Hitting Severe Turbulence - The European Airline Industry on a Collision Course

The European airline industry continues to suffer from the worst financial crisis in its history. Flag carriers have been forced to accept that their business models were fundamentally structurally unprofitable. Their aggressive low-cost competitors are still nearly the only players turning profits. But there was - and remains - a great deal of uncertainty as to how to respond and, hopefully, survive. Associate Professor of Strategy Javier Gimeno and the BP Professor of European Competitiveness Karel Cool offer an in-depth assessment of the woeful current state of affairs besetting the European airline environment as a whole.

by Karel Cool,Javier Gimeno
Last Updated: 23 Jul 2013

"The safest way to become a millionaire is to start as a billionaire and invest in the airline industry."

Richard Branson, CEO, Virgin Atlantic Airways

The European airline industry continues to suffer from the worst financial crisis in its history. Flag carriers have been forced to accept that their business models were fundamentally structurally unprofitable. Their aggressive low-cost competitors are still nearly the only players turning profits. But there was - and remains - a great deal of uncertainty as to how to respond and, hopefully, survive.

Associate Professor of Strategy Javier Gimeno and the BP Professor of European Competitiveness Karel Cool offer an in-depth assessment of the woeful current state of affairs besetting the European airline environment as a whole. While losses are nothing new and most analysts may argue that there are too many carriers in the market, the authors explain how forces such as bilateral "open sky" agreements with the US government and deregulation in Europe placed intense competitive pressure on all European carriers, especially those having grown used to generous state subsidisation.

The frenzy of alliances that formed as a result have helped to boost revenues and reduce overheads. But the industry continues to struggle with razor-thin yields and exposure to economic and political variables far beyond its control, particularly the sharp recent rise in fuel costs. Fixed assets still account for more than 80% of total assets. (The most basic and expensive, aircraft, still account for nearly two-thirds of these.) Operational reforms in recent years, such as changes to "hub and spoke" airport networking and flexible leasing arrangements, have only met with limited success in lowering operating costs.

Unsurprisingly, the clear and present winners amidst this havoc have been the no-frills, low-cost carriers (LCCs). The authors describe how the European LCCs that survived their first years, such as Ryanair and easyJet, have achieved costs per available seat kilometre 30-50% lower than full-service carriers in the same markets. They have also continued to benefit from the lessons learned since starting out as "virtual airlines", such as flying from secondary airports and remaining unhampered by the types of legacy costs common to flag carriers.

However, the current environment remains so unstable that it is even unclear if the LCC sector could continue to prosper. The study concludes with considerations of how the LCC sector's evolution over the next five to ten years will likely shape the European industry as a whole. Moreover, continued uncertainties on the political fronts in both the US and the EU continue to help create a volatile and fragile business arena for the vast majority of carriers, affecting the industry globally.

The industry is also quirky in a number of ways. The airlines are the only players in the logistics chain who are in the red. European airports, plane makers, caterers and other service providers are all generally prospering, thanks largely to industry consolidations. Moreover, the authors describe how carriers tend to multiply their fixed costs burdens by, when in doubt, over-expanding to meet perceived demand - itself a very tricky factor.

Other structural problems also plague the flag carrier sector, including strict EU regulations regarding M&A activities. Overall, the authors present a picture of an industry in near-meltdown, where even short-term solutions are in short supply.

INSEAD 2004

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