BA/AA link-up hits market turbulence

Date: 19/11/1998

By Chris Johnstone

BRITISH Airways' protests that its alliance with American Airlines is not dead but merely sleeping conjures up images of the Monty Python sketch where a pet shop owner tries to sell a deceased parrot to a bemused buyer.

The two airlines have indicated that the alliance could be revived when enough valuable take-off and landing slots at Heathrow and Gatwick airports have been found from other sources to dilute the demands made by the European Commission as its price for clearing the deal.

However, industry sources pour cold water on the idea that it can be resurrected in the near future and hint that the partners might already be casting around for alternative options.

They say a combination of practical problems such as the reorganisation of terminal facilities, the archaic rules governing the aviation industry which mean that governments broker market access for airlines, the Commission's slot-surrender demands, and a market downturn on the horizon have placed too many barriers in the way of a mould-breaking deal.

Some more cynical voices even suggest that British Airways and American's partnership was never sincere but was, instead, an elaborately staged manoeuvre aimed at forcing the Commission to impose tough conditions on rival partnerships which had already taken off.

This is too Machiavellian an interpretation perhaps; but if that was indeed the goal, then the duo can congratulate itself on its success.

British Airways does not expect to realise anything like its wide-ranging ambitions for partnership with American Airlines within five years. It adds that making the practical changes necessary for one airline to 'move in' with the other would take at least two years.

The latest plan does not even include code-sharing - the foundation of most of the rival alliances - since this would probably run into US objections.

However, after coming so far, the two companies are continuing to seek a final ruling from EU, UK and US authorities on what they would have to do to win clearance for a full-blown alliance. "The airlines are just trying to keep some momentum in their deal with the current scaled-down plans. British Airways is afraid that other carriers are circling American Airlines with alternative offers," said one government source close to the alliance saga.

Many of the airlines which met in Berlin last week for the twice-yearly international round of negotiations to pave the way for the 1999 summer schedules will take comfort from the fact that the regulatory conditions for the BA/AA clearance could be filed away in a drawer for a long time to come.

Competition Commissioner Karel van Miert demanded in July that British Airways and American should surrender 267 weekly slots, at least 200 of which should be at Heathrow, in order to win clearance for their alliance. Industry insiders are sceptical about BA's hopes that the Commission's demands for slot surrender will be diluted over time.

BA suggests that rivals' requests for slots could be met through the normal process of slot rotation or the special circumstances of a new aviation deal between the US and UK. However, only a handful of slots at London's congested airports - and much fewer at peak times - are made available every year. BA itself estimates that around seven new slots a year become available at Heathrow.

Industry analysts believe that BA and AA cannot hope that the natural process of slot turnover will solve their problems, especially since companies are being encouraged to hold on to slots by the belief that the EU could eventually agree new rules which would allow airlines to sell them.

British Airways is also hoping that a new bilateral deal between the US and UK will help to secure it a lower-cost alliance, in terms of slots, than currently proposed by the Commission. Its ideal scenario would be for a new bilateral accord to set off a big bang in transatlantic airline competition, with existing carriers and newcomers providing the slots for these services by juggling their existing routes.

KLM could, it is argued, drop some of its less attractive European routes and free up slots for new flights to the US for itself or its alliance partner Northwest. After a decent interval, and once the dust had settled, BA could be called on to deliver some slots; but nothing like the number currently being demanded by the Commission.

However, a new US-UK bilateral deal still appears to be a distant prospect after the two sides cut short discussions at the start of last month.

The latest halt in the slow-moving talks, which have been going on sporadically for more than two years, was triggered by the UK's rejection of the American offer: its standard off-the-shelf 'open skies' agreement which has been signed by most other EU governments.

The UK, believing it has a stronger hand that most of its European neighbours since London is the jewel in the crown of the transatlantic aviation market, is holding out for more.

British Airways has tried to put a positive spin on events, insisting that the negotiations were "premature". The airline's government affairs gurus are not, however, hazarding a guess on when a new bilateral agreement will be finalised. There is, in fact, little urgency since the existing accord can continue indefinitely.

Meanwhile, the US is pressing ahead with new open skies deals elsewhere in Europe, despite the Commission's recent decision to launch action in the European Court of Justice against those EU governments which have already signed such accords. An informal deal with Italy was sealed last week and Spain is likely to be next in line.

The bid to strike a new UK-US agreement is not the only imponderable in the alliance equation. The downturn which everyone is expecting in the aviation market has also been a contributory factor in dampening alliance fervour.

Although the cost savings resulting from the BA/AA alliance would look even more attractive in a downturn, the two admit that inviting other airlines on to transatlantic routes - adding extra capacity and forcing fares even lower - is the last thing they would want during a recession.

"The economic downturn helped to make the Commission conditions appear even more expensive than at first. In a growing market, it would have been easier to do," said Chris Allen of British Airway's government affairs department.

The warning signs of a downturn were confirmed by figures for the three months from July to September this year which showed a 4.1% fall in British Airway's yield (the airline measure of profitability) with fewer passengers paying top fares.

"There are signs of airlines taking capacity off Asian routes and putting it on to transatlantic ones," said Allen.

Analysts agree there is a discernible trend, with Paribas Capital Markets aviation analyst Chris Avery reporting signs of "too much overcapacity on the north Atlantic". But they bemoan the lack of clear figures.

In the US, the thin margins on international flights are forcing airlines to take a second look at expanding their home markets and sealing fresh deals with their domestic rivals.

This could spell more trouble for the BA/AA alliance. Although Washington recently blocked Northwest Airlines' plans to take a controlling stake in Continental Airlines, another round of US aviation industry consolidation is believed by analysts to be overdue.

The transatlantic deal could be the first casualty if American Airlines were to be caught up in such developments.