Air Transportation - A Mature Market?
by Kevin Michaels, Partner, AeroStrategy

Many industry observers (including this author) are surprised by the resilience of air transport production rates following the Great Recession. How can Boeing and Airbus possibly increase production rates while most capital goods industries – including business aviation – experience production rate declines of >20%? One factor underpinning the confidence of OEMs is the robust long-term air travel growth projections; most forecasts call for 4.5 – 5.0% annual growth over the next 20 years. This is nearly double the anticipated annual global GDP growth over the same timeframe and indicative of an industry in a growth phase. Moreover, these growth projections are higher than the 4.2% annual growth rate since 2002, and the 4.6% rate from 1990 - 2002. According to these forecasts, air travel demand could actually accelerate.

AeroStrategy believes that air travel – at least in North America and Europe - is in fact a mature market and that these forecasts are likely overstated. The first and obvious reason is the higher cost of fuel. Fuel costs have increased 500% over the last decade and now comprise 30% of an airline’s cost structure. Add to this the twin prospects of carbon taxes and increasing fuel costs and there is a significant probability that air travel will face headwinds from a cost standpoint. This means that airlines must either increase fares (and reduce demand) or swallow continued losses.

A second factor is the maturing of the US and European air travel markets. The US market has been deregulated for more than 30 years and is now shrinking. RPK growth is less than GDP growth, and consequently air travel accounts for a shrinking share of the national economy. This is a stunning fact for a market that accounts for nearly one-third of the global market. What if other regions follow the US pattern? This is exactly what appears to be happening in Europe where the stimulative effects of liberalization and growth of low cost carriers appears to be waning. Add to this the difficulty of adding new infrastructure, the socio-cultural attitudes of “green” consumers, and bleak near-term economic growth forecasts and it is highly likely that air travel growth is poised to slow considerably. With more than half of the global market in a mature state, the rest of the world must execute perfectly (growing at twice GDP) if the 4.5-5% growth rates are to be realized.

A third factor is the growing threat of substitutes, namely high speed rail in Europe and China. Europe is in the midst of a significant HSR expansion and already some lucrative routes are affected such as Madrid-Barcelona where air travel has lost 40% of its passengers in one year.

Even more dramatic is the massive HSR build out in China, where the government will invest $300B to create a national grid by 2012 – several years earlier than the original plan. China Southern Airways is already losing traffic on some routes. While HSR will not compete with air travel for routes of 800+ miles, it is worth noting that the aviation industry is counting on growth in the domestic China and European markets for approximately one-fifth of its absolute growth over the next 20 years. And some of this growth will be lost to HSR.

With headwinds blowing in the face of industry growth, perhaps is it time to think in terms of an industry with mature rates of growth – perhaps in the 3-4% range. This is not necessarily bad news if it facilitates airline consolidation and improved profitability.

Kevin Michaels is Co-Founder and Partner of AeroStrategy, a premier management consulting firm devoted to aviation and aerospace. He has 23 years of aviation experience, including hundreds of consulting engagements for leading aviation and aerospace companies across the globe with expertise in the aerospace OEM and MRO sectors, strategic planning, and industrial marketing.  www.aerostrategy.com