Key features of air transport markets - Brian Pearce – IATA - June 2014 OECD discussion on airline competition
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This presentation by Brian Pearce from IATA was made during a roundtable discussion on airline competition held at the 121th meeting of the OECD Competition Committee on 19 June 2014. Find out more at http://www.oecd.org/daf/competition/airlinecompetition.htm
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Key features of air transport markets - Brian Pearce – IATA - June 2014 OECD discussion on airline competition
- 1. To represent, lead and serve the airline industry Some key features of air transport markets Brian Pearce Chief Economist June 2014 www.iata.org/economics
- 2. City-pairs doubled – transport costs halved IATA Economics www.iata.org/economics 2 Source: IATA, ICAO, OAG 0.5 1 1.5 2 2.5 3 3.5 4 - 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000 1994 1997 2000 2003 2006 2009 2012 US$/RTKin2014US$ Numberofuniquecity-pairs Unique city-pairs and real air transport costs Unique city-pairs Real air transport costs
- 3. Falling costs passed through to consumers IATA Economics www.iata.org/economics 3 Source: IATA, ICAO - 1.0 2.0 3.0 4.0 5.0 6.0 7.0 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 1950 1960 1970 1980 1990 2000 2010 US$in2013pricespertonnekilometer US$in2013pricestoflyatonnekilometer Unit cost and the price of air transport Price (US$/RTK) Unit cost (US$/ATK) US deregulation EU deregulation Boeing 707 1973 oil crisis
- 4. Consumer demand extremely strong IATA Economics www.iata.org/economics 4 0 50 100 150 200 250 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Indexedtoequal1in1950 World scheduled air travel, freight and world real GDP Air travel (RPK) 212x GDP (constant prices) 10x Air cargo (FTK) 212x Source: IATA, ICAO, Haver
- 5. Profit margins extremely low IATA Economics www.iata.org/economics 5 Source: IATA, ICAO -6% -4% -2% 0% 2% 4% 6% 8% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Airline industry profit margin, after debt interest and tax Average 0.2%
- 6. Investor returns below cost of capital IATA Economics www.iata.org/economics 6 Source: IATA, McKinsey 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 %ofinvestedcapital Return on capital invested in airlines Cost of capital (WACC) Return on capital (ROIC)
- 7. Why? • Value chain as a whole sustainable? – Market power in parts of chain/ over-regulation elsewhere? • Excess capacity? – Imperfect capital markets? • Common and joint costs? – Hard to recover? • Empty core? – Financially sustainable equilibrium not possible? IATA Economics www.iata.org/economics 7
- 8. Much of air transport value chain is profitable IATA Economics www.iata.org/economics 8 Source: IATA, McKinsey 0 5 10 15 20 25 30 Return on invested capital in the air transport value chain, 2002-2009 ROIC WACC
- 9. But dwarfed by sub-normal airline returns IATA Economics www.iata.org/economics 9 -25 -20 -15 -10 -5 0 Investor returns in excess of cost of capital, $ billion a year Source: IATA, McKinsey
- 10. Easy and regular new entry IATA Economics www.iata.org/economics 10 Source: IATA, Ascend
- 11. But also significant failure, exit and merger IATA Economics www.iata.org/economics 11 Planet duo nexus Air Wales Thomsonfly Nordic airlink flyforbeans.com clickair Atlas-blue myair flyglobespan Go Debonair mytravellite dba Basiqair jetmagic Iceland Express AerArann Aerlingus Ryanair Monarch easyJet flybe Transavia germanwings airberlin WIZZ Volotea vueling SkyExpress Norwegian Pegasus Jet2 snowflake flyeco Skyeurope Hamburg airlines Helvetic VBIRD VirginExpress EUjet FlyMe buzz Volareweb Maersk Air Air Finland Flying Finn Kiss GetJet Aeris Smart Wings centralwings fly gibraltar HLX LTU Air polonia flybaboo flywest Viking SterlingCimber Air Turquoise Germania air lib express Clickair WindJet WOW Failed Survived European ‘LCCs’ Source: HSBC
- 12. There are significant common & joint costs IATA Economics www.iata.org/economics 12 Fuel, 33% Passenger services, 8% Airport & ANS, 7% Maintenance, 10% Station expenses, 9% Ticketing, sales, promo, 8% Flight crew salaries, 6% Aircraft rentals, 6% Depreciation, 5% Overhead & other, 8% Operating costs breakdown 2012 Source: IATA
- 13. Significant economies of scale in equipment IATA Economics www.iata.org/economics 13 Segment distance (NM) Aircraft type Seats Segment cost (DOC) Average cost per seat Marginal cost per additional seat 500 ERJ-145 48 $6,934 $144 E-190 100 $10,794 $107 $74 1000 737-700 129 $20,039 $155 737-800 168 $23,875 $142 $98 2500 A319 132 $41,607 $315 A321 190 $51,462 $270 $169 Source: IATA
- 14. But business customers demand frequency IATA Economics www.iata.org/economics 14 • Economies of scale in equipment incentivises: larger aircraft and fewer frequencies • But strong preferences of business customers – who value their time highly – for: frequent (daily) services and specific departure times • With free entry, unless very dense passenger flows, market outcome is: smaller aircraft and more frequencies • What fare structure would emerge in such a market?
- 15. Price ‘segmentation’ economically efficient IATA Economics www.iata.org/economics 15 • Two/multi-tier fare structure consistent with open competition • Preferences of business travellers prevent cost-saving larger aircraft • Business travellers should pay premium for higher unit costs imposed by more frequency • Premium reduced by larger aircraft made possible by attracting more price-sensitive leisure travellers • It is also a mechanism for allocating common/joint costs • This is an open competition outcome due to economies of scale, common/joint costs and preferences for frequency • Non-core ‘ancillary’ services perform similar role • Cover common/fixed costs while core transport product is offered at marginal cost – an economically efficient outcome • Similarly, different cuts of meat see price ‘discrimination’
- 16. Economies of density in route networks IATA Economics www.iata.org/economics 16 • Minimal economies of scale in firm size • But substantial economies from density of traffic flows • Business models are different ‘factories’ generating ‘route density’ Source: Lufthansa
- 17. ‘Metal-neutral’ airline JVs deliver efficiencies IATA Economics www.iata.org/economics 17 • Few city-pairs can support frequent point-to-point services • ‘Hubs’ generate route density where necessary • No single airline can provide ‘from anywhere to anywhere’ service demanded by business customers • Cross-border mergers mostly impossible • Airline innovation in response • Interlining • Code shares • Alliances • JVs under ATI • ‘Metal neutrality’ has been the successful development • Airline JV partners indifferent over who carries passenger • Generates efficiencies from increasing traffic density • Efficiencies lower with looser cooperation
- 18. As well as price/non-price consumer benefit IATA Economics www.iata.org/economics 18 • Lower fares for interlining passengers (no double marginalization) • Lower fares from economies of traffic density • Effect also can apply to overlapping hub-to-hub markets • Fares can be more easily combined in an itinerary • Passengers offered wider range of schedules • More seamless passenger experience
- 19. Summary IATA Economics www.iata.org/economics 19 • Economic benefit from connecting cities and cutting transport costs • Air transport 7x cheaper than 6 decades ago • Demand has grown over 212x compared to a 10x rise in GDP • Airline net profits close to zero • Airline ROIC consistently < WACC • Some parts of value chain make returns > WACC • Easy and frequent new entry • Significant common and joint costs – hard to recover • Economies of scale in equipment • But business customers demand frequency • Open competition outcome is a segmented price structure • Economies of density important – business model ‘factories’ • JVs can deliver efficiencies as well as non-price consumer benefits