2015 Progress Report. Supporting Airline Industry Achievement of Sustained Financial Health. IATA Financial Committee White Paper

Transcription

1 Supporting Airline Industry Achievement of Sustained Financial Health IATA Financial Committee White Paper September Progress Report Industry Initiatives Update September 2015

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3 TABLE OF CONTENT This document is a consolidation of the 2014 IATA Financial Committee White Paper and the 2015 Progress Report on Industry Initiatives launched to Support Airline Industry Achievement of Sustained Financial Health IATA Financial Committee White Paper Introduction 6 The challenge 7 Supply chain and distribution 9 Diagnosis of the low profitability 10 Addressing future risks 13 New approach: the four pillars Smarter regulation Value chain optimization Innovation Progress Report Status update: What happened in the past 12 months? 50 Economic update What has changed? 51 Progress update on industry initiatives: 1. Smarter regulation Value chain optimization Innovation Efficient processes 58 Financial Committee Governance Efficient processes 34 Conclusion 44 References 45 Contributors 46 3

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5 Supporting Airline Industry Achievement of Sustained Financial Health IATA Financial Committee White Paper September 2014

6 Introduction One of IATA s strategic objectives is to give the airline industry the means to improve and sustain its financial health. The IATA s Vision 2050 Report identified long-term challenges and possible outcomes for the air transport industry. It is recognized that as the industry continues to grow, it must address issues of capacity, environment, safety, security, and financial sustainability. This white paper targeted at senior airline financial executives includes an analysis of the drivers of the industry s poor financial returns and a set of recommendations offering a realistic path forward. It also focuses on initiatives that can be taken by IATA in giving the airline industry the means to improve and sustain its financial health. It is important to note that some of the identified causes of poor airline industry profitability cannot be addressed by a group of competitors, and have therefore been excluded from this paper, in full compliance with all applicable competition laws. In 2013, under the leadership of the Financial Committee, the IATA Financial Think Tank (FTT) was launched as a way for the senior financial community of the IATA membership to consider long-term industry programs that IATA could lead, aimed at supporting the industry improving and sustaining its financial health. It is important to note that IATA s scope is limited to supporting the industry through the provision of: Standards Tools Policies Positions It is up to each airline individually to consider whether to use or not any of these support mechanisms as part of its own strategy. Therefore, delivery of the initiatives contained in this document will not lead to improved sustained health on their own. These initiatives will only act as an enabler for the industry. Initiatives mentioned are currently at different stages of development, with some being current IATA initiatives, whereas others are new proposals for investigation. The intent is to update this white paper on an annual basis In order to drive development of such initiatives, a new structure of working groups reporting to IATA s Financial Committee was established in July 2014, in order to achieve alignment and delivery of the strategy under the mandate of the Financial Committee. It is recognized that there are inter-dependencies with other IATA objectives, in particular those related to the industry s regulatory and value chain environment, and that some of these areas are managed by IATA under the advice of different Industry Advisory Committees. The proposals are therefore inputs into IATA s overall strategy to achieve IATA s overall vision for a safe, secure, and profitable air transport industry that sustainably connects and enriches our world. 6

7 The challenge Air transport is one of those industries that has transformed the world and become an integral part of the global economy. Providing rapid connections between the world s cities by air has enabled the globalization that has shaped modern businesses and the experiences of individuals. Airlines and the wider air transport supply chain create substantial value for consumers and the broader economy, fostering economic development, international trade, and greater human understanding. This is why in the past forty years the volume of air travel has expanded tenfold and air freight has grown by a factor of fourteen compared to a three to four fold rise in world GDP, and despite repeated shocks from recessions, terrorism, and disease. Despite the clear value being created for customers and the broader economy, the airline industry has found it difficult to make an adequate level of profit. Although profitability amongst airlines varies, the average profit margin of 3% is representative of the industry, as 80% of airline profits in 2012 were within +/- 1% of standard deviation. In addition, although there 4 Z1is a negative skew to distribution, the mean is still close to the median. It is forecasted that airlines will generate revenues averaging just under US$221 per passenger in However, after paying tax and debt interest, net profit per passenger is expected to be only US$4.94, which already represents a significant improvement over the net profit per passenger generated in 2012 (a fairly typical year in the middle of the cycle) of US$2.54. It does not take much of a rise in costs, government tax, or demand shock to eliminate such a thin level of profit. This net profit figure also shows that there is little left to pay equity investors for risking their capital forecast worldwide airline financial results per departing passenger Worldwide airline net post-tax profit per departing passenger, 2014 $ $ $4.94 Ancillaries Fare Worldwide airline operating profit margin 2012 distribution Mean (weighted industry average) 2.8% Median (middle) airline 3% Frequency Outside 3 s.d. +/- 1 standard deviation (80% not 68% of airlines) 0 Cargo Revenue Cost Net profit Source: IATA. Costs include operating items and debt interest % -28% -26% -24% -22% -20% -18% -16% -14% -12% -10% -8% -6% -4% -2% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24% 26% 28% 30% Operating profit margin Source: IATA 7

8 Investors providing funds expect to be paid for risking their capital in the airline business, measuring profitability by what profit represents as a return on invested capital. That return is calculated before payments of debt interest. The Weighted Average Cost of Capital (WACC) shows what both debt and equity investors expect to earn from investing their capital in airlines. It is a measure of the intensely competitive structure of this industry that even at the top of the cycles over the past twenty years, the industry on average has never managed to generate returns that meet what investors would normally consider the minimum for a competitive industry. Over the past forty years, the airline industry has generated one of the lowest returns on invested capital among all industries. However, whereas other industries with low returns have been contracting, the airline industry has expanded regardless. This apparent defiance of the laws of economics suggests structural issues and government influence, with some capital investment not requiring direct returns. Industry median ROIC without goodwill % of invested capital Return on capital invested in airlines and their cost of capital Cost of capital (WACC) Return on capital (ROIC) Inadequate returns Source: McKinsey, IATA 8

9 Supply chain and distribution A comparison of returns on invested capital amongst the players in the Air Transport value chain makes it clear that airlines are surrounded by stronger business partners and that returns are unevenly and inefficiently distributed across the air transport supply chain. Every supply sector and distribution sector earned a higher return on capital during the past business cycle than airlines. Most earn more than or close to their WACC. Services - Maintenance Repair and Overhaul (MRO), catering, ground services - which have been outsourced by around half the industry, earn an average return of 11% compared to a WACC of 7-9%. Air Navigation Service Providers (ANSP), only a few of which have been privatized, earn an average return of 9% compared to a WACC of 6-8%. However during the past cycle, manufacturers, lessors, and airports have earned no more or less than their cost of capital. The highest returns in the air transport supply chain are earned in the distribution sectors. Computer Reservation Systems (CRS) services provided by Global Distribution Services (GDSs) earn an average return on capital of 20%, double their 10-11% cost of capital. Travel agents also seem to earn high returns but these estimates are highly uncertain as it is difficult to separate revenue flows from non-air travel business. However, it is clear that the distribution end of the air cargo supply chain is also very profitable with freight forwarders earning an average return of 15% compared to a WACC of 7-8%. On the other hand, the airline sector earns the lowest return on capital yet faces the second highest volatility of returns or risk. This indicates that market forces are not working to allocate risk efficiently. Source: McKinsey & Company for IATA Risk is also very unevenly distributed across the air transport supply chain. In competitive markets investors would expect to earn a higher return on investment if they face a higher risk or volatility on returns. That rule does not seem to apply to the air transport supply chain, as some of the sectors with the highest returns face the lowest volatility of returns. 9

10 Diagnosis of the low profitability problem The overall industry profitability is defined by the competitive intensity of a market. This can be clearly demonstrated by Michael Porter s 5 forces model, as illustrated below: advantages. Over 1,300 new airlines were established in the past 40 years, an average of over 30 each year (excluding those operating non- Western-built jets). Entry has been highly cyclical. Entry rates have shown no sign of slowing down despite low industry profitability. Similarly, market forces are also not working properly to adjust unprofitable capacity. The disappearance of capacity and the exit of companies are two key adjustment mechanisms through which other industries support normal rates of returns. In the airline industry, however neither of these two mechanisms work: o Aircraft capacity usually stays in the market, and disappears only in the very long run, even if particular companies might leave the market o Since the 1990s, there have been only about 20 airlines exiting the market each year, representing 2-3% only, partly due to government bail-outs Applying the 5 forces model highlights the severe challenges the airline industry faces. The bargaining power of suppliers is high, with concentrated oligopolies in aircraft and engine manufacturing, local monopolies at airports, GDSs insulated from competition by their market power, increased concentration in the supply of services, and powerful labor unions in many countries. The bargaining power of customers is also high, largely because of the perceived commoditization of air travel, low switching costs, and extent of cost transparency. By comparison to other industries, the airline industry does not appear to be able to achieve sufficient brand value to generate higher financial returns. The threat of new entrants is high, with easy entry into many markets, easy access to distribution channels, and limited incumbency Source: IATA using data from Ascend 10

11 The threat of substitute services is medium and rising, with improving technology for web-conferencing and competition from high speed rail on short haul markets. Competitive rivalry in the industry is high, partly because of the economics (high sunk costs per aircraft, low marginal cost per passenger, perishable product, and limited economies of scale). Competition is also high because of the commoditization of the airline product that is magnified by the indirect distribution channels currently encouraging competition on price and schedule alone. One indication that commoditization and industry dynamics may be important causes of poor profitability can be seen in the chart below. Real price of air transport, 2013 US$/RTK Real price of air transport and real unit costs Source: ICAO, IATA Airline unit costs Airline yields Source ICAO, IATA Real unit costs, 2013 US$/ATK The industry has managed to successfully halve its unit costs in real terms over the past 40 years. However, all of those efficiency gains have been passed through to customers in lower prices. This has created a lot of value to customers, a good thing, but the problem is that it has left the airline equity investors unrewarded for providing their capital. Government and consumer influence In addition to the market forces impacting the industry, the government continues to influence significantly the financial performance of the airline industry by impacting each of the 5 traditional forces above. Examples include: The privatization of infrastructure, without regulation to control the market power that emerged, and more aggressive pricing policies for government fees are increasing cost pressure on airlines Consumer protection laws, especially when un-coordinated also increase costs to airlines Government financing of substitutes and inconvenience and delays due to security procedures and air traffic control issues increase the attractiveness of substitutes in the short-haul market Bankruptcy laws and government bail-outs maintain uneconomic capacity in the market and allow companies to continue operations after writing off sunk costs, encouraging price competition at marginal costs Competition and investment rules create additional limitations to exit and the emergence of new business models Inter-governmental retaliatory measures impacting the industry. Finally a key issue is the relatively poor image and profile of the industry with the consumer and governments, in contrast to other industry sectors. This leads to the aviation industry being a vulnerable target for regulation and government actions. 11

12 The following chart illustrates how the impact of the forces outlined above for the industry ultimately results in low returns: 12

13 Addressing future risks Since the industry has survived and expanded for decades while this state of extremely poor profitability has persisted, it might be asked: does this matter? Cost of Financing Low profitability could potentially constrain capacity growth and access to service, due to decreased availability of affordable financing. However, there has been capital available so far to finance capacity growth. Many of these issues have so far been seen as signs of inefficiency or poor choices from airlines with the public having little awareness of the low profitability of airlines compared to all other industries. New regulatory measures There is a need to address and manage new regulatory measures that have the potential to further reduce the financial health of the industry, examples of which are shown in the next diagram. There is a need to attract US$ 4-5 trillion of new capital over the next two decades to buy aircraft to renew existing fleet and meet the needs of the expansion in Asia-Pacific and other emerging regions. Whether sufficient capital will be available and affordable to fund this demand remains to be seen. It is also important to note that debt finance is likely to become more scarce and costly due to the implementation of Basel III requirements and that the current policy of low interest rates from central banks may not continue. Societal costs Low airline industry financial health becomes an issue for other stakeholders if it has societal costs, such as: Reduction in service quality and reliability Financial burden for governments or employees Fragmentation into smaller companies leads to use of less-efficient small aircrafts, more congestion, higher operational costs, and greater environmental impact 13

14 Emergence of new dominant suppliers A study is currently being done on the potential risk and impact on the airline industry coming from players like Google or Facebook entering the airline distribution market. The study will be available as of December Sudden Shocks As recent incidents illustrate, for example: - the MH370 incident, - impact on flight paths of warzones - natural disasters (like volcanic eruptions) the industry remains vulnerable to sudden shocks. 14

15 New approach A new industry approach is needed to address the above root causes of lack of sustained airline financial health and to enable improved industry agility. To this end, four key strategic areas for the industry have been identified, within each of which there is a proposed supporting role for IATA. The four key strategic areas are as follows: 1 Smarter regulations Harmonizing the regulatory framework, making it more supportive and conducive to sustainable growth. This area will help address industry fragmentation, costs and complexity, as well as customer dissatisfaction, resulting from the current uncoordinated and patchwork regulatory approach. It includes addressing the image and perception of the airline industry with the public and governments. Value chain optimization 2 Optimizing the value chain, making it reflective of the relative risks to address surplus returns generated by key suppliers. This includes addressing the issues related to a highly competitive industry faced with monopoly and regulatory impositions. It also includes considering different relationships with partners focusing on service value and areas of mutual benefits. Innovation Enabling innovative and customer centric products to help combat increased commoditization of airline products. E Efficient processes Enabling lean, secure, and seamless end-to-end industry processes, thereby modernizing the industry, to achieve greater agility and adaptability for change with improved efficiency. 3 4 The Four key strategic areas and related initiatives to support Sustained Airline Financial Health 1. Smarter Regulations Harmonizing the regulatory framework making it more supportive and conducive to sustainable growth 1.1 Benefits of aviation 1.2 Environmental policies 1.3 Consumer protection legislation 1.4 Unruly passengers 1.5 Security regulations 1.6 Aircraft maintenance regulations 1.7 Flight training requirements 1.8 Ticket Taxes, Charges and Fees 2. Value Chain Optimization Optimizing the value chain, making it reflective of relative risks 2.1 Aircraft ownership costs 2.2 Airports and Air Navigation Service Providers 3. Innovation Enabling innovative and competitive customer centric products 3.1 New Distribution Capability 3.2 Customer Order Transformation 3.3 Industry Data Model 4.Efficient Processes Enabling efficient, secure, and seamless end-to-end industry processes 4.1 Fuel burn 4.2 Simplifying maintenance and ownership requirements 4.3 Shop-to-cash processes 4.4 Settlement and credit risk management 4.5 Payment methods 4.6 Fraud 4.7 Treasury 4.8 Purchase-topay processes 1.9 Fuel costs 4.9 Financial reporting 15

16 1. Smarter regulations Harmonizing the regulatory framework, making it more supportive and conducive to sustainable growth Government policies towards the airline industry have changed significantly over time, but at different speeds, leading to a high degree of heterogeneity in terms of the policy environment airlines face across countries. Deregulation has been partial, leaving the airline industry fiercely competitive in some areas whilst lacking the freedom to react to the consequences of intense rivalry in others. The increasing patchwork regulatory responses to global policy issues, consisting of uncoordinated country or region-specific approaches, reduce the industry s ability to live up to the full potential of economic and social benefits it can provide. Such an approach increases complexity and costs for the industry, which results in greater complexity and costs for consumers and businesses. As a global industry, global solutions are needed. Examples of key policies issues requiring a global framework are discussed below. In addition, the airline industry needs to address its image and perception with the public and governments and be more aggressive in exposing the market distortions that are constraining the industry structure and driving its poor performance, especially policies of governments. These areas are managed by IATA under the mandate and advice of IATA s Industry Affairs Committee. 16

17 1.1 Smarter regulations: Benefits of aviation Vision Where we are today Programs of work To achieve a positive image of our industry with consumers and key governments recognizing aviation benefits, to facilitate a stronger partnership between regulators and the aviation industry, as well as helping develop future sustainable transport policy. Change of mindset from regulators: from regulate to facilitate. Aviation provides the only rapid worldwide transportation network, which makes it essential for global business and tourism. It creates jobs and drives economic growth, with an economic impact estimated at US$2.2 trillion, equivalent to 3.5% of world gross domestic product (GDP). Aviation s competitiveness and connectivity should inform government tax and regulatory policies, but this is often not the case with airlines seen as a "cash cows" for governments. IATA and other aviation stakeholders have carried out a global initiative to produce detailed economic studies on the benefits of the aviation industry. In collaboration with the independent consultancy Oxford Economics, the goal was to identify the benefits that aviation generates for consumers, public finances, and the global economy. Wider recognition of these benefits can facilitate a stronger partnership between regulators and the aviation industry, as well as help develop future sustainable transport policy, and promote social and economic benefits across the world. Further initiatives to support the industry in promoting its benefits and improving its image are to be considered and evaluated, in particular developing regionally relevant strategies to promote value of air transport in the key markets where a positive image and strong partnerships matter most. Airlines are encouraged to use these benefits of aviation materials during their roadshows with investors, the press, and other stakeholders. IATA Governance: Industry Affairs Committee 17

18 1.2 Smarter regulations: Environmental policies Vision Where we are today Programs of work A single global market based measure with regard to CO 2 emissions, in the form of a mandatory offsetting scheme from 2020 without a revenue generating element, based on offsetting emissions growth post 2020 only. IATA Governance: Environment Committee Demonstrating our environmental responsibility is a key element of the industry s license to grow. To address the industry's 2% contribution to CO 2 emissions, the industry has agreed a four-pillar strategy, comprising new technology, improved operations, better use of infrastructure, and positive economic, or market-based measures. However, the industry requires the support of governments in the way of globally aligned and coordinated policy, instead of unilateral regional or national actions, to avoid the development of a patchwork of uncoordinated, overlapping, and costly policy measures. A worst case scenario analysis of a patchwork of different schemes and charges as well as a global tax on fuel or tickets could cost the industry US$ 100bn by 2020 and US$ 130bn by Even just extrapolating current measures and likely regulatory responses could cost the industry over US$ 50bn by A resolution passed at the IATA AGM in June 2013 on the implementation of the aviation Carbon Neutral Growth 2020 (CNG2020) strategy provides governments with a set of principles on how they could: Establish procedures for market-based measures (MBM) Integrate a single MBM as part of an overall package of measures to achieve CNG2020 IATA is now working with ICAO Environment Advisory Groups and CAEP (Committee on aviation Environmental Protection) to develop a global market based measure. In parallel, IATA is also carrying out bi-lateral advocacy with governments. 18

19 1.3 Smarter regulations: Consumer protection legislation Vision Where we are today Programs of work To achieve convergence and compatibility of consumer protection regimes based on the industry core principles approved at the IATA 2013 AGM. In particular the regimes should strike a balance between protecting passengers and industry competitiveness, and should be non-discriminatory towards aviation compared to other modes of transport. IATA Governance: Industry Affairs Committee Governments that have imposed passenger rights regimes typically include prescriptive provisions relating to passenger assistance and/or compensation in the case of denied boarding, delays, lost baggage, and cancellations. They can also mandate procedures to deal with passengers with reduced mobility, define how an airline can market its products, and what types of information must be provided to the passenger and how, when things go wrong. There is a legitimate role for governments to regulate protections for consumers, but a patchwork of differing, uncoordinated passenger rights regimes is coming into force (nearly 60 countries with passenger rights regimes exist today) that are not aligned, harmonized, or mutually recognized. There can be three or more different regimes that can apply on a given itinerary, with different levels of trigger points for different levels of compensation. This is defeating the purpose of providing passengers with clear, transparent rights that they can count on. In addition, the cost of such lack of harmonization is enormous. In 2012, the cost of the EU261 (0) legislation was a US$ 4bn annual liability to the industry. This cost could be increased to US$ 12bn by 2017 if other countries were to adopt a similar regime. A 4 pillar strategy has been agreed: Change the debate: inject a more balanced perspective into what is traditionally a defensive issue for the industry Greater convergence and compatibility: work at ICAO to bring about policy guidance that reflects the industry principles Avoid or delay damaging regulation: local advocacy campaigns in watch list countries No regulatory surprises: partner with regional associations to monitor and track development (0): Regulation 261/2004 is a European regulation establishing common rules on compensation and assistance to passengers in the event of denied boarding, flight cancellations, or long delays of flights 19

20 1.4 Smarter regulations: Unruly passengers Vision Where we are today Programs of work To minimize unruly passenger incidents on flights which will lead to a safer, more pleasant flight experience for all as well as major cost savings for airlines. This is to be achieved by: Airlines having effective policies and procedures to prevent and manage unruly passenger incidents. Governments ratifying the Montreal Protocol 2014 (1) to ensure airlines have an effective legal deterrent. Unruly passengers have become a significant daily operational issue for member airlines. Over 8,000 incidents (including assault, harassment, failure to follow safety instructions, and other riotous behavior) were reported to IATA in 2013, equating to 1 incident in every 1,600 flights. These incidents impact safety, disrupt the travel experience and plans of other passengers, cause operational disruption, and increase airline costs. Typical costs for diverting a flight to offload an unruly passenger are between USD$ 6,000 and US$200,000. The major issue is that many unruly passengers do not face punishment because police and prosecutors do not have jurisdiction over offenses committed on aircraft registered in a different State. Often unruly passengers are simply released without punishment which has no deterrent effect. A comprehensive approach is taken based on two themes that are detailed in the core principles on unruly passengers which were unanimously endorsed by members at the 2014 IATA AGM: Prevention and Management: Operational support materials to members to help them put in place policies and procedures to prevent unruly incidents and effectively manage them when they do happen. Deterrence: Advocate for revisions to the Tokyo Convention 1963 (TC63) (1) to ensure that legal gaps are closed and ensure that States have the necessary legal capabilities to deal with unruly passengers. IATA successfully lobbied for ICAO to revise TC63. The resulting Montreal Protocol 2014 was adopted in April. 22 States must ratify before it comes into force with all remaining States ratifying thereafter. Global advocacy campaigns with governments calling for the ratification will be necessary. IATA Governance: Industry Affairs Committee (1) The Tokyo Convention governs offences and other acts that occur on board aircraft inflight. It came in to force in This 50 year old Convention has served the industry well. However, a Diplomatic Conference was held between 26 March and 4 April 2014 to consider proposed revisions to the Convention to ensure that it is an effective deterrent to unruly behavior. The result was the Montreal Protocol 2014 which makes important changes to the original Tokyo Convention. 20

21 1.5 Smarter regulations: Security Vision Where we are today Programs of work To achieve risk-based and harmonized security measures, concentrating scarce resources where the risk is the highest to enable more effective security and a better passenger experience. Future passengers enjoy an uninterrupted journey from kerb to aircraft door, proceeding through the security checkpoint with minimal need to divest. To improve security and cost reduction from removal of unnecessary security controls and reduced connecting time by removal of the requirements to screen connecting passengers. To realize a potential annual benefit of US$ 1-2bn through cost reduction (delayed departure and gate screening), cost avoidance (deterred or foiled attack), and increased revenue (attractiveness of air travel). Today s passenger security screening process is an ageing platform based on a one-size-fits-all approach. Although it works, it is at great cost to authorities, the airline industry, and to passengers themselves who face long wait times and different procedures at different airports. Given the predicted growth in air travel, and continuously evolving security threats, today s model is not sustainable for the long term. In addition, one out of four passengers at the top 120 airports worldwide is a connecting passenger. This means that 325 million passengers are currently re-screened during their connections, most of them unnecessarily. Smart Security: securing state and airport commitment for testing of new technology around risk-based security and passenger flow. One Stop Security: Working with governments to facilitate agreements on recognition of equivalent security measures. IATA Governance: Operations Committee 21

22 1.6 Smarter regulations: Aircraft maintenance Vision Where we are today Programs of work To establish harmonized and modernized aircraft maintenance regulations, in order to simplify the approval and global acceptance of Approved Maintenance Organizations (AMO). Today s aircraft is maintained around the globe. However, global rules and regulations affecting the certification, approval, and acceptance of maintenance organizations do not exist. Active participation at ICAO's Airworthiness Panel in promoting the harmonized acceptance of AMOs. Facilitation of an EASA-FAA (2) Team to lay out what is needed for joint approvals in other states. There is already an example (TAECO (3) in China) that can provide the blueprint for such activities. (2) EASA - The European Aviation Safety Agency is the centerpiece of the European Union s aviation safety system comprised of the Agency, the European Commission and the National Aviation Authorities (NAAs) FAA The Federal Aviation Administration IATA Governance: Operations Committee (3) TAECO is a training center that acquired the HKAR-147, CCAR-147 and EASA Part-147 approvals in March 2002, September 2006 and December 2006 respectively. In addition, it has proved itself again to become the approved examination site for CCAR-66/HKAR-66/EASA Part-66 maintenance personnel licenses. 22

23 1.7 Smarter regulations: Flight training requirements Vision Where we are today Programs of work To harmonize the regulatory framework, creating a flexible, highly qualified workforce, and reducing by 50% the cost of training and time to recertify. Each government currently has its own pilot training programs and requirements that makes it time consuming and costly to transfer pilots from one country to another. The industry supports a competency based training system as recommended by the IATA Training and Qualification Initiative (ITQI). Multi- Crew Pilot License (MPL) guidelines and Evidence Based training (EBT) guidance have been issued. There is a need for global cooperation with major industry stakeholders such as ICAO and IFALPA (4) to ensure the necessary collaborative industry-wide effort to increase industry acceptance and implementation of such programs. IATA Governance: Operations Committee (4) IFALPA: International Federation of Air Pilot s Associations. In excess of 100,000 pilots in over 100 Member Associations around the world are currently in IFALPA Membership. Pilot Associations join IFALPA to become part of a worldwide pilots' federation to have a voice at all of the world's major aviation forums. 23

24 1.8 Smarter regulations: Ticket Taxes, Charges and Fees (TCFs) Vision To achieve greater harmonization of ticket TCFs and collection/remittance processes: Reduction of existing TCFs, avoidance of new TCFs or reasonable, cost-related TCF increases in consultation with airlines. Reduction in administrative cost of collection by reducing the number of different ticket TCFs through harmonization of the rules and industry-led standard practice for ticket TCF collection (including electronic reporting and standard audit requirements, where this is not currently the case), recognized by governments and airport authorities. Higher safety level of assurance to reduce number of legal cases and penalties due to unclear taxation environment. IATA Governance: Financial Committee Taxation Working Group Financial Services Development Working Group Airport Working Group Where we are today The airline industry is seen as an "easy target" for revenue generation for governments, who regularly increase or introduce new ticket TCFs. Although they are levied on passengers on behalf of a government or an airport authority, they increase cost of travel and therefore impact demand and ultimately airline revenues. They also have a negative impact on the national economy of the countries that levy TCFs in the long term. Excessive airport and air navigation charges also distort the industry. There are currently around 650 different ticket TCFs (of which some 230 are statutory government taxes) most of which are uncoordinated, changing constantly, and with different filing requirements, in many cases still manual, creating additional costs for airlines. Taking into consideration hidden administrative costs, there is a significant total cost of collection of these TCFs for the industry. 24 Programs of work - Analysis of the current picture o Locate where these problems occur (regions/countries) o Address what can be done to address them and how o Identify the stakeholders needed to be involved? o Create a working group - Prioritization of issues to tackle - Advocacy agenda to tackle priorities Efforts are undertaken to mitigate the global tax burden and this includes reducing ticket taxes/charges/fees when and where possible. Some recent examples are the withdrawal of the Irish Air Travel Tax of EUR 3 per departing passenger as of 1 April this year; the UK Air Passenger Duty has been reformed resulting in cost reduction for airlines and their passengers starting in The possibility to look into the harmonization of TCFs, in particular governmental taxes will need to be further analyzed before undertaken.

25 1.9 Smarter regulations: Fuel costs Vision Where we are today Programs of work To achieve competitive and reliable access to jet fuel and bio-fuels: Full and reliable open access to fuel infrastructure, a competitive jet fuel market and a reliable supply of jet fuel at airports, at transparent prices. Eliminate duties and taxes on jet fuel, and remove or moderate unjustified or excessive fuel fees. Bio-fuels available as economically viable alternative to fossil based jet fuel. IATA Governance: Environment Committee Financial Committee Commercial Fuel Working Group Fuel costs represent 30-40% of airlines operating costs, with most of the cost being in the price of the jet fuel molecule. Each additional cent per gallon of jet fuel costs the industry as a whole US$ 700 million. Fuel supply markets controlled by monopolies or where competition is lacking can adversely impact airlines fuel costs. Fuel concessions fees are an unjustified burden on airlines as they have no cost basis. Airports that apply such a fee are abusing their dominant position to boost their revenue collection at the expense of the industry. Opaque pricing practices, excessive throughput fees and the imposition of taxes on jet fuel for international operations, in contravention of ICAO policy, also add to fuel costs. Jet fuel supply disruptions at airports can cause significant extra costs for airlines associated with the need to tanker fuel from other locations and delayed flights or cancellations. Bio-fuels today are not economically viable competitors to fossil based jet fuel as they are still niche products but turning this situation around remains a worthwhile initiative. Finally, fuel prices remain a critical cost item, highly volatile and can easily erode airlines thin profit margins. It remains a central topic for the industry to address. The work to reduce the impact of fuel costs includes: Promoting open access to jet fuel infrastructure and competitive jet fuel markets at airports. Addressing unjustified fees, including lobbying for the regulation of concession fees. Opposing any form of taxation on jet fuel sold for international flights. Tackling the jet fuel price structure in many countries in order to bring transparency and ensure that cost items impacting the final jet fuel prices are cost-related. Ensuring that supply reliability issues are addressed with all stakeholders including the fuel suppliers, fuel infrastructure and service providers, the airlines and the airport, at all stages of the jet fuel supply chain. Lobbying for a political and legislative framework that incentivizes cost-effective production of bio-fuels. Co-operating with bio-fuels producers and supporting national and regional multi-stakeholders bio-fuels initiatives. 25

26 2. Value Chain Optimization Optimizing the value chain, making it reflective of relative risks Airlines are creating significant value to the economy and the entire value chain. However airlines earn the lowest returns whist bearing the second highest level of risk, indicating imbalances in the value chain (see more details in Page 5 of this document). In competitive markets investors would expect to earn a higher return on investment if they face a higher risk or volatility or returns. That rule does not seem to apply to the air transport supply chain, as some of the sectors with the highest returns face the lowest volatility of returns. On the other hand, the airline sector earns the lowest return on capital yet faces the second highest volatility of returns or risk. This indicates that market forces are not working to allocate risk efficiently. 26

27 `` 2.1 Value chain optimization: Aircraft ownership costs Vision Where we are today Programs of work To achieve a competitive OEM and maintenance spares market: No anti-competitive practices in the OEM market No barriers of entry for 3 rd party suppliers Harmonized spare parts regulation Harmonized spare parts types, with an industry-wide parts pooling service available Aircraft costs represent 20-25% of total airline expenses. About half of this cost is related to financing the aircraft, lease payments, lease transfers, costs related to ownership of spare parts, tools, and insurances related to the above. The remaining half is attributed to the maintenance of the aircraft and its components; e.g. engine material and parts costs representing about 4% of total airline operating costs. For example, even a reduction in total maintenance costs of 1% would lead to US$ 800 million annual savings at the Industry level. The limited number of aircraft components and engine manufacturers operate a pricing model whereby the airlines are locked in for a number of years to maintenance and parts pricing escalations often above inflation. In addition, there is very little opportunity for third parties to enter the maintenance space. The lack of standard aircraft spares prevents reduction and pooling of spares inventory, therefore preventing further savings. IATA is currently performing an analysis and investigating options available to address the issue of OEM anti-competitive practices as well as an action plan to be presented by end The analysis is covering the following: 1. Market analysis: Identify largest components (value) and players, competition in specific segments, certain business practices and abuses etc. Understand the relationship between air framers and other OEMs. 2. Legal analysis: what are the options that we have from a Legal perspective? What steps we need to make that ensure highest return for our efforts. 3. Economic analysis: role of primary product and aftermarket for the OEMs (from a competition perspective). IATA Governance: Operations Committee 27

28 2.2 Value chain optimization: Airports and Air Navigation Service Providers Vision Where we are today Programs of work A more balanced customer-supplier relationship between airlines and airports with partnerships that benefit the entire value chain: Cost-related charges set up in consultation with the airlines. CAPEX aligned to airlines needs modularly expandable and agreed by the airlines. Standardized operations for gro und handlers and shared efficiency in airline auditing. Meaningful engagement of airlines in airport and air navigation charges consultations. Where airports or providers are privatized to improve efficiency, a robust and effective economic regulatory framework is necessary. IATA Governance: Industry Affairs Committee Financial Committee Airports Working Group Operations Committee Airlines and passengers are estimated to have paid at least US$ 92bn for the use of aviation infrastructure globally in 2011, a 27% increase since These charges are now equivalent to 14.4% of the cost of transport, representing a 1.1% point rise since On a per passenger basis, charges rose 9% between 2007 and 2011 (4% for charges levied on passengers and 13% for charges levied on airlines) and by over a fifth on a p e r f l i g h t b a s i s. Conversely, g r o w t h in airline revenue per passenger over the same period has not even kept pace with inflation (0.1% increase only). The top 25 airports plan US$ 150bn in CAPEX over next 10 years. We need to ensure that this does not result in unnecessary increases in charges. In addition, airport service shortfalls impact airline bottom-line and ground damages cost the industry US$ 4bn p.a. while fragmentation of GOMs leads to multiple airline auditing. Airport and air navigation service providers (ANSPs) are, for the most part, natural monopolies which can arbitrarily raise their charges, resulting in excessive and unjustified profits and/or inefficient delivery of services. Strong, robust and independent economic regulation is required to give airlines sufficient protection against airports potential abuse of their dominant position. IATA pursues on-going advocacy efforts in order to reduce charges. The 2014 IATA board targets are: Reduce airport, ANSP charges, fuel fees, and taxes by US$ 750m. Reduce proposed taxes increases by at least 25% on average. Other current areas of work include: Working with the EC on stronger airport charges directive and ensuring more effective regulation in other states. Delivering key airport CAPEX alignment campaigns. Delivering effective implementation of A- CDM (Airport Collaborative Decision Making) Capacity monitoring database: driving early, proactive engagement on emerging airport capacity constraints. Securing service improvements. Increasing adoption of IGOM by airlines and GSPs. Reducing airline auditing costs. 28

29 3. Innovation Enabling innovative and competitive customer centric products One of the drivers of poor financial health is the commoditization of air travel. This is aggravated by indirect distribution channels currently encouraging competition on price and schedule alone. These channels do not cater for the product differentiation or personalized service that a 21 st century consumer has come to expect. Today s customer expects simplified options and door to door service. However, customers cannot experience a seamless integrated journey of a consistently high quality if travel partners are not connected. Under the Simplifying the Business (StB) program, IATA has launched a number of initiatives to start addressing these issues. 29

30 3.1 Innovation: New Distribution Capability Vision Where we are today Programs of work Industry adoption of the New Distribution Capability (NDC), providing airlines with the ability to differentiate their products across all distribution channels, i.e. bridges the gap between the direct and the indirect channels. Customers want more transparency and choice when buying products, they want to know the value of what they buy, not only the price. NDC will increase competition in airline distribution for the benefit of the consumer. The NDC capability will enable further revenue generation, yield improvement through product differentiation, and cost efficiency arising from an open standard.. IATA Governance: Simplifying the Business Passenger Distribution Group As we head into the last quarter of 2014, the NDC program has hit 3 critical milestones, and thereby finishing its inception phase: On 7 August 2014 the US Department of Transportation has granted final approval of Resolution 787, the founding document for NDC. In September 2014 we will have published the first comprehensive set of end to end NDC schemas. Today our relationship with key industry stakeholders has significantly improved and there is an atmosphere of constructive debate and open discussions will mark the beginning of phase 2 of the NDC program: Airlines, as well as their industry partners, now have the basic pre-requisites which enable to focus essentially on adoption and deployment. The key areas of focus for the deployment phase will be: Leverage our communications activities established in 2014 by creating valuable knowledge related to NDC, making it easily and widely available to all within the travel industry, and facilitating interactions between NDC players. Intensified engagement with key stakeholders i.e.: airlines and also corporate buyers and travel agents. A further enhanced version of the standards, based on feedback from the first deployments. Delivery of an NDC compliance tool which will give a dynamic overview of which players (IT providers, Airlines and distributors) have adopted which components of the NDC standard. Launch of the NDC Accelerator to stimulate market entry by emerging technology companies or new product development by existing companies to support member airline distribution needs and stimulate competition. Exploration of areas where industry utilities may be required in order to boost adoption. 30

31 NDC Roadmap

32 3.2 Innovation: Customer Order Transformation Vision Where we are today Programs of work One airline customer order: the passenger shopping basket. To move from the established industry booking and ticketing capability facilitated through the Passenger Name Record (PNR) and Special Service Requests (SSR) or Electronic Ticket (ET) and Electronic Miscellaneous Document (EMD) processes towards a single airline customer order: the passenger shopping basket. The vision is articulated around 3 core principles: 1. Customer oriented architecture 2. Efficient billing and real-time synchronization of relevant information between all parties 3. Simplified airline merchandising delivery IATA Governance: Simplifying the Business StB Steering Group For the customer, it s confusing: When it comes to check-in or requesting any changes to their itinerary, the airlines customers are confused which order references (airline PNR, GDS PNR or electronic ticket) they are supposed to provide. They would clearly benefit if they had a single receipt instead of a separate reservation (stored in a PNR) and a separate sales record (stored as an ET/EMD) that need to be synchronized to reflect a customer order. For airlines, it s not scalable: Current processes are far from being optimal to support a reliable booking and delivery of the complex merchandizing airlines wish to sell today. They are not scalable to fulfill interline ancillary products. For travel agents it s complicated: Travel agents welcome the convenience of the e-ticket, EMD or booking confirmation as receipts for their customers and as an accounting document. However, travel agents struggle to have consistent methods to book flights and ancillaries depending on airline business models. A modernized single customer order will further facilitate servicing, tracking and accounting of purchases. The customer Order Transformation project, a new StB exploration initiative, is investigating airlines core reservation and ticketing systems capabilities in an NDC context to simplify further current industry processes and facilitate airline merchandising trends. The objective is to ascertain if today s airline legacy order management processes (book-ticket-deliver) are fit for purpose in today s environment (NDC, explosion of ancillaries, bundled products, multichannel distribution). A new concept to move today s PNR and tickets to the passenger shopping basket: PNR/SSR/ET/EMD are in effect various forms of order identification which are replicating similar information given the evolution of the available technology to date. The aviation industry now needs to consider adapting a more modern retail approach - a single reference that will be extendable and capable of being shared across industry partners (travel agents, interline partners, airport systems, etc.). In parallel, NDC unlocks the opportunity to rethink the order management processes and introduce the notion of a Passenger Shopping Basket (PSB) approach rather than insisting on the need to integrate current reservation PNRs transactions and accounting ET/EMD documents. 32

33 3.3 Innovation: Airline Industry Data Model Vision Where we are today Programs of work Successful implementation of any business strategy requires understanding of the information and the processes which underlie running of the business. When two or more parties need to exchange data, such understanding has to be shared. This is why the use of common reference points such as industry data exchange standards, is integral to running any successful business. The Industry Data Model project aims to complement the current set-up with a living model with a defined structure and behavior. Requirements for future messaging standards will be translated into model elements, and messaging standards, such as messages schemas or web services definitions, will be generated automatically from the same model. There is a growing demand for new messages across the industry. The current message-by-message approach to standards development does not scale: Data definitions inconsistent across messaging standards. Methodology to develop & maintain labor intensive. There is no computer-readable industry reference for common data definitions and their relationships. There is a need to align/integrate standards with other industries adopting model-driven approach (ATMs, airports, travel). To build an Industry Data Model and strengthen the industry s capability to develop modern data exchange standards. The main benefit is Industry standards development (increased interoperability, quality, efficiency, elementary ability to deliver data exchange standards at the pace and scale required by the members, such as NDC, Fast Travel, Passenger Data, Loads control). Universal customer data exchange: A Universal Customer Travel Data Exchange would be a methodology by which entities could seamlessly assemble relevant information about customers from multiple sources of data, assuming that all data privacy concerns are addressed and specifically that the customer is in agreement with such data being shared. IATA Governance: Simplifying the Business StB Steering Group 33

34 4. Efficient Processes Enabling efficient, secure, and seamless end-to-end industry processes Elements of fuel and aircraft ownership costs are process rather than simply value chain related and operational improvements have the potential for significant savings and simplification. In addition, a significant portion of airlines financial support processes rely on old technology and processes designed for a manual environment and based on an old set of rules. Technological improvements, advances in the electronic environment, and the evolution of business practices provide opportunities for redesign, simplification, and automation. 34

35 4.1 Efficient Processes: Fuel burn Vision Where we are today Programs of work Reduction in fuel usage per ASK (and reduced associated environmental emissions) through optimized routes, air traffic management, regulatory framework, and operational management through resolution of the top ten industry wide issues (infrastructure / airport / routes) that lead to reduced efficiency. With fuel costs representing 30-40% of airlines operating costs, each 1% improvement in fuel efficiency across the industry can lower the fuel bill by around $2bn per year at current fuel prices. Currently, the lack of modern infrastructure and Air Traffic management systems and regulations with restrictive route regulations lead to additional fuel burn. IATA is working with industry partners to increase the industry s fuel efficiency and reduce associated environmental emissions and with individual airlines to ensure that they have a robust internal fuel conservation program. Initiatives include: Performance Based Navigation (PBN) Go Team workshops to engage ANSPs to provide access to more fuel efficient route structures. Fuel Efficiency workshops with more focus on potential fuel savings due to improved routing. Ongoing advocacy to advocate for access to User Preferred Routings as well as better route, climb and descent profiles. Promoting IATA facilitated ATM operational improvement projects. IATA Governance: Operations Committee Industry Affairs Committee 35

36 4.2 Efficient processes: Simplifying maintenance and ownership requirements Vision 100% electronic ownership and maintenance records with acceptance of electronic / digital documentation for aircraft records and digital signature for tasks, approvals, etc. Where we are today Whilst the cockpit has now become paperless, maintenance processes are still principally paper-based. Programs of work Like other IATA industry initiatives, such as e- ticketing and e-awb, the paperless aircraft operations initiative is another one of IATA s steps towards achieving a paperless environment which has been launched under the advice of the Operations committee and the Paperless Aircraft Operations Think Tank. With the help of harmonized innovative technologies and improved processes (such as e- signatures and Auto-ID/RFID), the aircraft should be able to talk to the operator about its history, airworthiness, technical condition, and costs. Additionally, all the records can be retained digitally from cradle-to-grave. IATA could also play a significant role by becoming the keeper of the aircraft ownership digital records (e.g. clearing house/registry for aircraft record) that can be accessed by whoever the airline and/or the aircraft owner assigns access to. IATA Governance: Operations Committee 36

37 4.3 Efficient processes: Shop-to-cash Vision Simplified and automated financial support activities with: Total quality management with NDC enabling the capture of the correct information from the start of the process. Simplification of airline financial support activities, including revenue accounting, as well as simplified pro-ration processes to capture the order, to decide how to accept payment and to issue the ticket without risk of changes by intermediaries, to issue the price availability and to drive ticketing. Cash flow improvement. Where we are today Airlines financial processes were developed in the early days of the airline industry, based on the absence of IT systems, with large amounts of paper and special rules. The current industry processes and systems are now outdated and lack the flexibility required for the modern world. Changes in the industry provide opportunities to redesign and streamline shopto-payment processes and automate revenue accounting. Programs of work The Customer Order Transformation study is exploring order management processes that may drive simplification of financial support activities. The NewGen Iata Settlement Systems (ISS) project aims to make managing industry funds cheaper, faster, safer, more timely and relevant. Finally, a new BSP for NDC project is ensuring that the BSP will remain relevant for NDC airlines. IATA Governance: Financial Committee Financial Services Development Working Group 37

38 4.4 Efficient processes: Settlement and credit risk management Vision Where we are today Programs of work To enable a modernized travel agent sales channel, with significant cash flow acceleration and reduction in losses resulting from travel agencies defaults and internal cost of airline credit risk management. Real time agency risk management. IATA Governance: Financial Committee Financial Services Development Working Group The resolutions issued by the Passenger and Cargo Agency Conferences form the basis of the industry distribution and settlement systems. The current model has shown little changes in years and is no longer suited to the evolution of the travel agencies business models like: Globalization of many travel agents, Travel Management Companies or online travel agents (that now form the largest proportion of indirect sales). Smaller travel agencies are leaving the BSP and are acting through consolidators. Even though limited in percentage, the unrecovered defaults represent between US$60m and US$150m of airline losses every year. Increasing the remittance frequency is a double edged sword; on one hand it reduces the moneys at risk; on the other hand, there is a natural cash flow tension between travel agencies, their customers and the airlines, which if stressed beyond a certain point, is incentivizing the usage of credit cards as airline settlement. Airlines may risk swapping a potential credit loss cost with certain and significantly higher amounting of credit cards merchant fees. Actions to mitigate this risk are developed in the next section of this document. The lack of agent credit limit management is a major cause of unrecovered defaults. Currently, by resolution, IATA performs a yearly financial assessment of travel agencies, but IATA is not mandated to either inform or intervene when agencies sales are going beyond a given amount. The concept of credit limit management does not exist at industry level. Some airlines have implemented additional measures to limit the risks with partial information only while still exposed to the overall industry risk. A ISS Business Plan has been launched which includes the following BSP objectives by 2020 (with annual targets), using 2013 as the baseline: Reduction by at least 50% of the time from sale to receipt of cash in the BSP through review of steps in the sales to cash end to end process. Reduction by at least 80% of the BSP net default rate through a more pro-active risk management approach with early warning mechanisms. Reduction by at least 20% in BSP operating unit charges including inflation. Simplified and strengthened agency programs governance structure. New accreditation model with a more global approach as well as relevance to current and future players in the indirect distribution space. 38

39 4.5 Efficient processes: Payment methods Vision Where we are today Programs of work To develop industry payment standards and tools for reduction in intermediaries, enabling reduction in distribution costs (including payment method costs) as a % of cost of sales and increased security. IATA Governance: Financial Committee Payment Methods Working Group Merchant fees paid by the airline industry amount to (*) US$ 6bn annually, representing 2.2% of air card sales and is one of the major distribution costs. There is a risk that more payments will move to card payments with the airline as a merchant, especially if the BSP rules tighten the agent credit for cash payments: Card payment is seen as a sign of modernity and is increasingly replacing cash payments The announced wave of payment wallet is mostly about initiating card payment in a new way, still attracting card acceptance merchant fees The acceleration of settlement frequencies reduces the benefits for agents to hold funds, therefore driving them to push card payment acceptance to the airlines in order to eliminate their own card acceptance costs and to avoid the cost of guarantees to be provided for BSP cash sales. Currently, only 30% (*) of BSP sales and 60% of direct sales are settled with card payments with the airline as the merchant of record, compared to 90% in ARC. A rise to 90% worldwide could increase total card costs for the airline industry by a further USD 5bn. In addition, new EU regulations preventing surcharges on consumer credit cards in return for capped and lower interchange rates will positively or negatively impact airlines net costs, depending on their existing policies. After forty years with little evolution in the method of payments, the payment sector is now going through major structural changes in the areas of technology, regulatory changes, and new entrants that provide both opportunities and risks to the airline industry. (*) : Source PhoCusWright Existing programs of work include: On-going lobbying activities to cap interchange fees. Implementation of prepayments methods. In addition, new programs of work are being investigated in relation to: Education role: in light of the structural changes and their potential financial impact, there is a need to provide guidance to the wider airline financial community on the evolution of future payment methods, new payment standards/scheme, and changes in regulations. A more proactive approach in identifying standards and tools to address the indirect payments for direct sales and enhance the direct payments for indirect sales areas. This could include the development of an industry payment solution that delivers value to the user (e.g. frequent flyer miles, lounge access, etc). Assess the possibility of changing the existing model, e.g airlines not acting as a merchant any longer. 39

40 4.6 Efficient processes: Fraud prevention Vision Where we are today Programs of work To eliminate global fraud (card, online, and frequent flyer). IATA Governance: Financial Committee Payment Methods Working Group Treasury Working Group Airline ticket sale is an attractive ground for fraudsters and airlines have to contend with several types of fraud: family or friendly fraud, frequent flyer fraud, travel agency fraud, crosschannel fraud, 3 rd party fraud, acceptance of stolen or counterfeit credit card account numbers, internal fraud, and theft of cardholder data from company systems. Credit card fraud is believed to cost the industry around USD 1bn annually in lost revenues, averaging 0.3% of revenues paid by cards, but with internet fraud estimated as high as 1.7%. It is estimated that card fraud also leads to increased merchant rates, costing an approximate additional USD 500m. Finally airlines have to bear the costs of fraud prevention tools, manual processes, fraud dispute handling, and charge backs, as well as lost sales associated with declined purchases ( false positives ). Develop a metric to monitor fraud and a roadmap to eliminate global fraud. Existing initiatives aimed at reducing the fraud costs include: Participation to Industry groups on Fraud prevention Active initiatives with Interpol action days Dynamic Industry Fraud database (Perseuss) supporting the various Fraud Prevention Tools Prioritize new initiatives including: Fraud prevention: o Educating o Fostering collaboration o Establishing a network for fraud prevention Card and FFP fraud: o Performing a comprehensive industrywide survey on airline fraud and on-going KPI benchmarking with a view to create best practices to be shared amongst the industry o Customer authentication o Central payment gateway Online fraud: o Fake s and invoices management o Click frauds o Fake travel websites 40

41 4.7 Efficient processes: Treasury Vision Where we are today Programs of work Guaranteed, fast, and document free cash repatriation and payments, with repatriation at the rate ticket was sold. Numerous regulatory issues regarding cash repatriation from a number of countries lead to hidden administrative costs on reporting requirements and significant delays in repatriation (with additional risk of devaluation of currencies). Separately, cross board payment standards (e.g. SEPA) are evolving, often without an active role from the Industry. Efforts have currently focused on lobbying action to facilitate cash repatriation in problematic countries. Areas to explore for Treasury to be in better control of their cash flow include: Possibility to combine BSP, CASS, ICH and ICCS cash flows. Repatriation of credit card funds from agents card sales. Tackling double taxation, i.e. if airlines have to pay income tax in their home country as well as in any other countries where they operate. IATA Governance: Financial Committee Financial Services Development Working Group Treasury Working Group Industry Taxation Working Group 41

42 4.8 Efficient processes: Purchase-to-pay Vision Where we are today Programs of work Achieve by 2020 full electronic invoicing, which will reduce both suppliers and airlines cost. Administrative efficiencies through standardization and automation. Improved incorrect charges detection. Airlines purchase-to-pay processes are still subject to significant manual processes. Most invoices received by airlines are received in PDF via and over half of the core suppliers are still sending paper invoices. IATA s Financial Exchange project is driving the adoption of standardized electronic invoicing of major industry suppliers. IATA Governance: Financial Committee Airports Working Group Commercial Fuel Working Group e-invoicing supplier mobilization Task Force 42

43 4.9 Efficient processes: Financial Reporting Vision Where we are today Programs of work To contribute to the development of high-quality accounting standards and uniform accounting policies within the Airline Industry and to provide technical advice and guidance to IATA member airlines on new accounting standards. To ensure a greater flexibility for the further development of financial accounting and its adjustment to new requirements, the development of uniform accounting principles within the Airline Industry should be advanced. The globalization of accounting standards is gaining pace. The approach is moving from a bilateral convergence of the International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Standards (GAAP) to a more inclusive, multilateral approach to standard-setting. The IASB as part of the global financial architecture intends to ensure that its Standards are capable of being applied and enforced on a globally consistent basis. At the same time, the investors and companies worldwide will gain from the full adoption of IFRS and the relevance and soundness of financial information. All of this will add to the integrity and efficiency of global financial markets. The program of work will include the following: Changing the existing Airline Accounting Guidelines to Airline Disclosure Guides: Issuance of Airline Accounting Guidelines which focus on providing benchmark airline accounting disclosure guidance and examples that will help to enhance the quality of accounting and financial reporting. IFRS 9 Hedge accounting & IFRS 15 Revenue from Contracts with customers: provide technical advice and guidance to IATA member airlines on these new accounting standards. IASB/FASB Lease accounting project: Follow up with the IASB during the finalization process for this standard so as to ensure that the Airline Industry position is put forward regarding specific aspects of the standard. IATA Governance: Financial Committee Industry Accounting Working Group IASB - Request for Views Agenda Consultation: Comment on the IASB work plan until 2020 with regard to the most pressing areas for improving International Financial Reporting Standards (IFRS) from an airline industry perspective. 43

44 Conclusion This white paper comprises an analysis of the major drivers of the industry s poor financial returns. It delivers a set of recommendations offering a realistic path forward to support the airline Industry in improving and sustaining its financial health, focusing on initiatives that can be taken by IATA. These recommendations are developed from the lenses of Airlines financial executives and therefore cover all areas of the business from a financial perspective. The topics covered in the strategic areas 1, 2 and 3 may also have other drivers than pure financial ones and those drivers should be combined when taking forward the initiatives in these areas. In order to support the programs of work highlighted in this document, IATA s Financial Committee has agreed a renewed structure of working groups for the activities under its remit. The new working groups will be meeting for the first time at the World Financial Symposium from 13 to 18 September Building from the recommendations highlighted in this paper and under the guidance and mandate of IATA s Financial Committee, the working groups will establish the agenda to address these issues in input of the wider CFO community gathered during the CFO Summit, the paper will be updated and distributed to the wider financial community. One of IATA s strategic objectives is to give the airline industry the means to improve and sustain its financial health and IATA is convinced that the recommendations from this paper, if implemented, will set the path towards achieving this objective. This paper is a live document that will be updated on a regular basis to provide the latest status on each initiative and add any other areas that may become relevant to support the airline industry in achieving sustainable financial health. This first version is shared with IATA s Financial Committee and its reporting working groups. The key analysis and recommendations in this paper will be presented and discussed at the CFO Summit also taking place during the World Financial Symposium. Based on the 44

45 References Links to key references to a number of the topics mentioned in this document are included below: Vision 2050 Profitability and the Air Transport Value Chain Benefits of Aviation Benefits of liberalization Environmental Policy Consumer Protection Unruly Passengers Smart security One-stop Security Simplifying the Business New Distribution Capability Airport and ANSP charges Taxation Sustainability and Fuel Efficiency Engineering and Maintenance Paperless Aircraft Operations IATA Financial Services for Airlines 45

46 Contributors Airline Delegates IATA Michael Doersam SVP Group Finance Emirates Martin Murray Chief Financial Officer Cathay Pacific Sponsor Aleks Popovich Senior Vice President, Financial and Distribution Services Daniel Ho Chief Financial Officer Qatar Airways Robert McDonald Chief Financial Officer Air New Zealand Erik Swelheim Chief Financial Officer KLM Subject Matter Contributors and Facilitators Stephan Copart Head of Strategy, Industry Services Transformation Juliette Iles Former Head of Business Planning and Reporting Corporate Planning and Control Valentina Révay Head SVP Office, FDS 46

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49 2015 Progress Report Industry Initiatives Update September 2015

50 Status Update What happened in the past 12 months? In order to better face the ever changing challenges illustrated in the next section Economic Update the Financial Committee has gone through some thorough changes in its own structure over the past 12 months. First of all, a Steering Group was created in order to ensure alignment between the Financial Committee and its Working Groups, and to oversee the delivery of the agreed industry objectives. This has led to a re-organization of the Working Groups themselves, which are now better equipped to address the challenges faced by the Industry and to deliver concrete results. An updated chart of the Financial Committee Working Groups can be found at the end of this document. As indicated in the 2014 IATA Financial Committee White Paper, the strategic actions to support airlines industry financial health are divided into four main pillars: Smarter Regulations, Value Chain Optimization, Innovation and Efficient Processes. The four pillars have formed the basis for the work and the initiatives of IATA and its Industry Committees and Working Groups in The past 12 months saw an intense activity across the industry and the following pages provide an update on the progress made. This year also saw the renewal of all IATA s Industry Committee, and the Financial Committee will meet for the first time with its renewed membership in September The Committee will continue its work and commitment towards Sustained Airlines Financial Health and will provide annual updates on the progress of work to the wider financial community. Enjoy the read, Michael Doersam Chair of the IATA Financial Committee Aleks Popovich IATA SVP Financial and Distribution Services 50

51 Economic Update - What has changed? In the past year some improvement in the financial performance of the airline industry became evident, to the extent that IATA predicted that 2015 would see industry aggregate return on capital exceed the average cost of capital for the first time. However, this does not suggest that the challenges driving poor airline profitability for most of its history have been overcome. The improvement in 2014 and so far in 2015 has been driven by a small number of large airlines, mostly based in the US. In 2014 there were just over 30 of these airlines, though they represent one-third of the capital invested in the airline industry worldwide and so have pulled up the industry total. The median airline was only generating a ROIC of just over 3% in 2014, less than half the average cost of capital, and the most common result the mode was a zero ROIC. Distribution of 2014 airline ROIC 14 Most frequent ROIC = 0% 12 Median ROIC = 3.2% number of airlines airlines ROIC > WACC (>33% invested capital) % return on invested capital

52 The spread of returns by airlines across different regions in 2014 shows clearly just how diverse performance was, and the sharp differences by region. North American airlines had a wide spread but not as wide as other regions and almost half of these airlines generated returns in excess of their cost of capital. In Europe, there was also a significant group of airlines generating above cost of capital returns, but also a significant number of loss-making airlines. In other regions there were only one or two airlines generating an above cost of capital performance return on capital by region 30% 20% ROIC as as % invested capital 10% 0% -10% -20% LA = Latin America ME = Middle East AF = Africa -30% N America Europe Asia Pacific LA ME AF What changed? The key common factor for the majority of North American airlines and those European airlines generating good returns was a diminution of fragmentation in some of their key markets. In addition, the structure of consolidation by ATI JVs on the North Atlantic generated efficiency gains from the denser traffic flows. That structural change coincided with a strong US economy and the substantial fall in fuel prices. US airlines were best placed to take advantage. The key challenges to profitability remain, even for US airlines. Most markets in the world remain highly fragmented. In fact, growth markets are likely to see more entry and perhaps more fragmentation in the future. Product differentiation is starting to benefit from the rise of ancillaries but commoditization remains a problem. Sharp imbalances in the airlines supply chain remain, with many suppliers having significant market power. Many governments continue to see the industry as an easy target for taxation and not the enabler of economic development and growth that it is. 52

53 1. Smarter Regulations 1.1. Value of aviation The focus of this campaign varies in different regions of the world. In Africa, we concentrate on the value that air transport can deliver through greater intra-african connectivity. The African Union and a number of individual African States committed publicly to open their markets by the end of In Latin America and Asia Pacific, focus is on the value that air transport can deliver if infrastructure is developed to meet growing traffic demand, while in Europe all efforts are concentrated on the value that air transport can deliver by addressing the inefficient use of airspace in the region Environmental Policies The Environment Committee is working on defining IATA s position on the design of a single global market-based measure (GMBM) and negotiations are ongoing with ICAO. An agreement on GMBM is expected to be reached at the 2016 ICAO Assembly Consumer Protection Legislation A collateral related to the Change the Debate campaign was showcased at the IATA AGM in June IATA will attempt to include extraterritoriality in the ICAO consumer protection policy guidance Unruly Passengers IATA has produced updated Guidance on Unruly Passenger Prevention and Management as well as new Guidance on the Safe Service of Alcohol to support member airlines and has engaged with Airports Council International on joint initiatives to highlight to passengers the types of prohibited conduct on aircraft and the need for responsible service of alcohol within airport restaurants and bars. Campaigns have been launched to promote the ratification of MP14 to government departments and regulators. Congo has already ratified and many more are in process. 22 States are required to ratify to bring MP14 in to force. The best estimate for this to happen is

54 1.5. Security Regulations For the past several years, research activities and proof-of-concept pilots to test innovative technologies, concepts and processes for passenger and cabin baggage screening have taken place in close cooperation with a select group of airports, regulators and airlines around the world most notably at Smart Security partner airports Amsterdam Schiphol and London Heathrow. Further proof-of-concept pilots will go live at Doha Hamad, Melbourne and Dublin airports this year and many other airports around the world are also undertaking specific trials, building on the lessons already learned. With a number of solutions reaching a critical stage of maturity, focus of the program is now shifting towards outreach activities to accelerate adoption and benefits to a wider group of airports and airlines. In late 2015, Smart Security will commence delivery of Smart Security Opportunity Assessments tailored on site visits and workshops helping airports and their stakeholders understand how Smart Security solutions can work in their unique regulatory, operational and business environment 1.6. Aircraft Maintenance Regulations IATA has been participating in the ICAO Airworthiness Panel development of two key changes for Maintenance. The first one addresses the approval and mutual recognition of Approved Maintenance Organizations (AMOs), which will result in a reduction of auditing. The second item covers the IATA proposed development of acceptance criteria by the States for the use of Electronic Aircraft Maintenance Records by the airlines Flight training requirements IATA has published the 1st Edition of the Guidance Material and Best Practices for the Implementation of Upset Prevention and Recovery Training (UPRT) to provide airlines with practical guidance in the development of their own UPRT program in view of the recent measures implemented by the Federal Aviation Administration (FAA) and the European Aviation Safety Agency (EASA), which will require operators to comply with recently issued UPRT regulations. EASA incorporated part of the IATA UPRT guide into their regulation. We also published the 2nd Edition of the Guidance Material and Best Practices for the Implementation of the Multi-Crew Pilot License (MPL), cobranded with IFALPA and harmonized with ICAO. This second edition of the MPL implementation guide provides regulators, operators and flight training organizations with best practices based on data collected since MPL s inception in IATA has also been involved in the revision of Flight and Duty Time Limitations (FTL) regulations and Fatigue Risk Management Systems (FRMS) implementation in Latin America, more precisely in Brazil and Colombia, where we have been invited to provide expertise in this area. 54

55 1.8. Ticket Taxes, Charges and Fees The highest impact taxes have been identified and a list of high level recommendations will be presented in September Various other actions are ongoing, e.g. lobbying the UN to align its model tax convention with the OECD, fighting various social contribution taxes on income in Brazil, Greece, Italy and India. The Secretary of the Industry Taxation Working Group will participate to ICAO s Air Transport Regulatory Panel in September 2015: taxation and how to enforce ICAO's policies with States is on the agenda. A focus item in 2016 will be the implementation of Advance Passenger Information (API) in various states, following UN Resolution 2178 on the prevention of travel for terrorist activities, and the tendency of governments to pass on the costs of security system development to the users through a user charge or tax. We are in touch with the main system providers to coordinate an industry position and working closely with the security department and the regions to ensure effective implementation according to international standards without creating additional cost to the users Fuel costs Long term campaign on fuel prices in Saudi Arabia has resulted in US$151 million annual savings. In Colombia, legal action against a 2,500% increase in the fuel concession fee at San Andrés resulted in not only the withdrawal of the fee but the cancellation of the concession contract. In parts of East and West Africa, airlines are still not seeing the lower price of oil reflected in jet fuel prices; the issue is being tackled together with the African Airlines Association (AFRAA). The Commercial Fuel Working Group is examining the possibilities of engaging with airports to ensure fuel supply reliability. IATA is also supporting the industry requirement for a more streamlined fuel tender/bid process and the related messaging standards. Note on Liberalization The 2014 issue of the White Paper included a section on Liberalization. However, since then the views of IATA s members on this issue have diverged to such an extent that it is no longer possible for IATA to take an industry position on liberalization. Therefore, all IATA advocacy activities related to liberalization have been put on hold for the time being. 55

56 2. Value Chain Optimization 2.1. Aircraft Ownership Costs IATA has retained external Legal Counsel to proceed with further competition law analysis related to practices by OEMs and elimination of options in the aftermarket services. Agreements have been signed with several airlines that would like to be more involved with the analysis and work with IATA and external counsel to assess the current conditions Airports and Air Navigation Service Providers US$490 million in reductions in airport and ATC charges, fuel fees and taxes have been secured against a target of US$800 million. Some 54% of proposed increases have been avoided, including US$42 million in airport charges. Revised Global Airport Charges position papers have been published and guidelines on transparency of the charges setting process have been developed. We have been campaigning at ICAO level to ensure the implementation of an effective global regulatory framework on charges, in particular, stricter user charges regulation provisions in the Multilateral Air Services Agreement template. The Airports Working Group has also been engaging with the European Commission (EC) for a stronger Airport Charges Directive (ACD). Several campaigns to improve regulation in individual states in the region are ongoing (e.g. Switzerland, Sweden, Germany). Further progress has been made in the Middle East and North Africa, with the engagement with the authorities on economic regulation in Sudan and Oman. In the Americas, a review of a draft regulation on airport charges in Curacao has just been launched. The focus in 2015 has also been on improving and leveraging information from the capacity monitoring database to identify capacity constraints and shift towards proactive CAPEX engagement. Proactive CAPEX campaigns in 2016 will focus on Beijing, Taiwan, Hong Kong, Mexico City, Lisbon, Addis Ababa, Navi Mumbai airports. Progress on other initiatives towards a more balanced customer-supplier type relationship between airlines and airports include a Model Service Level Agreement with concerned stakeholders, the development of a business case that can be applied to airport operations efficiency, and the adoption of the IATA Ground Operations Manual, already a reality for 87 IATA members. 56

57 3. Innovation 3.1. New Distribution Capability NDC messages are divided into two main categories: shopping and ordering and payment. The first official set of messages will be published on 1 September 2015, with a second version expected before the end of 2015 to fully support interlining. Several airlines are experimenting in using the NDC messages, especially for the shopping components. It is anticipated that eight airlines will be live in A total of 19 airlines have publicly announced plans to use NDC. As well as supporting the standard development, IATA has been supporting industry adoption of NDC through a series of activities, amongst which the publication of implementation guide and series of YouTube videos, the formation of a corporate buyer advisory group, the establishment of Innovation Fund (which has now received over 50 requests for funding) One Order The One Order initiative complements the NDC order management concept with new framework mechanisms that eliminate the need to issue ET or EMD records. The idea is to eliminate the current requirement to hold separate reservation and ticket records by instead keeping all the data elements in the order record and by adding flags for managing controls with interline partners and ground handlers. The One Order concept has been developed by a multi-disciplinary focus group in cooperation with Industry Committees. The One Order business case is ready and will be presented to the Board of Governors in December 2015 for the final Go/ NoGo decision. The Business case will focus on the benefits of One Order, the impact on long term IT costs, the benefits of easier interlining between full service carriers and ticketless carriers, the opportunities for more sophisticated sale of ancillary products and the implementation and transition costs Airline Industry Data Model The project will close at the end of The industry capability has been built and a new end-to-end message development methodology to be used by industry groups in need of new messaging standards has been created. This methodology covers modeling of business requirements, modeling information and message modeling. As of 2016, the newly built industry capability will move to operations to support day-to-day standards development activities. IATA already delivered successful industry training in February 2015 and the next session is scheduled for November this year. 57

58 4. Efficient Processes 4.1. Fuel Burn Flight Operations has developed a software application to facilitate tracking the actual results of the Fuel Efficiency Program in a timely fashion through a series of KPIs Simplifying maintenance and ownership requirements A draft plan to make aircraft technical operations paperless by 2020 will be presented in November 2015 to the 2nd IATA Paperless and RDIF conference. The plan includes: Regulators accepting electronic records and e-signatures; Ensuring electronic security is sustainable and cannot compromised; Agree with OEMs, lessors and other stakeholders on standardizing electronic records; Promoting RFID and other technology enablers to meet tracking requirements for aircraft parts and the aircraft itself Shop-to-cash The Financial Services Development Working Group (FinDev) is exploring opportunities for simplified financial services. The idea is that once NDC, One Order and NewGen ISS are fully implemented and existing industry interfaces are fully exploited, many areas could benefit from a simplification process and consequently from cost reductions, namely: Fare Filing, NDC Order Management (Sales Audit), Revenue Accounting, Cost of Payment Services (Merchant Services), One Order, Supplier-to-Airline (invoice processing) e-invoicing. 58

59 4.4. Settlement Processes and Credit Risk Management The vision for on-time, faster, safer industry funds based on a more relevant and customer centric settlement system is shaped around different programs. The ISS Business Plan is on-track to meet its objectives as stated in the Financial Committee White Paper. The NewGen ISS framework has been endorsed by the Passenger Agency Conference Steering Group (PSG), the governance body that is responsible for its implementation. It is now seeking Industry consultation on the program features. NewGen ISS consist of four main elements: 1. Agency Accreditation Models: Introduction of three accreditation models to increase the potential points for airline distribution via the BSP while mitigating airline risk through a smarter, targeted risk management. 2. Credit Limit Management: a limit on cash sales based on an established amount that better links the agent creditworthiness and financial guarantees. The introduction of a limit on cash sales is the primary and proactive means for reducing default losses from the current unlimited credit. 3. IATA Easy Pay (see section on Payment Methods in this paper) 4. Global Insurance Solution is intended to cover credit risk and credit card chargebacks of travel agency defaults. This will be a new financial guarantee type, which will be optional for travel agents and alternative to e.g. bank guarantees. A new Agency Management Solution is being developed and consists on a technology update necessary to the delivery of NewGen ISS. This is done by addressing process changes, defining the required data governance for Agency and developing the systems needed to support the processes and the implementation of agreed solutions. Finally, an Agency Credit Risk Management community has been created whereby an Agency Credit Risk Manager has been identified in each BSP member airline, as the main point of contact concerning any Agency Credit Risk issues. Moreover, Information Management Reports have been created and distributed to all BSP airlines. 59

60 4.5. Payment Methods The Payment Methods Working Group (PMWG) is working on a new payment methods called IATA EasyPay. It is a new and voluntary form of payment for IATA Accredited Agents, to issue and pay airline tickets through IATA. It will allow the implementation of the new Accreditation models and Credit Limit Management. Agents willing to use IATA EasyPay will need to open an EasyPay account and transfer funds. Based on a Pay-as-you-Go model, transactions will be final upon authorization, no charge back will be possible. The money will be transferred to the airlines within 48/72h since the ticket is issued through the BSPs. The Industry Business Case is being prepared and will be presented to the PSG in September Fraud Prevention The PMWG has focused in 2015 on credit card fraud for direct sales transactions where the cardholder is not present. An extensive Industry survey has been conducted amongst airlines to identify the size and root causes of the issue. The findings and suggestions coming from both airline interviews and airline survey conducted are consistent, which gives a high level of confidence that the project has identified correctly the issues common to most Airlines. Actions of both operational and transformational nature to improve fraud prevention performance are proposed for 2016 and are being presented to the Financial Committee for approval and include: Raise Industry s awareness of best practices for fraud prevention and for improving card transaction success rate. Research further on uneven success rate or usage of existing tools and security procedures; Facilitate Airlines access to fraud prevention publications and actions; Engage with the international card scheme as the Industry s advocate; Establish an Industry benchmark on fraud Treasury Cash repatriation remains the focus for the Treasury Working Group (TWG). A series of actions have been implemented to address the issue and include action plans developed per Country type: Top Focus Countries, Watch List Countries, Complex Procedure Countries. Additionally, Monthly Currency Repatriation Reports are developed and sent to Airlines Treasurers and a Currency Community Platform for stronger internal communication within IATA and between the airline treasuries and IATA is planned to be launched at the end of

61 The Working Group is also exploring and researching the various types and availability of credit to airlines for long term aircraft financing. Finally, the TWG is working on ways to share best practices including looking at Risk management, addressing treasury staff training and also providing guidance for the IATA Tariff and Pricing Exchange Rate (ICER), a service developed by IATA to be the reference source for exchanges rates Purchase-to-pay processes IATA s Supplier-to-Airline e-invoicing project (formerly IATA Financial Exchange) is driving the adoption of standardized electronic invoicing of major industry suppliers. An Industry standard, IS-XML, has been developed. The project is now assessing through five airlines visits that the standard is fit for purpose and allows for the expected level of accounts payable automation. The project will also deliver an Industry Business assessing benefits for the segment of Airports Financial Reporting The first Airline Disclosure Guides (ADGs) are being drafted and will include Hedging (IFRS 9), Aircraft Acquisition Cost and Depreciation, Maintenance Accounting and Segment Reporting. They will be ready at the end of 2015 and airlines will be able to request access to them. A letter has been addressed to the International Accounting Standards Board (IASB) to request a change in the draft of the new Leases Standard regarding the foreign exchange rate valuation mismatch and we are awaiting the issuance of this standard. 61

62 Renewed Structure of the Financial Committee Working Groups September