26-May-2013 12:40 PM

Premium air travel: structural demand slide provides revenue headwind, but who is most exposed?

Analysis

Across the world, premium air travel demand has slackened. And it is hurting the world's airlines.

In the early days of aviation, it was all about the glamour. Images from the 1930s and 1940s evoke an era of silver and linen service, with passengers and crew dressed as if they were in one of Europe's grand hotels rather than in a noisy metal tube dodging bad weather and landing to refuel on any flight longer than a few hours. As air travel became more popular and affordable, first class cabins remained the domain of the rich and famous, but the advent of business class gave busy executives a haven from their daily stresses and appealed to the ambitions of the aspiring rich and famous.

Now, in the era of low-cost carriers, aviation is mostly about getting from A to B as cheaply as possible. Airlines such as Southwest, Ryanair and AirAsia have led a popular revolution democratising air travel and making it as accessible and common-place as catching a bus.

So where do first class and business class, collectively known as the premium cabins, fit into this new world?

Summary

Premium air travel demand has suffered a structural hit since the 2009 recession, with premium traffic growth continuing to trend slower than economy traffic.
The reduction in premium traffic has led to a loss of market share, equivalent to a reduction of more than 15% in the number of premium passengers.
The Middle East to Far East and Europe to Middle East routes have experienced the highest growth in premium traffic.
The North Atlantic route, which accounts for the highest share of premium revenues, has seen a decline in premium traffic and revenues since 2010.
Premium traffic within the Far East and North America has recovered strongly, while Europe has seen minimal growth due to difficult economic conditions and competition from low-cost carriers.
The distribution of seats among the four classes varies by airline, with US majors having a higher proportion of first class seats, and Emirates, Singapore Airlines, British Airways, and Cathay Pacific having a high proportion of premium seats.

Premium traffic is highly cyclical, but has also suffered a structural hit since the 2009 recession

The first answer to the question above is that premium travel fits in less and less. Successive demand shocks have hit the industry over several decades - the oil price spikes of the 1970s and early 1980s, the recessions that affected the early 1980s, early 1990s and twice in the 2000s. Each of these have caused travellers (and, in particular their employers, who generally pay for the tickets) to question the need to pay between three and six times an economy fare in order to sit in a premium cabin. While each recession is followed by a recovery, premium traffic has tended to suffer a structural loss in demand afterwards.

Taking as an example the most recent global recession of 2009, sparked by the global financial crisis of 2008, the impact on premium and economy travel was markedly different. Year-on-year growth rates for premium traffic fell as low as -24% in May-2009, while the worst growth rates for economy traffic were around -9%. Moreover, premium traffic started to fall before economy traffic, as corporates anticipating the recession started to cut travel budgets. It also started its recovery later than economy traffic, as travel departments remained cautious or were under pressure to hold onto savings.

Year on year growth in premium, economy and total air passengers: Jan-2007 to Dec-2012

When economy traffic bounced back strongly a year after the worst negative growth rates were recorded, premium traffic did not enjoy the same bounce relative to the magnitude of the fall. Growth rates have broadly stabilised since 2011, but premium traffic growth has continued to trend slower than economy traffic.

From the pre-recession peak in 2008 to the trough in 2009, seasonally adjusted figures from IATA show that economy passenger numbers fell by around 7%, but premium passenger numbers fell by 24%. Economy travel regained its pre-recessionary levels in early 2010, but premium traffic did not recover to these levels until late 2012. Economy is now around 16% above the 2008 peak, but premium is only around 1% higher.

International passengers by seat class: Jan-2007 to Mar-2013

Reduced premium traffic puts a strain on revenues; a 4% drop is a deadly loss

This underperformance by premium cabins has led to a loss of its share of total air traffic. Before the recession, premium represented around 9.5% of total passengers, while now it is around 8%, after recovering partially from a 2009 low point of around 7.5%. This structural reduction in share of around 1.5ppts in market share might not sound like a big number, but it is equivalent to a reduction of more than 15% in the number of premium passengers that would have been flying today if premium had retained its 9.5% share of the total.

Moreover, given that premium fares are typically a multiple of four times economy fares, the loss in revenue is significant - around 4% of total revenues, all other things being equal (see schematic below). This is an important revenue reduction in an industry with such slim margins.

Schematic representation of revenue impact of reduction in premium traffic from 9.5% to 8.0% of total

	Pre-recession	Post-recession	Change
Pax
Premium	9.5	8	-16%
Economy	90.5	92	2%
Total	100	100	0%
Fare
Premium	80	80	0%
Economy	20	20	0%
Total	100	100	0%
Revenue
Premium	760	640	-16%
Economy	1,810	1,840	2%
Total	2,570	2,480	-4%

Data for the week of 20-May-2013 from Innovata show that first class and business class seats account for 6.2% of seats worldwide. This is lower than the 8% of passengers reported by IATA, suggesting either some differences in the methodology to gather the data, or superior load factors in premium cabins (or both of these things).

Premium passengers as a percentage of the total: Jan-2007 to Mar-2013

The Middle East is at the centre of the fastest-growing premium traffic flows

While premium traffic has fared worse than economy traffic in recent years, the story is varied according to region. The highest growing premium growth on major global traffic flows have been Middle East to Far East and Europe to Middle East. This is possibly a worrying sign for European carriers looking to stem the ride of passengers connecting between Europe and the Far East through hubs in the Middle East, although premium traffic on direct flows between Europe and the Far East has outpaced global premium traffic.

The North and Mid Pacific, which was hit hard in the recession, has also seen above average premium traffic growth, driven by strong economic growth in the Far East.

Year on year growth in premium traffic on major global intercontinental flows, (12 month rolling average, %): Dec-2007 to Mar-2013

North Atlantic takes biggest share of premium traffic, but is in decline

Also worrying for European (and US) carriers is the underperformance of premium traffic growth on the North Atlantic, which accounts for the highest share of premium revenues of any route region.

While this slow growth reflects tight capacity growth on the North Atlantic, the route has seen its share of premium traffic and premium revenues fall since 2010.

North Atlantic share of premium traffic and premium revenues: Jun-2006 to Feb-2013

Premium revenues by route region: Oct-2012*

Premium traffic by route region: Oct-2012*

Europe is weakest of major intra-continental premium markets

While only one major intercontinental route region (North and Mid Pacific) saw premium traffic fall more heavily than global premium traffic during the recession, all three major intra-continental regions were heavily hit in 2009. Since then, premium traffic within the Far East has recovered the most strongly and has been joined in healthy growth by premium traffic within North America, both growing faster than the world average.

Within Europe remains the most important region by share of global premium traffic (rather than share of premium revenues), but it has seen only minimal growth over recent months, as a result of the difficult economic conditions. European travellers also generally face short journey times, on which premium fares are hard to justify.

Moreover, full service carriers face considerable LCC competition in Europe, many of whom are now robustly challenging for business passengers.

Year-on-year growth in premium traffic on major global intra-continental flows, (12 month rolling average, %): Dec-2007 to Mar-2013

Distribution of seats among the four classes varies by airline

The definition of premium is first class and business class, so IATA's premium passenger figures do not include passengers in 'premium economy' class. This is a cabin that became popular when long-haul business class cabins started to introduce flat bed seats, increasing the gap between the economy product and the business class product. The premium economy product, pioneered by British Airways, helped to fill this gap and even used the same, or similar, seats that had previously been used in business class.

One of the results of the improved flat bed business class product that is now almost universal among the world's major long-haul carriers was to reduce demand for first class long haul. The product quality gap between business class and first class was reduced by flat beds, making it harder for some passengers to justify the gap in fares.

Comparing the distribution of seats across the four classes for selected major full service carriers in the principal aviation regions (based on Innovata data for the week of 20-May-2013) reveals some notable differences. Overall, most of the major global carriers have a higher proportion of premium cabin seats than the worldwide average. Of course, this is because the worldwide totals include single cabin low-cost carriers, but also reflects the importance of premium traffic to the business model of major full service carriers.

This importance stems both from the branding benefits of premium cabins and also from their economic contribution to the airlines. Long-haul services rely on a cross-subsidy from premium passengers to economy passengers for their financial viability. This is one of the reasons why long-haul low-cost airlines have struggled to establish themselves in the same way as on short-haul.

Even Michael O'Leary, CEO of ultra low-cost Ryanair, when talking about the possibility of setting up a long-haul operation has acknowledged the need to attract high yield premium passengers. His plan for a trans-Atlantic operation involves economy fares priced at EUR10 one-way and a very high quality business class charging EUR4,000 to EUR5,000.

Selected major full service carriers schedules by class of seat (% of seats): 20-May-2013 to 26-May-2013

The US majors continue to have a higher proportion of first class designated seats than other major airlines elsewhere in the world and more than they have in business class. Unlike airlines in other regions, they have a higher proportion of first class seats on their domestic networks than on their international networks, where business class is more favoured.

To a large extent, the US attachment to first class is more about perception and nomenclature than product. The first class cabins on most US domestic routes are not very different from business class cabins within Europe, for example.

Emirates, SIA, BA and Cathay Pacific have a high proportion of premium seats

The four carriers that stand out as having high proportion of premium seats are Emirates (15.8%), Singapore Airlines (14.5%), British Airways (14.3%) and Cathay Pacific (14.2%). When premium economy is included, BA has 18% of its seats available for higher yield passengers, twice the level of its major European competitors.

Given the extreme sensitivity of premium traffic to the economic cycle, this high focus on premium traffic should make these four carriers, and BA in particular, the most exposed to a downturn and the most geared to a recovery.

However, the relative weakness of the North Atlantic and the within Europe premium markets should be a cause for concern for BA and the other European FSC majors. Moreover, the loss of share of premium traffic relative to economy traffic provides a revenue headwind for all long-haul FSCs that has had to be countered with cost reduction and other restructuring measures.

Selected major full service carriers percentage of seats in premium cabins and premium economy (% of seats): 20-May-2013 to 26-May-2013