BA is meant to be soaring. What's gone wrong, Rod?

The economic slowdown means business-class trade has plummeted for our national carrier, and now they're relying on a transatlantic trade-off

Airlines used to think that business executives could not survive without luxury on their frequent international flights. So they travelled business class. They are offered laptop connections to keep up with their workload, the airline food has a less rubbery consistency, and nowadays there are even flatbeds for a lie-down after too much of the free champagne.

Business travellers are nuggets of gold to the airlines, because they pay through the nose for the extra benefits, and the bill is usually covered by expenses. Fares can be as much as three times the economy price, and even more if you take into account the heavy discounting and the new "no frills" airlines such as easyJet.

This is what prompted British Airways to start concentrating on providing for business travellers. Its dreadful financial results in 1999 and 2000 forced it to change this strategy, to cut down on its common-or-garden customers and try to bring in the big spenders with an expansion of its Club World service. The move was praised to heaven last year because the booming economy meant businessmen were queuing at the airport, helping BA return to profit.

Now, the strategy is coming unstuck. The global downturn is biting. BA has admitted that the number of premium-rate passengers it is carrying has gone down. The absence of Concorde, after last year's accident, has led to many premium customers reassessing whether they need to pay so heavily to fly supersonic. The economic situation has forced executives to cut back on air journeys, and those who have to travel are increasingly going by economy class, or low-cost airlines such as easyJet. Even prime ministers are shunning the more luxurious carriers. Tony Blair and his family flew on the low-cost Ryanair to their holiday in France.

BA's own City broker, Merrill Lynch, is predicting that the changing climate will mean the company will sink into losses again this year. Rod Eddington, BA's chief executive, must be hoping he won't suffer the same fate as Bob Ayling, his predecessor, who was forced to resign early last year, two months before the airline unveiled a £216m loss.

Last week BA's predicament was highlighted when it announced its passenger numbers had fallen in August, yet Ryanair announced that passengers were flocking to use its planes. BA then announced that 1,800 jobs are to go in an attempt to reduce costs. Shares are at an eight-year low. "At present the economic cycle is turning very much against BA," says Mike Powell, an analyst at Dresdner Kleinwort Wasserstein. "The business market is down 25 per cent, and BA is down 11 per cent, so in that sense they are doing well. But they are clearly suffering. To be reporting such bad, negative numbers in this quarter will affect profits significantly this year."

Although the low-cost airlines seem to be crunching BA underfoot, some industry observers say they have really widened the market, by encouraging more people to travel by air rather than plucking the lucrative business traveller from the traditional carriers. "About a third of business travellers have flown on low-cost airlines in the past year," says Michael Brooks, the managing director of Travel Research Centre, which monitors the habits of business travellers for major international airlines. "But a lot of the business is new and it's generated a lot more air travel. I don't think a lot of people are losing."

The low-cost airlines are also limited in the extent to which they can take on British Airways, because launching long-haul flights to the Americas and Asia is expensive, and those are the routes that are the most profitable for BA. Many industry insiders think BA will eventually pull out of the short-haul market. "In coming years, European travel will be either high-speed rail or low-cost airlines," said one source. So the real test for BA will be how it handles the crucial transatlantic market. Even if BA's concentration on corporate travellers does not prove to be an albatross around its neck, there are other major structural issues looming.

For some time, the UK and US governments have been discussing opening up competition on transatlantic flights, where major airlines including BA have a large share of the market. BA has encouraged this process, although that policy does seem to be shooting itself in the foot. It readily admits the transatlantic flights are its main money-spinner.

The airline's solution to the problem is to barricade itself from the effects by creating an alliance with American Airlines. The two transatlantic carriers will share profits, and collaborate on marketing and pricing, an effective merger of the transatlantic operations. But neither British nor European regulators are likely to allow this without a lot of concessions, because on some routes the combination would have a monopoly. BA could be forced to give up landing slots on its most lucrative routes.

Nick Anderson, the airlines analyst at Lehman Brothers, says these structural issues, rather than the economic downturn, are the real problem for BA. "We believe that US open skies is inevitable, but BA obtaining anti-trust immunity [for the AA deal] on the terms it wants is not. Consequently, open skies could have a substantial impact on BA's earnings." He's so negative on the company that he thinks the shares should be valued at 190p. Even after recent falls this is well below the present price of around 260p.

Should the proposed alliance with AA have to be shelved, there are not many options left for BA. Its only hope would be an alliance with a European carrier to improve the fortunes of its short-haul routes. KLM has been touted as the preferred choice, despite merger talks breaking down last year. But the Europeans are attached to their national carriers.

Rod Eddington indicated to the Independent on Sunday last month, that there is frustration in BA at not being able to secure a deal to bring some European consolidation. "The issue has been talked about for some time, but it comes up against the affection some European states have for their flag carriers," he said. "Until we see the first domino fall we won't see the deals that are needed."

It seems that the days of national carriers are numbered, however hard Europeans try to save them. But will BA be a victor in the world war for the air routes, or a victim?

Unhappy landing? The future of BA

Average number of employees:

1999/2000: 61,249

2000/2001: 58,000

After recent job cuts: 56,200

What BA says about its prospects:

"We are confident we have the right strategy in place to deal with the current economic climate. Our strategy was launched some four years ago and involves reducing our aircraft size on key routes and cutting excess capacity, while crucially maintaining the frequency of service to key destinations. The effect of the slowdown in the US economy, and foot-and-mouth disease, has meant that these capacity cuts have an even higher priority.

What BA's broker, Merrill Lynch, says:

"We believe estimates remain at risk going forward. This is in part due to the uncertain macro-economic outlook and upward pressure on costs. It also reflects impending wage renegotiations with pilots and other labour groups, and the potential effect in the first instance of remedies which may be required for anti-trust approval with American Airlines."

Dresdner Kleinwort Wasserstein says:

"Trading is worse than expected ... the July figures showed an 11 per cent decline and we suspect that the August figures, to be announced on Wednesday, will also be disappointing. This suggests that the September quarter ­ which usually provides around half of BA's annual operating profit ­ will be worse than anticipated."

Lehman Brothers says:

"BA's proposed alliance with American will focus the valuation debate on the reality of the stock-specific risks. We believe that the market is underestimating the risks to BA's earnings in an open-skies environment."