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The reality of the airline business
Journal
The reality of the airline business
Sir Charles Powell’s contribution to Open Forum in the September issue, 1994 l(3) of the Journal of Air Transport Management needs further comment: in particular, his judgement that the reality of the airline business is such that financial barriers, as opposed to the regulatory barriers, are so overwhelming as not to permit entry to the market. His analysis is mainly concerned with scheduled service entry, but he extends his belief that it holds good for charter airlines as well. The dilemma in this approach is the confusion between the classical analysis of inputs or factors of production, such as capital, which are needed to create a viable business entity, and the type or condition of market that the entity seeks to enter. The UK air transport market is not a perfect market. It is hardly a contestable in market, that a dominant supplier is rarely cajoled by the threat of new UK entrants. Despite the effort of regulators to deregulate, bilateralism is still a major influence. There is, to me, something almost unnatural about regulators being given the task of deregulating. Against the background of this market structure it is perhaps understandable that institutions are cautious in their approach to airline finance. There is also an historical basis to this attitude shown by UK lenders. The rational choice or judgement for new entrants is therefore to tailor their business plans to what the finance market perceives as being correct. To state that Air Europe, and then Dan-Air, failed because they ran out of money raises many other issues. Their management styles were markedly different. Air Europe commenced operations in 1979 with new aircraft, and was immediately
of Air
profitable. It remained so until the mid 1980s when a new business partner was introduced but failed to come up with his share of new capital when the new, extraordinarily ambitious business plans were developed. Mr Powell recounts the figures. The number of management changes was also unusual in such a new operator. However, Air Europe had no difficulty in raising the initial $60 million needed to finance its Boeing 737 fleet. Incidentally, this led to British Airways’ ordering Boeing 737 equipment for the first time. Dan-Air was founded in 1953 by Davies & Newman Limited, a leading firm of London shipbrokers, which had started an air-broking department on the Baltic Exchange. Although Dan-Air grew, particularly after used jet-equipment became available, there were few management changes, but the policy of investing in used aircraft continued. Perhaps this was an inherited attitude from its shipbroking parent, where it was quite normal for owners to invest in ships with a much shorter depreciation period compared with newly constructed vessels. This was a very conservative policy, but obviously led to competitive problems for Dan-Air with the rapidly changing technology of new aircraft. However, up to the early 1980s Dan-Air’s development was not hindered by the lack of finance, and more than 100 aircraft were financed and brought into service. However, in the late 1980s it was perhaps too late for Dan-Air to make re-equipment decisions. In the 1960s and early 1970s the UK institutions were reluctant lenders to privately owned airlines. As in mainland Europe today, they had the choice of lending to state-owned carriers, backed by Government guarantees that included currency protection clauses. In their lending portfolio, air transport was included with loans to the aerospace industry, which provided another limiting factor. In their search for ‘exit’ routes, lending
Transport Management Vol 2, No 1, pp. 55-57, 1995 Elsevier Science Ltd Printed in Great Britain. 0969-6997/9S $10.00 + .OO
might be limited to seven-year loans, an insufficient period for aircraft finance. Furthermore, the banks lacked the expertise or knowledge of what to do with a repossessed aircraft. However, the advent of ‘tax leases’, which had already been developed in shipping, broadened the lending market. The 1970s were characterized by the competitive entry to the UK market of US and Japanese banks and then by the growth of leasing corporations mainly in the USA, but oddly enough also in Ireland, which is one of the smallest countries in the EC, and geographically right on the edge of Europe. Vendor finance also became available as aircraft constructors sought to widen their market. The availability and sources of finance for the UK airline industry are much wider and easier in the 1990s than they were 25 years ago. I find it difficult to accept Mr Powell’s hypothesis that the two airlines he refers to simply ran out of money, and from that his dirigiste conclusion that there should be more structural regulation for the whole of the UK industry, including cuts in capacity coupled with fare increases. Martin O’Regan A founder director and first Chief Executive, Air Europe (1978-1982); and Finance Director, Davies & Newman/Dan-Air Services (1967-1978)
Can hubbing dent the bottom line?
Sir Hubbing - consolidating traffic flows to meet at a common point for redistribution, thus offering not one but multiple destinations - has become the in-word for airline planners, but it is offered all too quickly as a remedy for the problem besetting the scheduled airline industry: overcapacity. 55
The reality of the airline business
Sir Charles Powell’s contribution to Open Forum in the September issue, 1994 l(3) of the Journal of Air Transport Management needs further comment: in particular, his judgement that the reality of the airline business is such that financial barriers, as opposed to the regulatory barriers, are so overwhelming as not to permit entry to the market. His analysis is mainly concerned with scheduled service entry, but he extends his belief that it holds good for charter airlines as well. The dilemma in this approach is the confusion between the classical analysis of inputs or factors of production, such as capital, which are needed to create a viable business entity, and the type or condition of market that the entity seeks to enter. The UK air transport market is not a perfect market. It is hardly a contestable in market, that a dominant supplier is rarely cajoled by the threat of new UK entrants. Despite the effort of regulators to deregulate, bilateralism is still a major influence. There is, to me, something almost unnatural about regulators being given the task of deregulating. Against the background of this market structure it is perhaps understandable that institutions are cautious in their approach to airline finance. There is also an historical basis to this attitude shown by UK lenders. The rational choice or judgement for new entrants is therefore to tailor their business plans to what the finance market perceives as being correct. To state that Air Europe, and then Dan-Air, failed because they ran out of money raises many other issues. Their management styles were markedly different. Air Europe commenced operations in 1979 with new aircraft, and was immediately
of Air
profitable. It remained so until the mid 1980s when a new business partner was introduced but failed to come up with his share of new capital when the new, extraordinarily ambitious business plans were developed. Mr Powell recounts the figures. The number of management changes was also unusual in such a new operator. However, Air Europe had no difficulty in raising the initial $60 million needed to finance its Boeing 737 fleet. Incidentally, this led to British Airways’ ordering Boeing 737 equipment for the first time. Dan-Air was founded in 1953 by Davies & Newman Limited, a leading firm of London shipbrokers, which had started an air-broking department on the Baltic Exchange. Although Dan-Air grew, particularly after used jet-equipment became available, there were few management changes, but the policy of investing in used aircraft continued. Perhaps this was an inherited attitude from its shipbroking parent, where it was quite normal for owners to invest in ships with a much shorter depreciation period compared with newly constructed vessels. This was a very conservative policy, but obviously led to competitive problems for Dan-Air with the rapidly changing technology of new aircraft. However, up to the early 1980s Dan-Air’s development was not hindered by the lack of finance, and more than 100 aircraft were financed and brought into service. However, in the late 1980s it was perhaps too late for Dan-Air to make re-equipment decisions. In the 1960s and early 1970s the UK institutions were reluctant lenders to privately owned airlines. As in mainland Europe today, they had the choice of lending to state-owned carriers, backed by Government guarantees that included currency protection clauses. In their lending portfolio, air transport was included with loans to the aerospace industry, which provided another limiting factor. In their search for ‘exit’ routes, lending
Transport Management Vol 2, No 1, pp. 55-57, 1995 Elsevier Science Ltd Printed in Great Britain. 0969-6997/9S $10.00 + .OO
might be limited to seven-year loans, an insufficient period for aircraft finance. Furthermore, the banks lacked the expertise or knowledge of what to do with a repossessed aircraft. However, the advent of ‘tax leases’, which had already been developed in shipping, broadened the lending market. The 1970s were characterized by the competitive entry to the UK market of US and Japanese banks and then by the growth of leasing corporations mainly in the USA, but oddly enough also in Ireland, which is one of the smallest countries in the EC, and geographically right on the edge of Europe. Vendor finance also became available as aircraft constructors sought to widen their market. The availability and sources of finance for the UK airline industry are much wider and easier in the 1990s than they were 25 years ago. I find it difficult to accept Mr Powell’s hypothesis that the two airlines he refers to simply ran out of money, and from that his dirigiste conclusion that there should be more structural regulation for the whole of the UK industry, including cuts in capacity coupled with fare increases. Martin O’Regan A founder director and first Chief Executive, Air Europe (1978-1982); and Finance Director, Davies & Newman/Dan-Air Services (1967-1978)
Can hubbing dent the bottom line?
Sir Hubbing - consolidating traffic flows to meet at a common point for redistribution, thus offering not one but multiple destinations - has become the in-word for airline planners, but it is offered all too quickly as a remedy for the problem besetting the scheduled airline industry: overcapacity. 55