There
were recent upheavals in the airline industry affecting some airlines more than
others. Airlines like Monarch, Alitalia and Air Berlin have not survived recent
changes in the economy and adding to that their precarious financial position
led to their demise. In this essay, I will consider the reasons behind the
collapse of Monarch which was a British charter offering low cost flights and
how this has impacted airlines like Ryanair in the same industry as well as
firms in other industries. Is the collapse mainly because of changing economic
and world conditions or also because of changing structure of the airline
industry? I will first examine how the industry has evolved from being state-owned
to being liberalized. Then, I will move on to the main reasons behind Monarch’s
insolvency and finally, how has this impacted the micro and macro economy.

The
European airline industry as well as that in the US was state-owned and
carriers were viewed as precious national assets. Following a convention in Chicago
1944 which further gave more importance to that thinking, countries started to
engage in bi-lateral agreements among them which allowed other airlines to make
use of their territories. But fares were regulated by the states, capacity was
limited, and revenues were shared as well. Since fares were controlled,
competition was low. However, after 1970, the structure began to change with US
as the pioneer which advocated open skies policy where airlines were no longer
state-owned. UK followed the same path and soon, airports and air traffic
controls were privatised. Hence, fares were no longer regulated, and capacity
no longer fixed increasing competition. In Figure 1 below, the effects of
liberalization are illustrated (Button,2008).

  Figure 1: Effects of liberalization.

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(Source:
Button,2008, OECD).

This
figure illustrates the exchange of international airline services between two
countries A and B under the Chicago convention policies. Demand is assumed to
be a straight line (D1) and average cost per passenger is assumed to
rise continuously with increasing quantity of services supplied for simple
analysis and shown as C1. As the markets were regulated, capacity
was fixed (shown as the capacity constraint in the above diagram). As fares
were regulated and if we assume that both country A and B has reached an
agreement where they allow airline to recover their cost, then “it implies a
fare level up to F1” (Button, 2008, p.12) Under open skies
arrangement, both the capacity constraint and negotiated fares are removed
which increase competition resulting in firms engaging in cost cutting
strategies which led to reduced fares up to F*1. Reduced fares are
profitable to airlines which cover their costs like for short haul airline
Ryanair who uses secondary airports to further cut down cost and hence, can
operate at further reduced fare F2 as its average cost curve moves
downwards as shown by C2. But reduced fares can be problematic for
those airlines (Monarch) which have high fixed cost and cannot increase fares
as they face competition and the possible lost of passengers to other airlines.
We can, hence, deduce that the airline industry is an oligopolistic market as
firms engage in non-price competitions such as offering more comforts, more
destinations and accumulated mileage. It is oligopolistic as few airlines like
EasyJet and Ryanair provides 50% of total market capacity for low cost carriers
market in 2015 (Macdonald, 2017).

The
collapse of Monarch is mainly due to 2 main reasons – fewer destinations due to
terrorism and the depreciation of the pound sterling against the US dollar.
However, Monarch has been struggling for years and its profit and cash flow
position were not favourable as shown by the two diagrams below over a 9-year
period.

Figure
2: After tax profit/loss

(Source:
Amadeus)

Figure
3: Cash flows of Monarch

(Source:
Amadeus)

It
can be seen from the above that Monarch’s financial position has been
alternating between profit or loss for the last 9 years and its biggest loss
was in 2016; 1 year before its collapse. Also, it was generating negative cash
flows in 2014 while a positive one in 2015 which was the result of capital
influx by Greybull Capital which has improved its financial position from a
loss to a profit, but this has not been maintained resulting in negative cash
flow in 2016. Hence, it can be deduced that due to lower fares, Monarch is
unable to cover its costs to break even and cannot compete with the other larger
short haul airlines like Ryanair and Easy Jet.

Monarch
unlike Easy Jet focused mainly on leisure destinations while the latter deals
mostly with businessmen. Therefore, EasyJet has survived despite rigorous
competition as it offers more destinations for business travel at lower cost
and was not much affected by the lack of accessibility to some countries which
are holiday destinations like Turkey and Egypt. On the other hand, these were
two key destinations of Monarch but following terrorist attacks where a Russian
airplane was bombed in Turkey and the closure of Sharm el-Sheikh to British
airlines caused the number of passengers there to fall from 177,000 in August
2016 to 95,000 in August 2017 (The Economist, 2017). Monarch had to cancel
flights there and so focused mainly on the Western Europe destinations such as
Spain and Portugal as it had already stopped operating long-haul and charter
operations to Mexico and Florida in 2015 (Morris,2017). The obstacle was that
Spain has become one of the most popular destinations as data form OAG, an air
travel intelligence company showed that there were 16 million more seats in the
Spain airline market over the last 2 years and so, there was fierce competition
(Powley, 2017). Spain and Portugal represented about 80 percent of Monarch’s
revenue and so, unable to compete with even lower fares, Monarch had to declare
bankrupt.

The
other reason behind the collapse of Monarch was the depreciating pound sterling
against that of the US dollar. This depreciation is mainly due to uncertainty
following Brexit. Foreign investors were uncertain about the term of Brexit and
unwilling to invest more which caused demand for pound sterling to fall. As a
result, the US dollar appreciated. Since, fuel is a large proportion of
Monarch’s fixed cost and fuel is bought in dollars; it was now more expensive
to buy. Hence, Monarch had to pay £50 million more a year in terms of fuel
which is huge for a firm which is already suffering from lack of cash. Although
Monarch’s other competitors also faced this increase in fuel cost, they were
not as affected as Monarch was as for instance, Ryanair, which had positive
cashflows over the same 9-year period nearly 2 million euros in cash for 2016
and mostly positive profits reaching over 1 million euros (Amadeus).

The
collapse of Monarch has represented opportunities for airlines like Ryanair,
EasyJet and British Airways (BA) to gain even more market share and this is
leading to changing structure of the airline industry with few companies
monopolising the industry. They are willing to do so by buying the airport
slots of Monarch. British Airways has succeeded in buying the airport slots at
Gatwick and can now offer more flights and destinations from Gatwick. Also,
these airlines have seen their share prices rising with the removal of a
competitor- “EasyJet’s
shares 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 less
competition in the Spanish airline market and as a result, fares to Spain or
various destinations where Monarch, Air Berlin and Alitalia are no longer
operating will rise. This reduces the purchasing power of consumers and holiday
travel will now be more expensive.

However,
companies which have been most affected by Monarch’s demise are travel and tour
agencies and some hotels. Some travel agencies have been bankrupt while others
have 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 huge
cost in rebooking flights for over 6000 people which their insurance did not
fully cover. Saga, a tour
operating agency, on the other hand, after having announced a fall in their
earnings 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 tourism
industry if other airlines do not fill the travel capacity gap that Monarch
left in its demise. While the government was expecting 20 million overnight
stays in hotels at Algarve, the number may be much less as there have been many
cancellations to Algarve hotels for the Winter holidays and if these visitors
do not rebook a flight and a hotel reservation, hotels may see a decline in
their profit which will impact the tourism industry. Besides, GDP of Portugal
may fall depending on the effect of Monarch’s demise. Travel and tourism’s
total contribution towards its GDP was 16.6% in 2016 and expected to rise by
2.6% in 2017. But this rise may be much smaller than expected or GDP may be
lower than in 2016 since, several passengers have cancelled their stay at
Algarve which impact hotels, restaurants dependant on visitor contribution,
retail outlets providing hotel with food and beverages as well as other leisure
and activity resorts. It may also affect employment in the tourism industry
which consists of 8.1% of total employment and which was expected to rise by
3.4% 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 United
Kingdom economy was that huge cost was involved as the government engaged in a
repatriation 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 new
infrastructure to improve quality of life and the economy. This amount had to
be diverted from its original use. As a result, GDP which is the addition of
consumption (C), investment (I), government expenditure (G) and net exports may
fall as G falls by £60 million. Also, nearly 2000 employees of Monarch were
laid off and so, unemployment increases as not only these employees are now
searching for jobs but also employees from Chadwell travel. Monarch’s pilots
have more chance of being re-employed and so their unemployment is temporary as
Ryanair which has been facing pilot’s problems may hire them. Moreover, since
Monarch has stopped operating it means that there will be a gap in the market
where 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 export
of service and reduced spending on leisure goods and travel in UK. This will
cause a reduction in both exports of services and goods, thereby worsening the
existing current account deficit.

As discussed above, Monarch’s collapse has been
caused by both its financial position as well as changing condition in the UK
economy. This has resulted in closure, fall in share prices and profit of
travel agencies associated with Monarch. But from other airlines’ point of view,
Monarch’s demise is a blessing enabling them to further increase their market
power through the purchase of its airport slots. However, from the consumers’
perspectives, this could be harmful as with fewer airlines monopolising the
market, consumers may be exploited through higher fares. Though, this has
occurred at the microeconomy level, it has impacted on the macroeconomy in
terms of higher unemployment, possible reduction in GDP and possible worsening
of the UK current account deficit. It has not only affected the UK economy but
other countries like Portugal which was dependant on the income from visitors
which would have been travelling by Monarch to Portugal. Hence, depending on
where one is standing, this collapse could be profitable or harmful.

 

 

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