Winter is coming: The future of European aviation and how to survive it

Main uncertainties, and the industry’s structural weaknesses will continue. Airlines can prepare now to survive and thrive in the world to come.

The champagne corks had barely landed after a successful 2015 when European airlines received a jolt—and, in the wake of Brexit, warnings of reduced profits came from IAG (June 24, 2016), Lufthansa (July 20), and Air France-KLM (July 27).

So what does the future hold now—and how can flag-carrier airlines, in particular, best position themselves? This article argues four points:
1. European airlines have had a brief moment in the sun. The sector has been returning its cost of capital for the first time, after a decade that was, as usual, unforgiving for most European airlines, with only three generating enough profit to cover the cost of capital.

2. Four essential uncertainties will shape the aviation industry of 2020. Europe’s carriers should plot their scenarios against them: the meaning and impact of Brexit, the level of continued consolidation, the convergence of low-cost and full-service business models, and the future extent of Europe’s openness to foreign-carrier competition and control.

3. But there are three things we do know—which will continue to shape the underlying fundamentals and intensify pressure on European flag carriers. First, the industry is structurally competitive. The run of profits from 2015 to 2016 is the result mainly of an unanticipated fall in the price of jet fuel. Over the long term, however, airline unit costs and unit revenues have an almost perfect correlation, at more than 0.99, as cost reductions are passed on to consumers.

Second and third, the two prevailing winds of the past decade—the rise of low- cost carriers (LCCs) and the “Gulf Plus” airlines (the three big Mideast carriers Emirates, Etihad Airways, and Qatar Airways, plus Turkish Airlines)—are going to continue to reshape the sector. LCCs have almost doubled their capacity over the past decade, contributing to a 40 percent fall in yields on intra-Europe flights. The Gulf Plus airlines, meanwhile, doubled the number of European airports they serve and quadrupled the number of seats. On the Europe–Asia route, European flag carriers have lost one-third of their market, and average yields have fallen 22 percent.

4. Airlines should start preparing now with no-regrets moves. A temporary windfall, like today’s jet-fuel boon, can have a permanent effect if it is used wisely to fundamentally reset the cost structure or, for some airlines, to invest in product improvements or cash acquisitions of other airlines.

You can download the full article from McKinsey & Company here