Cost Competitiveness, the Legacy Airlines and the Gulf Airline Challenge

03.06.2015
By Peter Forsyth

How cost competitive are the legacy airlines, especially as compared to the Gulf airlines? Cost competitiveness is about the ability of an airline to match its competitor’s fares while making a profit. Many of the legacy airlines in Europe, Asia, Australia and now, North America are very concerned that they are less cost competitive than their Gulf competitors, such as Emirates, Etihad and Qatar Airways.
 
In spite of the timeliness of this question, there has been little research done recently on this - detailed studies such as that of Oum and Li, (2008) are now out of date. A useful recent contribution is that by CAPA (2014), which compares Emirates to IAG (British Airways and Iberia) and Virgin Atlantic. This suggests that Emirates has lower costs, though partly this is due to higher stage lengths. The CAPA study also analyses the cost breakdown of the different airlines, and indicates that much of the difference in unit costs is due to lower wage costs.
 
Sources of competitiveness differences
If this is the case, to what extent can the legacy airlines improve their competitiveness and match that of the Gulf airlines? There are several distinct possible reasons for this wage gap- some of these would be very difficult for the legacy airlines to match, but some can be matched. Five of these are: (1) possible subsidies given by governments to the Gulf airlines, (2) different tax rates in the Gulf countries, (3) generally higher wages in the home countries of the legacy airlines, (4) the payment of above-market wages by the legacy airlines, and (5) higher productivity of the Gulf airlines.

There in not much which the legacy airlines can do about the first two of these. Possible government subsidies are a very controversial issue- however, even if all of the claims about subsidies were accepted, the Gulf airlines would still have significantly lower costs with no subsidy (also, many legacy airlines are not subsidy-free themselves). Different countries have different tax systems, and these can work to the advantage or disadvantage of international airlines. For example, the Netherlands has low corporate taxes, and this works to the benefit of KLM. However, the tax regimes of the Gulf countries do help their airlines through lower wage rates.
 
In contrast, there is a lot that the legacy airlines, their governments, and unions can do to address the three remaining sources of lower competitiveness. Consider productivity first. Many legacy airlines, especially those from Europe, are not particularly productive. Several of the airlines themselves are well aware that they are not as productive as the Gulf airlines. For example, Qantas, an airline which has been very much affected by the Gulf airlines, has realised that it has not been very productive, and it is now actively cutting its costs.

Many of these legacy airlines are well aware that they are paying above market wages for their staff. It is not easy for them to reduce wages, since they are often locked in to contracts with their unions. Some have been setting up low cost carrier subsidiaries, such as Lufthansa’s Germanwings/Eurowings, and Qantas’s Jetstar. These subsidiaries pay much less for their labour. 

Finally, many legacy airlines are based in high wage countries. In spite of the fact that international airlines are in the business of moving people around, they typically do not make much use of the international labour market- in the way that their competitors from the Gulf airlines, and a few other airlines e.g. Cathay Pacific do. There are contractual, union and government regulation reasons why this is so. However, some legacy airlines are trying to make as much use of international hiring as feasible.

Options for Governments and Airlines
The legacy airlines of many countries are losing their competitiveness vis-a-vis those of the Gulf airlines. The governments have a choice. One option is to encourage these airlines to address their productivity issues, and allow them to make effective use of international labour markets- in the way that the Gulf airlines have done. Over the longer term this will be the most efficient choice. Another option is to take the protectionist route, which some are now tentatively adopting (de Wit, 2014). This may be good for the airlines, and in particular their staff, but it will be costly for travellers, connectivity and trade. A final option is to do little, and see the gradual erosion of their airlines’ market shares and profits.


ReferencesCAPA Centre for Aviation (2014) “Unit cost analysis of Emirates, IAG & Virgin: about learning from a new model, not unpicking it”, 11 Jan 2014 at centreforaviation.comDe Wit, J (2014) “Unlevel playing field? Ah yes, you mean protectionism”, Journal of Air Transport Management, 41 22-29Oum, T and M Li (2008) “Modelling Cost Competiveness: An Application to the Major North American Airlines”, in D Hensher and K Button (Eds) Handbook of Transport Modelling (2nd Edn), Oxford, Elsevier


Category: columns

 news