South Africa's existing low-cost carriers are incensed at the arrival of South African Airways' new subsidiary Mango. But is there room for all in the country's vibrant market?
The launch of new low-cost carriers combined with a buoyant local economy has created a recipe for unprecedented expansion in South Africa. The domestic market, which consisted of fewer than 7 million passengers in 2001, approached 12 million passengers in 2006. The market has grown 50% over the last three years alone and double-digit annual growth is expected to continue through at least 2010.
Low-cost carriers now account for a quarter of South Africa's domestic traffic and have seen their share steadily grow since the August 2001 launch of the country's first low-cost operator, Kulula, which in 2006 carried about 1.8 million passengers. In February 2004 1Time Airline became the second low-cost carrier. In 2006 it carried about 1.2 million passengers. In November 2006 South Africa got yet another low-cost player in Mango, a new subsidiary of South African Airways (SAA).
Mango's launch has been the most aggressive and, in terms of seat capacity, it has already has overtaken 1Time and matched Kulula (see chart next page). But 1Time and Kulula are not sitting still. Both are matching Mango's fares, adding capacity and are attacking Mango's ties to government-owned SAA.
"In this country we already have two state-subsidised carriers, SAA and South African Express Airways, both of which are unprofitable," says Kulula co-chief executive Gidon Novick.
Private competition
Adds 1Time chief executive Glenn Orsmond: "Our main issue is Mango is 100% owned by SAA and SAA is insolvent." Orsmond says the R100 million ($13 million) SAA is loaning Mango is essentially coming directly from the government because SAA does not have the spare cash to fund it. "The government is competing with the private sector. If they do it in the airline business why not do it in retail, car rental or other sectors? It's a bad principle."
Despite the complaints, South Africa's competition authorities approved the creation of Mango as long as it operates independently and has a separate management team.
"The airline is a wholly owned subsidiary of SAA, but operated at arm's length," says SAA chief executive Khaya Ngqula. "It will be flexible and able to move around quicker than we can."
But Orsmond claims Mango is not operating at arm's length because it is using SAA aircraft, money and crews. Mango is leasing its first four Boeing 737-800s from SAA but has hired its own crews, some of which formerly worked for SAA. Mango chief executive Nico Bezuidenhout says the leases are at market rates and the R100 million loan will be repaid over the next few years at commercial terms. But his competitors point out SAA leased the aircraft at rates that are well above the market average and SAA is covering the difference.
"It's meant to be at arm's length, but it is not," says Orsmond. "The whole thing is a big joke. It's like playing rugby against Australia with an Australian referee. You don't have a chance." A frustrated Novick adds: "The government are the investors, not an independent entity. They have control."
SAA's competitors have always had a close eye on the activities of the flag carrier. In 2005, a tribunal ruled SAA abused its dominant position by offering incentives to travel agents, causing traffic to divert and injuring full-service domestic operator Nationwide Airlines. Kulula parent Comair has since filed a similar complaint and Novick says it will closely monitor Mango and will make a formal complaint should it engage in any anti-competitive practice such as predatory pricing.
But SAA and Mango directors claim the new carrier is clean and competitors should instead focus on the market, which is growing fast enough to accommodate all the players. SAA chairman Jakes Gerwel says South African competition authorities advised SAA's board as its low-cost project was studied "to make sure nobody points a finger at us and says we're anti-competitive". Mango chairman Christo Wiese says all groups were given ample to time to voice their concerns and these all have been addressed.
Wiese says Mango is about creating a new market rather than cannibalising an existing one. According to Mango, less than 5% of South Africans are now air travellers and only 15% of urban residents have travelled in an aircraft in the last 12 months.
"Mango will open doors of safe and affordable travel for all South Africans, making air travel accessible for those who have never flown before, offering for the first time a real choice between the different modes of transportation, one of the backbones of our economy," says Wiese.
Adds Gerwel: "This airline is about taking air travel to the people."
SAA claims Kulula and 1Time have targeted SAA's passengers, persuading them through lower fares to switch allegiance and fly more frequently, rather than attracting first-time fliers. Mango is targeting poorer communities that do not have internet access and now travel by bus. New distribution channels include selling tickets at convenience stores. "Mango will be a true low-cost carrier in every sense of the word, a transparent, independent operation that will provide air travel opportunities to those South Africans who never flown previously," says Bezuidenhout.
But Kulula and 1Time say their growth has been generated by a mix of new fliers and existing fliers travelling more frequently. "There's been big growth since we introduced low fares five and a half years ago," says Novick, claiming Kulula's 50% reduction in fares created a new market.
Mango believes it can further reduce fares, allowing it to reach more of the population, because it has lower costs than its competitors. Bezuidenhout claims Mango has higher aircraft utilisation, higher seat density and a more fuel-efficient fleet than its competitors.
But Orsmond responds: "We don't see that. We've run their business model, so has Comair. If Mango sells our fare they'll lose R100 million per year."
He says Mango's plan for 12.5 hours daily utilisation per aircraft is not achievable given the congestion at its Johannesburg hub. He acknowledges Mango's 186-seat 737-800s are more fuel efficient and have more capacity than 1Time's 157-seat Boeing MD-82s, partly because the seat pitch is 3in (7.56cm) shorter, but this is more than offset by 1Time's lower lease costs. He claims Mango is paying about eight times more for its aircraft. In fact, Orsmond led a group of former Comair managers in creating 1Time because they saw an opportunity to undercut other domestic carriers in the aftermath of September 2001, when aircraft acquisition costs plummeted.
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"Mango will be a true low-cost carrier in every sense of the word" Nico Bezuidenhout, chief executive, Mango |
Novick says Kulula has studied the cost structures of low-cost carriers around the world and it ranks as one of the lowest, behind only AirAsia and Ryanair. "It's a load of rubbish," he says of Mango's claim that its costs are lower. "We've been operating for five and a half years as a low-cost operator. We've been looking at ways to lower costs since our launch. Mango is basically just an extension of SAA. If it's an extension of SAA you can bet your bottom dollar the cost structure isn't low."
Strong financial base
Comair estimates Mango is now losing R3 million a week. At that rate, Mango would run out of cash in less than a year and both 1Time and Kulula claim they will vehemently object if the government provides a second loan.
If the government does not intervene, 1Time and Kulula are confident they can outlast Mango because they have sound financials. 1Time, which is mainly owned by its executive team, turned an estimated R20 million profit in 2006. Comair, which operates Kulula as well as a local British Airways franchise, turned a R99 million pre-tax profit for the year ending 30 June 2006 on the heels of 15% revenue growth to R1.97 billion. Comair is 15% owned by BA and is traded publicly.
"We're a very strong business," says Novick, adding half of Comair's business still comes from its BA franchise. He adds domestic yields may plummet but "we'll manage it".
Orsmond says "survival depends on who has the lowest cost. If the government doesn't interfere we'll be the survivor because we've got lower costs."
But Mango says Comair's R3 million loss per week estimate is "fiction and, of course our competitors would never be privy to our internal business process.
"Our load factors are between 75-80%, a number we are most comfortable with. Our competitors seem to recycle the same two or three arguments every week and it's becoming rather tired. It would be most productive if all our competitors choose to focus on their business as opposed to their apparent obsession with Mango."
The only thing the three low-cost carriers seem to agree on is double-digit growth in South Africa's domestic market will continue.
Projected growth
Bezuidenhout expects 10-15% annual growth will continue at least until 2010, when South Africa hosts the FIFA World Cup. Orsmond says 5% GDP growth should continue and air traffic will grow at double GDP or even higher if fuel prices drop. Novick expects Comair will grow in the coming years at 8-10% annually, although this is down from the 15-20% annual growth it has enjoyed in recent years.
| "Survival depends on who has the lowest cost. If the government doesn't interfere we'll be the survivor because we've got lower costs" Glenn Orsmond, chief executive, 1Time. |  |
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The growth seems to be fast enough to support all three carriers, but whether they may kill each other through fare wars is another question.
Kulula and 1Time are both matching Mango's fares and say they will not let Mango undercut them even though some of the fares are unsustainable. Novick says the cost of flying one passenger between Johannesburg and Cape Town is R400 and the average fare including taxes must be at least R600 to break even. Novick says Mango's fares, which start below R200, could lead to a "blood bath". He adds: "Without any doubt when you get the taxpayer funding a new airline it can be very destructive to the market."
But Orsmond says: "It shouldn't be a blood bath if the market grows at 10%". He points out Mango only controls 7-8% of the market so that still leaves room for growth by other carriers. He predicts Mango will not take business away from Kulula or 1Time, although their growth will likely slow a bit, and will more likely take business away from the full-service carriers. "Mango will just take away market from the premium carriers - Nationwide, SAA and Comair," says Orsmond.
But Novick points out Comair's BA franchise has been growing for the past five years, although not as fast as Kulula, and will continue to grow because South Africa's corporate market is booming. Comair's BA business also has benefited from a growth in tourists to South Africa and additional short-haul international routes.
Nationwide also expects its business to grow, although financial director Peter Griffiths concedes its market share may drop a bit. Nationwide is not matching Mango's fares and relies heavily on overseas connecting passengers. About 40% of its revenues are already generated from overseas and this should increase through new codeshares with Air France and Delta Air Lines.
"From our point of view we're operating as we've done before. There has been no impact," says Griffiths. "We're not into low cost at all. We are a network airline and get a lot of our passengers from foreign carriers."
SAA's domestic business could be most affected by Mango's launch. Its share of South Africa's domestic market dropped immediately after Mango's launch and it now has a 30% share of the market, compared with 49% two years ago. This excludes South African Express Airways and SA Airlink, two regional carriers operating for SAA.
Ngqula says SAA needed to launch Mango to participate in the fast growth of the low-cost market as its own costs are too high to support a low-fare operation. SAA plans to continue its high-frequency domestic service, focusing on business and connecting passengers.
All the airlines agree the biggest obstacle to more double-digit growth is a lack of airport infrastructure. South Africa's three major airports desperately need upgrading and expanding. The Airports Company of South Africa (ACSA) has embarked on major expansion projects at Cape Town and Johannesburg and a new airport in Durban. But airlines say it is too little too late.
| "There's been big growth since we introduced low fares five and a half years ago" Gidon Novick, co-chief executive, Kulula |  |
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"They've been lagging growth by five years," says Orsmond. "That's what happens when it's government-owned." Ngqula agrees: "I think probably it's five years behind. I think we've all been overtaken by the way this economy has gone. In terms of services we've all been caught with our pants down. We have not planned for it."
ACSA chief executive Monhla Hlahla says South Africa is behind the growth curve because airlines "prefer to delay". She says three years ago SAA, when its business was losing money and traffic was stagnant, was unwilling to support any investment. "There's nothing you can build without industry consultation," she says.
New airport capacity
Domestic airlines are waiting for 2009, when a new combined domestic and international terminal will open in Cape Town with six domestic gates. In Durban, airlines will have to wait until at least 2010, when the new airport is set to open. The new airport - which some say will never open in time because construction has not yet begun - will initially be able to handle 7.5 million passengers compared with 4 million at the existing airport.
In Johannesburg, domestic airlines will also have to wait several years for relief because the current project involves the building a new international pier. ACSA says Johannesburg's domestic terminal, which only opened in 2002, does not need expanding because at peak hours it is operating only at 90% capacity. But queues can be long and most passengers are bussed to aircraft because there are only 11 gates.
"You can't operate a true low-cost airline from an inefficient airport," says Novick. He says Mango's plan to turn an aircraft round in 20 minutes at Johannesburg is a "physical impossibility".
Despite the infrastructure challenges and the bitter battle between private and government carriers, everyone's outlook for this highly dynamic market is as sunny as South Africa's weather. "It's a great country," concludes Orsmond. "We're optimistic about the country, about the growth. Everything will be sorted out eventually. It always is - that's the South African way."
To find out more on Mango, Kulula and 1Time read our web chief executive interviews with Bezuidenhout, Novick and Orsmond
Source: Airline Business
