Therewere recent upheavals in the airline industry affecting some airlines more thanothers. Airlines like Monarch, Alitalia and Air Berlin have not survived recentchanges in the economy and adding to that their precarious financial positionled to their demise. In this essay, I will consider the reasons behind thecollapse of Monarch which was a British charter offering low cost flights andhow this has impacted airlines like Ryanair in the same industry as well asfirms in other industries. Is the collapse mainly because of changing economicand world conditions or also because of changing structure of the airlineindustry? I will first examine how the industry has evolved from being state-ownedto being liberalized.
Then, I will move on to the main reasons behind Monarch’sinsolvency and finally, how has this impacted the micro and macro economy.TheEuropean airline industry as well as that in the US was state-owned andcarriers were viewed as precious national assets. Following a convention in Chicago1944 which further gave more importance to that thinking, countries started toengage in bi-lateral agreements among them which allowed other airlines to makeuse of their territories. But fares were regulated by the states, capacity waslimited, and revenues were shared as well. Since fares were controlled,competition was low.
However, after 1970, the structure began to change with USas the pioneer which advocated open skies policy where airlines were no longerstate-owned. UK followed the same path and soon, airports and air trafficcontrols were privatised. Hence, fares were no longer regulated, and capacityno longer fixed increasing competition.
In Figure 1 below, the effects ofliberalization are illustrated (Button,2008). Figure 1: Effects of liberalization. (Source:Button,2008, OECD).Thisfigure illustrates the exchange of international airline services between twocountries A and B under the Chicago convention policies. Demand is assumed tobe a straight line (D1) and average cost per passenger is assumed torise continuously with increasing quantity of services supplied for simpleanalysis and shown as C1. As the markets were regulated, capacitywas fixed (shown as the capacity constraint in the above diagram). As fareswere regulated and if we assume that both country A and B has reached anagreement where they allow airline to recover their cost, then “it implies afare level up to F1” (Button, 2008, p.12) Under open skiesarrangement, both the capacity constraint and negotiated fares are removedwhich increase competition resulting in firms engaging in cost cuttingstrategies which led to reduced fares up to F*1.
Reduced fares areprofitable to airlines which cover their costs like for short haul airlineRyanair who uses secondary airports to further cut down cost and hence, canoperate at further reduced fare F2 as its average cost curve movesdownwards as shown by C2. But reduced fares can be problematic forthose airlines (Monarch) which have high fixed cost and cannot increase faresas they face competition and the possible lost of passengers to other airlines.We can, hence, deduce that the airline industry is an oligopolistic market asfirms engage in non-price competitions such as offering more comforts, moredestinations and accumulated mileage. It is oligopolistic as few airlines likeEasyJet and Ryanair provides 50% of total market capacity for low cost carriersmarket in 2015 (Macdonald, 2017). Thecollapse of Monarch is mainly due to 2 main reasons – fewer destinations due toterrorism and the depreciation of the pound sterling against the US dollar.However, Monarch has been struggling for years and its profit and cash flowposition were not favourable as shown by the two diagrams below over a 9-yearperiod.
Figure2: After tax profit/loss(Source:Amadeus)Figure3: Cash flows of Monarch(Source:Amadeus)Itcan be seen from the above that Monarch’s financial position has beenalternating between profit or loss for the last 9 years and its biggest losswas in 2016; 1 year before its collapse. Also, it was generating negative cashflows in 2014 while a positive one in 2015 which was the result of capitalinflux by Greybull Capital which has improved its financial position from aloss to a profit, but this has not been maintained resulting in negative cashflow in 2016. Hence, it can be deduced that due to lower fares, Monarch isunable to cover its costs to break even and cannot compete with the other largershort haul airlines like Ryanair and Easy Jet.Monarchunlike Easy Jet focused mainly on leisure destinations while the latter dealsmostly with businessmen. Therefore, EasyJet has survived despite rigorouscompetition as it offers more destinations for business travel at lower costand was not much affected by the lack of accessibility to some countries whichare holiday destinations like Turkey and Egypt. On the other hand, these weretwo key destinations of Monarch but following terrorist attacks where a Russianairplane was bombed in Turkey and the closure of Sharm el-Sheikh to Britishairlines caused the number of passengers there to fall from 177,000 in August2016 to 95,000 in August 2017 (The Economist, 2017). Monarch had to cancelflights there and so focused mainly on the Western Europe destinations such asSpain and Portugal as it had already stopped operating long-haul and charteroperations to Mexico and Florida in 2015 (Morris,2017). The obstacle was thatSpain has become one of the most popular destinations as data form OAG, an airtravel intelligence company showed that there were 16 million more seats in theSpain airline market over the last 2 years and so, there was fierce competition(Powley, 2017).
Spain and Portugal represented about 80 percent of Monarch’srevenue and so, unable to compete with even lower fares, Monarch had to declarebankrupt. Theother reason behind the collapse of Monarch was the depreciating pound sterlingagainst that of the US dollar. This depreciation is mainly due to uncertaintyfollowing Brexit. Foreign investors were uncertain about the term of Brexit andunwilling to invest more which caused demand for pound sterling to fall. As aresult, the US dollar appreciated. Since, fuel is a large proportion ofMonarch’s fixed cost and fuel is bought in dollars; it was now more expensiveto buy. Hence, Monarch had to pay £50 million more a year in terms of fuelwhich is huge for a firm which is already suffering from lack of cash. AlthoughMonarch’s other competitors also faced this increase in fuel cost, they werenot as affected as Monarch was as for instance, Ryanair, which had positivecashflows over the same 9-year period nearly 2 million euros in cash for 2016and mostly positive profits reaching over 1 million euros (Amadeus).
Thecollapse of Monarch has represented opportunities for airlines like Ryanair,EasyJet and British Airways (BA) to gain even more market share and this isleading to changing structure of the airline industry with few companiesmonopolising the industry. They are willing to do so by buying the airportslots of Monarch. British Airways has succeeded in buying the airport slots atGatwick and can now offer more flights and destinations from Gatwick. Also,these airlines have seen their share prices rising with the removal of acompetitor- “EasyJet’sshares 5.2% higher, Ryanair rose 3.9% and BA owner IAG was 2.4% higher” (BBC,2017).
Moreover, with Monarch out of the industry, there will be lesscompetition in the Spanish airline market and as a result, fares to Spain orvarious destinations where Monarch, Air Berlin and Alitalia are no longeroperating will rise. This reduces the purchasing power of consumers and holidaytravel will now be more expensive.However,companies which have been most affected by Monarch’s demise are travel and touragencies and some hotels.
Some travel agencies have been bankrupt while othershave seen their earnings falling and as a result their share prices as well.Chadwell Travel is the travel agency that has folded as they had to face hugecost in rebooking flights for over 6000 people which their insurance did notfully cover. Saga, a touroperating agency, on the other hand, after having announced a fall in theirearnings for this current year as 860000 people cancelled their holidays costing£2 million to the agency has seen a 25% fall in their share price (Williams, 2017). Moreover,Algarve; southern region in Portugal may face a bleak future for their tourismindustry if other airlines do not fill the travel capacity gap that Monarchleft in its demise. While the government was expecting 20 million overnightstays in hotels at Algarve, the number may be much less as there have been manycancellations to Algarve hotels for the Winter holidays and if these visitorsdo not rebook a flight and a hotel reservation, hotels may see a decline intheir profit which will impact the tourism industry. Besides, GDP of Portugalmay fall depending on the effect of Monarch’s demise.
Travel and tourism’stotal contribution towards its GDP was 16.6% in 2016 and expected to rise by2.6% in 2017. But this rise may be much smaller than expected or GDP may belower than in 2016 since, several passengers have cancelled their stay atAlgarve which impact hotels, restaurants dependant on visitor contribution,retail outlets providing hotel with food and beverages as well as other leisureand activity resorts.
It may also affect employment in the tourism industrywhich consists of 8.1% of total employment and which was expected to rise by3.4% in 2017 which may not occur if business is falling in the tourism industry(World Travel & Tourism Council, 2017).The economic impact of Monarch on the UnitedKingdom economy was that huge cost was involved as the government engaged in arepatriation process as Monarch has left 110 000 passengers stranded overseas.This has cost £ 60 million of tax payers’ money to bring passengers back. This£60 million could have been used on alternative measures such as building a newinfrastructure to improve quality of life and the economy. This amount had tobe diverted from its original use.
As a result, GDP which is the addition ofconsumption (C), investment (I), government expenditure (G) and net exports mayfall as G falls by £60 million. Also, nearly 2000 employees of Monarch werelaid off and so, unemployment increases as not only these employees are nowsearching for jobs but also employees from Chadwell travel. Monarch’s pilotshave more chance of being re-employed and so their unemployment is temporary asRyanair which has been facing pilot’s problems may hire them.
Moreover, sinceMonarch has stopped operating it means that there will be a gap in the marketwhere less passengers will be brought to UK as seat capacity has fallen.Reduced passengers mean reduced spending on air travel to UK which is an exportof service and reduced spending on leisure goods and travel in UK. This willcause a reduction in both exports of services and goods, thereby worsening theexisting current account deficit.As discussed above, Monarch’s collapse has beencaused by both its financial position as well as changing condition in the UKeconomy. This has resulted in closure, fall in share prices and profit oftravel agencies associated with Monarch. But from other airlines’ point of view,Monarch’s demise is a blessing enabling them to further increase their marketpower through the purchase of its airport slots.
However, from the consumers’perspectives, this could be harmful as with fewer airlines monopolising themarket, consumers may be exploited through higher fares. Though, this hasoccurred at the microeconomy level, it has impacted on the macroeconomy interms of higher unemployment, possible reduction in GDP and possible worseningof the UK current account deficit. It has not only affected the UK economy butother countries like Portugal which was dependant on the income from visitorswhich would have been travelling by Monarch to Portugal. Hence, depending onwhere one is standing, this collapse could be profitable or harmful.