Sector Insight: Airlines - Steady ascent

Having suffered a slump since 9/11, airlines are seeking to build on rising passenger numbers.

The Background British travellers are now able to fly to more destinations, more cheaply than ever, and an increasing number are doing so. In the past decade, the rise of low-cost carriers has irrevocably altered the sector, but other more negative factors are also having an impact. There has been consolidation among the full-service airlines and some less profitable routes have been closed. A combination of rising oil prices, terrorism fears and increased competition has seen some operators struggle. However, as people continue to take more overseas holidays, the sector seems likely to prosper.

Rising awareness of the environmental impact of air travel and persistent terrorism fears have had little impact on the UK population's desire to fly. In 2004, 86m passengers flew from UK airports, up from 70m in 2000, according to Mintel.

However, the dynamics of the sector are shifting, with low-cost airlines such as easyJet rapidly expanding, and traditional carriers such as British Airways and Virgin reducing capacity.

The airlines are divided into three main types: scheduled or full-service, low-cost, and chartered or tour operators. The main British scheduled operators are BA, Virgin Atlantic and bmi.

In the low-cost sub-sector, the leading UK carriers are easyJet, bmibaby and Flybe - Ireland-based Ryanair, with more than 26m passengers, is the biggest, but does not feature in UK-only Civil Aviation Authority figures. All low-cost carriers fly direct, with no connecting flight network, and operate short-haul routes only.

The leading tour operators are MyTravel Airways, Britannia Airways (Thomsonfly), First Choice Airways and Thomas Cook Airlines. They offer chartered flights, which are usually sold as part of a package holiday through a travel agent. However, sales via this channel are decreasing, as direct bookings by phone or online rise.

The low-cost airlines have performed best in terms of capacity and passengers carried, helped by growth in the use of the internet, which has become an important sales tool for the industry. However, they too face a number of issues, especially as European budget carriers establish themselves and increase competition on many routes.

Co-operative strategy

One of the most significant developments has taken place in the full-service category, with the rise of airline alliances. These mean routes can be linked and airlines gain a wider network without having to launch additional routes.

These co-operative agreements also offer the benefit of the practice of codesharing, which enables one airline to sell tickets under its name for travel on an alliance partner's routes. Other advantages include linking frequent-flyer schemes and combining ticket offices.

There are three major alliances: Star Alliance, which includes United Airlines, Thai Airways and SAS; SkyTeam, taking in Air France, Continental and KLM; and oneworld, which includes BA, American Airlines and Cathay Pacific. Together, the three account for 60% of the world's airline capacity, according to the International Air Transport Association.

BA is the biggest of the scheduled airlines, flying to about 170 destinations in 76 countries. Its two-year business plan for 2003-2005 has focused on implementing technology to help it reduce external costs by £300m. This has included introducing self-service check-in kiosks and boosting the use of e-tickets. More changes may be afoot; last month the airline put its highly coveted £60m ad account up for review.

Virgin Atlantic is the UK's second-biggest long-haul carrier, serving 22 destinations. Initially hit by a post-9/11 drop in traffic, it now plans to expand further into Africa, India and China.

British Midland's rebrand as bmi in January 2002 aimed to give it a more international feel, in line with its network of routes; its destinations include India and the Caribbean. In March 2002, it entered the lucrative low-cost market with the launch of bmibaby, which is based at East Midlands Airport.

EasyJet is the biggest UK low-cost operator, carrying 22m passengers last year on its 98 aircraft. Since its 1995 launch it has grown rapidly, with passenger numbers rising by 23% between 2003 and 2004. Its mainstay is the leisure market, but this year it gave travel management firm Business Travel International access to its booking inventory, as it seeks to build sales to corporate travellers.

Changing shape

The future holds many changes for the industry. 'Super-jumbos' such as the Airbus A380 and Boeing's 787 Dreamliner are set to have a major impact on air travel. The two manufacturers are taking different approaches, however. Airbus has focused on increased capacity with its double-decker aircraft, while Boeing has kept its craft smaller and concentrated on efficiency.

The low-cost category is high-risk, with several carriers having failed, but Mintel predicts it will continue to grow at an annual rate of at least 30% for the next couple of years. Prices will stay competitive despite consolidation.

In the full-service arena, the alliances are expected to strengthen, accounting for 70% of capacity in the next 10 years.

As consumers continue to take overseas holidays, invariably more than one a year, airlines will prosper. By 2010, 130m passengers will take flights with UK airlines, a 13% increase on 2004.

UK AIRLINES BY CAPACITY* Airline 2004 2000 2000-04 capacity capacity % change 1 British Airways1 130,892 172,524 -24.1 2 Virgin Atlantic 38,820 39,228 -1.0 3 easyJet 25,176 5801 334.0 4 Britannia Airways 23,768 22,236 6.9 5 MyTravel Airways2 21,141 20,317 4.1 6 First Choice Airways3 17,199 19,939 -13.7 7 Thomas Cook Airlines4 15,563 15,598 -0.2 8 Monarch Airways 15,098 15,427 -2.1 9 bmi 12,547 9,376 33.8 10 Flybe5 2923 2060 41.9 Others 30,914 16,289 90.9 Total 334,041 338,795 -1.4 Source: CAA UK Airline Statistics *seats sold multiplied by km travelled on flight 1: includes franchises 2: previously known as Airtours International Airways 3: previously known as Air 2000 4: previously known as jmc airlines 5: previously known as British European UK AIRPORTS BY PASSENGER NUMBERS (000) Airport 2004 2002 2000 2000-04 % change 1 Heathrow 67,109 63,035 64,277 4.4 2 Gatwick 31,391 29,518 31,948 -1.7 3 Stansted 20,907 16,049 11,858 76.3 4 Luton 7520 6474 6164 22.0 5 London City 1675 1602 1581 6.0 Other 87,078 72,082 64,058 35.9 Total 215,681 188,761 179,885 19.9 Source: CAA/Mintel AIRLINE ALLIANCES Star Sky- one- Alliance1 Team2 world3 Number of partners 16 9 8 Countries served 139 137 135 Destinations 795 658 599 Daily departures 15,000 14,320 7528 Passengers (m) 383.8 341.4 223.1 Fleet size 2554 2064 1855 Source: Mintel 1: as at March 2005 2: as at summer 2004 3: as at January 2005

ANALYST COMMENT - IAN BELL, SENIOR UK & IRELAND MARKET ANALYST, EUROMONITOR INTERNATIONAL

The recent collapse of budget airline EUjet has brought the cut-throat nature of low-cost carriers into sharp focus. Rising fuel prices, up almost 60%, have created a difficult operating environment, as budget airlines try to maintain low ticket prices, while refusing to add fuel surcharges. The difficulties are exemplified by easyJet's widening half-year losses of £31m.

Despite 20 carriers going to the wall over the past two years, the number of low-cost carriers in Europe rose to 60 for the first time earlier this year.

Demand for cheap air travel remains high, with the most successful operator, Ryanair, expected to carry 35m passengers this year - a 25% increase, taking it ahead of BA in terms of numbers.

Although the Irish airline continues to grow rapidly, dark clouds are on the horizon. Further hikes in fuel prices remain on the cards, but there are also concerns over the environmental impact of air travel. Pressure groups maintain that its growth is environmentally unsustainable, with rising carbon dioxide emissions contributing to climate change.

Ryanair has become isolated by refusing to join the Sustainable Aviation Group, an industry body set up to reach out to environmen-talists. The Irish airline is against any suggestion of a fuel tax or emissions trading system to help tackle these concerns because the impact on ticket prices will be proportionally higher for budget carriers.

In a post-Kyoto Europe, it seems almost inevitable that, in the medium term, further taxation will be levied on air travel. With increased overheads likely, further collapses and consolidation of the sector seem almost certain.

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