2005 Outlook - Budget airlines move to a higher plane

By David Fullbrook

BANGKOK - Innovation, diversity and competition will define Southeast Asia's low-cost airlines in 2005, likely influencing new carriers taking off in China and India as well. Branding, ever-longer routes and airports are now all entering the equation as carriers in crowded skies seek an edge over competitors.

Last year saw a slew of low-cost carriers (LCC) take to the skies in the region, defying doomsayers who said the model would not work in a region with complicated rules restricting routes and traffic rights, and few secondary airports. "In fact there hasn't been any new entry into the Asian market for a decade or so until the new flock of carriers came in. In that time the market has trebled. New carriers are straying from the model, what we're seeing is diversification," said Peter Harbison, the Center for Asia Pacific Aviation's managing director.

Singapore's Changi airport, where LCCs now account for 7% of traffic from almost nothing at the beginning of 2004, is building a terminal just for these no-frills airlines. Bangkok's Don Muang, earmarked for closure later this year, may well soldier on as an LCC and charter flight hub. With passengers now spoiled by rock-bottom fares, carriers are fast graduating to Madison Avenue sophistication from nuts-and-bolts simplicity.

Thailand's Nok Air kicked-off services in July, with razzmatazz street campaigns and radio promotions pushing its brand as much as its prices. Meanwhile, LCC peers AirAsia and One-Two-Go reduced services. "When you're around the same price point, brand is an issue," says Ravindran Devagunam, Deloitte's aviation and transportation practice head in Singapore.

Nok, claiming total management independence from owner Thai Airways, needed to do something different with three other carriers also operating domestically in addition to AirAsia and One-Two-Go. Branding brings in sales of airline apparel, and partner products and services. Margins on these items are much higher than the 5-10% a modern airline earns from selling seats, or 2-3% legacy airlines expect. "I would imagine 20-30% of revenue will come from non-airline services and products by January," said Patee Sarasin, Nok's chief executive.

This January, Nok's brand will get a further boost from a new strategy, which Patee declilned to divulge, that will bring flights within the reach of the 5million to 6 million Thai families earning 20,000-30,000 baht ($500-750) monthly. "This one is really going to rock AirAsia - and everybody else," says a grinning Patee. In Phuket, Nok offers "beachside" check-in, issuing boarding passes at a hotel a few minutes from the airport. It takes a cut from revenues partners earnings from selling things like drinks, food, Internet, and transport to Nok passengers. Similar check-in centers are likely to follow at other destinations.

"Any carrier that can put together the good bits or some of the good bits is going to have an edge," said Harbison. "It's very much about making sure you've evolved into your niche, it's got to be a niche you can protect."

Nok will start selling ad space on overhead baggage bins, seat trays and the fuselage, pulling in more of that juicy incremental revenue. Nok is also introducing a loyalty scheme, possibly a smartcard later. In Thailand, Nok has teamed up with banks to allow passengers to pay for tickets via ATMs (automated teller machines) and 7-Eleven convenience stores for counter payments. This is something it hopes to repeat in China and elsewhere. "We are the only airline in the world selling tickets via ATMs," Patee says.

Having spent two decades with ad agencies in Thailand and the US, Patee is certain that loyalty lies in consumers' hearts, not their wallets. "Price is not the key to everything, people still have emotions, which can be stronger than price motivation. Unlike AirAsia, We are not focusing on price-sensitive clients. Ryanair is adding frills, which they charge for, because they know pricing is not the key to medium- to long-term success," he says.

Price, however, creates the market as the masses' wealth is rising pretty fast in Asia's booming economies. "One of the surprise things about low-cost carriers in Asia has been the huge elasticity of demand when you drop the price. It provides a huge increase. Asia doesn't remotely have the capacity to meet the demand. Down the track, the low-cost industry in Asia will be a big one," said Harbison.

Though Nok appears ahead of the Asian pack, other low-cost airlines, especially in Europe, are working hard to build non-airline revenues. Harbison noted that Easyjet and Ryanair earn "double-digit" revenues from cross-selling. Success is not certain though. Richard Branson's European airline Virgin Express has struggled, while Virgin Blue in Australia is flying high. "Brand-building has to be from the start, it is difficult for AirAsia to do that because their brand-building is built on price alone," said Patee.

That may be so, but the result is, AirAsia has a strong brand, spreading beyond Malaysia to Thailand, Indonesia, and quite probably China this year. Tony Fernandes, AirAsia's chief executive, also has that rare combination of charisma, confidence and ego to go with it. "When AirAsia was set up there was no flair, Fernandes was providing a bus service in the air: reliable, safe, easy travel. People tended to trust his product, building his brand," said Devagunam. "It sounds simple, some people are innately better at it than others. There's a first mover advantage."

AirAsia has not been standing still, a few months ago ordering 40-odd Airbus A320s for expansion and to replace leased second-hand Boeing 737s. It has been working hard pushing its holiday service, enabling passengers to bolt together all the things they need for a holiday via a website. Most carriers will need to do something similar to survive, especially as many low-cost passengers are taking their first holiday, which may also be their first trip overseas.

"When you go international, the linking of those other products is that much more important, people can feel confident they have everything tied up in a nice product, they don't have to worry," says Harbison. That means Nok has to work doubly hard to succeed long-term. "Differentiating from AirAsia is not easy, but there are probably a few ways out there, such as the JetBlue way," said Devagunam.

Nok intends to add five Boeing 737-400s this year to the three it already operates. Plans for routes to cities across southern China, from Chiang Mai, this year could accelerate to make up for lower traffic on southern Thai routes where many beach resorts lie in ruins after the tsunami. Phuket, which should be shipshape in time for the traditional high-season running between November and February, is in Nok's plans as a stepping stone to Bali and elsewhere.

Whether from Phuket or Bangkok, Bali is beyond the three-hour flight time considered the limit for LCCs to thrive. While that might be true in Europe or North America, Asia may well be different. Qantas subsidiary Jetstar Asia, based in Singapore alongside Tiger Airways and Valuair, is flying as far as Shanghai, a little under seven hours away. "I think that was more a matter of a lack of choice. I think they found Bangkok and Hong Kong pretty congested, so they were looking for alternatives when they were establishing their route network. But it is interested in pushing the boundary of the low-cost operation," said Harbison. If Jetstar can make such a long route work, other LCCs are certain to follow, especially opening routes from China to points across Southeast Asia.

Meanwhile in Indonesia, where at least 22 airlines, most falling in the low-cost bracket by default because of intense competition, Lion Airlines - the largest private carrier with around 25 aircraft - took control of Jakarta's old international airport Halim Perdanakusuma in December 2004. Terminal expansion work, taking a year, should begin soon, doubling the numer of gates gates to 16. Facilities will be better, including automated ticket kiosks. Lion hopes to lure foreign airlines now flying into Jakarta's Soekarno-Hatta airport. "It's downtown, it will attract passengers because of that," said Rusdi Kirana, Lion's president-director. Thailand's Bangkok Airways has chalked up handsome profits from a similar strategy beginning with cash-cow Samui airport in 1989. Well-managed airports earn as much, if not more, from retail and services as airline fees.

Southeast Asia's new airlines are taking the low-cost airline model pioneered in the US and developed further in Europe to new places. Their successful innovations cannot but fail to influence new players entering much larger and more promising markets of China and India over the next year or so.

 

Having fun and flying high
 

Tony Fernandes is proving that there is a market for budget airlines in Asia
 

“THERE'S a new girl in town. She's twice the fun and half the price.” Coupled with pictures of nubile flight attendants, the suggestive slogan fills newspapers all over stick-in-the-mud Singapore. It is the latest advertising campaign for AirAsia, the continent's answer to Europe's Ryanair and JetBlue of America.

When Tony Fernandes, AirAsia's chief executive, recently announced a new joint venture, he made sure he was photographed in front of the headquarters of Singapore Airlines, just to goad his rival. “You've got to have fun once in a while,” he says, echoing his own tag line. Like his friend, Sir Richard Branson of Virgin, Mr Fernandes has turned himself into his company's most effective marketing tool. Just 38, he sports a trademark red baseball cap, fondness for playing drums and an unconventional background—he is part Goan, part Malay-Portuguese and he used to make music videos for Virgin.

Sceptics have long argued that, when it comes to air travel, Asia is different from America and Europe. The élite will insist on being pampered on board and happily pay for it. And Asia's protected national markets, long distances and paucity of cheap, secondary airports means that prices remain out of most people's reach.

Mr Fernandes is proving such thinking wrong. His airline was founded on the premise that Asians, even rich ones, like a bargain as much as anyone else and that ruthless attention to costs can make ticket prices affordable for almost everybody. Timothy Ross, airlines analyst for UBS, argues that the region's lower average incomes should boost rather than restrain the appetite for cheap fares. Bargain prices, such as AirAsia's 499 baht (about $13) deal between Thailand and Singapore, are helping the airline expand the market.

The target consumer base for budget airlines is also enormous: 500m people live within three hours of AirAsia's hubs in Kuala Lumpur and Bangkok, more than Western Europe's entire population. And the boost to local tourism in towns served by low-cost airlines is so great that other barriers to entry are proving relatively easy to get around. To avoid the restrictive sovereign air-service agreement between Thailand and Malaysia, for example, AirAsia has set up a local joint venture with Shin Corp, the family company of Thaksin Shinawatra, the Thai prime minister. Secondary airports, such as Macau, are virtually begging the company to set up a base there by offering to reduce landing fees.

Experience in other countries shows that, once the rules start to relax, growth is bound to take off. In America, budget carriers saw their passenger numbers rise 48% annually in the five years following deregulation, compared with 4% for traditional airlines. The low-cost carriers now have roughly a third of the market. In Australia, the no-frills airline Virgin Blue took only three years to win a 30% market share.

AirAsia has similarly been a soaring success. Starting with two planes bought from a Malaysian conglomerate in late 2001, the airline will have 30 by the end of 2004. It operates 19 routes across Malaysia, recently started Singapore-Thailand flights and, from next month, starts flying to Indonesia. The company has no debt and has been profitable from the start. Its profit margins (before interest, depreciation, amortisation and aircraft leasing costs) at around 35% are the highest in the world, according to Michael McGhee, CSFB's airline analyst. For the current half-year,AirAsia expects to make a profit of 42m ringgit ($11m), more than twice what it made in the entire previous year. No wonder bankers seem to be falling over themselves to help Mr Fernandes take the company public, probably later this year.

His success is spawning a host of copycat carriers. In the past seven months, the number of budget airlines either flying or about to launch has doubled from seven to 15. Most are spin-offs from traditional airlines such as Thai Airways' Nok and Tiger Airways, run by Singapore Airlines. These tend to have neither the cost discipline nor the culture of genuine budget start-ups. Thai Airways, for example, has hired an advertising executive to run Nok who seems to be a pale imitation of Mr Fernandes, both in his marketing and operational ability. Eric Kohn, deputy chairman of dba—a company that did poorly as a low-cost offshoot of Britain's BA in its previous incarnation—believes that older airlines cannot easily make such projects work: “People at big airlines don't have accountability or a focus on costs. It is a lot easier to start an airline from scratch than to take a legacy airline and make a profit.”

As Mr Fernandes is proving. He has been helped by timing. During the air-travel slump that followed the September 11th terrorist attacks, AirAsia was able to negotiate sweet deals with aircraft manufacturers, airports and other suppliers. However, Mr Fernandes is keen to be more than just a flamboyant entrepreneur. “I am there at 2am studying the plane's engines. I know the price of every part,” he says. Guided by his operations chief Conor McCarthy, pinched from Ryanair, Mr Fernandes is obsessive about costs.

Low-cost carriers require such obsession. Drew Magill, director of market analysis at Boeing Commercial Airplanes, estimates that low-cost airlines earn around 45% less revenue per mile than full-service airlines (which can charge more for long-haul flights) and so need 50% lower costs. AirAsia achieves this by taking bookings via the internet rather than through travel agents; charging for meals; and having only one type of aircraft—Boeing 737s—to save on training overheads. The crew help to clean the aircraft to shorten turnaround times. But Mr Fernandes has gone much further, persuading his pilots, with whom he regularly shares the company profit-and-loss account, not to take off at full throttle and to fly their aircraft to cruising altitude immediately—saving some 26% on fuel costs, an airline's second biggest overhead. At 2.5 American cents per available seat-kilometre, AirAsia's operating costs are the lowest in the industry, calculates UBS.

Mr Fernandes's biggest challenges will be to manage growth, and to avoid both a destructive price war and the temptation to enter markets with fundamentally different economics, such as long-haul flights. For now, his lead over competitors looks unassailable. For Mr Fernandes, at least, flying should remain fun.

Can low cost airlines fly in Asia?

14 November 2002

The no-frills (or low cost) airlines are now well established in Europe and North America. Not just taking passengers away from the major airlines these new carriers have created new demand for air travel.

On a more limited scale the low cost model has come to Asia in the form of Air Asia, in Malaysia, and Virgin Blue, in Australia.

The big question is can this model operate on a wider scale in Asia.

The big answer is yes, but in time, and only with significant market liberalisation. The demand is certainly there. Air travel volume in Asia Pacific is forecast to triple by the year 2020.

To succeed low cost carriers need the following:

China : The Aviation Market for the next 25 years

14 November 2002

The rate of growth of the aviation industry in China should not be underestimated. Distances are huge; road and rail infrastructure is limited. It is reasonable to assume that domestic air travel in China will resemble the US market within the next 25 years but on an even greater scale given the larger population base.

At the same time the aviation industry will support a rapid growth in both outbound and inbound business and leisure travel.

Consider some statistics:

In 2002 12 million mainland Chinese traveled overseas to "approved destinations".  The big markets are to Hong Kong and Macau; over 0.5 million tourists each year travel to Thailand and to Vietnam. Travel to Australia and New Zealand is expected to grow by 20% per annum.  A young, educated population with money to spend is now ready to explore the world beyond China.

By 2020 China will receive 130 million tourists a year making it the world's leading tourist destination.

Airbus and Boeing expect to sell 1,800 commercial airliners to China over he next 20 years.

From Hong Kong you can fly to at least 40 cities in China.

57 airlines from 47 countries (outside China and Hong Kong) fly to 20 destinations in China.

Hong Kong's population is 7 million

In the Pearl River Delta there are 300 million people.

In China there are about 100 airports supporting 1.3 billion people; compare this to 429 commercial airports supporting 280 million people in the USA and Canada.

In the US over 11 million jobs are related to the civil aviation industry. Imagine what this figure might be in China in 20 years time.

Frills or no frills - that is the question ?

20 August 2002

In Europe the big boys are fighting back. BA and others have eliminated the old Saturday stay requirement for their new economy fares and no advanced purchase is necessary.

They are fast learning the magical art of yield management. If you are willing to fly at a specified time on a given date then you may well find that the major carriers have very competitive fares. You will always have to pay for flexibility and the right to change your schedule.

A couple of random comparisons between BA and Go/Easyjet/Ryanair found in some cases that the BA fare was very similar to the no frills carrier. With the bonus on BA of more flights per day from many destinations, using Heathrow or Gatwick (not Stansted) and flying into a city's main airport. And you get frills.

Why then do the no frills carriers still fly with such terrific load factors? Why do they remain so popular?

I have three rather British answers.

The British love the under-dog. They see Ryanair and Easyjet as upstarts fighting big ugly government supported European majors.

The British love a bargain. If you can commit months in advance then the no frills carriers will offer bargain fares that BA can never match. It is usually only when you get closer to your preferred departure date that frilly and no frills fares become comparable.

Marketing. marketing, marketing. The no frills carriers never miss a trick to get their name up front on the news, on their planes, on posters, on television features. The majors just dont know how to handle this. Southwest pioneered no frills marketing. Easyjet and Ryanair milk it for all it is worth. They will never be accused of being subtle. Imagine a BA plane with a telephone booking number emblazoned on it - I cant !

How long can the no frills carriers sustain this advantage or do they just become part of the airline establishment. There are already signs of Easyjet looking like BA at its worst with some dreadful scheduling problems in the busiest summer months. And there are more signs of BA looking like Easyjet with fast and efficient internet booking and more aggressive fare structures.

The US aviation industry needs to be competitive

15 August 2002

In the US the losses being made by the major carriers are staggering. But they carry on flying. Protected by federal loan guarantees and Chapter11. Bankruptcy protection probably does more harm to the US airline industry than good. Chapter 11 allows failing airlines to continue to fly; and worse still to slash fares to win market share while operating under court protection from their creditors. So all the over capacity remains.

The US labour unions baulk at any serious attempt to reduce costs and capacity. The good of the many must mean the sacrifice of the fewer. There has to be pain. And there is no reason why the US airlines should be immune from that pain.

In the meantime European airlines have been allowed to fail (Sabena and Swissair being significant examples); European airlines have slashed away at staff and operating costs. BA, Lufthansa, KLM, SAS and Iberia are all profitable. They are prospering alongside the growth of the no frills carriers such as Go and Easyjet. And in many cases crew made redundant by the major carriers will often find employment with the new airlines. That may not have the same pay and benefits and frills; but if you will forgive the mixed metaphor, the gravy train does not run forever. It should be noted that the no frills carriers currently fly only about 10% of European air travelers. People are flying in Europe. More now than before 11 September 2001.

Americans are still not flying; at least not at early 2001 levels. So there is huge overcapacity and too few people flying.  Why are they not flying - yes in part because of last year's events. But also because flying in the US is a fairly miserable experience; grumpy crew, dilapidated airports (Denver is a shining exception), obnoxious, ignorant and intrusive security. And no exotic destinations to renew the spirit when you get there - while Europe offers you no frills flights from Torp to Carcassonne to Verona to Prague (pre floods !).

Let US Airways fail; it has been a sick patient for many years. Let United fail; they do not have a given right to federal guarantees. Why should they have? Would Microsoft get federal loan guarantees; I don't think so. Let the US carriers merge and consolidate. And a stronger and more competitive industry will emerge.

Can no frills fly in Asia

14 August 2002

For the longest time I have wondered whether a no frills airline could make it in Asia - the answer, at least today, has to be a qualified no ! On a country by country basis a small scale airline can make it. But across borders....I dont think so !

Why do Easyjet, Go, Ryanair and others succeed in Europe. Simple. All airlines from European Union member states have the fifth freedom rights within the EU. They can fly between any two points, neither of which need be in their home country. Ryanair is an Irish airline. Its main base of operation is Stansted, NE of London.  In Europe the only real issue is finding an airport that you want to fly to that has landing slots available. Everything else is manageable.

Why do Southwest and JetBlue and arguably Airtran do well in the USA, and Westjet in Canada; they dont fly internationally. If you want no frills from New York to Vancouver you need to fly from New York to Buffalo on Jetblue, drive across the border and then fly from Hamilton Ontario to Vancouver on Westjet !

Simon Calder in his excellent read "No Frills" identifies the five main cost elements of running an airline as the 5 Ps....people, planes, petrol (jet kerosene), places (airports) and promotion. In Asia there is a 6th P. Permission.

Once you leave Europe the airlines are a protected species. Every country needs two things - a national anthem and an airline...and the airlines are often allowed to lose money, at the tax payers expense for ever! Olympic in Greece, Qatar Airways, Gulf Air; even the American majors are relying on handouts and loan guarantees or Chapter 11 protection ! Try starting up a low frills carrier in Australia where Qantas have at least 80% of the domestic market. Virgin Blue have done well this far; the failure if Ansett gave Virgin Blue the opportunity to be the necessary second carrier. But in Australia as in Canada there is a long list of failed start up airlines.

A relevant example of the complexity of flying in Asia is Cathay Pacific's application to start flying back into mainland China; Cathay gave up these routes to Dragonair in return for a major shareholding in the Hong Kong based carrier.

For Dragonair its routes into China, especially to Beijing and Shanghai are wonderfully profitable. Dragonair now has rights, and flights, to Taipei so can fly a same plane (change of flight number only) through service from Taipei to the two major mainland cities; this is a huge advantage over Cathay Pacific.

Now you could argue that if Cathay wants to fly there and has the crews and planes and can negotiate landing slots and fees in China then they should fly when they want ! If only it were that easy. In 2000 Hong Kong and Beijing signed an air services agreement designating Dragonair as the sole Hong Kong carrier to the mainland. The mainland carriers are likely to oppose Cathay's entry to this market.  But how many Chinese airlines serve Hong Kong; Air China has 5 flights a day to Beijing, China Southern one a day to Beijing, China Eastern, 10 flights a day to Shanghai; all these carriers have other destinations from HKG. And let's not forget China Southwest, China Northwest, China Northern and Xiamen Airlines - all flying to and from Hong Kong.

It may be years before Cathay can fly to China. And if Cathay cant fly there then what chance a new start up !

So where could a no frill carrier succeed in Asia. More on that tomorrow.