From the new issue of the Economist (see http://www.economist.com/node/16271573 ) this fascinating article about the rising Gulf-based airlines. Great news for travelers, and interesting political commentary on their competitors. It is amazing to me that the global recession has not hurt them more than it has. To see the charts and pictures that came with this article, go to the original (online or in print).
Aviation in the Gulf
Rulers of the new silk road
The ambitions of the three Gulf-based “super-connecting” airlines are bad news for competitors but good news for passengers
Jun 3rd 2010 | Dubai
THE view from Tim Clark’s office in Emirates’ new headquarters should strike fear into the hearts of rival airline bosses in Europe and America. Across the way is Dubai Airport’s Terminal 3, which opened without a hitch six months after the botched start-up of Terminal 5 at Heathrow, London’s biggest airport. Both terminals can handle about the same number of passengers—a little under 30m a year—and both were designed and built for the exclusive use of their incumbent flag carriers. But there the similarities end.
Whereas T5 was shoehorned into a cramped site, T3 covers three times as much space. And whereas the Heathrow terminal will never get any bigger, T3 will soon be the largest building in the world by floor space, thanks to a new concourse dedicated to Emirates’ growing fleet of Airbus A380s. When that opens in 2012, the terminal will be able to accommodate 23 of the leviathan aircraft on stand at the same time and handle 43m passengers.
About 42m people a year pass through the airport’s three terminals now, according to Paul Griffiths, Dubai International’s chief executive. Earlier this year it became the world’s third-busiest international airport (see chart 1). With passenger growth running at an annual rate of nearly 20% and capacity planned to reach 90m in the next few years, it will not be long before Dubai overtakes Heathrow.
Even as the existing airport grows, just up the road work on a new, much larger one, costing $50 billion, is gathering pace. When Al Maktoum airport at Jebel Ali is finished in the early 2020s (cargo flights will begin this year), it will be by far the biggest in the world, with five parallel runways and an annual passenger capacity of more than 160m. Emirates will move its entire operation there and the old airport will probably be sold for redevelopment. One of Mr Griffiths’s biggest headaches is deciding how much to invest in assets at the existing airport that are likely to have only a very brief shelf life.
The ambitions of two other Gulf emirates are equally extraordinary. In Qatar, Doha International airport, about 200 miles from Dubai, will open in 18 months’ time with a capacity of 24m passengers a year, rising to twice that in 2015 (see chart 2). Abu Dhabi’s airport, about 45 minutes’ drive from Jebel Ali, aims to increase its capacity to 20m in 2012 and to 40m a few years later. Thus within five or six years there will be more capacity at these three Gulf airports than there is now at Heathrow, Paris Charles de Gaulle and Frankfurt combined. Are these merely grandiose vanity projects, fuelled by more money than business sense? Or do the new airports—and the linked ambitions of the three emirates’ airlines—reflect a fundamental shift in global aviation power?
Probably a bit of both, but much more of the latter. To see why, look at the seemingly unstoppable rise of Emirates, which has provided the template for both Abu Dhabi and Qatar. It began 25 years ago when Gulf Air, a politically contrived joint venture between Abu Dhabi, Bahrain, Oman and Qatar, decided (inexplicably, in retrospect) to cut back its services to Dubai, which was already the region’s transport and trade hub. Dubai’s then ruler, Sheikh Rashid bin Saeed Al Maktoum, responded by asking his younger brother, Sheikh Ahmed, to launch a rival airline. With $10m of start-up capital, a couple of leased aeroplanes (a Boeing 737 and an Airbus A300) and two formidable British aviation executives (Maurice Flanagan and Mr Clark), Emirates was born. After losing a little money in its second year of operation, it has made a profit ever since and doubled in size every three or four years.
Wholly owned by Dubai’s sovereign-wealth fund, it is now one of the world’s most powerful airlines, with 138 planes, all wide-bodied, and 140 more, including 50 A380s, on firm order. Some recession-hit rivals have deferred or cancelled orders, but Mr Clark complains that he can’t get his hands on the new aircraft quickly enough. He sees no problems financing them and is negotiating for even more. By around 2020, Emirates expects to have a fleet of more than 400, dwarfing the long-haul capacity of any other airline. From Dubai, it flies to more than 100 destinations in over 60 countries, reaching every continent.
Sheikh Ahmed, Emirates’ chairman and chief executive, described the last financial year as the airline’s “toughest”. Yet profits rose more than fivefold, to nearly $1 billion, helped by lower fuel prices and other cost cuts. Passenger numbers went up by 21% to 27.5m (see chart 3). Seat load factors improved by more than two percentage points to 78%, even though capacity (measured by available seat kilometres) increased by a fifth. In the same period Air France-KLM, Europe’s second-biggest carrier, made a loss of €1.56 billion ($1.93 billion); embattled British Airways (BA) lost £531m ($758m).
Rivals allege that the secret of Emirates’ success lies in all manner of unfair and hidden subsidies (of which more later). But Mr Clark, the airline’s president, and Mr Flanagan, still there at 82, as executive vice-chairman, insist that it is simply a very lean, well-run airline blessed by its location and Dubai’s pro-aviation policies.
Those policies stem from a conviction that aviation could act as a spur to Dubai’s economy, by facilitating trade, financial services and tourism. At Sheikh Ahmed’s prompting, the government has implemented a highly liberal open-skies policy, encouraging other countries to open routes to Dubai and allowing Emirates to build its network. It has streamlined immigration and visa policies, making it easier for people to pass through or to stay. It has made sure that airport and air-traffic-control capacity have kept ahead of demand. And, unhindered by airport curfews in Dubai and flying mainly long-haul routes, Emirates has one of the world’s highest fleet-utilisation rates: its jets are in the air for about 18 hours a day.
An enthusiastic Mr Griffiths, who has been in his current job since 2007, contrasts his time running Gatwick, London’s second airport, with what happens in Dubai. At Gatwick, he says, “if you wanted to do anything, it involved negotiating with large numbers of different stakeholders: the relationship with the airlines was usually adversarial and local councils were hostile to any expansion of the airport.” In Dubai, government, the industry and consumers’ interests are aligned. “The government’s approach is to say, ‘Whatever you do, don’t restrain aviation in any way.’ To make a major decision here, there are probably no more than four or five people who are needed in the room.”
Location underpins Emirates’ business model. As Aviation Strategy, an industry newsletter, says, the region is a natural “pinch point” between westward and eastward routes. Sheikh Ahmed describes it as being in the middle of the “new silk road”. Nearly 2 billion people live within four hours’ flying time of the Gulf and twice as many within seven hours. Since the arrival of ultra-long-range airliners in the mid-1990s in the shape of the Boeing 777 (for which Emirates is the biggest customer), any two big cities on Earth can be linked via Dubai with no other stops.
Next, Emirates has built a strong presence in “secondary” markets, such as Manchester and Newcastle in Britain, Hamburg and Dusseldorf in Germany or Kochi and Kolkata in India, neglected by airlines like BA, Lufthansa and Air India, which focus on their own hubs. A passenger flying from, say, Manchester to Tokyo may not care whether he changes planes at Heathrow or Dubai, particularly if Emirates can offer a nicer time in transit, a cheaper ticket and a better in-flight experience.
Emirates has also thrived by entering markets in the rest of the Middle East, Africa, South-East Asia, India and Latin America that had hitherto been poorly connected to the global air-transport network because of over-regulation, the absence of a strong local flag carrier and the indifference of established airlines. Mr Clark says: “We had a hunch. As wealth creation spread through emerging markets, more and more people would want to fly.” Emirates has also exploited the growing market for freight to and from such places. Cargo, much of it carried in the belly of its passenger jets, brings in almost 20% of revenue, one of the highest shares in the industry.
Finally, having started with a clean sheet, Emirates has a flat management structure and the kind of flexible, highly productive workforce that carriers such as strike-torn BA and high-cost Lufthansa can only dream of. Although its pilots and engineers are paid at globally competitive rates, most cabin crew and ancillary staff are recruited on lowish wages from the subcontinent and South-East Asia. A locally based aviation consultant says that flight crews are worked right up to the regulatory limits.
Like other workers in Dubai, Emirates’ employees do not pay income tax, which means that gross salaries can be much lower than at European and American rivals. Staff costs at Emirates are around 15% of overhead, against well over twice that for a typical American or European network carrier, says Mr Flanagan.
While Emirates grew and prospered, Qatar and Abu Dhabi, both with far more oil wealth than their pushy neighbour, looked on with a mixture of admiration and envy. Qatar broke from Gulf Air in 1993, having become convinced that the joint venture could not serve its needs, but did not begin to develop its airline as a rival international carrier to Emirates until Akbar Al Baker, a young Qatari, was appointed chief executive in 1997.
Half owned by the Qatari government and half by “private shareholders” (mainly the royal family), Qatar Airways has 82 aircraft, but 180 on order, including five A380s and 80 brand-new A350s, for which it is the launch customer. It is also one of only six airlines to be awarded five stars for the quality of its service by Skytrax, a market-research firm specialising in aviation. Though held back a bit by a delay to the opening of Doha’s new airport, Qatar Airways is poised for rapid growth. In June it will add Barcelona, Buenos Aires and São Paulo to the 90 routes it already serves.
If Mr Al Baker is at all worried that the market may not be able to absorb so much new capacity, he doesn’t show it. He says that he and his local rivals are all growing at double-digit speed and that passenger numbers and yield show no sign of flagging. He thinks there is so much demand in the region that “conventional capacity discipline” is not required. He expects to need 70% of the slots at the new airport and that 75% of his passengers will be in transit there before heading to other places.
When pressed, though, he says there will be “at least two survivors” among the three Gulf “super-connectors”. He adds: “I am very confident of the operating model we have and we are now very profitable.”
However, he promises that whatever his competitors may do, he will not dump more capacity on the market than it can bear. Aviation analysts agree that Qatar controls costs better than any of its rivals, even Emirates.
The new kid is Abu Dhabi’s carrier, Etihad. Set up in 2003 by royal decree, it claims to be the fastest-growing airline in the history of commercial aviation. An $8 billion order for new aircraft in 2004 was followed by the biggest ever at the Farnborough show in 2008. Worth about $43 billion at list prices, it included 100 firm orders, 55 options and 50 “purchase rights”. James Hogan, a bullish Australian who used to be chief operating officer at BMI (a British airline now owned by Lufthansa), ran Gulf Air for four years before being plucked by Abu Dhabi’s government in 2006 to oversee the expansion of Etihad.
Although in many ways Mr Hogan is following the model established by Emirates, there are differences. Abu Dhabi sees the airline as just one part of what it calls its “Plan 2030”, an ambitious attempt to use its huge oil wealth to turn the capital city of the United Arab Emirates into a global hub for transport, financial services and tourism that will be home to 3m people—more than three times its present population. This approach contrasts with the more laissez-faire style that fuelled
Dubai’s astonishing boom and subsequent dramatic (if seemingly fairly brief) bust.
Etihad wants to be known for its quality as much as its size. Mr Hogan says: “Although no airline has ever ramped at the same speed as us, my mandate is not to build the largest airline, but the best in class.” He has made impressive strides in a short time. Etihad has won several international awards for the experience it offers its “guests”, as it likes to call its passengers, and it gives every impression of being a well-run airline that understands what it takes to become a leading brand. What Mr Hogan will not say, however, is whether he is meeting the financial targets set for him by his government shareholder. “I have to make money,” he says, “but the financial crisis and the H1N1 pandemic pushed our break-even out beyond this year.”
According to the always active Gulf rumour mill, Etihad lost $1.2 billion last year and Mr Hogan, under pressure to cut costs, may be looking for a dignified exit, perhaps to become the next director-general of IATA, the airline industry’s trade body. He insists that his deep-pocketed owners are in it for the long haul, but the biggest obstacles in the way of Etihad’s ultimate success are sitting on its own doorstep in the shape of mighty Emirates and the new mega-airport at Jebel Ali.
Abu Dhabi’s oil wealth makes it more than capable of financing its grand plans, which include the Ferrari World theme park, due to open soon, a branch of the Guggenheim museum and world-class hotels with worryingly green golf courses. But the place lacks the commercial vibrancy that has propelled Dubai’s sharp-elbowed aviation industry onwards and upwards. The airport company, ADAC, in particular, seems provincial and a bit dozy compared with its slick counterpart in Dubai.
The next phase of the airport’s expansion—a huge $6.8 billion midfield terminal—is said to have hit design problems.
Whatever Etihad’s local difficulties, the threat from the Gulf to international network carriers in Europe and America and even the Far East (where future airport growth is more constrained and geography less helpful) is real and growing. With tiny populations of their own, they are competing directly for passengers that some other airlines seem to think should be theirs by right. Complaints about unfair competition are becoming more strident as network carriers that have seen their short-haul businesses fall prey to low-cost airlines now fear something similar happening to their long-haul operations.
It’s not fair
In the vanguard of the campaign to blacken the reputation of Gulf carriers is Lufthansa, the most powerful airline in Europe and a prime consolidator in the industry. The list of allegations is long and predictable. The oldest canard is that the Gulf airlines must get subsidised fuel because their government owners are sitting on lots of oil. In fact, Emirates, Etihad and Qatar all pay slightly more for fuel at their home bases than at some of the international airports they fly to because of the lack of refining capacity in the region.
Another is that neither they nor their employees pay tax. That is not quite as significant as it seems. In practice, many European and American airlines pay little tax because they roll over losses from cyclical downturns to reduce their liability in good years. And a corollary of no income tax in Dubai is the lack of social services for expatriate workers. Emirates stumps up about $400m a year to provide schools, health care and accommodation for its staff.
Among other charges made against the Gulf airlines is that they receive government subsidies to finance aircraft orders and that they get favourable deals on landing and other airport charges at their home hubs. Not every Gulf airline is the same, but aircraft are mostly financed in the normal way using international banks, leasing firms and official export-credit organisations in America and Europe. Lenders may reckon that governments stand behind the loans, but the airlines claim that no sovereign guarantees are on the table.
Nor can most European and American network carriers argue they have never received state support, whether as pension-fund contributions or through the farce of operating for years under Chapter 11 bankruptcy protection. As for airport charges, at Dubai International the 126 other carriers that use the airport pay the same fees as Emirates, which by international standards are not especially low.
Another whinge from the European airlines is that from 2012, when Europe’s emissions-trading scheme includes airlines flying to and from European destinations, their non-stop services will be disadvantaged because the Gulf airlines will pay the tax only on one half of a two-leg service. But the European Commission is sceptical whether the extra costs are large enough to make “carbon leakage” a real issue.
For passengers, at least, the arrival of the Gulf super-connectors is unalloyed good news: more routes, lower prices and better service. In particular, the opening of entirely new networks to big, fast-growing but previously underserved cities in emerging economies is both a feature and a stimulant of globalisation.
There are good reasons, such as the scarcity of land and local environmental objections, why cities like London and New York no longer wish to accommodate ever-expanding mega-hub airports. If Dubai, Qatar and Abu Dhabi want to put aviation at the heart of their economies by taking the spillover from growth-constrained airports in developed countries and by building networks that European and American carriers, obsessed with stifling competition through mergers and alliances, could not be bothered with, they deserve not brickbats but applause.