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Dealing with Pearson’s Dilemma

Air Canada is hungry for more traffic. The airline is looking at the number of passengers travelling between the United States, Europe and Asia on non-U.S. airlines with an eye to growing its share of the market from 0.3 per cent to 1.5 per cent within five years.


March 3, 2014
By David Carr

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Air Canada is hungry for more traffic. The airline is looking at the number of passengers travelling between the United States, Europe and Asia on non-U.S. airlines with an eye to growing its share of the market from 0.3 per cent to 1.5 per cent within five years. The strategy is to plug more of its transborder traffic into an expanding long-haul network through its main hub at Toronto’s Pearson International Airport, and to a lesser extent, Vancouver.

GTA-Airport Morning  
“As Canada’s largest airport, it is important to work with our air carriers to further develop Toronto as North America’s premier gateway.” –Howard Eng, the GTAA’s chief executive. Photo: GTAA


 

The Greater Toronto Airports Authority (GTAA), the non-profit entity that has operated the facility since 1996, is a willing suitor. Approximately 30 per cent of the 36.1 million passengers who travelled through Pearson last year boarded flights without setting foot outside either of its two terminal buildings. That is up from approximately 27 per cent in 2012. Management would like to see the number of connecting passengers bumped again to 33 per cent, a figure that would still pale when compared against traditional hubs like Atlanta, Chicago and Amsterdam, and super-connector airports such as Dubai, Doha and Istanbul, which have all been built or rebuilt on hubbing strategies.

On Jan. 1, 2014, a five-year commercial agreement between Air Canada and the GTAA to work together and continue to grow Pearson as a global hub came into effect. “Toronto has the potential to become a preferred global routing because it offers some of the best elapsed travel times between the U.S. and major centres in Europe and Asia,” said Ben Smith, Air Canada’s executive vice-president and chief commercial officer. “It will transform our relationship with the GTAA.”

Pairing Air Canada and Air Canada Express’ 49 U.S. destinations (many with multiple frequencies per day) with its 16 Asian and European gateways creates more than 780 added international route combinations, which will grow as the Boeing 787 enters service and starts to anchor the airline’s international network along with the Boeing 777, especially over long and thin pairings that cannot support a 777 but are out of range or uneconomical using the older 767-300ER. By December 2015, the airline plans to be operating 12 of 37 787s on order, 23 777s, eight Airbus A330 and a dwindling number of long-range 767s that are being pensioned off to Air Canada rouge, the lower cost leisure carriers, as the newer Boeings arrive.

shut down Pearson  
The GTAA was forced to shut down Pearson for several hours in January due to extreme winter weather and cold.  Photo: GTAA


 

The airline estimates that a 1.2 per cent increase will translate into an additional 1.1 million incremental passengers and more than $400 million in revenue per year. The bulk of this growth will flow through Pearson, where Air Canada and its Star Alliance partners including United Airlines and Lufthansa already operate under one roof (WestJet is not a member of an airline alliance but has interline agreements with several major carriers serving Toronto including, Air France/KLM, British Airways and Delta), and a newly streamlined transit process is in place to expedite connections.

“Passenger flow is important because connecting traffic is what allows airports to truly grow into international hubs,” Calin Rovinescu, Air Canada’s chief executive recently told an audience in Vancouver. “I think of Schiphol in Amsterdam, which has a share of global traffic far disproportionate to the small size of Holland because its convenient design and location attract so much connecting traffic. KLM brings the traffic into the hub; there is good collaboration and growth for all.”

The agreement between the GTAA also stabilizes Air Canada’s operating costs at the airport with annual fixed aeronautical fees such as landing fees, general terminal charges and apron fees, and can even earn the carrier performance rebates based on connecting passenger volumes that surpass growth targets.

The Air Canada agreement is the latest in a string of incentive programs introduced to increase traffic levels and encourage airlines to add new flights to unserved and underserved destinations. The GTAA estimates that these measures have grown traffic and opened service on 10 unserved routes, including Turkish Airlines’ service to Istanbul, one of the world’s fastest growing hubs, and Ethiopian Airlines to Addis Ababa, inaugurating Pearson’s first link with Africa.

In 2013, five new airlines commenced services to Pearson, including Egypt-Air, with four times weekly 777 service to Cairo and Saudi Airlines, with a thrice-weekly 777 service to Jeddah and Riyadh. Aeroflot also returned with a thrice-weekly 767 service to Moscow following a lengthy absence.

“As Canada’s largest airport, it is important to work with our air carriers to further develop Toronto Pearson as North America’s premier gateway,” said Howard Eng, the GTAA’s chief executive. A refreshing departure from galloping fee hikes that put Pearson near the top of the deck in aeronautical charges.

In 2013, the GTAA shuffled that deck, lowering landing by more than 31 per cent per tonne while increasing smaller general terminal fees by almost 40 per cent for non-domestic passengers for a year-over-year reduction of approximately 10 per cent in aeronautical fees. The operator plans to hold the line on fees until at least 2016.

GTA-DEICING  
Pearson’s shut down of the airport due to cold weather in January was troublesome for travellers, but it was simply a blip that will have no direct impact on the GTAA’s hub strategy.   Photo: GTAA


 

Still, there are concerns that charges at Pearson remain stubbornly high compared with other airports and that the installation may continue to price itself out of a larger share of the connecting market. One reason is the ground rent that the GTAA shells out to the federal government each year. The annual rent payment dipped slightly in 2012 to $130,500, but accounts for 18.4 per cent of operating expenses.

“That is really [an] issue we need to focus on,” said Air Canada’s Rovinescu. “The federal government collected $989 million in 2012 from the Air Travellers Security Charge; airport ground lease payments; and, federal and provincial government excise taxes on jet fuel.”

It is these charges that have ranked Canada in the bottom five per cent of countries based on aviation cost structure (versus the top 10 per cent with regards access), according to the World Economic Forum, and is driving more than five million Canadians to U.S. border cities such as Niagara Falls and Buffalo to catch a flight.

“While it may not be obvious how a traveller who spends just a few hours at a Canadian airport connecting to somewhere else is good for Canada, Canadian airports and air carriers are direct beneficiaries of these passengers,” Daniel-Robert Gooch, Canadian Airports Council (CAC) president to a House of Commons Standing Committee in December. “Additional passengers make international routes more viable, help grow demand on existing routes, and increase competition to bring more travellers who are destined for Canada.”

International and connecting passengers are also more likely to open their wallets at airside shops, restaurants and bars than domestic passengers, helping the GTAA to expand non-aeronautical revenue. The Montreal-based Airports Council International estimates that 45 per cent of global airport revenues come from non-aeronautical activities, including car parking and concessions. Non-aeronautical revenues accounted for 40 per cent of Pearson’s revenue in 2012 when the airport improvement fee (clearly a grey area) was factored in, but only 13.4 per cent of revenue when the fee was stripped out, with only 7.1 per cent flowing from its share from the cash register.

According to Arthur D. Little, a Boston-based consultancy, retail will be the main driver of non-aeronautical revenue, suggesting that Pearson has room to grow, although the numbers of overall passengers who still keep their hands in their pockets at all airports remains stubbornly high despite an increase in consumer choices.

“The airport retail sector is a far larger business than it was 20 years ago, and it is growing at a faster pace than street retail for many reasons,” said Mike Ross, Director of Commercial Development for the GTAA. “With an increase in dwell time for passengers – particularly international tourists – there is an opportunity for people to spend that time shopping. Also, increasing traffic numbers bring more footfall to an airport retailers doors, which is an advantage compared to regular retail operations that must advertise and discount to drive traffic.”

Despite opening a new “brownfield” terminal in 2005, and being ranked North America’s second largest airport for international traffic, Pearson has lagged behind the retail component of other major international airports, especially in the luxury goods category. This is gradually changing as new stores such as a Hudson’s Bay Trading Company boutique and iStore are added and food and beverage offerings are expanded to reflect Toronto’s culturally diverse restaurant scene. HST-free shopping similar to what is available at major European airports would be a welcome boost to Pearson’s retail sector, but that would require a regulatory change, and right now the GTAA has a shopping list of larger priorities to grow the hub.

At the top of the shopping list, however, is an easing of visa requirements for emerging markets such as Mexico (a NAFTA trade partner), Brazil and Chile, and an expansion of the Transit Without Visa program that already allows travellers from certain Asian cities visiting the U.S. to transit through Canada without a visa.

“Visas impact Canada’s competitiveness as a tourism destination, the attractiveness of our international airport hubs for connecting traffic, the viability of potential new international routes, and the capacity to increase activity in global trade,” said the CAC’s Gooch, pointing to a Conference Board of Canada study that estimated that expansion of the existing Transit Without Visa program could set the stage for Canada to capture five per cent of connecting traffic between Asia and the U.S.

GTA-Automated-Passport  
 would like to see the number of connecting passengers at Pearson bumped again to 33 per cent. Photo: GTAA


 

For now at least, the GTAA’s largest headache will be operational. An extreme weather “ground stop” in January halted hundreds of North American flights over an 11-hour period, causing a ripple effect across the country that took days to clear up and triggering unfair comparisons with smaller cold-weather airports such as Halifax and Winnipeg. A computer glitch just a few days later compounded problems by knocking out check-in counters, forcing airline staff to process passengers manually.

At least one airline executive believes the authority made the right call. Michael Rousseau, Air Canada executive vice-president and chief financial officer, told the National Post that the tarmac was a skating rink. “So, the planes, rather than taking 20 minutes to tow, took an hour and half to tow. Things were frozen. Fuel tanks were frozen. We made the decision to stop flying into Toronto because we would have left customers on the tarmac for four or five hours because there were no gates. The GTAA
followed right afterwards.”

Even so, the GTAA’s Eng told CBC Radio’s Metro Morning  that the authority had “dropped the ball.” Vijay Kanwar, chair of the GTAA, has ordered a review of how the airport handles severe weather events, which will include the buildup of ice on the tarmac and customer engagement. The review will be made in public and will likely include recommendations for new investments in more winter resilient ground equipment.

Whatever the outcome, January was a blip that will have no direct impact on the GTAA’s hub strategy. The bigger threat may come from a shakeup to airport hubs 40 years after the concept was first introduced. Delta has pulled out of its Memphis hub and United Airlines recently announced it will be closing its Cleveland hub by June. Regional hubs using
50-seat jets no longer make sense economically, and low-cost carriers have been nibbling at legacy airline fortresses at the margins, wooing connector traffic of the mainline carrier’s long haul routes and weakening the effectiveness of the hub. None of this should affect Air Canada’s international hub strategy: its penetration into the U.S. by the mainline carrier and Air Canada Express is so strong it makes the bleeding of traffic by low-cost carriers less likely. At the same time, the 787 and the arrival of the Airbus A350 are redrawing network maps and making Toronto an attractive gateway for a larger number of foreign tails.

YYZ’s top 10 destinations

  1. Vancouver, British Columbia (YVR)
  2. Montreal, Quebec (YUL)
  3. Calgary, Alberta (YYC)
  4. Ottawa, Ontario (YOW)
  5. New York LaGuardia, US (LGA)
  6. Edmonton International, Alberta (YEG)
  7. London Heathrow, UK (LHR)
  8. Halifax, Nova Scotia (YHZ)
  9. Chicago O’Hare, US (ORD)
  10. Winnipeg, Manitoba (YWG)

Top five carriers (representing more than 340,000 flights in 2013)
Air Canada
WestJet
American Airlines / USAirways (Oneworld)
United Airlines (Star Alliance)
Delta Airlines (SkyClub)

Revenue 2012: $1,137,637
Landing fees, 28.3% ($322,433)
Airport improvement fee, 26.6% ($304,331)
General terminal fees, 19.8% ($224,934)
Car parking and ground transport, 11.6% ($132,797)
Concessions, 7.1% ($81,690)
Rentals, 5.6% ($63,556)
Other, 0.7% ($7,896)


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