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Plotting a course for Canada’s airline future, as Air Canada falters

22-May-2009

FRIDAY REFLECTIONS, WITH RON KUHLMANN & THE CENTRE. While all airlines have been in flux for decades, Canadian airlines in particular continue to look for a formula that can profitably serve a vast and unevenly populated home market while simultaneously supplying adequate links to the rest of the world. Air Canada and WestJet are on course to once again revive that seemingly insoluble conundrum.

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A curious, turbulent, but familiar history

In 1978, at the inception of US deregulation, there were seven Canadian airlines providing service with jet aircraft. International service was provided by Air Canada and Canadian Pacific with others offering regional domestic flights. At that time one of them, Wardair was still a charter carrier but would subsequently move into scheduled service. Like much of the rest of the world, the next 30 years would see Canadian aviation in a state of almost constant flux, with the players changing and numbers dwindling as some airlines were absorbed and others just faded away.

Nearing the end of the first decade of the 21st century, the dance card is small, with only Air Canada and WestJet in the primary markets. They are supplemented by much-smaller Porter in specific Eastern cities, and seasonal Air Transat operations.

Now, with Air Canada threatened by bankruptcy, WestJet may/should be looking to capitalise on that weakness.

Canadian aviation is not integrated with the US

Air Canada’s situation is not unfamiliar and can be found, with minor variations, in every geography. Immediately to the south, the US legacy carriers are all in some stage of financial disarray and their options are increasingly limited. But the US is a huge market, both domestically and internationally, with its carriers in most cases still dominating the supply of seats. Chart 1 amply demonstrates this route dominance by the US carriers on services to Tokyo.

Each of those services terminates in a major US hub with countless possibilities for onward connections. Furthermore, almost every one of those flights carries minimally one codeshare designator for either the Japanese partner carrier and/or other US alliance partners. There are a lot of seats and possible routings.

A passenger in St. Louis, for example, could choose on-line or alliance connections over multiple gateways that would provide choice and minimal connecting times. And that network availability is not limited to just US points. Passengers headed to/from cities in Canada, Central and South America will also find numerous alternatives for their journey.

Should (another) one of the US carriers fail or merge, choices might be briefly constrained but the ability to reach major cities or connect to other points would be quickly restored.

Chart 1: US airline dominance on Tokyo routes: Tokyo/Mainland US weekly nonstop frequencies

  DL (NW) AA UA CO NH JL Other
ATL 11            
CHI   7 7   7 7  
DFW   14          
DTT 11            
HOU       7      
LAX 7 7 7   7 7 14
MSP 7            
NYC 7 7   7 7 10  
PDX 7            
SFO 7   14   7 7  
SEA 7   7        
WAS 7   7   7    
Total 64 35 42 14 35 31 14

In Canada - not so much. There are two gateway cities and JAL, as the non-Canadian carrier, operates only one-third of the 21 total weekly services. Chart 2 stands in stark contrast to the buffet presented in Chart 1. Doubtless many passengers do connect via US gateways at present, but the post 9/11 security and visa requirements make that alternative far less appealing for non-US citizens.

Chart 2: Tokyo/Canada weekly nonstop frequencies

  AC JL
YYZ 7  
YVR 7 7
  14 7

So Houston (or Toronto), do we have a problem?

Studies consistently confirm the economic benefits of air service. In the case of international service, the gains can usually be measured in millions of currency units of direct and indirect revenue as well as secondary economic gains. But the markets are also flexible and able to quickly adjust. As noted, there are numerous alternatives to get from A to B and the disappearance of Pan Am, Eastern or TWA did not result in a dearth of alternatives across those now extinct networks. Similarly, the gaps created by the failures of Swissair and Sabena in Europe and Ansett in Australia have been easily filled by new or existing players.

According to Air Canada’s own figures, as released in September 2008 at CIBCs Institutional Investor Conference in Montreal, well over 50% of Air Canada’s ASMs are generated for international services. In market share, domestically the airline has 57%, 39% of the international sector and a 37% transborder slice.

Air Canada’s need to reduce capacity to stem the bleeding has major ramifications for the Canadian international market.

Time for the worry beads?

Consequently, if I were a Canadian businessperson, I would worry about the possibility that Air Canada might be significantly diminished. Based on the example in Chart 2, the disappearance of Air Canada, or a drastic cutback in its services, would have immediate ramifications not only for the gateway cities, but also for the rest of the nation that depends on “seamless” service. And even though we know the seams are always visible and often frayed, the links are nonetheless operational.

In the case of Japan, a worst-case scenario with the termination of Air Canada services would result in service to only one gateway city, Vancouver, with those seats provided by an airline – JAL - having no links or alliance partners for domestic on-carriage. While folks in Calgary might do just fine, residents of Whitehorse or Saskatoon could see higher costs as well as longer and perhaps more complex journeys. There is a possibility that either of the Japanese airlines would fill the vacuum, but, like most network airlines, both are more preoccupied with contraction at present.

Could WestJet fill the international gap?

WestJet has recently announced agreements with Southwest and Air France, making some routings more organic. But those developments aside, the same Investor Conference report showed that both American and United currently have a larger transborder share than WestJet, and Air France represents only a 4% share of the Canadian international service. This hardly constitutes a replacement for the current Canadian airline international network.

Furthermore, WestJet’s business model is aligned with that of Southwest: single aircraft type, generally point-to-point and intended to be free of alliance-type linkages, despite these tentative forays into that sphere. As a result, the Canadian domestic market will continue to be well-served by the competition and service alternatives that WestJet brings. The same, unfortunately, cannot be said of foreign routes beyond its links to the US.

While we have seen AirAsia X emerge as a long-haul extension of the regional service, there is nothing in the WestJet business plan that indicates a willingness to add some A330s to serve London and Hong Kong. Could happen, but…

WestJet maintains its efficient model

All but one of WestJet’s transborder routes serve warm-weather destinations in California, Florida, Arizona and Nevada. Flights further afield also target beach resorts in Mexico and the Caribbean and many services in both regions are seasonal. This is a great business model to maximize loads and profitability but is of little use to the business traveler trying to access major financial and manufacturing centers.

None of this is in any way intended to denigrate the profitability or service reputation that WestJet has generated. Quite the contrary, the airline has done an excellent job in providing a quality product that gets high marks and rave reviews. However, the business model has not expanded in ways that indicate it is either willing or able to fill the void that would result from a further decline of Air Canada.

(That is not to suggest that WestJet would necessarily remain glued to its format if the opportunity were large enough. In Australia, LCC Virgin Blue has evolved into the space vacated by Ansett, adapting away from its pure low cost model in the process. And GOL in Brazil picked up the failing Varig to pick up some of its international context. But neither of these moves has yet demonstrated that the higher risk levels involved have been justified.)

Wider impact of losing Air Canada

It is likely that any failure or significant reduction of Air Canada’s operation will entail bigger impacts than have been seen in other markets.

In Europe, distances are small and networks are dense so that the disappearance of Sabena, for example, did not carry the same consequences with regard to access to Japan. Numerous opportunities, some even with a rail connection, remained viable. Service to replace Sabena’s flights to New York has yet to be reinstated by its successor, SN Brussels, indicating that the route has been adequately (perhaps profitably?) covered by other foreign operators.

The same outcome will likely not prevail for a country with the size and diversity of Canada, where long distances and sparse populations make for few options other than air travel. The decline of an integrated international and domestic network will require alternative solutions and new ideas that are specifically tailored to the needs of the Canadian market. And, despite the proximity to the larger US market, there are many practical reasons why using US hubs would be an inferior option.

Canadian aviation appears to be caught in a Catch 22 situation, where any destabilization creates new problems. There can be little doubt that the young, growing and motivated staff at WestJet is pleasing more travelers than the shell-shocked and weary survivors at Air Canada. As a result, WestJet’s movement into expanded competition with Air Canada puts them at an advantage. With a cost base more than 30% lower than its legacy rival, it is able to charge less and provide more.

WestJet has made a renewed commitment to service improvements and has shunned additional ancillary charges, allowing it to take the moral high ground. Meanwhile, Air Canada has joined many of its legacy cousins in creating an ever-lengthening list of charges and fees for things previously included in the fare. All of this is clearly par for the course in a competitive environment. However, the outcome has far greater effects in this case.

For example:

  • Air Canada has three distinct segments in its operation (domestic, transborder and international) and they are interdependent for revenue generation. Losing passengers on some popular routes makes it more difficult to maintain broader service and generate vital operating revenue;
  • WestJet does not appear to have an interest in a significant portion, the international part, of its competitor’s business and thus far it has entered only a very specific subset of transborder cities. The airline in its present form is not a viable replacement for Air Canada in the way that American or United filled the Pan Am and TWA voids;
  • For instance, absent Air Canada, what Canadian carrier will fly between Toronto and Philadelphia, where smaller aircraft provide the frequencies necessary in a business market? The WestJet B737s are too large for the necessary frequencies and introducing additional aircraft types is contrary to the current business plan;
  • How will the global reach and network supplied by Star Alliance be replaced to provide the connectivity currently available? While it is true that bilateral agreements such as that recently made with Air France could be replicated, is this degree of integration and negotiation consistent with WestJet’s business model?
  • Numerous past failures indicate that Air Canada, operating solely as an international carrier, would not be viable. Integrated domestic feed is vital to a viable network model.

 

A very Canadian dilemma

All the aviation activity and evolution of the past 30 years has yet to resolve this very Canadian conundrum of big area, small population and global presence. The regulated and divided Air Canada/Canadian “competition” was continually problematic and ultimately unsustainable. More recently, Air Canada sought profitability in sub-fleets and alternative branding but that, too, was unsuccessful. The current competitive match between unequals has provided some new benefits to consumers but has not resolved the structural difficulties of the market.

Many criticize Air Canada’s inability to reform and right itself and that may be – probably is – a valid point. The larger question is, however, where Canada goes from here and, more importantly, how whatever solution is embraced continues to provide the aviation infrastructure necessary for economic success in the global marketplace.

It is an economic reality that the Chinese entrepreneur choosing between St. Louis and Saskatoon will be influenced by the ease and cost of travel, a factor that both concerns and transcends airlines and makes a functioning, integrated air service network vital to Canada’s economic health.

Anyone with a nifty solution probably has a great job opportunity in Ottawa. And there will certainly be major opportunities for creative new models. Canada will need them.

If you would like to comment on this topic, please email The Centre. (Please say if you do not want us to post your views on this site).


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