MIAMI — The biggest aviation story of the last four decades (basically since deregulation of airlines in the United States) has been the rise of the Middle Eastern airlines giants Emirates, Qatar Airways, and Etihad, as well as their rival to the north Turkish Airlines.

In Part II of our analysis of these carriers, we take a look at some of the headwinds that these carriers have faced in the last couple of years, and consider what the future may hold for them.

The MEB3 + 1 have run many shared headwinds

It’s no accident that the recent downturn in the fortunes of the MEB3+1 has coincided with a period of sharply lower oil prices and thus jet fuel prices.

Many of the factors above, whether related to political will or location, helped give the MEB3 an overarching cost advantage, and in the 2005-2014 run of seemingly never ending growth, one of the biggest reasons that passengers chose the MEB3+1 over European and Asian rivals was indeed price, along with the convenience (in certain markets) of clearing immigration at their destination airports. 

The MEB3 + 1 could offer lower prices due to a mixture of economies of scale, strong cost discipline, and favorable regulatory regimes, particularly on cost-line items such as labor expenditure and maintenance (a benefit of their newer fleets). They also had a strong cost advantage based on fuel prices thanks to their younger fleets. And passengers chose them in droves based on pricing, often backtracking to fly the MEB3 on itineraries such as London – Dubai – Dakar.

The cost advantages for the MEB3 in an environment of high fuel prices were massive, enough to allow the MEB3 to discount their fares by several hundred dollars versus the market on many connecting itineraries. But with lower prices, the nominal fares in pretty much every market have come way down, which in turn has squeezed the ability of the MEB3 + 1 to compete on price.

On a percentage basis, the MEB3 + 1 offer just as much of a discount as they used to, but whereas a 20% discount might represent a $300 savings on a $1,500 fare, it is only a $150 savings on a $750 fare (this is an extreme example but illustrative). The percentage savings are the same, but since most consumers think nominally (i.e. in terms of absolute dollars) as opposed to marginally (in terms of percentages) the MEB3 + 1 options are much less attractive. 

Flying via an MEB3 + 1 hub does present some inconveniences, whether longer flight times due to imperfect routings or discomfort flying 10-abreast economy class on the ubiquitous 777-300ERs.

While you might choose to fly Johannesburg – Doha – New York for a $500 savings over the one-stop via Atlanta, that much shorter travel time (10+ hours saved) with Delta looks a lot more appealing when the price difference is a couple hundred bucks. Across the board this puts the MEB3 + 1 in a quandary.

They can either offer deeper discounts to restore their nominal pricing advantage, or accept less full planes. Even during peak business periods, the MEB3 + 1 are volume businesses with margins in the low single digits (as compared to the high teen figures of the US carriers wrapped in the cocoon of their oligopoly), so they’ve largely opted for deeper discounts and full planes, hoping for pricing pressures to moderate. In the meantime, profitability has suffered.  

Pricing is not the only headwind faced by the MEB3 + 1 on the demand side, as the threat of nonstop flights utilizing the newest generation aircraft technology and overflying the Middle East hubs continues to grow. More and more Boeing 787s and Airbus A350s ply the skies each day, and these are used increasingly for routes like Tokyo – Dusseldorf, San Francisco – Tel Aviv, and Toronto – Mumbai.

While the MEB3 + 1 are still competitive one stop options on these routes, the new nonstop options have siphoned away premium cabin and higher yielding economy class business travelers that would have previously flown via Doha or Istanbul. This has also cut into revenues, as has the lack of a true international premium economy product. 

Moreover, three of the four carriers (excepting Etihad) offer at best 2-2-2 configurations for international business class (Emirates and Turkish have some planes configured in a shudder-inducing 2-3-2), save for Emirates in its A380s and Qatar Airways in its new jets (A380, A350, 787).

These are all comfortable and functional products to be sure, and Turkish Airlines is considered best in class by many for its business class catering through its supplier Do&Co. But the gold standard for international business class has shifted to the 1-2-1 configurations with each seat having aisle access, and the MEB3 + 1 do not meet that standard. This limits the revenue premium that they can generate over peers in the market. 

One final headwind shared by the MEB3 + 1 is market access through bilateral air service agreements (ASAs). Despite years of lobbying and trade negotiations, the MEB3 + 1 remain blocked in several key developing and developed markets around the world, blocking them from some of the most lucrative and growing air travel markets around the globe.

For example, Turkish Airlines and Qatar Airways are largely spectators in the Indian market despite years of negotiations, while Emirates cannot add service to more than a dozen Chinese airports that serve more than 20 million passengers a year. All four carriers are severely restricted in the Canadian market even as a resurgent Air Canada adds flights around the world including to MEB3 + 1 hubs like Dubai and Istanbul.

For the MEB3 + 1 to grow further, they need better access to both mature and fast-developing markets. Right now, they aren’t getting that access.  

Each carrier has its own woes 

In addition to a series of shared issues, the various MEB3 + 1 carriers do each face their own headwinds with varying degrees of severity. Starting with the runt of the litter (admittedly a pretty large runt), Etihad has unique challenges with its partnership and equity alliance strategy as we explored in an analysis and podcast last month (What’s Wrong with Etihad’s Business Model and Etihad’s Podcast Strategy [Deep Dive #8]).

Etihad also has by far the smallest base of O&D traffic to rely upon out of any of the MEB3 + 1 and has the region’s 800-pound gorilla an hour’s drive to the North in Dubai to compete for what O&D traffic it does enjoy. Etihad’s business model flaws have led some particularly “visionary” commentators to propose a joint airport or operation between Abu Dhabi and Dubai, with Etihad’s business functionally being folded into that of Emirates.

On its own merits, this isn’t the worst idea in the world as the combined power of Abu Dhabi’s deep pockets and Dubai’s business savvy and O&D demand would make the combined carrier and hub the most fearsome power in the history of global aviation (that is not meant as hyperbole). Unfortunately, political reality and the sibling rivalry between Abu Dhabi and Dubai will likely prevent that from ever happening. Still, it’s an entertaining hypothetical.

Turkish Airlines, sadly, has been hit hard by the double whammy of political instability after the attempted coup of President Recep Tayyip Erdoğan and a rise in terrorism, including the tragic attack at Istanbul’s Ataturk International Airport in June 2016 that killed 45 and injured 230.  

The attacks and Turkey’s unfortunate geographical positioning on the border with Syria (and thus along the pathway to Europe for many refugees) have taken a huge bite out of tourism, which is reflected in the dismal airport traffic results for Turkey in 2016 (Turkish Airlines had not yet reported financials at the time of publication).

Istanbul Ataturk has slipped back to 5th place amongst Europe’s busiest airports, falling behind Amsterdam and Frankfurt in addition to Paris Charles de Gaulle and of course London Heathrow. Even more reflective of the overall market woes is Antalya, which lost just under 9 million passengers in calendar 2016, or a third of its 27.7 million total in 2015. 

Emirates and Qatar are in relatively better shape, but Emirates has always been the closest of the core MEB3 to functioning as an independent business, and it has sent signals that it is pulling back some on growth.

The biggest issue for Emirates however, is the capacity constraints of the current airport as Dubai International is already bursting at the seams. Will Emirates choose to move up its shift to the now operational Dubai World Central super-hub (currently planned for 2025).

Qatar Airways doesn’t really have many unique headwinds per se, but the nation of Qatar more broadly is facing some backlash around its treatment of workers in advance of the 2022 FIFA World Cup. That geopolitical pressure around human rights (regardless of veracity), if it elevates, may end up ensnaring Qatar Airways.

I’m a long run MEB3 + 1 bull

Despite spending more than a thousand words laying out all the headwinds facing the MEB3 + 1, in the long run I am still extremely bullish on the prospects of all four carriers (even Etihad). In fact, will go on record predicting that all four airlines will be amongst the 20 largest in the world by revenue passenger miles by 2025, and that at least three will be inside the top 10. Furthermore, at that time, Dubai World Central, Doha Hamad, and Istanbul’s new airport will all be amongst the top 15 busiest in the world, and Abu Dhabi will be amongst the top 30 busiest in the world.

This is not necessarily a popular opinion in the industry right now, as there are indeed several adverse short term indicators for all four carriers. 

But in the long run, I believe that the market and situational fundamentals will win out. These are still airlines whose hubs sit within 6 hours’ flight distance of some 3 billion people, and that combined with the all-important political will allow the MEB3 + 1 to win. We’ve simply seen this work too many times before, whether with Singapore Airlines, Korean Air, or even KLM and Lufthansa in decades past. As long as Europe’s hubs keep shooting themselves in the foot with NIMBY-driven infrastructure constraints, the Middle East hubs will soak up much of the natural long run growth in global aviation.

Istanbul and Dubai increasingly justify the large flight banks purely on O&D volume, and Doha and Abu Dhabi are developing their own tourist and business O&D through a mix of forced stimulation (on the margin capacity can beget business activity and O&D demand) and natural economic growth. 

The best analogy to use for the MEB3 + 1 is that of a technology startup – these carriers are still very much in their infancy as powers in global aviation. To present a specific example, back in 2014 around the time of its IPO, Facebook was in an uncertain place. It was still unprofitable and its cost of user acquisition had skyrocketed.

Investment analysts raised a furor over the IPO valuation of $104 billion, claiming that the value could never be realized for investors.

Today no one blinks at Facebook’s $395 billion valuation and along with Apple, Netflix, and Google, it is considered one of the pre-eminent forces in the new global economy. I’m willing to bet that the story of the MEB3 + 1 will play out in much the same manner, just over a longer time horizon.