Rise and fall of all-business class airlines
On 23 May 2008, trading in Silverjet's shares was suspended on the London Stock Exchange and on 30 May 2008 the company was placed into administration. All attempts at a rescue plan by the administrators of the company were abandoned by mid June. Silverjet had commenced operations in January 2007 and it was the last of three all business airlines launched in the last 3 years to cease trading. The other two, Eos Airlines who had commenced operations in October 2005 with their inaugural flight from New York to London and MAXjet Airways commencing operations in November of the same year, had each ceased trading in April 2008 and December 2007 respectively.
Why did these airlines fail?
The product
MAXjet, Eos and Silverjet each launched a one product shop with aircraft operating in a business class only seating offering extremely competitive fares for flights between London and New York. This was an attractive product for many business travellers who welcomed these new entrants to this market.
Eos and Silverjet were pitched at the top of the market with a product closer to the first class cabins of many airlines than to the traditional business class seating of MAXjet. In terms of cost, the fares for a return trip from London to New York offered by each of these start ups was at least 50% cheaper than the established scheduled carriers charging about £4,000 and £5,000 for a return business class ticket from London to New York. MAXjet was the cheapest with a fare of around £800 for a return trip, followed by Silverjet at £1,150 and Eos at £2,000.
These new start ups claimed that their operating costs were substantively reduced because they focussed on one type of aircraft with one configuration, flying one route. In essence, by using a similar model that was so popular with the short haul low-cost carriers, cost savings were able to be achieved by these operators although their focus was on a service with frills designed for those wishing to travel in comfort.
The operating bases of Stansted (Eos and MAXjet) and Luton (Silverjet) met with mixed reviews as they were not favoured locations for some business travellers although the easy access to those airports from the City of London and Canary Wharf was for some an advantage over Heathrow and Gatwick.
What went wrong?
The start-ups were launched in an era of strongly rising demand for air travel and before the sub-prime US crisis struck the financial markets. They then faced very tough economic conditions in what has been heralded as the worst industry climate ever with the downturn in the economic cycle, the tightening of credit, the consequent decline in consumer spending and volatile performance of exchange rates coupled with the steep rise in the price of oil for much of 2007 and 2008. In these difficult trading conditions, in 2008 alone the death toll sounded for approximately 50 airlines worldwide, so these start ups were not alone.
The new entrants under estimated what a capital intensive business the aviation industry is and how quickly cash can be spent. Sir Richard Branson is reputed to have responded "start out as a billionaire" to the question, "how do you become a millionaire by running an airline?" Clearly these start ups were not major scheduled airlines but nevertheless had to meet day to day operational costs, financing costs and ultimately make a return to their shareholders.
The start-ups certainly did not start with billions. Silverjet raised an initial £25 million when it listed on the Alternative Investment Market (AIM), another £24.6 million in April 2007 and just 6 months before it went into administration a further £22 million was raised in November 2007. MAXjet also raised £50.5 million when it listed on AIM in June 2007, some 6 months before it filed for Chapter 11 in the United States.
Cash was soon eroded by the ever increasing price of aviation fuel. Estimates of the cost of fuel for a round trip for Silverjet to fly from London to New York in May 2008 was about £44,000 compared to £28,600 when the airline started flying in January 2007.
As new carriers these start ups were more exposed to rising fuel prices because they had not had time to develop the hedging positions of more established airlines. This together with operating an ageing fleet (averaging over 15 years old which industry analysts state is about 15% less energy efficient than a new aircraft), did not assist in conserving cash flow when fuel prices were increasing.
Set against the environment of ever increasing oil prices which was imposing a very great strain on most airline finances, the basic economics of, for instance, the Silverjet operation seemed to be ill founded. Lawrence Hunt (Silverjet's CEO) stated that the cost of flying a 300 seat B767 aircraft on a London-New York round trip was £65,000. Once those 300 seats were substituted by 100 flat beds he said:
"If we sell 65 seats at £1,000 per round trip we break even. If we sell 80 seats round trip every day, we make a £5.2 million annual operating profit on that aircraft."
Mr Hunt's sums were simple; Silverjet required a 65% load factor to break even. However, in 2007 Silverjet�s average load factor was 58% and in January 2008 their load factor was 54%, 11% below Hunt's estimated break even load factor.
Each of the start ups found it increasingly difficult to compete with the established carriers who upped their game to fend off competition from these new entrants in this lucrative market. Competition on the routes operated by all three start ups increased with the US-EU Agreement on Open Skies which increased trans-Atlantic frequencies which meant more operators in the same market. Competition meant business fares decreased for flights between London and New York and their reduction has continued. By way of example, in July 2007, American Airlines started operating the same route as Eos, flying between New York and London Stansted offering a discounted round-trip business class fare which competed aggressively with Eos.
In the face of this competition, combined with a decline in business travel as the credit crunch began to deepen, the inflexibility of these start ups with their offering of only one or two flights a day became unattractive to many business travellers who required choice and flexibility to change flights at short notice. The more established carriers offering loyalty incentives such as frequent flyer programmes were also attractive to the business traveller. In comparison to the flight schedules and frequencies of the start-ups, American Airlines offered the business class traveller 20 flights daily from New York to the three London airports, together with a frequent flyer programme and operated newer and more efficient aircraft with upgraded business class seats.
Can a one product business class only airline survive?
There is no doubt that business class travel is a highly profitable and lucrative source of income for the major carriers who have tailored their services in many instances to provide either an all-business class service or one where a greater proportion of the aircraft is occupied by a business class configuration. Singapore Airlines offer different products across its route network tailored to the profile of each region and operate large aircraft with as few as 100 seats in an all business class configuration. Lufthansa also operates an all business class only flight between Newark and Frankfurt, Swiss started an all business class service between Zurich and Newark in January 2005 and KLM operates 44 seat Boeing business jets between Amsterdam and Houston. In June 2008, British Airways launched direct flights between Paris Orly airport and JFK, New York through OpenSkies using Boeing 757 aircraft with 82 seats shared between business and premium economy with just a few rows of economy seats at the rear of the aircraft. Expected soon is the announcement by BA of its all business service from London City Airport to JFK, New York to launch in autumn 2009. Travel which offers greater comfort is obviously attractive to the business traveller as demonstrated by the response of the major carriers in providing it.
Aviation is, however, a highly cyclical industry subject to the vagaries of economic boom and bust. Business travel declines as travel budgets are cut in an economic downturn. In that environment, any business only class airline without being part of a larger group with deep pockets would find it extremely difficult to survive if its income is wholly dependent on one class of travel. This much was borne out by Christophe Bejach (co-founder and chairman of L'Avion) who said, in July 2008 when it was announced that BA would acquire L'Avion, that it made sense to gain the protection of being part of a much bigger group in the face of the sharp rise in fuel costs which was serving only to increase its losses. A total of &euro50 million had been invested in L'Avion up to July 2008 since it was founded in 2006 in its operation of two Boeing 757 aircraft between Paris Orly and Newark Airport in an all business class configuration.
The inability of a standalone business only class airline to offer any other type of service in a time of slow economic growth with the consequent inability to achieve a break even load factor and declining yield would mean survival would be difficult unless the entity concerned was bank rolled by someone with very deep pockets indeed.
Conclusion
The combination of several factors was responsible for the demise of Eos, MAXjet and Silverjet; the weakening global economy, the steep rise in fuel prices and the increase of competition on the transatlantic route. The start up carriers were unable to offer any other service such as cheaper economy fares and did not have the advantage of the larger carriers in being able to absorb the crushing expense of the steep increase in fuel prices. On current predictions their failure will be followed by further airline failures in what has been forecast to be the first truly global recession the airline industry has ever faced. There is still over capacity and the International Air Transport Association (IATA) has estimated that airline revenues will, in 2009, fall by $36 billion.
Given the right set of circumstances an all business class airline, operating profitably with enough aircraft could potentially survive but the question must remain how long they could survive particularly when the aviation industry is in one of its downward spirals.
On current industry predictions, it looks unlikely that there will be any new airlines launched in the near future let alone any stand alone all business class airline so our chance to see whether such a product can survive is unlikely to be tested in the near future.
Alison Wilds (Partner)
Aviation and Finance Group
Harbottle & Lewis LLP
Alison Wilds is a partner and heads the Aviation and Finance Group: alison.wilds@harbottle.com Tel: 020 7667 5266
The Aviation Group at Harbottle and Lewis LLP, led by Alison Wilds, comprises a team of specialist aviation lawyers with expertise in aircraft and engine leasing and financing transactions, as well as commercial, operational, regulatory and litigation matters. We are consistently regarded by independent guides to the legal profession as a leading firm in aviation work. For further details on our people and expertise visit www.harbottle.com and go to the aviation page.