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Gulf airlines under fire. Aside from the rhetoric and dust flying, what’s the underlying agenda?

10-Apr-2015

There’s no shortage of heat and light in the US vs Gulf airlines battle. But much less clear is why the Gulf airlines’ relatively limited impact should attract so much focus. After all, their impact on the US airlines is marginal; and many airlines which operate to the US, under open skies or not, are subsidised in one form or another – as are many of Delta’s SkyTeam partners. Many of their competitors have argued the US majors are heavily subsidised too.

The fact is subsidy is rampant in aviation, in one form or another, both directly and indirectly, always has been and always will be.

So, leaving aside the name calling, there has been little of substance to explain quite why Delta - apparently supported by an otherwise publicly shy American and United – is so trenchantly opposed to the operations of Emirates, Etihad and Qatar Airways. If in fact the playing field is uneven, the ones who should really be most aggrieved are India’s airlines. It is "their" traffic at the heart of the squabble.

Not all of the US airlines are with the big three of course; FedEx wants no part of it and neither do many others. But the noise is music to the ears of Air France and Lufthansa – whose services are impacted by the Gulf airlines and who have been agitating strongly for restitution of their sixth freedom status quo.

Meanwhile, as five of the world’s largest airlines push to wind back the clock, the consumer’s interests are apparently not on the table.

Consumer interests are entirely neglected in the White Paper

In many ways the White Paper is a throwback to aviation policies of 30 years ago. It contains only one reference to consumers in the entire 50+ page statement, and that is merely a token quote – “… Open Skies has been highly successful in opening new markets for U.S. air carriers and promoting competition and consumer choice.” From there on the orphan of consumer interests is cut adrift. From Page 2 onward, the Paper never looks back. Not another word about consumers.

This fundamental element of US aviation policy - and more general trade policy - is entirely neglected as a feature in the changing new world. For aviation, this is a world of greatly increased consumer expectations around inflight products, customer service and direct flights. The Gulf airlines have seized on this demand – and responded to it.

Necessarily the interests of consumers do not prevail in every case, regardless of circumstances, but it is essential to allocate substantial weight to this category of national interest. Worldwide, consumers (embracing businesses, regional economies etc) have benefitted enormously from the new availability of one-stop service to any significant point in the world.

The attractions of these operations are much more than mere pricing; they are in providing unprecedented accessibility to points otherwise out of easy reach. They exist because of the combination of geography and new long haul aircraft technology. These are all elements of a new world environment that five of the world’s largest airlines would like to see reversed.

The impact of the Gulf carriers on US airline markets, unlike Europe’s, is heavily limited by geography

What makes the present uproar so hard to understand is that the Gulf carriers’ operations are largely unsuitable as substitutes for US airline services. Quite the reverse; there is enormous complementarity. Hence there is a strong argument that they make much better allies than enemies.

This short review considers the implications of the Mar-2015 “White Paper” presented by the big three US airlines and tries to get to the heart of the real motivations behind what is occurring now. The Paper’s focus is firmly on the issue of subsidy, but there is a lot more to airline strategy than that ubiquitous element.

Subsidy and lack of “fairness” have always been present in the airline industry, as has the uneven playing field.

Importantly too, while they are extremely important, there is today much more to international airline operations than supporting the interests of flag carriers.

For European airlines, the threat to the status quo is more obvious; it is mostly about sixth freedom traffic

For the European network airlines the threat posed by the Gulf airlines is quite different from their US peers. Lufthansa and Air France are vociferously opposed, fearing the loss of valuable east-west sixth freedom flows over their hubs.

Lufthansa in particular has been the strongest and most active critic of the Gulf airlines, among other things concerned at losing its previously dominant and highly lucrative position in the Indian transfer market. Lufthansa is also concerned that its near-monopoly position in the German market is challenged by a revitalised airberlin, thanks to Etihad’s minority investment in the smaller carrier. And it is affected by the rebirth of Alitalia, for similar reasons.

Air France however, despite its opposition, has been slightly more pragmatic, establishing a relationship of sorts with Etihad.

But not all European airlines are so concerned. International Airlines Group (IAG), always much more entrepreneurial than its peers, has wholly embraced the new environment, even inviting Qatar Airways into the oneworld Alliance; Qatar has since acquired a friendly minority equity share in IAG.

The irony of (re)disruption: sixth freedom traffic is at the core, for the Europeans at least

Elsewhere in the world, the reality is that, like it or not (and many of them don’t like it), most airlines have accepted that the status quo has again shifted – just as it did three or four decades ago when sixth freedom transfer traffic, close to the heart of the current debate, became legitimate.

Back then, as new airlines began to challenge the bilateral supremacy of the established flag carriers in the 1970s, the concept of sixth freedom operations was introduced. Bilateral agreements had been intended to govern all air services between two specific countries. They sought to prevent leakage of passenger flows over other routings than the direct ones, on their respective national airlines.

So, when KLM started carrying US passengers to Amsterdam then transhipping them to German points, this was branded “unfair” use of the respective bilateral agreements.

But eventually it was the sheer power of then-budding consumer interests that forced the changes. Such obviously artificial, unhelpful and effectively anti-competitive activities were now circumvented in a new era, as black markets arose and market forces partially prevailed.

All of the major established flag carriers, attuned to carrying point to point traffic under their closed bilaterals, had fiercely opposed sixth freedom carriage, supported by their governments. But water, when allowed, will flow, even if government sanctioned interventions slow the flow.

And, with the merest touch of irony, leading opponents of that change were: no other than the heavily subsidised and government owned Lufthansa and Air France, concerned that airlines like KLM and Singapore Airlines were stealing “their” end-to-end traffic.

Yet it was not too long before they themselves too learned the value of hubbing foreign traffic.

Now, in the bizarre currency of aviation, this sixth freedom traffic has gravitated to being “owned” by the same airlines that once opposed its existence. The new status quo is under attack again.

Subsidies are bad, yes – but what’s so special about the Gulf carriers?

The heavily researched “White Paper” recently provided by the three major US airlines to the US government contains enormous detail on alleged subsidies. Whether or not these are accurate is not the purpose of this analysis.

But the White Paper is short on substance when it comes to documenting any serious impact on US airlines caused by the expansion of the Gulf carriers in the US.

Much of the calculation relates to jobs that might theoretically be lost in future; even if accurate, they amount to a small figure stacked up against the likes of Boeing and engine manufacturers’ employment numbers, let alone the tourism and consumer benefits, the gains to smaller airports…..and so on.

Hence the question – what is the real agenda here?

The issues raised go to the heart of US aviation policy post-Chapter 11/airline consolidation. The Paper puts the whole nature of open skies back on the table, with frightening potential for the negativity to ripple outwards, just as the positive movement did in the past.

For example, US airlines are keen to establish open skies with China so they can take advantage of immunised metal neutral JVs – yet the major Chinese airlines continue to be, when needed, heavily subsidised, as well as directed by Beijing. The Department of Transportation has made it clear that open skies is a prerequisite to these JVs, yet if subsidy is ruled inconsistent with open skies, open skies with China would not be possible; and in turn nor would the JVs.

Although the bulk of foreign airlines resisted the US’ disruption of the old restrictive entry and capacity regimes in favour of greater freedom, most have moved on, becoming more competitive and productive in the process. Most airlines have to survive in a multi-jurisdictional world where they aren’t able to generate the bulk of their revenues inside a neatly protected domestic market. So they are changing. It is often a painful process, but is making their models more sustainable in the long run.

To focus on the nebulous issue of “subsidy” is to open a can of worms

The subsidy argument is a nebulous one, particularly when it embraces protected markets; there can be no more obvious subsidy than trade protection - and aviation is rife with it. All of today’s major airlines grew up in a highly protected and regulated environment. Most would not exist today had it not been for that “subsidy”, in one form or another. If subsidy were the basis for cancelling bilateral agreements, all would be at risk.

Then there are US bankruptcy laws. All of the major European airlines for example have in the past complained bitterly that Chapter 11 is, as British Airways’ then-CEO Rod Eddington described it in 2004, “back door state aid”. The currently superior unit cost base of US majors clearly illustrates the benefit that US airlines generated from their recent excursions into Chapter 11.

From being higher cost, the US majors exited bankruptcy much leaner than they went in. Few genuinely deny the value of the bankruptcy process in renewing the validity of formerly overweight legacy airlines; but it is a major advantage that only US airlines (and one or two other jurisdictions like Japan and Canada) can enjoy. Indeed, the reduced cost levels post-bankruptcy account for most of the profits the US majors are now making.

Likewise their ability to merge – impossible still in international markets – has established a new oligopoly in the US domestic arena.

And policies like Fly America, enshrined in legislation – where any US government employees, their dependents, consultants (American or otherwise) and others must use a US airline where possible – has long been a contentious issue, delivering millions of dollars to US international airlines..

Even the inherent value of the closed North Atlantic JVs – closed to all, including other alliance members – gives its participants a distinct market advantage. Otherwise they would not be in it. Whether that is subsidy, or some other form of commercial advantage, is debatable. It is certainly a market advantage, with clear financial advantages.

These are all hoary old arguments and, in the scheme of things, no more or less valid than most other subsidy arguments.

The point is, no-one comes to this subsidy contest with clean hands.

The quest for “fairness” is woven through aviation history – with many different meanings

The White Paper seeks a fair marketplace, a “level playing field”. Such a simple concept as “fair” should seemingly be open to objective analysis. But far from it; fairness is highly subjective; and its definition changes.

In the network of bilateral air services agreements – where “open skies” is a relatively recent development – the original use of “fair” was originally contained in the template wording that required giving all airlines a “fair and equal opportunity to operate”. This was the original “level playing field” that has since proved so elusive to pin down.

What that effectively did was to handicap the more powerful airlines. Obviously, in this reading, it was considered “unfair” for the relatively massive US airlines, made powerful by access to a large home travelling market, to go head to head with a small airline from Ireland or the Netherlands, or Australia, or even the UK. The fear was US airlines would quickly have prevailed all over the world, just as so many other brands have succeeded in unregulated markets.

So, fares were fixed by the government-backed airline cartel IATA, and capacity, frequency and gateway access were all fiercely controlled. And it was “fair”.

Adding consumers to the policy mix has changed the definition of "fair"

The turning point in aviation regulation has been the ascendance of consumer interests. Gradually, as consumers started to gain relevance in government thinking around the world, the US began to persuade its aviation partners – with a combination of carrot and stick - to change the phrase to “fair and equal opportunity to compete”, meaning that the size handicap was gradually removed. Now the US airlines received the opportunity to compete “fairly”, while still holding the key to their domestic market.

This then gave way to a variety of more liberal agreements, promoted mostly by the US, until full open skies – itself with many shades of meaning - became widely acceptable. A couple of hundred bilateral agreements (out of some 3,000), mostly involving the US, are now open skies to a greater or lesser extent. In this evolutionary process, the pre-eminence of national airline interests gradually gave way to a spectrum of other public interest priorities.

Even those bilateral agreements that are not open have moved towards much greater acceptance of new foreign access, including allowing third country codeshare.

In seeking a motive for the White Paper it seems job “losses” are hard to account for (and they are not net national losses anyway)

According to the White Paper, every daily widebody “lost or foregone” by Gulf carrier competition costs “over 800 US jobs”.

This is a difficult equation to address as it presumes US airlines would add services over and above the levels they flew before the advent of the Gulf carriers. And if they do not add service, that it is attributable to the Gulf airlines.

It also appears to assume there is no job creation where new foreign airline services are added, that there is no netting out.

The fact that in most cases US airlines have chosen not to add international service previously suggests there is hardly a rush to embark on riskier new long haul routes in the now profitability-driven US market. On the North Atlantic for example, the approach has been to refine capacity discipline, working closely with European alliance partners in the ATI-protected JVs.

One route – Milan - where direct competition from Emirates appears to have diverted traffic, on a rare fifth freedom basis, this can largely be attributed to addition of a greatly improved product; after all consumers do have some influence. But the central battle is not about fifth freedom traffic.

Beneficiaries include the shared interests of North Atlantic JV partners

It is these European partners – at least Lufthansa and Air France (IAG’s British Airways and Iberia are not complaining) - whose shared interests the White Paper looks to protect.

For Delta in particular there is very little potential for direct overlap with the Gulf airlines. The vast majority of Delta’s international capacity is either in Europe (mostly within the protected metal neutral JVs), within the Americas and to and from Northeast Asia. None of these markets is directly open to any serious threat from Gulf airline services, aside from the European airlines' sixth freedom flows.

Delta Air Lines international weekly capacity (seats) by region (6 Apr-2015-13 Apr-2015)

One region where US airlines have added new services is in the burgeoning North Asian markets - and the Gulf airlines can't hurt them there

On the North Asian routes the Gulf airline threat is minimal. The Gulf carriers are scarcely able to contest them – but is here that future growth potential is the greatest. There is some value in North Asia-US East Coast service via the Gulf, but that much longer routing has only been attractive where only limited services were available on the third and fourth freedom airlines (so that for example the westbound one-stop service on a Gulf airline was preferable to two or three-stop eastbound service on other airlines).

The White Paper also makes a literally circuitous argument that the Gulf airlines are about to steal US airlines’ traffic in Southeast Asia. As direct routes these are tenuous - it is 14,000km (8,800 miles) between Singapore and Los Angeles and the fact that few direct services currently exist suggests limited viability.

They are, as a consequence, wide open to intermediate sixth freedom competition. Moreover, as the White Paper notes: “traffic between the eastern portion of the United States and Southeast Asia is a market where U.S. carriers (and their JV partners) have a competitive advantage over the Gulf carriers owing to less circuitous routings via their west bound Asian stopover points, as compared to stopovers in the Middle East.” Clearly it is only where the consumer proposition is better that passengers would prefer the longer routing.

In short, the cost allocated to supposed diversion of US airline traffic over the Gulf is a less than compelling argument, especially given the substantial offsetting consumer and economic benefits to the US of new foreign airline operations.

By definition all foreign airlines have some network advantages in their US routes

In general the Gulf airlines - like other foreign carriers - are able to deliver added value through a greater variety of offerings behind the main US gateways.

By contrast, US airlines – like most flag carriers - are naturally keen to concentrate their long haul international services over one or two main domestic hubs, where they are then best equipped to connect onto their domestic services. The drawback with this is that passengers from other points have to connect domestically over the hub before continuing on the long haul sector.

This conflict is a common phenomenon in reasonably open markets in today’s changed marketplace. For example, Lufthansa’s biggest challenge is actually not the Gulf airlines; it is Turkish Airlines, a major third and fourth freedom operator in its own right. Where Lufthansa chooses to hub its domestic traffic mainly over two hubs, Frankfurt and Munich (so travellers from any other point in the country either have to add a flight or a train journey to connect), Turkish is able to offer near-worldwide non-stop service direct from 14 points in Germany, from its Istanbul hub.

Notably, Turkish, despite being a leading Star Alliance member, is not permitted to join Star’s exclusive North Atlantic JV party.

It is easy to understand why home hub airlines in any country are not keen to support added competition to airports behind their gateways – but there is clear evidence that it does generate much greater consumer and business connectivity and regional economic stimulation.

It seems likely that solidarity with European partners is a key reason for challenging the Gulf airlines

But the point of this analysis is to try to elicit the real reasons behind the extreme reaction of the elite group of US airlines towards the Gulf carriers. In any serious measure of impact on the American operators, the Gulf airlines are scarcely a major threat.

As the White Paper notes: “It is no coincidence that over this same period, the Gulf carriers’ share of U.S.-Indian Subcontinent bookings more than tripled (from 12.0% to 39.8%), while U.S. carriers and their JV partners lost nearly 800 bookings per day”.

Realistically it seems that it is really these services where the big three anticipate longer term problems from the Gulf airlines. The bulk of these (potential) “losses” are sixth freedom traffic carried on the metal of the big three European airlines, then blended into the closed trans-Atlantic JVs that are operated like a single airline.

The value of anti-trust immunised, metal neutral joint ventures on the North Atlantic should not be understated. They are extremely valuable in allowing European and North American airlines alike the ability to provide a much better range of product. The European Commission and the US DoT have authorised them because of the resulting consumer benefits.

But it is hard to believe that either authority intended these JVs to be made bullet proof from external competition, especially when it comes to protecting sixth freedom traffic – as the White Paper appears to suggest should be the case. This is not the North Atlantic market per se (these routes cannot be affected unless passengers are prepared to make massive detours), but actually for markets from beyond Europe into America.

These sixth freedom traffic flows, even in the archaic regulatory structure, does not create any supposed “entitlement” in the same way as third and fourth freedom flows.

For the big three US airlines in these cases it is not merely a matter of solidarity in supporting their European counterparts; necessarily some of the benefits flow through to the US JV partners - but undoubtedly there is a substantial coalition of interest in opposing any threat to the status quo.

Meanwhile, the “level playing field” is a matter of perspective. It certainly isn’t level for the Indian airlines

If it were not so sad, the most delightful part of the “stolen” traffic syndrome (stolen from the “U.S. carriers and their JV partners”) is that it is largely inspired by the diversion of Indian traffic over the Gulf.

Yet, if there is one airline that has every right to feel aggrieved at the lumpy playing field, it is Air India. While the world’s biggest airlines squabble over what used to be Air India’s birthright (Indian source traffic), the languishing Indian flag carrier is far from being in a position to capitalise on the growing flows to the US, very much out in the cold in this debate.

At least Air India supposedly has the “right” to compete on equal terms with most of the major airlines in Asia and North America. That is hardly an equal contest in itself – but such is the new world.

More importantly though, Air India is locked out of the powerful Atlantic joint ventures that are feeding on its national traffic. Although it is now a Star Alliance airline, it has to sit on the sidelines as the bigger European and North American airlines privately divide up its India traffic between them, funnelling it over their European hubs.

Yet, it gets better: even more ironically, at least some of that traffic over the Gulf diverted away from the “U.S. carriers and their JV partners” is now actually being carried by another Indian airline, Jet Airways under codeshare with Etihad.

To suggest that Jet Airways, an Indian airline can be stealing its “own” traffic from foreign sixth freedom airlines which have grown used to feeding on the Indian market is surely a little north of cynicism. Yet it does point to the obscurity of this whole Alice in Wonderland regulatory argument.

The influence of pilot and other unions is obvious; if this is a Faustian bargain with organised labour, it carries long term risks

Throughout the past two decades of turbulence leading up to this century’s bankruptcies and industry consolidation, US pilot associations and other unions have been highly active to a level not apparent elsewhere in the world. That intervention has been both positive and negative. A high water mark was perhaps the recent union intervention in American Airlines’ bankruptcy proceedings. In today’s more settled environment, it is evident that no current airline CEO, targeting higher profits wants to rock the boat in the near term by challenging this enhanced influence of the unions.

The pilots’ and other union voices are readily apparent among the many statements in the White Paper.

One point forcefully made relates to the advantage gained by the Gulf airlines as a result, among other things, of use of non-unionised labour. It is not entirely clear how this is relevant to arguments about unfair competitive practices. Many other countries’ airlines which operate to the US also rely on non-unionised staffing.

But it does tend to indicate the source of the chorus, reinforcing the view that a strong motivation behind the White Paper derives from union pressures.

To quote: “As the International Transport Workers’ Federation has observed:
Emirates, Qatar Airways and Etihad Airways are among the fastest growing airlines in the world. They employ more than 70,000 pilots, cabin crew and ground staff between them. More than 90 percent of their employees are non- UAE/Qatari nationals – all of whom have to rely on obtaining temporary work visas under a sponsorship programme. Although these foreign workers are vital to the success of the airlines, they do not enjoy the basic labour rights (including freedom of association and the right to collective bargaining) which apply in their home countries and in virtually all the nations whose airlines compete with Emirates, Etihad and Qatar Airways.”

This particular argument – aimed at the wrongs of non-union workforces – even if relevant to the wider argument - does lose its underlying validity when the CASK of US airlines is compared with Asian (mostly non-unionised as well) and Middle East airlines.

If the point is that this is an obscure form of subsidy, it misses the mark. On a distance adjusted basis, the post-Chapter 11 US full service airlines actually have lower costs on average than their foreign counterparts in the Gulf – as shown above.

There are many other airline cost inputs that affect these comparisons; for example, in many cases pilot remuneration (as well as productivity) at the Gulf airlines is higher than for US carriers. Also, the US airlines’ use of much older fleets implies a much lower capital ledger for them.

That these arguments are either irrelevant or misguided – or both – is one thing. More importantly, if their part in the White Paper is an indicator of its overall motivation, history suggests this is a dangerous course to follow. Placating labour in this way has historically worked in the short term; but in the medium term it tends to end in tears.

If indeed much of the big three’s position is generated at the union level, this has the potential to create distortions that are in nobody’s interest, least of all the unions themselves.

Rather than seeking to wind back the clock, US airlines would be better advised to look for future opportunities

The relative absence of genuinely substantial threats to the US airline industry (illustrated by the fact that many US airlines oppose the stance taken by the big three) would suggest that there is much more to be gained by US airlines in partnering with the Gulf airlines than from such staunch opposition. The geographic complementarity makes for almost ideal fits.

Even IAG/British Airways – ostensibly much more challenged by the sixth freedom operations of the Gulf carriers than any US airline can ever be – has seen fit to forge a close relationship with Qatar Airways. So there would have to be at least a reasonable presumption that acceptance of a new aviation order may be a sound strategy.

IAG’s is however a longer term strategy, largely inconsistent with the seemingly shorter horizons that some US airline managements appear to be operating with today. This risks leaving the US airlines behind, notably in international markets, where short term risk aversion might prevent establishing longer term platforms for growth.

Given the already close – and logically commercial – links that American for one has with the Gulf airlines, it will be interesting to see how long it is before rationality prevails.


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