Airlines to Ride out the Recession

However the boost to growth in domestic airline passenger numbers provided by post-deregulation fare cutting is in danger of being lost unless the Australian economy begins to show significant signs of recovery in the latter part of this year. Growth in the economy remains the most important factor influencing passenger numbers and an early end to the recession is required to sustain the current high levels of activity.

However, when assessing the impact of post-deregulation fare cutting on traffic levels thus far and in the future, it is important to bear four points in mind.

Firstly, in the greater competitive environment brought on by deregulation and with airlines fighting hard to establish market share, the depressed economic situation and modest forward bookings has forced the airlines into protracted fare discounting in an attempt to fill otherwise empty seats. That is not to say that fare discounting will “disappear” once the Australian economy picks up. However, with accelerating economic recovery the need to fill a significant number of otherwise empty seats on an ongoing basis will be reduced, enabling airlines to discount fares more selectively.

Secondly, there seems little doubt that many of the passengers flying on discount fares are satisfying a pent-up demand to make a once only trip to distant locations such as Perth, or bringing forward future travel plans. Therefore the market response to discount air fares is likely to “soften” as short term travel plans are fulfilled.

Thirdly, no matter how low air fares are, people only have limited time and a fixed budget for discretionary travel. In this respect the airline market is similar to other sectors of the economy – even with very low air fares on offer, Australians are not going to fly in large numbers if household budgets are tight and employment is insecure.

Finally, research undertaken by Australian Economic Advisers (AEA) suggests that only around 25% of the passenger market fly on tourism related routes where travel could be considered truly price responsive (that is, price elastic in the jargon of economists). This is an ultimate limitation to the ability of fare cuts to stimulate the total market size in the longer term. It is thus interesting to speculate on future growth in the Australian domestic air passenger market, the likely distribution of this growth and some possible implications for the nation’s major carriers.

The demand models for individual domestic routes AEA has developed over recent years have shown that market growth is driven by four major variables, namely, real air fares, the real level of economic activity, the real price of alternative modes of transport and the level of inbound foreign tourism.

The modelling work clearly suggests that the level of Australian economic activity is the most important determinant of market growth and this is increasingly so in the longer term. In the long term, the growth on over 50% of routes will be driven solely or primarily by growth in the Australian economy. In passenger terms this means that about 75% of the total market travel on routes where economic activity is the most important factor governing growth.

AEA has forecast that the total size of the passenger market will be 14. 7m in 1992 [all years are calendar years] compared to the 12. 9m passengers carried in 1990. Some interesting insights can be drawn when the expected distribution of this growth is considered according to a number of important network submarkets.

The overall growth rate forecast for the Australian market as a whole is largely dependent on expected growth along the so-called ‘golden triangle’ extending along the eastern seaboard from Brisbane to Adelaide, including Canberra. Routes between these centres account for 60% of the total passenger market and include all routes within the “top 10” with the exception of services linking Melbourne with Hobart and Perth respectively. Collectively, the total number of passengers carried within the Golden Triangle is forecast to increase at an average rate of over 6% per annum in the short term (ie. to the end of 1992).

The transcontinental services linking Perth Melbourne and Sydney have provided a cornerstone to Compass Airlines’ successful entry into the domestic network. This strategy would appear to have been well founded with the strong growth on these routes evident thus far expected to continue. Together, passenger numbers on these two routes are forecast to increase at an annual rate of almost 11% in the short term.

Another market expected to continue growing strongly in the short term is the Red Centre. Both Australian Airlines and Ansett Australia substantially lifted the capacity offered on routes to and from central Australia from early 1991, which resulted in Eastwest withdrawing from one of its key markets. In the short term, the routes linking the Red Centre with Cairns and Sydney are forecast to collectively grow at an average annual rate of about 12%.

The North Queensland market is one of contrasts. While traffic levels are expected to continue to remain relatively flat at Mackay and Townsville, the Cairns market, another targeted by new entrant Compass Airlines, is forecast to continue growing strongly in the short term.

The one distinct market segment where a relatively modest rate of post-deregulation growth is forecast in the short term is Tasmania. Average growth of about 3% is forecast for the group of routes linking Hobart and Launceston with the mainland. Here it is interesting to note that this is perhaps the only market where intermodal competition has strengthened in the deregulated environment with the commencement of the Sea Cat services across Bass Strait.

When the short term forecasts are brought together according to an airport basis, the FAC’s airports (which is the focus of AEA’s recent research) fall into three distinct groups.

The first is the nation’s four busiest airports, Sydney, Melbourne, Brisbane and Adelaide, where short term growth in passenger numbers of between 5. 6 and 6. 6% is forecast.

The second group includes three centres where leisure travel is likely to be more important, namely, Perth, Coolangatta and Alice Springs. This group also includes Canberra which, among other things, is benefiting from the introduction of high frequency ‘shuttle’ services to both Melbourne and Sydney. Passenger numbers are forecast to increase at an average annual rate of between 8. 8 and 12. 6% in the short term at these airports.

Finally, the group of “other” airports owned and operated by the FAC are forecast to record short term passenger growth of up to 3. 2% per annum, with the exception of Darwin where average annual growth of 6. 4% is forecast. Other airports included in this third group are Hobart, Townsville, Launceston, Mt Isa and Tennant Creek.

One of the major question marks raised concerning the wisdom of deregulation was the ability of the Australian network to support more than two major operators. Using the market size criteria alone, passenger growth recorded to date and that forecast in the short term suggests that the Australian market can comfortably support the third major operator, Compass Airlines.

A key assumption of the initial Compass business plan was to capture 10% of the Australian market, requiring that Compass obtain around 20% of the market on each of the routes the airline flies. Figures for the June quarter 1991 suggest Compass is well on the way, holding just over 8% of the total market.

If Compass maintains a 10% share of the total market throughout 1992, AEA’s short term forecast suggests Compass will carry about 1. 5m passengers in the full 1992 year. On this basis, Australian, Ansett and Eastwest will together carry 13. 2m passengers in 1992, which is about 2% more passengers than these airlines carried collectively in 1990. In other words, the Australian market is growing sufficiently fast to allow the new entrant airline, Compass, to establish its market share, whilst still providing some growth for the long established carriers.

Two important qualifications regarding this result are relevant. In particular, the available growth for the long established carriers is measured against the 1990 result, which was a very poor year for an industry still feeling the effects of the protracted pilots dispute. Furthermore, the outlook for all airlines would deteriorate rapidly if another new entrant successfully begins large scale domestic airline operations. While Transcontinental is nowadays most often mentioned as the most likely potential start-up operator, names synonymous with potential new entrants in the early years of deregulation hype such as Southern Cross Airlines and Capitol Airlines still have active management teams while most recently AAA Airlines has also signified its intentions.

In the longer term somewhat more modest rates of growth are forecast. The total size of the domestic passenger market is forecast to increase from the 12. 9m in 1990 to 20m in the year 2000 and 29m in 2010. The forecasts imply an average annual increase of 4. 2% over the entire 20 year period to 2010 but with a higher than average growth rate expected until 1995 (that is, 5. 4%).

The long term growth forecast is well above actual growth across the 1980s (1% per annum), but is less than the average growth of 6. 5% per year recorded during the last upswing in domestic aviation activity from 1983 to 1988. At the nation’s busiest airports (Sydney, Melbourne, Brisbane and Adelaide), long term average annual growth is projected to range between 3. 2% and 3. 8%.

The airports expected to achieve the fastest growth in passenger throughput are those where VFR and leisure traffic is likely to be most important. These include Alice Springs, Coolangatta, Darwin and Perth. At these four ports average growth of between 5. 3% and 7. 1% is forecast over the 20 years to 2010. The high growth rates forecast for Alice Springs and Darwin are partially a consequence of the expected increase in passenger numbers being applied to a relatively low base.

The forecasts discussed in this article draw on a consultancy AEA recently completed which was commissioned by the FAG. The full set of forecasts were published by the FAG in the report, ‘Forecasts of International and Domestic Airline Traffic 1991-2010’ as reported in the August edition of AA (refer p. 22 & p. 24 August 91 AA).