Wings of Change
GC reports on trends in the fast-evolving and cutthroat European aviation market.
Trends in aviation
One thing is certain in Europe’s aviation sector: uncertainty.
The dramatic collapse of two established major European airlines demonstrated the volatility facing many sections of the industry, with British-headquartered Monarch Airlines and German-based Air Berlin becoming the latest casualties of turbulence in the market.
‘Airlines are no longer seen as your triple-A bet,’ says Catherine Ledger, general counsel of UK-based regional airline Flybe.
But, like the aircraft themselves (at least when they’re not grounded), aviation is a market that never stands still. When a carrier takes a nosedive, there are competitors aplenty ready to run with the assets – not only the aircraft themselves, 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.’
Topping the list of storms to have hit the aviation world in recent years – particularly the short-haul market – has been 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 and complementary refreshments and baggage check-in from the passenger offering, in return for cut-price fares.
The New Economy (Class)
The transformative impact of LCCs on the short- and medium-haul market has come at a price for full-service, or ‘legacy’ carriers, which have found themselves increasingly under pressure to compete on price, or risk losses and even failure. Reports point the finger – at least in part – at competition from low-cost carriers in the demise of Air Berlin (which had itself previously experimented with a hybrid-LCC model).
This pressure has been felt in more ways 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 (FSCs) – 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.
‘By expanding their presence in airports other than their traditional hubs, a number of large airline groups now operate multiple hubs. There are now recent examples of these groups moving aircraft between these hubs, and as a result of these developments, these groups have greater buyer power than they did in the past,’ explains Danijela Popadic, general counsel of Serbian flag carrier, Air Serbia.
Making your connection
To spread the cost (and sometimes the risk), cooperation is the name of the game for FSCs (and others), with some even going as far as consolidation, as was the case with International Airlines Group (IAG), the parent company of flag carriers Aer Lingus, British Airways and Iberia, as well as low-cost airline Vueling.
Even without formal consolidation, there are many collaborative arrangements that airlines frequently enter into in order to extend their reach beyond their traditional routes, or to increase efficiency. A codeshare agreement, for example, enables passengers to book tickets for a route with one carrier, while the flight is actually operated by a different carrier sharing the flight number.
‘People like to be able to have a seamless flying experience where possible, and therefore it makes sense in lots of ways for airlines to have arrangements like codeshares to make the travel experience a lot more straight forward,’ says Ledger.
'When a carrier takes a nosedive, there are competitors aplenty ready to run with the assets.'
‘We’re now doing far more codeshare arrangements with different airlines, which enables passengers to book a ticket which 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’s one transaction rather than trying to buy two lots of tickets. It’s certainly something that’s a growth area for us.’
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’s 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 a bit more for the shorter hop regional flying, which doesn’t fit in with the larger aircraft,’ explains Ledger.
Further down the road of cooperation is the risk share, more akin to a joint venture, 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 quite interesting because there’s lots of new, different ways of doing things. Sometimes we’re doing things that haven’t quite been done before. Our team has to be quite 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 doing with other carriers, that introduces costs into the equation,’ says Owain Jones.
Under pressure from the low-cost sector, FSCs have succumbed to pressure to diversify, adopting options such as economy products that were previously the domain of the LCCs. However, Danijela Popadic believes that consolidation in terms of service levels is happening in all sections of the market:
‘In-keeping with their core objective of keeping costs low, LCCs have traditionally operated flights with no frills such as beverages or meals, only one class of seat and predominantly non-flexible fares, no loyalty programmes or access to lounges, and surcharges for checking in bags. In an attempt to attract business passengers, most LCCs have modified their practices in these respects. These trends imply that LCCs are increasingly competing for business passengers, a demographic that traditionally flew with FSCs.’
But the advance of the 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 – Centre for Aviation 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.
‘It is expected that low-cost carriers (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 the LCCs did on short haul’ says Popadic. ‘That’s because many of the features which enable LCCs to compete so effectively with the FSCs are less applicable on long haul.’
The politics of flight
Low-cost operators like Ryanair, easyJet and Wizz are opening up new markets by making flying ever more affordable and accessible. Some, like Wizz Air, are even able to harness geopolitical tail winds to further 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. So we are bringing new people into the flying franchise,’ says Jones.
'It’s really critical to have the right aircraft for the right route.'
‘It’s a very different game to Western European airlines, which are battling it out to take customers from one another. In Central and Eastern Europe, the rate of travel by air is still around quarter of what it is in Western Europe, so significantly higher GDP growth is what’s contributing to our strong growth.’
Despite expanding economies putting money in the pockets of their general public – who are willing to spend it on foreign travel – there is a limit on the sky’s potential for propping up the aviation industry. In an increasingly competitive environment, not everyone can be a winner.
‘I think 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, in the case of airlines, the strongest airlines are the ones with very controlled cost bases. If you look at the US, which started liberalisation quite 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 that – 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.’
He adds: ‘We think there are a number of other airlines that may be driven by political decisions at the moment. There are some airlines that don’t have a particularly rational approach to business. That will shake itself out, so I think there’s going to be quite a change in the aviation landscape in the next 10-20 years,’ argues Owain Jones.
Following last year’s collapse of Air Berlin, LCC 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.’
But, despite Ryanair CEO Michael O’Leary’s demands that German and European Commission competition regulators block the ‘anti-consumer stitch-up’, in September 2017 the 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.
While attaching strict conditions to the loan, the Commission found that the German government’s rescue package was not in contravention of state aid laws. 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. European Commission guidelines, however, do not expressly prohibit state aid to airports and airlines.
For FSCs and LCCs alike, however, the greatest uncertainty currently is Brexit. In an interview with UK newspaper 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.
‘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 Owain 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 European Commission 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’ (European Commission, Directorate-General for Mobility and Transport, January 2018) – in other words, 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 (AOCs), while British easyJet is setting up a new UK subsidiary alongside its European one in an attempt to operate in both jurisdictions.
‘We can’t afford to sit back and 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, and that has continued. The benefits of a liberalised aviation industry in Europe are without question.’
Airlines aside, the potential implications of the Brexit deal reverberate around the entire aviation sector, with even a tariff-free environment likely to prove deeply disruptive to cross-border trade in the hardware keeping the industry airborne.
‘The devil is in the detail,’ says John Harrison, general counsel of aircraft manufacturer Airbus, which has 14,000 employees and £6bn of activities in the UK.
‘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 actually 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. If there is increased bureaucracy and form-filling in 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 are small and some of them don’t have the bureaucratic size to be able to deal with form-filling. They don’t even have the data to be able to fill in the forms.’
Harrison 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.’
In other regulation…
On the regulatory side, General Data Protection Regulation implementation ahead of the May 2018 deadline has been the most significant concern facing aviation operators in recent months, along with European businesses in all sectors – including the UK, given the British government’s confirmed commitment to the regulation.
‘One of the major areas that needs to be closely monitored in the upcoming period is GDPR regulation, in order to exclude any exposure to high penalties, but also to maintain reputation as an airline that takes care of personal data with the highest possible attention,’ says Popadic.
Innovating on the fly
In a world as competitive as aviation, staying abreast of the innovation curve is key and, like many airlines, Flybe has recently upgraded its digital platform to accommodate this need.
‘Technology generally has been quite a big issue over the last few years 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 which will help us with a lot of things like GDPR, but also in terms of our IT position. It provides 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.’
Maximising digital capability can also be a differentiator when it comes to passenger choice.
‘At Wizz, we have the youngest customer profile of any major ULCC [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’s 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,’ says Jones.
Leveraging technological advancements in aircraft design is a fundamentally important way that both airlines and their suppliers can stay competitive, both from an economic perspective – as a minimal reduction in fuel costs can have a huge impact on an airline’s bottom line – and a customer/shareholder one.
'The benefits of a liberalised aviation industry in Europe are without question.'
‘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 just delivering margins, we have to be thinking about how we’re perceived in the market and do the right thing. When we develop products, we think about the environment as well, and we think how we can make our aircraft less polluting.’
For Wizz, this is an integral contributing factor to 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 A321 Neo aircraft, which is equipped with new engine technology,’ says Jones.
‘We believe that 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 benefitting from innovation on the maintenance, repair and overhaul side of the market.
‘We’ve had a lot of programmes that are trying to reduce fuel, for example, you can wash an engine every three or six months and then the engine uses less fuel than without washing. Or you can have winglets on airplanes, which reduce fuel consumption as well. 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 Dr Olaf Johannsen, head of legal Americas at Lufthansa Technik.
In particular, digitalisation is increasingly expected to enable ‘predictive maintenance’ – a concept whereby big 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,’ explains Harrison at Airbus.
Depending on your vantage point within the industry, aviation continues to be buffeted by head and/or tailwinds. Seismic market shifts, political and regulatory fallout and technological advancements continue to challenge players in this space, and their in-house lawyers seeking to keep the balls in the air. To survive in today’s fast-paced and febrile climate, operators must be flexible, resourceful and poised to take advantage when it presents itself – and their in-house lawyers must be likewise. Integrated with the business and often responsible for a variety of business-critical functions (like data protection) in addition to the regulatory and contractual bread and butter work of legal, aviation general counsel are viewed as strategic contributors to commercial decision-making, and therefore vital to the streamlined operation of this often bruising sector.