The story
Background to formation
Since its beginning in the 1950s, the UK package tour industry has been characterised by its cyclic trade (with pronounced periods of growth and contraction).
The first two periods of major growth had occurred during the mid-1960s and early 70s, respectively. These were followed by a period of major contraction during the mid-70s, mainly as a result of the 1973 oil crisis; this, in turn, was followed by renewed expansion during the second half of the 1970s.
The industry's spurt of growth in the late 70s was accompanied by a growing shortage of whole-plane charter seats, which was further exacerbated by Laker Airways' decision to curb its short- to medium-haul charter activities, as a result of that airline's increasing focus on its long-haul, transatlantic Skytrain scheduled no frills services, as well as by British Caledonian's decision to withdraw completely from the market.
Therefore, a regional niche market opportunity arose specialising in short-haul.
Radical departure from established practices in the charter airline industry
During his time as Dan-Air's associate director in charge of the airline's operations, Errol Cossey oversaw the successful introduction of new jet aircraft types into Dan-Air's fleet, beginning with the de Havilland Comet series 4 in 1966 and continuing with the BAC One-Eleven 400 series in 1969, the Boeing 707-320 "Intercontinental" in 1971, the Boeing 727-100 in 1973 as well as the BAC One-Eleven 500 in 1975. He assumed control over the charter fleet, numbering 28 aircraft during the mid-1970s. At that time, Intasun contracted a growing share of its business to Dan-Air. Intasun, like Dan-Air at that time, was shunned by doubtful writers as 'no frills'. It was mainly competing on price with the other tour operators, notably market leader Thomson Holidays.
A factor behind Air Europe's undercutting of prices while continuing to expand profitably was that it first waited for all the other operators to place their business with Dan-Air and only then placed its contracts, fitting in with whenever aircraft and crews were available. This meant that a lot of Intasun's business involved mid-week and night flying. This, in turn, was a win-win for both operator and airline. It enabled Intasun to charter aircraft at substantially lower rates than its competitors, who had to pay a premium for chartering planes at weekend peak times and it permitted Dan-Air to increase its fleet's utilisation, thereby boosting the company's overall profitability. However, the high fuel consumption of Dan-Air's "mix'n match" fleet – especially the Comets, which at that time made up the bulk of its charter fleet – against the backdrop of steeply rising jet fuel prices in the aftermath of the 1973 oil crisis made it more and more difficult to offer Intasun the rates at which it was prepared to contract its business to Dan-Air.
Errol Cossey became convinced that he could offer Intasun these rates without difficulty, and do a lot more business with it, if Dan-Air had more modern aircraft with a substantially lower fuel-burn and overall lower direct operating costs in its fleet. He was also aware that Britannia Airways, Thomson Holidays' sister airline and Dan-Air's main rival in the charter market, had already begun building up a fleet of brand-new Boeing 737-200 jet planes, which had lower operating costs and a better operational performance than the older, second-hand jets operated by Dan-Air.
Therefore, Errol Cossey, Martin O'Regan, and Alan Snudden, Dan-Air's managing director, tried to convince Fred Newman, Davies and Newman's majority shareholder as well as Dan-Air's long-serving chairman, that operating a brand-new fleet of Boeing 737-200 Advanced series jet aircraft – at the time the very latest, state-of-the-art aircraft – was the only way to secure Dan-Air's long-term future as a major player in the charter airline industry. Their argument to Fred Newman was that operating the latest series 200 Advanced model of the 737 would not only give Dan-Air far better cost figures than any of the existing aircraft types in its fleet but would also allow it to leap-frog Britannia, which initially operated only the basic 200 model of the 737. That model lacked important enhancements, such as a short-field capability enabling operations at airfields whose runways were too short for the basic 737-200 model.
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After failed attempts to convince Fred Newman of their plan's merits, Errol Cossey, Martin O'Regan and Alan Snudden decided to leave Dan-Air.
Cossey presented the plan forged with O'Regan and Snudden. Goodman agreed to support it as an equity holder. This was the point at which Air Europe was incorporated; however, Snudden decided to join Monarch Airlines.)
The fact that the charter airline industry—Dan-Air in particular—were shunned by some travel companies meant broad appeal was needed at the outset, especially in terms of on-board service, including the in-flight catering. Standards were set to rival the leading scheduled service airlines, with an aim of establishing a new benchmark for the industry and for charter airlines in particular; this would enable the new airline to fly longer seasons as travel companies were expected to cancel their contracts with rival airlines—an increase in aircraft utilisation that would translate into higher profits.
One of the ways in which the new airline was planning to set a standard for high-quality in-flight service was by completely revamping the seat-back catering practised by most contemporary charter airlines. At the time, this consisted of serving spam salad on all flights out and sandwiches back. This seemed to be a low-cost way of minimal catering on inclusive tours but was labour-intensive especially when taking into account that these meals needed to be prepared freshly several hours before departure. Caterers were charging for fresh preparation and seasonal produce. However, the salad leaves tended to wilt and the sandwiches acquired quickly staled due to the dry atmosphere inside an aircraft cabin. As a result, many passengers disliked the food. Thus Air Europe resolved to serve proper, restaurant-style meals including at least three courses – a starter, a hot main course and a dessert — on all flights, time permitting. This saw bulk-purchase of deep-frozen ingredients only to take advantage of lower rates. Eschewing inbound local catering, the frozen food could stay in the aircraft's holds, which would generally not be filled to capacity. Other than operating only brand-new aircraft from the very beginning, this was a second unique selling point.
Improving profitability in a very competitive marketplace characterised by low profit margins and excess capacity were not the only reasons for exclusively using brand-new equipment – generous capital allowances for new equipment reduced tax liability, thereby increasing the enterprise value.
Legal affiliation to a tour operator (Intasun) gave indirect access to customers' deposits for use as working capital. This was of particular importance to reduce market barriers – the first plane had not yet arrived but it could meet up-front expenses. Also many suppliers would have to be paid in February – the dead season – before the summer flying programme commenced in April.
To attract higher-margin business from upmarket tour operators Air Europe was chosen from a short-list, which aimed to distance Air Europe from Intasun.
Long-term strategic planning instead of opportunistic growth
Cossey and O'Regan consciously rejected a second-hand fleet, variable food and ephemeral expansion: from the late 1940s until the early 1960s a short-termist approach was typical for new independent airlines, being critical of the undercutting, opportunistic risks taken by Dan-Air, an airline that became highly diversified – many of its sectors never turned a profit. This weakness overwhelmed its management with activities that were seeing a negative return on investment. Dan-Air justified a diversification strategy by its low marginal cost as aircraft and crews were already available. For many years for Dan-Air each aircraft type represented a "cost centre line" that was financially accountable for itself.
A typical example of Dan-Air's opportunistic diversification into activities was its long-term commitment to start a comprehensive network of regional scheduled services linking secondary airports across Europe, many of which operated on a seasonal basis only. This took up massive resources – financial and managerial. It never became a financial success.
Cossey and O'Regan therefore honed in on low-risk activities, specifically few but core activities.
Their long-term strategic plan was to penetrate the market for:
Short-/medium-haul charter flights
Long-haul charter flights
Scheduled services serving markets where half of the available capacity could be profitably filled with Intasun customers
Air Europe branded airlines in other European countries.
A particular financial strength was:
Favourable finance leases of new aircraft allowing it to take on more debt (such as further leases) against their fixed residual dollar valuations.
Beginning
Air Europe became the first British charter airline to use new equipment from the outset and provide food and service that were reviewed to be comparable to established scheduled carriers.
Due to the package tour industry's seasonality, Air Europe needed to ensure that it had high capacity through the entire June–September peak season: the airline needed to have finance in place to pay up-front for the deposits to take over the delivery slots of three brand-new Boeing 737-200 Advanced aircraft that had originally been booked by another airline that been forced to cancel its order. Financing these aircraft, which were due to roll off Boeing's production line during May 1979, was its biggest challenge of that year.
In the late 1970s major financiers were reluctant to provide start-up capital to newly constituted airlines (dubbed 'paper') unless part of or enjoyed the backing of well-financed organisations. Their reluctance was based on a decade-long high failure rate of UK airline ventures. Therefore, Air Europe's promoters were compelled to approach non-UK institutions, lenders and venture capitalists.
Ultimately, C. ITOH and the Marubeni Corporation, two Japanese conglomerates, whose commercial activities included purchasing brand-new aircraft from the United States and leasing them on to non-US airlines as part of Japan's effort to reduce the then huge trade imbalance with the US, were prepared to lend Air Europe the required amount, following complex and lengthy negotiations. The type of aircraft finance Air Europe procured from C. ITOH and Marubeni was known as "Samurai" leasing. It consisted of a combination of full repayment mortgage and partial repayment (hire purchase) finance spread over ten years for each aircraft. Boeing provided their deficiency guarantees underwriting greatly the Japanese financiers' outstanding loans (equal to fair depreciated resale values).
Air Europe's first commercial air service was on 4 May 1979, with a brand-new, 130-seat Boeing 737-2S3 Advanced, named Adam (registration G-BMHG) flying Gatwick to Palma de Mallorca with a full passenger load, flight KS 1004. The second plane was delivered to Gatwick that day. The last of the batch of the three arrived, post-testing, likewise on 31 May 1979, in time for the start of the peak operating season.
Air Europe became the first new UK charter airline to be profitable during its first year of operation.
Becoming a major player in the charter airline industry
The first year's success instilled stakeholder confidence and gave a financial platform.
Air Europe opened its second base at Manchester Airport in the autumn of 1979 and became its fastest-growing UK departure point over the next few years.
A major reorganisation was completed in 1981 when Intasun became a unified company, leading to its first flotation as Intasun Leisure Group plc on the London Stock Exchange's then Unlisted Securities Market. In 1987, the group, which by then had become the International Leisure Group (ILG), delisted from London's stock exchange proper.)
A third base opened at Cardiff Airport in 1982 when Air Europe's core fleet consisted of seven from-new Boeing 737-200 Advanced aircraft. A further three operated under a swap-lease arrangement with Air Florida between May and September. Air Europe expected to carry 1.2 million passengers during 1982.
In 1982, Air Europe:
took over the purchase agreement of British Airways for a pair of brand-new Boeing 757-200 aircraft to arrive 1983 and 1984. These were among 19 the UK 'flag carrier' had placed with Boeing prior to starting BA's privatisation process which as such had become surplus to its strict requirements.
ordered five Boeing 737-300s but with deliveries from 1987.
Intasun Leisure Group plc's annual results for the financial year to the end of March 1983 were released in August. These results showed that the group's pre-tax profit for that period was £6.8 million (up 26% on the year before, namely as the travel operator alone) and that the group carried 1.26 million passengers, most of whom by Air Europe. Air Europe accounted for half of the profit.
Air Europe's first Boeing 757 named Fiona (registration G-BKRM) operated its maiden commercial flight on 24 April 1983, between Gatwick and Faro. The airline's second 757 (G-BPGW) entered commercial service on 29 March 1984, between Gatwick and Milan. An order for a third, the first directly ordered from Boeing, followed in 1984 and further such aeroplanes operated.
During the early 1980s, the Federal Aviation Administration (FAA) began rethinking its policy on the minimum number of engines an aircraft needed to be permitted to fly long distances non-stop over water. The FAA's rethink had been prompted by the increasing reliability of jet engines powering new widebodied airliners as well as other technological advances. Mid-air engine shutdowns that necessitated an emergency landing at the nearest diversion airfield and which could harm the structure and/or occupants had become a rare phenomenon. The result was ETOPS, a set of rules permitting twin-engined aircraft to fly long over water routes, provided that there were usable diversion airfields within 120 minutes' non-stop flying distance plus a 15% margin from the aircraft's route.
Following the introduction of the new rules in the mid-1980s, Air Europe became one of the first airlines to have its 757s ETOPS-equipped to take advantage of the aircraft's design range, which was sufficient to permit non-stop flights to the East coast of North America, the Caribbean and Central America as well as certain parts of South America and Asia.
This enabled Air Europe to become the first British charter airline to operate its 757s on transatlantic charter flights between various points in the UK and Orlando, Florida, from 1989.
The first three planes were sold in April 1985, when the company cashed in on their dollar-denominated residual values. The contractual ability to sell in this way meant keeping the fleet young with a policy or replacing planes whenever residual values happened to exceed the costs of leasing new replacements, such as capacity temporarily leased in from other operators.)
Air Europe placed an initial order for five, larger 400-series Boeing 737s. These aircraft were delivered during 1989.
ILG's 1989 annual report, which covered financial and operational performance during Air Europe's tenth anniversary had summary statistics:
Group operating profit of £35.5 million
31 jet aircraft operated across the group
20 scheduled routes
Total surplus aircraft valuations of £360 million
A combined share of 20% of all slots at London Gatwick
Total passenger numbers for all the group's airlines of 5.8 million
Total passenger numbers for all the group's tour operators of 2.7 million.
Each of these was a record for these benchmarks.
Aircraft leasing
Air Europe frequently used day-to-day operating leases as well as finance leases.
The former includes long-term swaps of surplus capacity with other airlines whose seasonality was opposite to Air Europe's as well as short-term leases for temporary capacity shortfalls.
The latter is an efficient secured finance method to pay for aircraft, whereby these aircraft are sold to related or external lessors from whom they are then leased back, with the airline retaining a substantial interest in the aircraft's residual values.
The charter airline business was highly seasonal, with most of the annual commercial activity taking place over a relatively short period of barely four months between the end of May and the beginning of September. As Air Europe was operating a fleet of brand-new aircraft that incurred high financing charges unlike the older, second-hand jets operated by Dan-Air and many other rival airlines, it could not afford to kerb its fleet utilisation over the winter months. Dan-Air, by contrast for example took half of its operational Comet fleet out of service at the end of the 1976 summer season and put the aircraft into storage at Dan-Air Engineering's main base at Lasham Airfield the following winter season and saw reduced use of other aircraft in the winter. Dan-Air was able to do this as these predominantly older, second-hand aircraft had much lower acquisition costs and were already largely or fully depreciated at the time they entered its fleet.
Air Europe therefore sought business partners whose seasonality was counter-cyclical to its own so that its surplus aircraft could be leased out to other operators in winter and those operators' surplus capacity could be leased in for the busy summer period. Air Europe agreed an aircraft lease-swap with Air Florida, which commenced at the start of the 1980/81 winter season. Under this deal, Air Europe leased three of its aircraft to Air Florida to cover that airline's peak season, which occurred in winter. In return, Air Florida leased two of its aircraft to Air Europe to cover the UK airline's summer peak period. The number of aircraft Air Europe leased from Air Florida during the summer months subsequently increased to three.
Although this arrangement initially worked to both airlines' satisfaction, Air Europe decided to terminate it at the end of the 1982/83 winter season due to Air Florida's growing financial problems such as paying its rent on time. Further not all aircraft returned to the UK on time along with the aircraft Air Florida was contractually obliged to supply from its own fleet at the start of the UK carrier's summer season.)
Air Europe replaced the defunct deal with a similar arrangement with British Airways, which it had negotiated with the UK flag carrier in 1982. (This was part of a wider deal that had resulted in Air Europe purchasing two brand-new Boeing 757s from British Airways (BA).)
The Air Europe—BA aircraft swap lease involved BA leasing back the two 757s it had sold to Air Europe along with a number of that airline's 737s to cover the shortfall resulting from aircraft being taken out of service during the winter when BA's scheduled maintenance occurred. This deal lasted from 1983 until 1986.
An example for a short-term lease to bridge a capacity shortfall was Air Europe's intended lease of a pair of Boeing 747s to enable the launch of a new long-haul charter programme in 1989.
The launch of this programme in May 1989 necessitated the temporary lease of suitable wide-body aircraft capacity, as Air Europe did not have any aircraft suited to this type of operation in its fleet. The original intention was to lease two 460-seat Boeing 747s.
From Wikipedia’s article on Air Europe, shared under CC BY-SA 4.0.4