Airline profitability unlikely to be experienced before 2015

It is widely acknowledged that business follows the flag. But such has been the turmoil caused by the economic crisis that Lufthansa has decided to adopt a wait-and-see attitude, meaning this time the flag will follow business. Which does not mean the German airline is sitting pretty.

In a way, the forecasts made at the so-called Lufthansa Summer Academy in Seeheim, outside Frankfurt, echoed what Giovanni Bisignani, director-general and CEO of the International Air Transport Association, said in IATA's annual report for 2009, released in June.

Air transport, he predicted, would be a smaller industry for at least the next few years. "The challenge is to reshape and resize for profitability. To start, airlines will need to carefully match capacity with demand. The task will be made more difficult by the planned delivery over the next three years of 4,000 aircraft ordered in more optimistic times. The results of the last months show that airlines that acted fast and most aggressively are reaping the benefits."

Wolfgang Mayrhuber, chairman of the executive board and CEO of Deutsche Lufthansa AG, made a surprise appearance one evening during dinner. His brief off-the-cuff address was an incisive one all the same. This was his bottom line: We must change our cost structures to respond to declining consumption. There will always be mobility but that is changing."

No doubt, he was enunciating group-wide philosophy. Indeed, at the table where I was sitting, Karsten Benz, Lufthansa's vice-president sales and services Europe, was making that very same point.

We must be flexible. Traffic (volumes) will return to 2008 levels in 2011-2012 but revenues will take longer to recover, possibly not before 2015, he kept insisting.

Yet, the sentiment expressed throughout the two days of the academy was not one of doom and gloom. Indeed, it was one of hope and the speakers did not only come from Lufthansa. They also included the vice-presidents marketing of Rolls Royce and of Boeing Commercial Airplanes.

Things had been looking good for the aviation industry until the economic crisis struck. IATA had been forecasting constant growth every year up to 2012, ranging from 4.7 per cent to five per cent. But the whole scenario then changed, with IATA's predictions being revised downwards, ranging from -10 per cent to -12 per cent in the period under review when compared to original predictions.

Dr Benz notes that the crisis did not only affect the number of people travelling but also how they travel, and this is no more pronounced than in premium traffic. A slide in his presentation indicated that, in 1990, 58 per cent of the load on short-haul flights would consist of business passengers, the rest flying economy.

This dropped to 25 per cent in 2000 and to just nine per cent this year. On long-haul flights, the share of first/business class to economy dropped from 26 per cent in 1990 to 16 per cent in 2000 and rose to 18 per cent this year. Overall, premium traffic in June this year fell by 31 per cent over a year earlier.

"Will premium travel as we used to know it before the economic crisis return? We really cannot say and it's not in us to speculate. Perhaps long-haul it will, but not necessarily short-haul. Yet, we must be flexible enough to be able to react to customers' decisions, whatever that may be," Dr Benz says.

He lists how Lufthansa plans to be prepared: maintain pole position in terms of innovation and quality; implement flexible price and revenue management; ensure product diversification to suit different target groups; aim for organic growth (as was the case with Lufthansa Italia) and non-organic growth (such as Brussels Airlines, Austrian Airlines and BMI); practise smart cost management and, finally, lay stress on brand and people.

Lufthansa, he points out proudly, cut costs by €1 billion by "going back to simplicity.

We are an old company, so we need to assess all operations to ensure good value for money.

It is all about smart cost management, not control in German fashion!"

Ironically, 9/11 or, rather, its aftermath, is what is raising hopes in the civil aviation industry. The terrorist attacks in the US on September 9, 2001 were followed by a sharp decline in airline traffic but the pick-up was just as marked. The same is expected to happen this time, only it is possible the business will take longer to recover.

Drew Magill, Boeing's vice president marketing, put it this way: "We thought we would never get over 2001 because of security costs and long waits for security checks. But we did. We are confident the same will happen this time around."

He spoke so confidently, even if his presentation did not contain much good news. The economic downturn has hit the bottom but the speed of recovery remains uncertain. World traffic growth is contracting. Losses in the aviation industry are forecast in all regions of the world, ranging from $0.5 billion in Africa to $3 billion in Asia and $9 billion globally. Oil prices rise in anticipation of a global economic recovery and airlines are reducing capacity on most flows.

And yet, Mr Magill reported, only three per cent of in-production aircraft are parked and over the next 20 years - until 2028 - airlines will need 29,000 new aircraft valued at a whopping $3.2 trillion.

It may look like a very big number of planes and it surely is. But consider this. Almost 2,000 Boeing planes fly in Europe alone every day, carrying almost one million passengers. A slide in Mr Magill's presentation indicated that at 7.09 a.m. last March 5 there were 12,532 flights in progress around the globe.

In the next two decades, Boeing forecasts that the world fleet will nearly double and older airplanes will be retired. The majority of flights will be on single-aisle airliners.

Air traffic within Europe is expected to grow by 3.4 per cent annually between now and 2028. European airlines will need 7,330 new planes by 2028, meaning that almost all existing aircraft will be replaced.

Airlines, Mr Magill insists, will continue to adapt to market realities and position for recovery. And Boeing is firmly positioned to provide the market-driving products and services needed for the challenging environment and recovery. His opposite number at Rolls Royce, Robert Nuttall, is on the same wavelength.

"I don't wear a tie; that's marketing. But I wear a jacket because that's strategic," he tells his audience to explain what his role is about. Then, as if to explain what a tough job he has, he quickly adds: "It's really complicated out there."

Many, older, less fuel-efficient aircraft were retired last year. Indeed, 2008 was a record year in terms of planes that were taken out of service. Mr Nuttall does not tire stressing the attention airlines give to fuel efficiency. He even shrugs off the usual figures mentioned in terms of CO2 growth in the aviation industry, insisting this actually stands at about two per cent.

He explains that the mistake that is made when working out CO2 growth is that only the increase in capacity is taken into consideration rather than fuel consumption, "and planes are becoming more fuel-efficient".

And fuel costs are crucial when Rolls Royce is working on new engine designs. Indeed, a number of projects are being studied by RR engineers, three in particular: Option 15 - advanced turbofan; Option 20 - integrated turbofan system, and the open rotor.

The open rotor project seems to be attracting a lot of attention for a number of reasons: it offers 25 to 30 per cent better efficiency when compared to turbofans in service; 10 to 15 per cent better efficiency when compared to any advanced turbofan (ATF); is quieter than present aircraft; meets Stage 4 noise requirements; 20 per cent lower nitrogen oxide when compared to any AFT and, furthermore, RR claims that a single open rotor powered aircraft saves the same amount of CO2 as planting 250,000 trees.

The aim of the open rotor is to secure turboprop efficiency at much higher speeds (Mach 0.75 to 0.8). The plans are to start flight-testing the open rotor sometime around 2013, with entry into service following in 2020.

There are many choices and a lot of decisions to make. One wrong move and the results could be catastrophic. Nico Buchholz, Lufthansa's senior vice-president, fleet management, spoke of targets, which are really decisions all the way. There is the pursuit to improve passenger comfort (including cabin flexibility), safety, reliability and environment protection. And there is also the need to cut fuel consumption, weight, manufacturing and maintenance costs and cockpit and cabin crew workload.

It's a delicate balancing act. On the one hand, airlines must offer the best possible product to attract clients and, on the other hand, they must cut costs to ensure profitability.