Global Economics

Skirmishing in the Open Skies


As transatlantic carriers jockey for gates—and market share—at Heathrow, British Airways' OpenSkies airline plans to skip the crowded airport altogether

The new Open Skies agreement between the European Union and the U.S. won't come into effect until Mar. 31. But the high-stakes battle for lucrative transatlantic air passenger traffic is already heating up.

British Airways (BAY.L) has just fired the biggest salvo to date, announcing plans to launch a new airline serving the U.S. directly from Continental Europe. By flying from the Continent to the U.S. without stopping over at London's crowded Heathrow airport, BA aims to claw back some of the business it may lose when American and European rivals add competing flights to Britain from the U.S.

Ferrying Premium Passengers Past Heathrow

The BA carrier, set to be called OpenSkies, takes its name from the treaty to liberalize air travel that will allow operators from either side of the Atlantic to fly anywhere within the EU and the U.S. (BusinessWeek.com, 3/21/07) Pending regulatory approval, OpenSkies will launch daily flights from New York (from either JFK or Newark) to Brussels or Paris Charles de Gaulle in June, 2008, using one Boeing (BA) 757 from its existing fleet. (A second aircraft will be added by yearend to fly to the other destination.) In the future, OpenSkies plans to fly to other business centers, including Amsterdam, Frankfurt, Milan, Madrid, Zurich, and Geneva.

While European rivals such as Air France KLM (AKH) and Deutsche Lufthansa (LHAG.DE), concentrate on developing their existing Continental hubs, BA aims instead to challenge them in their own backyards. Hoping to capture a bigger chunk of premium transatlantic passengers, the airline will reserve more than 70% of the 82 seats on each OpenSkies flight for business and premium economy passengers.

No wonder. BA likely will get two-thirds of its estimated $1.3 billion in 2008 profits and 40% of its $17 billion in revenues from transatlantic and premium traffic, reckon analysts at Dublin-based brokerage NCB. Notes Peter Morris, chief economist at London-based aviation consultancy Ascend: "This is about BA taking advantage of its reputation and distribution network in the U.S. to focus on premium service."

BA chief executive Willie Walsh says the unusual choice for the new venture's name is intended to keep up the pressure on the European Commission and the U.S. government, who are set to open up talks on the second phase of the treaty before 2010. BA is one of the most vocal proponents of relaxing foreign ownership rules in the U.S., which currently prevent non-American carriers from having more than a 25% voting stake in U.S. airlines. The name, says Walsh, "signals our determination to lobby for further liberalization in this market."

Transatlantic Traffic Jam

It also signals the importance to BA of finding new sources of revenue beyond Heathrow, Europe's biggest and most profitable hub to the U.S., as rival European and U.S. airlines scramble to secure capacity there. BA is currently the airport's biggest carrier, controlling 42% of the airport's takeoff and landing slots. And as of now, only BA, American Airlines (AMR), UAL's United Airlines (UAUA), and Virgin Atlantic Airways operate nonstop services to the U.S. from Heathrow.

That's about to change. The jostling for slots began in Oct. when Delta Airlines (DAL) and Air France-KLM—already partners in the SkyTeam alliance—announced a landmark deal to share costs and revenues on transatlantic routes (BusinessWeek.com, 10/22/07). Under the agreement, Air France will give three of its slots at Heathrow to Delta to use for flights to New York and Atlanta, while the French carrier will start a new service between London and Los Angeles. More recently, Continental (CAL), Northwest (NWA), and US Airways (LCC) announced they plan to launch direct flights from the U.S. to Heathrow as well.

That means one of the world's busiest airports is set to get a lot more crowded. And some analysts are questioning whether in the face of worsening economic conditions there will be enough demand to fill the 22% of additional seats on U.S. routes from Heathrow likely to be added this summer. "The EU-U.S. Open Skies' agreement makes the transatlantic market particularly vulnerable to irrational capacity increases," analysts at Dublin-based Davy Research warned in a recent note to investors.

Moreover, that extra capacity will eat into BA's market share at Heathrow. Analysts at NCB say BA's share of prime slots at Heathrow will fall by 7% this summer. And the airline's dominance could be further eroded if, as many analysts expect, a sizeable chunk of the slots at Heathrow currently being used for short-haul routes, such as those held by British Midland (BMI), Aer Lingus (AERL.I), Iberia (IBL.DE), and SAS (SAS.ST), are sold to transatlantic carriers.

Lufthansa, with its 30% stake in BMI, has the inside edge to acquire slots from the midsize British carrier. BMI is already the second-biggest player at Heathrow after BA, with 11% of all slots, so its coveted capacity could be a big boost to Lufthansa.

Still, buying additional slots won't come cheap. In December, Alitalia (AZPIA.MI), which is currently in merger talks with Air France-KLM (BusinessWeek.com, 12/11/07) sold nearly a quarter of its Heathrow slots in three separate deals for a total of $137 million. Alitalia has not disclosed the identity of the buyers, but analysts say Continental Airlines, US Airways, and BA each likely snapped up a pair of slots.

With the cost of slots sky-high, cash-strapped U.S. carriers will find it tough to build up bigger stakes at Heathrow. Instead, United and American are currently trying to boost their cachet—and margins—by upgrading their premium cabins to better compete with BA and Virgin (BusinessWeek.com, 1/7/08).

Realigning Alliances

As the battle wears on, analysts expect to see the Open Skies treaty provoke a major restructuring of the big global airline alliances, SkyTeam, OneWorld, and Star Alliance. Air France-KLM, for instance, has already supplied its SkyTeam alliance member Continental with two slot pairs at Heathrow, while KLM has offered three to SkyTeam partner Northwest. Next up is likely to be a deal among Star Alliance members Lufthansa, United, and BMI. Still to be sorted out is the somewhat awkward relationship between longtime OneWorld alliance partners-cum-rivals BA and American.

Brokerage NCB reckons in the near future there will be three "supersized" joint ventures dominating Heathrow. "Global connectivity will become an increasingly important selling point," NCB says. "These carriers will compete aggressively for transatlantic premium transfer traffic, which is second only to premium point-to-point traffic in the profitability stakes." This dogflight has just barely begun.


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