Air Scoop May 2008

Highlights in this Issue

Oil and LCCs: High Prices to Pay Flybe « Fake Passengers » Affair Exploring Major Investors of Ryanair and Wizzair SWOT Analysis of Centralwings Will High Fuel Prices Destroy Some LCCs?

p. 2 p. 3 p. 4 p. 10 p. 18

The Low Cost Carriers Analysis Newsletter

EDITORIAL The Five Plagues of Low-Cost Carriers

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here are currently 5 main issues facing European low-cost carriers: 1. Oil prices increase and its impact on LCCs; 2. Overcapacities and drop of the load factors; 3. Environment pressure on LCCs; 4. Illegal Subsidies received by LCCs from public entities; 5. Important and regular fall of LCCs shares. The increase of oil price is definitely THE issue that will deeply modify LCCs industry in Europe, and will probably have an impact on most business models. Facing this “storm”, only the strongest will survive. Some have started important cost-cutting programs; while others raise ancillary charges, such as check-in taxes (p. 2), and hidden charges. Flybe has adopted other means to fill its planes, by hiring fake passengers, and therefore to reach the quotas needed (p. 3). Despite these different measures, it is now clear that some LCCs won’t escape bankruptcy, and 2008 could be a turning year in this market (p. 18). Centralwings, a subsidiary of the national polish carrier LOT, could be one of them in a short term (p. 7). Therefore, we have made a detailed SWOT analysis of this carrier (p. 8). Another option for carriers to carry on is to merge with others. In Spain, Vueling and clickair, both in difficulties, are a good example. Some like Ryanair and Wizzair (p. 4) seems to have thighs through their major investors.

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AIR SCOOP ANNOUNCEMENTS A Glimpse of Headlines News! EasyJet Posts Wider Net Loss, Aims to Boost Fuel Efficiency EasyJet PLC on Wednesday posted a wider fiscal first-half net loss amid higher fuel prices and said it will speed up the removal of less-efficient airplanes from its fleet to trim operating costs. The U.K.-based budget airline posted a net loss of £43.3 million ($85.4 million) for the six months ended March 31, compared with a year-earlier loss of £12.7 million. Airline websites still ripping off consumers, Brussels says The 8th of May, the European Commission said EU consumers are still getting ripped off when they buy airplane tickets online and threatened the industry with «further measures» if the situation does not change within one year. «It is unacceptable that one in three consumers going to book a plane ticket online is being ripped off or mislead and confused,» said consumer commissioner Meglena Kuneva when presenting the findings in Brussels. Ryanair, EasyJet decline after Merrill cuts estimates Ryanair Holdings Plc, Europe’s biggest discount carrier, fell in Dublin trading after Merrill Lynch cut its share-price estimate for the airline by 7.3 percent, citing increasing fuel costs. EasyJet Plc, Ryanair’s biggest competitor, and British Airways Plc, Europe’s third-largest carrier, also declined after Merrill lowered earnings estimates. Merrill cut its price target for Ryanair to 3.80 euros a share from 4.10 euros, the bank said today in a note to investors. The Dublinbased carrier dropped as much as 4.6 percent.

3. Exclusive Interviews of LCCs Market Top Executives

Ryanair faces sanctions over fares hike Ryanair could be facing sanctions over its treatment of some Munster fans travelling to the Heineken Cup final in Cardiff on May 24.

4. Coverage of Main European LCCs Events

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Air Scoop - May 2008

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BIRD’S EYE VIEW Oil and LCCs: High Prices to Pay With oil prices having crossed the $110 a barrel threshold, LCCs are getting ready to tighten their belts. In the light of potential bankruptcy budget airlines seek to reduce the impact of record high fuel prices by all possible means. To begin with let’s look at some figures. It comes as no surprises that LCCs will experience a significant loss in earnings. Raising oil prices hit the pockets of LCCs and are expected to cause as many as £45m of additional costs. Some experts estimate a cut rate in earnings between 12 % and 53%. O’Leary himself has warned investors about a painful year forecasting a 50% fall in profits. Ryanair is probably the worst affected airline as it remains unhedged throughout this fiscal year. Although there is no sign of oil prices going down, Ryanair is only going to hedge if they drop below $110. However, the Irish carrier keeps its promise not to add any fuel surcharges to tickets. Passing on price increases to tickets will undermine the entire low-cost model. Nevertheless, certain surcharges will be passed on to passengers as Ryanair is most likely going to introduce higher check-in and baggage fares. Against the backdrop of economic breakdown, weakening dollar and oil crisis, getting high yield revenue might be quite problematic as this backdrop will certainly affect purchasing power of consumption and have its impact on the load factor. In response to increasing prices Ryanair, for example, is

planning to launch a cost-cutting programme. One the one hand, it will include negotiating ground handling contracts with airports to reduce all possible costs. O’Leary pointed up his tough intentions and stressed that it would not take him long to close operations at airports reluctant to come to terms with Ryanair. Facile airports will, on the contrary, receive additional flights. If the situation gets worse, it will probably mean the wind down of many less profitable bases. On the other hand, the programme also includes cutting inner costs by freezing top-management salary. If prices remain high, 36 executives should not expect to receive any salary bonus or pay increase. Since then, Ryanair said the salaries of its staff not on multi-year pay agreements have been frozen which include pilots and cabin crew. Though most LCCs will have hard times ahead with profits cut up to 50%, the economic situation will definitely secure them from any further competition. While past economic breakdowns gave birth to airlines offering lowcost services, this time it is highly unlikely that any new carrier will enter the market due to oil prices, new environmental regulations and profit uncertainty. Additionally, it will sweep away weaker LCCs providing the stronger with more space. That is to say, that the stronger LCCs may even benefit from the recession. According to one of the managing directors of easyJet, there will be only three or four LCCs left in the nearest future. Most likely, some less competitive airlines will prefer merging to leaving the business.

EVENTS

World Low Cost Airlines 2008 September 23 to 24 in London

Air Scoop is proud to be media partner of the World Low Cost Airlines 2008. Plans are starting to take shape for the World Low Cost Airlines Congress 2008. Earlier this year over 650 of you joined us in London for an action packed two days. To remind yourself of the day (or to see what you missed!) we have put together a short video of the highlights. To see it simply visit our homepage. (You’ll need to have flash installed on your computer.) Don’t miss out on next year’s event. To have more informations about last edition of the World Low Cost Airlines, read the full coverage in Air Scoop October 2007. For more information on the World Low Cost Airlines 2008, visit www.terrapinn.com

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BIRD’S EYE VIEW Flybe « Fake Passengers » Affair Puts LCC Business Model Into Question The story was published on April 1st, but it is far from being a joke: at the end of March, British LCC Flybe tried to hire temps to fill two extra flights on its Norwich-Dublin route. Why such an absurd decision? Flybe receives from the Norwich airport a 280.000 £ yearly reduction on passengers fees, under one condition : it has to reach a certain amount of passengers per year, globally and on some specific routes. The twelve-month period was ending at March 31st. The global amount of about 60.000 passengers had been reached, and even exceeded by far. But on the specific Norwich-Dublin route, the quota of 15.000 passengers had not been hit. 172 passengers were missing. Therefore, the LCC decided to set up extra flights, and chose some rather radical methods to fill them : first, it published an advertisment on its website, offering free flights on 200 return tickets to « celebrate 2 years flying on our popular Norwich to Dublin route » ; secondly, it published another ad on a specialized website, StarNow, to hire actors for 80 £ a day, plus free bar and in-flight entertainment, just to fly from Norwich to Dublin and back, with up to three flights on the same day. Finally, it also asked its staff to stand ready, in case the two first solutions were not sufficient. Setting up extra flights and hiring people to fill them was indeed less expensive than losing the benefit of the fee reduction. Unfortunately, Flybe’s weird strategy was made public, and led to a harsh quarrel between the airline and the airport. « We have a deal with Norwich airport. We had to deliver 60.000 passengers. We have delivered 136.000, but there was a clause buried in the bowels of the contract that we had to hit 15.000 passengers on Dublin to Norwich, » Mike Rutter, Flybe’s CCO, told on an Irish radio station.

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The airline also accused the airport to have rejected a last minute deal about a partial fee reduction if the quota was not totally reached. It called the airport authorities « intransigent » and « greedy ». Richard Jenner, managing director of Norwich airport, refuted Flybe’s arguments, disapproved the company’s methods and said these « unusual » passengers would not be counted by the airport anyway. Environmental campaigners also charged Flybe with polluting the atmosphere needlessly by making planes fly « for nothing ». Flybe admitted its fault, and promised to offset the carbon emissions caused by the extra flights. All the more since on its website, the Exeter-based British regional airline, operating 78 planes to about 50 destinations, proudly pretends to be « at the forefront of the efforts by the airlines to reduce the environmental impact of air travel and promote sustainable growth in the aviation industry »... Beyond its quite pathetic aspect, this story questions the whole LCC business model, partly based on subsidies paid by the airports to low-cost carriers under certain traffic conditions, which leads to such an absurd thing as paying customers to consume! With this new example, the European LCC business seems quite artificial. It frenetically creates new routes, injects new planes in the European sky, and reaches overcapacity, trying to create essential demand to fill the aircrafts and to survive on this very competitive market. On the other hand, it relies on subsidies to compensate damages of hard competition and the eventual lack of passengers. Many analysts today agree that such a model is not completely sane, and raise a question: Do LCCs still wonder if there is still a demand for all their flights?

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DOWN TO EARTH A Real Battle? Exploring Major Investors of Ryanair and Wizzair In October 2007, Ryanair announced the entry to Budapest and started to operate flights on several routes from the Hungarian capital since the beginning of November. One of those routes was the Budapest – Frankfurt-Hahn connection. Wizzair had been offering flights on this route for more than three years but soon after Ryanair’s press conference in October, the Hungarian low-cost carrier decided to withdraw from the route. A potential explanation to this could be that Wizzair did not want to be involved in a direct competition with Ryanair on this single route. However, rumours were already spreading about the significant overlap between the major investors of the two companies. Therefore, the withdrawal of Wizzair might have been an outcome of previous, informal negotiations. In this article we will try to collect evidence that may support the existence of a potential “co-operation” between Ryanair and Wizzair. First, Wizzair is the only European low-cost carrier besides Ryanair, which is classified as ultra low-cost. In terms of the business model, Wizzair has therefore successfully imitated Ryanair to a great extent. Based on recent data, Ryanair’s average fare including taxes and charges revolves around 40 euros, while the same indicator for Wizzair is 50-55 euros. This is about 30-50 % lower than most of the average fare of European low-cost competitors. It is not surprising that Wizzair has been able to imitate Ryanair’s business model so well, what is more interesting is that it is only Wizzair that managed to do that so far. Does this imply a stronger than usual tie between the two companies? It is a rather hopeless enterprise to obtain detailed data on Wizzair’s financial performance as the company refuses to reveal any sort of “commercially sensitive” information. However, it is known that their major investor is Indigo Partners, an Arizona based private investment firm, which is run by former America West Airlines head, Stanford graduate William A. Franke. Indigo Partners is specialized in the transportation sector and is also the initial investor in Singapore-based low-cost carrier, Tiger Airways. Mr Franke holds the chairman position both at Wizzair and Tiger Airways. Indigo Partners have already invested around 50 million euros in Wizzair, which makes the company one of the best capitalized Central European LCCs. Indigo Partners was founded in 2002 by Mr Franke, Steve Johnson and David Bonderman. The key figure in this puzzle, as we will see later, is Harvard Law School graduate Mr Bonderman, who has served as a director of Ryanair since 1995, and since 1996 he has been the Chairman of

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the Board. In essence, the close business ties and mutual investments of Bonderman and Franke link Ryanair and Wizzair together but how close their relationship is?

William Franke

David Bonderman

Bonderman established Texas Pacific Group (TPG) in 1992, which has become one of the world’s richest and most successful private equity companies. In 1993, Bonderman through TPG and other partners helped Continental Airlines out from bankruptcy. The total investment amounted to $450 million. As a result, he became one of the directors of Continental and took a seat in the Board of Directors as well. Next year, in 1994, Bonderman, along with other investors like Fidelity Investments and Mesa Airlines, offered $220 million for a 37.5 percent stake in America West, second largest low-cost carrier of the US at that time, being in bankruptcy. In 1994 William Franke was the chief executive officer of America West Airlines (served in this position between 1993 and 2001). The deal was made, America West was saved and the beginning of the close business relationship between Bonderman and Franke probably dates back to this period. In 1996 Bonderman invested in yet another airline. For £25 million, through TPG, he took a 20 percent stake in Ryanair. Since then, Ryanair has literally been soaring, and has grown from a minor player to a globally significant air carrier and the biggest one in the world according to the number of international passengers carried in 2007. It is also worth mentioning that Bonderman’s presence at Ryanair probably made negotiations with Boeing much smoother, thus Ryanair got control of its new fleet under favourable financial conditions. Building on the successful track record in air transportation investments, Indigo Partners became the joint enterprise of Bonderman and Franke aimed to conquer Asian and Central and Eastern European markets. In 2004, Indigo Partners helped establishing the first Asian low-cost air carrier, Tiger Airways. Tiger Airways is backed by Singapore Airlines (49 % stake) and the Singapore government’s investment arm Temasek (11 %), while Indigo Partners contributed with a 24 % stake, whereas the investment vehicle of Ryan

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DOWN TO EARTH family (including Tony Ryan, the co-founder of Ryanair), Irelandia Investments took a 16 percent share. The size of the total investment has not been disclosed. Wizzair was the other LCC, which was financially backed since the beginning of its operation by Indigo Partners. Even though Bonderman withdrew from Indigo Partners after these deals and officially he does not hold now any positions in the equity firm, he is still affiliated with it through TPG’s share in Indigo Partners. Since the largest investors of both Ryanair and Wizzair have strong affiliations with both Bonderman (chairman of Ryanair) and Franke (chairman of Wizzair), one may legitimately argue that these ties may be reflected in the day-to-day operation and business strategy of the air carriers. In other words, a direct battle between these airlines would not be in the interest of their investors. In order to highlight the magnitude of co-operation between Bonderman and Franke, the recent story of Russian lowcost carrier, A1 is a good example to raise. A1 was established in 2007 and according to its business plan it is going to offer domestic flights. As Russia’s daily on-line business journal, kommersant.com reported last June, private foreign investors own a 49 percent stake in A1, out of which David Bonderman has 35 percent, while the co-owners of Indigo Partners (including Franke) got 14 percent. What is even more intriguing is that Michael O’Leary, CEO of Ryanair is also involved. He is expected to consult A1 in business development issues. What is more, A1 has allegedly signed an agreement with Indigo Partners for buying a stake in Wizzair!

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The above presented evidence does not mean to suggest that there is an ongoing informal co-operation and negotiation between Ryanair and Wizzair that may raise concerns about a potential division of the market between themselves. However, the article do suggest that due to the substantial overlap between the major investors of the two air carriers, it may not be in the interest of the companies to engage in a heated rivalry and direct competition. This is clearly reflected in the fact that even though both have gained a quite significant share in the Central and Eastern European low-cost market, there is not even a single route on which both of them offer flights! Moreover, there are only three city pairs (Gdansk-London, Poznan-London, Wroclaw-London) that both Ryanair and Wizzair serve, however, the London destination differs as Ryanair flies to Stansted while Wizzair flies to Luton. Bearing all of this in mind, one may get a more nuanced picture of the European low-cost market. Especially regarding the Central European region, Wizzair may be in a very advantageous situation and it seems that its positions are not and probably will not be threatened by one of the biggest potential rivals, Ryanair. This may hold true as long as acquisitions and mergers or new entrants do not shake up the current European status quo.

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BIRD’S EYE VIEW

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EVENTS

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DOWN TO EARTH The Fate of Centralwings Jacek Ksen, member of the Board of Supervisors of the Polish flag carrier LOT, announced earlier this year that LOT is planning to divest its low-cost subsidiary Centralwings as it has not turned profitable since it began operating in February, 2005. Centralwings poses a textbook example of how not to position and run a low-cost airline. In this article we will try to highlight the main reasons for its failure. In 2004, low-cost carriers flew 1.2 million passengers on the Polish market, way much above the estimations, which a year earlier predicted about 580 thousand for 2004. The significant growth of this market segment and the parallel shrinking of the market share of traditional carriers urged LOT, the most exposed traditional carrier in Poland to the competition from LCCs, to react quickly. The dilemma was the following: LOT would either become a low-cost carrier itself or would launch its own low-cost subsidiary as a response to the arrival of other LCCs. The management of LOT committed itself to the latter option, therefore Centralwings was born. However, this commitment was rather half-hearted. Very limited financial assets were dedicated to Centralwings, LOT has provided a capital investment of a mere $1.6 million. In comparison to this, after the first year of its operation, Wizzair received a total capital injection amounting to €40 million. Despite being undercapitalised, LOT expected Centralwings to make profit soon. The second mistake was the mismatch between the positioning of Centralwings in the low-cost market and its business model. At the beginning, the company was targeting UK destinations, which seemed the most profitable; however, Centralwings had to face the toughest competition there. EasyJet, Sky Europe, Wizzair and Ryanair had already been offering flights between Polish cities and the UK, moreover, they all had a much more favourable cost structure than Centralwings. As a result, the Polish LCC’s average fare price exceeded that of its competitors’, thus it failed to match the intense price competition. Moreover, Centralwings have constantly been lacking a focused network, a problem Sky Europe also had to face. This significantly harmed the profitability of Centralwings as it was unable to clearly target a market niche. Third, Centralwings was unable to take advantage of economies of scale given its small fleet size (in May 2008 they still operate with 9 Boeing 737-s). Furthermore, its fleet with an average age of 12.3 years (data from March 2008) is significantly older than the fleets of its closest rivals. This

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directly raises the operating costs as older aircrafts use more fuel and are less efficient than younger ones and may require higher maintenance costs as well. Fourth, the soaring oil prices seriously affected Centralwings’ cost structure. The low revenues (under €6 per seat) and the unsuccessful attempts to raise ancillary revenues coupled with rising costs left the company in a dire financial position. In 2006 Centralwings reported to make an operating loss of 65 million Polish zloty (about €19 million), while in 2007 the deficit increased to 73 million (about €21 million) versus a planned €35 million zloty. Fifth, the Polish government is planning to sell LOT and the first phase of it would be to list it on the stock exchange later this year. This further casts shadows on Centralwings’ future. As Waldemar Krolikowski, CEO of Centralwings revealed to Polish business daily Puls Biznesu in February, 2008, ‘the stronger players are driving out the weaker ones, first from the profitable routes, then from the market. This may be Centralwings’ fate as well.’ This is well reflected in the fact that Centralwings decided to cancel operations on eight routes this year (Shannon – Gdansk, Manchester – Gdansk, Manchester – Warsaw, Lille – Warsaw, Birmingham – Cracow, Cork – Cracow, Edinburgh – Poznan, Dortmund – Szczecin). Most of them are routes between Poland and the UK or Ireland, where the tough competition may have forced Centralwings to abandon operations. Krolikowski also mentioned that the business plan of the carrier had been revised and in the future they would like to focus on charter flights and escape the “violent competition” in the scheduled market. However, for this plan to execute, Centralwings needs capital, but in a situation close to bankruptcy the management has been unsuccessful at securing additional funds. What is more likely is that Centralwings is going to follow the fate of former Polish low-cost carrier Air Polonia, which declared bankruptcy after three years of operation. It is also very probable that Centralwings will be sold to a third party. In light of the above, LOT’s board member Mr Ksen’s following remark sounds ironic enough exactly three years after Centralwings began operation: ‘Our withdrawal from Centralwings should have been carried out three years ago. Creating the low-cost airline was a mistake”.

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BIRD’S EYE VIEW SWOT Analysis of Centralwings Introduction There are approximately 50 low-cost carriers in Europe, with new ones emerging and old ones dying regularly. The largest is Ryanair (Ireland), followed by easyJet (U.K.) and Air Berlin (Germany/Spain). Other significant players currently are Germanwings (half owned by Lufthansa), Clickair and Vueling (Spain), Sterling (Denmark), Virgin Express (Belgium). Further east, WizzAir (Poland) is the low-cost leader which has negatively impacted the performances of SkyEurope and state-owned Centralwings. Besides these there are several charter and semi-scheduled airlines which compete for European traffic. Globally, 2008 is anticipated to be a year of economy slowdown, rising fuel prices, lower consumer spend and consolidation (mergers or bankruptcies) in the airline industry. After two years of hefty growth, the European LCC industry is slowing down. In May 2007, EasyJet had already warned about ‘weaker market conditions’ and expressed worries about its summer activity. In June, Michael O’Leary, Ryanair’s CEO, had predicted a difficult winter for LCCs. He had corrected the company’s expected profit growth for 2007 down to 5%, the slowest rate in four years. He warned about decreasing yields in 2008, combined with rising costs. “We expect a big downturn in the next 12 months”, he said. There are several reasons for this downturn. First, the air transport market is cyclical, and after two years of growth and rising yields, it is likely to slow down. As the fares have grown too high, the demand is softening. Secondly, costs are rising – airlines are extremely anxious about the tax increases on air transport, higher charges at airports and increasing oil prices. Although LCCs often claim to be less affected by increased fuel prices as they operate modern fuel-efficient planes, experts believe that rises in fuel price will do a lot to slow the entire industry. Consumers may be less euphoric than before as carriers are most likely to pass the additional costs to their passengers in one way or another. Third, all European LCCs tried to grow fast and big very quickly and at almost the same time, opening new routes and buying new planes. In a highly competitive air transport market, which has not yet been consolidated, airlines have to constantly increase their capacity to keep a chance to exist. Ordering lots of aircrafts is also a way of showing their prosperity and their confidence into the future. But these abundant orders could finally lead to congestion, overcapacity and price wars. Now, the most popular and profitable routes are overcrowded and the

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SWOT TEAM transport capacity seems to be now in excess. According to some analysts, the decline of load factors could be a result of an overcrowded sky, even if the airlines themselves deny it. Recently, several airlines announced a reduction of either their capacities or plane orders. Lastly, environmental concerns are increasing and environmental campaigns against LCCs are affecting sales. European governments may enforce greater accountability towards the environment on low cost carriers in the near future. There does not seem to be many growth possibilities left for LCCs. They can either fight a temporary cost and price war to gain market shares, or develop their offerings, by consolidating their existing network, finding new secondary airports to win new customers, or exploring more distant destinations in the South, the East or the North. Many of them are weakened by their quick and strained development. Some examples of struggling airlines are Centralwings, Vueling and SkyEurope. The market is bound to enter into a phase of maturation and consolidation. According to a Cranfield University forecast, the low-cost airlines sector in 2015 will be dominated by 2 or 3 large carriers carrying up to 80 million passengers approximately, flying 250 air-crafts, along with a few niche players. Two models that would most probably survive are: the Ryanair kind with reduced fares, flying to secondary airports, relying on leisure cus-tomers, earning high ancillary revenues and the EasyJet / Air Berlin type, with mid-fares, flying to main airports, challenging big carriers and gathering leisure and business customers. Polish airline market Among the Eastern European countries, Poland maintains strong growth and now has the 4th highest low-cost market share with 21%. The International Air Transport Association had forecast that, during 2005-2009, Poland would become the fastest-growing air transport market in the world. Its average annual growth in passenger numbers was expected to be 11.2 percent over that period. Along with the growing economy of Poland, the number of passengers is also predicted to grow tenfold, with passenger numbers for low-cost carriers alone are expected to reach five million in 2010. The top-10 air carriers in Poland now include five budget airlines: Hungary’s Wizz Air, Britain’s easyJet, Ireland’s Ryanair, Germany’s Germanwings and the LOT Polish Airlines’ own Centralwings. Polish airports: Poland is the largest of the new member states of the European Union with a population of 38.1 million (2006) and a surface area (313 thousand km2) that

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BIRD’S EYE VIEW roughly equals to that of Italy. This implies great potentials for commercial air transport. Currently, there are ten international airports in Poland that are served by at least one low-cost carrier. Most of these airports have undergone major reconstruction and extension. The biggest of all is the Frederik Chopin Airport in Warsaw, which handles more than 50 % of all air passenger traffic in the country (in 2007, Warsaw airport served more than 8 million passengers). The capacity of the airport of Poland’s capital has increased to 10-12 million passengers per year with the addition of a new terminal. The second busiest airports are in Krakow and in Katowice, which are capable of serving around 3.5 million passengers annually. Other Polish airports like Gdansk and Wroclaw have also undergone modernisation. New passenger terminals were built at airports such as Poznan, Bydgoszcz and Szczecin. Polish governments seem to have consciously followed a policy of modernising airport facilities, thereby investing in infrastructure that may generate several beneficial effects in the long run. The national carrier of Poland is LOT Polish Airlines which is more than 75 years old and also the most successful airline in Poland. Migrant labour market of Poland: The boom in Poland’s low-cost carrier business is reflected by the development of air transportation between Poland and the UK, a result of the British and Irish labour markets opening up to Poles following EU accession. Many carriers have chosen Poland, as it is the only country with a sizeable population and one with extremely poor road infrastructure. Before EU enlargement, passengers could fly directly to the UK only from Warsaw and Krakow to London or Manchester. But now short-term migrants such as plumbers or builders are routinely flying to Britain and Ireland from almost every Polish airport. A research study has indicated that, in 15 years, the number of passengers served in Poland could reach 39 million, rising to 63 million by 2030. The low cost airline market: Poland has seen an unprecedented growth in low cost carriers which has resulted in multiplying the number of international passengers entering the country. However, the LCC market in Poland seems rather concentrated. Currently, there are more than 15 low-cost, low-fares carriers that fly to Poland but only three of them can be considered dominant ones. Ryanair is the only carrier that serves all the 10 airports, while the Polish LCC, Centralwings flies to 8 of them. Even though the Hungarian WizzAir is present at only 5 airports, it is the biggest low-cost carrier in Poland. The significance of the Polish market for WizzAir is clearly reflected in the fact that for 2007, the LCC carried about 4.6 million passengers. With these figures WizzAir is clearly the biggest low-cost airline in Poland. Ryanair, which carried around 3 million passengers in 2007, is the second largest carrier in Poland.

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WizzAir and Ryanair together take more than 50% of the market share of low-cost air traffic in Poland, leaving the competitors far behind. It must also be noted that almost half of the flights offered from Polish airports are to UK and Ireland (among 18 countries) which has been attributed to the massive outward labour migration from Poland to the UK and Ireland. In the first ten months of 2007, 39.80% of total passengers flew to or from the UK and Ireland! The second most popular country was Germany (with 13.03% of passengers), while Italy finished third with 11.07%. The strategy followed by WizzAir and Ryanair in Poland seems to be sustainable and profitable. Both offer flights at the lowest prices to UK and Ireland from airports that are located in those regions which inhabit the labour migrants. This has enabled them to keep far ahead of the competition. Thus, a well-established airport infrastructure combined with a constantly increasing demand for air traffic, due to labour migration, growing foreign investments, and a booming property market, coupled with hosting European Football Championship in 2012, makes Poland, a place to be closely observed in the future. The Polish State Airline: LOT Polish Airlines (Polskie Linie Lotnicze LOT, short name PLL LOT) is the national airline/flag carrier of Poland, based in Warsaw. The name Polskie Linie Lotnicze means «Polish Airlines» in Polish, while lot means «flight». It was established in 1929,to become is one of the oldest airlines in the world. The airline is owned by the Polish government (67.97%), SAirLines B.V. (a member of SAirGroup) (25.1%) and employees (6.93%).[2] It has 4,199 employees (March 2007). In the late 1980s, with the fall of the communist system, the fleet shifted back to Western aircraft, beginning with acquisitions of the Boeing 767-200 in April 1989, followed by the ATR 72 in August 1991, Boeing 737-500 in December 1992 and Boeing 737-400 in April 1993. From the mid1980s to early-1990s LOT flew from Warsaw to Chicago, Newark and Toronto. In December 1992 the airline became a joint stock company, as a transitional step towards partial privatisation, which was effected in late 1999, with the SAirGroup acquiring a 37.6% stake. The Polish government has retained a controlling 51% holding. [1]. It operates scheduled passenger and cargo services. Domestic services link Warsaw with ten cities. Over 50 routes are operated throughout Europe and to the Middle East, North America. Its main base is at Warsaw Frederic Chopin Airport. On 26 October 2003, it became the fourteenth member of the Star Alliance. The airline also signed a codesharing agreement with Star Alliance partner Singapore Airlines.

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BIRD’S EYE VIEW The present network of LOT Polish Airlines’ scheduled flights covers 60 cities in Europe and beyond, plus 8 within Poland. LOT operates a fleet of 7 wide-body Boeing 767s, 8 single aisle B737s, 6 Embraer 175s, 10 Embraer 170s (LOT was the launch carrier for this type), 9 Embraer 145s and 14 ATRs, offering two-class service (Economy and Business) on all international flights. LOT will be the first network carrier in Europe to fly Boeing 787 Dreamliner. LOT’s market share was 41% in 2004 which slightly increased to 43.8% in 2005. But this further eroded to 36.6% in 2006 due to more open competition with increased number of budget carriers. LOT created low cost arm Centralwings in 2004 as a way to compete better with other European budget carriers – particularly Wizz Air and SkyEurope Airlines, who had captured significant market share at that time. Centralwings, as its name suggested, operated from the Central European market, Poland to 36 destinations. The airline started operations by taking over LOT’s charter flights. It operated a fleet of nine Boeing 737-300 and 737-400 aircrafts, leased from its parent. The airline had planned to increase its fleet to 15 aircraft by 2010. LOT earlier this month had reported an operating profit (EBIT) from its core business of 83 mln zlotys in 2007, slightly above the airlines’s forecasts, while its net profit rose fivefold to 161 mln. The Polish state treasury, which has a majority stake in it, plans to float LOT on the Warsaw bourse in the third quarter and has said it does not rule out selling its entire 51 pct stake in the company as it seeks ways to find a new strategic partner for the airline. Overview of Centralwings History: Centralwings is a low-cost airline based in Łódź, Poland. It is a low-fare subsidiary of LOT Polish Airlines, operating international and charter services in Europe. The airline was established in December 2004 and started operations in February 2005. Its main base of operations was Warsaw Okecie airport, from where it started flights to 10 destinations: Bologna, Catania, Gerona, Hanover, Lisbon, London Gatwick, Malta, Nuremberg, Prague and Rome Ciampino. But Centralwings also operated from Krakow to London Gatwick and Rome Ciampino, and Katowice to Cologne and Hanover. The carrier also served charter routes to locations in Bulgaria, Egypt and the Mediterranean. Charter services were also operated from other cities in Poland such as Wroclaw and Poznan. Before the commencement of its flights on 1st February, 2005, Centralwings forged a partnership with Germanwings. This deal involved Germanwings hosting Centralwings’ IT services and the linking of the two carrier’s websites for ticket sales. The main competitors at that time were Wizz Air and SkyEurope. (Ryanair had not en-

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tered Poland till then). But the carrier stood apart from the pack when it came to one important detail: Centralwings is owned 100 percent by LOT Polish Airlines and is therefore state-owned. That translates, within reasonable boundaries, to a virtually unlimited source of financing and removes the threat of losing financial fluidity. Technical service support would be provided by LOT. The launch of Centralwings followed the collapse of independent Polish low-cost carrier Air Polonia. Centralwings’ budget and charter flights from Poland included destinations in Greece, Great Britain, Ireland, Italy, Germany, Spain, Malta and Portugal. From the UK, Centralwings’ scheduled low cost flights were on offer from 3 airports namely London Gatwick, London Stansted and from Edinburg. In Republic of Ireland, Centralwings flew from Shannon, Dublin and Cork. Centralwings served 15 cities, five of them converted from charter, and hoped to carry 400,000 charter passengers and 300,000 passengers on scheduled routes in its first year (2005). Polish low cost carrier Centralwings is planning to more than double its fleet from five to 12 planes by 2006, and attain 40% market share in the budget carrier market by 2006. Its then President and CEO Piotr Kociolek had stated that the by 2010, it aimed to have a fleet of 24 planes. In the future, more charter destinations would be transformed to low-cost destinations. Also there was the possibility of taking over some of LOT mainline routes. While it believed that its charter business would remain stable, it expected to double passenger figures on its low-cost operations to 600,000 in 2006. Growth: Within five months of its commencement, Centralwings had flown 160,000 passengers on chartered flights and 101,000 on scheduled flights. Their major routes included flights from Warsaw and Krakow to London Gatwick. Their timetable during March-May 2005, had routes between Warsaw and Bologna (Guglielmo Marconi), Lisbon, Malta, Girona, Prague, Nuremberg, Catania, from Krakow to Rome (Ciampino) and from Katowice to Cologne-Bonn and Hanover. They later launched flights from Poland to Greece starting May 2005 till mid-October. They also operated services from Warsaw, Poznan and Krakow to Crete (Chania) and to Thessaloniki from Poznan and Katowice. They also planned to fly weekly to Palma (Mallorca) from Warsaw from 20th May 2005 for the summer season. In September 2005, Centralwings announced that it planned to post its first profits in 2007. It would increase its fleet of 5 airplanes to ten in 2006. It also aimed to achieve 40% share in the budget carrier market by 2006 which seemed to be an over - ambitious target in a very com-

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BIRD’S EYE VIEW petitive market. Centralwings introduced new routes for its winter timetable. These included flights from Warsaw to Shannon, Edinburg and Milan (Malpensa). They also commenced flying to Dublin from Katowice and Wroclaw. In December it announced that it would launch 5 new routes to the UK and Republic of Ireland for the summer 2006 season. They would launch a route to Dublin from Gdansk. They would also launch a route from Lodz to Dublin in direct competition with Ryanair, who also announced that they would start flying this route from 04 April. In addition, they would fly on the routes to Edinburgh from Gdansk and Katowice, and to Leeds (Bradford) from Warsaw. At the same time, Centralwings will also launch a route from Krakow to Bologna (Guglielmo Marconi). All routes would commence at the end of March 2006. It carried 750,000 passengers by the end of 2005 and hoped to carry 1.5 million in 2006. In 2005 Centralwings serviced 26 links from airports in Warsaw, Cracow, Katowice and Poznan. According to Centralwings, in December 2005 the company was in the second place on the low-cost aviation market with the share of 14.01% in Poland, following Wizz Air, which has the share of 41.26%. The third place belongs to EasyJet with 13.95%, followed by SkyEurope (13.72%), Ryanair (7.75%), Germanwings (6.87%), Norwegian (1.76%) and Dauair (0.70%). But this positive picture started to change when competition in the market intensified with Ryanair’s entry. This airline with its least cost fares captured 12% of the Polish low-cost airline market in the QI of 2006, where the leader was Wizz Air (38%). This impacted the performance of Centralwings negatively in the market in the following years (2006, 2007). Besides the increased competition and a small fleet, this ‘daughter’ airline was too dependent on its parent for finance and strategy. In February 2006, the airline announced that it would operate more often from regional airports so as to not come in the way of its parent company. In 2005, Centralwings carrier 378,000 charter passengers and expects to boost that number to 469,000, thanks to the expansion in regional airports. During March, Piotr Kociolek, Chief executive officer of Centralwings resigned as losses approached zł.60 million. According to the business plan of the company, the target was only PLN 42m (EUR 10.9m) of net loss in 2005. It had PLN 59m of loss”, Leszek Chorzewski, the spokesman of LOT reportedly said. Another reason for the conflict in the group was direct competition on certain routes, e.g. on the flights to Milan. “The group should cooperate and not compete”, Leszek Chorzewski stressed. As it continued its rapid expansion with the launch of

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five new routes, Centralwings – Poland’s fastest growing low cost airline – had indicated significant progress towards its aim of carrying one and a half million passengers during 2006. As promised earlier, the airline started flights between Leeds Bradford and Warsaw, between Dublin International and Łódz,, from Gdansk to Edinburg International and Dublin International and between Edinburg International and Katowice in the last week of March 2006. The airline would also become the first low cost carrier to operate a weekly flight from their Warsaw base to Kavala in Greece from 22nd May, 2006. According to a spokesperson of the company the UK and Ireland routes have been pivotal to its growth. In April, for the first time in history of the low cost airline industry, Centralwings offered 20% discount on standard adult fare tickets for children between the ages 2 to 16 years on all flights. The number of air passengers in Poland had increased so dramatically that IATA predicted that within the next four years Poland would become the fastest-growing air market in the world. So Centralwings seemed to be at the right place at the right time. But this did not help its operations as it defaulted in May 2006. During May, Centralwings unexpectedly cancelled its Warsaw-Leeds Bradford flights. Wizz Air stepped in by offering the stranded passengers free seats for which they had to pay only the taxes and the extra charges. Centralwings began flying between the Polish cities of Warsaw and Wroclaw from 26th May, 2006. This was one of the first examples of it operating regional flights. On May 31st Centralwings welcomed its millionth passenger who arrived in Krakow-Balice Airport onboard the flight from Bologne. The passenger received flowers and was driven home in a limousine. In June Centralwings had included many new routes in their winter schedule for 2006/2007 which was put up for sale. These included: flights from their Warsaw base to London (Stansted), Lille and Grenoble; between Krakow and Cork; Gdansk and Shannon. The Irish routes seemed to be a direct challenge to Ryanair. On 25th July 2006, it was reported that LOT Polish airlines had appointed Maciej Kwiatkowski as its chief executive. He replaced Piotr Kociolek, who had resigned in March. According to the carrier: «One of the first priorities for the new CEO will be to participate in the creation of a new strategy for the LOT Group – in which Centralwings is a very important element. We have already proved that we have a strong market offer and we look forward to utilising the newest technologies and distribution channels as we continue to grow.»

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BIRD’S EYE VIEW During the summer of 2006 (June-August) the Polish low cost airline carried 57% more passengers than in the same period during 2005. It had carried more than 1.5 million passengers since the start of its operations and had achieved 6% share of the Polish aviation market. This year it also became the fourth largest in the Polish low cost carrier market after Wizz Air, Ryanair and SkyEurope. But the progress of this ‘daughter’ airline has been like a sine curve. Whenever there appears a peak, it seemed to be immediately followed by a fall. In October Centralwings cancelled its Katowice-Cologne and Wroclaw-Cologne routes, making Wizz Air again a saviour for the stranded passengers. In November, the low cost airline announced flights between Dublin and Szczecin in Poland commencing on 19 February 2007. It would also operate two routes from Lodz to Rome (Ciampino) and Paris (Beauvais) from the same date. In an interview, Maciej Kwiatkowski who had been in the hot seat at Centralwings since July, had claimed that inefficient and expensive Polish airports (especially Warsaw) was the main challenge faced by Centralwings. They were considering relocating its base to a city west of Warsaw, like Krakow or Poznan where the airport fees were lower. This decision represents “the most important step for our strategy moving forward”, he says. Kwiatkowski said that he planned to addressing cost reduction issues and creating a new low-cost base as part of “a big strategy” for the airline in the coming years. This strategy included adding more routes to its network in 2007, with the UK and Ireland forming the carrier’s “number one markets”, followed by France and Italy. Centralwings would also avoid launching routes already operated by parent company LOT. The carrier no longer operated any routes flown by LOT because the Polish flag carrier “was not happy” about competing, something Centralwings would “take into consideration for future routes”, he stated. However, he also cited the example of Warsaw-Milan, where Centralwings withdrew from the market because it was going head to head with LOT. Shortly afterwards another low-cost carrier moved in. “Surely it is better to have a low-cost ally than a low-cost enemy,” he reasoned. “We need to talk more.” Kwiatkowski admitted that competition was getting “tougher and tougher”, particularly from fellow central European budget carriers SkyEurope and Wizz Air. “There is no question there will be strong competition, mainly in Poland,” says Kwiatkowski. However, he was confident that the carrier would become profitable in 2008 in spite of the highly competitive LCC market. In December the Treasury Minister granted permission for a partial privatization of Centralwings, a low-cost airline currently owned by the state-owned carrier LOT. But this

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would happen only after the IPO of LOT airline scheduled to take place sometime in 2007. During the year 2007, Centralwings operated almost all of the routes operated in 2005/2006, in addition to some new ones. But during this year also it was plagued by delays and cancellations. Some of the major new routes it announced for the summer season included flights from Warsaw to Faro, Varna, Heraklion and Rhodos and also Krakow-Lisbon route. It also operated weekly flights to Malaga and Bourgas in Bulgaria from Warsaw in summer. It introduced three new routes from Poznan to Rome (Ciampino), Paris (Beauvais) and Edinburgh. During the winter season it had launched many new routes namely: Warsaw to Manchester; from Krakow to Dublin, Manchester, Athens and Girona; Krakow to Birmingham, Amsterdam and Hamburg (Fuhlsbuettel). They would also operate a weekly flight from their Katowice base to Hurghada in Egypt. Current status: The commencement of 2008 was made with announcements of many new routes by Centralwings. But the picture turned sour with the announcement of its financial results for 2007. Unlisted Centralwings, the budget arm of Poland’s profitable state airline LOT, slid to an operating loss of 73 mln zlotys last year versus a planned 35 mln, and greater than the 65 million loss reported in the previous year, putting the future of the cheap airline in doubt ahead of LOT’s IPO this year. Rising oil prices, aggressive competition, growing airport fees and not enough airplanes had hampered its growth as expressed by the Director of Centralwings, Waldemar Krolikowski. “This was supposed to be our last year in the red. We estimated that the losses would amount to PLN 35m. Unfortunately, market conditions deteriorated substantially and our costs grew by 13.4 percent”, Waldemar Krolikowski, Centralwings CEO explained. Dziennik daily reported that the airline was ‘close to bankruptcy’ and business daily Puls Biznesu quoted Centralwings Chief executive Waldemar Krolikowski as saying it could be sold off or pushed out of the market. But the final decision would rest with its owner – LOT Polish airlines. Centralwings cancelled many unprofitable flights during the months of March and April. Since April 1 Centralwings was serving only one route from the mid-western Polish city of Poznań to Rome. The connections to Paris and Edinburgh were put on hold. New flights to Amsterdam and Manchester which were supposed to take off in April were cancelled. Flights from Warsaw, Gdańsk, Kraków, Szczecin, Wrocław disappeared from the departure schedules on its website. Some of the routes would be canceled for good.

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BIRD’S EYE VIEW But Centralwings’ charter flights - to eg. Hurgharda, Sharm el Sheikh, Thessaloniki, Heraklion and Palma de Mallorca, would go ahead according to timetable. “We were forced to cut the flight schedule in April. We are updating our route network, and for now we are able to offer only the minimum number of connections we are certain to operate» – said Kamil Wnuk, a spokesperson for Centralwings. «We are not disappearing from the market, we will work on our development, it is just that we are waiting for new planes. We are scheduled to receive two 737 Boeings in late April and one more in May» - he added. Currently, Wizz Air has stepped in to rescue hundreds of Poles left stranded by the current wave of cancellations, and the leading Hungarian-Polish budget operator has said it may take over many of the connections Centralwings has cancelled. In the second week of April, Centralwings had decided to stop the majority of its flights from Dublin, Shannon and Cork airports. The axed routes include Shannon to Katowice and Warsaw and Dublin to Katowice, Krakow, Szczecin and Wroclaw. It had already pulled its services from Cork Airport with the last flight from Cork to Krakow leaving on March 26. Three-time weekly flights from Dublin to Warsaw and Gdansk will remain. Later Centralwings had put on sale, flights from their Krakow base to Barcelona commencing from 1st May, 2008 operating three times per week. They seemed to replace the withdrawn flight-route between Krakow and Girona. On 24th April, 2008 PLL LOT SA declared that the process of restructuring Centralwings was in progress, which aimed at developing charter connections as they offered the greatest potential. In addition, cost cuts were being planned, along with the liquidation of the least popular regular connections in favour of the most rewarding ones. The restructuring plan in question will not impact the existing charter connection agreements. On the contrary, the expansion of the charter offer is planned, with the introduction of the so-called charter mix. «At this time we’re trying to change our orientation,» Krolikowski says. «I’m trying to find a more profitable market. The charter market will be stable for the next couple of years in my opinion. Therefore we will look to take a place in the charter market. It’s not as competitive as the low cost market.» Centralwings was not the only low-cost carrier which struggled in the Polish market. Bratislava-based SkyEurope had a base in Krakow but dropped it late last year and completely exited from the Poland market. CentralWings,

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which had two aircraft based at Krakow, picked up some of the routes SkyEurope dropped but quickly discovered there were unviable and dropped them. «At the time being it’s very difficult and very competitive because a lot of big players are in this market,» Krolikowski said. «They offer very cheap tickets and I can’t give such cheap tickets to the people. You can see how hard it’s to fight in the Polish market.» Business Model Centralwings operated like an LCC-Charter flight offering both low-cost scheduled flights and charter flights to long-distance tourist destinations. So it was similar to Germanwings as it was Legacy airline’s ‘daughter’ and similar to Air Berlin only because it offered charter flights. The airline is 100% owned by LOT Polish airlines and is therefore state owned. It operates nine Boeing 737 400s and 300s. The fleet is serviced and maintained at a certified technical base of PLL LOT. They also offer two options for travel insurance, group rates, special offers, car rentals, hotels and much more. Their Call Centre is available in five language versions and their Website – www.centralwings.com - is one of the three most popular websites in Poland with more than six million page views per month. Their booking procedure is quite simple, clear and easy to follow. It is the only Polish low cost airline operating from seven regional airports in Poland. The airline slogan is: Pay less, expect more! Their mission statement is: “We bring the world closer to people who want to reach their destinations in an inexpensive, reliable and friendly way”. The main features of its business model are explained below: Ticket booking: The customers can make payments for the tickets online through credit card or through bank transfers. The tickets can be booked through their customer call centres, through travel agents, at the cash counter in super markets and online. The charges are higher when booked through travel agents. An extra fee has to be paid for booking through its call centre. Children aged between 2-16 years old are eligible for a 20 % discount on adult passenger fares at all times. Rebooking and cancellation: Tickets for flights on Centralwings can be rebooked for a fee by paying the additional difference in fares at that point in time. Centralwings allows name change on tickets at an extra fee, provided that the change is requested at least two hours before departure and that the cost of the ticket is above a certain amount. Baggage rules: These rules are similar to a long haul flight except for the hand baggage. Each traveller can check-in luggage with a weight of maximum 20 kg at no extra char-

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BIRD’S EYE VIEW ge. One piece of hand luggage with only a weight of 5 kg is allowed free of charge. Pre-booking of excess baggage can be done online at a discounted price. Personal belongings, such as a small handbag, overcoat, umbrella, walking stick, camera, video camera, binoculars, notebook, etc are free of charge. It is also possible to take non-standard luggage like skis, snowboards, bicycles and surfing board at additional charges quoted on their website. Pre-assigned seating: Seats are assigned at time of check-in at the airport itself. Therefore there is no rush for getting the seats. Other special services: There is a special offer for children who fly with Centralwings - the ‘Captain Bear’ menu. Toys and gadgets are available to keep youngsters amused during the flight. Passengers also have a unique opportunity to send a postcard from onboard the plane, with greeting courtesy of Centralwings. Adverts can be placed on tip-up tables, seats, headrests and a range of other surfaces. They also have an in-flight magazine. Catering: Food and drinks are provided on board at reasonable prices. Some flights have been reported to offer free small snacks. Conclusion Centralwings is already undergoing a complete restructuring and also the IPO of LOT Polish airline is expected to take place this year. So the final shape of things to come in the Polish aviation market can only be seen after the occurrence of the above events. But in the current scenario the revival of Centralwings again as a low cost player seems doubtful.

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BIRD’S EYE VIEW

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BIRD’S EYE VIEW

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DOWN TO EARTH

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Air Scoop - May 2008

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BIRD’S EYE VIEW Exclusive Analysis for Air Scoop www.airlinebulletin.com

Will High Fuel Prices Destroy Some LCCs? Over the previous weeks, several small US LCCs, including Aloha, ATA, and Skybus, have shut operations due to high fuel costs. Because these carriers were so small, they lacked the cash reserves to weather the fuel price spike, which put them over the edge. It is important to remember that while three LCCs shut down over a matter of days, these carriers had operated at the margin of the industry, and in at least one case (Skybus) with an unsuccessful business model. While larger US LCCs such as Southwest are struggling, they won’t disappear anytime soon. The airlines that are most likely to declare bankruptcy and potentially shutter operate older aircraft (which use fuel less efficiently), have limited cash reserves (to dip into to pay high fuel bills), and face significant competition (leading to insufficient yields). Since ATA, Aloha, and Skybus were pushed over the edge, could the same thing happen in Europe, a far different market than the US? The short answer is yes. First and foremost, it’s important to note that the largest European LCCs, while potentially taking a hit in traffic growth and profits from the spike in fuel costs, won’t likely go bankrupt with fuel costs at this level. Moreover, carriers that generate revenue in euros or pounds have an advantage over carriers that generate revenue in US dollars, since euros and pounds are much stronger currencies (and oil is priced in dollars) helping to soften the blow of higher oil prices. Ryanair, easyJet, Flybe, and Air Berlin, should all survive this fuel spike, although they may diminish their capacity (or at least reduce future growth) in order to cope. But, some smaller LCCs that have low cash reserves and inefficient aircrafts are vulnerable. As in the United States, the very small carriers operating at the margins of the air transportation business are those that are most likely to go under. In the short-haul market, smaller carriers that mostly rely on discretionary leisure traffic and are having their niches co-opted by larger LCCs or legacy carriers are the most vulnerable. WindJet, Blue Air and Jet2 are all susceptible to a potential shutdown, because of limited route networks, use of smaller or older aircraft, and increasingly competitive markets. But these carriers represent only a sample of the potential bankruptcy candidates. Carriers need to have sufficient cash on hand to operate and

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deal with high fuel prices while they reassess their route networks. Small carriers and recent start-ups simply don’t have enough. Is consolidation the answer? Possibly, if the match is a very good one. LCCs that have complementary route networks and aircraft fleets could merge to create a larger carrier better equipped to compete in the marketplace. But the acquiring carrier will still see a lot of cash tied up in a merger or buyout, cash desperately needed for fuel. A combination could benefit both carriers in the long-term, but carriers need to have some mechanism to deal with their short-term woes, and consolidation will not provide that. What is more likely to happen are not mergers, but rather the failure of smaller carriers, and the acquisition of selected assets of these carriers from larger LCCs. To some extent, there will be regional consolidation, with significantly fewer, but larger LCCs dominating in certain markets. The potential merger of Vueling and Clickair demonstrates this model in Spain. Air Berlin’s acquisitions have created a powerful LCC in the German market. Similar consolidation could occur in Italy, Scandinavia, and Eastern Europe, creating larger, regional LCCs to compete against pan-European Ryanair and easyJet. While shorthaul carriers are vulnerable, some low-cost long-haul carriers could be in even deeper trouble. Most charter operators should survive this bump, because their packaged holidays give them a little more leeway with pricing and revenue generation. But carriers that rely less on packaged holidays could feel squeezed. One carrier of concern is Flyglobespan. They have expanded very quickly (some would argue too quickly, as the carrier has developed a strong reputation for poor service). As a consequence, Flyglobespan has had to keep its fares low to fill seats, diminishing yields and inhibiting the carrier from becoming profitable. Given their current operating circumstances, I seriously doubt the long-term viability of this carrier without a significant shift in their business model. But other long-haul carriers with smaller networks could also feel the pinch. Canada-based Zoom, which has set up a UK subsidiary to offer flights between London and seve-

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BIRD’S EYE VIEW ral destinations in the Americas, might also be in trouble. While not acquiring the same poor reputation for service as Flyglobespan, Zoom operates long, low-yield routes, with difficult competition from larger US and European carriers. With Open Skies already creating pressure on legacy carriers to lower fares, Zoom may find that passengers will opt for a slightly more expensive ticket that offers a significantly better travel experience. Even in the higher-yield premium class market, small, standalone carriers have suffered. MaxJet shut down late last year, and Eos recently shut its operations on April 27. Silverjet has been rumored to have significant difficulties filling its planes, and is looking for a significant cash infusion. With older aircraft, a small operation, and limited cash on hand, it is another candidate for shutdown and possible liquidation unless it immediately secures the financing it needs. All carriers, LCCs and legacies alike, are examining their current capacity and route structure, and will trim routes that aren’t profitable with current fuel prices. Airlines in the States have already started to do this by reducing capacity particularly on longer, lower-yield routes. In Europe, LCCs will work towards reducing unprofitable routes. This will mean fewer flights from the UK to destinations in Eastern Europe, the Canaries, and North Africa. LCCs will focus on adding routes of an optimal length (likely routes with flight times between 1.5 and 3 hours). But these additions notwithstanding, the trend for all carriers will be one of slower growth. LCCs will continue to delay new aircraft deliveries and reduce new capacity. For existing aircraft, fleet utilization will almost certainly decrease. Ryanair, for instance, will likely ground 20 aircraft this winter if fuel prices remain at their current high levels because the carrier sees it as more profitable to ground the planes than to fly them. Ultimately, oil prices need to come down to make LCCs viable. Unfortunately, LCCs rely too much on discretionary traffic, and during a period of high energy prices, fewer customers will be willing to pay for jet fuel when they need to pay for other, more basic, necessities. Oil at these levels could lead to long-term reductions in travel and capacity. What is needed is a better energy policy from the US and EU, and it’s up to business leaders, especially those in hard-hit industries like commercial aviation, to lobby for it. An energy policy that offers incentives for developing nations, such as China, India, and those in the Middle East, to adopt alternative technologies for transportation and energy will reduce the world’s need for oil,

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helping to lower the price. It’s absolutely ludicrous that airlines (or any business for that matter) are not making a sustainable energy policy their number one lobbying priority. This issue will affect all businesses much sooner than most people (and especially politicians) realize. Business leaders need to do all they can to prevent a future energy shortage from harming their companies, because such a shortage could come with little warning, and could severely hamper many business activities. Once the crisis hits, it may be too late to do anything about it. Moreover, a foreign policy that helps to reduce the threat of terrorism will help shrink the substantial risk premium that buyers currently pay on each barrel of oil. Unfortunately, there is no viable alternative yet to petroleum-based fuels in the airline industry. But, there are alternative sources of energy for automobiles, and these should be pushed as a way to reduce oil demand in the short-term, until viable alternatives for aviation can be developed. There is no reason why oil prices have to come down substantially anytime soon. LCCs need to have low fares in order to generate sufficient demand, but they will be unable to provide those with high fuel costs. LCCs must mitigate current prices with efficiency and conservation measures, as well as hedging. Nevertheless, LCCs must also adapt to a changed environment. Higher-yielding, non-discretionary traffic needs to be targeted as a way of softening the blow. But ultimately, the LCC industry could look very different in a few years. By that time, oil could easily hit $200, and carriers need to prepare themselves for that reality.

Remarks, questions… Join Sam by email (samsellers@ gmail.com) or on his website to comment this article… http://www.airlinebulletin.com.

Sam Sellers provides analysis and commentary on the airline industry at his website, www.airlinebulletin.com, and is the author of Take Control of Booking a Cheap Airline Ticket, an ebook for travelers in the United States who are interested in purchasing cheap airline tickets.

Air Scoop is a Registered Trademark of Global Wings Publications. Subscription to Air Scoop: 290 euros for 1 year (10 issues) Copyright 2006-2008 - Unauthorized distribution or reproduction is forbidden. http://www.air-scoop.com ; http://airscoop.blogspot.com (free portal news)

Air Scoop - May 2008

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