11-May-2013 8:00 AM

Why Emirates and friends will soon reshape American aviation

Analysis

Shortly after Emirates Airline announced its remarkable breakthrough partnership with Qantas in Sep-2012, Emirates CEO Tim Clark said he had also been talking to American Airlines for some time and publicly expressed hopes that the two would also establish a close relationship. This was despite the fact that American already had an extensive codeshare relationship with Etihad; and the third Gulf carrier, Qatar Airways, has since been invited to join the oneworld alliance - which American leads.

The Gulf airlines, and particularly Emirates, have had a devastating impact on European long-haul hub carriers. The impact will be different for US airlines, but despite the different geography, it will be much bigger than most expect. For one thing they will cut across the developed boundaries of the global alliances.

Summary

Emirates Airline's rapid expansion and large fleet make it the world's largest international long-haul operator.
Emirates' growth is driven by its extensive network and ability to disperse over a wide range of global points.
The Gulf carriers, including Emirates, are capturing a significant share of global premium traffic.
Emirates is seeking to enhance its partnerships and expand its own services to further grow its network.
The partnership dynamics between Emirates and American Airlines are pivotal in the worldwide alliance regime.
Infrastructure limitations, particularly in Dubai, pose challenges for Emirates' expansion plans.

Emirates is the world's largest international long-haul operator by a wide margin; even on a seat basis, only three European airlines (Ryanair, easyJet and Lufthansa) head it, thanks to their high density short-haul operations.

World top 20 international airlines ranked by ASKs: 6-May-2013 to 12-May-2013

Emirates' all-widebody 200-strong fleet already contains, among others, 32 A380s and some 120 Boeing 777s. Moreover, it continues to grow at a remarkable rate.

Emirates fleet: as of 8-May-2013

Emirates' phenomenal expansion continues

Another 191 widebody aircraft (currently including 58 A380s, 70 A350s and 63 777s) are on order.

The delivery schedule provides for an average of at least two of these aircraft entering service every month for the next five years.

Emirates projected delivery schedule for aircraft on order with manufacturers: 2013 to 2024

Inevitably, with this global coverage, Emirates has numerous airline partnership opportunities, aside from the Qantas joint venture. This is no minor operation either. (Despite Australia's small population there is a high propensity for international travel and the country's relatively strong economy means that several sixth freedom airlines each fly around 100 widebody weekly services into Australia; Emirates operates around 11,000 seats daily into that market.)

Emirates international capacity (seats) by region: 6-May-2013 to 12-May-2013

Necessarily, the bulk of Emirates' traffic is networked over its Dubai hub (although a growing amount is now end-to-end; Dubai receives more inbound tourists than India). Emirates' geographic position and increasing ability to disperse over a wide range of global points (currently to 119 cities non-stop) encourages massive flows between the Indian subcontinent ("South Asia") and Europe, for example.

Given the relative geographical differences the dynamics of the US market are different, but they are no less potentially compelling.

The US-Emirates proposition differs from the European hub geography

As can be seen from the graph above the US is still underdone when it comes to Gulf carrier penetration. This is both because it is early days and because the hub proposition is different for the US.

Although Emirates is undoubtedly well placed to service Indian travellers between the US and the sub-continent, the hub value for the US market deteriorates the further east the origin point is.

So, few would think of flying between Shanghai and San Francisco via Dubai; but Shanghai-New York over the Gulf becomes potentially competitive, as a search on Expedia will show. And, the further south the East Asian point, the more competitive it becomes - for example, a daily Ho Chi Minh City service by Emirates over the Gulf, one-stop to New York offers a direct challenge to any other product (as a combination of elapsed time, inflight quality, frequency, network coverage, price etc).

Then, for Bangkok, where Emirates has a five-times daily operation, or Singapore, with thee daily non-stops from Dubai, connecting with three-times daily New York flights, the "product", especially for business/premium travellers, emerges as a winner for travellers to the Big Apple. This is one reason the Gulf airlines, with their extremely high quality inflight product, are capturing the lion's share of global premium traffic, just as many airlines are cutting back on front-end capacity.

For the still small, but fast growing and high yielding African market, the Gulf carriers are becoming a more and more attractive proposition from US points. Their extensive networks in the region and their explosive entry into partnerships with many of the key African carriers are positioning the Gulf airlines to compete aggressively with European hubs, where the rare direct services are not available.

Yet it takes time to build network strength. For the time being the US (and Canada) does not have adequate capacity, frequency and network to have the pulling power the hub carrier enjoys in Europe.

Thus, strategically, Emirates must achieve two goals:

First, enhance its partnership/reciprocal codeshare linkages. This will allow it to feed its network via third party airlines, both providing Emirates with more traffic and its partner with greater access to a global network; then
Secondly, having constructed its foundation, expand its own services.

As European, Australian and African based airlines have learned, the first part of this equation becomes almost unavoidable, on the basis of "if you can't beat them join them". Air France for example had been so sternly opposed to the expansion of the Gulf carriers that, when the carrier last year agreed to codeshare with Etihad, IAG CEO Willie Walsh described the about-face as being the equivalent to Air France "talking to the devil." Mr Walsh had meanwhile persuaded Qatar Airways to join oneworld and Emirates was dealing with Qantas.

Consequently, working with Emirates offers a highly attractive alternative, even though it may appear to limit the longer term options of the foreign airline. And, if it does so limit the airline, well, the reality is that the Gulf carriers have changed the world - there is no looking back.

The new partnerships will cut across the previous evolution of the multilateral alliances

This development is occurring just as the major airlines (and their host airports) have begun to settle into a regime where there are three global teams, each with their various allegiances and internal connectivity. The upshot will be upheaval for airlines and, in many cases, airports alike.

As the post Sep-2012 world unfolds, enormous changes are occurring beneath the surface. Things may look the same, but they are not.

For one thing, Emirates had, prior to its Qantas deal, eschewed the concept of partnerships, beyond a number of codeshares and some FFP cooperation. It saw itself as being large enough to achieve its goals without resort to other airlines - and certainly was not going to constrain its freedom of movement by allying with Star, SkyTeam or oneworld.

In this respect oneworld co-founder American Airlines is in the tantalising position that it will now become a bellwether of the future pattern for alliances.

As American emerges from its relatively brief hibernation in Chapter 11, now under new ownership, it finds itself at the centre of a love triangle in what could be pivotal moves in the worldwide alliance regime.

American has an important and extensive codeshare agreement with Etihad; meanwhile its British Airways partnership and oneworld membership point it in the direction of oneworld member-elect Qatar Airways. Yet, as part of Emirates' new approach to US expansion, Mr Clark, last year publicly expressed hopes that a deep partnership could be established between his airline and American.

The intriguing prospect that American/US Airways now faces is the opportunity to partner with all three of the Gulf carriers. In a previous world, this would have been unthinkable, with such a formidable assortment of potential conflicts. Today perhaps the real issue is how to manage those conflicts, not how to avoid them. If conflict management becomes the corporate thinking, there will indeed be a revolution afoot.

At that stage others become impelled to respond; as has happened in Europe in 2012, one such move can quickly trigger a chain reaction.

The fast spreading role of pragmatic partnerships is changing the world, as Emirates announces a Milan-New York service

Yet another dimension was added to Emirates' operations when on 08-Apr-2013 it announced the launch of the airline's first trans-Atlantic (Europe-US) operation since it dropped Hamburg-New York in 2008. Emirates from 1-Oct-2013 will operate 777-300ER service between Milan and New York JFK as an extension of one of Emirates' existing three times daily Dubai to Milan flights, making for a total of three times a day service by Emirates into New York (the other two being non-stop from Dubai).

Mr Clark said at the announcement, "Operating a trans-Atlantic route has been on our agenda for some time. Having carefully monitored traffic flows we have identified strong demand for both a direct connection and, importantly, for the Emirates product. The route is currently underserved, particularly with a strong premium product offering this is where we see a clear opening for Emirates. We intend to capitalise on this opportunity, stimulating further demand and encouraging additional traffic flow in both directions."

The partnership dynamics are made even more intriguing as Emirates will also leverage its relationships with JetBlue (also an American partner) in the US and, in Europe, its frequent flyer partnership with easyJet to help feed each end of the operation.

The often-restrictive ENAC (Italy's Civil Aviation Authority) has authorised the Milan-New York operation "on an extra-bilateral basis". The fifth freedom route approval was somewhat unusual, as the Milan-JFK route is also served on a daily basis by home-grown Alitalia (which is frequently protected by the Italian administration) as well as by Delta, United and American itself. The decision was specifically made on the basis that it would deliver "significant economic benefits for the Italian economy, exporters, tourism and airports".

This is a seemingly obvious driver for governments, but in international aviation it represents an important shift in emphasis away from supporting the national flag carrier, regardless of the negative impact the policy had on other stakeholders.

In the present context it is a fundamental change which allows Emirates and the other Gulf carriers to gain the access they need to expand their networks. And it is the other key piece of the jigsaw that opens the door to Emirates and the others negotiating on such powerful terms with the established flag carriers.

In the case of the Emirates-Qantas JV (and others like it formed by Etihad) the key to liberal access is utilising so-called third country codeshare rights (where a third country's airline "metal" is used in exercising bilateral rights between two other countries); the Italian example goes a step further up the liberalisation path, using fifth freedom rights.

And, if Italy, not renowned for its liberal approach to air services rights, is prepared to allow third country airlines to support a local economy, how long will it be until other regional communities in European countries argue for similarly enlightened access?

Protectionist barriers are eroding quickly, but there are still some holdouts

Despite the enormous shifts in global attitudes to market access, there are however still a few major logjams for Emirates' expansion.

Not all countries are so enlightened. These simultaneously present short term barriers to entry, while holding out the promise of mid-term future opportunities as liberalisation inevitably erodes government support for nationalist protectionism. Austria is a case in point, where Lufthansa-owned Austrian Airlines is able to use obscure bilateral wording to prevent either Emirates operating its A380 into Vienna or allowing partner Qantas to offer seats on a third country codeshare basis - despite Australia having bilateral access rights.

As noted above, Air France and its government also maintained a typically protectionist/mercantilistic approach against admitting the Gulf carriers. But once Etihad secured a toe in the door with its announcement of a codeshare agreement with Air France, the opening is likely to be followed by fellow SkyTeam member Kenya Airways also joining forces with the Abu Dhabi carrier. This does not directly help Emirates, but it indicates clearly that the last defences are crumbling.

In Europe Emirates makes the point forcefully that protecting the relatively lower economic value of the national airline is illogical where Emirates is the largest single buyer of Airbus aircraft and notably of the iconic A380. In Apr-2013, Mr Clark noted that his airline contributes EUR200 million annually into the French economy as a result.

Canada too occupies a position at the protectionist end of the spectrum, although, as with Air France, an Apr-2013 announcement that Air Canada signed an MoU with Etihad with a view to future codesharing again accentuates the pressures on national administrations (and the partnership potential for airlines) to open doors to the highly attractive consumer opportunities offered by the Gulf carriers.

Lufthansa, although it once came close to breaking ranks and dealing with Etihad, is now instead electing to work with fellow Star member and neo-Gulf carrier, Turkish Airlines, itself embarked on a rapid growth trajectory. Lufthansa and Germany consequently are the standouts in the European market as far as liberalised access is concerned.

Even with a supportive government, airport and airways infrastructure is still a problem where airline growth is so rapid

But even the Gulf carriers are hostage to infrastructure limits. The rapid growth trajectory of Emirates (and other airlines operating into Dubai airport) has placed enormous strains on Dubai Airport to expand to accommodate future growth while maintaining day-to-day operational integrity. Added to the expansion of Dubai Airport, a second, massive airport, is in construction nearby, but there is more to the challenge than simply laying concrete.

Inevitably Emirates' remarkable expansion has done wonders for the airport's growth. For the full year to 31-Dec-2012, Dubai handled just under 57.7 million passengers, making it the fourth largest airport by international traffic, after London Heathrow, Paris Charles de Gaulle and Hong Kong. Unlike its main competitors though, Dubai is still experiencing high growth levels.

Passenger numbers exceeded five million for the fourth consecutive month in Mar-2013, handling a record 5.8 million passengers in Mar-2013. Passenger traffic grew a phenomenal 20.6% year-on-year, the highest growth since Aug-2012. Cargo volume increased 14.7% to 213,248 tonnes and aircraft movements increased 8.3% to 31,713 (reflecting both higher load factors and larger gauge aircraft when measured against the much bigger increase in passenger numbers). For the first three months of 2013, passenger traffic increased 15.6% to 14.3 million.

According to CAPA's airport rankings, applying weekly seat capacity from Innovata, Dubai Airport's international seat offering was at the end of Apr-2013 only 20,000 less than London Heathrow, so Dubai is poised to soon become the biggest international airport in the world.

Dubai Airport's world ranking based on weekly seats, ASKs and frequencies: as of 6-May-2013

Dubai International Airport annual passenger traffic and growth rates: 1996 to 2012

Traffic has doubled at Dubai in less than seven years while seat capacity has almost tripled since 2004. The airport is projecting traffic of over 65 million passengers for 2013, an addition of nearly eight million passengers over last year. Traffic at the airport has already outstripped the airport's own 2010 projections and is now close to a year ahead of estimates.

Dubai International Airport passenger traffic growth projection: 2010 to 2020

The UAE's open skies policy and the simple fact of increased transfer activity has increasingly attracted foreign airlines to serve Dubai, progressively reducing the total market share that Emirates holds. As partnerships and connectivity opportunities expand, so the share will diminish further.

Dubai capacity share (% of seats) by carrier: 6-May-2013 to 12-May-2013

Meanwhile, on CAPA's rankings, Qatar Airways' base of Doha Airport is 20th largest globally in international seats offered and Etihad's home airport Abu Dhabi stands at 35th. With each expanding at similar rates, the pressure on the region's ANS systems is immense.

There is no shortage of funding, or of the political will, to expand the respective airports, but it is the air traffic control systems that are proving the real Achilles heel of the system. Here multinational politics, as always, creeps in. The multiplicity of ANS jurisdictions, along with a substantially reduced airspace thanks to military restrictions, is beginning to inhibit growth, causing sometimes substantial delays.

For hub operations this can become a very costly impediment, where on-time arrival and departures are not possible. The problems will be solved, but they are proving complex and time consuming.

Shifting the global axis, as access is made easier

Emirates will overcome these obstacles, seemingly expanding remorselessly. As the partnership changes filter through the US system and Emirates and friends increase their presence, unthinkable things begin to occur on long-haul connectivity.

The carrier's initial A380 "flagship" deployment strategy was based around key destinations such as New York, London and Sydney, which feature exceptional traffic volumes and a high proportion of premium travellers. Key aviation 'megacities' - to borrow Airbus' term for destinations with more than 10,000 long-haul passengers per day - formed the backbone of the carrier's A380 network.

At present there are 39 of these aviation megacities according to Airbus' estimates. By 2031, Airbus estimates that this number of aviation megacities will increase to 92, and 95% of long-haul traffic will operate on routes to/from or via these destinations.

Meanwhile, the carrier's ubiquitous 777s serve numerous smaller cities. Once the main city gateways are secured and frequency is locked in, supporting the overall network, the second phase of expansion begins. This next stage, as experienced in Europe, can be even more startling.

The second phase of Gulf airline expansion targets regional centres

At first when Emirates began serving non-capital "regional" cities such as Manchester and Birmingham in the UK, or even Dublin (with its population of just over a million), there were cries of "capacity dumping". The market response has generally given the lie to that, as new global one-stop travel opportunities opened up..

Today, Greater Manchester, with a population of around 2.5 million, and only 290km (180 miles) from London, is host to seven widebody services each day from the three Gulf carriers: an A380 and two 777s from Emirates; two A330s from Etihad; and two A330s from Qatar Airways - well over 2,000 seats daily.

These airlines have the power to transform the landscape, and not just around major hubs.

They are accordingly - and Emirates in particular - highly dangerous competitors and, by the same token, increasingly attractive airline partners. Their expanding presence in the world market will continue to be highly disruptive. As a result, this change process will continue not just to redirect passenger flows, but also to transform the fundamental nature of alliances and partnerships.

The past year has proven that, for alliances, the unlikely becomes commonplace and the impossible a reality. Who knows, by this time next year, Emirates may well be Lufthansa's new best friend.

And the distinctive tail, in its UAE colours, will be much better known across the North American continent, as well as the EK code on US airlines' flight information displays. Partnership conflicts will abound, as new equilbria are built - and rebuilt. And soon it will not just be the major gateways that are chasing Emirates tails.