Online Extra: Airing Ryanair's Beef With The EC

CEO Michael O'Leary says the commission's ending of incentives from public airports will wind up raising fares

On Feb. 3, the European Commission ruled that Ireland's Ryanair (RYAAY ), Europe's first and largest discount airline, will be forced to repay an estimated one-third of the $18 million in financial incentives it has received from Brussels Charleroi airport since 2001. After an 18-month investigation, the EC deemed the reductions in landing charges, ground handling fees, and other perks Ryanair received from the publicly owned airport were incompatible with European Union state-aid law.

EU Transport Commissioner Loyola de Palacio faced a tough struggle to balance Europe's need to promote economic growth in underdeveloped regions such as Charleroi, a bleak town about 60 kilometres (37 miles) outside Brussels, with the EC's long-stated goal of clamping down on state subsidies. The EC plans to use the ruling as the basis for determining what incentives publicly funded airports such as Charleroi will be able to offer the growing number Europe's discount airlines in the future.

The EC's decision comes less than a week after Ryanair's first profit warning in 14 years, which sent the shares of Europe's largest airline (by market value) plummeting nearly 30% in a day. BusinessWeek London Correspondent Kerry Capell spoke by phone with Ryanair CEO Michael O'Leary after the verdict. Following are edited excerpts of their conversation:

Q: How does this decision affect your strategy?

A:

The EC ruling will have two effects: It will increase costs at publicly owned airports throughout Europe, and this in turn will lead to higher fares. The EC itself said they expect fares to rise between 6 to 8 euros ($7.50 to $10) per passenger. I think it will be more than that. Publicly owned airports account for 20% of our traffic. Now that these airports will have to impose the communist "everyone pays the same price rules," it's inevitable that we will pull some routes at these state-funded airports, and fares there may rise.

Q: Still other European airlines, including your main rival discount airline EasyJet, say they aren't worried.

A:

Well, the reason why high-fare airlines including EasyJet welcome this decision is because it will increase airfares, which ultimately reduces the pressure on them. This decision would never have been made in the U.S. I mean can you imagine the U.S. Transportation Dept. coming up with this kind of deal? It's only in communist Europe where the commission can't even run its own bloody budget would they dream of telling ordinary people to pay higher fares so we can have some mythical level playing field.

Just look at what is happening with Virgin USA where a handful of cities are fighting one another, offering all sorts of incentives to get Virgin to set up its headquarters in their city. In contrast, the EC [says] that kind of competition is now illegal in Europe.

Q: What about fares and routes at privately run European airports?

A:

We'll cut them. There's a fare war going on in Europe, and we will win it by reducing fares in the same way Southwest (LUV ) did in the 1990s. During the first calendar quarter of 2004 our fares will be 25% to 30% lower than in the comparable quarter of 2003. About 25% of that drop will be because of the weakness of sterling against the euro. EasyJet gets a yield increase because they report in sterling but have 40% of revenues in euros. So the sterling weakeness against euro dilutes our yields and increases theirs.

Q: The EC says it's trying to balance the goals of regional economic development in areas such as Chareleroi with the need to level the playing field and protect competition law.

A:

The EC's decision is applying the economics of North Korea. What's bizarre about this decision is that they're about to screw publicly owned airports that will no longer be able to compete with private ones. So publicly owned airports like Charleroi, even if it's empty, must charge higher prices.

Why should a Wal-Mart located outside a city center, for example, pay the same rent as those in city-center locations? It's like saying that Wal-Mart (WMT ) will only get the same discounts as the corner grocery store, and if Wal-Mart asks for any discounts on bigger volumes they will be told no.

In every marketplace, even the state-aid rules allow an underused asset to discount its prices in order to build utilization. Before we showed up, Charleroi had no passengers, no income, and no money. Today they have all three. I've been told that the Walloonian authority that runs the airport has received 13 different offers from the private sector to buy it. What the EC should have done if they wanted a level playing field is tell all the complainers [other airlines and airports that protested the incentives Ryanair receives from airports] to go to Charleroi and get the same offer.

Q: Will you appeal the EC decision?

A:

Yes, as soon as the EC publishes their decision, which we expect will be in the next few weeks. Yesterday three other airlines told me they plan to appeal as well.

The big difficulty with this case is that we haven't been able to submit anything to the EC because it's the Belgian authorities who are the defendants, not Ryanair. So part of the problem is that this was a case of one half of Belgium [the one that owns Brussels Zaventem, the city's main airport] suing the other bit that owns Charleroi. The Belgians handled it ineptly. The Belgian commissioner didn't know whether he was coming or going.

Q: You think you have a chance?

A:

It's a certainty. In our appeal, the EC will have to justify why they're refusing to allow Charleroi to comply with the private market investor principle -- that's to deal on the same basis as privately owned airports. And secondly, the commission suggested yesterday that no private investor would do these deals. That was a downright lie because they know these deals are being done at privately owned airports all across Europe.

Q: You had your first profit warning in 14 years, seriously spooking investors. Have you expanded too fast?

A:

Our rate of expansion this year is almost exactly the same as last year, and last year profits grew 59%. This year profits will decline by a possible 10%. But in both years operating costs were reduced by 8%, to 10%. The only difference is that last year average yields declined by 6%. This year, average yields have declined by 15%. This is not due to overcapacity. It's the result of the ongoing fare wars under way across Europe, and we're winning them.

It's like Southwest in the U.S. When they first went into California, their stock price fell by 40% to 50% due to fare wars with the likes of the United [Airlines] (UAL ) shuttle and other California carriers. Ten years later, Southwest owned California. Any share price jumps up and down, and ours is no exception. But as long as the basic business model is sound and you're executing it properly, nothing will stop you -- certainly not a bunch of EU commissioners who think everyone should pay higher fares

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