Emerging challenges for the Middle East’s Big Three airlines
ANYONE that has flown recently on Emirates, Etihad and Qatar airlines might think that the owners and shareholders of these airlines are making money hand over fist. In my experience, every flight is full to maximum, from an A380 to the ‘smaller’ 777. These three airlines are known for superb customer service and lavishly appointed aircraft interiors and features for first class travelers. Their growth has been phenomenal, steadily averaging between seven per cent to 10 per cent in a global airline market growing at two to three per cent per year. These carriers have served over 600,000 Americans flying to and from Europe and the Middle East.
So what is the problem? Why does Tim Clark, CEO of Emirates, in an interview in Aviation Week and Space Technology magazine last month, say that profitability and growth will be distinct challenges for the airline in the future? Etihad’s Hogan is leaving by the end of 2017 after a rash of partnership investments. How can these airlines be having difficulties? The challenges to the GCC’s big three airlines can be grouped into two categories: Self-inflicted and competitive.
Self-inflicted difficulties are those that occur when businesses enjoy year-on-year growth, greater than the industry in which they participate. Some would call it hubris but it is very difficult for managements and investors to believe that the business models and strategies that have worked so well for so many years have cracks in them that could lead to problems. The strategies of all three are based on a number of assumptions that were all reasonable at the times they were made.
Assumption 1
Oil prices will remain stable, generating a steady stream of premium travelers to the Middle East and allowing the ME3 airlines to enjoy relative fuel price advantages over competing US, European and Asian airlines. The showers, beds and private suites installed on many of the ME3’s aircraft are there to meet the demand generated by very frequent and very premium flying customers. But, oil prices have fallen and many projects planned throughout the GCC region have been delayed or cancelled. The first class cabins and the private suites are not in such great demand today. In aviation jargon, yields have declined, which are impacting revenues and profitability. In addition, fuel prices have fallen for everyone, reducing the ME’s relative price advantage and increasing price competition throughout the globe.
Assumption 2
There is no limit to growth, so the major concern of management has been to continually increase capacity. All three of the ME3 operate Airbus A380s, a huge aircraft that can make huge amounts of money as long as it’s flying full or close to it. The A380s are flying full today but Emirates has ordered more. It’s retiring some but the net result is still a very large increase in capacity. Most of the A380s in service today are used to shuttle workers from India and South Asia into the Middle East. These people are economy flyers, looking for the lowest cost fares; not private suites with showers and beds. Even if these planes are full, the prices paid by today’s passengers negatively impact yields.
The other major difficulty that A380 operators face is that with the impending replacement and retirement of older A380s, aftermarket prices will fall, lowering lease rates to airlines interested in operating these large aircraft in 100 per cent economy class, resulting in more price competition.
Assumption 3
Focusing on long-haul services, supports the hub-to-hub business strategy and generates higher yields of premium travelers. Hubto-hub service has been the MEs ‘s strategic mantra for many years. But the market is changing to a vision more in tune with Boeing’s, emphasizing point-to-point direct flights to and from secondary and even tertiary city pairs. This shift in the market has caused the ME3bbto explore ways to generate feeder traffic to their main hubs. Etihad has invested heavily into troubled European airlines like Alitalia, airberlin and others to gain greater feeder traffic to and from Europe. Emirates has just announced the intended purchase of A320 aircraft to serve smaller cities and shorter flights to and from DXB to feed its long haul fleet. The days of a vast fleet of A380s for hub-to-hub service maybe over.
The other challenge to the GCC’s big three is competitive. New and legacy airlines have stolen a chapter from the ME3’s playbook. Long haul flights using large and full aircraft are very profitable. In addition, several airlines are using the ‘state-less’ business model of serving routes all over the world. Norwegian Air is the latest and biggest threat to both legacy carriers in Europe and to other large hub-to-hub airlines. Norwegian Air offers extremely low-priced travel between Europe and the US. The ME3 also participate in US to Europe routes and will face increasing pressures from low-cost carriers like Norwegian. Turkish Airlines is also targeting the ME3 with lower cost tickets and higher flight frequencies. Its stated goal is to displace all of the ME3’s as the largest air carrier serving the Middle East.
The strategic options for the ME3 focus on acting like large established international airlines: Offer lavish but not over-the-top and fewer first class accommodations, increase frequencies, increase feeder traffic, reduce capacities to match the market and be prepared for price wars on certain routes. The success of the ME3 has caused them to shift roles from market disruptors to established carriers protecting their turf. The Hajj, Worlds Fair, World Cup and vacationers will continue to fill the ME3 planes but there will be more competition and more price pressures.
The writer is partner, Cedar Management Consulting International. Views expressed are his own and do not reflect the newspaper’s policy.