem arises from the imbalance between airport capacities and ATC capacities. If runway capacity

Conclusion

These are formidable threats to the achievement of the full potential of air transport and tourism growth. Moreover, no mention has been made of an additional problem which worries some people in the industry - the possibility of serious shortages of trained and skilled personnel like pilots and maintenance engineers. But despite these threats and problems I remain optimistic about the growth which will be achieved in the next decade. A recognition of problems is the starting point for solving them. The high level of concern in the air transport industry about the seriousness of these challenges supports the belief that they will be tackled and overcome.

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current trends in aviation

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