Plenty of life left in the low-fares model

Conor McCarthy argues that while Ryanair can absorb the immediate impact of the EU ruling, it may bode ill for the regions and their airports

What did the European Commission decide?

That Ryanair was the recipient of illegal state aid from Belgium through the government-owned BSCA company that runs Charleroi.

Why?

The Commission, investigating a complaint from the main airport at Brussels (Zaventum), believes that the agreement struck between BSCA and Ryanair in November 2001 did not follow the private investor principle and was discriminatory in that it was not publicly offered to all airlines. It argues that many of the components of the deal would not be offered by a privately owned airport seeking a return on investment for its shareholders.

Is it all illegal?

No. Some elements of the BSCA-Ryanair agreement are considered to be justified, but the Commission has laid out conditions that must be complied with in order to justify these elements.

The Commission has also ruled that the 15-year term of the agreement is not justified and has put a much shorter time limit of three or five years. (Whilst its most unusual "We Love Low Fare Airlines" explanatory paper allows five years for intra-European flights, its official journal quotes a more penal three-year period).

The Commission has ruled that no more than 50 per cent of the new route launch costs may be subsidised by the airport (presumably on the basis that the airport can pay its 50 per cent share and all costs are covered).

What must be repaid?

The Dublin-Charleroi route supports must be repaid (despite this route only reaching its fifth anniversary in May 2002).

The once-off lump sums amounting to €250,000 for hotel accommodation and €768,000 for pilot training must be repaid as they were deemed to be unrelated to any deliverable benefits on the part of Ryanair.

The net loss (if any) of the ground handling after adding in the profits made by the airport in its commercial activities (shops, restaurant, car park, etc.), must be repaid by Ryanair.

All other supports, including the all-important new route and per passenger marketing supports paid by BSCA to Ryanair have not been ruled illegal per se, but the Commission has insisted that BSCA justify its current and future payment on the basis of a sound business plan linked to costs and targets.

Given the wordiness of the judgment in this matter it's unlikely that the amount to be repaid will be significant in Ryanair bottom-line terms. The real issue is what happens in the future.

So what happens now?

It looks like the airport needs to get its act together in providing a credible and justifiable business plan to support its incentive scheme. Clearly, the implications for all other government-owned airports are that they must ensure that any scheme they have can stand up to scrutiny and is transparent, non-discriminatory and equitable.

The Commission has held that the airport may wish to revise its standard terms and conditions so that these are more attractive to all airlines without the need for long-term special incentives to airlines such as Ryanair.

Ryanair will no doubt be scrambling to rewrite many of its airport agreements in a manner that protects it from further cost erosion. Given the additional burdens placed on publicly owned airports, many of which are totally dependent on the consumer-spending power delivered by Ryanair, I would not be surprised to see some pass to private ownership.

The shortened duration of these airline-attracting incentives is one that will affect Ryanair (and the many other beneficiary airlines) most. This five-year maximum term appears to be an arbitrary figure taken by the EU transport directorate rather than one that should be justified on a case-by-case basis. I expect this to be challenged vigorously.

In the meantime, Ryanair may review its new route launches to take maximum advantage of the shorter duration incentives, so that instead of its usual one to two flights per day on new routes, it will launch with higher frequencies and get the maximum benefit of this support.

The repayment of pilot training costs and their hotel accommodation has implications for not just Ryanair. Surely the provision of extra flights and a new operating base at Charleroi requires trained pilots?

What of the EU-sponsored programmes for pilot training in the past, which Aer Lingus availed of? Does this mean that the grant aid received by Intel, IBM, Microsoft and Dell from the government for jobs, new factories and training costs constitutes illegal state aid?

What if Philips Semiconductor in the Netherlands complains that Intel is being illegally supported by the Irish government? Based on the Commission's judgment in this case the community/regional benefits attributed (rightly in my view) to Ireland Inc will not be taken into account.

Many commentators have raised the question of whether the low-fares airlines business model is now dead (and a few asking if they'll get to dance on Ryanair's grave into the bargain). The answer is an unequivocal "no".

However, it would be wrong to underestimate the importance of this issue to all airlines, Ryanair being the most extreme example with its "you pay us" airport deals. The real difficulty will lie with the Cinderella airports who need to fill empty facilities and who must ultimately come up with a framework to attract airlines to take what is the real commercial risk, in return for a lower cost or route co-marketing.

Perhaps one of the long-term benefits will be that these capital-intensive beasts (i.e. airports) will manage their cost base much better than heretofore, stop building marble mausoleums and provide high-efficiency services that reflect their airline customer needs. The Commission won't mind once the cost base is covered.

Will Ryanair continue to profit and grow?

It has a strong management with a good track record and clear ability to change more quickly than others. I have no doubt that it will find a way to keep costs in check and grow new markets (their most recent "poor" \ results showed that profit margins continue to exceed 20 per cent, and unit costs reduced by a further 8 per cent against a backdrop of 50 per cent passenger growth). The question for government-owned airports will be "does that include us?"

Whilst the Commissioner for Transport will probably be wishing that this issue can be laid to rest, it is unlikely that Michael O'Leary will lie down and see his all-important low cost base increase (even after five years). The airport charges basket (landing fees, control tower, passenger fees, handling charges) can constitute as much as 25 per cent of an airline's costs in Europe. Ryanair has deliberately targeted regional and secondary airports to maintain efficient operations and secure lower costs.

It uses this to offer fares that break through customer resistance to some of these airports and build completely new markets as a result.

As legendary Liverpool manager, Bill Shankly, would have said if he was the chief executive of a low-cost airline: "Airport charges are not a matter of life and death, they're much more important than that."

Conor McCarthy is a co-founder of Asia's first low-cost carrier, AirAsia, and former director of group operations at Ryanair and chief executive of Aer Lingus Commuter.