Should Aer Lingus and IAG get together? Maybe…

Much has been written about the Aer Lingus saga over the last year. A decision now seems to be immenent, that the government will sell its stake to BA. Ryanair will, presumably, follow.

A good way to make a small fortune in the airline industry is to start with a large one. Running airlines is a losing proposition. As of about 5 years ago the cumulative profitability of all US airlines over the previous 60 years was negative. Indeed over perhaps a century the industry has lost money, cumulatively. That is an astounding figure. These losses are not down to a few catastrophic years either but reflect regular cycles of large losses and small profits.

Given that, and given the unfavourable economics of the industry – high entry costs, a structural need for excess capacity, limited asset substitutability, atomised demand and a secular rise in fuel costs – it perhaps does not make sense for nation states to be involved in the industry. This indeed was the argument made when FF sold off aer lingus, that it could prosper better with freedom to raise and deploy capital outside state control. What is at question now is whether the state is better off with a retained stake or not. This might be easier to answer if we had not blown the National Pension Reserve Fund on a zombie bank, but in principle there is nothing wrong with stakes in airlines, no more than in banks or other firms.

For Aer Lingus there is a dilemma. As the airline industry is one that loses money a red queen race is in operation. To remain amongst the few that make profits airlines need to be prepared to spend more and more. There is a financial economy of scale at operation here, as well as economies of scale more generally. Thus mergers and other scale enhancing activities are the norm. It is possible, if a firm is lucky, plucky and rich enough to gain that scale and grow. This is what the likes of Ryanair and EasyJet did. But now that they are large they have the organizational and financial firepower to see off most challenges.

Herein lies the problem I and I suspect many have with this sale. Back in the day, before the plucky underdog Ryanair (yes, they were that once) came on board we had a nice cartel on the Dublin London route. Fares in the middle 1980s of hundreds of pounds were routine. It took competition to break that and to drive down fares and to drive up capacity to where we are now. With upwards of 5m passengers on the various Dublin-London routes, any fare increase or decrease is meaningful. But competition doesn’t really exist with two and that is what we will have here. Competition, whether in airlines or radio or newspapers, that is the lifeblood of innovation and customer satisfaction. It is hard to see how this deal improves competition on the major route which Aer Lingus operates. If anything it has the potential to retard rather than enhance it.

Aer Lingus was in a bind. To grow it needed capital , lots of it. Even with rates as low as they are now and a market boom airlines are never, for the reasons noted above, a great bet. Thus the need to get with IAG.There are other benefits also. My own research suggests that while financial hedging is good for airlines operational hedging, a mix of fleet types, may also be as beneficial.

The state cannot mandate competition. They can mandate the conditions under which competition can flourish. But as we have seen with Denis O’Brien and a very concentrated ownership of media, as we have seen with the tardiness of the opening up of the legal system, this government doesn’t really seem that concerned about competition. That’s a pity.

Published as a column in the Irish Examiner 29 May 2015

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One thought on “Should Aer Lingus and IAG get together? Maybe…

  1. Maurice coleman

    The key issue for Aer Lingus is market access rather than capital access. It already has substantial cash and liquid reserves to fund growth. However over 10 years privatised it has struggled to identify profitable opportunities to utilise these reserves. Such growth is most unlikely short haul with a redefined Ryanair aggressively expanding on Dublin. Long haul eastbound is tied up by Emirates and Ehiad (Turkish are also looking for a share). So growth is dependent on the transatlantic. It’s difficult to see much immediate year round growth on frequencies – the JFK daytime service is an imaginative initiative. New gateways are diiicult to define – Los Angeles and maybe a second Midwest City after Chicago. That’s where IAG come in . With their market reach – u can add in American in the U.S. – maybe they will provide the volumes to enable such expansion. Or maybe with a lower cost base Aer Lingus can operate from UK Provincial points to the U.S. Direct – something BA cannot do profitably. Or maybe it’s just about the Heathrow slots portfolio long term

    Reply

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