This presentation by Brian Pearce from IATA was made during a roundtable discussion on airline competition held at the 121th meeting of the OECD Competition Committee on 19 June 2014. Find out more at http://www.oecd.org/daf/competition/airlinecompetition.htm
Key features of air transport markets - Brian Pearce – IATA - June 2014 OECD discussion on airline competition
1. To represent, lead and serve the airline industry
Some key features of air
transport markets
Brian Pearce
Chief Economist
June 2014
www.iata.org/economics
2. City-pairs doubled – transport costs halved
IATA Economics www.iata.org/economics 2
Source: IATA, ICAO, OAG
0.5
1
1.5
2
2.5
3
3.5
4
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
1994 1997 2000 2003 2006 2009 2012
US$/RTKin2014US$
Numberofuniquecity-pairs
Unique city-pairs and real air transport costs
Unique city-pairs
Real air transport costs
3. Falling costs passed through to consumers
IATA Economics www.iata.org/economics 3
Source: IATA, ICAO
-
1.0
2.0
3.0
4.0
5.0
6.0
7.0
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1950 1960 1970 1980 1990 2000 2010
US$in2013pricespertonnekilometer
US$in2013pricestoflyatonnekilometer
Unit cost and the price of air transport
Price
(US$/RTK)
Unit cost
(US$/ATK)
US deregulation
EU deregulation
Boeing 707
1973
oil
crisis
4. Consumer demand extremely strong
IATA Economics www.iata.org/economics 4
0
50
100
150
200
250
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Indexedtoequal1in1950
World scheduled air travel, freight and world real GDP
Air travel
(RPK)
212x
GDP
(constant
prices)
10x
Air cargo
(FTK)
212x
Source: IATA, ICAO, Haver
6. Investor returns below cost of capital
IATA Economics www.iata.org/economics 6
Source: IATA, McKinsey
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
%ofinvestedcapital
Return on capital invested in airlines
Cost of capital
(WACC)
Return on
capital (ROIC)
7. Why?
• Value chain as a whole sustainable?
– Market power in parts of chain/ over-regulation elsewhere?
• Excess capacity?
– Imperfect capital markets?
• Common and joint costs?
– Hard to recover?
• Empty core?
– Financially sustainable equilibrium not possible?
IATA Economics www.iata.org/economics 7
8. Much of air transport value chain is profitable
IATA Economics www.iata.org/economics 8
Source: IATA, McKinsey
0
5
10
15
20
25
30
Return on invested capital in the air transport value chain, 2002-2009
ROIC WACC
9. But dwarfed by sub-normal airline returns
IATA Economics www.iata.org/economics 9
-25
-20
-15
-10
-5
0
Investor returns in excess of cost of capital, $ billion a year
Source: IATA, McKinsey
10. Easy and regular new entry
IATA Economics www.iata.org/economics 10
Source: IATA, Ascend
11. But also significant failure, exit and merger
IATA Economics www.iata.org/economics 11
Planet
duo
nexus
Air Wales
Thomsonfly
Nordic
airlink
flyforbeans.com
clickair
Atlas-blue
myair
flyglobespan
Go
Debonair
mytravellite
dba
Basiqair
jetmagic
Iceland Express
AerArann
Aerlingus
Ryanair
Monarch
easyJet
flybe Transavia
germanwings
airberlin
WIZZ
Volotea
vueling
SkyExpress
Norwegian
Pegasus
Jet2
snowflake
flyeco
Skyeurope
Hamburg airlines
Helvetic
VBIRD
VirginExpress
EUjet
FlyMe
buzz
Volareweb
Maersk Air
Air Finland
Flying Finn
Kiss
GetJet
Aeris
Smart Wings
centralwings
fly gibraltar
HLX
LTU
Air polonia
flybaboo
flywest
Viking
SterlingCimber
Air Turquoise
Germania
air lib express
Clickair
WindJet
WOW
Failed Survived
European ‘LCCs’
Source: HSBC
12. There are significant common & joint costs
IATA Economics www.iata.org/economics 12
Fuel, 33%
Passenger
services, 8%
Airport & ANS,
7%
Maintenance,
10%
Station
expenses, 9%
Ticketing, sales,
promo, 8%
Flight crew
salaries, 6%
Aircraft rentals,
6%
Depreciation,
5%
Overhead &
other, 8%
Operating costs breakdown 2012
Source: IATA
14. But business customers demand frequency
IATA Economics www.iata.org/economics 14
• Economies of scale in equipment incentivises: larger
aircraft and fewer frequencies
• But strong preferences of business customers – who
value their time highly – for: frequent (daily) services
and specific departure times
• With free entry, unless very dense passenger flows,
market outcome is: smaller aircraft and more
frequencies
• What fare structure would emerge in such a market?
15. Price ‘segmentation’ economically efficient
IATA Economics www.iata.org/economics 15
• Two/multi-tier fare structure consistent with open competition
• Preferences of business travellers prevent cost-saving larger
aircraft
• Business travellers should pay premium for higher unit costs
imposed by more frequency
• Premium reduced by larger aircraft made possible by attracting
more price-sensitive leisure travellers
• It is also a mechanism for allocating common/joint costs
• This is an open competition outcome due to economies of scale,
common/joint costs and preferences for frequency
• Non-core ‘ancillary’ services perform similar role
• Cover common/fixed costs while core transport product is
offered at marginal cost – an economically efficient outcome
• Similarly, different cuts of meat see price ‘discrimination’
16. Economies of density in route networks
IATA Economics www.iata.org/economics 16
• Minimal economies of scale in firm size
• But substantial economies from density of traffic flows
• Business models are different ‘factories’ generating ‘route density’
Source: Lufthansa
17. ‘Metal-neutral’ airline JVs deliver efficiencies
IATA Economics www.iata.org/economics 17
• Few city-pairs can support frequent point-to-point services
• ‘Hubs’ generate route density where necessary
• No single airline can provide ‘from anywhere to anywhere’
service demanded by business customers
• Cross-border mergers mostly impossible
• Airline innovation in response
• Interlining
• Code shares
• Alliances
• JVs under ATI
• ‘Metal neutrality’ has been the successful development
• Airline JV partners indifferent over who carries passenger
• Generates efficiencies from increasing traffic density
• Efficiencies lower with looser cooperation
18. As well as price/non-price consumer benefit
IATA Economics www.iata.org/economics 18
• Lower fares for interlining passengers (no double marginalization)
• Lower fares from economies of traffic density
• Effect also can apply to overlapping hub-to-hub markets
• Fares can be more easily combined in an itinerary
• Passengers offered wider range of schedules
• More seamless passenger experience
19. Summary
IATA Economics www.iata.org/economics 19
• Economic benefit from connecting cities and cutting transport costs
• Air transport 7x cheaper than 6 decades ago
• Demand has grown over 212x compared to a 10x rise in GDP
• Airline net profits close to zero
• Airline ROIC consistently < WACC
• Some parts of value chain make returns > WACC
• Easy and frequent new entry
• Significant common and joint costs – hard to recover
• Economies of scale in equipment
• But business customers demand frequency
• Open competition outcome is a segmented price structure
• Economies of density important – business model ‘factories’
• JVs can deliver efficiencies as well as non-price consumer benefits