Strong prospects across Asia-Pacific's increasingly interdependent economies, and led by the continued rise of China, are helping fuel volume growth for the region's airlines, but pressures remain on costs
Airlines from the Asia-Pacific region have always considered themselves different. But rarely has this conviction been as much the cause for celebration as it is today. While the industry logs record losses elsewhere in the world, in Asia-Pacific the profits and volumes have kept on flowing.
Even for the fiscal year 2001/2, which included the worst six months in the history of civil aviation, the carriers of the Asia-Pacific Airline Association (AAPA) recorded a highly respectable 4.1% operating margin on international service. AAPA head Richard Stirland summed up the mood at the recent annual meeting of airline presidents in the Philippines when he observed that "gloom and doom is not universal throughout the world".
Among the biggest keys to the success has been burgeoning traffic on flights within the region. Historically, Asia-Pacific carriers have lived and died with the performance of their long-haul services to North America and Europe, but the industry appears to have entered a new era.
A key reason behind this evolution is the growth in output and sophistication of the region's economies, which less and less look to the West for capital - financial or human. This is feeding a growing sense of interdependence that as much as anything is fuelling the movement by air of people within the continent. "Asia now has its own dynamic," Stirland notes.
Chief among the factors responsible for the rapid growth of the intra-regional market is the relative youth and strong performance of the South-East Asian economies, and above all that of China.
Managing director of the Sydney-based consultancy Centre for Asia Pacific Aviation Peter Harbison says that "the economic evolutionary cycle is about 20 years behind here". With Asia therefore still in growth mode, he adds, the number of people travelling in the region will continue to multiply.
Boding even better for Asia's airlines, Harbison contends, are prospects for heightened levels of lucrative premium-class traffic. "A lot of the growth will be created by the burgeoning class of new-rich. There is a massive and growing number of people who will want to travel in the front of the aeroplane and be looked after."
The China factor
Key to the region's prospects for sustained robust growth is the continued emergence of China. Thus far, it shows no sign of disappointing. One participant in the regional sector explains: "The engine of growth that is China is filtering down to the rest of Asia and its airlines. You look at the carriers operating into China and even in the downtime their services didn't even have a blip. And these effects are beginning to spin off around the edges."
The importance of the Chinese tide to lift all boats is illustrated by the fact that forecasters believe services connecting North-East Asia with the rest of the region - among the few weak points in the intra-regional picture - will thrive.
JP Morgan regional aviation analyst Peter Negline is among the voices that are bullish on air traffic between the two, largely owing to the anticipated flow of people and goods between China's industrial cities in the northeast of the country, and Korea, Japan and Taiwan. Harbison agrees, noting that recent business travel and air freight patterns reveal China already beginning to supplant historically dominant services to the USA.
And the benefit of China's growing economic power is not limited to business traffic in the north, as countries to the south will tap into the massive tourism potential of the world's largest country. Robert Martin, managing director of Singapore Aircraft Leasing Enterprise (SALE) expects the expanding individual affluence of large numbers of Chinese to produce a leisure traffic windfall for South-East Asia's carriers.
Harbison adds that by 2020, 100 million tourists will venture forth from China - many of them staying within the region - and a further 250 million will visit the country. He further believes China, which is already experiencing a large increase in business thanks to its accession to the World Trade Organisation, will be a huge positive factor for the regional airline industry.
The manner in which the country's government has presided over the Chinese airline sector, however, has raised questions internationally. For example, the centrally mandated consolidation of the 10 major airlines under the control of the civil aviation administration into groups controlled by Air China, China Eastern and China Southern Airlines is being conducted in a manner not necessarily consistent with standard Western business practices.
Jim Eckes, managing director of Hong Kong-based consultancy Indoswiss Aviation, states that China Southern, for instance, is being forced by the state to absorb loss-making airlines in total, rather than selecting the assets and routes it deems worth having. This occurs, he says, even though it is surely not in the best interests of the shareholders of the carrier, which is traded on the New York Stock Exchange.
Harbison acknowledges that there are still inherent uncertainties in conducting business in China, not least its occasionally unpredictable politics. However, he argues that the potential benefits for other economies in the region are simply too great to ignore, regardless of any such dangers. "The biggest risk is that China does not become a big risk," he says.
Most agree and feel that WTO membership will help accelerate Chinese compliance with Western corporate practices. In any case, the rate of business flowing into China seems to indicate that investors believe the market's size compensates for its unpredictability.
The world's largest country is also making its force felt in another key component of the regional industry - cargo. Cathay Pacific Airways director for corporate development Tony Tyler, for instance, highlights its importance. "In a good year, cargo accounts for 30% of our revenue. For American Airlines, it's in the low single digits," he says.
Vibrant cargo
The Asia-Pacific region as a whole has the right conditions to sustain a vibrant air cargo industry. Its economy is heavily industrialised, while its geography - with long distances between cities, often separated by water and other physical boundaries - makes surface transportationproblematic. Another driver is the development of just-in-time manufacturing concepts, which demand fast delivery of components as they are needed on the production line. The region's strength in the production of high-tech equipment - lightweight but valuable - also plays in favour of fast air transport.
Such factors conspire to make Asia the biggest player on the world cargo scene. Tom Crabtree, Asia region director for Boeing's cargo analysis unit, says that 45% of the world's air cargo moves to, from or within Asia, a figure that is constantly increasing. In its long-range 20-year forecasts Boeing estimates that by 2021 around 55% of world airfreight will pass through Asia.
Here too Chinawill play a key role as it takes on the mantle of workshop to the world. Crabtree points to China as a main driver behind forecasts of 8.4% average annual growth over the next two decades - the highest growth rate in the world. He further predicts that almost 10% of global airfreight tonnage will be carried within China by 2021, more than double today's figure.
Not only is cargo responsible for over 20% of the region's international revenue, it also serves several other less-understood, but important functions. Cathay's Tyler explains, for instance, that because cargo traffic patterns move in a different cycle than those for passenger traffic, an airline's profitability is considerably more even than it would be if it relied strictly on passenger business.
More importantly, analysis of cargo trends serves as a leading indicator for future developments on the passenger side of the business - a useful tool for fleet and network planners. Tyler says that signals transmitted by freight activity played a role in Cathay's decision in early 2002 to reactivate five passenger aircraft it had parked after 11 September.
Having a firm grasp of revenue trends has never been more important, as the industry's business model enters new territory. The Asian financial crisis of 1997/8 caused some structural market shifts which are still at play today, despite the industry's relative health. Before the crisis, carrier earnings were driven in large part by high yields. While yields have recovered, they are still more than 13% lower than their pre-crisis levels. Now, Negline says, earnings are being volume driven, so much so that carriers are, unusually, making good profits in the back of the aircraft.
Carriers are reacting to the changing climate accordingly. Philippine Airlines, for example, reconfigured its eight Airbus A330s by taking capacity out of its premium classes to add 24 economy class seats. That added a total of 192 new seats to its intra-regional fleet. Chief financial officer Andrew Huang explains the decision, saying that, "our yields are not high, but we've got a lot of people sitting at the back of the bus".
Maintaining these volumes is critical, as nobody seems to believe that yields will rise over the long term. Negline says that high volumes can compensate for lower average fares, but should traffic levels fall - such as could well happen in the event of a regional economic downturn - the eroded yields will cause considerable pain. Conversely, he adds that the current positive revenue performance is being generated against the backdrop of a weak global economy, and when this improves there should be a healthy boost to premium-class volumes as corporations relax today's restrictive travel policies.
Given this reliance on volumes, keeping expenditures in check has become critical. Tyler at Cathay says: "The long-term trend for yields is definitely going down, therefore it is imperative to keep costs moving in the same direction." The results thus far have been positive, something many attribute to the experience of the financial crisis, when cost-cutting skills were fast learned.
Now as then, some of the cuts have represented, in Tyler's words, "low-hanging fruit", of which he insists plenty remains. In future, however, managers will find much of the cost-reduction "fruit" higher on the tree and will need more ingenuity to pick it.
Some of these trimming efforts will revolve less around strict costs and more on work-rule changes, which enable carriers to better utilise their equipment and employees. Tyler reports progress on both fronts, claiming that Cathay is "getting more for less".
AAPA's Stirland agrees, stating that management capability is a major reason behind 2002's surprising performance. He notes that several carriers, including Cathay, increased their profitability even as revenues fell.
Low-cost opportunity?
The issue of costs is very much at the fore, as the industry debates whether there is scope for genuine participation by low-cost airlines in Asia. Opinions on the matter vary widely, with some believing it simply is not feasible and others thinking it is imminent.
Stirland puts himself firmly in the camp of those sceptical of low-cost opportunities in the region. "None of the conditions inherent in what they do and how they do it are present in Asia." He cites in particular that in both the USA and Europe, the low-fare players all have the luxury of operating in a single market with few constraints on which cities they serve and how often they do so. That is in dramatic contrast with Asia's strictly regulated, bilateral intensive regulatory environment.
He adds that the narrowbody workhorses that have proved so successful for budget carriers in the West would be unable to connect many of the biggest markets in Asia, which are further away from one another and over water. The AAPA head also notes that the secondary airports, which have proved so critical to low-fare success elsewhere, simply do not exist in sufficient mass in Asia.
Stirland is not alone. Tyler argues that the unit costs and revenues of Asia's widebody-intensive carriers are already lower than those of their Western counterparts. "You'd have a pretty tough job coming in under our yields on the intra-Asian routes," he warns.
Others feel that there will be some incursion by low-fare competition, but that it will mostly be on domestic routes. Martin at SALE believes that countries with large internal markets will be the first to experience meaningful low-cost service, pointing to China, India and Indonesia as candidates.
Negline believes that there could well be some low-fare emergence, which will win a lot of headlines, but that it will be a relatively minor phenomenon. He says low-cost carriers will realise the dangers of competing directly with the major airlines on trunk routes, and consequently will limit themselves to serving secondary markets, as Air Asia is doing at Johor Bahru in Malaysia.
On the other side of the argument, consultant Harbison says that regional low-cost service is likely to emerge soon, citing two reasons why Asia-Pacific governments will change tack and allow it: the growing importance of tourism to the national economies, and hub airport under-capacity.
He predicts, for example, that Hong Kong's new airport will reach capacity in 2006, Kuala Lumpur's only three years after that and 11 other regional airports will be similarly saturated by 2010. Together, he says, these facts will compel the region's governments to rewrite their restrictive aviation rules.
Harbison says there are 427 under-utilised airports in the region capable of handling a Boeing 737 or Airbus A320, 100 of which serve cities with populations of between 500,000 and one million. He believes the combined pressures of hunger for more tourists and the inability of the main airports to process them, will usher in a period of "soft liberalisation".
By allowing increased international flights from these facilities, he says, governments can increase visitor throughput without subjecting flag carriers to politically unpopular competition. This is already happening in small degrees, such as on Bangkok Air's service from Chiang Mai, Thailand to Xian in China
Harbison concedes that there are no certainties when it comes to predicting the shape of future regulations, but he cannot imagine that the Asia-Pacific governments will not allow, or even encourage, this type of air access. "It's just so much in their economic interests," he says.
Source: Airline Business
