Franchising the Future

Aer Arann is betting on a new franchise agreement with Aer Lingus to bring it back to growth

The past couple of years have notbeen easy for this small Irish regional carrier, whose origins date back to 1970 as an island-hopping air service between Galway and the three Aran Islands off the west coast of Ireland. The initial activity still exists and trades as Aer Arann Islands operating from a base at Connemara with three Britten-Norman Islanders, whereas its larger sister carrier Aer Arann has its headquarters at Dublin and operates 14 ATRs on 33 routes to destinations throughout Ireland, the UK and France (where it serves two airports).

Among the 33 routes, 12 are operated as Aer Lingus Regional following a franchise agreement with EI that took effect with the start of the summer schedule. Five are PSO routes under contract with the Irish Ministry of Transport. The PSOs, which represented some 16% of the airline’s revenue last year, are due for renewal in 2011.

Passengers peaked at 1.1 million in 2007 but declined 10.5% in 2008 and a worrisome 21.8% last year, when Aer Arann enplaned just 766,000. To be sure, 2008-09 were challenging years for the entire industry, yet Europe’s regional operators managed to ride out the storm with aggregate boardings declining just 4.2% in 2009 after tiny growth of 0.4% in 2008, according to the European Regions Airline Assn.

“It is fair to say that we had a difficult two years,” says CEO Paul Schutz, conceding the airline lost money in both 2008 and 2009. As a privately held company, Aer Arann does not publish financial results, but Schutz describes the losses as “small but significant.” He predicts 2010 “will be a year of some growth,” mainly owing to the Aer Lingus franchise operations. “We expect passenger numbers to be back over 1 million and revenue to increase some 20% to approximately €100 million. Assuming there will be a recovery in some shape or form by 2011, then 2011 will mark a return of profitability for Aer Arann. For this year, we were planning on a breakeven result but this may not be achievable now because of the losses incurred due to the volcanic ash disruptions, which hit Irish airlines particularly bad.”

“I think 2009 was the low point,” Schutz continues, arguing that Aer Arann “took action very early. We started our restructuring end 2008; we looked at our network, launched an internal cost-cutting program and as we went through 2009 we restructured our debt with creditors and suppliers. The financial restructuring is complete. We are trading quite comfortably now.”

Back To Its Roots 

Most of the debt arose from the acquisition of four ATR 72-500s, part of a €180 million order for 10 placed in 2006. “The order made absolute sense at the time,” insists Schutz, who joined the airline in 2006 and was appointed chief executive in January 2009. “We took delivery of five of them in 2008, but then it became apparent that we would have to essentially stop our planned growth and look at what we were doing. We took the view that it made more sense to extend some of the existing operating leases rather than take on more new aircraft.” One of the five new ATR 72s was resold “at no loss” while the remainder of the order initially was deferred and soon after cancelled “without penalty,” he says, adding, “There is an understanding with ATR that at some point we will revisit placing a new order.”

As part of its rationalization program, the carrier also wet-leased one aircraft to Flybe and returned two leased ATR 72-200s to the lessors, reducing the fleet to 11 aircraft (five ATR 42-300s, two 72-200s and four 72-500s) at the end of 2009. It cancelled a number of loss-making scheduled routes and pulled the plug on the franchise agreement with Next Aviation through which it had been operating a BAe 146-200 on services to Amsterdam, Portugal and Spain.

Aer Arann does not disclose traffic or capacity numbers as it views this as “commercially sensitive information,” but according to data filed with ERA, ASKs were reduced 21.8% last year to 545.8 million and the number of flights fell 12% to 23,777. Staff took an average 7% pay cut while head count was slashed by more than 20% to 330 employees across the organization, including pilots.

It also realigned its business model, distancing itself from the pure low-cost-carrier positioning that it adopted in 2006 and introducing a renewed focus on “being a regional carrier” operating in low-density niche markets, aiming predominantly at business traffic and providing air connectivity between “a limited population base at one end of the route and a hub airport at the other end of the route,” Schutz explains. For example, it connects Cork, Galway, Knock, Sligo, Donegal, City of Derby and the Isle of Man with Dublin; Galway with London Luton, Edinburgh, Manchester and Lorient; and Waterford with LTN, MAN, Birmingham and LRT.

A typical niche route is Isle of Man-London City, which it launched in February 2009 following the collapse of EuroManx and currently serves thrice-daily with an ATR 72-500. Aer Arann and ATR certified the ATR 72 for LCY operations. The airline has a main base at Dublin where it overnights five aircraft and other bases at Isle of Man, Galway, Cork and Waterford. GWY also houses its maintenance facility. Average flight time is just under 1 hr., with its longest sector being 100 min. and its shortest hop (DUB-IOM) just 20 min. On average, each aircraft flies eight sectors daily. As is typical of turboprop operations, it offers a one-class configuration across its fleet.

Noncompulsory online check-in is free of charge, as are seat assignments; it distributes free newspapers onboard but sells snacks and drinks. Up to 92% of its sales are booked online and the remainder through GDSs. “We adopted the best practices from the low-cost model while keeping a friendly, more customer-focused, softer touch,” Corporate Affairs Director Andrew Kelly believes. “The Aer Arann and Aer Lingus brands sit very well together on that front.”

Aer Lingus 

Following several months of negotiations, Aer Arann and EI signed a franchise agreement in December initially covering 12 routes from Dublin and Cork mainly to UK regional airports. Three routes are new, seven are previous RE routes and two are former EI routes. More routes are anticipated in the winter schedule. All franchise flights are sold and distributed through aerlingus.com but EI has no blocked-space commitment on the services.

Under the terms of the six-year contract, EI receives a franchise fee for providing its brand and product suite to Aer Arann and RE assumes full operational and commercial responsibility for the routes. It carried the cost for painting its aircraft in the new Aer Lingus Regional livery and has dedicated four ATR 72-500s to the venture. To support expansion of the Aer Arann-branded operations, in April and May it took delivery of three ATR 72-212s on a five-year lease from ASL Aviation Group.

“This is a win-win for both carriers,” Schutz emphasizes, while dismissing suggestions that it may be unwise to embark on a cooperative venture with an airline that is undergoing severe challenges and sustaining heavy losses, including €130.1 million in 2009.

A Deal That Makes Sense 

“There is risk in everything but the risk is relatively small and worth the reward,” he tells this magazine. The venture does not involve any equity stake and that “is not something that has been considered. It is a commercial deal that makes sense.”

For the 43-year-old chief executive, the biggest advantage arising from the franchise deal is the ability to establish a real presence in the UK. “While we are a well-recognized brand in Ireland, we will freely admit we are not well established in the UK,” he acknowledges. “To establish an Aer Arann brand in the UK, which is our biggest market on our doorstep, is incredibly expensive and next to impossible to do for a small company like ourselves. This is where the upside is.” He anticipates the franchise operations will represent up to 40% of the company’s revenue and transport some 350,000 passengers per year. 

Aer Arann is open to replicating the EI franchise partnership in other markets and/or operating longer stage lengths, possibly with regional jets, “but this would be the long-term strategic plan,” Schutz concludes.