What the Open Skies agreement really means

The opportunities and risks for El Al; how the small airlines will cope; whether fares will really fall; and whether El Al is a more or less attactive prospect for FIMI.

There are no experts in Israel on the economics of aviation. Not really, not objective ones. If there is one, and he isn't employed and financed by El Al, then it's not clear who he can be. The answers to the following questions were gathered from various sources, with broad and opposing interests, who know the industry well.

The Open Skies agreement with the European Union is based upon equalization of aviation rights between countries. There are 27 countries in the EU with many airlines. Israel is one country with one medium-to-large airline, relative to Israel, and two small ones. What sort of fight can they give the Europeans?

"The aviation world has changed in recent years, and it comprises several new formats. There are regular airlines, once called scheduled airlines, like El Al. They fly to fixed destinations, at fixed days and times. The flight leaves at the designated time whether the plane is full or empty. They offer a meal, a set, high standard of service, and they have customer clubs. El Al is such an airline.

"In the past two decades, airlines of another kind have come into the market. The low-cost airlines have low operating expenses and low flying costs, and hence cheap tickets. The seats are cramped, they operate out of second-tier, usually remote, airports, the service is basic, and anything beyond the flight itself costs money. As far as their method of operating is concerned, today they are run as scheduled airlines, with fixed flight frequencies and times.

"Alongside these are the low-fare airlines. These are veteran companies that offer flights that are more expensive to operate than those of the low-cost airlines, but on which the cost per customer is relatively low. Low-cost and low-fare airlines fly to wherever their immediate economic interest takes them. Their per-flight cost is low. Arkia and Israir are such airlines. By contrast, El Al, as a regular airline, invests a great deal in building itself for the long term. When it decides to open a new route, it takes several years of building up the business and much expense until it manages to generate a profit.

"A further type of company is the charter company of yesteryear. Essentially, as soon as an Open Skies agreement is signed, they become irrelevant in their former format, because in any case any airline can fly wherever it wants. It should be pointed out that airlines such as our own Arkia and Israir base their business models not just on profits from flying, but also on sales of vacation package deals."

What are "aviation alliances", and what lies behind their growing power?

"An alliance is a grouping of airlines from all over the world which, until about three years ago, offered the customer a network of international routes, ramified code sharing, and a unified frequent flyer program. There are three alliances: oneworld, of which the main members are American Airlines and British Airways; Star Alliance, led by Lufthansa and Continental, which merged with United; and SkyTeam, led by Air France and KLM. Three years ago, alliance members began to upgrade and strengthen the relationships between them, with the approval of the antitrust authorities in the EU and the US. Airlines within an alliance do not compete with one another, and operate a single profit center and sales center for all of them. In Israel, incidentally, that is considered an infraction of the Restraint of Trade Law.

"In effect, each alliance works as though it were a single airline. According to most aviation experts, this is causing a change in the world's aviation mix. It means that, in the new world, there will only be room for aviation alliances, low-cost airlines, and low-fare airlines. It means that airlines of the order of size of El Al and with its particular flying format will not last long. They will disappear from the map, regardless of the agreement with the EU. And they are already disappearing. Airlines similar to El Al that have joined one of the alliances have been swallowed up by the big airlines in the alliance. Austrian Airlines and Swiss, which got into difficulties, were acquired and swallowed up by Lufthansa. Spain's Iberia was bought by British Airways. This is the format of the current world of aviation."

What can El Al gain or lose from the agreement with the EU?

"The agreement with the EU does not significantly worsen El Al's position. The number of scheduled flights to Israel by scheduled airlines will not change substantially, not in the first few years, and probably not afterwards. The low-cost airline Ryanair of Ireland will review its activity. The UK's easyJet will certainly add flights from other places. It should be pointed out that if they fly from additional places, that will not come at the expense of El Al, but at the expense of the regular or other European airlines that fly from them.

"The main point is that the new agreement gives El Al many possibilities, a new, wide world, which it did not have within Europe in the past. It can, for example, fly Tel AvivParis-Washington. Up to now, it couldn't do that because of other agreements with the EU. Now it can. El Al could sign agreements in France with airlines that don't fly to Washington, and become their carrier on that route. El Al can collect passengers, in a way it could not do up to now, from different destinations in Europe, for Tel Aviv, and direct to South Africa. El Al could also, if it went about it in the right way, fly under a different name, and not always necessarily under the Israeli flag, from places in Europe and to destinations all over the world. As an ostensibly European airline, it could demand additional landing rights that would make it an equal among equals vis-a-vis the Europeans, and then El Al would be able to make new, specific cooperation agreements in European countries where it has added value, and so create new markets for itself. El Al could, for example, take advantage of the crises in those European countries where airlines face bankruptcy, and offer international products. It could offer a Greek or a Spanish passenger flights under their own flag, or in collaboration with those airlines, and also deliver its aircraft to them on Saturdays, when it does not fly, with or without their crews, under a European name and flag. And that is just the start."

What about Arkia and Israir? What chance do they have?

"Very small airlines like Israir and Arkia are no threat, and therefore they will survive, of course if they run their business right."

"In principle, nothing bad is going to happen to them. They are small, they are based more on sales of package deals, they make more on the hotels than on the flights. They will however have to give up on the dream, which as far as one can see in any case was not coming true, of becoming regular airlines. They will focus on their ability to be a tourism company that sells vacation packages with a flying bus attached, an aircraft. Like Thomas Cook, which goes a long way back, and which will not operate a flight unless it is making money from the tourist packages on it. As far as it is concerned, the flight is a means, not an end."

The EU looked after the interests of its own countries and airlines. Did Israel's Ministry of Transport, Airports Authority, Ministry of Finance, and cabinet look after the interests of their airlines with the same determination?

"Absolutely, yes. After all, the EU is the strongest kid on the block. For example, within its own regulatory framework, the EU does not allow recognition of government subsidies for the security outlays of companies with which it signs agreements. Nevertheless, here the EU took a large, a huge step in favor of Israel and El Al by allowing the deal to be signed even though Israel greatly subsidizes its airlines' security costs. In addition, the EU is not known as Israel's best friend in the political and diplomatic sphere, and it's well known that there were voices in the EU that not only opposed the agreement, but even call for a boycott of Israel. This is therefore a huge achievement from a diplomatic point of view, and certainly from the point of view of aviation."

What if Israel doesn't sign the agreement?

"First of all, there will be a diplomatic problem. Beyond that, this agreement represents a genuine opportunity to reduce fares for the Israeli customer, and huge potential for bringing in hundreds of thousands more tourists a year. Companies like Ryanair and easyJet, as soon as they fly to a certain country, become a tourism and security stamp of approval certifying that the destination is worthwhile and safe for the European tourist. As soon as Ryanair flies to Israel, the Irish won't ask questions. They know that their airline has done the work for them, and that Israel is safe for them. Just as Israelis travel to any destination that El Al flies to, because if El Al flies there, it must be alright.

"For example, the introduction of easyJet flights from London to Tel Aviv a few years ago considerably strengthened the Tel Aviv brand around the entire world, and turned the city into an attractive tourist destination. easyJet exposed Tel Aviv in Britain. The same thing happened with Air Berlin, which strengthened the Tel Aviv and Israel brands in Germany. The result is many more tourists, not to mention the Israelis who travel in their thousands at cheap fares to Berlin."

Will air fares really fall?

"At the beginning of the 2000s, an Israeli tourist paid over $1,000 for a tourist class flight to London in the summer. The price has dropped in recent years to $600-700, and that's at peak periods. Full opening of the skies will lead to levels of fares to a destination like London or Paris of $400-500, at peak periods. And that's nice. In the winter, fares will even fall to $150-200."

Was El Al aware of the talks with the EU? Was it surprised by the agreement?

"El Al has been aware of the talks since 2006. It was involved in everything. The minister of transport said the same thing yesterday."

Could El Al have prepared itself for Open Skies? Why has it not done so?

"El Al is in commercially stagnation, and has extremely heavy operating costs with which it is not coping. The airline has not changed its commercial format since it was a state-owned company, apart from opening the route to Eilat and a route to Sao Paulo, which it shut down after two years because it was not catching on and fuel prices finished it off. To this day, the company has not dealt with its employment agreements, and so what Minister of Transport Yisrael Katz said yesterday is correct. Air Berlin has 187 aircraft and about 9,000 employees. El Al has 38 aircraft and over 6,000 employees. That's the story…"

What will El Al have to do in order to join one of the major alliances?

"El Al will find it hard to join one of the three alliances because of the Arab boycott. It will therefore have to think of a different commercial format. Beyond that, it must become more efficient. It must undergo a general revolution, commercially, economically, personnel-wise, and in its infrastructure, and not necessarily do the easiest thing first, which is replacing its aircraft fleet. El Al has a reasonable fleet, and that is certainly not its biggest problem."

Is El Al hurt by its high security expense?

"Security expenditure has risen all around the world because of the terrorist attacks on the Twin Towers, both for airlines and for airports. Alongside the good image that El Al has as a safe airline, it should be mentioned that El Al is also harmed by this security, since non-Jewish travelers, and also Israel Arabs, choose not to fly with it because of the intrusive questions and the uncouth behavior of the security inspectors at airports in Israel and around the world. This matter is the responsibility of the General Security Service, and El Al has limited influence over it. The agreement with the EU and the discussions in the government are an opportunity for El Al to demand a review of the entire format of the security arrangements for its flights."

The direct cost of security is $120 million for all three companies together, most of it for El Al. The state finances 70%, and has undertaken to finance 80% once the Open Skies agreement is signed. El Al claims that it is left with an actual cost of over $30 million a year.

"The Ministry of Finance never wanted 100% or 97%, because then the General Security Service, which determines the format and the cost, would be liable to start operating with no budgetary restraint. The $30 million number also needs to be examined, independently of El Al. It should be pointed out that there is an argument that since El Al operates the security arrangements for the General Security Service, for all three airlines, it is in that respect a monopoly by coercion. It has been compelled to deal with security for all aircraft in Israel. It could be that it knows how to exploit this to its advantage, it could be that it overcharges. That is to say, when it flies out the security teams, and that's a lot of tickets a year, it perhaps charges the highest fare, making it another profit item."

It seems that everything is stuck because of this.

"This is the main claim of the airline and its employees, and so, in order to get the Open Skies agreement through intact, it should be possible to make a gesture and set a financial supplement to the agreement, but not in percentage terms, rather to set a sum in dollars or shekels of additional annual aid, a last grant for approval of the agreement."

They say that it won't be worthwhile for FIMI to invest in El Al because of this agreement.

"Think about the possibility that this actually suits FIMI very well. Perhaps it brings down the cost of taking a stake in El Al, perhaps it signals to the El Al workers committee that the party is over, perhaps it opens wide a door to deep and significant change at the company."

Published by Globes [online], Israel business news - www.globes-online.com - on April 22, 2013

© Copyright of Globes Publisher Itonut (1983) Ltd. 2013

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