Aviation focus: Winds of change

Uncertainty seems to be the only thing lawyers working in Europe’s aviation sector can count on these days.

The recent collapse of two established major European airlines demonstrated the volatility facing many sections of the industry, with UK-headquartered Monarch Airlines and Air Berlin becoming the latest casualties of turbulence.

‘Airlines are no longer seen as your triple-A bet,’ says Catherine Ledger, general counsel (GC) of UK-based airline Flybe.

But, like the aircraft themselves, aviation is a sector that rarely stands still. When a carrier takes a nosedive, there are competitors ready to seize the assets – not only the aircraft, but vacant routes and prized slots at key airports. For airlines, being opportunistic and agile is the key to staying airborne.

‘We had very little overlap with Monarch, but it did allow us to consolidate our presence in London Luton, where we are the second largest operator, and which remains Europe’s largest travel market,’ says Owain Jones, chief corporate officer of Hungarian airline, Wizz Air.

‘The collapse of Air Berlin, which then led to their subsidiary, Niki, disappearing [in December 2017], has enabled us to put in operations in Vienna, and later we’ll be starting a base in Vienna, with routes not just in Central and Eastern Europe but also to some western Europe routes as well.’

Some of the challenges are self-inflicted in a highly-competitive sector with the short-haul market being turned on its head by the advent of low-cost carriers (LCCs), which first arrived in Europe in the mid-90s. The ‘no-frills’ business model stripped the flight experience to the bone, removing seat classes, lounges, in-flight entertainment, complimentary refreshments and baggage check-in, in return for cut-price fares.

The transformative impact of LCCs on the short and medium-haul market has come at a price for full-service, or ‘legacy’, carriers, who have found themselves under pressure to compete on price, or risk losses and even failure.

This pressure has been felt in more than ticket prices, forcing a shift in the business models by which routes are devised and offered to customers. The ‘hub and spoke’ model typically favoured by full-service carriers – whereby airlines fly their aircraft through ‘hub’ airports, and then out along various ‘spokes’ to smaller ‘node’ airports – is increasingly giving way to the ‘point-to-point’ model utilised by LCCs, in which flights are offered directly between destinations.

‘We stimulate markets. Our low cost means we then stimulate a demand among people who have never travelled by air before. We are bringing new people into the flying franchise.’
Owain Jones, Wizz Air

‘By expanding their presence in airports other than their traditional hubs, a number of large airline groups now operate multiple hubs. There are recent examples of these groups moving aircraft between these hubs, and as a result, these groups have greater buying power than they did in the past,’ notes Danijela Popadic, GC of Serbian flag carrier, Air Serbia.

Making your connection

To spread costs and commercial risk, co-operation and consolidation is increasingly in vogue among legacy operators, as was the case with International Airlines Group, the parent company of flag carriers Aer Lingus, British Airways and Iberia as well as low-cost airline Vueling.

There are also many collaborative arrangements that airlines enter into to extend their reach beyond traditional routes, or increase efficiency. A code-share agreement, for example, enables passengers to book tickets for a route with one carrier, while the flight is operated by a different carrier sharing the flight number.

‘People like to be able to have a seamless flying experience. It makes sense in lots of ways for airlines to have arrangements like codeshares to make the travel experience a lot more straightforward,’ says Ledger.

‘We are now doing far more codeshare arrangements with different airlines, which enables passengers to book a ticket that takes them from Exeter to Manchester, and at Manchester they can connect to a Virgin aircraft to fly to the States. As far as they’re concerned, it is one transaction rather than trying to buy two lots of tickets.’

Other forms of collaboration include wet leasing, where one airline provides and operates the aircraft, crew, maintenance and insurance for an aircraft for a fixed period, but it flies under the brand of a different airline.

‘It is really critical to have the right aircraft for the right route, and if you want the route to fit in with your network, you might have a look at somebody else to operate it for you. The big legacy carriers are leasing more for the shorter-hop regional flying, which doesn’t fit in with the larger aircraft,’ notes Ledger.

Also more common are risk-sharing models, comparable to joint ventures, where two airlines operate a route together, each providing different elements – for example, the aircraft, crew, marketing, advertising, and so on – and then sharing in the risks and rewards.

‘From a legal perspective, it can be interesting because there are lots of new ways of doing things. Sometimes we are doing things that have not been done before. Our team has to be willing to be flexible,’ says Ledger.

Not all airlines are as keen to share, however. ‘We have a very specific business model, of generating growth from our home markets without the need to get into the complications of cooperating with other airlines. A key point at Wizz is achieving low operating costs. When you start dealing with other carriers, that introduces costs into the equation,’ says Jones.

New business

Under pressure from the low-cost sector, established carriers have diversified, offering low-cost options that were previously the domain of the LCCs. However, Popadic believes that consolidation in terms of service levels is happening in all sections of the market: ‘To attract business passengers, most LCCs have modified their practices. These trends imply that LCCs are increasingly competing for business passengers, a demographic that traditionally flew with [traditional carriers].’

‘The use of big data is going to transform the way that we build and maintain aircraft. This data should mean we will be able to develop an aircraft quicker.’
John Harrison, Airbus

The advance of LCCs continues apace, even into the long-haul market. Of the 15 low-cost, long-haul operators launched globally since 2012 according to 2017 CAPA figures, five (Norwegian Air Shuttle, Eurowings, WOW air, French Bee and Level) are European. New aircraft technology has greatly reduced operating costs on long-haul routes, enabling carriers to encroach into intercontinental routes, increasing customer choice of airports in the process through the LCC model of bypassing traditional hub airports.

Popadic is not too concerned: ‘LCCs will operate more on long-haul. However, the long-haul, low-cost business model will not make such a huge impact on the air transport market as on short-haul. Many of the features which enable LCCs to compete so effectively are less applicable on long-haul.’

The politics of flight

Operators like Ryanair and easyJet are opening up new markets by making flying more affordable. Others, like Wizz, harness geopolitical tail winds to drive growth.

‘We stimulate markets. We have the benefit of operating in Central and Eastern Europe, one of the highest GDP growth regions in Europe. GDP growth leads directly to airline growth; there’s always an increase in demand for air travel. Our low cost means we then stimulate a demand among people who, in some cases, have never travelled by air before. We are bringing new people into the flying franchise,’ asserts Jones.

‘It is a very different game to western European airlines, which are battling to take customers from one another. In Central and Eastern Europe, the rate of travel by air is still around a quarter of what it is in western Europe, so significantly higher GDP growth is what’s contributing to our strong growth.’

Despite the scope of expanding economies in an increasingly competitive environment, not everyone can be a winner.

‘Some rationalisation with capacity in Europe was long overdue. One of the functions of a liberalised market tends to be that the strongest survive and the strongest airlines are the ones with very controlled cost bases. If you look at the US, which started liberalisation some time before Europe, there were a very large number of airlines. Now four airline groups provide around 80% of the capacity,’ says Jones.

‘Europe is way, way behind – we’re still a very, very fragmented market, even with the low-cost carriers. Failures are part and parcel of aviation; rationalisation in Europe has to happen and we still have a number of airlines which are supported by the state – whether that’s legally or by contravening state aid laws.’

Following last year’s collapse of Air Berlin, Ryanair was a vocal critic of the German government’s provision of €150m in state aid, as its August 2017 news release attested: ‘This insolvency is being timed to allow Lufthansa to take over a debt-free Air Berlin (its major German competitor) which will be in breach of all German and EU competition rules, and this Lufthansa monopoly has been supported by the German government providing €150m of state aid.’

Nevertheless, the European Commission (EC)approved the loan and, in December of that year, approved Lufthansa’s acquisition of certain Air Berlin assets – with the notable exception of Niki.

But the issue of state subsidisation continues to dog the aviation sector, as LCCs and legacy carriers alike condemn perceived attempts by state actors to undermine competition. EC guidelines, however, do not expressly prohibit state aid to airports and airlines.

‘There are a number of other airlines that may be driven by political decisions at the moment. There are some airlines that do not have a particularly rational approach to business. That will shake itself out. There is going to be quite a change in the aviation landscape in the next ten-20 years,’ argues Jones.

Hurricane Brexit

For established carriers and LCCs alike, the greatest uncertainty currently is Brexit. In an interview with The Telegraph, the founder of Monarch’s major shareholder, Greybull Capital, highlighted a weak pound and Brexit, along with terrorism, as reasons for the airline’s failure.

‘We were publicly against Brexit – we think it’s a step backwards.’
John Harrison, Airbus

‘That is at the forefront of every airline’s mind at the moment and, like every other airline, we are talking to every authority that we can to try and get clarity on what’s happening,’ says Jones.

As it currently stands, the UK’s aviation industry will ‘continue to benefit from the existing liberal market access until the end of 2020’ (Department for Transport, April 2018), although the EC has stated that, eventually, after exiting the EU, UK-based carriers will no longer ‘obtain and keep an EU operating licence and benefit from the intra-EU air traffic rights’ (EC, Directorate-General for Mobility and Transport, January 2018) – the EU single aviation market.

A February 2018 CAPA article noted that Dublin-headquartered Ryanair and Budapest-based Wizz Air had applied for UK air operator certificates, while British easyJet is setting up a new UK subsidiary alongside its European one in an attempt to operate in both jurisdictions.

‘We cannot afford to wait and see. Our view very much is that the liberalised industry, which started back in 1994 in Europe, has produced huge benefits both for businesses and for citizens of Europe,’ says Jones.

‘Liberalisation has resulted in the growth of carriers like Wizz Air, which provides opportunities for people to travel throughout Europe, connecting the newer countries in the EU to the West. Liberalisation is something which was long fought for and, ironically, long fought for by the British.’

Airlines aside, the potential implications of the Brexit deal reverberate around the aviation sector, with even a tariff-free environment likely to prove deeply disruptive to cross-border trade in the hardware keeping the industry airborne.

John Harrison, GC of aircraft manufacturer Airbus, which has 14,000 employees and £6bn of activities in the UK, notes: ‘We make more than 80,000 business trips between continental Europe and the UK every year. If Brexit causes a delay to each of these trips, that will have a big impact – even just the bureaucratic and administrative impact. The turnaround time to load a wing into one of our Beluga aircraft – which fly parts around – is very carefully timed and if you add 45 or 75 minutes, that can have a bad impact on production. If we have to warehouse products because of a slowdown in the supply chain, this is going to add cost. Then there is increased bureaucracy and form-filling for goods coming out of the UK and into the UK. Because 70% of what we do is outsourced, we have more than 4,000 suppliers in the UK, and some of them don’t have the bureaucratic size to be able to deal with form-filling.’

He adds: ‘The problem is, you’ve got the political message up here, but then you’ve got the down-to-earth, practical reality of delivering parts. You can’t deliver an aircraft if the toilet doors are not there. This is all impacted by the single market, by no tariffs, by free movement. By introducing friction, the impact could be absolutely dramatic. So, we were publicly against Brexit – we think it’s a step backwards.’

Innovating on the fly

In a world as competitive as aviation, keeping pace with change is crucial and most players are investing in online platforms. Flybe, for instance, has recently upgraded its digital platform.

‘Technology generally has been a big issue over the last few year for airlines – there’s a need to get on board and make the passenger experience as good as possible,’ says Ledger.

‘We are adopting a programme that will help us with a lot of things like GDPR, but also in terms of our IT position. It provides with a whole new ticketing system, a whole new passenger booking platform, a central e-commerce platform to enable us to do our marketing and a departure control system, interfacing with all the airports in terms of check-in, managing baggage and assessing aircraft load.’

Jones echoes the need for strong online presence: ‘We have the youngest customer profile of any major [ultra-low-cost carrier] or low-cost carrier in Europe. That means we need to be looking at our e-commerce capabilities, our website, as that is how our generation of customers operate. We need to make sure that we are delivering their needs in terms of how we communicate, how we make our products available.’

Leveraging tech in aircraft design is another area in which airlines and their suppliers strive to get an edge on rivals in terms of operational efficiency providing more comfortable craft.

‘I see a growing trend in questions about integrity, sustainability and the environment. If you take the new engine options on our aircraft, they are 15% more fuel efficient, so our environmental footprint is becoming more favourable each year,’ says Harrison.

‘In addition to delivering margins, we have to be thinking about how we’re perceived in the market and do the right thing.’

For Wizz, this is an integral part of its low-cost model: ‘We make sure that we use the latest equipment, our fleet is four years old and, in January 2019, we are scheduled to start taking the first of our Airbus A321neo aircraft, which is equipped with new engine technology,’ says Jones.

‘New engine technology will deliver significant savings in terms of operating costs, which then directly feeds through to our pricing, and keeps that virtuous circle of bringing more people into the flying franchise.’

The sector is also benefiting from innovation on the maintenance and overhaul side of the market.

‘We’ve had a lot of programmes to reduce fuel. With every new aircraft type, like with the modern fleets, the reduction of fuel is one of the main topics the airlines try to implement,’ says Olaf Johannsen at Lufthansa Technik.

There is also much talk now of ‘predictive maintenance’ – a concept whereby data analysis will allow aircraft maintenance and repair companies to predict requirements more precisely.

‘The use of big data is going to transform the way that we build and maintain aircraft. You’ll say: “You have to change this part next year in February, because all of the digital predictability that we’ve got from the fleet that’s in operation tells us this has to happen.” This data should ultimately mean that we will be able to develop an aircraft quicker, which means it will be cheaper and brought to market quicker,’ says Harrison (see box below).

Depending on your vantage point within the industry, aviation continues to be buffeted by head or tailwinds. Seismic market shifts, political and regulatory fallout and technological advancements continue to challenge players, and their in-house lawyers. LB

catherine.wycherley@legalease.co.uk