Norwegian Air Shuttle’s long-haul business model. “Flag of convenience” or fair competition?


On 31-Dec-2013, Norwegian Air Shuttle implemented changes to its corporate structure, involving the establishment of two fully owned subsidiaries – one in Norway and one in Ireland. Each has its own air operator’s certificate (AOC), although the Irish company, which is the vehicle for Norwegian’s long-haul operation, does not yet have a permanent AOC.

Norwegian’s fledgling long-haul network includes services from Scandinavia to Bangkok and two US destinations: New York and Fort Lauderdale. From summer 2014, it will add Los Angeles, Oakland and Orlando to its US destinations and London Gatwick will become its first trans-Atlantic base outside Scandinavia.

Norwegian’s new structure aims to minimise the costs of its long-haul operations, in particular labour costs. With widebody aircraft registered (and an AOC application) in Ireland, crew based in Thailand and elsewhere, a Norwegian brand and destinations increasingly focused on the US, Norwegian’s long-haul business model is market leading to say the least. US airlines and unions predictably oppose its foreign air carrier permit application, deriding its “flag of convenience” (a misnomer in this case) approach to gaining an "unfair" advantage.

Two principal operating subsidiaries and 'country-specific resource companies'

Under Norwegian new corporate structure, there are two principal operating subsidiaries. The Norwegian operating subsidiary operates from NAS’ existing Scandinavian bases and employs all pilots permanently employed in Scandinavia on the same wages and conditions as previously. Norwegian’s statement says that other staff remain employees of the parent company, Norwegian Air Shuttle ASA.

However, it has also been reported that its Swedish cabin crew are to be transferred to contractor Proffice (Afonbladet/Boarding.no/TheForeigner.no, 19-Dec-2013).

In Oct-2013, when announcing the planned changes to the corporate structure, NAS said “fully owned country-specific resource companies will be established”. Pilots hired outside Scandinavia were to be offered permanent employment in the respective resource companies, starting with those in Finland in 1Q2014, followed by those in Spain and the UK. Currently, these pilots are contract staff rather than permanent employees.

The Irish company awaits a permanent AOC and a US foreign air carrier permit

The purpose of the Irish operating subsidiary is to secure traffic rights to fly out of Europe and so is Norwegian’s long-haul vehicle. This subsidiary, named Norwegian Air International Limited (NAI), has a temporary AOC, with the authorisation of Norway’s aviation authorities, pending the approval of its application to the Irish Aviation Authority for a permanent AOC.

NAI has also applied to the US Department of Transport for a foreign air carrier permit to access traffic rights in accordance with the US-EU Open Skies agreement. While neither application has yet been approved, sources in Norwegian told CAPA that both are proceeding according to its plans. In the meantime, Norwegian is continuing to operate its international operations with existing AOCs and its existing long-haul subsidiary Norwegian Long Haul. Norway is part of the European Economic Area, but not part of the European Union. An Irish AOC for NAI will give it the same traffic rights as other EU-based carriers.

Predictable opposition from US airlines and labour unions

The US foreign air carrier permit application has met with strong opposition from some major US airlines and from US pilot representative bodies, including the Air Line Pilots Association (ALPA) and the Southwest Airlines Pilots Association (SWAPA).

Delta, United, American and US Air submitted a joint reply to NAI’s application on 20-Dec-2013, in which they referred to Article 17 bis of the US-EU agreement. According to the carriers’ joint reply, this recognises that “the opportunities created by the Agreement are not intended to undermine labour standards or the labour-related rights and principles contained in the Parties’ respective laws.”

They argue that not only do NAI’s plans violate the US-EU agreement, but they also fail to meet the DoT’s public interest standard. They say that a key objective of the standard is “strengthening the competitive position of [US] air carriers to at least ensure equality with foreign air carriers”, but that US carriers’ competitive positions would be “unfairly and unlawfully compromised by approval of the NAI scheme”.

In a press release on 17-Dec-2013, ALPA took a similar line to that of the US airlines and said “Norwegian Air International was clearly designed to attempt to dodge laws and regulations, starting a race to the bottom on labour and working conditions”.

ALPA added that the NAI scheme raised the spectre of the “flag of convenience” business practice that “undermined the U.S. maritime industry”. It also called on the Irish government not to grant NAI an AOC. For its part, on 23-Dec-2013, SWAPA criticised Norwegian for attempting to utilise a “venue shopping strategy”, whereby a carrier chooses “which” set of regulations from “what” country it chooses to follow.

Cheaper labour: a key objection for opponents and a key motivation for Norwegian

A key element of the objection expressed both by the US airlines and pilot bodies is that NAI will reportedly employ crews under lower wage employment contracts that are neither European nor US (the ALPA press release suggests that individual employment contracts are governed by Singapore law).

This is also a key element of Norwegian’s motivation for this new structure. Norway is a very high wage economy and also has substantially higher social charges than in most European countries (or the US). Norwegian law prohibits the employment of staff from outside the European Economic Area. Not only will NAI avoid Norwegian labour costs, but it will also avoid Irish labour costs under the proposed scheme as Irish regulations are more flexible.

Norwegian is already using such tactics to minimise labour costs on long-haul operations, employing crew based in Bangkok. This led to complaints by Scandinavian labour unions, almost prompting a pilots' strike in Oct-2013. According to reports in the Scandinavian media, pilot union Parat claimed that Thai cabin crew are paid only NOK3,000 (USD540) per month, below the minimum wage in Norway and other parts of Europe. The reports also say that the airline puts the figure at NOK15,000 (USD2,700) per month after taking account of various allowances. Norwegian says that its Bangkok cabin crew wages are the same as other Asian-based crew.

Norwegian’s head of communications has defended his airline’s attempts to bring new competition to routes between Europe and the US, rejecting the complaints of US carriers. “These airlines have dominated the skies over the Atlantic, and keep ticket prices high,” said Anne-Sissel Skånvik, “they certainly don’t want competition.” (NewsinEnglish.no, 27-Dec-2013).

Norwegian is also recruiting US-based crew, who will be on US contracts.

See related report: The airline base concept: European LCCs love to base aircraft and crew abroad, unlike others

Norwegian's wholly owned Irish aircraft finance company

In Aug-2013, Norwegian announced the establishment of a fully owned asset management company incorporated in Ireland, with USD as its functional currency. The asset management company operates as lessor of Norwegian-operated widebody aircraft, beginning with the Boeing 737-800 delivered in Sep-2013. According to the CAPA Fleet Database, two of Norwegian’s three Dreamliner aircraft are owned by DP Aircraft Ireland Limited and leased to Norwegian.

At the time of the Aug-2013 announcement, Norwegian said: “Ireland is the largest aviation finance cluster in Europe which makes the country a natural location given Norwegian's global expansion and large aircraft orders.” In addition to limiting the group’s currency exposure, the new company allows it to take advantage of favourable tax rates in Ireland.

Every possible tactic to minimise costs on long-haul, but there are challenges

Norwegian appears to be using every possible tactic to minimise costs for its long-haul operations. While having an Irish operating subsidiary may also give it increased flexibility in terms of traffic rights, its principal advantage would seem to be the flexibility it gives to employ staff in other countries, wherever they may be based.

This allows it to avoid Norway’s high labour cost environment. Its decision to establish an asset management company in Ireland allows it greater efficiency in its aircraft-related costs. Nevertheless, even according to Norwegian’s own expectations, long-haul profitability will take some time to achieve. Moreover, a leisure focused point-to-point long-haul network with remotely based employees and aircraft brings marketing and operational challenges.

See related report: Norwegian improves its 1Q2013 results, but widebody profits may be one for the long-haul

Other European LCCs have taken advantage of EU liberalisation of traffic rights and, to some extent, labour laws, to establish pan-European operations. Norwegian is the first to attempt to circumvent the web of regulations that have previously prevented any carrier from establishing truly pan-global operations. Norwegian is still very small on long-haul, but it is clear that US competitors do not feel comfortable at the threat its future growth could bring.

Norwegian needs to secure the pending approvals, but US airline whinging is misplaced

Just as the likes of easyJet and Ryanair have occasionally bumped heads with regulators in Europe, often prompted by competitors and unions, it is to be expected that Norwegian will not always enjoy a totally smooth path on its own expansion trajectory. As long as its applications for a US foreign air carrier permit and Irish AOC remain outstanding, there is a risk that they will not be approved. US carriers have become more vocally protectionist recently, notably voicing objections to the planned expansion of the Gulf carriers into US markets.

What is clear is that Norwegian needs to secure the pending approvals for operations that will allow it lower labour costs than the very high levels that apply in Norway if its long-haul ambitions are to remain economically feasible. Even then, as CAPA has commented previously, the opportunity to find meaningful sources of cost advantage on long-haul is not as great as it was when LCCs started to eat into the short-haul market.

See related report: Norwegian Air Shuttle: Asia's longhaul LCC model comes to the N Atlantic (but watch falling profits)

On the other side of the debate, and especially in the light of this latter point, the whinging of Norwegian’s trans-Atlantic competitors seems misplaced.

They would perhaps be better served by seeking to lower their own costs and to promote their products and networks than by attempting to harness regulators to prevent competition that will surely come from somewhere, some time. As long as there are regions of the world where labour costs are lower than in other regions, it is inevitable that a global industry such as aviation will find ways to arbitrage those differences.

But a US industry that is now reaping the financial benefits of Chapter 11 restructuring and consolidation is reluctant to rock the boat with the powerful pilots' unions - a strategy that may come back to bite them as those same unions become more anxious to share in the new-found profitability of their employers.

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