A Dark Future for Europe’s Legacy Airlines

Over the last decade, Europe’s big three airline groups, IAG (owner of British Airways/Iberia), Air France/KLM, and Lufthansa Group, have all been in much better shape than their American counterparts. While US airlines floundered and filed for bankruptcy, they grew and became stronger. But now, the tables are turned as a variety of different things are conspiring to make life very difficult for the European legacies. So far, the response has been the same failed strategies we’ve seen before on this side of the Pond.

European Three Amigos

One of the biggest problems these airlines face are their own governments. As much as I complain about the state of the US government’s approach to air travel, Europe is much, much worse. Some of this is on the macro level with the European Union’s much criticized carbon trading scheme. Some, however, is country-specific.

The poster-child for terrible government policy is the United Kingdom. Not only has the country levied some of the harshest taxes ever seen in aviation (the UK Air Passenger Duty is now approaching £100 on some tickets), but it fundamentally refuses to add capacity in London where it is needed most. Discussions around a new runway at Heathrow or a new airport way out in the Thames estuary remain just that – all talk and no action. We won’t see any sort of capacity increase there for decades, and the country has already begun to suffer the effects.

Bad government policy isn’t unique to the UK. Germany has begun to stab itself in the heart with airport curfews. The biggest impact is felt in Frankfurt, where night flights have stuck a dagger in the air cargo market. (In the first three months of this year, air cargo at Frankfurt dropped more than 10 percent.) There is also over-taxation there and in most other European countries.

Fighting Low Cost Carriers With Familiar Strategies
This wouldn’t be an issue if there were no competition, but of course, there is plenty. For flights within Europe, low cost carriers have only grown stronger. Though they deal with the same governmental issues, they have operating costs far lower than the legacy airlines and they can profit with much lower fares. Does this sound familiar? It should, because it’s what happened in the US.

You’ll recall that over the last decade or two, US airlines tried all sorts of things to become competitive. They opted for “airline-within-an-airline” low cost carriers that all were complete failures. They’ve looked at b-scale wages over the years. They’ve had aggressive cost cutting campaigns. In the end, it was only Chapter 11 bankruptcy that allowed them to become more competitive. European airlines don’t have such a convenient option.

Instead, they are trying the same tactics that didn’t work in the US. IAG has started a low cost carrier in Spain called Iberia Express. Nothing is different except that the wages are lower so it’s a cheaper operation to run. Iberia employees are angry and striking, but it hasn’t stopped the airline from pushing forward. In Germany, Lufthansa has started to turn over more short haul flying to its low cost subsidiary Germanwings. Most of Stuttgart flights, for example, are now flown by Germanwings instead of Lufthansa. The French are also plotting a strategy to shift short haul flights to a low cost carrier.

The shorter distances within Europe as compared to the US make this an even more pronounced problem since people on shorter flights care less about the difference in amenities. For most legacy airlines, however, they can take solace in the fact that in the long haul world, they are still king.

Trouble in the Gulf
Traditional low cost airlines have tried and failed many times on long haul routes. The most recent was Air Asia X which canceled all of its European services. That has been the saving grace for American carriers, which have made major efforts to shift the balance away from domestic flying toward long haul. This is good for European airlines because they have traditionally had more long haul flying than short haul as compared to the US carriers.

But there’s a big problem in Europe: the Gulf carriers.

A whole host of airlines in the Middle East have sprung up with luxury service combined with lower fares. The pack is led my Emirates, which still is planning on filling about 100 A380s a day in addition to its massive fleet of 777s. Etihad in Abu Dhabi along with Qatar Airways in Doha and even Turkish in Istanbul have flooded Europe with cheap capacity thanks to lower costs.

This has created major headaches for European airline flying to Asia and Africa. While Emirates and the like don’t fly the routes nonstop, they have good, fast connections that draw away a ton of traffic. Lufthansa alone has seen this erode profits to the point where it has pulled flights to Hyderabad, Kolkata, and Guanghzou. Nanjing, Chennai, and Bangkok are now on the chopping block.

While European airlines had been relying on government intervention to keep these big guys out, that won’t work forever. At the Phoenix Aviation Symposium in March, IAG chief Willie Walsh said that he was downright jealous of the Middle Eastern carriers because they have governments that believe in the importance of aviation for economic growth. They help the airlines and provide good taxation environments to help them grow.

And grow they have. Emirates has six daily flights from Heathrow to Dubai (4 on A380s) and two daily 777s out of Gatwick. But even more importantly, Emirates flies to smaller cities like Newcastle, Glasgow, and Birmingham, providing better flight options than even BA can offer to those folks.

That leaves the European airlines in a good position only to the Americas. No low cost carrier has found a way to make that work (though many more will try and fail). But in the US, they have formed joint ventures with their American counterparts. American carriers are much more likely to take on upgrades and lower fare traffic. That puts pressure on the European carriers and their often superior options when the revenues end up being shared.

Problems are Easy, Solutions are Hard
This post has been easy for me to write because I just talk about the problems and don’t have to come up with solutions. That’s the hardest part of all and it’s what the European legacy carriers struggle with every day. If I knew what to do, I’m sure I’d be a rich man.

Does that means there’s no solution? Of course not. But it’s not a simple problem to solve. These airlines see tremendous pressure in nearly all parts of their business. With the governments not interested in budging on their terrible policies and labor not seeing the reality of the cost problem, it’s going to be tough to make much progress.

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