How European Airline Consolidation Will Impact Both Sides of the Atlantic

After a series of bankruptcies, some resulting in mergers, the number of players in the transatlantic airline market has shrunk drastically. Across Europe and the United States, pending airline consolidation continues to effect the competitive landscape for carriers. Everyone is watching to witness who will seize the majority of the traffic and potentially dominate the transatlantic airline sector.

Mack Institute executive director Saikat Chaudhuri joined Kenneth Button of George Mason University to discuss the significance of airline consolidation in an interview for Knowledge@Wharton, which was originally broadcast on SiriusXM Channel 111, Business Radio Powered by The Wharton School. They analyzed the recent events taking place across the industry and provided insight on the future impact of these events on consumers.

Listen to their interview or read a lightly edited transcript below.

Saikat Chaudhuri
Saikat Chaudhuri

Loney: A few years ago, we saw quite a bit of consolidation in the airline industry, specifically within U.S. carriers, that has pared down the major carriers and made them run more efficiently. But we could be getting ready to see an even greater type of change in the airline industry overseas. Recently, Air Berlin filed for bankruptcy, and talks have begun with Lufthansa about its acquisition of that airline. Saikat Chaudhuri is Executive Director of the Mack Institute for Innovative Management, and he’s also an Adjunct Professor of Management here at the Wharton School. He recently took a long look at this possibility, airline consolidation, and he joins us here in the studio to discuss it. Also joining us on the phone, our friend Ken Button, who’s a university professor at the School of Policy and Government at George Mason University. Saikat, great to see you again. Thanks for coming in.

Chaudhuri: Great to be back.

Loney: Ken, great to have you with us as well.

Ken Button
Ken Button

Button: Thanks, very nice to talk to you.

Loney: Thank you. So take us through what you were writing about and what we’re seeing over in Europe right now.

Chaudhuri: Sure, and let me start. I’m sure Ken will have a lot of things to say about this as well, but there’s a deal that’s in the works. Negotiations are going on for Lufthansa and a few others like easyJet to take over pieces of Air Berlin. Now I’ll give a bit of context because people may not quite realize why this is so important and how it affects the North American carriers as well. In Germany, there was always a second largest carrier called Air Berlin. We all know Lufthansa, and Lufthansa has bases in Frankfurt and Munich. Air Berlin was strong in Dusseldorf and in Berlin.

Now, Germany’s economy is quite distributed, and Dusseldorf, with its catchment area in the metropolitan region, is actually the third largest economy in Europe after Greater London and Greater Paris from a long time ago. So it becomes really important. On top of that, European airports tend to be slot-constrained. Berlin is, to some extent, because the new airport is not complete. Dusseldorf has been, due to regulatory reasons and environmental reasons, for a long time.

So airlines like Lufthansa, British Airways, as well as others like Air France, have been battling both low-cost carriers, as well as the Middle Eastern airlines like Emirates, Etihad, and Qatar in both the continent, as well as in overseas routes to Asia. They’ve been trying to battle that, and here Etihad had taken an investment in Air Berlin, which was trying to transform itself into a network carrier and battle Lufthansa, but ran into financial headwinds. Eventually, this was sucking up a lot of money, there was mounting debt, and Etihad pulled the plug.

Now Air Berlin, which built a nice long-haul operation out of Dusseldorf on the transatlantic sector, is about to go under. A lot of players are interested in buying it, or at least in getting a piece of it, especially in getting access to the slots. Let me stop at that juncture because that’s a lot of background, and then we can get into the issues.

Loney: Ken, what’s your reaction to this going on right now?

Button: Oh, it’s quite interesting in Europe. We’re talking about Air Berlin, but of course, Alitalia was another rather disastrous investment for the Gulf carrier Etihad; it’s lost a lot of money there. Alitalia has been bailed out until the end of the year with, I think, 600 million by the Italian government to keep it operating. So there’s quite a lot of things going on in Europe. It’s not simply Air Berlin; there’s a movement in Europe, and we could see some new configurations of airlines emerging from it. I think one has to take a little bit beyond Air Berlin and look at it more broadly as a general trend which is happening in Europe. They’ve had deregulation and it’s taken some time for the residue of the old system to disappear. Air Berlin started as a low-cost carrier and it’s failed. Alitalia started as a very major network carrier. So different models, but there’s significant change going on across Europe in general.

“It’s not simply Air Berlin; there’s a movement in Europe, and we could see some new configurations of airlines emerging from it.” – Ken Button

Chaudhuri: Yes, in fact, to add to what Ken’s saying, the first round of consolidation took place with British Airways, for example, taking over Iberia in essence, Lufthansa buying Swiss and Austrian, and Air France taking over KLM. Now, as Ken was saying, that wave is continuing. Virgin Atlantic’s another one where Delta took a 49% stake, and now Air France has taken a stake as well. Brussels Airlines was taken over by Lufthansa, and now Alitalia and Air Berlin are on the block. There’s a massive reconfiguration and round two of consolidation essentially taking place as we speak.

Loney: What has been the impact here in the U.S. with the consolidation that we’ve had over the last 5 to 10 years? It seems that you have now pretty much three or four main carriers and a lot of the regional jet companies are now under the control of the bigger carriers.

Button: The consolidation has taken place in America already with American, US Airways, Delta, Northwest, and United Continental. We’re down to three major transatlantic carriers now, really from the—actually I’m in Europe, so I can’t really say on this side of the Atlantic—but on the American side of the Atlantic. And I think there’s a lot really taking place in Europe. It’s been slowed down because we’re dealing here with airlines which have been traditionally flag carriers. I was in Italy this summer, talking to some of the people engaged in trying to salvage Alitalia, and you still get the feeling that this was an Italian airline, not a European airline. That’s the feeling that prevails across Europe in many places, and it’s taking time for that to evaporate.

Loney: With this potential merger of Lufthansa with Air Berlin and other pieces, U.S. carriers are interested in this as well, correct, Saikat?

Chaudhuri: Yes, absolutely. Like Ken was saying, there’s consolidation on both sides. Now, where people make money is on the transatlantic sectors. At least, they were. There’s a lot of capacity in the market right now. Domestically, there’s a lot of competition from low-cost carriers. Internationally, it’s begun with the likes of Norwegian, for instance, and low-cost subsidiaries of the major airlines like Eurowings, which belongs to Lufthansa, or Level, which British Airways launched. You’ve got these traditional airline alliances, SkyTeam, OneWorld, and Star. They used to enjoy heavy profits in the transatlantic sector, especially on business travel. That’s come under pressure as well.

“These traditional airline alliances…used to enjoy heavy profits in the transatlantic sector, especially on business travel. That’s come under pressure as well.” – Saikat Chaudhuri

So, what’s happening now is that these airline configurations on the individual airlines need to really think about how they want to protect their turf across the pond as well. That’s why people are watching because when you’ve got these European airports major slots becoming available, there’s a risk that these low carriers like the Norwegians could come in and steal a lot of the traffic. Instead, these major airline groupings would prefer to keep it for themselves.

Loney: How much of an impact have these low-cost carriers had over in Europe over the last few years?

Button: Ryanair’s the world’s largest international airline in terms of passengers carried. You’ve gotten, the last few years, the development of the world’s largest international airline. Ryanair flies within Europe and international flights, a very huge impact in Europe. I’m currently in England on business and talking earlier to people today, and they think nothing of just popping off for a day trip or two or three-day trips to places in Europe. It’s a common feature now. It’s become part of life. They’ve become more like bus services within Europe, but they’ve not really branched out outside of Europe very much. They’ve been doing stuff short-haul, usually using either Boeing 72, 73, 7 aircraft, or Airbus 320-style aircraft. Now there’s clearly some fault on the part of these airlines. They’re actually getting into the long-haul market either as players themselves or linking in in some way or another with some of the other carriers already in the market.

Loney: One of the interesting elements you brought up in the articles, Saikat, is the fact that we have seen, and it’s been a concern of the U.S. carriers, of government supported airlines. That’s a concern surrounding Etihad and Emirates and some other carriers. The German government, where this is concerned, is playing a role a little bit, correct?

Chaudhuri: They are, and it’s also due to the same concern. I think the American carriers were the first ones to make their voices heard. In particular, Delta’s former CEO really took the lead in some controversial manner, too, and then the others jumped on. But then the Europeans, led by Carsten Spohr of Lufthansa, were very aggressive in also pushing the government. The German government has made it clear they prefer some national champions and some European carriers as well in order to retain their influence here. It’s actually come up for a lot of debate and discussion in the local press. So Europe’s been conscious.

The EU has taken this up as well. They perhaps haven’t taken as strong a stance as someone like Donald Trump, at least in his remarks. But here the German government, in this particular case with Air Berlin, has also provided a bridge loan. The reason for that is also that national elections [took place in September]. They don’t want jobs to be lost and chaos, and people not being able to come back from their summer holidays. So that’s another political reason, but what I will dare say is that Carsten Spohr of Lufthansa played this pretty well. He’s been an active proponent of consolidation in Europe. Willie Walsh of BA did that with IAG and they kind of made peace with Qatar, who took a small stake, 10, 20% stake in the grouping. But Carsten Spohr’s been doing it. He’s been playing a very nice game, understanding the interests of the government and the different players involved.

“[Carsten Spohr’s] been playing a very nice game, understanding the interests of the government and the different players involved.” – Saikat Chaudhuri

Button: That’s absolutely right. I’d go back a bit further. If you go back to even the 1980s, 1990s, which feels ancient history now, it was quite clear at that time the European Union envisaged the European market having externally about three major players, and it was fostering mergers of one kind or another as far back as then. They sort of see themselves, I think, as being a bit like the United States when it comes to external affairs, and to have a limited number of external players. I don’t think the European Union itself thought of having a German player, or Spanish or British player, but rather to compete in the world, they wanted three large players. That’s what you’ve got in the States now; they’ve probably got that in Europe almost.

Loney: You also mentioned, Saikat, that in terms of the Air Berlin and the bridge loan and trying to keep them up and running, there’s a certain type of customer that Air Berlin has really been focusing on. And it’s important for them to keep this up. They don’t want to lose those people going to other air carriers, certainly, as this whole process develops.

Chaudhuri: Yes, and that’s where the North American carriers come in. The tricky part is that Air Berlin started as a low-cost carrier, but over time tried to transform itself into a traditional network carrier, full-service carrier, at least when it came to the transatlantic markets. It had long-haul services, in particular out of Berlin and Dusseldorf. Berlin’s an important tourist destination but a bit lower yielding because it’s not so much of a business destination.

So [Air Berlin] built up a transatlantic network with the support of Etihad. Now, that was geared towards the business travel, including business class and premium. What Europe has been focusing on a lot is Lufthansa bought British Airways on building up their lower cost platforms like Eurowings, Level; Air France is launching one, too. The problem with it is that’s not consistent with the business clientele. So Brussels Airlines, which Lufthansa recently bought, they integrated it, at least from a holding point of view, into this Eurowings subsidiary, which is the low-cost subsidiary. But it has all the diplomatic travel, the EU traffic, and other business traffic going abroad, which certainly expects a different kind of offering.

In the integration, Lufthansa will have to do some thinking on the back-end in a holding sense, and with the contracts, in order to keep the labor costs lower. They could keep a Eurowings platform, but both with Brussels Airlines and with Air Berlin, they’ll have to be careful. Otherwise they’ll lose the very business traffic they want, especially out of Dusseldorf, and then others will jump into the fray and try and capture that. Like Ken was saying, it doesn’t matter so much in the continental European flights, but it matters a lot when it’s the transatlantic flights.

“You’ve got to beware of diluting your fare base. You’ve got to have very distinct products to make sure you hit the right note for potential customers. And that’s not easy to do.” – Ken Button

Button: Yes, it’s absolutely right. You’ve got to beware of diluting your fare base. You’ve got to have very distinct products to make sure you hit the right note for potential customers. And that’s not easy to do. There’s been ups and downs in the market. It does depend a little bit whether you want to focus more on the business market or more on the leisure market, depending on things like the business cycle. We have been talking in a static sense. Of course, there could be quite a major downturn in the near future in the market that may have other implications. But it’s very, very tricky to actually keep a market if you’re in the airline business because it’s quite easy for someone else to replicate what you’re doing. It’s not a market which is difficult if you’ve got the funds to provide the extra capacity to compete. The crucial thing is whether you’ve got the gates at airports, which is really where I think we started this conversation.

Loney: Let me ask you this: You mentioned Ryanair a little bit ago and the growth that it has seen. What is its take on all of this going on with these carriers, and specifically with Lufthansa and Air Berlin, Ken?

Button: I really don’t know because Michael O’Leary doesn’t normally say very much. They go their own way, they do their own thing, they always have done. Certainly, the Ryanair model has been changing a little bit. It’s becoming a little bit more sophisticated; travelers have more choices and so on. But basically, Ryanair has stuck very much to the European market, but gradually moving out with ties and links to getting into the transatlantic market. And we may well be seeing them make a move in the future. But dealing as a researcher at a university, the airline…you get as much information out of North Korea as you do out of Ryanair. They’re not very forthcoming.

Chaudhuri: Building on what Ken’s saying, Ryanair’s very frustrated right now because Brexit is also happening, so that leads to a little bit of uncertainty around what’s going to happen with the status of Britain and the ability to have free flights, essentially open skies. Ryanair’s complaint is that they’re being shut out. While England has been a fairly open market, both Germany and France have been fairly protected, in large part because the slots are so hard to come by. That’s the case for Heathrow, too, in London, but there’s also Gatwick and Stansted and so forth. As a result, a lot of people want to keep Ryanair out because of their size.

Even in this deal, what it looks like is that Lufthansa wants to take a large piece of it. Then easyJet is the favorite choice to give some other routes to keep some competition alive within the continental European market and to shut out Ryanair. Now, Michael O’Leary likes to complain. One problem he’ll have anyway is that he just wants the slots and not really any piece of this particular target because they’ve got different aircraft types. He’s got 737s. Air Berlin’s got A320s, so that fits with Easy, that fits with Lufthansa Eurowings, but it doesn’t fit with Ryanair anyway. So he wants the slots.

Loney: Ken, as we saw here in the United States, as these mergers kind of play out, what is the expectation of what you think the airline industry is going to be in Europe in the next decade or so?

Button: Well, within Europe, or between Europe and America, it’s not going to change dramatically. There’s a big difference for the type of air traveler. The bulk of the travel within parts of Europe are recreational: north, south, find some sun in the summer for the English, that sort of traffic. So there’s a lot of recreational traffic within Europe which Ryanair caters to, and other low-cost carriers as well. It’s a very, very fluid market. We think of Ryanair, we think of easyJet, but there’s numerous players that enter and leave the market on a very regular basis. So it’s a fluid market.

“The market on the North Atlantic, partly because the traffic is different, is going to stabilize a lot more. We’ve got many more slot constraints in place.” – Ken Button

I think the market on the North Atlantic, partly because the traffic is different, is going to stabilize a lot more. We’ve got many more slot constraints in place. In Europe, it’s quite easy to find a small airport to fly to. Ryanair changes its network very regularly. North Atlantic’s much more difficult, and there’s certain plum routes across there. They love flying into Heathrow, the prices of slots are kept down, and there’s a limited number of them, so there’s a lot of monopoly profit to be made out of utilizing this low-cost facility. I think we’re going to see really three sort of services cross. What we might see is less traffic going indirectly between Europe and America, and perhaps some other countries coming in taking longer-range flights directly. We already have it from the Gulf, but other parts of the world as well.

Loney: That’s seemingly of concern to, as we mentioned earlier, a variety of the U.S. carriers—the impact that some of these airlines coming from the Gulf are going to have here on the U.S. going forward.

Button: That’s exactly right, although the Gulf carriers themselves seem to be not so good at making investments outside their homeland. As we said earlier, they lost a lot of money on Alitalia. We forget, Italy has some major airports which could be, with care, integrated into the network services across the Atlantic. Etihad has not been too successful overseas in its investments. The other carriers, I think, have been fairly cautious in moving forward, but who knows? They’re building more capacity at the major airports in the Gulf and also in Turkey, so they’re going to want some flights to fill them.

Chaudhuri: Yes, I agree with that. And, you know, Etihad’s struggling right now. Even Emirates has some issues. And then with Qatar, basically, it was a matter of joining forces, so they became part of OneWorld and took a stake. There’s another angle to this which we haven’t touched upon, which is the whole anti-trust type of issue and the competitive elements. What we’ve seen in the U.S. in terms of consolidation is that airline profits are really up. They’re doing well. And there’s a lot of discussion around whether prices are a little too high, and Europe’s going through that too as they think about the consolidation piece.

Within Europe, like Ken was saying, it’ll be a little bit easier to find and always have alternatives, especially if the open skies are maintained, also post-Brexit. And then the transatlantic sector, depending on how these Norwegians do. But there are a lot of open gaps that have to be filled somehow. Like Ken was saying, Rome is ripe. Rome is a bit more of a leisure market, so I think this type of a low-cost approach can work, just like Barcelona has. But it’s exciting in a way, I think, how the dice will fall. It’s headed towards that original vision that Ken was talking about, with some major network carriers doing the overseas flights and remaining competitive, and then a whole bunch of players duking it out in the continental European market as well.

Loney: What is the state of competition and potentially moving forward, Ken, overseas, because of all these different carriers?

Button: First of all, let’s go back to an earlier comment. The airlines are vaguely profitable at the moment, by any criteria. Now the later return on airlines is certainly a profit, but it’s not a huge profit compared to other sectors. And they’ve lost money for 30 years or so. So then if you look at the billions of dollars they’re making, as a percentage it’s not very large of the overall cash throughput. So I’m not sure they’re doing that brilliantly. And of course, they’ve had to re-equip, and I think that with the possibility of the downturn in the market, they get hit every time. It’s one of the first things which people cut back on, air travel. So I think that’s a problem. I think the modeling which is taking place with the airlines is becoming a little bit more sophisticated, and I think the thing we’ve not discussed is with the product which consumers will be getting. It’s becoming much more personalized, an aircraft has several different classes on it, the gifts you’re given, the lounges, the frequent flyer miles and that. The product is changing. It’s not just the suppliers, it’s what the customers are being offered, and what, presumably, the customers are seeking if the airlines are doing their job properly. And I think that’s something which often gets forgotten.

Chaudhuri: And that’s a really great point that comes back to, Ken, what you were saying earlier, which is that the real challenge today is matching the right capacity but also the right type of product on a particular route and in a particular market. And that’s dynamic and not just static, to cater to these kinds of travelers and what they need. That’s not easy. So we’re in a proliferation phase in some sense, consolidation phase in another. I think it’ll take some time for these things to settle down, but even then, they keep on evolving.

“The real challenge today is matching the right capacity but also the right type of product on a particular route and in a particular market. And that’s dynamic and not just static.” – Saikat Chaudhuri

Loney: Well, here in the U.S., Ken, obviously if you’ve taken a flight any time in the last few months, you realize that there are very few empty seats on any flight these days. Is that a major concern by the carriers over in Europe as well?

Button: Well, it’s about 84% filled in America, so it’s pretty full-up. In Europe, the load factors are somewhat different because a lot of flights are more seasonal in their orientation by the low-cost carriers, so there’s that element to it. They tend not to have such high load factors, but clearly, they’re very good at pricing in Europe. The people at Ryanair and easyJet are very good at actually squeezing money from the passengers in terms of the structure of the fares they offer and the quality of services they offer. And the market’s essentially the same. You’ve got diverse range of people who want to fly at different times, and they want diverse services. The airlines have rather more rigidity in what they can offer, but usually put their product on the market 6 months before it’s due to be consumed. You can buy your tickets up to 6 months in advance, in other words. So there’s a bit of rigidity on the supply side and quite a lot of flexibility to this dynamism which is much greater on the consumer side. And it applies on both sides of the Atlantic.

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Michelle Eckert is Marketing and Communications Coordinator for the Mack Institute, where she works to engage students, researchers, and corporate partners in opportunities for collaboration. Michelle received her B.A. in Art from Valparaiso University in 2007. Her background includes two AmeriCorps terms of service working to teach mathematics, computer literacy, and job readiness skills to out-of-school youth in Philadelphia, focusing particularly on promoting access to post-secondary education.

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