Guest Editor Aaron Newman

Guest Editor Aaron Newman

Power Shift; Gulf Carriers Threat to Alliance Airlines

By Aaron Newman

There are not many days that go by without seeing news come from the Middle East’s emergent airlines. Emirates Airline (Dubai), Etihad Airways (Abu Dhabi) and Qatar Airways (Doha) have been populating the headlines with large aircraft orders, launching new routes, new state-of-the art airports, and lavish onboard improvements. These three airlines have made established legacy carriers across the globe uneasy as they present a real threat to the established airlines bottom line. Alliance airlines like British Airways, KLM-Air France, Lufthansa, American and United have long dominated trans-oceanic high-yielding business markets. Are these industry mainstays slowly losing their grip?

Emergence of Gulf Carriers

Rapid economic development of Persian Gulf countries in the 1970’s and 80’s were due largely in part of the discovery of vast oil and gas reserves and the growth of OPEC. This caused large amounts of capital to flow into these small Gulf nations. Over time, small oil nations began looking for ways to diversify their country’s portfolio in a fear that oil reserves will eventually run out. These three state owned airlines are now an integral part of their countries respective economies. Qatar Airways for example, claims to count for 11% of the state’s GDP. Supported by friendly regulatory environments, government spending on airport infrastructures, and new, reliable long-haul aircraft, these carriers have transitioned from small regional airlines to global mainstays in a decade’s time.

Keys to Success

Access to cheap capital; the Gulf States have access to large cash reserves from oil and gas resources. This enables Persian Gulf nations to finance rapid growth, and offers support with airport development and infrastructure.

Graph Source: wsj.com

Regional competition; the Gulf airlines cooperate on many issues but also vigorously compete with each other, creating the need for efficient operations and continual product development to attract new customers.

Geography; the Middle East is ideally placed to link major global population centers. It sits at a cross-road between Europe, Africa and Asia.

Emerging market demand; demand from emerging markets is rising fast as a rapidly growing middle class has the time and money to consider travelling by air for leisure and business. The Gulf is located between the mature economies of Europe and the emerging markets of South East Asia, India, China and Africa.

A New Formidable Opponent

The Gulf airlines have combined home markets of only 7.5 million people, and so must rely on connecting passengers with a hub and spoke system. European airlines have been particularly hard hit by this, watching their natural customers travel on Gulf carriers instead of the country’s national carrier. Christoph Franz, former CEO of Lufthansa Group, highlights the challenging future of his prior company on a new Emirates route from Lisbon to Dubai saying , “we are talking about passengers who until now were primarily attracted by flights from Lisbon to Munich, in order to go on to Asian destinations. At least part of them are not flying via Germany anymore,” he says. “In the beginning we were talking about a competitive threat on paper – now we are talking about reality in our markets” (ft.com).

Copyright Photo: Keith Burton/AirlinersGallery.com. Etihad Airways Airbus A340-642 A6-EHF (msn 837) departs from London’s Heathrow Airport.

In a June warning to its investors, Lufthansa cautioned the possibility of downward revisions to the airlines earnings outlook. Chief Financial Officer Simone Menne cited pricing pressure from the Gulf carriers’ expansion into Europe as a major contributing factor. Gulf airlines, which are adding capacity in major European cities such as Paris and London, are also ramping up service in secondary cities like Barcelona and Hamburg. This means that they’re grabbing market share from the European carriers not only at their hubs, but also at their spokes.

Competing on American Soil

The Gulf three now send nearly 120 large, new planes weekly to a growing number of American cities (WSJ.com). Though the United States and Canada are geographically better positioned than their European counterparts, the Gulf carriers still pose a credible threat. Airlines and governments in North America have been fighting back where they can. In Canada, the government has limited the number of planes that Etihad, Emirates and Qatar can land at its airports–a move to protect Air Canada, and its partner Lufthansa.

Graph Source: Emirates.

“Essentially, these are not airlines—they’re governments,” said Delta CEO Richard Anderson. “They have the ability to gain advantages in markets because profitability doesn’t matter.” He said the U.S. government should revisit its air treaties with other nations to ensure there is “equity” in commerce (wsj.com). Many industry analysts say U.S. opposition has slight chance of slowing down the Gulf carriers in the deregulated era. Washington is unlikely to alienate its Mideast allies, and Boeing, the U.S.’s biggest exporter, gets 10 percent of its wide-body orders from the Gulf carriers.

Looking Into the Future

With a backlog of more than 500 wide body aircraft orders, do not expect these airlines growth to subside. According to a recent report by Credit Suisse, Etihad Airways, Emirates, and Qatar Airways will increase the number of seats offered on their Europe-to-Asia flights between 8 and 18 percent a year between now and 2020 (thefinancialist.com). I believe you will continue to see these airlines enter more secondary markets to grab market share from legacy carriers. I envision cities like Chengdu, Sapporo, Brasilia, and Charlotte N.C. as cities that Gulf carriers will have their eyes on for future growth. With new airports and new aircraft, growth is inevitable; at this point it is not a matter of if Gulf carriers will continue to grow, but it appears to be a matter of when and where.

What can European, Southeast Asian and North American airlines do in response to the new threat to their long-haul business? Airlines must first cut costs. This is critical, particularly for European airlines to remain competitive. For example, Lufthansa needs to reduce costs on flights to Southeast Asia by 40 percent to stay competitive. Another example, according to Credit Suisse, Air France and IAG (British Airways Parent Company) has 30 percent higher unit costs on flights to Southeast Asia than some Asian competitors, Turkish Airlines, and Emirates (thefinancialist.com). Secondly, airlines could reduce route competition and shelter revenue by developing mutual partnerships with the Gulf carriers.  These relationships would make it easier for both Eurasian and North American carriers to get more customers into the Middle East, India and developing nations in Africa with little investment required. As the saying goes; if you can’t beat em,’ join em.’

Emirates: 

Etihad Airways: 

Qatar Airways: 

Bottom Copyright Photo: Stefan Sjogren/AirlinersGallery.com. Airbus A380-861 A6-EDJ (msn 009) of Emirates arrives at London (Heathrow).