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Who has the right model for European aviation? Pan-European airlines lead, but models vary

There has never really been a consensus on the question of what defines success in the airline industry. However, that now seems to be changing and opinion is coalescing around the idea that financial performance is the best demonstration of success. 

Chapter 11 bankruptcy, followed by consolidation has helped profitability in North America, but this process has slowed to a trickle in Europe’s more fragmented airline sector, forcing each European airline to devise its own formula.

Judging by operating margins in 2014, European Low Cost Carriers (LCCs) are enjoying greater success than Full Service Carriers (FSCs). Unit cost analysis highlights the continuing CASK gap, emphasising the imperative for cost efficiency, and also allows a more detailed strategic segmentation of Europe’s airlines. Ultra-LCCs seem particularly successful, but one of the keys to LCC success is to have pan-European operations.

For Europe’s major network airlines, successful LCC subsidiaries are rare and require a distinct culture, while creating new lower cost platforms within the mainline brand presents significant industrial relations challenges. Meanwhile long-haul competition continues to intensify. With a few exceptions, niche FSCs often find themselves squeezed out by LCCs in short-haul and by the larger network carriers on long-haul.

There are many ways to assess financial success, the most important being return on invested capital

However, the calculation of return on invested capital is not straightforward and there are a number of methodological variations. For simplicity’s sake, we present a comparison of operating margins, which measure operating profit as a percentage of revenue for Europe’s listed airlines.

The chart below ranks Europe’s stock market-listed airlines by operating margin in 2014. For our purposes, operating profit is EBIT (earnings before interest and tax) before exceptional charges for restructuring and other one-offs. It also excludes non-operating gains such as asset disposals.

There is a wide range of performance from healthy double digit to negative margins, and LCCs typically performed better than legacy airlines. Most of the higher margin airlines improved in 2014, while most of those at the lower end of the scale suffered a fall in margins. Convergence of business models does not show itself in convergence of financial performance.

Beyond the listed airlines, Europe has a large number of mainly small and unprofitable airlines, which drag down the aggregate margin of the continent’s airline sector. Europe’s traffic growth and load factors are relatively healthy by world standards, but its margins are held back by its fragmented market structure.

We will return to the subject of Europe’s weak margins and the prospects for European airline consolidation elsewhere in this report. At this point, suffice to say that further meaningful consolidation in Europe is likely to be difficult as long as restrictions remain on market access and ownership and control.

Ryanair was the most profitable listed European airline in 2014 (and in 2013), ranked by operating margin

The least profitable among this sample was airberlin (for both 2013 and 2014).

The results provide considerable ammunition for those who argue that the LCC model is superior to the legacy model. Convergence and hybridisation notwithstanding, LCCs generally are more profitable. Five of the top six and all of the top three by operating margin are LCCs. Moreover, all of the top three improved their margin in 2014 versus 2013.

Ryanair (whose financial year ends in March, although we show calendar year margins in our chart) benefited from its core strength of low costs and combined this with an improved customer service offer to drive up yield, load factor and, hence, margin. Wizz Air, already (like Ryanair) an ultra-LCC, managed its unit cost down further while also raising its unit revenues. easyJet continued to take advantage of its network of primary airports and its lead over other LCCs in terms of initiatives towards business travellers and customer service.

However, it is not all good news for LCCs. The number of LCCs with increased operating margins, four (the top three and Jet2.com), was equal to the number of LCCs with falling margins.

Although still credibly profitable, Vueling and Pegasus recorded lower margins in 2014 than in 2013. Vueling experienced some growing pains at its new Rome Fiumicino base and Pegasus was affected by currency factors and increased competition from Turkish Airlines at its Istanbul Sabiha GÖkÇen hub. Nevertheless, Pegasus remained more profitable than Turkish, whose margin also dipped in 2014.

Two of the eight LCCs in the list were even loss-making in 2014. These were Norwegian, whose profitability has suffered since launching a long-haul network, and Transavia, whose losses are attributed by its parent Air France-KLM to the ramp up of routes from France (apparently ignoring the fact that most other LCCs are also ramping up routes quite profitably).

The only FSC/non-LCC to break into Europe’s top six airlines by operating margin is Aegean Airlines

Aegean is also the only FSC to record a double digit margin in 2014, helped by strong cost control and the successful absorption of its Olympic Air acquisition.

Among the FSCs, four improved their margin in 2014, while six suffered a drop in margin. Icelandair stayed at the same level and retained its position as the most profitable niche flag carrier in Europe (if we do not count Aegean as a flag carrier). IAG’s margin improvement was mainly due to the restructuring and turnaround of Iberia and this also helped it to consolidate its place as the most profitable of Europe’s Big Three legacy groups (although it was still only at number eight in the list overall).

IAG is reaping the rewards of confronting labour restructuring, in particular, earlier than either of the other two. Both Lufthansa and Air France-KLM suffered damaging strike action in 2014, which not only weighed on their results for the year, but also highlighted the ongoing challenge of seeking strategic change while ensuring that employees are comfortable to move in the same direction.

Although Lufthansa reported an increased margin according to its audited accounts, its margin would have been lower year on year without a change in depreciation policy in 2014.

Aer Lingus now represents the middle of the road of Europe’s airlines

Its margin improved very slightly in 2014, but remained firmly in the middle of the pack, just as strategically it positions itself between the LCCs and the major network carriers. IAG, if successful in its bid for the Irish airline, should help Aer Lingus to make the next step up in profitability.

The Aeroflot Group suffered a large drop in operating margin in 2014. Demand on its international network was weak as a result of the political situation in Ukraine in particular, which also indirectly led to the suspension of its first attempt at a LCC subsidiary, Dobrolet, which was targeted by EU sanctions. Aeroflot promptly launched a second LCC subsidiary, Pobeda.

SAS also suffered a heavy fall in its margin, as a result of competitive capacity growth, sluggish demand and weak pricing, in spite of good progress with cost cutting. Finnair faced similar challenges and fell into an operating loss, underlining a disappointing year for the three Nordic airlines in the list. airberlin, with the lowest margin among listed European airlines, managed to reverse what had been a trend of rising unit costs. However, it also experienced the reversal of a trend of rising unit revenues and remained loss-making.

Our analysis of the operating margins of European airlines highlights the wide range of results. Nevertheless, some broad conclusions can be drawn:

  • While business models show some signs of convergence, financial performance is diverging;
  • The bigger pan-European LCCs are typically higher margin businesses than the legacy airlines;
  • Europe already has the highest penetration of LCCs of any region in the world and LCCs' market share continues to grow.

Analysing Europe's airlines according to their level of unit cost and average sector length provides a useful means of comparing and segmenting them

A plot of cost per available seat kilometre (CASK, on the vertical axis, see graph below) versus average sector length (on the horizontal axis) tends to slope downwards from left to right.

In general, the cost of producing a seat km falls as average sector length increases since the fixed costs are amortised over more seat kms and variable costs, such as fuel, are more efficiently consumed in longer flights.

Plotting CASK vs sector length allows the relative cost efficiency of different airlines to be compared visually. It also helps in identifying different categories of airline and their strategic positioning.

Our analysis reveals five broad categories of airline in Europe, two of which cover full service carriers and three for the LCCs.

It is also important to note that this CASK analysis confirms what might seem obvious. This is that there is still a unit cost gap between FSCs and LCCs, in spite of moves from both to replicate elements of the other's business model.

For the major network carriers, one of the biggest challenges is that there is strong price competition on short-haul

This occurs, unfortunately for them, from all the other categories. The Big Three European legacy groups have responded by setting up or buying low-cost subsidiaries for short-haul point to point operations.

These have met with mixed success: among the LCC subsidiaries of the legacy groups, only IAG's Vueling is generating a healthy margin (although this fell in 2014). As easyJet Group Commercial Director Cath Lynn said at CAPA's Airlines in Transition conference in Mar-2015, it takes a “phenomenal amount of discipline” for a full service carrier to successfully run a true LCC operation within its portfolio.

The major network carriers' response to low-cost competition on short/medium-haul has also included taking on some of the product/service and pricing features of the LCC model on some or all of their short-haul network. However, this response has been relatively slow, given that LCCs started to appear on the European scene 20 years ago.

Instead, for much of that time, big network carriers have tended to focus on their long-haul networks

This has been their main point of differentiation. To supplement this, they have also led the development of the branded global alliances and formed so-called metal neutral joint ventures with alliance partners on key long-haul route areas, most notably the North Atlantic, but also (in some cases) on certain Europe-Asia routes.

Long-haul was perceived as a refuge from the fierce short-haul competition, where new entry was more complex and expensive.

However, the developing problem for major network carriers on long-haul is that they now also face strong competition from airlines following a connecting strategy using hubs based in the Gulf and Turkey to capture global traffic flows. The Gulf carriers and Turkish Airlines not only have a quality of product, service and frequency that is usually better than the long-haul offer of the big European groups, but also have lower unit costs.

What is more, there is a new emerging category of threat: that is that long-haul low-cost operators are now beginning to make their presence felt on routes to/from Europe.

Although the long-haul low-cost model has yet to prove itself a success in terms of profitability, this form of competition looks to be here to stay; and it is likely to continue to evolve towards financial success.

The larger full service airline groups have also led the consolidation of Europe's airline industry

This has embraced a number of cross border mergers and acquisitions within the continent creating today's Big Three legacy groups. As demonstrated by North America's airlines, consolidation can be a positive factor in improving industry profitability, but the success of this approach in Europe has been limited by two main factors.

First, the degree of integration between the operating airlines of the Big Three appears to be less than seen at merged groups in North America (such as Delta after its acquisition of Northwest and the merger of United and Continental). Typically, the Europeans have made progress with the centralisation of certain administrative, financial and procurement functions. However, the national airlines within the large European groups continue to operate as distinct brands, each with its own fleet, operations and labour structures.

There is a host of historical and cultural reasons why integration within the European Big Three has been slower than in North America, the most important being resistance by labour and residual government influence (even after the divestment of shareholdings), but this has served to limit the synergies derived from these mergers.

The second factor limiting the success of consolidation involving European airlines relates to global restrictions on market access and on foreign ownership and control. As Association of European Airlines CEO, Athar Husain Khan said at CAPA's Airlines in Transition 2015: "We have to see more consolidation in the European market, but everyone is running into the brick wall of regulatory impediments".

These impediments are barriers to consolidation in all regions, and particularly across regions. However, Europe's major legacy carriers are more exposed to intercontinental routes than are their North American counterparts and so these restrictions effectively have a greater impact on Europe than on North America. EU liberalisation of market access and ownership and control does not do much for consolidation that reaches beyond the bloc's borders.

As illustrated above, IAG is currently the most profitable of the major network airline groups in Europe, although considerably less so than the leading LCCs. IAG's LCCs, Vueling, is the highest margin LCC owned by one of the legacy groups, in contrast to losses at Air France-KLM's Transavia (and undisclosed results for Lufthansa's Germanwings), although it is no longer among those with double digit margins. IAG has also gone further than its major European rivals in embracing Gulf-based airlines.

The niche full service carriers often appear to be stuck between a rock and a hard place

Professor Rigas Doganis, Chairman of the European Aviation Club and Visiting Professor at Cranfield University, succinctly highlighted their problem when speaking at CAPA's Airlines in Transition 2015. He noted that mid-sized and small legacy airlines are too small to compete effectively against the majors in long-haul markets and too high cost to compete effectively with true LCCs in short-haul.

The chart from previous page showing the operating margins of listed European airlines does not contain a large number of these smaller FSCs, since many of them are not listed. Although detailed financial information is scarce, the profitability of the niche FSCs is typically low or negative (with a very few notable exceptions).

As Professor Doganis noted, these airlines face challenges both on the demand side and on the supply side. Regarding demand, they tend to have small home markets and limited networks, with sub-scale long-haul networks (or none at all) and hubs that are often too peripherally located for effective hubbing. These factors mean that they lose traffic to larger rivals in neighbouring locations.

There are some exceptions. A number of airlines has successfully used geographic location to build a long-haul network

The market between Europe and long-haul destinations in other regions tend to be less competitive than short haul. The principal examples include Icelandair to North America, TAP Portugal to Latin America and Finnair to Asia. Aer Lingus is now starting to join this group with its North American network from Dublin and (to a lesser extent) Shannon.

Nevertheless, out of these four, only Icelandair has been able to sustain reasonably healthy operating margins, around 7%, in recent years (probably thanks to lower levels of LCC penetration in its feeder markets, although this is now growing). Aer Lingus has been profitable for a number of years, a creditable performance when Ryanair is based in its backyard, but margins of around 4% are not sufficient for it to cover its cost of capital.

Turkish Airlines should also be mentioned in this context. Although generally regarded as a major network carrier, Turkish's level of CASK ranks it among the niche FSCs. Moreover, it has been one of the world's most successful airlines at using the geographical location of its Istanbul hub to attract global connecting traffic flows. This has allowed it to achieve impressive growth: 55 million passengers in 2014, compared to 14 million in 2004.

Nevertheless, Turkish Airlines' operating margin has suffered since the 2007-2009 period, when they were double digit. Since then, its margin has only once been above 6% and was 5.4% in 2014. This still makes it one of the most successful niche FSCs in Europe, but it will be anxious to reverse the declining trend.

There are also those smaller airlines with no long-haul network, but which focus on a short-haul niche

Even the biggest pan-European airlines do not operate from everywhere to everywhere in Europe. Provided that the airline serving a smaller country, typically its national carrier, has a competitive cost base, it may be able to maintain a profitable operation based on a strong market share in its geographical niche.

UK regional airline Flybe's strategy depends on a version of this approach. Although still undergoing a cost restructuring programme, its CEO Saad Hammad shared with Airlines in Transition 2015 his hopes that the airline's core network strength, a "focus on routes where other airlines don’t operate", will allow it to return to profit.

A related issue is the short-haul to short-haul connecting model in Europe

Pan-European low-cost operators increasingly offer point to point connections across the continent, bypassing the traditional hubs, which continue mainly to focus on short-haul to long-haul connections. However, unless and until the LCCs start to provide universal coverage of Europe (unlikely given their increasing focus on major airports), there remains a role for short-haul to short-haul connections. Niche FSCs and regional airlines will continue to play their part in this, both within their own hubs and networks and in feeding the larger hubs to onward destinations that they do not serve directly.

The question remains, however, as to how sustainable the short-haul niche model is in the long run. The continued growth of the larger LCCs across the continent is taking them into many markets previously left alone. The combination of their superior networks and, usually, lower costs, may eventually squeeze out the local airline.

The issue for governments in those countries may then be how to maintain connectivity with the main European long-haul hubs, which are perhaps not well served by LCCs. The main defence for small national airlines is to ensure that they have as efficient a cost base as possible.

In addition to the demand disadvantages already noted, smaller and mid sized FSCs also often have cost disadvantages versus LCCs in short-haul markets. These typically arise from:

  Smaller gauge aircraft;

  Diseconomies of scale (including small fleets);

  And (often) high levels of unionisation.

  Government interference in the running of the airline, coupled with difficulties in attracting funds into government-owned carriers, can also be a problem in some cases.

There is one notable exception to this observation on costs. Aegean Airlines has a unit cost level that is very close to that of LCCs such as easyJet (although higher than Ryanair’s, which is now a growing competitor in the domestic Greek market). It is also the most profitable European FSC, as noted earlier.

Unlike their larger FSC counterparts, very few of the niche FSCs have set up low-cost subsidiaries

LOT Polish Aielinwa CEO Sebastian Mikosz told CAPA's Airlines in Transition 2015 that there were only two successful legacy-owned LCCs: Vueling, which was not created by IAG, and Jetstar. Speaking at the same event, CityJet chairman Pat Byrne argued that LCC subsidiaries fail for the same reasons that it is not possible to convert the parent into a low-cost airline: "It cannot work," he said, "It's a cultural issue".

In Europe, it is certainly the case that LCCs owned by legacy groups Lufthansa and Air France-KLM have failed to reach profitability, while those owned by smaller FSCs are currently non-existent. SAS made an unsuccessful attempt with its Snowflake branded LCC concept in 2003-2004, while LOT closed its Centralwings LCC subsidiary in 2009, because, according to Mr Mikosz, labour unions could not accept a different pay structure.

Instead of attempting LCC subsidiaries, many smaller European legacy airlines have embarked on cost reduction programmes in order to lower their own costs. Aside from the cultural challenge in establishing a low-cost subsidiary, the markets typically addressed by niche FSCs are not big enough to sustain two vehicles owned by the same parent. This has led to a blurring of the boundaries between categories. As noted above, Aegean Airlines has a unit cost (CASK) very close to that of the pan-European LCCs. Air Serbia CEO Dane Kondic told Airlines in Transition 2015 that his airline’s CASK is similar to that of easyJet, having taken out more than 400 staff from the business and revisited all its procurement contracts since it received an investment in 49% of its shares from Etihad. Latvian national carrier airBaltic is classified in the CAPA/OAG database as a LCC.

For many of Europe’s small and mid sized FSCs, life is not easy. As noted above, those blessed with a geographical advantage (and with management with the talent to spot and to exploit this advantage) allowing them to carve out a successful niche can sometimes achieve profits, but not always enough to cover their cost of capital.

This report on CAPA's Airlines in Transition 2015 discussions appears also in Issue 28 of CAPA's Airline Leader journal  http://www.airlineleader.com/

The global alliances are becoming clubs for the big boys, say some smaller FSCs

With only small operations to destinations outside Europe (or none at all), most of them attempt to create virtual long-haul networks through codeshares and alliance membership. Nevertheless, the benefits of global alliances are not universally appreciated by all of Europe’s small and mid size legacy airlines.

LOT’s Mr Mikosz said that the advantage of global alliance membership was mainly perception in the eyes of the passenger (for example, lounge access and FFP points). However, with no joint procurement by the Star Alliance, he added that the smaller carrier does not benefit much. “Alliance partners often push LOT out of markets,” he said. “Alliances mainly benefit the big boys, who then also form joint ventures to keep others out”. Their toughest competition, he argued, often comes from the big alliance partners, who “know all about us”.

There is a greater degree of consensus among small and mid size airlines on the benefits of codeshare agreements with partner airlines on a bilateral basis. This can provide them with virtual access to a wider network, but without the burdens imposed by alliance membership.

Unlike the major network carriers, the niche FSCs are rarely in a position to lead the consolidation of the European airline sector

Of course, some may become part of the process, if a larger airline shows interest. However, the acquisition of small or mid size European airlines by the European majors has been rare in recent years, with no transactions of this nature since 2011, when IAG bought BMI from Lufthansa (and then broke it up, selling bmi regional, closing bmibaby and absorbing the mainline operation into British Airways).

Also in 2011, airberlin acquired NIKI and, in 2013, Aegean acquired Olympic, but these deals were both between two smaller airlines. IAG acquired Vueling in 2013, but this was an example of a major buying a LCC, which further highlights the lack of interest shown by the major FCSs in their niche brethren.

If anything, there has been more de-consolidation than consolidation involving niche airlines in Europe in recent years

The sale of bmi regional by IAG, Air France-KLM’s disposal of CityJet and SAS’ selling of Widerøe are all examples of regional airlines regaining their independence. According to CityJet’s Pat Byrne, “the entrepreneurial spirit of a regional doesn’t belong with a large mainline”. Being owned by a larger group leads to the regional airline becoming “sloppy and complacent, losing the very basic instinct for survival”. For some smaller FSCs, particularly regional airlines, the regaining of independence may offer a more sustainable future.

A number of niche national carriers owned by their governments are currently seeking external investors. These include TAP Portugal, LOT Polish Airlines, airBaltic, Croatia Airlines and Cyprus Airways. In an ideal world, privatisation brings both much needed fresh capital and greater freedom from government interference, but it has not been an easy process so far. Many of them have been on and off the acquisition market for several years, without finding a buyer.

In fact, Cyprus Airways went into liquidation in Jan-2015 after failing to find an acquirer and after the EU ruled that funds received from its government were in breach of rules on state aid.

A “new” Cyprus Airways is nevertheless planned, with the hope that private investors will be involved. Both Aegean Airlines and Ryanair had expressed interest in Cyprus Airways before its liquidation, but their bids were rejected by the government as insufficient.

This highlights the difficulty faced by niche FSCs in finding salvation in consolidation, unless they can demonstrate either profitability or the potential for profitability. This requires both an efficient cost base and freedom from government interference. It is not always easy to achieve both of these, according to LOT’s Mr Mikosz, who told Airlines in Transition 2015 that his airline had achieved significant CASK reductions. Nevertheless, “Politicians are not elected because of EBITDA results,” he said. “When legacy carriers that have the name of their country on them get into trouble, that means political trouble.”

Even then it may often make more sense for potential bidder airlines to allow the smaller carrier to wither and die, before moving into its market (witness Ryanair’s entry into market gaps left by Malev in Budapest and Spanair in Barcelona

Deals between European majors and niche airlines may have ground to a halt

If IAG is successful in its bid for Aer Lingus, this will be the exception that proves the rule, but non-European airlines have played an increased role in rescuing struggling European small and mid size airlines in recent years.

This is most obviously illustrated by Etihad’s investments in Air Serbia, airberlin, Etihad Regional (formerly Darwin Airline) and Alitalia. Nevertheless, even the Gulf airlines’ pockets are not bottomless and this type of transaction is likely to be less common in the future as Etihad seeks to concentrate on maximising the value of its existing portfolio. It seems that consolidation through market exit will remain a significant form of consolidation.

Broadly, it seems very likely that the growth in market share of LCCs on routes within Europe, illustrated above, will continue to grow, most notably on point to point routes. Although the definition of what constitutes a LCCs is becoming less clear, those airlines with sustainably lower CASK will take more and more traffic from their higher cost competitors in short/medium-haul markets. On trips of one or two hours, why pay more? And, as FSCs are increasingly forced to reduce frequency to cut losses, the LCCs’ services become increasingly attractive.

Even if the product/service differences between LCCs and FSCs on intra-European routes are becoming increasingly blurred, the differences remain clear in CASK terms

This is illustrated by our scatter plot analysis.

The growing ability of LCCs to offer a product that mimics that of the FSCs on short-haul, but at a considerably lower price, surely means it is only a matter of time before the bigger LCCs start to provide feed to the long-haul networks of FSCs in some shape or form. It may be more likely to happen through contract flying arrangements, as this would involve minimal change to an LCC’s core business while also ensuring it received adequate compensation for services provided to a third party airline. However, it is also possible through interline, codeshare and other forms of commercial cooperation.

This is already happening, albeit only to a limited extent. For example, Vueling has an interline agreement with oneworld member Qatar Airways that facilitates feed at both Rome Fiumicino and Barcelona. This relationship seems likely to develop further as Qatar Airways deepens its commercial partnership with IAG.

Vueling also codeshares on routes across Europe with Iberia and, to a lesser extent, British Airways. However, these agreements mainly cover Vueling’s services to/from Barcelona and only touch the main long-haul hubs of its IAG sister airlines in the form of Vueling’s routes from Florence to Madrid and from La Coruna to Heathrow.

CAPA’s CASK analysis divides the LCCs into three categories: pan-European LCCs, ultra-LCCs and leisure LCCs. The chart of 2014 operating margins shows that LCCs are broadly more profitable than FSCs, but there are some differences in the relative financial success of the three categories.

In the margin chart, two out of the top three and three out of the top six airlines are ultra-LCCs. One in the top three and two in the top six are pan European LCCs. Although this is not sufficient evidence to prove a law of nature, this suggests that the ultra-LCC model is slightly more successful than the pan European LCC model.

However, it is also important to stress that there is considerable overlap between these two categories. In particular, airlines in both have pan-European operations (in other words, they fly point to point routes to/from, and have operational bases in, several countries).

This seems to be an important feature for success, thanks to economies of scale and scope. easyJet Group Commercial Director Cath Lynn picked up this point at Airlines in Transition 2015. “Scale is important, brand is important”, she said, adding that LCC subsidiaries of full service carriers, such as Transavia and Eurowings are “so far behind Wizz in Eastern Europe, behind easyJet across most of Western Europe and Ryanair, that it’s a heck of a mountain to climb. I am not so sure I would have packed my bags to climb that mountain if I’d been them”.

The size that comes from having a pan-European network allows purchasing efficiencies with suppliers and buying power with airports.

In addition, a multi-base, multi-country strategy leads to brands that enjoy recognition by passengers at both ends of the routes (since they are not skewed to one country for their originating passengers). Having a presence across a number of countries also allows access to local pools of labour on a more cost efficient basis than is possible for airlines that are primarily based in one country.

By contrast, the best-placed leisure LCC, Jet2.com, is ranked only 10th and its 2014 margin of 5.0% was 3ppts below that of the lowest ranked ultra-LCC Pegasus. Transavia had a negative margin and the other principal leisure LCC in Europe, Monarch, had a 2013 margin of less than 4% (it is not listed and has not published 2014 results).

These three leisure LCCs mainly operate from one country in north-western Europe (the UK for Jet2.com and Monarch), or two countries in the case of Transavia (Netherlands and France) to leisure routes in the Mediterranean.

It is harder for these airlines to build sufficient scale, a drawback that Air France-KLM appeared to recognise when it announced plans to establish Transavia Europe with bases outside the Netherlands and France, only to drop these plans in the face of opposition from its pilots.

Ultra-LCC Pegasus is an exception among those in its category, since, unlike Ryanair and Wizz Air, it does not have bases in several countries. In some ways, it is more like the leisure LCCs in reverse. It is based in Turkey, with routes to other points in Europe (and the Middle East).

However, Pegasus has much greater scale than the airlines in our leisure LCC category (around 20 million passengers in 2014, double that of Transavia, which is the biggest of the three in its category), built on a large domestic network with multiple bases.

Pegasus also benefits from low labour costs. Nevertheless, it is the lowest margin ultra-LCC and its lack of true pan-European presence may partly explain this.

Europe’s airlines in aggregate have the second lowest EBIT margin among the world’s regions. According to IATA, only Africa was less profitable in 2014.

North America jumped ahead of Asia Pacific, but these two regions have been the most profitable, measured by EBIT margin, since the recovery from the global financial crisis.

Of course, there are other reasons why European airline profit margins are lower than those of North America.

In particular, Europe’s legacy carriers have been slower to confront labour restructuring than their North American counterparts, whose progress in this respect was given a considerable boost by a series of Chapter 11 bankruptcies resulting in court-sanctioned changes to employment contracts.

Nevertheless, as our chart demonstrates, Europe’s fragmented market structure is an important factor in its low profitability.

As discussed elsewhere in this report, the consolidation process has not made any meaningful progress recently.

Consolidation through the exit of weaker players continues to inch forward, but this has been slowed down by a wave of acquisitions of life-saving minority stakes by non-European airlines in European airlines that may otherwise have failed.

It is self evident that consolidation in Europe is essential/inevitable, but there are vested interests that make this difficult

Europe’s airline sector must press regulators to remove barriers to further consolidation, but this may be a lengthy process.

Meanwhile, if they are to avoid being victims of consolidation through market exit, it is imperative that European legacy airlines redouble their efforts to push through labour restructuring in order to improve their profitability.

This report on CAPA's Airlines in Transition 2015 discussions appears also in Issue 28 of CAPA's Airline Leader journal  http://www.airlineleader.com/

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