# Presentation: 767899

## Freighter Airline Strategies

**Freighter Airline Strategies**
**For Growth & Financial Viability**

**Ron Lane**
- Chief Marketing Officer

***Presentation To***
**30****th**** Annual FAA Aviation Forecast Conference**

**March 17, 2005**

**Notes:**
Good morning Mr. Secretary, ladies and gentlemen.  Thank you for the introduction Roger.  I am glad to be here this morning and hope that I can leave you all with some information that you will find interesting, if not useful about the air cargo industry.  

## AGENDA

- Company Overview
- Industry Structure
- Supply / Demand Outlook
- Freighter Airline Strategies
- Conclusions

**Notes:**
Review Agenda.

## Company Overview

## Atlas Air Worldwide Holdings

- World’s largest Boeing 747 freighter operator
- 20 Boeing 747-400Fs
- 22 Boeing 747 “Classic” Freighters (-200s/-300s)
- Global network serving all major trade lanes
- Diversified portfolio of businesses
- Scheduled, airport-to-airport (Polar)
- ACMI Outsource (Atlas Air and UK-based GSS)
- Charters

**Company Overview**

**Primary Operating Units**

**Notes:**
Atlas Air Worldwide Holdings is the parent company to Atlas Air and Polar Air Cargo. Global Supply Systems (“GSS”) is a UK certificated carrier in which Atlas Air is a minority shareholder.  All three airlines are all-cargo carriers operating a fleet of 747 freighter aircraft.
Both Atlas and Polar commenced operations in the early nineties in a freighter capacity vacuum.  Atlas started solely as an ACMI contract service provider and continues to offer these services today.  Polar Air Cargo started as a scheduled service carrier and today operates a scheduled service network.   
Following the market downturn four years ago, AAWH acquired Polar Air Cargo to diversify its business portfolio. The formation of GSS was started in 2001 to permit the supply of freighters on a wet lease basis to British Airways. 
The company operates an all- B747 freighter fleet.  It is a mix of modern B747-400 and older B747 classic freighter aircraft.  At present, Atlas, Polar and GSS on a combined basis operate the largest 747 freighter fleet in the world and Atlas and Polar are the only U.S. carriers operating the B747-400 freighter aircraft. The overall fleet consists of 20 B747-400 and 22 B747 classic aircraft operated by the carriers.  Atlas operates 27, Polar 12 and GSS 3. 

## AAWH’s operating units participate in all major air trade lanes around the world.

**Company Overview**

**AAWH Capacity Deployment: 2004**

- Source: Atlas Air Worldwide Holdings.  Data reflect scheduled services, charters and ACMI Outsource operations.

**Notes:**
AAWH offers, through Atlas and Polar, a diversified portfolio of air freight services to forwarders, airlines, charter brokers and to governmental and non-governmental agencies.  Each Service Type has its own strategy and role within the organization.  The companies operate in all major air trade lanes around the world.  This is a global capacity map showing the routes scope of operations of  Atlas and Polar during 2004 for each of their customers.

## Polar’s scheduled service network

- Hub networks at Chicago, Amsterdam and Seoul
- Serving most major intercontinental markets
- Recently awarded China authority

**Company Overview**

**Notes:**
This is Polar’s global scheduled service network on a stand alone basis showing only the network routes.  North and South America are repeated on the left and right of the slide so the Atlantic theater is on the left and the Pacific on the right.  Polar has hub operations at Chicago for the Americas, Amsterdam for Europe and Seoul for Asia.  It serves most of the world’s major markets.  Polar was recently awarded traffic rights to serve China and commenced service to Shanghai in December 2004.  Thanks to the Departments of Transportation and State for making that expansion possible.

## Industry Structure and Major Airline Competitors

## There are two basic business models: integrated and non-integrated.

***There are two basic business models: integrated and non-integrated.***

**Agent**

**Destination**

**Forwarder**

**Airline**

**Origin**

**C**
**O**
**N**
**S**
**I**
**G**
**N**
**E**
**E**

**S**
**H**
**I**
**P**
**P**
**E**
**R**

**Airport-Customer Interface**

**Customer-Airport Interface**

**Airport-To-Airport**
**(A-T-A)**

**Integrated Carrier**

**Integrated Carrier**

**Integrated Carrier**

**Retail competitors **deal with shippers

**ACMI and Charter carriers provide primary and supplemental capacity to Shippers, Forwarders, Airline’s and Integrators**

**Industry Structure**

**Retail**** competitors deal with shippers**

**Wholesale**** competitors deal with retail firms**

**Notes:**
There are two basic business models in the airfreight industry:“integrated” and “non-integrated”.  The “integrated” business model is one in which the carrier acts as forwarder, airline and agent in the collection, transportation and delivery of air freight for shippers and consignees.  
The “non-integrated” business model involves the interface of several entities providing a coordinated service to shippers and consignees.  It is one in which forwarders collect the freight from shippers and tender this to airlines for transport.  At destination, the freight is released to agents and delivered by these agents to the consignee.
ACMI and Charter operators provide primary and supplemental capacity to the market on an ad hoc, seasonal or long-term basis.

## The consolidation trend is well underway...

- Forwarders are free to acquire and merge as they see fit.
- Carrier consolidation is limited by national-ownership rules.
- Integrator business model requires large-scale operations, so there are virtually no small players.

**Rest**

**100% =**

- /a International air freight traffic only.
- /b IATA members only; Scheduled freight FTks – Freight Tonne-Kilometers.
- /c	Integrators defined as: DHL, FedEx and UPS.  Data represent U.S. air and ground parcel shipments.

**TRAFFIC SHARES: 2003**

**2.6 bn**
**shipments**

**12.6 mm metric tons**

**109.7 mm FTKs**

**Top 15**

- Sources: MergeGlobal, Inc. primary research, IATA World Air Transport Statistics, company reports.

**Industry Structure**

**Notes:**
The industry is very concentrated, and consolidation among air freight transportation service providers is well underway.  Today, the top 15 forwarders handle 61% of all international air freight and the leading 15 cargo carriers transport 64% of the world’s air freight.
Consolidation continues among forwarders and integrators primarily through acquisition.  Among carriers, it is done more commonly through alliances due to regulatory constraints.  In the case of Atlas and Polar and previously in the case of FedEx and Flying Tigers, this was possible because in each case both parties were US carriers.

## The Top 16 Cargo Airlines by freight tonne-kilometers (CY 2003)

***The Top 16 Cargo Airlines by freight tonne-kilometers (CY 2003)***

- FedEx
- Lufthansa
- Korean
- UPS
- Singapore
- [Atlas/Polar]*

- Cathay
- Air France
- China Airlines
- EVA Air
- JAL

- Cargolux
- British Airways
- KLM
- Northwest
- Emirates
- Polar Air

- Source: International Air Transport Association and company data

- *Consolidated Traffic

**Industry Structure**

**Notes:**
We can look at this from a slightly different angle to see how carriers have been ranked.  In terms of scheduled service freight-tonne-kilometers, the top 16 scheduled carriers accounted for approximately 66% of global traffic moved by air.  The top 50 represented 96%.  I have included the 16th to show where Polar ranks globally to give some perspective of its size.  Each of the top 16 operate large freighters in their cargo networks.  British Airways and Emirates are the only ones that don’t operate freighters internally, but wet lease significant large freighter capacity from AAWH affiliates.  UPS and FedEx together account for nearly 15% of global traffic.  Polar’s ranking relates to its scheduled service operations only. However, the FTK’s produced by the combined freighter fleets of Atlas and Polar would rank the company as the 6th largest cargo carrier.

## Supply / Demand Outlook

## Overall air freight market prospects are good.

- According to IATA, 2004 saw 13.4% world air freight traffic increase over 2003
- Forecasted average market growth rate to average 6.3% per year compared to 5.4% average growth in large freighter capacity increase*
- ACMI lift represented 8.2% of capacity in 2003, up from approximately 5% in 1995 *
- Charter market rebound attests to supply/demand constraints

- * Source: Boeing 2004/2005 World Air Cargo Forecast

**Supply / Demand Outlook**

**Notes:**
Overall, the current prospects for the airfreight market are good.  We have seen significant year-over-year growth in airfreight globally.  IATA reports 13.4% growth in FTK’s in 2004.  Boeing projects that growth in world air freight demand is expected to exceed growth in large freighter capacity over the longer term by nearly 20%, which will cause continued pressure on freighter capacity.  
Global port congestion issues will also contribute to higher air freight demand. 
These are favorable indicators for scheduled cargo carriers, but also for ACMI operators that base their business substantially on the need of carriers to outsource additional capacity to keep pace with demand and competition. 

## Cargo demand is growing faster than passenger traffic.  More freighters will be required to handle the demand.

**Supply / Demand Outlook**

**Forecast**
- Index (2003= 100)

**Passenger Traffic Growth =**3.1% CAGR

**Freight Traffic Growth = **
- 6.2% CAGR

**Passenger Traffic Growth =**5.2% CAGR

**Freight Traffic Growth = **
- 6.3% CAGR

**Historical**
- Index (1990 = 100)

**Intercontinental Passenger/Cargo “Growth Gap”**

*Source: IATA historical data and Boeing forecasts (contained in Commercial Market Outlook and World Air Cargo Forecast)*

**Notes:**
Historically, demand for air cargo services has grown at nearly double the rate of demand for passenger services.  Cargo demand is forecast to continue to outpace passenger demand.  This promises that there will be a need for a greater number of freighters.  We have already seen production and conversion lines gearing up as a result of growing demand. 

## Asia will account for the majority of the world’s air freight growth in the next five years.

- Forecast Growth In U.S. Intercontinental Air Freight Demand
**Thousands Of **_**Additional**_** Metric Tons Compared To 2004**

**Asia/Pacific**
**Europe**
**Latin America**

**+246**

**+1,042**

**+127**

**+271**

**+405**

**+698**

**+418**

**+568**

_**Exports From The U.S.**_

_**Imports Into The U.S.**_

**Asia/Pacific represents ****≈**** 60% of new import tons!**

- Source: MergeGlobal, Inc.

**Notes:**
If you look at the U.S. market, air freight tons for the past five years have increased faster in the North America-Asia market than anywhere else.  Projections for the next five years indicate that trans-Pacific growth will continue to outstrip growth in all other regions.  
This is where the demand for large freighters will be felt most. 

## Near term growth in Large Freighter capacity will come principally from MD-11 and B747-400 conversions.

- MD-11 conversions are continuing at a high pace.  Eventually, the feed stock will be used up.
- 747-400 conversions will begin to come on line in 2006.  Production capability will increase over time.
- Retirements of less productive 747 Classics will continue as new capacity comes on line.
- Production of 747-400F/ERF aircraft is continuing.
- New types of freighter production will come at the end of the decade (A380, B777, B7XX)

**Supply / Demand Outlook**

**Notes:**
In the next several years, much of the growth in large freighter capacity will come from MD 11 and B747-400 passenger to freighter conversions.  MD 11 freighter conversions have been underway for a number of years as have conversions of 747 Classics.  Classic conversions have all but come to an end.  The 747-400 conversions are just now in the certification process.  The first converted aircraft will not go into service in significant numbers until 2006.  As the conversion lines at Taeco and IAI develop, production capability will expand.  In the next several years however, additional capacity production, new and conversions, offset by retirements will lag growing demand.  New types of freighters which are on the drawing board now will not come into production before the latter part of the decade. 

## Air freight is inherently a cyclical market driven by demand that is more flexible than supply, leading to pockets of problems and opportunities.

***Air freight is inherently a cyclical market driven by demand that is more flexible than supply, leading to pockets of problems and opportunities.***

- 747-200 Freighter
- Equivalents

- * Data and projections from MergeGlobal 2003 Study

**Historical**

**Projected**

**Global Freighter Supply and Demand***

**Supply / Demand Outlook**

**Notes:**
Air freight is generally a leading indicator of trade and trade balances.  So, the market is inherently cyclical and driven by demand that is more flexible than supply.  In the not too distant past you can see on this Supply vs Demand graph that the economic downturn in the early 2000’s came with simultaneous growth in the production and delivery of additional freighter capacity.  Much of this capacity had been ordered in earlier and stronger market periods.  This downturn was perhaps more dramatic than others.  Usually, the growth in the airfreight market tends to slow down as the market changes, but in 2001, as it did in 1991, we actually saw the market shrink.  Looking forward, you can see that demand is forecast to outstrip capacity.

## Freighter Airline Strategies

## Two logical extremes capture and project the main issues in freighter strategy.

**Strategy**

**High Revenue**

**Low Cost**

**Philosophy**

- “Air cargo is a commodity”

- “Air cargo is segmentable”

- Complex product range
- Heavy marketing spend
- Large network – emphasize scope, scale and quality
- Superior operational execution – especially with regard to revenue integrity!

- Bare-bones product
- Little or no marketing – willing dependence on key customers
- Small network (“cherry-picking”)
- Focus on being absolute low-cost producer

**Freighter Airline Strategies**

**Notes:**
Two logical extremes capture and project the main issues in freighter airline strategies.  In the high revenue model, the philosophy maintains that Air Cargo is segmentable.  The strategy is to provide a complex product range, requires a heavy marketing spend, a large network that emphasizes scope, scale and quality with high performance levels.
The low cost model presumes that air cargo is a commodity.  The strategy is to provide a barebones product, little or no marketing, a small network in large markets, with a focus on being the low cost producer.
How a carrier is able to compete between these extremes depends, among other things, on their position in the market, network reach and their cost structure.
Lufthansa is certainly a good example of a carrier on the high revenue end of the market, but their recent product simplification announcement suggests there is a limited scope of segmentation of the wholesale A2A market.

## Low costs do not guarantee profit or survival in a network- based business.  It is critical to understand scale effects on both costs and revenue.

***Low costs do not guarantee profit or survival in a network- based business.  It is critical to understand scale effects on both costs and revenue.***

- Minimum Competitive Scale (MCS) is the fleet size below which unit revenue will not exceed unit cost over the long term.
- Both unit revenue and unit cost curves are unique to each airline.
- Objective is to maximize the profit envelope, not unit cost or unit revenue.

**Fleet Size (Freighters Or Equivalents)**

**USD Per Block Hour**

**Unit Cost Versus Unit Revenue**
- USD Per Block Hour

**ILLUSTRATION**

**Average Unit Cost**

**Average Unit Revenue**

**Minimum Competitive Scale (MCS)**

- Source: MergeGlobal, Inc.

***Profit***

**Freighter Airline Strategies**

**Notes:**
On the other end of the spectrum, a low cost structure does not guarantee profit or survival in a network based business.  It is critical to understand the effect of scale on both costs and revenue.  With any type of service it is important to reach a Minimum Competitive Scale to become or remain competitive.  Both unit costs and unit revenues are unique to each carrier, but a carrier that is too small cannot achieve sufficient customer leverage or allocation of its fixed costs over sufficient operating units to be competitive, and on the other hand, a large network carrier faces the challenge of growing into successively lower producing routes as the carrier expands.
For these and other reasons carriers adopt different strategies and approaches to the market.

## AAWH has adopted a Diversification Strategy

- Achievable only with a large fleet
- More complex approach to business
- Portfolio of different services between which capacity can be reallocated as market conditions change
- Reduces overall risks

**Freighter Airline Strategies**

**Notes:**
Through its two principal subsidiaries, Atlas and Polar, AAWH offers the full range of key services for the widebody airfreight market.  Within the AAWH Companies, we offer significant capacity in each of the ACMI wet leasing, Scheduled Service and Charter  business segments of the industry.  Offering and maintaining diverse services is one of the central strategies of the Company.  Each business is quite different in terms of its underlying customer base, the type of service that is performed and its method of doing business.  This strategy is generally only achievable with a large fleet as the carrier needs to meet the Minimum Competitive Scale in each Service type to be competitive, but this strategy does limit downside risk as the markets change.

## Atlas Air Worldwide Holdings – Sales Channels

**U.S. Gov’t **
**Brokers **
**Direct Shipper**

**Sales Unit**

**Customer**

**Service**
**Type**

**Scheduled**
**Service**

**Freight**
**Forwarders**

**Polar**

**Airlines**

**Charter Business Unit**

**ACMI**

**Atlas**

**ACMI**
**Charter**

**AMC &**
**Com’l Charter**

**Forwarder**
**Charter**

**Freighter Airline Strategies**

**Notes:**
With respect to Atlas and Polar, each customer is served through a consistent sales channel, irrespective of the carrier that may perform the service.  This prevents competition between Atlas and Polar with respect to any individual customer.
While each of the service types has its own commercial strategy, we have the ability to move capacity between service types to optimize the utilization of the fleet, to take advantage of a scale of operations and to adjust the revenue mix for the best overall outcome.

## Conclusions

## Conclusions: 

- Air freight demand will continue to grow – but will be volatile
- Tight supply versus demand is projected to continue for several years – resulting in stronger yields
- Higher fuel costs will require higher yields, but will make efficient fleets more competitive over the long term
- Consolidation will continue in the industry making scale and scope of operations important competitive factors
- Carriers with greater market reach and diversification will be better able to profit by the market circumstances and be better equipped to weather any volatility

**Conclusions**

**Notes:**
In conclusion, I would like to summarize as follows: