Introduction: Gulf's aviation market matures

06 November 2007
While the big three Gulf airlines are taking an ever larger share of the global market, and the region's new low-cost carriers have got off to a profitable start, many others in the industry are struggling to find a niche.

The Gulf's top three carriers are now major players in global aviation. Respected and feared by their international competitors, they are claiming an increasing share of the prestigious long-haul market. Within the region, the low-cost market is also burgeoning, with a host of new economy carriers coming to the market in recent years.

Despite these successes, the profitability of the sector as a whole remains poor and doubts persist over the sustainability of the recent extraordinary growth.

For the big three Gulf carriers, 2007 has been another landmark year. Emirates Airline, Etihad Airways and Qatar Airways were the stars of the Paris Air Show in June, each placing huge orders for new aircraft in a series of lavish spending sprees. These deals were in stark contrast to Bahrain's Gulf Air, which has announced deep cutbacks to plug the holes in an operation that was haemorrhaging cash at a rate of more than $1 million a day. The Gulf's aviation elite has been reduced to three.

Predictably, given their pre-eminent position and financial strength, the three main Gulf carriers are no longer looking over their shoulders at the regional competition. Instead they are targeting ever-greater rates of growth and a larger international market share. Indeed, Emirates expects to become the world's largest airline by 2015. Given the Dubai-based carrier's achievements since launch, and its enviable financial position, few would bet against the company meeting that target.

'It is not the other Gulf carriers that we see as competition,' says James Hogan, chief executive officer of Etihad. 'It is the European and Asian hubs that we want to take traffic from.

'Since we launched there, our Sydney traffic has been a real winner to the point where we are starting a second Sydney service later this year. Sydney to Abu Dhabi to London is the most convenient way to link the two. All the directional traffic west from Asia passes over the Gulf. This is the main thing driving the growth of Middle East aviation the shift in the traffic over the hubs and the huge change in the quantity of revenue from this.'

Advantageous location

Location is of course critical to the success of the Gulf carriers. The advent of next-generation long-haul aircraft, such as the A380, the Boeing 777-200LR and the Boeing 777-300ER ULR, will soon put the Gulf within reach of any destination on earth in a single journey. With the vast but underdeveloped markets of China and India now being targeted by the world's major airlines, the three big Middle East carriers are perfectly placed to shuttle the huge volumes of passengers and freight anticipated between Asia and the West in the coming years.

'The Middle East's geographic position with 2 billion people within the radius of a five-hour flight enables it to act as an air crossroads for passenger and cargo flows across the globe,' says Tim Clark, president of Emirates.

Emirates' service to Beijing, launched in 2006, was oversubscribed from the start. Etihad begins services to the Chinese capital in the first quarter of 2008 and expects a similar response from the market. From their hubs in the Gulf, the airlines provide excellent connectivity with Africa and Europe.

A report released in 2006 by Airbus forecasts an annual growth rate of 6.27 per cent in passengers and revenue within the Middle East between 2006 and 2025, compared with a 4.8 per cent global average. The aircraft manufacturer predicts that more than 1,000 aircraft will be required to meet this need. Given that Emirates alone currently has firm orders for 112 aircraft, a shortfall in future capacity seems unlikely.

But despite this rapid growth and the pervasive optimism of the Gulf, profitability remains a distant prospect for many Middle East airlines. Although their share of the global aviation market doubled between 2003 and 2006 to 8 per cent of total passenger traffic, according to the International Air Transport Association (IATA), many Middle East airlines are struggling financially. In September, the IATA slashed its 2007 prediction of total profits for Middle East carriers to $200 million from $500 million.

With few financial records publicly available, it is difficult to make assessments of individual businesses. But as Emirates' results state that it made net profits of AED 3,096 million ($843 million) from the airline and its associated business in 2006/07, if the IATA figures are correct, the other carriers in the region are more than $600 million in the red.

Small populations

While Etihad and Qatar Airways admit to making losses, their share of the long-haul travel market is growing rapidly and both expect to break even by 2010. However, questions remain over the sustainability of growth in flights within the region, given the relatively small populations of the Middle East. Although the emerging low-cost carriers have started brightly, tapping into the appetite for business traffic and the developing market for expatriate workers, some industry observers have queried how long this will continue.

Citing the same Airbus report, Gilles Duquet, a partner specialising in aviation at French law firm Gide Loyrette Nouel, is sceptical about the growth of the region's low-cost carriers. 'I am not sure that the low-cost airlines will develop that far,' he says. 'Pilgrim traffic and business will be their core markets, but the internal market is not huge and is only predicted to grow by 4 per cent in the Middle East, below the global average. Middle East growth is based on the international market.

'There are a large number of airlines, many of which are not profitable. I can see a time in the future when the region enters a phase of mergers and acquisitions.'

Companies are adding new capacity at a time when airlines are contending with a range of rising costs. Record-breaking fuel prices and a shortage of skilled labour and qualified pilots have driven up wages and put severe pressure on the bottom line. An airline that has not correctly identified its market and aligned its operations accordingly could find itself in deep financial difficulty, and while its government may continue to bail the company out, its reputation may be irrevocably damaged.

The example of Gulf Air should be a salutary lesson to other carriers. The fall of Bahrain's national airline from the elite of Middle East aviation has been precipitous, although the business is ordering new planes and talking of renewed expansion. However, it is unlikely ever to properly compete again in the prestige long-haul market, and is modifying its ambitions accordingly.

Mouna Moussi, industrial affairs director at the Arab Air Carriers Organisation, says some of the regions strongest and weakest airlines can be found in the intermediate market between the large international and local budget airlines.

'In some ways, the different markets complement each other, but we will get to a situation eventually where only the strongest survive, and it will not necessarily be the biggest airlines that will be fittest,' she says.

'Small carriers may be strongest to survive within their markets, while among those airlines serving niche markets, you find some that are well-run and others that are not.

'An airline like Royal Jordanian, for example, is not huge but it is well run. It fits well within its market and is financially strong.'

Niche market

Ultimately, though government pride may prevent some from collapsing, Middle East airlines will have to find their niche to remain viable businesses. The recent management changes at Kuwait Airways (see feature, page 55) demonstrate that government benevolence for a failing business is not inexhaustible, even when that company is a flagship carrier.

The big three carriers appear set to continue their global expansion, while the start-up low-cost airlines, without the burden of old legacy systems and a large residual workforce, can be more nimble in managing their costs. It is in the middle ground where companies must act to avoid falling further behind.

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