Europe to North America in 2025: A gradual evolution

LCCs like Norwegian, WestJet, WOW air, Air Canada rouge and Lufthansa's Eurowings, will continue to grow the market and their own market share. (Norwegian's rate of growth may depend on whether or not it is given final approval for its Irish subsidiary's US foreign carrier permit.)

As long haul low cost operation evolves into a more connective model, others can be expected to adapt to the North Atlantic conditions. Meanwhile US LCCs, most likely JetBlue, may start trans-Atlantic services with narrowbody aircraft as new suitable equipment arrives. The US majors are unlikely to set up LCC subsidiaries in this market. Turkish Airlines may eventually join the Atlantic++ JV within the Star Alliance as it grows rapidly to North America. If the UK's existing traffic rights cannot be recreated post-Brexit, British Airways and Virgin Atlantic could be forced out of their respective JVs. This currently seems highly unlikely, but is a possibility while the future UK-EU relationship remains unknown.

After decades of unprofitable operation in the world's most valuable premium market, consolidation in the domestic US market has provided
a platform for establishing three intense JV partnerships based around the major global alliances. An important part of predicting the shape of this market in 10 years time depends on whether this system will continue. It also will depend on the way route networks develop.

For the time being, the market is defined largely by the traditional hub-to-hub system; this in turn is a feature of a combination of aircraft efficiencies and the dominance of flag carriers. Each of these features is undergoing change; new city pairs are developing and smaller, twin jet operations are allowing point-to-point operations - along with new airlines - to reshape the market. This will greatly influence the competitive dynamics over the next decade, assuming the continuation of a relatively liberal access environment. There have however been signs over the past two years that some forces will seek to limit new competition and, if unchecked, could significantly hinder that future development.

In terms of its current leading participants and their share of ASKs, the North Atlantic market has different nuances depending on how it is divided up. The top 10 airlines - effectively operating as three - by number of ASKs between Europe and North America for the summer 2016 season, control 73.7% of ASKs.

The list is headed by the US Big Three of Delta, United and American. The leading European airlines in this market are British Airways and Lufthansa, but Air France ranks behind Air Canada. Virgin Atlantic, Turkish Airlines and KLM complete the top 10. In total, there are 54 airlines operating on the North Atlantic in summer 2016, according to OAG.

If the list is rearranged according to airline groups, the top 10 control 82.7% of ASKs. European groups IAG and Lufthansa Group leapfrog the US Big Three to claim the number one and number two positions. Air France-KLM takes the sixth rank, behind the US three and ahead of Virgin Atlantic and Turkish. The number 10 slot is taken by Canadian leisure airline Air Transat.

But to get a full picture of the competitive situation, it is necessary to account for the immunised JVs on the North Atlantic. This is the market where the revenue sharing JV concept on a market scale was pioneered. Participants in these arrangements are legally permitted to coordinate prices and schedules, a practice that would otherwise be prohibited as collusion. As such, and although they still operate their own aircraft and under their own brands, each JV is, in effect, a single economic unit acting to all intents and purposes as a single competitor.

The three leading JVs on the North Atlantic are based on the leading trans-Atlantic operators within each of the three global alliances. The Star Alliance's 'Atlantic++' JV (United, Air Canada, Lufthansa, SWISS, Austrian, Brussels Airlines) is the largest competitor, followed by the JV within SkyTeam (Delta, Air France, KLM, Alitalia) and that inside oneworld (America, BA, Iberia and Finnair).

These three JVs each have more than 20% of the market and they control 71.7% of North Atlantic ASKs between them in summer 2016.



The next largest operator, Virgin Atlantic, has 4.8% of ASKs and operates in a separate JV with Delta. All told, the four JVs control 76.6% of the market. IAG's Aer Lingus is expected to join the JV within oneworld by 2017 and this would take the total JV share to 78.3%.

Treating the three main JVs as three single competitors, the top 10 operators control 89.3% of ASKs on the North Atlantic in summer 2016, considerably more than the 73.7% figure attributable to the top 10 individual airlines.

After the three main JVs, Virgin, Turkish and Air Transat, the top 10 is completed by Norwegian, Aer Lingus, SAS and airberlin.

Once Aer Lingus moves into the oneworld JV, Icelandair will be promoted to the list of top 10 competitors, which will then control 90.6% of the market in aggregate (based on the summer 2016 figures from OAG).

The share of North Atlantic capacity covered by the three immunised JVs peaked in summer 2014 at 80.0% of ASKs. As noted, the JVs' share in summer 2106 is 76.6%, or 78.3% if

^United/Air Canada/Lufthansa/SWISS/Austrian/Brussels Airlines
*Treats immunised JVs as a single entity
**Virgin Atlantic's North Atlantic capacity operates in a JV with Delta (separate from Delta's JV with AF-KLM and Alitalia)

Aer Lingus is included in the oneworld JV. This may be down from the peak, but is much higher than the 23% share that was in immunised JVs 10 years ago.

The summer of 2014 was the last time that the share of North Atlantic capacity inside a JV increased in the summer schedule compared with the previous year. In that summer, US Airway's capacity joined the JV within oneworld, as a result of its acquisition by American Airlines, and Virgin Atlantic's capacity entered its JV with Delta.

*Note that capacity share shown for the three global alliances relates only to ASKs in the JVs that operate within the alliances and not to all alliance capacity on the North Atlantic; Aer Lingus has not yet joined the oneworld JV, but is expected to do so by 2017

This market dominance is likely to be the highwater mark under this type of regulatory oversight. The drop in the JVs' combined share of North Atlantic ASKs between summer 2014 and summer 2016 has been accompanied by an increase in the share operated by leisure groups and LCCs. These new participants might loosely be termed disruptors and give some comfort to those who worry about the anti-competitive effect of the JVs.

Airlines owned by leisure groups (primarily Thomas Cook Group and TUI Group) have grown their share of ASKs from 1% in summer 2014 to 2% in summer 2016, while the share operated by LCCs has increased from 1% to 3%. Note that these LCC figures do not include airlines that are designated as LCCs, but which are also owned by a leisure group (and so already included in the share operated by the leisure groups).

The combined 5% of North Atlantic ASKs operated by leisure groups and LCCs in summer 2016 is higher than it has been for any summer season over the past decade. Norwegian, WestJet, WOW air and Lufthansa's Eurowings are leading the LCC growth.

There has been an increase in Turkish Airlines' share of ASKs between Europe and North America, from just under 3% in summer 2014 to almost 4% in summer 2016. Turkish Airlines had considerably less than 1% of ASKs on the North Atlantic in summer 2006.

The share of ASKs between Europe and North America operated by airlines from Russia and the Commonwealth of Independent States has also increased, from 2% in summer 2011 to 4% in summer 2016. The share of North Atlantic ASKs flown by fifth freedom operators has remained steady at 2% since summer 2011, but has fallen from 3% in summer 2006.

The share of airlines that are not in a JV, are not LCCs or part of leisure groups, Russian/CIS airlines, fifth freedom operators or Turkish Airlines has dropped from 16% in summer 2011 to less than 8% in summer 2016.

By comparison with the airlines operating on the North Atlantic, the airports that have services between Europe and North America form a more fragmented market. The top 10 airports account for 50.9% of ASKs

*Capacity share for the JVs within the alliances plus Virgin Atlantic from summer 2014; Aer Lingus capacity included from summer 2016 (although it is not expected to join the oneworld JV until 2017)

and the top 20 for 71.2% (week of 21-Sep-2016, source: OAG).

Of the major hubs London Heathrow is the largest airport by ASKs on the North Atlantic; it is followed in the top five by New York JFK, Paris CDG, Frankfurt and Toronto. The top 10 are completed by Amsterdam, New York Newark, Chicago, Los Angeles and Washington Dulles.

The number of routes is increasing. Based on OAG data for the week of 12-Sep-2016, there are 411 passenger routes between Europe and North America in summer 2016. This compares with 349 routes in the equivalent



week of 2014, an increase of 18% over two years. Compared with one year ago, there are 45 new routes in summer 2016.

Of these new routes, 22 are operated by airlines with what might loosely be termed 'alternative business models'. This includes LCCs, airlines owned by leisure groups and other new entrants. Legacy airlines are operating on 25 of the new routes (there are two new routes that have an airline from both categories).

The fact that LCCs and leisure groups are responsible for almost half of the new routes, but have an ASK share of only 5% between them in summer 2016, highlights the increasing importance of the alternative business models in driving growth on the North Atlantic. Their combined 5% share compares with 3% in summer 2015.

There are only two new entrant airlines on North Atlantic routes in summer 2016, namely Eurowings and Air Serbia. In summer 2015, WOW air was a new entrant. There has been market exit this summer by the bankrupt Transaero.

The 45 new routes involve 26 European airports and 27 North American airports. Only 15 of these involve an airport ranking in the top 10 by ASKs between Europe and North America, although a further 25 involve an airport ranked between 11 and 20.

There are five airports that are new to trans-Atlantic services, two in North America and three in Europe. This is not a large number, but represents almost 4% of the 132 airports that have flights between Europe and North America, a noticeable percentage.

The new North American airports are San Jose Mineta (Lufthansa to Frankfurt and British Airways to London Heathrow) and Winnipeg (WestJet to London Gatwick). The European airports that are new to North Atlantic services in summer 2016 are Belgrade (Air Serbia to New York), Cologne Bonn (Eurowings to Boston and Miami) and London Stansted (Thomson Airways to Orlando Sanford and Thomas Cook to Orlando - the latter not strictly new this summer, but only previously operated in the month of Jul-2015).

The UK referendum vote in favour of leaving the European Union at least raises questions about the JVs involving UK airlines. A condition of antitrust immunity from the US authorities is that the overseas partner airlines in a JV are from countries that have signed an open skies agreement with the US.

The Netherlands and Germany had opens skies agreements with the US before the EU started to negotiate EU-wide agreements, but the EU-US open skies agreement of 2008 paved the way for the JVs to embrace multiple European members, including UK airlines. The UK's future relationship with the EU remains uncertain, but it will probably need to negotiate to remain part of the EU-US open skies agreement in order to preserve the integrity of the JV within oneworld (which includes British Airways) and the JV between Virgin Atlantic and Delta.

There is a precedent for non-EU countries to be parties to the EU-US agreement, since Norway and Iceland are signatories, and it may be assumed that the UK could negotiate to enjoy a similar status to them. However, this may be conditional upon the UK's acceptance of EU principles over the freedom of movement of people, goods, services and capital.

It is currently far from certain that UK politicians will want to commit the UK to continued freedom of movement of people, since immigration control was a key theme of the referendum campaign. It may be two years or more before the UK establishes its post Brexit traffic rights environment, both within Europe and on long haul routes.

Alternatively, the UK could seek to negotiate a new UK-US open skies-style bilateral, but this would not in itself give UK airlines the freedom to fly from, say, Paris to New York. It may also, for example, call into question Norwegian's rights to fly from the UK to destinations in the US in competition with UK airlines.

A likely casualty of the Brexit decision, at least until the new UK-EU relationship is clarified, is the application by Norwegian's British subsidiary, Norwegian Air UK, for a US foreign carrier permit. Indeed, on 30-Jun-2016, the DoT dismissed NAUK's request for an exemption, while continueing to review the permit application. Norwegian's Irish subsidiary, Norwegian Air International, has been given provisional approval for a US permit, but this has not been made final and the Brexit uncertainty (although not directly relevant) could be used as an excuse for the US Transportation Secretary to sit on his hands for longer.

If the UK wanted to re-create synthetically the traffic rights environment of the EU-US agreement, after coming to a new UK-US bilateral, the UK would also need to negotiate with the EU and US to allow non-UK airlines to fly UK-US routes and to allow UK airlines to fly EU-US routes (BA's Paris-based OpenSkies subsidiary could be threatened without such a negotiation).

British Airways and its parent IAG are currently firm advocates of competition and market liberalisation, but future scenarios could arise whereby UK airlines may lobby for a more restrictive stance on UK-US competition from non-UK airlines. Under such scenarios, the UK could feasibly look to retreat from a liberal trans-Atlantic traffic rights regime that continues to mimic the existing EU-US open skies agreement.

Again, although it may now seem that the most likely scenario is that the UK will re-negotiate the same US traffic rights for UK (and EU) airlines that apply currently, there is at least some degree of uncertainty over the situation. The implications for the North Atlantic immunised JVs involving UK airlines are unclear.

IAG will be keen to ensure that the future traffic rights regime will still allow BA to collect US-bound traffic from EU countries via its UK airports and allow Aer Lingus to carry UK passengers to the US via its Irish bases. The UK is the largest European O&D market on the North Atlantic, but connecting traffic is important. At least IAG has options through its ownership of three trans-Atlantic airlines, one of which is UK based and the other two of which are EU based.

The implications for the growth of trans-Atlantic low cost operators such as Norwegian are also unclear. Norwegian has a long haul base at London Gatwick in order to tap into the lucrative UK-US market. Norwegian's future operations from the UK to North America could be threatened by a changed regulatory backdrop.

In addition to the uncertainties now surrounding UK-US operations, the fragmentation of the existing EU-US open skies regime would provide more opportunities for anti-competitive forces to enlist the bilateral regime to raise protectionist barriers in the future. For example, it is even possible that the more protectionist France and Germany could seek to exclude the UK from the EU-US agreement as a competitive barrier to the BA JV.

US airlines have achieved historically high profit margins through a process of consolidation and by focusing on the domestic market. In ASK terms, domestic routes are 55% of capacity for United, 61% for Delta and 67% for American (based on reported traffic data for the first five months of 2016).

The US market is now very mature, offering little growth and nobody has a strong incentive to disrupt pricing by pursuing aggressive domestic expansion. Against this backdrop, Delta CEO Ed Bastian said at the IATA AGM in Jun-2016 that his airline's international operations would grow to represent 50% of its activity. Assuming a 10 year growth horizon, Delta would need to grow its international ASKs at an annual rate around 5ppts faster than its domestic capacity in order to achieve a 50/50 balance. So far in 2016 (Jan to May), its international ASMs have fallen by 1.3%, so implementation has not yet begun. Clearly this sort of growth will not be achieved on the North Atlantic.

Nevertheless, it seems inevitable that the US Big Three will increase the proportion of their activities that come from international routes over the longer term. They will undoubtedly need to make greater use of partnerships as part of their strategies to achieve this.

The North Atlantic seems unlikely to be their preferred market for high growth rates. Airbus forecasts an average RPK growth rate between the US and Western Europe of only 2.8% p/a for 2014-2034, compared with 4.7% p/a for all international long haul traffic. Boeing forecasts 3.0% p/a RPK growth for North America-Europe, compared with 4.9% p/a for all traffic over the same time frame.

Capacity growth on the North Atlantic has stepped up to 12% in summer 2016, compared with 6% in summer 2015, according to data from OAG. Even after allowing for the greater length of this summer's schedule versus last year, this is a significant increase and makes the North Atlantic the second fastest growing region from Europe after the Middle East.

Seat growth on the North Atlantic has generally been accelerating since 2013, but the 10 year average annual growth rate of 3% p/a in this region is the lowest from Europe. This low growth reflects the relatively tight capacity control resulting from the dominance of immunised JVs in this market. However, the accelerating capacity trend also reflects increasing competition from newer and smaller participants and, in some cases, a switch of long haul capacity from other regions.

For all the big players on the North Atlantic - the members of the immunised JVs - the incentive would seem to be to preserve the existing market structure that allows them a dominant position. There are higher growth markets elsewhere and they do not want to upset the stability of pricing.

In the first five months of 2016, Delta cut ASKs by 1.1%, United cut by 1.0% and American grew ASKs by only 1.0% on the North Atlantic. Delta has specifically stated its Atlantic capacity will fall by 3%-4% for the winter season versus the summer.

Among the leading Europeans, the Lufthansa Group's hub airlines' ASKs to the Americas grew by 7.5% in the first five months of 2016. This is not split between North and South America, but is mainly focused on the North Atlantic and partly offset by JV partner United's cuts. In spite of Lufthansa Group's strong ASK growth, its 1Q2016 yield performance on North American routes was better than average across its network.

IAG's North Atlantic ASKs were up by 2.6% (with Aer Lingus included in the base figures) and Air France-KLM's by 4.2% in the first five months of 2016. Air France is currently shrinking its long haul network, while KLM is growing, as part of its attempt to force its pilots to agree to new productivity improvements.

New Air France-KLM CEO Jean Marc Janaillac averted a planned strike by Air France pilots in Jun-2016 by suspending productivity measures that had been implemented, asking for four months to provide a fuller response. At this stage, the new CEO's stance on long haul growth is not known.

Turkish Airlines is growing faster in North America than in any other region and increased its ASKs there by 34.1% in the first five months of 2016. Turkish does not compete in the vital Western Europe-North America O&D market, but it does provide competition to that part of the major European airlines' trans-Atlantic capacity that relies on feed from/to points in the Middle East and Asia Pacific. In this respect, it is similar to the three Gulf based super connectors Emirates, Qatar Airways and Etihad, all of whom are targeting North America for growth, albeit from a fairly small base.

Turkish is the most significant North Atlantic operator not to be included in a JV, although it is a member of the Star Alliance. Moreover, tension between Turkish and Lufthansa led to the end of codeshares between the two in 2013.

Nevertheless, Star Alliance outgoing CEO Mark Schwab said that a case could be made that Turkish Airlines could add value if it joined the Atlantic++ JV. "On a theoretical basis, it would make sense," he said at CAPA's Airlines in Transition 2016 event. " He added that it would "add bulk", providing a bigger network to offer corporate customers, but he did not expect it to happen any time soon. If Lufthansa and Turkish can resolve their differences, the case for embracing the Istanbul-based airline in Atlantic++ could become stronger by 2025.

Technology is also changing the way the industry works, regardless of competition rules. Although collusion is only legal within the JVs, the revenue management systems of many of the leading operators adopt similar algorithms and prices tend to look alike regardless of the JV or alliance. This is not to say that pricing is uniformly high. Far from it, competition between the alliances is strong and all offer a proportion of their inventory at discounted prices at any given time. However, much of the pricing in the market looks similar.

Of course, LCCs such as Norwegian, WestJet and (in the indirect market) Wow air are disrupting the market structure up to a point, offering some very low fares, although they still have only a small share of the market. Although the LCCs are growing rapidly, the North Atlantic market leaders have not generally been tempted to follow suit in terms of capacity expansion.

For the big players, premium cabins and routes with primary airports at both ends are still a core focus and the LCCs are largely shut out of these market segments. The majors only really feel the growth of LCC and leisure airlines at the bottom end of the market, where their response is to engage in discounted pricing for a relatively small portion of their inventory.

The initial impact of LCC entry into aviation markets is often that it grows the total market and there is some evidence of this on the North Atlantic. All this suggests that the LCC share will continue to grow, generating incremental traffic in the market, but that the JVs will continue to pursue more measured growth plans.

Nevertheless, most of the leading JV airlines on the North Atlantic (with the notable exception of IAG) have been involved in campaigns to limit new entrants in recent times.

Led by Delta, United and American and supported by Air France-KLM and Lufthansa in addition to a number of labour organisations, there has been highly visible opposition to Norwegian's Irish-registered subsidiary Norwegian Air International and to the three Gulf super connectors. The incumbents know that, while new entry may initially help to grow the overall market, eventually a more efficient competitor can take business away. Fearing this, and knowing that their own operations are not yet efficient enough, they have attempted to enlist regulators to limit competition.

The Lufthansa Group is attempting to have the best of both worlds by launching new routes to the US and Caribbean operated by its LCC brand Eurowings from Cologne/Bonn. Air Canada has also has an LCC brand, rouge, which operates trans-Atlantic routes from Toronto, Vancouver and Montreal to European airports including London Gatwick, Edinburgh, Glasgow, Manchester, Dublin, Nice, Lisbon, Prague, Barcelona, Venice, Warsaw and Athens deploying Boeing 767-300 equipment.

IAG is unlikely to establish a long haul low cost operation, particularly on the Atlantic, where it values BA's premium positioning and sees Aer Lingus as already providing a value proposition. Air France-KLM management acknowledges that long haul low cost is not something to disregard, but it is sceptical about the sustainability of year-round profits of this activity.

US airlines have not had much success with LCC brands in the past and do not currently look likely to attempt one on the Atlantic. However, if a US LCC were to launch trans-Atlantic services, the US majors may be tempted into a response.

Among the US LCC/hybrid operators, jetBlue is probably the most likely to enter long haul markets to Europe. It would likely focus on routes between the US east coast and Western Europe, initially sticking to longer range narrowbody aircraft. It is due to receive A321neo aircraft from 2018 and is known to have been considering the long range variant. JetBlue also has existing partnerships with European airlines that could facilitate feed (it has codeshares with Aer Lingus, Icelandair, TAP and Turkish Airlines).

Among the larger European LCCs that are not currently involved in long haul activity, Ryanair has most frequently been linked with a possible trans-Atlantic operation. For many years, the Irish airline's CEO has often suggested that he has a plan to establish a separate long haul entity (ie not Ryanair itself), but this has never been implemented.

One of the key ingredients of Ryanair's success has been its ability to secure large orders of narrowbody aircraft at very competitive prices. The lack of opportunity to acquire widebodies at attractive prices any time soon has been an important cause of Mr O'Leary's reluctance to enter long haul markets.

In addition, Ryanair has historically probably also lacked the primary airport network and corporate customers that would be needed to feed a trans-Atlantic operation. This is slowly changing as Ryanair's product and service moves in the direction of being more upmarket. Nevertheless, Mr O'Leary's focus seems likely to remain on growing Ryanair in the European short/medium haul markets. Anything is possible by 2025, but he will only pursue his long haul plans if the right aircraft deal arises.

The North Atlantic is the largest and most mature of the major intercontinental traffic regions. It is also the most concentrated, if the immunised JVs are considered as single competitive entities. At both ends of this market are the two regions that have made the greatest contribution towards the global liberalisation of aviation markets.

However, in different ways, both are now showing troubling signs that liberalisation could go into reverse. It is to be hoped that this is a pessimistic view. There is a chance that, in spite of the necessary entry of new and disruptive business models into the North Atlantic, this market may not undergo a significant change in market structure by 2025. Alternatively, there can be a path where the combination of profitability and competition can coexist.

The prospect of new, efficient aircraft able to serve smaller city pairs, along with steady economic growth generating new traffic flows is a more likely scenario. This process will be accelerated where liberal market conditions apply, allowing new entry and new routes to materialise. To some extent this will inevitably undermine the relative significance of the existing hubs - especially where they have no ability to expand their capacity - and the incumbent airlines. Understandably, the affected airlines and airports will seek to resist this evolution.