International Airlines Group (IAG) is targeting winter 2012/13 as its first opportunity to fully incorporate the 42 daily London Heathrow slots it will acquire as part of its purchase of bmi from Lufthansa, now approved by regulators with only minor concessions. The initial integration will look to bring the predominantly short-haul bmi operation to breakeven by increasing seat capacity on each slot pair, making network changes and leveraging IAG's marketing and distribution power on the inherited bmi network. The medium-term integration will see the short-haul bmi slots allocated for services on IAG carrier British Airways' (BA) long-haul operation, which is smaller than its major European rivals. BA will target emerging markets including Asia, Africa and Latin America.
This new and large increase in Heathrow capacity will require significant fleet adjustments, and already BA plans to delay retirement of Boeing 747 aircraft as well as to re-examine its purchase options, which it holds on 787 and Airbus A380 aircraft. It will also seek clarity from Boeing on its 777 successor programme.
The medium-term integration will commence in 2013 and by 2015 IAG expects the vestiges of bmi to contribute, perhaps optimistically, EUR100 million of profit.
The initial GBP172.5 million deal with Lufthansa will be diluted, according to undisclosed pre-sale agreements, due to IAG not being able to acquire bmi's full 56 slots because of competition concerns. Further concessions will be granted if IAG has to acquire bmi Regional and bmibaby, the latter of which Lufthansa announced an undisclosed buyer for in Feb-2012 but without the deal concluding yet.
Note: This analysis was updated in May-2012 to reflect the latest developments. Jump here to go to the update.
IAG to offer intricate concessions, but only on select routes
As expected, IAG had to make relatively minimal concessions for the European Commission to clear the arrangement. Notably, IAG offered the concessions – they were not imposed – allowing IAG a sound negotiating position. While the concessions can be exacting, stipulating what type of cooperation IAG must offer to competitors, they affect only a minimum number of routes. They fit into five categories: London Heathrow slots, fare combinability, special prorate agreements, frequent flyer concessions and IAG's codeshare with Royal Jordanian.
The 42 slots IAG will acquire is 14 fewer than the 56 announced at the time of the Dec-2011 deal when IAG assumed, publicly, it could acquire all of bmi's slots. Of the 14 sacrificed slots, IAG has reached an agreement with Russia's Transaero for two slots. London-Moscow (all airports included) is served by four carriers: Aeroflot, bmi, British Airways and Transaero. BA is already the largest operator and with bmi's existing capacity would have twice the capacity of the next-largest carrier, Aeroflot. Transaero deploys the least amount of capacity, and unlike SkyTeam-aligned Aeroflot, is not a member of a global alliance, making it an ideal candidate to support, as the direct competitive impact will be the least. (Russian oneworld member S7 does not serve London, but even if it did would have been unlikely to be eligible for additional slots, although its service on the route may have allayed competition concerns and not require concessions on the Moscow route.)
Moscow to London (seats per week, one way): 19-Sep-2011 to 30-Sep-2012
If Transaero does not end up using the slots, IAG will offer them to another carrier looking to serve the London-Moscow route or on the five other destinations the EC has flagged as where IAG's sacrificed slots can be used to (so called designated city pairs): London to Aberdeen, Cairo, Edinburgh, Nice and Riyadh, all bmi destinations. Transaero taking up two slots leaves 12 IAG more that it needs to concede. Five will be for use on the designated city pairs (Aberdeen, Cairo, Edinburgh, Moscow, Nice and Riyadh) while the remaining seven will be explicitly for Aberdeen and/or Edinburgh. On these routes, IAG was judged to have too large a hold on the market, either by number or proportionally.
Cairo, Nice and Riyadh
Following IAG's acquisition of bmi, Cairo, Nice and Riyadh have become duopoly routes from London, with BA sharing capacity with EgyptAir to Cairo, easyJet to Nice and Saudi Arabian to Riyadh. Cairo has not seen greater capacity or competition due to the absence of low-cost carriers, a result of Egypt restricting LCC access to Cairo.
London to Cairo Airport (seats per week, one way): 19-Sep-2011 to 30-Sep-2012
Nice is a leisure destination and easyJet is very unlikely to apply for slots given its absence at London Heathrow. Transavia, the LCC of the Air France-KLM group, may be a contender as it seeks to expand its presence, but its lack of capacity in France, as well as no operation at Heathrow, would be a deterrent to the EC, which is in charge of distributing the 14 Heathrow slots.
London to Nice Cote D'Azur Airport (seats per week, one way): 19-Sep-2011 to 30-Sep-2012
Riyadh is a small market although bmi is understood to have performed well, making it a possibility Virgin would enter, even though bmi had the strength of its short-haul network to support it.
London to Riyadh Airport (seats per week, one way): 19-Sep-2011 to 30-Sep-2012
UK domestic routes: Aberdeen and Edinburgh
The UK routes targeted for additional slots (Aberdeen and Edinburgh) see far more capacity than the international routes. London-Edinburgh is the largest UK domestic route by seats and London-Aberdeen the fourth largest. London-Aberdeen would not fall to a duopoly situation owing to capacity from flybe and easyJet. London-Edinburgh could fall into a duopoly situation with only BA/bmi and easyJet (as well as Air France's CityJet unit into area airport Dundee).
Assuming a scenario in which five of the seven slots are awarded for Edinburgh services and two of the seven for Aberdeen, and the flights are operated daily with 180-seat aircraft, 6300 weekly one-way seats could be shifted in the London-Edinburgh market; this is approximately bmi's current capacity.
London to Edinburgh Airport (seats per week, one way): 19-Sep-2011 to 30-Sep-2012
Under similar conditions, 2520 weekly one-way seats would be shifted in London-Aberdeen; this too is approximately the same as bmi's current capacity.
London to Aberdeen Dyce Area Airport (seats per week, one way): 19-Sep-2011 to 30-Sep-2012
Top 10 UK routes ranked by seats: 09-Apr-2012 to 15-Apr-2012
|1||EDI||Edinburgh Airport||LHR||London Heathrow Airport||33,498|
|2||MAN||Manchester Airport||LHR||London Heathrow Airport||22,849|
|3||LHR||London Heathrow Airport||GLA||Glasgow International Airport||18,662|
|4||LHR||London Heathrow Airport||ABZ||Aberdeen Dyce Airport||17,679|
|5||EDI||Edinburgh Airport||LGW||London Gatwick Airport||16,884|
|6||LGW||London Gatwick Airport||GLA||Glasgow International Airport||15,510|
|7||LPL||Liverpool John Lennon Airport||BFS||Belfast International Airport||12,792|
|8||LHR||London Heathrow Airport||BHD||Belfast George Best City Airport||12,288|
|9||LHR||London Heathrow Airport||NCL||Newcastle International Airport||12,068|
|10||BHX||Birmingham Airport||BHD||Belfast George Best City Airport||11,200|
IAG secured against losing early morning slots
The European Commission has stipulated that IAG does not need to release more than three pairs of slots between 6:00 and 8:20, the peak period for carriers, British Airways especially, with its network needs. The European Commission stated in a brief that it will award slots to carriers without prejudice of their country or principal place of business. It will award slots based on which carrier can provide the most effective competition, favouring carriers that can fulfill two of three criteria: the requesting carrier 1. has had the largest number of seats or services for two seasons; 2. offers pricing structures and service offerings that would provide the most effective competition; 3. intends to offer traffic feed to other carriers, thereby further opening the market.
In the event airlines do not take up the slots or fail to meet minimum service requirements, the slots will default to IAG.
Virgin Atlantic argues for 12 slots to be sold together, but faces challenges to enter domestic market
The European Commission is opening the possibility for existing operators to strengthen their presence or for new entrants to arrive, although it is not clear which new carriers could serve these routes. The EC appears likely to favour a number of operators to assume the 12 slot pairs, although Virgin Atlantic is now lobbying for the dozen to be auctioned together in order to maximise the leverage a competitor (such as itself) could have against IAG.
While Virgin Atlantic was still lobbying to buy bmi, it pledged it would not use bmi's slots exclusively on long-haul routes and offered the launch of a domestic operation. Since the concessions were announced IAG CEO Willie Walsh has leveraged Virgin's previously stated goals, telling The Guardian: "I would expect Virgin to honour the commitments they have made. They have said they would start flights to Scotland. They now have the ideal opportunity."
Virgin had never discussed general details of how it, a widebody-only operator, would make this work, although Virgin Atlantic briefly in past decades did operate Airbus narrowbody jets for leisure routes, since withdrawn. Virgin has since made statements indicating it would be prepared to launch a domestic/narrowbody operation in summer 2012. If Virgin successfully obtained all 12 slot pairs, it would be required to use seven for Aberdeen and/or Edinburgh while the remaining five could be used to bolster Aberdeen and/or Edinburgh or used on the international routes to Cairo, Moscow, Nice and Riyadh. Virgin is unlikely to want to enter Nice but could be considering the other international points.
The prospect of Virgin entering short-haul markets poses a significant quandary: can it be profitable on short-haul? That achievement has plagued its legacy competitors across Europe. An important indicator is that the slots it could potentially inherit are from a carrier sold off because its short-haul-focused network was unprofitable – even despite its large scale and being able to pull traffic from Star Alliance, neither of which Virgin can offer, so long as it remains independent. European legacy carriers this year are turning a serious eye to restructuring their loss-making short-haul networks. The proposed solutions so far are to strip down service to compete with LCCs. The latest restructuring, Iberia's creation of Iberia Express, has a tight pitch, no free food or drinks in economy and no free checked luggage for those on the cheapest economy fares.
While such low, non-existent frills are not synonymous with the image Virgin Atlantic has portrayed of itself being focused on service, the Virgin Group does have lower-cost short-haul experience with Virgin America and Virgin Australia. Both however, required significant investments in markets more likely to offer profitability. For all the changes occurring with legacy European carrier's short-haul networks, it is too early to see if the carriers can achieve a profitable short-haul operation. Virgin Atlantic has subsidised well without its own direct feed, using interlines with bmi and British Airways (in fact, British Airways interlines are understood to have contributed to Virgin more passengers than from bmi). The days are long past for an airline to operate a European short-haul network for pride alone.
The EC has stipulated that any carrier that increases capacity on one of the designated routes (Aberdeen, Cairo, Edinburgh, Moscow, Nice or Riyadh) can enter into a "fare combinability" agreement with IAG. This will allow the other carrier to sell IAG flights on the route, increasing its schedule proposition and, hopefully in the eyes of the EC, increase competition. The EC has not stipulated if this is to be an interline or codeshare arrangement but that IAG flights may comprise only one direction of travel. The EC stipulates the roundtrip fare should be half of IAG's and half of the other carrier's and allow for recovery of fuel surcharges. Fares are not allowed to be "less favourable" than any agreement the other carrier presently has with IAG. Agreements are to be in force for five years and monitored by an independent party.
The EC has also stipulated that IAG enter into prorate agreements (effectively interlines) to allow other carriers favorable rates on IAG services. The rates are applicable for carriers linking a relevant short-haul point (anywhere in Europe as well as a handful of points in West Asia, the Middle East and Africa – many of which bmi served) with a relevant long-haul point.
EC's deemed relevant cities: Mar-2012
|Long-haul||Category I: Boston, Chicago, Houston, Los Angeles, Miami, New York, San Francisco, Washington, Calgary, Edmonton, Halifax, Montreal, Ottawa, St John's, Toronto, Vancouver, Cape Town, Johannesburg, Sydney|
|Long-haul||Category II: Beijing, Delhi, Doha, Dubai, Hong Kong, Lagos, Singapore, Tokyo|
|Short-haul||Any point in Europe; outside Europe: Addis Ababa, Agadir, Almaty, Amman, Amritsar, Baku, Beirut, Bishkek, Cairo, Casablanca, Damascus, Dammam, Freetown, Jeddah, Khartoum, Marrakech, Moscow, Riyadh, Tbilisi, Tehran, Yerevan|
Exceptions are also made for carriers with, either on their own or with partners, a hub in London and "Category I" cities. However, since no carrier aside from British Airways and Virgin Atlantic has a hub in London, this is for now a moot point. It will, however, have an effect on Virgin Atlantic in the likely event it joins a global alliance. In the case of the trans-Atlantic market, should Virgin join SkyTeam, it will not be allowed to have a prorate agreement on IAG flights if the passenger's origin is New York since the EC lists New York as a Delta hub. (Curiously, Atlanta is not considered a Delta hub for the EC's purposes.) Similarly, should Virgin join Star, it will be cut off from New York as United is deemed to have a hub there (as well as Chicago, Houston, Los Angeles, San Francisco and Washington). While there is strong O&D traffic between New York and London, there is also considerable connecting traffic.
While transfer traffic has not been a mainstay of Virgin, which has relied on the strong local London market, as alliances and joint ventures have proliferated Virgin has been left without equal partners and has lost revenue synergy opportunities. It will need a new strategy going forward, and better incorporation of transfer traffic will need to be an element. The EC ruling will block Virgin's access on IAG if any new Virgin partners have hubs in listed cities. While this is fair to not force IAG to have a relationship with a strengthened competitor, it does return to the origin of Virgin's problem that it lacks both feed at London as well as growth opportunities.
This clause largely assures Virgin Atlantic that its interline agreement with IAG can continue so long as Virgin does not join an alliance. While Virgin Atlantic had lampooned the sale of bmi to IAG, saying it stood to lose all of the feed bmi provided it, British Airways had been a far larger source of network feed for Virgin. Nonetheless, Mr Walsh seized the opportunity to spin the concessions, telling The Guardian: "It must be humiliating for Virgin and Branson to have to rely on the BA network to feed their traffic."
Carriers are assured of securing similar rates as they previously had with IAG or bmi, and agreements are valid for an initial five years with rolling one-year extensions.
The EC prescribes that any carrier (aside from oneworld members or carriers affiliated with oneworld members) that increases service on designated routes and which does not have its own frequent flyer programme (FFP) can be hosted in IAG's FFP for the designated routes. Given the proliferation of FFPs this is unlikely to come into use.
Should IAG continue to operate bmi's services between London Heathrow and Amman (currently served 10 times weekly on A320s/A321s), IAG will terminate its codeshare with oneworld partner Royal Jordanian on the route. London-Amman is the only route that will become a oneworld monopoly following bmi's incorporation into IAG. This would not be a welcome development for Royal Jordanian.
From a network perspective, the bmi acquisition is a story about London Heathrow, and in turn supremacy: BA growing – profitably – in its largest hub and where BA has been starved for growth while rivals have been flexing muscles at their less-congested hubs. Of Europe's four major long-haul carriers, only BA in 2010 carried fewer passengers than in 1998. Air France, KLM and Lufthansa all grew by 42-53%.
BA's reasons for carrying fewer passengers are varied but include its decision early last decade to focus on carrying more premium travellers and fewer economy passengers in order to increase revenues in the absence of hub growth. This focus on yield has positioned the carrier relatively well, financially at least, in its European competitive stakes, although reducing its global reach.
Passengers carried annually on select European carriers: 1998 to 2010
Total passengers carried across all airlines at Heathrow from 1998 to 2010 grew by only 10% while Frankfurt grew 23%, Amsterdam 32% and Paris 49%. IAG CFO Enrique Dupuy, after announcing the bmi acquisition, did not mince words in making clear that the attraction was not with the airline, remarking "Our preferred asset in this transaction is the slots".
Annual passenger movements at select European hubs: 1998 to 2010
The non-preferred assets in the transaction were the other two brands in the bmi portfolio: bmibaby and bmi Regional. bmibaby has no Heathrow slots while bmi Regional serves Heathrow primarily via slots it has leased from bmi mainline. IAG has no interest in either and did not include them in the deal, but has secured itself undisclosed discounts from Lufthansa if it is obliged take them. Lufthansa previously announced a tentative deal for bmibaby, but this has not been confirmed. There were early discussions about interest in bmi Regional but here too nothing is confirmed.
Of the two, bmi Regional holds a stronger outlook. The Scotland-based subsidiary of bmi primarily operates domestic flights within the UK and its financial status according to Mr Dupuy is "very near break even". There had been local reports suggesting a Scotland-based consortium was interested in acquiring bmi Regional. While Mr Dupuy at the time of bmi's initial sale did not comment on specific bidders, he was confident bmi Regional could be spun-off. "The opportunities that we have been envisaging and Lufthansa is envisaging about selling bmi Regional, are much more clear or even close opportunities." IAG has not made subsequent statements about bidders.
bmibaby is bmi's low-cost subsidiary that operates a fleet of 14 737 classics to continental Europe from bases in northern England that lack strong geographic advantages. If Lufthansa cannot sell bmibaby by May-2012 and IAG has to take bmibaby, the included compensation would keep IAG's financial projections for bmi mainline on tract. "The amount that we have negotiated as a discount leaves us comfortable about the final exit...not impacting negatively our business case on bmi mainline," Mr Dupuy said. IAG would also receive compensation if it cannot acquire any of bmi's leased slots.
Virgin Atlantic has also bid for bmi, unsuccessfully putting in a bid in the six weeks between IAG's non-binding agreement in Nov-2011 and the binding agreement on 22-Dec-2011. IAG had been confident regulatory authorities would clear the deal as it holds 44% of Heathrow's slots and bmi's 56 slots accounted for 9%. The 14 slots IAG is giving up will see it assume 7% of Heathrow's slots for a total of 51%. This majority had been a sore point for Virgin founder Sir Richard Branson as Virgin Atlantic holds 3% of Heathrow's slots. But IAG's majority is well below the monopolies enjoyed by its rivals. Air France accounts for 68% of movements at Paris Charles De Gaulle, Lufthansa accounts for approximately 55% at Frankfurt and KLM 57% at Amsterdam. Mr Dupuy has even pointed to the imbalances at London Stansted, where Ryanair holds 44-53% of slots based on time of day. (But at Stansted there is closer competition with easyJet holding 25-31% of slots.)
Lufthansa escapes from bmi substantially financially damaged as bmi exits the Star Alliance in Apr-2012
In addition to taking a large loss on the sale, Lufthansa will itself pay the hefty fees associated with bmi's exit from Star Alliance. In a statement, Lufthansa says that after reductions it expects the bmi transaction to be "significantly negative". Earlier this month Star member Asiana posted a note, since taken down, that bmi would leave the alliance on 18-Apr-2012. IAG has not confirmed a departure date while bmi has issued a statement saying: "It is the intention that bmi will leave Star Alliance at the date of completion of sale, which we expect to be around 20-Apr-2012." Earning and redeeming opportunities on Lufthansa Group airlines will cease on 19-Apr-2012.
While IAG publicly remarked at the time of sale it would consider using the bmi brand, it has since decided to integrate bmi fully into BA, which will see the end of the bmi brand in the near future. Further details are expected to be disclosed once the transaction closes later this month. Shedding the brand is unsurprising as the BA brand is more powerful and duplicative branding adds few benefits while risking detraction.
While IAG expects restructuring to occur over three years and be "significantly lower" in total than bmi's current annual losses (EUR145 million in 2010), the largest restructuring at bmi mainline will occur in IAG's initial few months of ownership, Mr Dupuy said. During that time IAG will look to integrate bmi's network and right-size the fleet serving London Heathrow in order to improve unit revenue and costs. At Heathrow, bmi uses 50-seat regional aircraft on approximately 25% of its slots and its average aircraft size per slot in the summer 2011 schedule seated 119 passengers compared to BA's 200 and Heathrow's average of 201.
Average one-way seats per slot at London Heathrow
|Airline||Average seats per slot|
IAG CEO Willie Walsh said in an interview with Bloomberg that bmi routes would gain an immediate improvement from IAG's marketing and distribution. "By utilising the brands within IAG – British Airways and Iberia – we can give them much greater sales presence and enhance the revenue opportunity of bmi."
British Airways has already commenced codeshares on some bmi services across Africa, West Asia and the Middle East. Ironically, many of these routes – with significant profitability – bmi inherited from its 2007 acquisition of British Mediterranean, a BA franchise. The routes will now return to the BA portfolio, and Mr Walsh has said "a lot" of bmi's routes will be retained.
CFO Mr Dupuy said IAG will look to replace routes not kept with services to destinations that require longer sector lengths, stemming losses. Outside of the UK and Ireland, the bmi and BA networks are complementary with bmi largely skipping over continental Europe in favour of North Africa, the Middle East and West Asia. BA has a strong presence on continental Europe but is less covered in North Africa and the Levant and is entirely absent from resource-rich west Asia where bmi holds corporate contracts to serve the resource industry.
bmi route map: Winter 2012
bmi's short-haul network is heavily concentrated around the UK and Ireland with multiple daily flights, including up to six daily flights from Heathrow to Belfast and Edinburgh. The network tapers farther out with destinations including Cairo and Moscow seeing daily service while Casablanca and Khartoum see services only a few times a week.
Rationalisation can be expected, especially in the UK in which Mr Dupuy flagged dropping shorter routes for longer ones. BA and bmi control capacity between Heathrow and Manchester and have flights throughout the day, including some flights departing within 20 minutes of the other's service, making that route an easy target for consolidation and freeing up slots. Other flights could be rationalised into a single flight on a larger aircraft, such as upgauging A319 services to A320s, which adds approximately 24 seats and delivers better unit costs. IAG is now evaluating replacing its older A319s with A320s; it is due to take delivery of 19 A320 family aircraft before 2015.
BA could then explore using the short-haul slots to bolster services on bmi's less frequently served mid-haul destinations that typically have high fares, such as in North Africa, where BA at its Nov-2011 Capital Markets Day flagged interest in expanding in. If bmi has already struck a balance between supply and demand (and not been limited by slots), BA can generate additional demand with its marketing and distribution.
With these measures IAG aims to have bmi match, at the very least, the undisclosed (but not flattering) margin on BA's short-haul Heathrow network. IAG foresees a conservative scenario of the bmi network breaking even in 2013. IAG had flagged it could make some initial slot adjustments for the summer 2012 season, schedules for which commenced at the end of Mar-2012. bmi has sent a notice to passengers advising its summer schedule will be operated as planned, although this could easily change. Quicker slot changes, Mr Dupy said, "will enhance the opportunities to reduce the loss-making interim period as much as possible". An eventual profit comes from long-haul usage.
IAG projects the vestiges of bmi to add EUR100 million of profitability in 2015 to IAG's previous forecast of EUR1.5 billion; this will be done as IAG uses bmi's slots for more profitable long-haul services. (IAG has only made statements about the EUR100 million figure in the context of acquiring bmi's 56 slots. The reduced slot acquisition may require refinement to profit targets.)
Blocking quicker long-haul expansion is IAG's lack of long-haul aircraft. bmi's fleet has only two A330s, in different configurations, while its narrowbody fleet is primarily leased, offering little help.
IAG has a handful of 777s for delivery in the short-term, but the first phase of fleet replenishment does not kick in until mid-2013, when BA is due to start taking delivery of its 24 787s and 12 A380s on firm order.
IAG fleet plan: Nov-2011
IAG expects to receive 16 787s and nine A380s before the end of 2015, and deliveries in 2013 would optimistically see a half-dozen 787s and a few A380s. Those initial aircraft were planned as replacements for BA's ageing 747-400s and 767-300s, but IAG has now delayed retirement of the 747 fleet for an unspecified period. The bmi acquisition further pressures IAG for a follow-up aircraft order in the short-term. IAG is evaluating existing options on A380s and 787s but is also very interested in Boeing's 777 successor programme and will want clarity on details before placing an order. A step change in economics for the 777 successor, due to enter service at the end of the decade, could see the aircraft become more favorable than the A380 or 787 in certain scenarios.
For interim capacity, BA has a handful of 747s parked, but their individual operating costs are higher and BA has previously remarked on potential buyer interest. While IAG has near-term deliveries in the form of eight A330s pegged to Iberia, it is very unlikely they would be transferred to BA. Deliveries start in early 2013, providing little earlier capacity expansion before BA's own aircraft later in 2013. The A330 would also be new to BA whereas it shares commonality with Iberia's A340s. Financials are on Iberia's side, too. Iberia CEO Rafael Sanchez-Lozano remarked at IAG's Capital Market Day last year that if Iberia had 16 A330s (eight firm and eight options exercised), its operating profit would be improved by EUR100 million. In comparison, the EUR100 bottom line profit IAG forecasts for better use of bmi's slots would require significantly more than 16 widebody aircraft.
IAG could turn to its partners. Taking over struggling Kingfisher's forthcoming A330s is unlikely although not unprecedented. More likely in this partner scenario is BA rationalising its trans-Atlantic routes in favour of service on American Airlines, with whom it has a metal-neutrality anti-trust agreement. American has signalled it will consolidate routes as part of its bankruptcy protection, and some trans-Atlantic flights are understood to be loss-making. (Already American has freed up two 777s by ending its Chicago-Delhi service.)
While IAG will have a list of destinations it wants to serve, some initial services could be determined by new partnerships. IAG and oneworld member elect Malaysia Airlines (MAS) are keen to work together, which could see BA launch flights to MAS' hub in Kuala Lumpur for onward services to Asian destinations BA will not be able to expand its reach to in the short term. LATAM, the holding company of merged carriers LAN and TAM, will make a decision on whether the combined group will join LAN's oneworld or TAM's Star Alliance.
oneworld is heavily favoured, and Mr Walsh said LATAM choosing oneworld would result in closer ties; it is easy to see more flights between Europe and South America, but Iberia's Madrid hub, and not BA's Heathrow hub, has proved itself to be the more popular hub. There are still growth opportunities ex-Heathrow for South America, although LATAM joining oneworld – and IAG possibly taking over Portugal's TAP – will result in the alliance controlling significant capacity between Europe and South America, lessening the urgency for more flights, unlike Asia where the crowd is building and IAG/oneworld do not have a majority position.
Future partners – strategic or equity – would also influence expansion. For a look at what carriers may be in IAG's future, see related article: British Airways/IAG with bmi looks to re-establish world leadership – and long term survival
Europe-Africa and Europe-Asia traffic are the two largest sources of growth IAG identified at its Capital Markets Day last year, with Latin American growth coming in further down the line. A handful of slots could be initially used to expand long-haul routes while in the medium term as more long-range assets come into the IAG portfolio, it is conceivable for the majority of bmi's slots to be used on long-haul services. The calculation is straight forward: short-haul European flying is generally unprofitable while long-haul flying is not.
While IAG is very strong and often the market leader in sub-Saharan Africa, it is a minority player in North Africa, where the Air France-KLM group has a strong presence, partially due to colonial and cultural ties. "This is an area where we definitely feel that we can and we want to grow our combined position," IAG director of strategy Robert Boyle has remarked. If IAG keeps bmi's African routes, it will significantly boost its presence in Morocco.
AF-KLM, IAG and Lufthansa weekly frequencies to top five North Africa markets: Nov-2011
North Africa can conveniently be served by narrowbody aircraft, which IAG will free up in the short term as overlap flying is eliminated with bmi. Iberia has started a new round of North Africa expansion, with a new service to Nouakchott (as well as Accra). With the region more easily accessible than southern Africa, and with IAG already well represented in southern Africa, further expansion in this region is more likely.
See related article: Iberia increases African presence with services to Accra and Nouakchott
bmi is more spread out in sub-Saharan Africa, with infrequent service to Freetown, Khartoum and Addis Ababa, although all three are new destinations for IAG (assuming it keeps the routes), with Addis Ababa not served by the Air France-KLM or Lufthansa groups. In terms of the five largest sub-Saharan markets, IAG is already a leader. South Africa has seen capacity movement with Iberia ending its Johannesburg service while BA increased its frequency there.
AF-KLM, IAG and Lufthansa weekly frequencies to top five sub-Saharan Africa markets: Nov-2011
Mr Walsh has been particularly keen to talk of growth opportunities in Asia, where IAG has a minority position. All IAG capacity in Asia Pacific is supplied by British Airways – Iberia operates no flights – which skews the capability of the airline groups as most airlines in the Air France-KLM and Lufthansa groups have significant capacity deployed to the region. But at the end of the day, Air France-KLM and Lufthansa still have greater opportunities for profits to trickle down.
AF-KLM, IAG and Lufthansa weekly frequencies to top five Asia-Pacific countries based on GDP: Nov-2011
IAG has reduced its capacity to low-yielding Australia but elsewhere will grow. Bilateral restrictions are generally not expected to be limiting in the near-future; there is capacity in the UK-India bilateral for additional daily flights to India's main cities of Delhi and Mumbai as well as secondary points. The standout is China, where the bilateral is still relatively restrictive, as is China's bilateral with US, measurements largely in place to give Chinese carriers – still growing and enhancing their services – what is deemed by China as a fair advantage.
Up until as recently as 2004, UK carriers were restricted to Beijing and Shanghai. IAG's presence in mainland China is actually considerably weak as it has included in its definition of "China" Hong Kong, where it deploys significant amounts of capacity relative to the Air France-KLM and Lufthansa groupings. Elsewhere, Japan has an open skies arrangement with the UK.
Mr Walsh has on several occasions flagged potential service to Indonesia, Malaysia and South Korea, none of which IAG presently serves. South Korea sees significant capacity into London from Asiana and Korean Air, although the two are able to gather sixth-freedom traffic over their Seoul hubs. BA in contrast would be restricted for feed at Seoul as Asiana is a member of Star Alliance and Korean Air in SkyTeam. While BA has the larger IAG European network, many connections would require backtracking, unlike if connecting through competing Amsterdam, Frankfurt or Paris hubs. IAG's lack of a strong continental base not on the periphery of western Europe (as London and Madrid are) will continue to be a deterrent for expanding services east. This is not to rule out Seoul services, but capacity would be less than from Asiana or Korean Air.
Seoul to London (all airports) (seats per week, one way): 19-Sep-2011 to 30-Sep-2012
In Malaysia, while BA could launch services to Kuala Lumpur with oneworld member-elect Malaysia Airlines providing onward transfers, MAS already offers double daily service to London and is struggling with lower yields. Additional capacity may not be welcomed by MAS unless MAS were to reduce its services in favour of a joint services arrangements with BA. The viability of a BA service without local Malaysian feed is not clear.
Jakarta is the obvious point to serve in Indonesia. Range, however, is an issue. If BA were to operate 777-200s, whose commercial capacity is appropriate for Jakarta, it would likely have to look at making an intermediate stop, such as in Singapore, as Lufthansa does, or Kuala Lumpur, as KLM does. Longer-range aircraft such as the 777-300ER or 747-400 could operate the route non-stop but would probably provide too much capacity in the current environment. Additionally, there is decent demand, especially in premium cabins, between Jakarta and Southeast Asia, and BA should be able to secure fifth freedom traffic rights on at least some of those routes.
Room for growth in Brazil, but TAP acquisition could address that market
IAG has much the strongest position in Latin America of the three major European airline groups. It is the largest carrier in four of the continent's five largest markets, with the exception of Brazil. However, the very likely decision of the merged LAN and TAM airlines to select oneworld as their alliance will considerably strengthen its position, as would an IAG acquisition of TAP, which has an extensive and enviable network in Brazil.
AF-KLM, IAG and Lufthansa weekly frequencies to top five Latin America markets: Nov-2011
IAG's acquisition of bmi is the growth mechanism IAG has been waiting for at London Heathrow, and no other opportunity – short of a contentious third runway or lifting of the night curfew – will present as much growth capability for IAG. The additional 42 slots, even if not the full 56 – whose full acquistion was always unlikely – cannot come soon enough. IAG is lagging its competitors in high-growth Asia where, even during a slowdown, is still growing at rates faster than other global markets.
IAG's strong presence in Latin America will only grow, with the very likely introduction of TAM to oneworld, and possibly TAP too, as IAG considers acquiring the Portugese carrier. The long-haul growth will take longer, eventually allowing IAG to replant itself and its London Heathrow hub as a formidable force.
The price of BA's strategic contraction over recent years has been to place the carrier in a position where it needs to rely more heavily on partner airlines to cover the global map for it – something that a fairly shaky set of oneworld linkages does little to support. Lead partner American Airlines is in Chapter 11 bankruptcy and there is a possibility (admittedly remote) of American moving to SkyTeam; new member airberlin recently widened its ties with Etihad; BA can no longer codeshare with Royal Jordanian in the main city pair market; Qantas serves a market in which BA has rapidly diminishing interest and Cathay Pacific has a steadily growing need to focus on its Chinese ties, including its equity relationship with Star Alliance's Air China; LAN is considering its membership in oneworld as it joins with TAM (although oneworld is favoured); and even Japan Airlines is ambiguous about committing wholly to BA/IAG in its European operations.
Hence AIG CEO Willie Walsh's keenness to indulge in new acquisitions. Now that the bmi transaction is becoming locked in, the next stages could follow soon.
Since the original version of this analysis, IAG has provided further insight into the transition. With regards to bmi mainline, IAG in May-2012 will begin transitioning bmi routes and aircraft to the BA AOC, a process BA expects to complete by the end of 2012. Leveraging BA's marketing and distribution has gained new prominence due to what Mr Walsh said was a declining customer base at bmi as the carrier faced uncertainty. "Seat factor is around 50% ... that is appalling for Heathrow.”
BA expects to use one-third of bmi's slots for long-haul services (flagging increases in long-haul flights require increases in short-haul connectivity; using one-third of bmi's slots for long-haul maintains BA's current proportion, which it believes to be optimal). The first example is Seoul, which BA will serve from Dec-2012.
See related articles:
- British Airways resumes Seoul service with more Asian destinations to come as BA integrates bmi
Depending on final slot usage, equipment and load factors, IAG could see its passenger numbers rise 8% per annum. IAG would still be Europe's third-largest airline, by some distance, after Lufthansa and Air France-KLM.
On 10-May-2012 IAG signed a binding agreement to sell bmi Regional to Sector Aviation Holdings Ltd (SAH) for a total consideration of GBP8 million in cash. The sale includes all bmi Regional's fixed assets and long-term liabilities, including owned and operating lease aircraft.
BA has yet to find a buyer for bmibaby and is planning to wind the carrier up.
See related article: UK carriers rush to snap up bmibaby’s planned route closures
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