As liberalisation comes to Asia-Pacific, the regions flag carriers have a limited window of opportunity to reform before competition - including from the low-cost sector - arrives
There is no doubting the growth potential of the Asia-Pacific market with its vast geography and booming economies. Yet remarkably little attention has been paid to the region when it comes to shaping future strategies for world aviation - that role has largely fallen to the USA and Europe. There is apparently a tacit assumption that things are not changing in Asia-Pacific. But such assumptions are dangerous indeed.
In reality, the Asia-Pacific market is becoming more liberal, opening the way to new entrants and even higher traffic growth rates than recent history would suggest. At the same time, the growing complexity and competitive heat in intra-regional markets and between long-haul hubs is creating difficult strategic questions for the region's airlines. The imminent emergence of low-cost airlines in several domestic and international markets means that some entrenched and profitable flag carriers must hasten to restructure before, rather than after, their competitive positions deteriorate.
It is true that in the past, moves to liberalisation were largely concentrated on long-haul routes rather than within the region. Asian flag carriers tended to see neighbouring airlines as major competitors, and so their government owners were reluctant to relax local access provisions. At the same time, the relative underdevelopment of intra-Asian trade, compared with that on long-haul routes, meant there was little impetus to change. The geographic separation of the region's major capitals - Singapore is a three-hour flight from 'neighbouring' Bangkok - also ensured that air travel was not challenged by other forms of transport.
During the 1990s, a small number of new international airlines assumed substantial roles in the region's markets. Second airlines, operating intra-regional and intercontinental routes, were designated by Japan (All Nippon Airways), South Korea (Asiana Airlines) and Taiwan (EVA Air), each privately owned. But given a substantial increase in the overall market, this limited new entry still left incumbents with plenty of growth.
Yet regulatory protection and state ownership no longer provide the comfort that once they did for the major carriers. Many governments are becoming attracted to the idea of wider entry and a more liberal marketplace. Some are actively looking to sell down their holdings or to increase access opportunities for new private national operators. And the former concentration on major long-haul hubs is starting to give way to a new competitive landscape. In particular, the short-haul market is rapidly becoming the focus of attention for several key reasons. First trade between Asia-Pacific countries is increasing and so is tourism.
Some 80% of international arrivals now originate within the region, and the proportion is growing. Tourism authorities themselves are becoming more vocal and influential in demanding change. Meanwhile new, smaller airlines are starting to emerge.
Progressive liberalisation is also playing its part delivering greater access to regional points. Under-serviced until now, there are numerous regional airports with large catchments that will respond instantly to direct, well-priced flight operations. The impact of this is potentially enormous. China and India alone have some 43 cities with populations above one million and Asia-Pacific as a whole counts 130 - one third of the world's total. In all there are over 235 cities in Asia with populations exceeding 500,000 and few have international air service of any kind.
China opening
China's sheer economic muscle and low labour costs is soaking up foreign investment. And as its influence grows, for example with booming outbound tourism, so its policies will become more influential. In the past, China's international expansion has been cautious, concerned that it would jeopardise the fortunes of its international airlines, already facing 'excessive' competition at home. But, in the past year, Beijing has shown a willingness to experiment with discrete liberalisation's as it grows more confident that its new big three airline groups - Air China, China Eastern and China Southern - will be able to flourish in the international marketplace.
Neither should the influence of this year's SARS epidemic be ignored in looking at the shifting dynamics of the aviation in Asia-Pacific. The outbreak cut a swathe through the industry in the second quarter of 2003. Traffic levels across Hong Kong and Macau, the Chinese mainland, Singapore and Taiwan were decimated.
Almost as startling as the impact has been the pace of the recovery. With some pump-priming in the form of aggressive low prices, traffic has returned much faster than most of the impacted airlines had anticipated.
For instance, from being in a position where there was public discussion of Cathay Pacific grounding its entire fleet in June, its market was restored to 95% of 2002 traffic levels by the end of September. Cathay had expected full recovery to take until December. Singapore too, from a seemingly desperate situation, recovered through a combination of prompt government action and a remarkable community response.
In each case, the impact was felt most keenly as the flag carrier relied on a major connecting hub to generate traffic. Consequently, the drop was not just in point-to-point traffic, but transit traffic quickly re-routed via other alternatives. Much of this diversion was of higher-yielding business travel, hurting the airlines even more than the raw numbers disclosed.
The SARS_episode has left an interesting legacy. For certain, it clearly illustrated the power of the region's economies - allowing a massive impact to be shrugged off in a matter of weeks. But it has also left many participants in the travel and tourism industries with a very different attitude to risk management. Any recurrence of the disease this winter will immediately activate contingency plans from governments, airlines and airports.
There were some fears that the damage inflicted by SARS might have reversed the move towards a more liberal operating environment, but several factors appear to have held this negative reaction at bay, with the prospect that it may even accelerate the move toward a more liberalised sector.
Airport-led reform
Another growing influence on liberalisation comes from the major airports, as they find themselves challenged not only by competition from other major hubs, but also from the threat of a return of SARS and by the increasing number of services, which bypass hubs. Made possible by a combination of more efficient long-haul aircraft and rapidly growing economies of non-hub city pairs, non-stop services are coinciding with the transition of Asia-Pacific aviation from a predominantly intercontinental activity to a more intra-regional one.
Many of these larger airports also have at least one eye on privatisation. As a consequence, they are putting pressure on their government owners to maximise value through greater passenger and aircraft throughput, even if it means exposing the flag carrier to greater risk. Their national governments are increasingly listening. If maximising value means reducing the market share of an incumbent carrier then it is now seen as a risk worth taking. Two or three years ago, it would not have been.
SARS also made airports and carriers in South East Asia more acutely aware of the emerging role of the Middle East airlines and their transfer capabilities. Here was a routing that now offered a realistic hub alternative to the Australia/New Zealand market. Responding to that threat means relaxing entry requirements. The opening up of China also continues to loom over policy in the region.
However, there is another major factor provoking a serious rethink of the airline model - the emergence of the low-cost carrier in Asia. As recently as a few months ago this was widely discounted by industry analysts. Indeed, with almost no penetration as yet and apparently massive barriers to international entry, as well as entrenched - and mostly profitable - flag carriers, the low-cost model may seem an unlikely spur to change. But, despite its limited market presence, the low-cost shadow is spreading across all industry thinking - and capturing the public imagination far ahead of any current operational impact.
The popular attention paid in Singapore, for example, to the operation by Malaysia's AirAsia from across the border is hardly justified by its initially limited service. Thai Airways is developing its own low-cost subsidiary, Singapore Airlines is evaluating the strategy and Qantas has recently announced it will commence a domestic subsidiary, complementing its international budget airline, Australian Airlines.
With liberalisation in the air and the intra-Asian market booming, all the pieces are set in place that will make the progression of the low-cost model inevitable in the region.
Majors now have perhaps a year, maybe two, before the trickle of private secondary airlines becomes a major flood. How long the breathing space lasts will depend on how long it takes aviation officials, increasingly impressed by the popular and political potential of the low-cost model, to adapt their national policy.Most majors are using this breathing space, so long as it lasts, to review and restructure their operations. And the most likely new low-cost entrants in the short term are likely to be subsidiaries of the majors.
The current reorganisation at the Qantas Airways group is a case in point. It will emerge with four separately managed airlines: the traditional full service operation; a regional; a low-cost international in the shape of Australian Airlines; and a new low-cost domestic contender due to commence service next May .Qantas had little option but to move quickly, as its domestic market share was fast evaporating in the face of Virgin Blue's aggressive low-cost push into _the Australian market. Following its arrival in 2000 this low-cost, low-fares competitor has made rapid and sizeable market share gains.
The Thai Airways low-cost subsidiary is also due to commence in the first half of 2004. It is primarily charged with stimulating domestic tourism, but it will quickly look to fly internationally. Singapore Airlines, too, is being provoked into action, in this case by AirAsia, just across the border in Malaysia.
But, for many others, the immediate pressure is not so strong, and here lies a risk. With this lack of pressure, there will be a great temptation to take the soft option of focusing on traditional areas of reform. Under this strategy, they would centre efforts on expansion through global alliances, maximising government support, controlling distribution and, perhaps, divesting non-core activities and other areas of cost-cutting.
And this approach is not without benefits: it can help make these airlines increasingly competitive in traditional markets, where market access and distribution standards prevail. It may in some cases even be the best option: it could prepare the carrier better to make the necessary transition at a later date, once the new market environment clarifies. However, it also carries several critical risks. Specifically:
relaxation of the international regulatory structure and national policy trends in this region have passed the point of no return. This makes it dangerous to rely on continuing and unquestioning government support; it is often no longer politically acceptable for most governments. As a result, more point-to-point route access, more fifth freedom operations and more new entry will be permitted; if the market does not grow rapidly, or if there are major setbacks, competitive pressures will mount. In such a situation, it is inevitable that the many government-owned airlines would fall back on traditional strategies of fierce discounting. Also, fleet expansion is a part of most airlines' strategy to accommodate the anticipated growth and maintain market share. Many of these new aircraft will join the competitive mix regardless of market conditions, adding capacity faster than traffic growth and driving down yields; delay in making major moves - merely chipping away at the edges - may both entrench old work practices and leave the airline in a weakened condition when major surgery becomes unavoidable; market fragmentation is already accelerating major changes in the distribution system, reducing many competitive advantage of the incumbents, leaving them especially vulnerable to competition from more efficient carriers.Unsustainable model
The precedents for establishing low-cost subsidiaries are of course not encouraging - although many US airlines are again moving in this direction. These carriers could all be pursuing a fatally flawed strategy, but there must be some reason why they are revisiting it: probably because they recognise the old model is unsustainable in head-to-head conflict.
A central concern with these subsidiaries remains the risk of cannibalising the mainline services. It is reminiscent of the man who was trapped alone in the wild last year, his arm pinned beneath a fallen rock. He had two options: to remain there and hope to be rescued, the odds of which were long; or to cut off his own arm and escape. In the end, he cut it off and lived.
The risk of 'self-cannibalisation', of gnawing the airline's metaphorical arm off to survive, may actually be lower in the long term, even though it seems potentially life-threatening now. That is, it may be a safer strategy than taking a chance and waiting for the end.
Taking this approach involves a careful analysis of the effects such a move will have on many facets: managing share-market behaviour, or at least debt ratings will be an important part of this process. Most investors still have little feel for the complexities which make up the Asia-Pacific aviation market, consequently making this appear a relatively higher risk option than even the reality might suggest.
So an integral part of the process must under any circumstance involve careful preparation of the investment community, sharing with them the full reasoning behind adoption of the strategy - whether it is to take the subsidiary option or to wait. If the wait option proves to be wrong, those same investors who resisted the subsidiary approach may be the first to complain when the rock is still holding the company down.
In any event, it is clear that liberalisation's time has arrived for the Asia-Pacific region. It is unlikely now that there will now be any turning back. Airline 'restructuring' which relies on cost reduction alone will no longer be forgiven by a paternalistic government. A risk now may mean long-term survival.
BY PETER HARBISON AT THE CENTRE FOR ASIA PACIFIC AVIATION IN SYDNEY.
About the author
Peter Harbison is managing director of the Centre for Asia Pacific Aviation, which he founded in 1990. Harbison has over 25 years experience in aviation. His consulting background includes privatisation studies and project management, passenger and freight supply chain analysis, regulatory review feasibility policy and strategy studies.
Harbison perviously worked in the Australian Department of Aviation, ICAO and IATA. He currently chairs a regulatory reform group for IATA.
Source: Airline Business
