Commission policy Essay
The US Congress adopted an emergency package of measures on 21 September: 1. Direct and immediate aid of $5 billion to compensate airlines for losses directly stemming from the closure of airspace and traffic reduction. This will be a cash contribution, distributed to all airlines according to their available seat-miles operated prior to 11 September. So far, 50 per cent of this has been paid. 2. A further $10 billion will be available in the form of government loan guarantees for airlines.
Loan requests will be evaluated by an Air Transportation Stabilization Board according to criteria “fixed by the President”. It is thought unlikely that airlines will have to provide collateral in terms of title to aircraft, most of which are in any case already pledged to secure existing loans. Only one airline, America West, has so far applied for this support, and is awaiting approval for a $400 million loan. The aid is subject to a freeze on salaries above a certain level until 11 September 2003, and obligations to maintain essential air services.
An additional $3 billion was allocated for safety and security measures from the victims’ compensation fund. Government support also included provisions for: • limits on airline liability
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• a two-year pay freeze for executives of airlines obtaining loan guarantees, if they are already paid more than $300,000 per year. The Government has made it clear that there would be no more congressional handouts to the airlines. In Canada, the Government intends to introduce a tax on air tickers to cover expenditure on increased air transport security measures. The tax, set at C$12 per one-way domestic trip, C$12 for a return United States trip, and C$24 for any other international return trip, will be in force for at least five years, over which time it is expected to generate C$2. 2 billion.
The European Commission approved government support for compensating airlines for the extra cost of insurance incurred since 11 September. This was initially limited to one month, while they looked for a more permanent solution. The Commission did not, however, relax the rules on coordination of schedules and fares, but said it would give favourable consideration to such moves where they were essential to maintain services. It also proposed drawing up a “Code of conduct” with the US authorities to prevent unfair competition. The European Union (EU) aid package also offered the following:
• looking at airline mergers more favourably, and thus allowing further consolidation to take place more easily; • government to help fund the increased security measures at airports; and • airlines will be entitled to compensation for the days that they were grounded following the 11 September attack. EU governments have extended their aid in underwriting aviation insurance in relation to war risk cover for three more months. The European Commission has approved aid granted in this way by the Governments of Belgium, Sweden, the United Kingdom, Luxembourg and Portugal.
There are ongoing discussions between insurers, airlines and governments on establishing an insurance pool in which governments would act as an insurer of last resort. This would mean that governments take on claims if they rise above a certain limit. The European Commission has also relaxed the slot rules – “use it or lose it” principle – for the 2002 summer season. Therefore, EU carriers will receive the same slot allocation in the summer of 2002 as they had in the summer of 2001. The relaxation of slot rules for winter 2001-02 would also appear very likely.
The Commission has also emphasized that the 11 September crisis must not undermine Commission policy or be used by governments as a pretext for “exceptional measures” to grant their flag carriers financial support. The Belgian Government was given approval by the European Commission to lend €125 million to the ailing carrier Sabena for restructuring. This decision is likely to be followed by requests from the Irish, Italian, French and German Governments. Alitalia has asked the Italian Government for 600 to 700 billion lire to cover payments for staff redundancies through the cancellation of the 10 per cent ticket tax.
30 This is in addition to the airline’s receipt of the third and final 750 billion lire tranche of aid that was approved by the European Commission in October 2001, on a “one-time, lasttime” basis and subject to various conditions. Carriers are counting on compensation payments to stay in the black this year. Air France is to receive $70 million, although the airline claims it lost approximately $130 million in ticket sales since 11 September. However, Lufthansa failed to secure compensation from the German Government for the losses (around $150 million) incurred in the four days following 11 September.
Both Japan Airlines and All Nippon Airways have asked for financial assistance from their Government, in addition to underwriting increased insurance costs for six months. They specifically asked for government help with increased security costs. In the Republic of Korea, the Government has asked for parliamentary approval for it to provide “soft” loans of up to 250 billion won ($192 million) to Korean Air and Asiana, as well as tax relief on aircraft purchases and jet fuel imports. The total package is thought to come to over 900 billion won.
31 However, such options are not open to Singapore Airlines and Cathay Pacific Airways. In general, governments seem to be more sympathetic towards airlines, in particular with regard to consolidation. Scandinavian Airlines (SAS) has received approval from the EU and Norway’s competition authority to acquire 100 per cent of Norwegian carrier Braathens. The Japan Airlines merger with JAS has also been accelerated in Japan. Further I am going to discuss alliance and company marketing strategies in response to the crisis.
Owing to regulatory and national considerations, it is through alliances that the aviation industry has so far responded to changing needs of customers and forces of globalization. One of the key questions is how alliances will evolve following the 11 September events. Although alliances offer the benefits of bigger networks, they create uncertainties for investment decisions, entail transaction costs, and impose other limitations that could be overcome by the full integration that is possible in other industries.
Cooperation within alliances poses several challenges to managers: the size of the alliance, the need to intensify cooperation and the harmonization and standardization of common processes, and the search for synergies to reduce costs. However, in times of crisis, alliances do not necessarily prevent stiff competition between the partners. At present, five alliances – OneWorld, Star, Wings, Sky Team and Qualiflyer – stand out as the core groupings around which other airlines with strong regional networks will come together to form worldwide networks and can be described as global alliances.
But they remain fragile creations subject to competing attractions and economic forces. Over the years, several companies have switched from one alliance to another. Austrian Airlines, for example, moved from the Qualiflyer to the Star alliance. Air France has recently floated the idea of creating a Mediterranean alliance with Alitalia and Iberia. To make this three-way deal possible, Iberia would have to leave the OneWorld alliance. Airlines took the various short-term measures that have been described above, but few changed their longer term strategies.
The network carriers did cut out some unprofitable routes, and reduced frequencies on others. The 11 September events provided an important catalyst for such measures, as well as others described above (such as grounding older aircraft and reducing labour costs). In addition to grounding aircraft, airlines also cut all non-essential capital expenditure. Investment in aircraft already contracted for had to be paid in most cases, but investing in other airlines was not considered possible in the short term.
The most common response by airline companies to the crisis has been to freeze recruitment. Other cost-cutting measures designed to avoid laying off core staff include the non-renewal of temporary contracts, probationary staff not being transferred to full-time contracts, greater temporal flexibility such as shorter working time, part-time working and work sharing, pay cuts for management, pay freezes for airline staff of varying duration, pay cuts for non-managerial staff and voluntary furloughs.
Some differences were evident in Europe, for example, in the responses of British Airways and KLM, which both discounted air fares, as compared with Air France, which generally maintained fares, frequencies and services, and took a hit on its load factor. The first two carriers eliminated some unprofitable routes, and reduced frequencies on others. British Airways, for example, discontinued its Belfast/Heathrow service, the crisis subsequent to 11 September providing it with a good reason for a politically difficult decision.
The crisis also provided the catalyst for other measures described above (e. g. the grounding of older aircraft and reducing labour costs). In addition to grounding aircraft, airlines also cut all non-essential capital expenditure. Investment in aircraft already contracted for had in most cases to be paid for, but investing in other airlines was no longer considered as a strategic objective in the short term. Some airlines did consider investing in airlines that became available as a result of bankruptcies.
For example, Virgin Express evaluated investing in a new “Sabena”, and Virgin Blue in a new “Ansett”. In each case they declined. Few of Sabena’s assets have so far been acquired from the liquidator, but Qantas has acquired some Ansett assets to fill the gap left by the demise of the Australian airline. Qantas has, at the same time, significantly increased its share of the Australian domestic market. The Austrian Airlines Group is cutting 12 per cent of its workforce and slashing capacity.
It decided to continue to cut costs aggressively and build on its strength as a niche player in Central and Eastern Europe. Alitalia, as part of its two-year industrial plan, has announced that it will focus its activities on domestic air travel and that it will keep only selected intercontinental routes. Scandinavian Airlines System (SAS) considers that it is in a fight against time to carry out necessary restructuring to be in a position to resume growth in 2003 and avoid being reduced to a regional feeder carrier.
Czech Airlines has dropped plans to expand its fleet in 2002 in view of the decline in demand since 11 September. It will not trim its 30-aircraft fleet but will aim at maximum utilization of the fleet, which means that the aircraft will be operated more frequently and their daily utilization will be higher. Air New Zealand, recapitalized by the Government, has adopted a five-year business plan as part of its survival strategy.
The key objectives are: (i) minimizing cash operating costs in the current financial year; (ii) adapting to lower demand for air travel by reducing the network to a sustainable core in the medium term; (iii) securing distribution in Australia to make up for the loss of feeder traffic caused by Ansett’s collapse; and (iv) ensuring that the airline retains its competitive advantage in its core markets. (D. Riordan: “Air NZ’s delicate balance”, in New Zealand Herald online, www. nzherald. co. nz, 6 Dec.
2001. ) Summing up to the aforesaid, it would be desirable to emphasize, that in fact before 11 September, the industry was already some months into a significant downturn. This was most evident in worldwide air cargo traffic, but the passenger markets in North America and regional operators in Europe were also affected. Similarly, a number of airlines in the United States, Canada, Europe and Australia were in serious difficulties as a result of the fierce competition for a stagnant or declining market.
Airlines in Asia, Africa and Latin America were more sheltered from this competition, and would also be less likely to collapse, given their government ownership and support. The 11 September events caused a much sharper decline in traffic than would have otherwise been the case from a recession, which some experts predict would be moderate and possibly avoidable. Most airlines were also entering their low winter season, when demand is traditionally weak and difficult to stimulate by offering deep discounts.
Thus, by the end of November 2001, traffic in the major originating regions of the world was still well below the same month of 2000, albeit less depressed than for September and October. Forecasts for total world air traffic predict a decline of 3 to 6 per cent for 2001, followed by a fall of between 0. 5 and 5 per cent for 2002. The recovery is predicted for 2003, with estimates of growth of between 9 and 17 per cent. Many of the major airlines reacted by cutting capacity by between 10 and 20 per cent, and similar staff reductions.
Aircraft were retired early or grounded. Cost reductions or concessions were sought from suppliers such as aircraft and equipment manufacturers, banks and leasing companies, and third party maintenance and handling companies. Airport charges vary with traffic levels and have thus been reduced automatically with the decline in flights and passenger numbers. Airlines should have benefited to some extent from lower fuel prices, although some might have been locked in higher prices through hedging contracts.
Because many airline costs are fixed in the short term, sharp reductions in revenues inevitably mean large losses for the airlines most badly affected. Industry operating losses of $11 billion have been forecast for 2001, 2002 and 2003, with net losses after financial charges of $27 billion for the same three-year period. While cash flow is expected to be positive overall, the financing of deliveries of over 3,000 aircraft over this period will result in large external financing at higher margins compared to pre-11 September. (Aviation Strategy, Issue No. 50, Dec. 2001).
The US carriers, most directly hurt by 11 September and its aftermath, received the most in government support. European governments, on the other hand, resisted strong pressure for compensation and help from reduced taxes. In the rest of the world, the Governments of Japan, the Republic of Korea and New Zealand provided aid in the form of soft loans and equity. A major result of 11 September has been a much stronger emphasis on safety and security worldwide, with increased investment and training in all related areas. This is already occurring.
What is not clear, however, is whether changes will be speeded up towards further liberalization of air transport to enable it to restructure and consolidate like any other industry. The European Commission still does not have the mandate to negotiate with the United States on opening up the transatlantic area, and no open skies agreement has yet been announced between that country and the United Kingdom.
1. ATA News Release, Geneva, 30 Oct. 2001. 2. AEA Information Sheet (Brussels), 6 Nov. 2001. 3. Airline Business, Nov. 2001. 4. British Airways News, 6 Dec. 2001. 5. 2002 Global outlook for air transportation, Special Edition (Avitas), Nov. 2001. 6. Peter Spence Morrell and Fariba Alamdari “The impact of 11 September on the aviation industry” 2002 WP. 181. 7. Prof. Peter Turnbull and Geraint Harvey “The impact of 11 September on the civil aviation industry. Social and labour effects” 2002 WP. 182. 8. “Tripartite Meeting on Civil Aviation: Social and Safety Consequences of the Crisis Subsequent to 11 September 2001” International Labour Organization, Geneva, 2002.