The Aer Lingus plan to cut the air fares on about one third of its seats comes after a year when traditional airlines lost out heavily to the low-cost/low-fare airlines which have the operational flexibility to respond quickly to changing market conditions.

Warren Buffett, after observing that the total profits made since the dawn of the aviation industry by all airlines was zero, famously commented that if he had been at Kitty Hawk in 1903 as a favour to future capitalists he would have shot down Orville Wright. Thanks to the economic slowdown and the September 11th attacks, 2001 has proved to be a record loss-making year for the world's aviation industry. And the prospects for 2002 are not too bright either, all seeming to support Buffet's view.

In Ireland we have one outstanding example of how an airline can add value for shareholders - Ryanair. The airline has been one of the few unqualified success stories of the industry in the last decade, and this is set to continue. Deregulation has allowed full access to the market for low-cost airlines, which have expanded demand by offering product at price points that were previously unexploited in the market.

Rigid labour and other cost structures severely disadvantage national carriers leaving them almost powerless to halt the emerging dominance of the European short-haul market by low-fares airlines, of which Ryanair is the leader. The events of September 11th deepened the turmoil and precipitated retrenchment among the flag carriers and enhanced the prospects for European low-fares airlines by strengthening their negotiating positions on aircraft and airports. At Merrion, we believe that Ryanair is likely to continue to deliver above average returns for investors over the long term, even if these are not be as high as those of recent years.

So, what does this mean for Aer Lingus and other traditional national airlines? In five to 10 years from now, there will probably be three or four major European airlines (BA, Air France, Lufthansa, and possibly KLM), dominating dominate long-haul services in and out of Europe. The short-haul market will be dominated by two categories. Point-to-point markets will be dominated by two to three low-fares airlines (Ryanair, easyJet), while the dominant long-haul carriers and their smaller partners will provide feeder services into their hubs.

Apart from the majors, there may be very little transatlantic service available from other European airlines. The non-European competition for the major European carriers on the transatlantic route will be three or four North American airlines, which will also dominate long-haul services in and out of the US. These "first division" European airlines will be fed by a network of relationships with smaller airlines.

The "second division" of the European airline industry will include carriers with a major home market, which do not emerge as winners on the long-haul routes (Alitalia, Iberia, SAS). The size of their domestic markets and the premier position of these airlines in those markets will give them an advantage in negotiating with "first division" European carriers and should allow them to survive successfully. Aer Lingus does not have a sufficiently large home market to qualify for this category.

Below this level, there will be a diverse pool of carriers, some acting as feeders into the bigger carriers as part of trading relationships, some concentrating on end-to-end short-haul services and competing mainly on price, some focusing on very local regional markets. Aer Lingus will have to find a place for itself among these.

In five to 10 years from now, Aer Lingus will probably be:

(a) a feeder into a larger carrier (or carriers) for the transatlantic and other long-haul routes and

(b) a competitor on end-to-end short-haul routes, where competition is based largely on price.

It is possible Aer Lingus will not be operating an independent transatlantic service, but it may have a strong code-sharing arrangement with a transatlantic carrier (or carriers) that may offer direct departure from Ireland on some of the services. It is quite possible that the long-haul partner will be a shareholder in Aer Lingus.

On the end-to-end short-haul routes, Aer Lingus is likely to be going head-to-head with Ryanair and other low-cost carriers. It will have no choice but to compete on price and cost

Notwithstanding the limitations on Aer Lingus international development, Merrion's view is that the company has some considerable resources that may be overlooked in some of the current debate and it could present an interesting investment opportunity if and when the company, its workforce and its major shareholder all face up to the realities of its situation.

The operating cost base has to be completely overhauled, which will involve ending the top-heavy seniority-based staff structures in flight crew and cabin crew and the streamlining of the entire management structure.

Aer Lingus has to lose all explicit and implicit political answerability and responsibility. If the state, or any other party, wants the airline to provide certain services, let them pay a market price in one form or another.

There is some evidence that the company (and the unions and the Government) are beginning to understand the way in which the operating cost base must change.

Linking the interests of the employees to the company's equity value will be essential in creating a sound environment for managing the cost base.

The obvious exit options for an outside investor would be IPO or sale of the stake to another airline. It is likely that one or both options could be available within five years.

Airlines need not be all bad for capitalists, Warren.

John Mattimoe is an airline analyst with Merrion Capital