We called them 'The New Breed' - those Latin American airlines which emerged on the heels of deregulation to challenge the newly privatised flag carriers. Led by entrepreneurs with overseas experience, these startups were to breathe fresh air into a stodgy old system and ensure that new laws designed to put the commercial ingredient back into aviation would do so. Five years ago The Economist counted 47 of these newcomers and predicted they would revolutionise Latin America's skies. But so far, it hasn't happened.
Domestically, this new breed has done reasonably well. Argentina's Lapa and Colombia's Aces are now the second largest carriers in their countries while AeroContinente has become number one in Peru. Domestic barriers persist, but the big obstacles seem to emerge when these airlines try to grow beyond their borders. The need to grow is clear. International traffic is mushrooming and without it the Latin carrier is marginalised. Not only does every carrier need to be in on the growth, but diversifying brings additional strength. Only 15 per cent of National of Chile's passengers are now international; in five years it hopes to double that. Aces hopes to boost foreign revenue from 20 to 40 per cent in the next two years. 'We need that to provide a better hedge against foreign exchange risks and more balanced vulnerability to different markets,' explains Aces CEO Juan Emilio Posada.
Inexperience and undercapitalisation head the list of some of the obstacles shared with startups around the world. And while startups elsewhere also confront intransigent incumbents and rules designed to protect them, in Latin America these barriers are especially formidable. 'The problems upstarts face today go back to the way Latin airlines were born and raised,' explains Julian Sevillano, a Miami airline consultant. A Cuban exile who now advises airlines throughout Latin America, Sevillano recounts how military dictators took over Latin airlines after World War II and created a patriarchal system. 'It was the almighty government,' says Sevillano, 'the protector, the one who gave you money when you needed it, the one who could change the rules to help when you were in trouble.'
Despite privatisation, Sevillano says those attitudes remain. 'Incumbents still have ties with the government,' he says. Governments keep control by ensuring that the incumbent remains strong, but dependent on the government for that strength. 'The incumbent is a daughter that has been raised by the government. The upstart, obviously coming from a different angle, never enjoyed the government's direct protection. Upstarts are just entrepreneurs who opened their own businesses,' he explains. 'A number of these entrepreneurs, especially the younger guys, have new ideas about free markets, open skies, and all of that,' adds Sevillano. 'The old system is passing. But many old timers are homesick - nostalgic - because "my father's not protecting me anymore." '
These attitudes show up in the favouritism flag carriers still enjoy. 'Incumbent airlines in Latin America are still seen as strategic assets of the country,' warns William Alderman, former senior vice-president of Aviation Sales Corporation. 'They are treated as critical to the national economy and a vital part of the country's infrastructure. They are a source of national pride.'
Right of first refusal
Pride produces protection. When Argentina privatised Aerolineas in 1990, for instance, it shielded the airline from local competition for five years on regional routes and 10 years on longhaul routes. AeroPeru has a similar right of first refusal on most routes from Peru. Lima recently reduced that to attract investment in other airlines, but AeroPeru still retains first rights to 63 per cent of new US frequencies beyond Miami and at least 70 per cent of any new routes to Argentina, Brazil, Chile, or Mexico.
In other countries an airline's eligibility for international routes depends on its status. In Brazil, for instance, some airlines are designated
'national' while others are only 'regional.' And moving from one list to the other requires a considerable effort.
However, Latin startups are pressing their governments to relax these rules. Argentina's Lapa has applied for longhaul rights that Aerolineas does not use to Puerto Rico and Los Angeles. Lapa contends Aerolineas deserves no protection on unused routes, an argument that has already met with some success. Lapa has gained rights to Atlanta and plans to operate the route soon with a new Boeing 757.
Since 1995 Argentina has followed a multi-airline policy on routes to other Mercosur countries as well as Chile. These open regional opportunities for Lapa and Dinar. Once implemented, the Fortaleza 'open skies' agreement for new city pairs within Mercosur could open many routes for startups in South America's southern cone. 'We plan more passenger and cargo routes under this,' says Jesus Diez, president of Chile's National Airlines and its new parent, Avant Airlines.
Incumbent privileges are sometimes informal, but equally effective. Many bilaterals still only allow single designation. Authorities pay lip service to competition, but then point to the bilateral and shrug. 'It is very difficult for us to convince the government to open up a bilateral or to provide for a second carrier in a bilateral, because Avianca would always oppose it,' complains Aces' Posada.
Even when the bilateral allows dual designation, landing an award is still not easy. Posada recalls last year's debate over seven new frequencies to the US. Aviation authorities in Bogotá favoured giving Aces more of them because it started with less, but others within the government council felt Avianca deserved equal treatment. The result was an impasse. Three of the seven frequencies remain unawarded. Carlos Morales, AeroContinente's CEO, voices similar complaints. 'AeroPeru controls approximately 24 of the 42 frequencies now allowed to the US, but it really only flies seven in its own right.' He is unsure how many more AeroPeru operates through its Mexican partners. 'On international routes, the future of AeroContinente depends on what happens to AeroPeru.'
For years Chile has allocated routes by auction - a seemingly even-handed system. But National Airlines complained last year that LanChile outbid it on routes to Mexico, Brazil, and Uruguay for anti-competitive reasons when LanChile bid an aggregate US$1 million for those routes. The case was settled after LanChile agreed to give National seven of its US frequencies.
Unholy alliance
Incumbent-startup differences have grown especially contentious in Mexico. Aeromexico and Mexicana are required to compete against each other despite their common ownership by Cintra. Mexican banks initially owned Cintra but, through various government loans and guarantees, the government has assumed effective control.
Last November Mexico's competition commission accused Aeromexico and Mexicana of using their dominance to restrain competition. Now, an emerging Mexican carrier claims the government has been part of this unholy alliance. Taesa, one of Mexico's two independent airlines, has held its tongue because of delicate negotiations with the government over its own restructuring. But AeroCalifornia, Mexico's other major independent, has unleashed a double-barrelled barrage. Raul Antonio Arechiga, AeroCalifornia's CEO, claims Cintra is using its close government ties to create 'unfair and artificial bureaucratic barriers for the purpose of impeding the independent Mexican airlines.' Arechiga contends Aeromexico and Mexicana are behind this campaign, with one of their aims being to disrupt AeroCalifornia codeshares with American Airlines. He cites numerous examples of what he claims to be official anti-competitive acts motivated by the government's desire to protect its wards.
Cintra has declined to comment on these charges. The only comment from anyone else in Mexico's government has come from the under-secretary of communications and transport, Aaron Dytcher, who says the government will try to sell its Cintra stake when Cintra makes its public offering sometime this year.
Even when relations with an incumbent are less stormy, Latin startups face other problems in extending beyond their borders. The reasons for a startup's local success may actually work against it. The same passenger who delighted in low local fares may be cautious about using that carrier for a longhaul flight. 'Our customers are very conservative,' says one Latin airline official. 'Who wants to fly what they see as a low cost international airline?'
Moving beyond local obstacles, the fear of extending the fifth freedoms operated by foreign airlines poses another barrier to startups. This is especially true in mid-Latin American countries like Venezuela and Colombia, where foreign airlines have historically stopped en route to points further north or south. Fear of expanding these fifth freedoms becomes another reason for not opening bilaterals to benefit a startup. For example, Aerolineas Argentinas enjoys fifth freedoms between Colombia and the US. Amending the Colombia-Argentine bilateral to add capacity to benefit Aces would probably require giving Aerolineas more fifth freedoms through Bogotá.
'Argentina is a difficult one because going to Chile and Argentina is quite a convenient triangle. So Argentina is valuable. I do understand the issue of the fifth freedom rights, but I cannot just allow Avianca to limit our ability to go international. If it is too expensive for them to allow us to operate to Argentina, they have to give us oxygen somewhere else. Right?' argues Posada.
Gringo onslaught
Fifth freedoms and the growing US invasion pose a challenge for all Latin airlines, but make life doubly difficult for startups. Incumbents beg local authorities to restrain homegrown competition so they can concentrate on the 'gringo' onslaught. And if a startup is contemplating its own north-south routes, it must face the giants itself.
Those giants are more than just another batch of foreign rivals. The big four - American, Continental, United, and Delta - dominate Latin America, carrying as much as 53 per cent of all South American and 62 per cent of all Central American traffic. They even carry two thirds of all Latin business travellers flying to the US. A Latin airline launching flights from a comparatively small nation into the teeth of this faces daunting prospects. Aces' Posada notes: 'We have to be careful with mega-carriers. They have demonstrated that they are more than capable of putting a whole tonne of seats in the market.'
It is hardly surprising, then, that Latin carriers have opted for North American alliances, concluding that this is the way to survive. When 80 per cent of the passengers on American Airlines' flights operating south of the border are not US citizens, the handwriting is very clearly on the wall. Every startup's nightmare is that the incumbent will form an alliance with one of these US giants and, in the worst version of this nightmare, that giant is American Airlines.
In Colombia, Chile, and Argentina, American's proposed pacts with Avianca, LanChile, and Aerolineas respectively are seen by startups as the nightmare come true. 'If the AA/Avianca alliance is approved, we would be at a clear disadvantage,' fears Juan Emilio Posada. Aces and National Airlines have asked their governments to withhold approval, but they know the momentum is against them.
One solution is to counter with an alliance of your own. Thus Aces has linked with Continental and Argentina's Lapa and Colombia's AeroRepublica are reportedly talking to Delta. National signed a letter of intent to align with Delta, but its new owner has decided instead to pursue a partnership with Continental. Jesus Diez, president of Avant and National, predicts an accord by April. 'Continental has no chance in Chile against American and LanChile without an alliance,' he predicts.
The bigger issue both these Latin startups and their US suitors face is how much chance they will have, even with an alliance, when they confront the combined might of the local incumbent and the largest US carrier in Latin America. Maria Garrido, vice-president of International Aviation Group, says startups do not only need US alliances to stay in this race. Garrido, who acts as a consultant for many smaller Latin carriers, claims they need US partners to outgrow the 'ethnic airline image' - a perceptionn that only Spanish-speaking locals would fly that airline. An alliance with frequent flyer benefits, smooth interlining, and an aura of endorsement and support from its US partner, is the only way a Latin startup can attract non-ethnic business, Garrido claims. 'It's easier to just stay with your own people,' she warns. 'It's harder to gain the gringo business. But gringos can be loyal once they've had a chance to experience the service and see that this airline can be as good as United or American.'
The final barrier is the US Federal Aviation Administration's safety assessment programme, well known for the competitive edge it hands US carriers. The less obvious impact is how it stifles competition between Latin carriers by discriminating against startups. The Latin incumbent in a Category 2 country is grandfathered at its current US service level. Only the new entrant is blocked and becomes the casualty of its country's poor rating.
Thus, AeroContinente could not even apply for US authority before the FAA upgraded Peru to Category 1. Aspiring airlines in Belize, Bolivia, Colombia, Ecuador, Guatemala, Nicaragua, Paraguay, Honduras, Uruguay, and Venezuela can only wait and watch while foreign airlines add capacity and lure away all the US traffic. Once startups gain the right to fly, they face a major task in wooing it back.
Latin America's free-market revolution is far from over. Old ways may be passing, but further reforms are still needed before the new breed of Latin airlines can really prove its potential.
Source: Airline Business
