Comment Joe GillIf airline management was a sport, it would be ice hockey without the body armour. Rapidly moving product (passengers), dynamic supply (aircraft can be moved and funded quickly) and demand that is ultra-sensitive to wider geopolitical factors (terrorism) provide a melting pot for success and failure.
Because airlines are so capital-intensive, poor management decisions on route selection, pricing or capacity can trigger relatively large cash outflows. While the barriers to entry may seem low (due to low interest rates and an excess supply of airplanes), going out of business is a regular event.
Of the 100 airlines established in the US since the mid-1970s, fewer than 10 remain. In this milieu, there is one truism - firms with the lowest unit costs can withstand and profit from the industry's vagaries.
Irish airlines are at the heart of a revolution in civil air transport. A new wave of carriers is sweeping the old forms of travel aside (typified by overnight restrictions and high fares) and replacing them with scheduled, point-to-point, low-fare services. Both Ryanair and Aer Lingus are key participants in this trend, while related parties are advancing the low-cost airline phenomenon elsewhere, particularly in the Asia-Pacific region.
It is in Europe where the most dramatic changes are underway. The old state carriers were originally established as extensions of state commercial and tourism policies. They evolved with state-owned structures (rigid labour practices, gradualist change) and cultures that neatly mirrored a highly regulated market for air services. Their market dominance and pricing power left air travel in the domain of the elite.
Liberalisation (EU-wide since 1997) has helped blast that legacy system apart. The marketplace now dictates demand and supply (subject to regulated safety and traffic control standards), providing fertile ground for flexible and dynamic airlines.
The state carriers are encumbered with restrictive work practices, expensive airports and marketing charges, and a hub-and-spoke model that sustains high unit costs. While they retain a large but diminishing market share (over 60 per cent of intra-European volumes), their profitability has eroded and, in some cases, disappeared. Alitalia, Air France and British Airways, for example, admit their short-haul operations in Europe are losing money.
It is against this backdrop that the Irish airlines are excelling. Ryanair's business model operates with the lowest unit costs in the western world (via flexible labour, well-timed aircraft purchases and low-cost airport deals), so it can profitably expand its model across the European market. With bases in Ireland, the UK, Belgium, Germany, Spain, Italy and Sweden, the group is building a sustainable backbone. Yet, while doing so, it will report an operating profit of over €260 million for the year ending March 2004 from carrying over 23 million passengers.
Aer Lingus has not yet taken its model outside of Ireland but has done something no other European flag carrier has achieved - it has made short-haul European travel profitable. Through a relentless programme of cost-cutting (in some cases aping the practices of its neighbour across the car-park) and route management, the company has moved from an operating loss of €52 million in 2001 to a profit of €83 million in 2003.
Its challenge now is to develop a model that can further expand the existing business out of Ireland (the Atlantic is a key focus) and migrate its model into other markets.
Beyond Ireland, Irish executives also operate at the core of the low-cost trend. Air Asia, which operates from Malaysia, is the fastest-growing airline in its region and plans a market flotation in the next year. Its model was built using a Ryanair template (a key adviser and investor previously worked with Ryanair and Aer Lingus).
In Singapore, the local government and Singapore Airlines have signed up with the Ryan family to establish a low-cost airline in the second half of 2004 (Tiger Air) while the Australian carrier Qantas is developing its own low-cost unit (Jetstar) using a former Aer Lingus senior executive as CEO.
This low-cost phenomenon is radically changing the notion of air travel. Ryanair's average one-way price across its entire range will be about €40 this year. Aside from stimulating new markets, these low fares make air travel affordable to people who previously flew at most once a year and usually on a charter flight.
Today, a typical low-cost flight contains students, migrant workers and elderly people, in addition to the suits. It is this highly progressive feature of the low-cost wave that raises an important question: why do left-leaning politicians and unions criticise something that makes air travel such an available service to the constituency they supposedly represent, i.e. low-income earners?
And if this phenomenon is exploding across Europe (low-cost traffic will grow fourfold in the next 10 years), why are we still waiting for it to explode in our own country?
The answer may lie in the unique way Ryanair can aggravate certain people, but policy-makers need to step above such a furore. Ireland needs a radical shake-up of its airport gateways as a means of unleashing a far greater flow of travellers to the island. Then we can all fully share in a truly revolutionary paradigm shift.
Joe Gill is head of institutional equity research at Goodbody Stockbrokers
