Should This New Competitor Have Major U.S. Airlines Worried?

Traditional airlines have long faced competition from new competitors but what does the approach of one Northern European airline mean for the transatlantic market?

May 29, 2014 at 11:15AM

Airlines face challenges every day in getting passengers and cargo to their destinations. But the introduction of a new competitor could shake up the lucrative transatlantic market by introducing a new low-cost carrier to compete with existing airlines. How this will happen is not all certain and it depends on the actions of major airlines, unions, government officials, and the low-cost carrier itself.

A discount threat
Discount airlines have frequently been a threat to traditional airlines and Norwegian Air Shuttle could cause trouble via its intention to offer trans-Atlantic flights at rates well below those charged by major airlines.

To do this, Norwegian wants to create an Irish subsidiary for labor flexibility and access to the Open Skies agreement between the U.S. and the European Union while operating a fleet of Boeing 787 aircraft to cut fuel expenses. 

The Air Line Pilots Association union, or ALPA, has urged the U.S. Department of Transportation to block Norwegian's plan and has argued that the Irish subsidiary is being used as a flag of convenience that will allow Norwegian to use cheaper foreign labor. Delta Air Lines (NYSE:DAL), United Continental Holdings (NYSE:UAL), and American Airlines Group (NASDAQ:AAL) have all joined with ALPA in opposing Norwegian's plans for the operation of flights from an Irish subsidiary.

While ALPA objects to the plan's threat to labor rates, the airlines oppose Norwegian's move because it would add more capacity and lower fares to the transatlantic market. The U.S.-based airlines also have transatlantic codeshares -- Delta with Air France-KLM, American with British Airways, and United with Deutsche Lufthansa -- in which both partners would be hurt should Norwegian carry out its strategy.

Valuable market
For major airlines such as Delta, American, and United, the transatlantic market is where they can charge some of their highest fares. Not only can airlines profit from economy class passengers but the airlines are in a fierce battle for transatlantic business travelers. With new flight options such as lie flat seats, improved food, and suite style accommodations, major carriers are competing through both price and product.

However, if Norwegian is able to enter the market under its current plans, the carrier would have lower labor costs than major carriers allowing it to offer fares well below current market levels. Norwegian's cheaper fares would be seen as highly attractive to passengers looking for just the cheapest price posing a threat to sales of economy class tickets by major airlines. 

Norwegian's current layout of the Boeing 787 does not include a business class instead including a "Premium Economy" which, while a step up from ordinary economy, is not comparable on a features or comfort basis with the latest in business and first class offerings. With Norwegian focusing around being a low fare airline, this is not surprising but the lack of a business class offering from Norwegian means that major airlines should not feel as pressured on their higher revenue business class offerings.

Change in plans?
For its own part, Norwegian is reported to be reconsidering its plans for creating an Irish subsidiary. Reuters noted in late April that Norwegian suspended its talks to purchase an additional 20 Boeing 787 aircraft because of delays in receiving approval in the U.S. If the Irish subsidiary does not get the green light, Norwegian could still operate long haul flights from its native Norway but in doing so, it would give up the Open Skies advantages and be subject to Norway's labor laws.

Since Norwegian would still benefit from having fewer legacy costs and more efficient aircraft, it could still operate as a low cost carrier offering lower fares than competitors. However, without the Irish subsidiary, Norwegian would pose less of a threat to major airlines because its would not be able to offer even cheaper fares.

So far the Transportation Department has not made a decision, but the airline industry will be watching closely.

A new challenge
The airline industry is always full of challenges and the entrance of a new competitor is the latest one for Delta, American, and United. With a new business strategy, Norwegian Air Shuttle could begin offering fares far below current levels due to a lower cost structure and discount airline approach. But like many smaller airlines, Norwegian's path to growth is uncertain. Over the next several months, investors should get a better picture as to whether Norwegian will be able to operate these flights and what levels of fares they will offer.

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Alexander MacLennan owns shares of American Airlines Group and Delta Air Lines. Alexander MacLennan has the following options: long January 2015 $22 calls on Delta Air Lines, long January 2015 $25 calls on Delta Air Lines, long January 2015 $30 calls on Delta Air Lines, long January 2015 $17 calls on AMERICAN AIRLINES GROUP INC, long January 2015 $32 calls on AMERICAN AIRLINES GROUP INC, and long January 2015 $40 calls on AMERICAN AIRLINES GROUP INC. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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