Cabin pressure

by Andrew White and Claire Ferris-Lay on Thursday, 05 June 2008

When Silverjet suspended its operations last week, it became the third business class-only carrier to close within the last six months. With fuel costs soaring and heavily subsidised competition, the Gulf's non-state-owned airlines could be the next to face turbulent times.

While the news might have come as a shock to hundreds of passengers left stranded in New York, London and Dubai, analysts weren't so surprised when business class-only carrier Silverjet suspended its operations last week.

It joined Maxjet Airways and Eos on the list of business class-only airlines to have collapsed within the last six months, crippled by a combination of soaring fuel prices and reduced consumer confidence.

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Fuel going up by even a little can wipe out budget airlines’ profits on a whole swathe of routes.

Now the budget airlines of the Middle East are also facing mounting cost pressure as they struggle to compete with state-supported carriers.

The global aviation industry is braced for losses of at least US$2.3bn this year if the price of crude remains at current levels and analysts see storm clouds looming over the low-cost carriers of the region.

"A large part of the budget airlines passenger segment is much more price sensitive," says Brian Pearce, chief economist for the International Air Transport Association (IATA).

"If budget airlines try to recover the increase in fuel costs they are going to lose more passengers. Fuel also makes up a much larger proportion of their costs than for network airlines."

Silverjet launched between London and New York in January 2007, adding its London-Dubai route in November, amid great fanfare. The airline offered a unique selling point: a ticket on an all-business class carrier for a third of the cost of a traditional carrier's business class seat.

The airline struggled from the start. In its first year Silverjet's market value plunged from US$155m to US$21m, and in January alone shares plunged 28% after a broker said the airline was "likely to fail" and gave its shares a target price of "0 pence".

In November, property tycoons David and Simon Reuben agreed to loan the airline US$19.4m, convertible into shares. However, the brothers later declined to convert the loan, blaming market conditions.

"Having seen the other two airlines in this category fail already, it looked increasingly like the writing was on the wall for Silverjet," says John Strickland, director of aviation specialists JLS Consulting.

The carrier fought to the last, and just last month Hunt assured Arabian Business that Silverjet would survive. The CEO thought he had secured a US$8.4m loan facility from Abu Dhabi-based investment house Viceroy Holdings, which would secure the carrier's immediate future.

However, the deal never materialised and Silverjet suspended its operations, sliding into administration and leaving disappointed customers to seek refunds from their credit card or travel companies.

"The airline business is a very risky, low-margin business, so you have to spread your revenue sources,' argues Paul Griffiths, former executive director of Virgin Atlantic and current CEO of Dubai Airports.

"When you get a carrier that is purely basing its revenues on a fairly narrow sector of the market, then it is even more exposed to variances in that market without any cushion," he continues.

"Because of the huge cutback in the banking sector and the dire straits that the economies of the US and Europe are now in, unfortunately Silverjet was exposed to extremely weak markets where it just couldn't sustain the level of revenue required in order to offset the increase in the cost of fuel."

The cyclical nature of air travel also served to clip Silverjet's wings. It is widely accepted that the business class market is particularly time sensitive and day-of-the-week sensitive - in the middle of the week the demand for business class services drops dramatically, as it does on Saturdays.

Without the economy market to counterbalance that, Silverjet and its peers were left vulnerable to variations in demand that were not able to be influenced by price - as the airline discovered when a series of two-for-one deals and special offers launched in the last few months, failed to improve the carrier's prospects.

The budget airlines of the Middle East are exposed to similar risks because of their exposure to the opposite end of the air travel market.

"Budget airlines are at completely the other end of the spectrum because they rely on high load factors, and variable prices to get those high load factors," says Griffiths.

"The budget airline business model is far more resilient than the business class-only model, but whether it'll be resilient enough to make the whole thing work, we'll have to see."

There are currently six low-cost carriers operating from bases across the GCC including Jazeera Airways, Bahrain Air and Air Arabia. While low-cost carriers still only account for 2% of passengers in the Middle East, the industry is booming and airlines are adding more and more scheduled flights to cope with demand.

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