January 2006

Global Aviation & Transport Services

Air Transport in 2010

Structural changes in the airline industry will be crucial to the future success of the industry. The insatiable growth of low cost carriers will continue to open new markets and the long-haul aircraft will provide new supply to far flung destinations. Research projections show an expected transition from the extremely volatile swings in demand of the last four years to a period of stable growth which will be led by routes within Asia Pacific, largely due to the strength of economic expansion and the liberalisation of markets in China and India. Routes in Central and Eastern Europe are expected to grow at a faster pace than in Western Europe. However, whilst the above indicators paint a picture of stable growth, the industry continues to be haunted by the twin spectres of global pandemic and economic slowdown.

Air transport will continue to be an essential influence on the tourism industry. Airlines and airports will become part of everyday life for the millions who until a few years ago had never flown before.
We have selected five key issues and tried to explain what the airline industry might look like in the future. Although the reality may turn out to be different, it is worth examining each aspect along with its impact on the industry and economy worldwide.

From North to South

The future of air travel is rosy, with skyrocketing numbers of passengers flying in 2010. Over 1.6 billion passengers worldwide use the world's airlines for business and leisure travel. Research indicates that by 2010, this number could exceed 2.3 billion. Our analysis shows that Revenue Passenger Kilometres (RPKs) are expected to reach 5,000 billion by 2010. A breakdown of RPKs by major region is shown in the chart below.

Over 1.6 billion passengers worldwide use the world's airlines for business and leisure travel. Research indicates that by 2010, this number could exceed 2.3 billion.

World RPK growth 2004-2010

5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0
2004 2010

RPK (billion)

Asia - Oceania North America Europe - CIS Central & South America Africa

Source: Deloitte estimates on Boeing, IATA and Airbus data

In 2005, more than 50% of total passenger traffic was generated within North America and Europe, an additional 4% of passengers flew within or to and from Japan. Research estimates that more than 70% of the USD 400 billion of airline revenues is generated in North America, Europe and Japan. This will change dramatically in the next few years. The insurgence of China and India as new economic superpowers will capture around 15% of the expected global growth of passengers. This will be driven mainly by economic activities, but new inbound and outbound tourism flows will account for a significant slice of the traffic. What is most important is that there will be a whole new market and most of this growth will come from people who have never flown before. What has so far been mainly an industry for the western industrialised mass market will increasingly become a truly global business. Other than economic growth, factors that are likely to accelerate or slow down this process are liberalisation of domestic and international traffic, fuel prices and political stability. Whatever the pace, the process is bound to see a shift in traffic from North to South and from West to East.

recognisable trends showing clear upward market segmentation are: Increased on-board comfort levels with possible shower facilities, gym and massages. Seamless and pervasive technology, with broadband as the "bare minimum" and possibly video conferencing. Mood lighting to aid jetlag and assist sleep. On-board entertainment to move into "home from home", including the option to play games with fellow passengers and online gaming. Amenities which will focus much more on the personalised needs of travellers (based on enhanced CRM), including favourite reading materials, menu items, wines, etc. Segmentation of the physical space to allow interaction or solitude. Door-to-door rather than gate-to-gate service. In a certain way, we can argue that air travel, with all its amenities and luxury facilities, will become, at least for certain segments, part of the tourism attraction itself. Consequently, in spite of its very nature of being a commodity product, air travel will still be differentiated between value conscious and luxury seeking passengers.

profit coming from related activities such as on-board sales, car and hotel rentals, ground transportation tickets fees, etc., can be easily envisaged. In the Middle East, where the LCC revolution has just started, the same kind of LCC mania over the next three to five years that we have observed in South-East Asia and Europe in the past decade can be expected. But in the long run a shake-up of the LCC segment such as the one now looming in Europe and Asia is inevitable.

Hub & Spoke vs. Point to Point

Will the transformation of the LCC model imply an end to the Point to Point network promoted by budget airlines? Although the Point to Point model is overall less economically efficient, it better serves the needs of passengers moving from A to B. Other things being equal (especially the price!), it will always be preferred over any network link that requires a connection. Furthermore, in the last few years the economic benefits of the Hub & Spoke model (essentially asset allocation and slots utilisation) have been more than balanced by the cost of complexity built in by airlines to run huge network operations. There is evidence that major network carriers have already reduced the thickness of their hub operations, either reducing the number of waves or withdrawing from certain airports which they had established as secondary hubs. In any case, there are noticeable exceptions to this trend. Emirates, an airline with no domestic market, is building its success and whole bold strategy based on its Dubai hub. By 2010 Emirates intends to be the biggest long-haul carrier in the world. But the airline has built its strategy on market liberalisation of air traffic which could be the reason behind the definitive success of the Point to Point model. The UAE has open skies agreements with all the major countries, making it possible for Emirates to link secondary airports in Europe, Asia, Africa and the Pacific Region and leverage on its natural hub position. Should the recently agreed open skies agreement between the EU and the US be ratified, it will pave the way for a wave of similar agreements around the world. It will then be possible to fly from any city to any other city of the country or region that adopts the agreement, making connection stops at super-hubs (such as London Heathrow), redundant. Obviously this will only be possible if the airport infrastructure is ready to accommodate long-haul aircraft and the

Business vs. Leisure traffic

There is no doubt that people will continue to fly for both business and leisure reasons. The real question is: does the difference matter? What we have seen in the last few years, both in America and in Europe, is that the distinction in product offering is blurring. Some airlines have abolished their business class on short and medium-haul flights (e.g. Aer Lingus), while low cost carriers (LCCs) have introduced features to attract business clients, such as inflight entertainment and departures from first tier and business friendly airports. This trend has been triggered by the fierce competition between LCCs and traditional carriers and the need for airlines and corporate travel managers alike to cut costs. But as the airline industry stabilises and the corporate market recovers, there will be new room for differentiation of services, including business and luxury services. There are clear signs of this on intercontinental traffic, where some airlines are now offering all business flights (e.g. Air France, British Airways, KLM, Lufthansa and Virgin) and all the major network carriers are investing considerably to improve their products. Some of the

LCCs: growth or decline?

The continuous expansion of LCCs in the US, where the model was first invented in the 1970s, proves that the very nature of this business model is sound and responds to the needs of a significant chunk of the market. We can expect some major overhaul in the LCC segment amongst its players, especially in Europe and in Asia, where the phenomenon is more recent (eight and three years respectively) and where LCCs are experiencing unprecedented challenges. With new market creation that is reaching saturation (at least in Northern Europe) and strong reaction from network carriers (which in Europe and Asia are in much better shape than in the US) and charter airlines alike, what can be expected is a wave of consolidation among the LCCs, either through acquisition or the market exit of many start-ups. LCCs survivors will continue to be among the most profitable airlines in the world. A world where less than 50% of their revenues will be generated by ticket sales; with most of the revenues and all of the

increasing number of passengers at any given time that intercontinental traffic entails. Again the future of air transport will depend on product innovation and customer preferences as much as on public policies and local community support for huge infrastructure investments (not only runway capacity, but also ground transportation, logistics platforms, retail and commercial activities, etc.).

Cost of capital/access to financial resources Investment decisions of airports to accommodate super jumbos Final customer preferences Traffic congestion and Air Traffic Control (ATC) regulation Industry specialists believe that there is enough aircraft demand for both types of airplanes. The recent boom in aircraft orders has been stretching Boeing and Airbus production plants to the limit. Boeing was booming with about 1348 orders under its belt towards the end of 2005 while Airbus displayed its order book with 1373 aircraft on order till Nov 2005 (source: ATI). It might be worth noting that the numbers in 2005 were about a quarter higher than the number of total orders set in 1989!

seats directly on line) and airports will become competitors of tour operators, competing on the overall customer spending potential (the more you spend at the airport and on-board, the less you will spend at the destination). Government policies, international cooperation and public opinion concerns will dictate the pace of the transformation looming ahead.

Super Jumbos vs. Sub Jumbos

Differing views on what business models will prevail in the future is what lies behind the investment decisions that airlines are now taking. Those who believe that the Hub & Spoke model will eventually prove its potential economic superiority are ordering the so called Super Jumbo, such as the double deck Airbus A380 (with 550-800 seats), but also its Boeing archrival stretched B747-800 or smaller B777 or A340. Those who believe that passenger preference is for Point to Point travel are ordering the new Sub Jumbos, i.e. the 250 seats aircraft like Boeing 787 and the renewed Airbus 350. Several elements will influence what the preferred long-haul aircraft will be for the first half of the 21st century, including: Oil prices Environmental concern and relative regulation

Contacts Libero Milone Global Leader, Aviation & Transport Services Tel: +39 02 8332 2111 Email: lmilone@deloitte.it Paul ONeill Global Aviation & Transport Services Tel: +44 20 7303 7110 Email: paoneill@deloitte.co.uk Alessandro Cassinis Global Aviation & Transport Services Tel: +39 348 015 304 238 Email: acassinis@deloitte.it

Conclusion
Air transport will continue to be an essential influence on the tourism industry. Airlines and airports will become part of everyday life for the millions who until a few years ago had never flown before. Technology (both IT and avionics) will enable easier market segmentation and channel disintermediation alike. Airlines (especially charters who now offer up to 35% of their

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