Low-cost carriers expand reach through cross-border deals

Low-cost carriers are increasingly overcoming border restrictions and spreading their reach through offshore bases and cross-border joint ventures

A growing number of low-cost carriers, particularly in Southeast Asia, are entering into cross-border joint ventures as a way of expanding their operations and brands internationally. For European Union carriers, which can operate to anywhere from anywhere within the EU, borders hardly matter anymore. Beyond Europe, however, borders and the rules that go with them still restrict airlines to bases within their own countries unless they can find a foreign partner willing to help them create an offshore base. This involves more than ­interlining or codesharing it requires shared ownership, control, operations, and more.

One carrier that has been active in venturing into cross-border deals is AirAsia. The ­carrier's chief executive Tony Fernandes ­explains why: "We started airlines in Thailand and Indonesia because it was the only way for us to grow. We hope to become a pan-ASEAN airline with the most extensive point-to-point connections in southeast Asia, just as Ryanair has done in Europe. The difference is that Ryanair is allowed to base operations anywhere in Europe and we cannot do the same here. So we have to create these ventures."

Middle Eastern carrier Air Arabia has been following a similar strategy. The carrier's chief executive Adel Ali says: "Outside of the EU and America, there are so many borders and sovereignty rights that an airline does not have a free hand in setting up hubs." Entering cross-border joint venture opportunities is the only option, Ali adds.

"Outside of the EU and America an airline does not have a free hand in setting up hubs" Adel Ali Chief executive, Air Arabia

Australia's Qantas is no low-cost carrier, but it has a low-cost subsidiary (Jetstar), and took stakes in low-cost carriers in Singapore (Jetstar Asia) and Vietnam (Pacific Airlines). Qantas chief financial officer Peter Gregg, who plays a leading role in this effort, explains: "Qantas has 65% of the Australian domestic and 35% of the Australian international market," he says. "Competition authorities aren't going to allow us to get any bigger. From here, our growth in the Australian ­market is going to be organic. For us to grow, we certainly have to look offshore."

In the Asia-Pacific, Tiger Airways has also been setting up overseas joint ventures and subsidiaries because with a Singapore operators' certificate it could only grow within the restrictions of the bilaterals Singapore has with other Asian countries. "With Australia that has changed," says Tiger chief executive Tony Davis. "We have already set up 12 routes there in four months. It's a different regulatory market." Tiger Australia, which is wholly-owned by Tiger, launched late last year and Davis says it is already cash flow positive.

Tiger also plans to launch a joint venture carrier in the Philippines with Philippine ­regional carrier Seair, and a joint venture in South Korea with the Incheon metropolitan government. "In Asia, you can never have all your eggs in one basket," says Davis. "We've tried to have multiple opportunities in tandem. Those that become available first are ­implemented first."

The growth in long-haul, low-cost carriers contributes to cross-border ventures by encouraging long-haul airlines to form feeder hubs at the ends of their long routes. Spain's Air Comet was a pioneer with Air Comet Chile, which serves routes within Chile from the end of Air Comet's Madrid-Santiago route. As more low-cost carriers launch long-haul routes, this will likely become more widespread. So far, however, we see cross-border ventures mainly in regions where all the ­affiliated airlines operate within the range of narrowbody aircraft. Southeast Asia is ­becoming a hotbed for this phenomenon.

Another low-cost carrier in this region, ­Indonesia's Lion Air, is also looking to expand its reach beyond its home country by establishing joint venture carriers in other markets. Lion Air president director Rusdi Kirana says Australia and Thailand are high on its list of target countries, and Malaysia is also of interest. He adds that the carrier is still talking with potential partners and is not in any rush to firm up deals, as there is enough growth to be had in Indonesia in the near future.

"Indonesia is a huge market but we also know that we have to expand to other countries," says Rusdi. "We have to spread our wings to have the connections. We cannot put all the aircraft just in one place." He points out that despite reports that SkyAirWorld is Lion's chosen partner in Australia, no firm deal has been done. While he acknowledges that Lion is most interested in partnering with SkyAirWorld, Rusdi says that when it comes to choice of partner in a given market, "it could be anybody, as long as we can fulfil the ownership regulations in that country".

Delivering Benefits

Many agree that cross-border ventures deliver far more than commercial alliances. Even if interlining and codeshares could match the benefits of joint ventures, most low-cost carriers are also wary of them because of the extra costs they add. The bigger point is that commercial alliances simply do not deliver what most airlines want in a cross-border arrangement. Even if the bilaterals allowed it - and often they do not - AirAsia, for instance, could not benefit from a codeshare with Garuda on flights within Indonesia to the same extent that it can with its own Indonesia ­AirAsia. "We want to own the operation, not just receive or pay money to another airline," says AirAsia's Fernandes. "We are trying to integrate our operations throughout the region into a single network."

"For us to grow, we certainly have to look offshore" Peter Gregg Chief financial officer, Qantas

Gregg of Qantas elaborates: "From our perspective going into Singapore and Vietnam was a question of how to enlarge our strategic footprint, and how to build traffic feed within Asia to satisfy our growth needs as a long-haul carrier and as a tourism operator into and out of Australia. Commercial relationships don't deliver these kinds of strategic benefits."

Gregg cites two advantages of cross-border equity ventures over commercial alliances. The first is that alliances may face closer scrutiny from competition officials than an equity-based venture. A parent airline and its subsidiary can agree on fares and capacity without antitrust concerns because they are regarded as one company. A single company that misuses its dominance can still run into competition problems, but not for agreeing with itself on prices.

Conversely, when separate airlines agree on prices, they are headed for certain trouble. The cross-border joint venture falls somewhere in between. As Gregg explains: "Australia would see the level of our investment in Jetstar Asia as more like a subsidiary - ­basically one company." But, he warns that "every country's competition laws look at it slightly differently".

Gregg's second point is that commercial ­alliances sometimes simply are not an option. If the foreign airline lacks the resources, there will be no alliance. "If we only worked on a commercial basis, Jetstar Asia would never have started, and Pacific Airlines may not have got going," he says. "Pacific had basically failed as Vietnam's second airline. The government restructured it, we came in and we're helping them rebuild the airline." In April ­Pacific was rebranded Jetstar Pacific.

In short, equity ventures may be the only way to launch a cross-border operation ­because the local partner may be a small ­domestic operator which lacks the capital to do much on its own. In acquiring a local stake, veterans of these ventures also warn about the importance of appearances: do not be seen as the big foreign takeover specialist, but as the white knight riding to the rescue of a shaky local company.

This raises the question of how to pick a partner. By far, local airlines are the most common partners, and they offer distinct ­advantages. They may already hold the necessary air operators' certificate and they may enjoy some level of credibility with local ­authorities. They know the laws and local sensibilities, so they can ease an outsider's entry into the market. But a local airline also has its own methods and culture. As ­Fernandes warns: "If you buy another airline, you're inheriting all their culture and all their issues. I'm very much an organic growth sort of person." Having broken his own rule, Fernandes can also speak from experience: "It's a lot easier to form your own airline and instill your own culture, rather than try to change or merge the culture of another company with your own."

Even when the local partner is an airline, cultural clashes may be avoided, as in Air Arabia's venture with Nepal's Yeti Airlines, if the local carrier sticks to what it was doing before and leaves operation of the new carrier to its foreign partner. Besides airlines, other potential partners could be shipping companies (AirAsia's planned Vietnam venture), cities (Tiger's planned Korean venture), and national governments (Virgin Blue's venture in Samoa).

Typically, the out-of-country investor in any cross-border venture is limited to a minority stake. Atypically, Australia and Chile allow 100% foreign-owned airlines into their domestic markets if they meet certain national interest tests. Several other countries turn a blind eye. Foreign ownership caps vary, and some countries add other requirements.

Understanding the rules is especially critical for ventures such as Air Arabia's FlyYeti.com and Qantas' Jetstar Asia, which rely exclusively on designation as an airline of their host country to operate international routes.

Nationality disputes, usually stirred up by rivals, are a major hazard of cross-border ventures. For example, Zoom UK had to weather questions over the dual Canadian and UK citizenship of its principal owner, while LAN faced nationality challenges in every place it based an affiliate airline in Latin America. Ownership is fairly easy to prove, but many nations also impose a requirement of local control, and, as the disputes between the US Department of Transportation and Virgin America revealed, lawyers can build careers on this issue. Complicating this further is the confusion between control and management. Regional Air Lines of Morocco is giving management rights to Air Arabia for a joint venture airline they plan to base in Morocco. Grants of management rights are fairly common, but can a minority foreign partner manage an airline without also controlling it?

Gregg thinks so. He says Qantas managed Jetstar Asia during its start-up and no officials in Singapore complained. "We have an agreement with the Vietnamese where we provide a number of services to Pacific Airlines, ­including reservations support, pricing and yield support. But the company is effectively run and controlled out of Vietnam," he says.

Ali insists on working only in those countries willing to accept foreign management control. Otherwise, he says, "we don't go in".

Structuring ownership

AirAsia's solution is to structure the ownership of each venture so that AirAsia's holding company owns 49%, its foreign partner owns 50%, and the venture airline's management owns the 1% balance. Both ownership and management are obviously local. Any ­challenge would have to show that the local managers were in fact puppets, or that the overseas partner wields an effective veto.

These interrelated questions of ownership, control and management could benefit from a great deal more clarity. The point for prospective cross-border venturers is that these can be complex questions and the answers can vary depending on where they are asked.

This is fundamental to all issues about cross-border ventures. Whether it be rights of establishment, competition rules, ownership, control, or designation for international flights, this is no place to operate on hunches. As Fernandes warns: "Incumbent airlines will do anything they can to try to block you, including an appeal to nationalism. You face political, legal and cultural issues wherever you go."

For example, AirAsia agreed last August to establish a carrier in Vietnam with a local partner but is still waiting for government approval. "I think Vietnam Airlines and Pacific will do everything to block us," Fernandes says.

Tiger's Philippine venture, established in 2006, also has not yet launched because it has failed to secure government approval in the face of strong opposition from other Philippine airlines. "We would still like it to happen," says Davis. "We're frustrated about it. Ultimately it's the tourism ministry and the people of the Philippines who are losing out." He adds that under Tiger's plans to establish a new low-cost carrier at Clark outside Manila, "the whole country would benefit. But ­ultimately it's up to the regulators to decide."

Davis is also lobbying the South Korean government to lift a new rule that will restrict Tiger Incheon Airways to only the domestic market in its first two years. The new rule was put in place shortly after Tiger agreed to set up the carrier, frustrating its launch plans. Tiger Incheon now aims to launch in early 2009.

Gregg warns that even the best-informed can face surprises: "The issues are specific to the country where you're trying to do it. You try to start with a full knowledge of them, but typically you find more as you go along."

For more on how airlines are bridging the divide between southeast Asia and Australia, see: flightglobal.com/integration

Source: Airline Business