Brexit has been in the news since the referendum vote in summer 2016. It is clearly debatable whether or not the vote to leave was a reasonable decision but it is fact that it will have huge economic implications. In the past two years, the pound didn’t only become considerably weaker, which has created big uncertainty among investors and overall domestic product, but the immediate future does not promise any improvement. Recent estimates of the Financial Times show that the overall cost of Brexit accumulates to around £450m a week which translates as £870 per household every year. Overall, depending on estimates, the cost for the UK economy is between £20bn and £40bn (Giles, 2018). One of the industries that are affected the most by this referendum is the aviation industry due to its international nature. It is not only a change in the industries environment that the companies need to react to but is also an actual threat to their existence due to the fact that the UK aviation industry has been developed through EU law. If the UK is not able to come to an agreement with the remaining EU member states about staying in the current regulatory framework that lets them fly in the EU, they have to build a completely new one (Warner, 2018).
Many more regulatory instances have to be ensured to keep air travel to the UK steady after Brexit, but how is one of the UK’s biggest airlines preparing for day zero? In this paper, I will discuss what the changes in British Airways external environment due to Brexit are and how they should be reflected in their strategy. I will do so using the PEST framework plus an analysis of their ownership structure. In the end, I will reflect on my proposed strategy by comparing it to what is known about IAG’s strategy for Brexit.
PEST ANALYSIS
Firstly, I will analyze the changes in the external environment in which British Airways operates in using the PEST framework. This framework is, therefore, clarifying what changes in the political, economic, social, and technological environment are going to impact the company in light of a ‘hard Brexit’.
Political:
The European Union has centralized many of the official regulations for almost every market for its member states and the aviation industry is no different. From the point of a consumer, flying, in general, is very simple and there is no awareness of the advanced regulations needed to fly in different airspaces to different airports. Up until now, the UK is part of the European Common Aviation Area (ECAA) which is a single market for its 36 member states. This elaborate system allows liberalized air travel to EU member states and also allows foreign airlines to fly domestic routes in other countries (Warner, 2018). When Brexit takes place, the UK will automatically have to leave this agreement and if they are not able to make a separate deal for flying rights, they will no longer be able to fly over or to/from countries that are in the agreement. This means that air travel to and from the UK to EU member states would shut down completely. Furthermore, they will have to renegotiate deals with Canada and the United States as deals with those countries were also made through the ECAA (Institute for Government, 2017). This again would mean that air travel between those countries would be prohibited until a new agreement can be made.
Economical:
With Brexit, the biggest economic impact was and still is the devaluation of the British Sterling-pound. Almost immediately after the announcement of the referendum, the value of the Sterling-pound started dropping which also affected British Airways/IAG margins because they earn their profits in pounds but pay for the fuel for their planes in US dollars. Therefore, the fuel became more expensive which in turn increased their expenses and led to a loss of €148m in 2016 (Palmer, 2016). As the pound has stayed considerable weak, IAG’s profits remain lower than expected due to their direct connection to the currencies exchange level. Considering the possibility that the pound could become even weaker once Brexit is finalized, their profits could even further decrease.
Social:
DISCUSSION
Social changes due to Brexit are not a very big environmental driver for British Airways but nonetheless, their earning potential decreased due to a rise in domestic holidays in the UK from 64% in 2015 to 71% in 2016 (Livingston, 2017). Even though UK citizens are less likely to travel since Brexit, international travelers to the UK remain steady which a study by Barclays shows. 97% out of 700 holidaymakers would still like to visit the UK in the following months (Livingston, 2017). This shows that the interest in the UK is not being influenced by the decision to leave the EU, however, overall the passenger numbers could per estimations still decrease by 3-5% by 2020 (IATA Economics, 2016).
Technological:
The airline industry and therefore British Airways and the IAG heavily rely on the latest technology for the safety and security of their planes as well as customer comfort. Nonetheless, British Airways will have no restriction in access to the technologies needed for that as most of them are provided by Airbus and Boing. Furthermore, the technologies they need for the best booking mechanisms is still going to be available to them after Brexit.
FURTHER ANALYSIS
Secondly, I will now analyze the impact Brexit could have on British Airways ownership structure. I believe due to its unique situation of being owned by the IAG it is worth expanding the analysis because as research has shown, Brexit could have drastic implications on it.
IAG (International Airlines Group), British Airlines owner that also owns Air Lingus, Iberia and many more, is very optimistic that there will be an open skies agreement. However, if there shouldn’t be an agreement, their company is at risk of being broken up into its different airlines. If the IAG wants to stay in the EU’s agreement after Brexit, they have to prove that at least 50% of their shares are held by EU nationals and is therefore effectively controlled and owned by EU citizens. However, estimates show that IAG could fall below 50%, forcing them to either buy back shares for non-EU citizens or split apart. This poses an extreme ownership challenge which, according to many sources, the leadership of IAG is in complete denial of. Estimates of Bloomberg and other firms show that IAG’s shares are only 20% owned by EU citizens (McClean, 2017). For British Airways, this means trouble. In case there shouldn’t be an agreement and the IAG is going to be forced to split up, they might be on their own. This means they have to negotiate for an agreement by themselves which could be very challenging and expensive and have to set up a completely new leadership and governance structure.
STRATEGIC SUGGESTIONS
All of the above means that due to the changes in its external environment British Airways/IAG should be preparing a strategic plan for when Brexit actually takes place, which from my point of view they are barely attempting at the moment. In the following, you can find my suggestions:
The biggest risk for BA at the moment is the loss of flying rights due to falling out of the European Common Aviation Area. Therefore, they have to make negotiations with the EU about these regulations a top priority, so that a loss of flying right can be avoided in case of a ‘hard Brexit’. Without an alternative agreement, their business will make a huge loss due to a severe decrease in flights.
As mentioned above, BA is currently earning all of their profits in Sterling-pound even though a certain part of their expenses are in US dollars or Euros which makes them very reliant on the currency exchange rate. Because the value of the Sterling-pound after Brexit is very hard to predict, I would recommend that they find a way to either secure their revenues in another currency that proves to be more stable or make deals with their suppliers to ensure a stable price for their products in Sterling-pound. This could be done by introducing Futures with their suppliers which means that they sign a contract that says that they will buy a certain amount of product at a set point in time for a set price. This could be done every year and therefore their expenses wouldn’t be as dependent on the currency exchange.
Due to a possible decrease in customers, I would suggest offering special packages and deals for people traveling to and from the UK to minimize losses due to falling passenger numbers. This can be done by decreasing the flight fares or offering free luggage or a discount on airport transfers, etc. I would suggest partnerships with other tourism services like for example National Express and Heathrow Express as they will be experiencing lower levels of customers as well.
Even though Brexit won’t influence BA’s access to the technology, they need to deliver their services. However, I would consider it a priority that their relationships with their main suppliers, Airbus and Boing, is as good as possible. Through open communication especially about future deals, their relationship can remain stable. It is crucial that Airbus and Boing remain calm and happy to ensure the best possible pricing for future contracts.
Some of the most important preparations are the ones needed in case of a separation from the IAG if they are not able to prove that 50% of their shares are owned by EU citizens. For this possibility, extensive preparation in form of structure and leadership without the IAG needs to be made. I would recommend doing so as soon as possible to ensure a smooth transition and to avoid any unnecessary cost.
CONCLUSION
In conclusion, I believe that British Airways has a lot to prepare for in light of Brexit. I personally consider IAG’s approach to Brexit very naïve up to this point in time. They are blindly assuming that there is just going to be a deal that keeps them in the European Common Aviation Area and are not preparing for any other scenarios. This can be seen in a recent interview that William Walsh, CEO of the IAG, had with the Financial Times. In this interview, he says “There will be a comprehensive open skies agreement. […] Anybody who doesn’t believe that is living in cloud cuckoo land.” To the question of how the IAG is planning to manage to remain in the EU regulations, he answered “Magic.” (Khan, 2018).
William Walsh, CEO of International Airlines Group (StuBaileyPhoto)
Though I am sure that the risk of the IAG having no flying rights in the EU is very small, I believe that due to its huge possible impact it is something that still needs to be prepared for. I believe that following my strategic suggestions can give the airline a good standpoint after Brexit where they are prepared for every possible scenario. In light of how big the impact of Brexit could be otherwise, I believe that is very important.