Deregulation in the air

The decision to open up transatlantic routes to unlimited competition will cause severe consolidation and drive down airfares. David Benady and Rupi Gohlar look at the problems besetting the four airlines that currently hold exclusive rights to these profitable routes

 Flights between London and New York could be a third cheaper following the Open Skies Agreement struck by regulators in the US and Europe. The deal, announced last month, throws open the door on unlimited airline competition for flights between Europe and the US from March 2008. Its effects are already being felt as speculation mounts about a takeover offer for BMI.

Deregulation of transatlantic flights will trigger a fierce marketing battle on business routes from Heathrow to New York. Meanwhile, small operators will line up to launch a new round of leisure services from London to US cities and prices will be pushed down. The established players will not take this lying down.

This heightened competition could lead to the creation of a slew of new brands and sub-brands, both at the level of cabin segmentation and by the airlines themselves. One suggestion is that BA could launch a low-cost transatlantic brand, similar to its Go no-frills service launched in 1998.

However, observers say that deregulated Open Skies across the Atlantic are unlikely to lead to the sort of rock-bottom prices seen in Europe from no-frills operators such as Ryanair and easyJet, triggered by the deregulation of European airspace in the early 1990s.

Wide-bodied aircraft
Relatively few players will have the resources to buy the wide-bodied, safety-enabled aircraft necessary for transatlantic flights. EasyJet has ruled itself out of transatlantic competition and Ryanair is not expected to get involved.

But fresh in people’s memories are the lessons of the recent deregulation of flights to and from India, which has led to prices falling by up to half.

The great opportunity for this new round of Open Skies is on the business routes between Heathrow and New York, which are the most profitable in the world. Business travellers pay up to £4,500 for a round trip in business class, while flying to New York from a European city costs nearly half this.

Deregulation means that Heathrow-to-New-York margins will come under pressure and spells trouble for the four airlines, which, at present, have the exclusive rights to these routes – US operators United Airlines and American Airlines and the UK’s BA and Virgin Atlantic – which are thought to make over half their profits on these routes.

Heathrow is crucial for transatlantic business travellers as a hub to travel onto other international destinations and is well connected to central London through the Heathrow Express. For the well-heeled business traveller, no other UK airport will do. With the opening of Terminal 5 next year, Heathrow’s stature will grow. Some 90,000 travellers a week fly from Heathrow to New York in peak times.

For competition on the Heathrow-to-New-York routes to increase, it will be vital for rival carriers to secure the prized take-off and landing slots.

BA has over 40% of Heathrow slots and BMI has about 13%, while Virgin Atlantic has 3%. It is expected that BMI will take full advantage of its position by converting domestic slots to international ones, and commence flights to the US next year. Industry insiders believe this will hit the business market at Heathrow hard.

There is much speculation about the future of BMI. Its Heathrow slots make it an ideal acquisition target for BA, Virgin or any other carrier. Meanwhile, other international carriers, such as Iberia, Lufthansa and KLM could, in theory, switch their Heathrow slots from European destinations to the US, adding to the competition.

Observers estimate that if serious competition kicks in, Heathrow-to-New-York return business prices could plummet by a third to £3,000.

Heathrow has already experienced a scramble for runway slots, which are vital for launching competitive flights. This week BA bought 51 pairs from BMI for £30m and Virgin Atlantic has confirmed it is definitely in the market for purchasing slots – although such opportunities are unlikely to occur, as 98.5% of slots are allocated and new slots become available only rarely. The administration of slot allocations is handled by Airport Coordination, which manages the procedure at 16 airports in the UK and EU, including Heathrow.

Additionally, BMI and United Airlines’ application to the US Government for the formation of an alliance has poured fuel on the fire as competitive tensions mount. Such an alliance could be a defensive move against a predatory acquisition.

One possible move by the established business operators is flying from other European airports, and carriers such as Virgin have expressed interest in the idea.

In terms of leisure travel, Open Skies is expected to lead to new services launching from Gatwick, and a number of airlines have declared their intention to spark a price war on these routes. As some airlines switch operating slots from Gatwick to Heathrow to take advantage of the new market for business flights, their spaces will become available for other carriers.

Monarch Airlines says it will look to obtain slots at Gatwick. It is already launching a service from Gatwick to Orlando, Florida, in May. Managing director Tim Jeans, a former sales and marketing director at Ryanair, says: “These are not markets into which you would enter on tip toe – we would have to have a substantial war chest for marketing and advertising.

“We, along with most of the airlines in our sector, are looking again at the North American market. Most don’t have the capability to fly across the Atlantic, so we won’t see a rush of new carriers. There is a relatively limited set of airlines involved, namely those with the take-off and landing slots to do things.”

But he says that airlines may play a waiting game to see how much capacity is added to the market. “”We don’t want to join a Klondike-like rush, and there is every possibility that might happen,”” he adds.

Meanwhile, Scottish airline Globespan and Canadian operator Zoom also intend to ramp up transatlantic operations from Gatwick. A Globespan spokesman says: “We already operate flights to Canada from Gatwick, but we are always looking to expand.”

Although insiders say the leisure sector is already competitive and does not offer much scope for off-peak price cuts, peak-time return leisure flights to New York costing about £500 could fall to £350. Jeans says demand is extremely responsive to price cuts, with a 20% reduction likely to lead to a 20% increase in demand.

Business customers
It should be noted that an open skies policy has operated for regional UK airports flying to the US for over a decade. Recently, new airlines have been launched catering for business customers, such as Silverjet operating out of Luton and the premium Eos Airlines and Maxjet, which use Stansted. Where established operators, such as BA and Virgin, charge high rates to business travellers offset by economy class at the back of the plane, these new operators offer only business class.

However, these two airports are hamstrung by their poor transport connections into London. Meanwhile, the UK’s weak transport infrastructure also means there are few Americans willing to fly into regional airports. So competition will focus on Heathrow and Gatwick.

The full effects of the Open Skies agreement could take some time to become apparent. Charles Trevail, founder of consultancy Promise, says: “Open Skies is going to cause massive consolidation and create opportunities for price cutting – it has already had an effect on the BA share price. You might see BA launching a price-fighting brand for transatlantic long-haul. There are many opportunities for brand differentiation.”

He speculates that BA could buy BMI and use it as a price-fighting brand to protect its profitable business routes. But he warns that falling prices could lead to a serious diminution of the service offered to customers. “Efficiency isn’t going to be the only factor,” he adds. “Customer care and service are going to be at an even greater premium.”

Deregulating transatlantic flights is just a stop-over on a much longer and more significant journey towards worldwide airline deregulation. Worldwide Open Skies really will create unprecedented marketing opportunities. But there could be a long wait in the departure lounge for take-off.

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