The persistent economic downturn is nullifying capacity gains the U.S.-EU Open Skies agreement brought to the transatlantic market last year, as a soured demand environment has turned carriers to reverse their 2008 capacity surge between the United States and the European Union.
However, the magnitude of the transatlantic cuts is likely not enough to mitigate the ongoing deterioration in demand, particularly the dwindling appetite for premium class travel, airline analysts said. That suggests pricing power among transatlantic airlines is poised to weaken, giving corporate travel buyers with significant volume a degree of further negotiating leverage.
For the first time since the first quarter of 2003, European capacity will be down across short-haul and long-haul markets, said UBS European airline analyst Tim Marshall in a report issued last month. However, he noted that European carriers have lagged in capacity reductions when compared with their U.S. counterparts.
The transatlantic air travel market in the first quarter of 2009 will shed nearly 6 percent of its capacity, compared with the same period last year, according to UBS. That is nearly a point higher than OAG first-quarter capacity data pulled in December. The reduction is surprising, given that new service flooded the market in the second quarter of 2008, after the enactment of Open Skies. Capacity between North America and Germany, Switzerland and the United Kingdom will see the biggest reductions this quarter.
In April 2008—the first full month operating under the Open Skies agreement—scheduled flights from Europe to the United States grew from 2007 levels by nearly 10 percent. More than half of that involved London's newly unrestricted Heathrow Airport, the focal point of many carriers' new service
(BTNonline, April 28, 2008).Just as London was the beneficiary of the transatlantic capacity surge, it now is disproportionately scaling back seats, "with capacity from London to the U.S. down around 20 percent," UBS's Marshall said in a research note.
British Airports Authority data show transatlantic capacity from Heathrow increased by 19 daily services last summer, representing 20 percent capacity growth from 2007.
"Subsequently, there has been market retrenchment," BAA said last month, citing Virgin Atlantic reducing New York frequency, Air France killing Los Angeles service and Northwest halting Seattle service.
Marshall noted that American, United and Northwest are among the leaders in pulling back transatlantic European capacity this quarter. That includes American "taking 17 percent out of the U.K. market," making the carrier "the major loser from the Open Skies deal, which opened Heathrow to Delta, Continental, US Airways and Northwest," Marshall said.
"Arguably these cuts are not taking place quickly enough or on a sufficient scale," he said. "Further capacity should and will come out of the European market this year. We expect the industry revenue outlook to deteriorate in 2009, which should lead to businesses pulling back capacity or ceasing operation."
Transatlantic premium demand in the past year has taken a marked hit as corporations tighten belts and the financial services industry—a longtime loyal patron of the front cabin—cuts employment and travel.
"We started to see a softening in premium cabin trends way back in the spring of 2008, and that certainly grew as we went through the year. We're currently operating in about that area today," said United COO John Tague during the carrier's fourth-quarter earnings call last month.
Delta president Ed Bastian said, "Internationally, we've also seen a slowdown in demand. Booked load factors are down seven to nine points for the February and March periods with most of the weakness being in the transatlantic, especially connecting financial centers like JFK to London."
In the past month, Delta canceled Seattle-Heathrow and Detroit-Gatwick service, and removed its second daily from Atlanta to Gatwick, according to Delta executive vice president of network planning and revenue management Glen Hauenstein.
"The laggards are really in the London market, where the financial services and the front-end cabin has taken a beating. We've taken some very aggressive scheduling actions to mitigate that," Hauenstein said.
Continental president Jeff Smisek during the carrier's fourth-quarter earnings call last month said transatlantic bookings are up to 7 points behind where they were last year, noting "significant degradation of front cabin" revenue. "Our transatlantic operation is suffering the most from this phenomenon. The back cabin is holding up much better as many international business travelers appear to have shifted their flying from the front to the back."
The International Air Transport Association in a report released last month, said that by November 2008, "following the collapse in the banking sector in September," premium passenger traffic on the North Atlantic declined 9 percent from the same period in 2007. "Further declines in premium travel should be expected," IATA said.
Tague said, "As corporations are tightening their travel budgets, we are seeing a double-digit decline in international premium traffic, year over year." He said passenger revenue in the fourth quarter on the Atlantic was down modestly, even as the carrier increased overall transatlantic capacity by more than 2 percent. "Our results were particularly impacted in the London market, where passenger unit revenues were down 4 percent," he said.
Tague said United in the past year has reconfigured about 25 percent of its international fleet to reduce premium seats by more than 20 percent, as front-of-the-plane demand has plummeted.
Advito vice president Bob Brindley said carriers are taking the capacity out of the system to try to maintain a grip on pricing. "They're going to do that before cutting fares where they can," he said. "We've seen on the North Atlantic some price competition and promotional fares."
Advito, BCD Travel's consulting unit, revised its 2009 transatlantic pricing outlook downward, noting "fare actions and promotions that could mean potential year-over-year fare reductions" on specific routes.
"Except for promotional fares in certain markets, in general the mainline carriers are going to approach the drop in demand with capacity cuts. If they have to compete on price, they're going to compete via their top corporate customers because they can see marketshare improvements or build in some marketshare commitments from those clients in exchange for that pricing," Brindley said. "They're going to do those types of non-published discounts before they go to the last resort, which is to cut the published fare. It does open up some opportunities in negotiations, but I wouldn't overstate that. The airlines realize that while fuel prices have come down and relieved some of their pressure, they are very concerned about this drop in demand and they want to manage their capacity as much as possible."
Air Transport Association data show yields—a per-mile measure of airfares—grew steadily last year across the Atlantic but witnessed its first drop of the year in December, falling nearly 4 percent from the same period in 2007. Still, overall transatlantic yields among the largest U.S.-based airlines grew about 7 percent in 2008 over 2007.
UBS's Marshall expects transatlantic yields to reverse their growth this year.
"We are assuming that yields return to levels seen in the early 1990s and don't assume a significant bounce back in 2010," Marshall said, "which has been the reality in previous downturns."