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

There’s no shortage of heat and light in the US vs Gulf airlines battle. But not much to make it clear why the Gulf airlines’ relatively limited impact should attract so much focus. 

After all, 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. The issue of subsidy is an opaque one; many foreign airlines strongly argue that US airlines are heavily subsidised, directly and indirectly.

The intensity of this confrontation can be judged in terms of Delta CEO Richard Anderson’s remarkable outburst in Mar-2015 placing the 9-11 Trade Centre attacks in the same context as the Gulf airlines. 

But more importantly, there has been little of substance to explain quite why - apparently supported by an otherwise largely silent American and United – Delta is so trenchantly opposed to the operations of Emirates, Etihad and Qatar Airways.

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

The Gulf carriers’ operations are largely unsuitable as substitutes for US airline services. In fact there is enormous complementarity. There is a good 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 White Paper’s focus is firmly on the issue of subsidy, but there is a lot more to airline strategy than that. 

Subsidy and lack of “fairness” have always been present in the airline industry. Importantly too, while they are extremely important, there is today much more to international airline operations than supporting the interests of flag carriers.

The White Paper contains only one reference to consumers in the entire 55-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.

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. 

Necessarily the interest of consumers do not prevail in every case, regardless of circumstances, but allocating this category of national interest substantial weight is appropriate. 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 not merely in pricing, but in sheer accessibility to points otherwise out of reach. These are all elements of a new world environment.

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 dominant position in the lucrative 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. It is also affected by the rebirth of Alitalia for similar reasons.

Air France however, despite its reservations, has established a relationship with Etihad. And for example, Air France-KLM works with the Gulf airline in their African hub of Nairobi in the East African Kenya.

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

Elsewhere in the world, the reality is that, like it or not, 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, at the heart of the current debate, became legitimate. 

As new airlines began to challenge the 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 national airlines. So when KLM started carrying US passengers to Amsterdam then transhipping them to German points, this was considered “unfair” use of the respective bilateral agreements.

But eventually it was the sheer power of consumer interests that forced the changes. Such obviously unhelpful and effectively anti-competitive activities were circumvented in this new era; black markets arose and the water started to trickle downhill. 

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 downhill, even if government sanctioned interventions may slow or even prevent 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. But it was not too long before they themselves learned the value of hubbing foreign traffic.

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

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

But the 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 calculations relate to jobs that might theoretically be lost; even if true, it is 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.

This therefore begs the question – what is the real agenda here?

The issues raised go to the heart of US aviation policy post-Chapter 11/airline consolidation. It 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, this would arguably not be possible.

The reality is that, although most foreign airlines resisted the US disruption of the old restrictive entry and capacity regimes, they have moved on, becoming more competitive and productive in the process. Most of them have to live 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. Painfully often, but more sustainably in the long run.

The subsidy argument is a nebulous one, particularly when it embraces protected markets; there can be little more obvious subsidy than trade protection and aviation is rife with it. All of today’s major airlines grew up in a highly protected environment and most would not exist today had it not been for that “subsidy”, in one form or another.

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 (see graph on pp.11) clearly illustrates the benefit that US airlines generated from their recent excursions into Chapter 11. Few genuinely deny the value of this 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. 

And Fly America – where any US government employees, their dependents, consultants (American or otherwise) and others must use a US airline where possible – is worth hundreds of millions of dollars a year in subsidy to US airlines.

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 contest with clean hands.

Such a simple concept as fair should be seemingly open to objective analysis. But far from it; fairness is highly subjective. 

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 also 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 “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 done in unregulated markets. 

So, fares were fixed by the airline cartel IATA, and capacity, frequency and gateway access were all fiercely controlled.

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. 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 acceptable. Implicitly in the evolutionary process, the pre-eminence of national airline interests gradually gave way to a spectrum of other public interest priorities.

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 that US airlines would add services over and above the levels they flew before the advent of the Gulf carriers. It also appears to assume there is no job creation where new foreign airline services are added.

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

For Delta at least 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 in the protected JVs), in the Americas and Northeast Asia; neither of the latter is under any serious threat from Gulf airline services.

 One region where US airlines have added new services is in the burgeoning North Asian markets. These are routes that the Gulf carriers can scarcely contest and where future growth potential is the greatest. Here the Gulf airline threat is minimal. There is some value in North Asia-US east coast via the Gulf, but that has mainly been where relatively limited services were available on the third and fourth freedom airlines.

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

Moreover, as the 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 would only be where the consumer proposition is better that passengers would prefer the longer routing. 

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

By definition foreign airlines have some advantages in route selection. In general the Gulf – like other foreign – airlines are able to deliver added value through a greater variety of offerings behind the main US gateways. US airlines are naturally keen to concentrate their long-haul international services over a limited number of main domestic hubs, where they are then best equipped to connect onto their domestic services; but this does imply that passengers from other points have to connect domestically over the hub before continuing on the long-haul sector.

This 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 Airways, 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, to its Istanbul hub.

Notably, Turkish, despite being a leading Star Alliance member, has not been invited to Star’s North Atlantic JV party.

Understandably home hub airlines are not keen to support this added competition – but there is clear evidence that it does generate much greater consumer and business connectivity and regional economic stimulation.

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 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”. 

It would appear realistically that it is really these services where the big three anticipate longer term problems from the Gulf airlines.

The value of anti-trust immunised, metal neutral joint ventures on the North Atlantic should not be understated. They are extremely valuable in providing a much better range of product for European and North American airlines alike. 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 would consider that these should be made bullet proof from external competition, especially when it comes to sixth freedom traffic – as the Paper appears to suggest should be the case.

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

As noted previously, this traffic flow is sixth freedom, which even in the archaic regulatory structure does not create supposed “entitlement” in the same way as third and fourth freedom flows.

Throughout the past two decades of turbulence leading up to the recent bankruptcies and industry consolidation, US pilot associations and other unions have been highly active to a level not apparent elsewhere in the world. 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.

Their voice is readily apparent among the many statements in the Paper.

A point forcefully made relates to the advantage gained by the Gulf airlines as a result, among other things, of the 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.

It does however reinforce the view that a strong motivation behind the White Paper derives from union pressures.

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 – does lose some overall validity however in this context, when the CASK of US airlines is compared with Asian (mostly non-unionised as well) and Middle East airlines. 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 (see graph above). There are many other cost inputs and, for example, in many cases pilot remuneration, as well as productivity, at the Gulf airlines is generally higher than for US carriers. Also, operating much older fleets in the US implies a much lower capital ledger.

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 (and many US airlines do not support 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 operate 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.

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. 

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