07 Jul 2015 20:43 IST

How West Asian airlines leverage Moore’s Law

The power of the network effect today governs purchases in the airline sector

The Paris Air Show (15 to 22 June), an annual event which attracts the world’s airline customers to shop from the major aircraft suppliers Boeing and Airbus, was no different this year; there were no new aircraft orders from the established western air carriers - Lufthansa, American Airlines, British Airways, Air France, United or Delta Airlines.

Carriers from West Asia had come in with fat wallets. Saudia placed orders for 20 high-density, lighter weight A330-300 aircraft, while Qatar Airways added 10 Boeing 777X-8s to its order book. Emirates didn’t order any planes this year because in 2013, at the Dubai Air Show, it had placed the world's largest order for aircraft: 150 of Boeing's new 777 mini-jumbos and 50 Airbus A380s, in a deal worth $100 billion. Emirates is already the biggest A380 operator and will be the owner of 140 of the big jumbos when all the orders are in.

Moore’s Law

The Arabs are not just investing in new, state of the art aircraft. Last September, the Emir of Dubai announced a $32-billion expansion plan to construct Al Maktoum International Airport which may well become the world’s largest commercial airport when it opens in 2017.

These numbers are truly staggering not only because of the scale but also for how lopsided the equation is when compared to similar investments by airlines and governments in the west. The Arab carriers are relying on a principle etched into the annals of technology and innovation: Moore’s Law. According to it, computing hardware power doubles every 18 months while the price drops in half. A modern laptop has more power than a mainframe of the 1960s and costs vastly less.

Moore’s Law applies to aviation just as well. The new planes are a lot more fuel efficient and can carry passengers at a lower seat-per-mile cost than those of the western majors, allowing the Arab carriers to set lower prices. The range of these planes is much higher making 15 hour non-stop flights the norm on long-haul routes. Abu Dhabi-Los Angeles and Dubai-San Francisco non-stops mean that passengers no longer need to fly into an expensive, age-old European hub to connect to flights to North America. For a flight from India to the US, British Airways charges $245 in government taxes (including a clean fuel tax) to connect through London’s Heathrow; Etihad, $45 to connect via Abu Dhabi. The flying experience is better too - the new planes offer cabin features such as personalised games, movies and WiFi unavailable in older models enticing customers to try them out.

Western Response

How are the western airlines responding? For one, they complain that the Arab carriers are heavily subsidised by their governments which extend interest free loans and even inject direct cash into new equipment and airports. This, they contend, violates the rules of international trade. But the whining is somewhat dishonest. The western giants have used permissive laws to repeatedly reorganise in bankruptcy court. In each instance, creditors were forced to forgive debt sometimes accepting only 15 cents of each dollar owed.

Such court ordered bankruptcies result in massive asset transfers from creditors to debtors, the same kinds of transactions that western airlines oppose when Middle Eastern governments invest in Etihad, Qatar or Emirates. The source of the cash is different but the effect is the same.

The public complaints disappear when the western airlines look inward. Labour strife is constant because their employees are controlled by powerful unions. In March, Lufthansa pilots simply walked out of their jobs for four days throwing the carrier’s big hubs in Frankfurt and Munich into absolute chaos. In April, French air traffic controllers went on strike for two days resulting in extensive flight cancellations all around the country. Helpless here, and operating inefficient fuel-guzzling fleets, the western airlines have decided that the only way to compete against the Arab carriers is to simply get bigger - so big that the network effect will ensure their survival.

Network effect

In the last few years in the US alone, Delta merged with Northwest, US Airways with American Airlines and Continental with United Airlines, each merger occurring as a result of bankruptcy proceedings. American now operates 965 planes, Delta 792, and United 710 planes. (Etihad has 115 planes in its fleet). With so many planes, these US carriers can offer frequent schedules from important hub cities that they monopolize, control seat inventory and therefore price. Customers travelling from Dallas to Chicago can choose from 20 daily flights from American Airlines alone. Delta owns traffic in Atlanta, Detroit and Minneapolis; United is king in Houston, Newark, Denver, San Francisco and Chicago. A flier in these cities almost has to choose the major airline in that city because just about everyone else does. The network effect is powerful. We use Facebook because others do.

Heavy profits

The Gulf carriers are making money as the western majors are reporting their own record profits. In April, Delta’s profits were triple what they were last year. United Airlines turned a 2014 first quarter loss into a sizeable 2015 profit. The two business models actually complement each other. For example, Etihad flies to just six US cities but American Airlines reaches nearly 100 US cities. Etihad, therefore, completed a commercial agreement to feed its incoming passengers to the American Airlines network. Now, both companies profit heavily from the deal.

All of which brings us to an even older rule in business that has existed for almost as long as humankind has: It doesn’t matter which legal model businesses use as long as they can return profits to their shareholders.

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