Gulf Aviation: Rebalancing partnerships in networks

Airline Leader

Airshows are often judged based on how many aircraft orders are produced. By that metric, the Dubai Airshow in Nov-2017 will continue the lull seen since the record 2013 show that notably featured orders for A380s and Boeing 777Xs.

  • The Dubai Airshow in November 2017 is expected to see a lull in aircraft orders compared to the record-breaking 2013 show.
  • Emirates is likely to place an order for medium-sized widebody aircraft, such as the Boeing 787 or Airbus A350, signaling a shift in strategy and a need for greater sustainability.
  • The airline's order for medium-sized widebodies will allow it to reach markets that are currently not viable for its larger aircraft, and potentially increase frequency on existing routes.
  • Emirates' partnership with flydubai will also contribute to its strategic objectives, allowing for network coordination and increased sales through codeshare agreements.
  • Etihad Airways is reviewing its equity investments and partnerships, following a change in management and a weakening economy in Abu Dhabi.
  • Qatar Airways is facing challenges due to the ongoing blockade by neighboring countries, which has resulted in restricted airspace access and lost access to regional markets. The airline needs to find new partners in the US market after the termination of its codeshare agreement with American Airlines.

More important was the lasting impression in 2013 of Gulf aviation's global expansion being unstoppable.
At the 2017 Airshow, Emirates could place an order for 787s or A350s, medium sized widebodies that lack the public attention of the A380 that Emirates has come to symbolise. An order for a seemingly modest aircraft marks an adaptation to a new environment and may raise more questions about Gulf aviation's confidence.
Yet such an order would be another indicator of Gulf aviation recalibrating, preparing for the next phase of growth and ultimately seeking greater sustainability.
There are two developing maxims: bigger is not always better, and partnership expansion can be more fruitful than organic growth. These run contrary to previous strategies and take a different form at the region's three most visible airlines, the Gulf superconnectors: Emirates, Etihad and Qatar Airways. Through aircraft and partnership adaptations, many airlines are rebalancing their networks.
Two significant developments from Emirates will have long lasting implications. These are its forthcoming medium sized widebody aircraft order and its partnership with flydubai.
Emirates found success with a network strategy comprising serving markets at least daily with a 777-300ER or A380. After smaller and older aircraft types were phased out, Emirates' 777-300ER with over 350 seats effectively became its smallest aircraft type. (Its handful of 777-200LRs are often earmarked for specific missions, operationally and strategically.)
However Emirates appears to have saturated opportunities and markets with its existing production platform; new scales of growth are needed.
Emirates by the end of 2017 - and most likely during the Dubai Airshow - is due to place an order for medium sized widebodies. Emirates in 2014 cancelled its 2007 order for 70 A350s, 50 of them the smaller -900. The A350 and 787 are officially the aircraft in the running, but the favourite has come to be the 787.
Surely a contributing factor to Emirates' decision is the future of the A380. Airbus has declined to build a re-engined A380 - dubbed the A380neo - that would take the A380 family into the late 2020s and 2030s. Emirates needs a next-generation A380 to replace its existing A380s.
Yet with the A380 programme already being limited in popularity (and thus profitability) and no major prospective A380neo customers besides Emirates, Airbus is unwilling to take the risk to build a new aircraft essentially for one operator. Even with Emirates' fleet needs, an Emirates A380neo order appears not enough to see the A380neo programme be sustainable.
Emirates president Sir Tim Clark has even extolled the superjumbo's benefits in a bid to drum up more customers for Airbus.
With Airbus unwilling to deliver an A380 replacement, Emirates is perhaps not inclined to giving additional business to Airbus in the form of the A350. Even though the A380 and A350 are two very different types, Emirates has entwined the issue in an apparent all-or-nothing deal.
Once Emirates receives its medium sized widebody, it can extend its network to reach markets currently not big enough for its "small" 777-300ER. Other markets could be right sized or see capacity broadly maintained but frequency increased.
Based on Apr-2017 data, Emirates and Qatar overlap on 109 destinations. Qatar serves 49 destinations that Emirates does not. Of Qatar's unique 49 destinations, two are served by large widebody aircraft; two a mixture. But 11 are flown exclusively by medium sized widebodies; and then 34 points are flown exclusively by narrowbody aircraft.
There is an aeropolitical benefit from the widebody order. Key markets like India for Emirates have an air services agreement based on seats, not frequency. Having more aircraft types and smaller aircraft in the fleet allows Emirates more schedule combinations to try to utilise as many of the provisioned seats as possible.

Emirates, Etihad and Qatar annual capacity (ASKs*)

Emirates' widebody order has similar strategic objectives to its partnership with flydubai. The inability to compete effectively with the narrowbody aircraft at Etihad and Qatar that allow them to reach thinner markets, can be rectified by an ability to right-size existing services and boost regional frequencies (where there is strong O&D demand).
Hence, after resisting the urge since flydubai appeared on the scene, Emirates and flydubai in Jul-2017 announced a wide ranging partnership that will have them coordinating networks and increasing sales on each other's network via codeshare.
Emirates earlier in 2017 had mooted having their own narrowbody operation, but this would conflict with flydubai's existing presence.
This raises the question of why they would stop at this level of cooperation when there could be a full merger. Although there is significant opportunity to increase Emirates-flydubai joint sales, the existing partnership traffic is low. Even once sales are ramped up, flydubai will still be anchored on traffic that is wholly within its network and often point-to-point Dubai. A full merger into Emirates' operating and financial model risks losing the majority of traffic.
The Emirates and flydubai partnership does not merely add up to the sum of the parts. Although their opportunities are being combined, the two airlines themselves are not consolidating to one. The guiding principle then is that "1 + 1 equals 11", representing the combined benefit but still two separate airlines.
Nor is the Emirates-flydubai tie up the classic dual brand strategy of the LCC being under the full service unit. Emirates and flydubai have the same Dubai government shareholder but one airline is not subservient to the other. The classic dual brand dynamics prevail: the larger full service airline is possessive and wants to dictate to the smaller LCC. The LCC meanwhile sees itself as a more agile model for the full service airline.
Debates between Emirates and flydubai will be inevitable, just as they have been at dual brand combinations. These debates can be healthy to find what Dubai has famously achieved: what exactly is the best outcome at the end of the day for the hub and for the economy.
A later decision for Emirates will be how to manage a post A380 future. With no future aircraft nearly as big as the A380, replacing the A380 means either using a smaller aircraft and thus reducing capacity or increasing frequency.
The question is most profound for Emirates since its network is built on A380s feeding A380 transfer traffic. For most other airlines, A380s are a token contribution to the fleet and used for high O&D routes with connecting traffic fed by a variety of aircraft. At Emirates, take out the A380 and the production model needs significant adjustment.
To use London Heathrow as an example, Emirates' six daily services are mostly flown by the three class 517 seat A380. Boeing's sample configuration for the 777-9X suggests a three class configuration of 349 seats. This is less than Emirates' 354-364 seats on its 777-300ER, which is about two metres shorter than the 777-9X will be. A notable difference is that Boeing's configuration suggests for the 777-9X direct aisle access seats in business, which Emirates offers on the A380 but not the 777-300ER.
Boeing also proposes a two class configuration seating 414. Assuming a theoretical Emirates 777-9X configuration of 390 seats, replacing Heathrow's six daily A380s with six 777-9Xs will see a capacity reduction of 25%, or 762 seats.
If Emirates wants to preserve the existing capacity generated by six daily London A380s, it would need to two more 777-9X flights for a total of eight. Those additional two sevices would need to be matched by growth across the network. Peak scheduling banks will need to accommodate more aircraft to maintain passenger volume.
Airports like Heathrow, Sydney and New York raise the practical matter of whether slots can be obtained and at the right times to facilitate hub transfers. Additional flights will not be an option for markets (such as Australia today) where traffic rights are based on frequencies, although presumably there will be some liberalisation.
The nature of equity partnerships in the Middle East are shifting, from Etihad Airways to Qatar Airways. Qatar's pursuits are its oneworld members: IAG, LATAM (and, unsuccessfully, American Airlines). In comparison, Etihad sought airlines with typically depressed pricing in strategically relevant markets. (Qatar's IAG and failed American investments would have been in very relevant markets.)

Emirates, Etihad and Qatar destinations served: 2006-2017, Emirates and flydubai forecast to 2022*

The change now for Etihad is that the depressed pricing represented an airline that could not turn around, with airberlin and Alitalia the starkest examples. Strategic benefits were questionable: Etihad routinely cited partnership traffic as evidence of success, but it was never clear if the partnership traffic was profitable. Etihad itself was break even operationally with no disclosure of net position when considering losses from investments.
Etihad has undergone a management change with the exit of James Hogan, who was CEO nearly from the start. Mr Hogan crafted Etihad's equity strategy but he was also dealt a difficult hand from Etihad's Abu Dhabi government shareholder. Strategic investments in airberlin and Virgin Australia became complicated by Abu Dhabi's sovereign agenda that involved Air Seychelles and Air Serbia being taken under Etihad's management (Abu Dhabi is close to the Seychelles and Serbia).
The recent sudden changes at Etihad were also the result of Abu Dhabi's economy weakening from the direct and indirect impact from lower oil prices. At the same time, a new minister questioned Etihad's equity approach.
Interim management has signalled investments were under review. In Jul-2017, Etihad sold its stake in Switzerland's Etihad Regional (formerly Darwin Airline) to German private equity fund 4K Invest, which bought Slovenia's Adria Airways in Jan-2016.
Etihad Regional was perhaps the easiest investment to review and dispose of, but even then it took significant time. Nearby are bigger troubles: loss-making airberlin and insolvent Alitalia.
Etihad and Lufthansa reached a deal to transfer some airberlin aircraft to the Lufthansa Group. Although seemingly odd bedfellows, it is in Lufthansa's interest to see a weakened airberlin survive rather than exit the market, which would pave the way for expansion from Ryanair and easyJet, which would pose a larger threat.

Emirates and flydubai fleet comparison*

Etihad and Lufthansa are also growing closer on their own operations. This is mostly in ground based businesses, but for flying activities Lufthansa codeshares on Etihad's Frankfurt-Abu Dhabi service while Etihad codeshares on limited Lufthansa services beyond Abu Dhabi-Frankfurt. Critically, Lufthansa is not cooperating on Etihad services beyond Abu Dhabi and thus has not embraced Etihad's fundamental business model.
Etihad's USD1.9 billion loss for 2016 mostly comprised one-off events, notably fleet depreciation, suggesting Abu Dhabi wants to clean Etihad's slate for the next management. The one-off events and staggering size of the loss obscured further weak performance in the Etihad-branded operation. The loss did not include a share of losses from investments.
The financial future of the equity investments is yet to be determined but operationally the synergies are ending; most of Etihad's investment and codeshare partners have ended flights to Etihad's Abu Dhabi hub.
Qatar Airways is confronted by short and medium term challenges. Qatar's regional neighbours - Saudi Arabia, Bahrain, UAE and Egypt - implemented a blockade prohibiting flights to/from Qatar and banning Qatar Airways from using their airspace to transit to another country. This created two layers of setback: the ability to access key regional markets and the longer flying times resulting from not being able to use the blocked airspace.

Domestic codeshares on American Airlines with selected partners*

In early Aug-2017, some airspace alleviation (but not full restoration) was in progress through the work of ICAO. Except for Saudi Arabia, the countries that closed their airspace are signatories to the ("Two Freedoms") International Air Services Transit Agreement signed at the 1944 Chicago Conference, which permits unrestricted overflight access. The blockading countries contended that closing airspace to Qatar was on national security grounds, beyond the Transit Agreement's commercial realm.
Improved airspace access will reduce flying diversions, saving time and helping to restore Qatar Airways' schedule. Most disrupted were flights to other Middle East countries as well as East Africa, which resulted in significant diversions around closed airspace.
The lasting impact is Qatar's lost access to regional markets (airlines from those countries are also prohibited from flying to Doha). When the ban started, the impact on Qatar Airways was approximately 56 daily services (significantly more than the lost flights to Doha from the other affected airlines, combined). These services are short haul and often under an hour in duration, so the direct ASK impact was 3%.

Domestic Emirates/Etihad/Qatar codeshares on US airlines*

The true network impact is higher since passengers were connecting to other flights, and often with very long flights. For point-to-point traffic, regional fares can be high. The blockade started in the low season for the Gulf, when regional services are cut back, but has continued through to what is normally a strong part of the year, thereby further increasing the impact. With the situation heavily political, there is limited room for Qatar to try to alleviate pain.

For the medium term, Qatar needs to find new partners in the US, a significant market for it. Qatar's main codeshare partner American Airlines ended codeshares with Qatar and Etihad after Qatar sought to invest in American Airlines (an intent it has since dropped). The codeshares terminate in Mar-2018 although interlines continue.
Qatar has a partnership with jetBlue, although it is much smaller than Qatar had with American (or what Emirates has with jetBlue). Qatar likely needs to grow its JetBlue partnership while seeking further partners - and possibly investing in them. Until Etihad and Qatar form replacement partnerships, Emirates and jetBlue will have the largest partnership.
The loss of American Airlines' partnership is a setback for Etihad and Qatar, although perhaps in the long run one of them would have forced out the other. It is an unwelcome development to add to an already busy time.
As Gulf airlines take on greater prominence, maintaining the network is not guaranteed. Growing is not as easy or low key as it used to be. The sheer push for growth is now giving way to more tailored market solutions.