Impact of Deregulation in the European Airline Market Term Paper

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Deregulation in the European Airline Industry

The European airline market:

Transport is one of the key sectors in Europe with commercial, economic and cultural implications for the European Union citizens. It accounts for over 10% of Europe's GDP and provides jobs to nearly 10 million people. In the last two decades, air transport has shown the maximum rise in passenger volumes, with an average annual growth rate of 7.4%, in terms of passenger per kilometer. Passenger strength rose by 19% during the period 1998-2001, driving demands in the European air markets. Since 1970, cargo traffic moved by air transport has increased five-fold. More than 25,000 planes fly over the European skies on a given day. The European Union is likely to have additional population of some 75 million in the medium term, as ten countries are expected to join the Union in the near future. These countries shall become party to the European Union's open-Sky Treaty that will provide for point-to-point services from any member country. National flag carriers or state-owned airlines dominate the European airline market and enjoys a massive share of about 70% of passenger traffic. Such airlines include respected names such as British Airways, Air France and Lufthansa.

However, the dominance of flag carriers is now being challenged, as free market forces are increasingly swinging the market dynamics. For instance, in 1998, the Flag-Carriers accounted for 75% of all passenger traffic, while only 2% went to the low-cost segment, with the remaining 23% under Charter airlines. Just three years later, the market share of low cost airlines increased to 7%, while Flag Carriers found its traffic reduced to 72% in 2001. A major demand driver is the increasing affordability of flying for Europeans, with the average fare of low-cost airlines being only 3% of the average European Union industrial wages. Of the 280 airports in Europe, over 100 are served by low-cost airlines. The major hub airports, however, are ruled by a handful of Flag Carriers - British Airways (Heathrow), Lufthansa (Frankfurt) and Air France (Paris Charles De Gaulle). These three airlines held market shares of 11%, 12% and 7% respectively in year 2001, followed by Alitalia and Iberia with 7% each, SAS 6% and KLM 4%. The remaining share was shared between several other smaller players. (Riley, 2003)

De-regulation of the European airline industry:

For many years, the European airline industry was under tight regulation. Low passenger traffic and high prices led to unfavorable economic conditions in the airline operations forced governments to subsidize airline industry, especially for political gains. The Unites States of America took the lead in economic liberalization of airline sector by promulgating the Domestic Market Deregulation Act in 1978,. By mid eighties, the U.S. airline industry had been more or less deregulated and the benefits were clearly visible. The European Union, in 1987, kick-started liberalization measures with the main aim of allowing a lot of freedom to the airlines as long as they have no significant business links with non-European Union airlines and subject to the condition that they do not practice price discrimination or cartelization. The market transition was phenomenal - from a highly controlled, duopolistic market based on bilateral agreements between countries, the European airline industry transitioned to a very competitive single market.

The final package of liberalization was implemented in 1988 and the European Union was well on its way towards a market driven airline industry, free from the clutches of state control00. One of the far-reaching reforms was that the influence of state authorities was reduced and airlines were given immense levels of freedom to decide on fares, routes and capacities. This meant that the market would be driven by economic and financial considerations and it was expected that the market would be customer friendly in terms of service, safety and price. As part of the progressive policies on 'freedoms of the air', any airline with a valid certificate of operation in the European Union cannot be prevented from flying on any route within the Union. Called as the seventh freedom, this includes the right to pick up passengers in one country and fly them to another country, without a halt in the home country. The seventh freedom is seen as a major step towards free movement of people and goods around the European Union.

Although deregulation led to formation of a good number of regional low-cost airlines, the European airline market is still distorted because the state controlled airline enjoy a lot of subsidies, which gives them competitive advantage over private owned players, especially the smaller ones, in terms of costs. In an attempt to cut costs, large airline companies are pulling out from routes that are not profitable and instead using subsidiaries and franchisees to serve such routes. For the present, airlines may not be able to plan mergers and acquisitions as they wish, a facility, which is available to other industries within the European Union under the single market. This is because Airlines are allowed to only operate from their national base. Fallout of this restriction can be seen from the fact while there are only six airlines on the American side for the transatlantic routes; there are as many as twenty airlines on the European side. (Doganis, 2001)

European airlines are limited to a single market and thus often have to depend on a single hub for intercontinental services. This means that the companies cannot offer routes as they wish and may lose out on profitable opportunities. On the other hand, an U.S. airline can have several hubs from where they can offer intercontinental services to several locations based on alliances with other airlines. Post de-regulation, airlines have the liberty to fix and revise fares as they wish. It could be seen that close to 85% of the commuters travel on reduced fares within the Union. On some routes, the fares are still higher and this deprives passengers of low cost options. Another drawback is the duplication of flight services on busy routes and lower size of aircrafts to increase frequency. These initiatives have increased the fuel consumption per passenger, raising energy conservation and environmental issues. Critics point out that the short-term and profits oriented approach of the private airlines is the main reason for this situation and governmental intervention is therefore required to stem further deterioration.

Low-cost airlines:

Liberalization of airline industry has resulted in the birth of low-cost scheduled airlines, primarily aimed at providing cheap alternate mode of transport for the average citizen, thus increasing passenger traffic. Cheaper fares are possible only if the operational costs are significantly lower than the traditional airlines. Lower costs are achieved by several techniques - use of internet for sales, maximizing utilization to reduce unit cost, direct sales of tickets, the option of traveling without the need for a ticket in physical form and no free airline food. The extensive use of internet for ticketing and the elimination of commission agents lead to significantly lower operating costs. Other measures include using smaller airports and running a fleet with only one type of low-cost aircraft, which leads to lower maintenance and training costs. The U.S. airliner Southwest Airlines was perhaps the first to initiate the low cost model way back in the early 1970s. Europe was a laggard and it was only in the late nineties, the concept of low-cost airline service was introduced. Ryannair, EasyJet, Virgin Express, Go and Buzz are some of the lines offering low cost travel.

A major advantage of the low-cost air transport is that it has encouraged even middle-income groups to venture out air travel for the sheer enjoyment and more and more people are opting air transport for leisure travel (Graham and Guyer, 1991). Fares on these lines are tempting even for the budget traveler. In 2001, one-way fares from London to Frankfurt were UK Pounds 5 and from London to Brussels, Stockholm and Dublin, UK Pounds 8, which were much lower than the fares prevailing four years earlier, that is before the low cost services came into existence. In the United Kingdom, low-cost airline traffic is expected to grow at 6.6% per annum for the years 1998-2015. (Humphreys, 2003). A good portion of this demand growth is due to passengers previously traveling by road or rail, upgrading to air mode due to obvious advantages. For example, travel time from London to Scotland is four times quicker by air and with little or no difference in travel costs.

From the demand perspective, it appears that low-cost airline service will run away with top honors. According to the International Air Transport Association, overall air transport market growth rate in Europe was a little over 5% per year during the years 1999-2003. On the other hand, the low-cost sector, which carried a mere 4% of the passengers in 1999, could increase its share to 12-15% in 2010 and would turn out to be major lines in future. For the players, it is no easy task to survive in the low…

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