insightpaper
THE FUTURE OF AUSTRALIAN AVIATION
What does it mean for Australian airports?
DECEMBER 2014
MAR BELTRAN
Investment Director,
Airports
IN THIS PAPER WE DISCUSS...
ABOUT THE AUTHOR
Mar Beltran is Investment Director of
AMP Capital’s airport investments.
Previously, Ms Beltran managed AMP
Capital’s first social infrastructure fund,
the AMP Capital Community Infrastructure
Fund, as well as AMP Capital’s retail focused
Core Infrastructure Fund. Prior to the Core
Infrastructure Fund’s inception in October
2007, she served as a portfolio manager of
AMP Life and the Future Directions Fund
infrastructure portfolios, as well as the
manager of AMP Capital’s investment in
Australia Pacific Airports Corporation.
Ms Beltran holds an Executive MBA
from the Australian Graduate School of
Management and has a Senior Aeronautical
and Industrial Engineering Degree from
Madrid Polytechnic University in Spain.
—T
he airline adaptation cycle – what is it?
—W
here various global regions are in the cycle
—T
he considerations for airports based on previous lessons learnt
As legacy airlines around the globe respond to the competitive
market dynamics created by low cost carriers, there is a distinct
cycle of adaptation for the industry. This happens to recapture lost
market share and reposition carriers for financial performance.
Airport operators must continuously assess elements of airport
services and terminal design depending on where legacy and low
cost carriers are in their respective ‘adaptation cycles’.
What can we learn from the airline models adopted around the
world? Is the model adopted by Australian carriers sustainable,
and how will this impact Australia’s largest airports?
WHAT IS THE AIRLINE ADAPTATION CYCLE?
As evidenced globally over the past 10 years, there is a distinct
cyclical nature to the adaptation of legacy and low cost airlines.
This is in response to competitive market dynamics and changing
consumer demands.
The airline industry adaptation cycle
Full Service
As shown in the following diagram, the cycle commences with
existing legacy carriers offering a full service product with a high cost
base for a high ticket price. This is followed by the entry of low cost
carriers who offer a ‘no frills’ or ‘low frills’ product off a lower cost base
for a cheaper ticket price.
As this occurs, the market grows through price stimulation during
which there is a period of proliferation of low cost carriers. New
entrants back themselves to compete for stimulated demand off a
lower cost base. Legacy carriers respond through a combination of
strategies which may include launching their own low cost off shoots
and segmenting their networks and products.
As stimulated market demand begins to saturate, the low cost
carriers need to find new ways of differentiating their price point to
compete. They begin to de-bundle their service offering into individual
components, establishing a lower base fare with a choice of ancillary
product features. This may include the purchase of in-flight food and
beverage, pre allocated seats, in-flight entertainment and/or a choice
of two or three fare types with or without a change in fees. At this
point there is a consolidation of low cost carriers.
We believe that those that can retain the low cost base, maintain a
consistent level of service and loyalty, and find the right combination
of de- bundling to tap into ‘value segments’ are those that will survive.
De-bundled
Low Cost
Consolidation
Hybrid
Low Cost
LOW
COST
CARRIERS
Consolidation
Proliferation
De-bundling
LEGACY CARRIERS
De-bundling
Source: AMP Capital analysis
Network
Adjustment
Low Cost
Subsidiary
WHERE ARE WE NOW IN THE CYCLE?
Where various regions are in the cycle
The following diagram shows the evolution of these cycles
in each of the global regions. It shows the impact on market
share, adjustments to airlines models and the impacts on
financial performance.
Full Service
North America
North America
UK/Europe
De-bundled
Low Cost
UK/Europe
Hybrid
Consolidation
Low Cost
LOW COST
CARRIERS
Proliferation
Low Cost
Subsidiary
Australia
Asia
Consolidation
De-bundling
Asia
Australia
LEGACY CARRIERS
Network
Adjustment
De-bundling
Source: AMP Capital analysis
Legacy carriers have been repositioning, and
further segmenting their networks, as well
as launching premium economy products
to regain cabin yield. Within a competitive
domestic environment this has not been
enough and in response to getting their
premium value proposition right, have also
commenced their own processes of product
de-bundling.
Within an unprecedented industry
environment that has included deregulation,
wars, SARS, the September 11 terrorist
attacks and economic recession, there has
been incredible pressure on performance.
This has seen the legacy cycle, unable to
adapt quickly enough to its high cost base,
and pass through a period of consolidation.
In the European market, Air France has
merged with KLM, Lufthansa with SWISS,
Brussels Airlines and Austrian Airlines, and
British Airways with Iberia and Vueling.
In North America, American Airlines has
merged with US Airways, United Airlines
with Continental Airlines and Delta Airlines
with Northwest Airlines. These carriers are
now managing their integration programs
and are delivering substantial profits off a
scaled cost base.
The low cost carrier cycle is also coming
full circle, with those that remain slowly
moving across into the consolidated legacy
airline space. They are increasing their
product and service offerings, tempted by
the higher yielding corporate market sectors
to create hybrid models. These models are
providing an increasing level of in-cabin
product and service, with attributes chosen
and packaged together by consumers to
create their own value products. How far
these hybrid models pitch into the legacy
space by offering a medium and long haul
network off a competitive cost base will be
an interesting dynamic to watch.
Low cost carriers are expanding and gaining
market share stimulating demand with
attractive fares and new routes. In 2014
AirAsia was again awarded the world’s best
low cost airline for the sixth consecutive year
in a row.
Europe and North America have passed
through the legacy and low cost carrier
consolidation phase. Within these regions,
the industry has now evolved to the point
where financial performance has improved
following significantly restructured and
scaled back cost bases, and where the gap
between legacy, hybrid and the individual
brands of low cost carriers has become
blurred. Most carriers are now looking to
compete with an enhanced product offer
that remains de-bundled, but which can be
packaged by the consumer, to determine
their own value for money.
Australia is at the point in both legacy and
low cost cycles where product differentiation
through de-bundling is the competitive
edge. Within Australia, it is important to
note the significant underperformance of
the Qantas international flying business, and
the impact this has on the industry. Unlike
the other global regions, regulation through
the Qantas Sales Act is preventing Qantas
from doing what other global legacy carriers
have done – i.e. merge with a partner to
rescale its cost base, leverage operational
synergies and reposition its brand. It
would appear that Qantas may need more
flexibility to adapt its business model and
the biggest constraint is the Qantas
Sale Act 1992. If freed from these regulatory
restrictions it is likely the Australian aviation
industry would move forward in line
with other global regions to deliver
better financial performance and a more
certain future.
Asian low cost carriers are in infancy stage,
but pace of change has accelerated. The
industry has lagged behind that of North
America and Europe - however it is now
beginning to grow rapidly as the region
continues to develop economically. It
continues the process of deregulation and
liberalisation and adapts its infrastructure to
accommodate the low cost carrier model.
The Oceanic region is half way through the
cycle and in ‘unstable’ territory. In this
region the models of adaptation are not
quite as far advanced as the European and
North American markets. Legacy carriers
are fully de-bundling their service offerings
to turn performance around and may be on
the verge of consolidation in the low cost
carrier space.
For a deeper analysis of Australian carriers,
please contact our Infrastructure team via
ampcapital.com
CONSIDERATIONS FOR AIRPORTS
How might various scenarios impact terminal capacity?
All of these potential airline futures raise some interesting
considerations for the airports with whom they interface.
We analysed the potential impact on terminal capacity at
Melbourne Airport for a few potential scenarios. The results of
these scenarios are represented in the chart, which highlight the
change in the number of years available for each terminal before it
reaches capacity. The results show that from a capital management
perspective, there is the potential to reshuffle supply and adjust or
defer a medium-term capital program.
Looking globally, we can see airports have and are adapting their
infrastructure to meet the needs of low cost carriers. Airports are
building dedicated low cost terminals, often separated from the
main international terminals, with a menu of services available for
use at discounted rates.
One of the lessons that airports have learnt is that there is
no guarantee of low cost carrier loyalty. As the cycle of airline
adaptation evolves, low cost operators are changing their models
and slowly moving back into hybrid airlines. This, in turn, raises
questions about the future of dedicated low cost carrier terminals
and whether, in fact, airports are better to avoid exclusive
arrangements and remain more flexible in their terminal designs.
At the other end of the spectrum, legacy airlines are also looking to
enhance their consumer’s airport experience, and extend the debundling and segmentation of the offer into the airport.
Discussion in the industry includes future airport designs that
segment the airport infrastructure vertically, designing a full
premium experience for passengers, a premium economy
experience, and a different experience again for economy
passengers. This design could also facilitate a low cost offering.
The benefits of such a design eliminates the need to build dedicated
and isolated terminals, but allows for scale to be consolidated within
a centralised terminal building that offers a streamlined and tailored
passenger experience for all airlines offering a similar segmentation.
A common user approach such as this cushions the airport against
industry cycles - i.e. against consolidation and the shifting of carriers
between models and service offerings.
Other terminal design options include the model of integrating
home carrier domestic and international terminal services, as
these airlines look for a competitive home advantage. In the case of
Sydney and Brisbane Airports, one could readily see the benefits of
integrating the Qantas domestic and international services as the
terminals from which they currently operate are physically isolated
from each other.
This opportunity is also available for Melbourne Airport when Jetstar
relocates into a dedicated low cost carrier terminal, and frees up
substantial capacity in the current Qantas Terminal 1. However,
given the uncertainty around the future of Qantas, particularly
with its international business, a dedicated terminal might not be
sustainable in the short-term.
There might also be a future where de-bundling of the domestic
product could position Jetstar and Qantas to merge their businesses.
This could allow Jetstar to take over the flying network of Qantas
to leverage its lower cost base but retain integration of premium
services at the lounge and frequent flyer program level. In this
scenario, the purpose built low cost carrier terminal would be less
than ideal for a merged Jetstar and Qantas carrier.
Terminal base case: Terminals are configured where only Qantas
is operating out of Terminal 1 in 2015 and Jetstar and Tiger are
operating fully out of Terminal 4. Terminal 2 continues to service
the current portfolio of international airlines and Virgin Australia is
operating out of Terminal 3.
Terminal 1 base case and international: Qantas domestic and
international services are combined into Terminal 1.
Terminal 1 base case and international merger with Middle
East carrier: Qantas mergers with Emirates - all the associated
international traffic of QF and Emirates shifts into Terminal 1.
Terminal base case – slower domestic growth: Same as terminal
Base Case but with a lower outlook on forecast domestic growth as
a consequence of Qantas and Virgin managing for yield.
Number of years till terminal capacity is reached
Terminals
base case
T1 base case +
international
T1 base case +
international merger
with Middle East carrier
Terminals base
case slower
domestic growth
0
5
10
Impact T4
Impact T3
15
Impact T2
20
25
Impact T1
Source: AMP Capital.
Note: Terminal capacities are a measure of passenger throughput not aircraft
movements, and as such make no comment as to the ability to handle the
corresponding number of required aircraft movements or aircraft sizes. Further,
these terminal capacities do not take into account any pattern associated with
peak hour handling.
Given the future uncertainty of our airlines, and the potential
changes in the operating models across the next 10 years, it may be
more prudent to retain as much flexibility in terminal arrangements
as possible. It will also be important to avoid entering into exclusive
arrangements that may prohibit a reshuffling of supply and impact
a suboptimal capital program.
In addition, airports will need to be constantly
assessing the social and environmental
impacts of terminal reconfigurations and
construction, as these can have a major
impact on the commercial, financial and
reputational components of the business.
There are multiple social issues that will
need to be assessed including impacts from
noise, visual amenity, safety, and passenger
grievances or losses.
We will continue to monitor changes in the
Australian aviation landscape, in particular
any further changes to the Qantas Sales Act,
and look to other global markets for lessons
to be learnt as it manages its investors’
interests in airports.
CONTACT US
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