Like the Andean condor, Chileans are a rare breed. Among Latin Americans the 14 million residents of this long, thin country are alone in seeking to impose a quid pro quo for open skies on Washington.
Consequently, if President Clinton had delayed his trip to Santiago beyond April he might have made it a more auspicious aviation event. In June, Continental will become the third US airline starting flights to Chile. And by then regulators may have approved LanChile's strategic alliance with American Airlines or Clinton might have been able to sign the first US open skies aviation bilateral with a South American country.
But then some of these events may never happen at all. What is certain is that Chile will reject US-styled open skies unless Washington approves LanChile's alliance with American Airlines and grants it antitrust immunity.
How Chile can demand that Washington concede antitrust immunity in exchange for open skies is really a story about how this country and its flag carrier have become such significant international players that few can afford to ignore them.
The story begins late in Augusto Pinochet' s military reign, when his regime became serious about restoring democracy and liberalising Chile's economy. The resulting market reforms have led to continual annual GDP growth since1984 and an impressive 6 per cent average growth per year for the last six years. Inflation is now below 5 per cent. In the meantime democracy has returned and employment is up. Over the past decade Chile's middle class has nearly doubled.
Chile is now an associate member of Mercosur, the multilateral trade group linking Argentina, Uruguay, Paraguay and Brazil, and regional and international trade has boomed. Exports and imports both stand at around US$15 billion a year. Last year Chile and Canada ratified a free trade pact while Clinton wants Chile to join the North American Free Trade Agreement.
Aviation has followed this pattern of reform and growth. Santiago deregulated domestic skies and opened international routes to competition in 1979. In the late 1980s it started privatising LanChile, selling the last government shares in 1994 and enabling the Cueto family to gain a controlling 38.7 per cent interest. LanChile then took control of Ladeco in which Iberia held a 38 per cent stake. Iberia challenged government approval but lost its last appeal and sold its stake last June. Since then LanChile has owned 99.4 per cent of its former rival.
Helped by the Ladeco purchase and the robust economy, LanChile has prospered. Its revenue in the past five years has grown at an average annual rate of 31 per cent and this year looks certain to break the billion dollar mark. Merrill Lynch describes LanChile as 'one of the most cost effective airlines in the world,' with a 'strong' operating margin of 7.2 per cent.
Chile's anti-monopolies commission required LanChile and Ladeco to continue operating separately, but this has not prevented the integration of management, maintenance, outstation ground handling and a host of back office functions. LanChile took over Ladeco's international network leaving Ladeco to operate domestically only. The carriers coordinate their domestic schedules but do not differentiate their service for leisure and business traffic. 'The Chilean market is not big enough to segregate that way,' says LanChile's CEO, Enrique Cueto.
LanChile dropped Ladeco's unprofitable routes to Central America, but has used others to its considerable advantage. 'We're strong believers in frequency,' says Kryl Acton, LanChile's senior vice president for planning and development. One of the airline's tenets is to add frequencies on proven routes rather than start new ones. By combining Ladeco's frequencies with its own LanChile has boosted capacity to match inbound competition in key markets like Santiago-Sao Paulo.
Overall, LanChile now carries 40 per cent of Chile's 3 million or so annual international passengers. That share varies from 73 per cent in the Mexico City-Santiago market to a low of 27 per cent on secondary routes into Bolivia. On thin or seasonal routes LanChile looks for codeshares, such as one it recently entered into with TAM on flights to Asuncion. LanChile operates an average 178 weekly international flights and international traffic accounts for 54 per cent of its passengers. By industry standards that is high.
Since absorbing Ladeco's cross-border operations, LanChile has built on that strength. The first step was to standardise its fleet. It now uses the Boeing 767-300ER for all longhaul routes, and plans to replace its 737-200 domestic fleet with A319/320s. The speed of replacement will depend on market conditions when the new aircraft start arriving in 2000. 'Our rate in retiring the old 737s will depend on how many aircraft we need at that time,' explains Cueto. LanChile has 20 A319/320s on order with options on another 20. 'Our fleet policy is based on flexibility,' stresses Cueto.
In January LanChile joined forces with TAM and the Taca group to negotiate an order for 100 A319/320s. Cueto recalls how he and Federico Bloch, an old friend and Taca's CEO, started talking about how they both needed the same type of aircraft. Their talks expanded to include TAM, which also sought the same aircraft type. The three of them saw advantages in ordering the same aircraft and concluded that they might gain similar prices to a big airline if they ordered jointly.
'We decided to negotiate as a group, not only to lower the price but to buy the same aircraft with the same specs,' Cueto recalls. 'We could go to Boeing and Airbus and say "We need to buy 100 jets with the same spares, engines, simulators, and pilot training."That way if TAM, for instance, had a problem in Brazil, we could trade delivery positions.'
None of the three carriers offered to guarantee the others' orders. Each reserved the right to adjust its own order and negotiate its final terms. Yet, 'the manufacturers understood from the relationship between the three of us that this was not just talk,' Cueto explains. 'They knew our decision would go one way or the other as a group.'
In the meantime LanChile had made the joint decision to abandon its sole reliance on operating leases and launch a public offering to raise some of the capital needed to buy aircraft. The five 767s arriving this year and next will be the first owned aircraft in LanChile's fleet. The company plans to keep a balance between leased and owned aircraft, with the mix depending on market conditions. As Acton stresses: 'We will look at the economics of each deal. We are not speculators in aircraft residual values.'
While last November's IPO did not go as well as LanChile had hoped, mostly due to investor fears over the spread of Asia's malaise, several related goals were achieved. The company changed its mix of primary and secondary offerings at the last minute -- a switch that put less cash in the Cueto family's pockets. 'We didn't need the money so we decided to expand the primary offering and reduce the sale of family shares,' says Cueto. The Cueto family and the other three families who control LanChile had planned to sell 25.4 million of their own shares for $120 million, but finally sold only 12.5 million shares for $50 million. The company still raised the $120 million it needed by boosting its primary offering.
With 15 per cent of LanChile's shares now in the market, the family remains firmly in control. 'We'd like to increase the liquidity of ownership,' says Cueto, but adds that another offering will not come soon.
Analysts generally blame the poorer than hoped IPO result, as well as a slide in share prices since then, on investor fears about Asia and falling copper prices. But LanChile's management is quick to add that the carrier was the first Latin airline to list on the New York Stock Exchange. 'A lot of these other Latin carriers aren't in financial condition to allow a public offering,' claims Acton.
Cueto stresses the difference between a public offering and the private placements several other Latin carriers, including AeroPeru, have opted for. 'A public offer leaves us free to compete. A private offer brings restrictions. It is very important that our decision flexibility continues. That was the problem when we first proposed to buy Iberia's shares in Ladeco. Iberia wanted a veto. We are not going to give a veto to any shareholder of this company.'
LanChile may boast about freedom of decision-making, but the airline still faces several challenges. At home, the combined market share of LanChile-Ladeco has slid in the past 18 months from 82 to 75 per cent. National's takeover by Avant Airlines makes a further decline in LanChile-Ladeco's position likely. But LanChile's Acton sees a brighter side: 'We prefer strong competitors over weak ones who are always looking for cash.'
LanChile flies from Santiago to 15 cities within Latin America and operates to three US cities, Madrid and Frankfurt in Europe and Ester Island and Tahiti in the Pacific. But Chile's bilaterals with its neighbours restrict the regional growth both Cueto and Acton believe LanChile needs. They would like to expand LanChile's Sao Paulo gateway to Europe, but Brazil limits frequencies and fifth freedoms. And Venezuela still restricts Santiago-Caracas to two weekly flights. Cueto shakes his head and complains, 'that's incredible.'
'Chile's government is a strong proponent of deregulation and LanChile supports efforts by Mercosur and the Andean Pact to open trade because trade generates traffic. But we are light years away from a common market in air transport,' adds Acton.
However LanChile has made progress in expanding its Lima hub for north-south traffic. Peru's new transport minister, Antonio Paucar Carbajal, recently allowed LanChile to start operating two of the three Lima-US routes, to New York and Los Angeles, gained under a bilateral revision last November. Only the important Lima-Miami route is still on hold. 'The nub of it is that AeroPeru wants less competition,' Acton complains. Still, he and Cueto predict Peru will eventually relent and allow LanChile the Lima-Miami route, perhaps starting on a staged basis. LanChile serves all three US cities from Santiago.
Elsewhere, Germany still restricts LanChile's fifth freedom rights from Frankfurt. LanChile flies daily via Sao Paulo to Madrid, but can continue to Frankfurt only five times a week. Morgan Stanley Dean Witter analyst Kevin Murphy warns: 'On LanChile's European routes, which just became profitable last year, additional frequencies are needed to boost returns.' Acton agrees. 'These quotas are deeply anticompetitive. Lufthansa is big enough to look after itself.'
LanChile's biggest challenge comes from the market that provides over half its revenue - North America and especially the US. With so much at stake it is vital for LanChile to get its strategy right. At present it controls 49 per cent of the US-Chile market, but Continental was set to challenge that in June by starting daily nonstops from Newark and becoming the third US carrier serving Chile after American and United.
Every US airline that flies or wants to fly to Santiago has approached LanChile about an alliance. Cueto observes: 'We are seen as attractive.' Last September LanChile agreed to a strategic alliance with American Airlines covering reciprocal codesharing, frequent flyer programmes and the coordination of pricing and schedules. In a joint application to the US DOT, LanChile and American have requested approval and immunity from US antitrust laws. Similar approvals will be needed from Santiago.
US and Chilean negotiators initialled a new open skies bilateral last October, but Chile made its acceptance contingent on US approval of the LanChile-American alliance, including antitrust immunity. However, as a matter of policy Washington will not give antitrust immunity to gain open skies, even though open skies are a precondition for immunity. But Chile will not give open skies without that immunity.
Acton explains LanChile's position, which he claims is identical to Santiago's: 'The US-Chile bilateral is relatively balanced but limited. We're moving towards open skies. But so long as the US domestic market is closed, there will never be equality of access. The US is not about to change that. Chile's position is equivalent to that of all European governments. Acceptable alliance approvals are required to ensure equality of opportunity. We will require those approvals in exchange for open skies.'
On the specific question of antitrust immunity, Acton explains: 'If we are to compete with strong carriers who work with alliance partners, such as the Star alliance or KLM-Northwest-Continental, we require the same [immunity]. We are competing with airlines that are multiples of our size.'
It is unclear how DOT can untangle this regulatory snarl and assess the merits of antitrust immunity before Chile accepts open skies. If it were just a sequencing problem, creative lawyers might find a solution. But DOT will find it hard to explain any decision on immunity without compromising its policy of refusing to grant immunity to gain open skies.
Meanwhile Continental is likely to form an alliance with National/Avant Airlines and both United and Continental will continue railing against the LanChile-American deal as anticompetitive. The question is to what extent these issues can be considered separately. As LanChile's Acton says: 'This could be the first open skies deal between the US and South America. This is something like the Dutch agreement. It could be the start of genuine deregulation.'
Source: Airline Business
