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Japan's StarFlyer looks to expand its successful niche – but change is afoot

24-Jan-2013

Japanese aviation is dominated by All Nippon Airways and Japan Airlines, who account for nearly 75% of capacity in the world's fourth largest domestic market. A number of carriers divide the rest, and while they may be small, they are looking to grow domestically, branch out internationally and be innovative to set themselves apart from the ANA and JAL behemoths.

StarFlyer is one of those carriers, and has had profits to support its strategic positioning. It is now slightly accelerating aircraft deliveries to grow domestically – it was the second-largest recipient of newly released slots at prized Haneda airport – and is looking cautiously at the international market.

But mighty change is afoot in Japan, and as LCCs offer seats at prices never before seen and incumbents like Skymark flex their muscles, StarFlyer will see tests of its model of boutique flights that come at a yield premium to the LCCs but priced lower than ANA or JAL. There is comfort in obscurity, with ANA codesharing and taking an equity stake in publicly-listed StarFlyer.

But there are many chapters still to be written in Japanese aviation.

Seven year-old StarFlyer overshadowed by one-year old LCCs

StarFlyer was established in Dec-2002 but did not launch operations until 16-Mar-2006. Shinichi Yonehara is the carrier's second president and CEO and joined in 2009.

While StarFlyer has grown and built up market share (based on ASKs) from about 1% in 2007 to 1.5% in 2012, it is being supplanted by fast-growing LCCs.

Japan domestic ASKs by carrier: 21-Jan-2013 to 27-Jan-2013

For the week commencing 21-Jan-2013, barely six-month old Jetstar Japan is about 40% larger than StarFlyer. Peach, launched in Mar-2012, is approximately the same size. StarFlyer took seven years to achieve its growth; LCCs are doing that in seven months. Profitability and sustainability are different stories: the LCCs are young and not expected to be immediately profitable. StarFlyer has a respected and established brand and reputation while the LCCs are still experiencing expected teething situations as the Japanese market largely discovers for the first time what a no-frills operation entails. StarFlyer has also had bouts of profitability, some better than others.

This trend in size will continue as StarFlyer steadily expands by one or two aircraft a year while the LCCs induct easily double that amount. StarFlyer, however, does not position itself as a LCC and is not pursuing that high growth trajectory.

It is brains, not brawn for StarFlyer, whose model – by its own call – is like JetBlue: good service at affordable prices on trunk routes with good corporate traffic. The service component comes at a CASK tradeoff; StarFlyer's all-A320 fleet seats 150 with 34" pitch compared to the LCCs' 180 in 28" pitch; even ANA can have around 31" pitch in economy. StarFlyer's plush seats with footrests, power outlets and personal TVs – a novelty in the Japanese domestic market – add weight, further driving costs up. While meals are not served, the carrier serves coffee, chocolate and soup; competitors have only a light beverage service.

Cost reductions become a goal as LCCs bite and ANA slims

StarFlyer's CASK is around JPY11 (USD12 cents) and it hopes to lower this to JPY10.5 in 2014. ANA is undergoing a cost reduction exercise to bring its CASK down to JPY9.5 (USD11 cents) by 2014. While this CASK is lower than StarFlyer's, it is flattered by ANA's long-haul operations, which occur at a far lower CASK than its domestic operations; comparing the carriers route-by-route, StarFlyer will have an advantage.

For a larger view of the domestic Japanese market, and its potential for more efficient operations, ANA projects AirAsia Japan to have a CASK of JPY6 (USD7 cents) around 2014, which may be on the ambitious side. StarFlyer notes that the CASK of LCCs is based on 180 seats. If it configured its A320s with 180 seats, its CASK would fall and be more comparable. StarFlyer additionally reports its utilisation rate to be 9.6 hours, higher than incumbents. It plans to increase utilisation as its fleet grows and gain scale.

For now, the market is willing to give StarFlyer a yield premium on its thin network. StarFlyer has achieved ANA or JAL-like yields on a lower cost base.

Japanese carrier yield summary: three months ending 30-Sep-2012

  • Passenger yield per RPK: JPY18.3 (USD 23.3 cents), -1.6%;
    • Japan Airlines: JPY18.9 (USD 24.0 cents), -0.5%;
    • All Nippon Airways: JPY19.0 (USD 24.2 cents), -1.0%;
    • Japan TransOcean Air: JPY17.6 (USD 22.4 cents), +6.7%;
    • Skymark: JPY13.5 (USD 17.2 cents), -4.9%;
    • Air Do: JPY19.0 (USD 24.2 cents), -2.6%;
    • Solaseed: JPY14.5 (USD 18.4 cents), -11.0%;
    • StarFlyer: JPY17.9 (USD 22.8 cents), stable;
    • Peach: JPY9.7 (USD 12.3 cents);
    • Jetstar Japan: JPY7.9 (USD 10.1 cents);
    • AirAsia Japan: JPY8.0 (USD 10.2 cents);

Japanese carrier yield summary: three months ending 31-Mar-2012

  • Passenger yield per RPK: JPY16.7 (USD 21.11 cents), -4.6%;
    • Japan Airlines: JPY17.1 (USD 21.57 cents), -2.8%;
    • All Nippon Airways: JPY17.4 (USD 21.95 cents), -4.9%;
    • Japan TransOcean Air: JPY15.5 (USD 19.56 cents), -1.3%;
    • Skymark Airlines: JPY12.5 (USD 15.77 cents), -4.6%;
    • Air Do: JPY17.0 (USD 21.45 cents), stable;
    • Solaseed Air: JPY14.8 (USD 18.67 cents), +1.4%;
    • StarFlyer: JPY17.8 (USD 22.46 cents), -7.8%;
    • Peach Aviation: JPY8.2 (USD 10.35 cents);
    • Average sector length: 916 km, -0.2%.
    • Japan Airlines: 954, -0.3%;

StarFlyer knows it cannot compete head-on with LCCs. With a small network, that makes expansion challenging. StarFlyer's yield in the three months ending 30-Sep-2012 was twice that of the LCCs; it cannot use price as a stimulant for fast growth.

Until the Jul-2012 introduction of its first scheduled international flights – between Kitakyushu and South Korea's Busan – all services were to and from Tokyo Haneda, the convenient downtown airport whose highly prized slots were the genesis of StarFlyer. An expansion in late 2012 of an additional 25 daily domestic slots – a 6% increase – was heavily contested, with national media coverage and heavy lobbying. At the same time StarFlyer must identify growth markets and new markets; it is relying on greater access to Haneda, which will come, but only in waves and with no guaranteed outcome.

StarFlyer second-largest recipient of Haneda slots

StarFlyer emerged victorious in the late-2012 Haneda slot expansion, receiving the second-largest allocation of slots: five (ANA received eight; the other local heavyweight JAL only received three). But even with this expansion StarFlyer is still a minnow, having the smallest number of Haneda slots at 19 pairs a day. However, its gap with Japan's second-tier carriers is narrowing.

The allocation of slots is a complex process and subject to influence: carriers argued, successfully as it turned out, that JAL should receive fewer slots as a result of its bankruptcy and government support. Japanese regulators evaluate performance but are also careful not to over-strengthen bigger carriers like Skymark, the largest of the second-tier operators by far, in a bid to ensure a level playing field.

Smaller carriers receive disproportionally higher preference. But this can disadvantage bigger carriers who have earned their stripes. As the gap between small and large carriers narrow, future Haneda slot expansion may not favour the smaller challengers like StarFlyer.

Tokyo Haneda domestic slot expansion: Nov-2012

StarFlyer is based at Kitakyushu but all domestic flights are to and from Tokyo Haneda

StarFlyer inaugurated services on 16-Mar-2006, the same day the airport at its home in Kitakyushu officially opened. Kitakyushu is located in western Japan, 60km from Fukuoka. It is considered the 13th largest city in Japan and was a major industrial zone in Japan last century, which has carried over to this century with industries including steel still based in the city. Toto, Japan's famed bathroom fixture supplier, is based in the city as well. Automobiles are a heavy draw: Daihatsu, Nissan and Toyota all have major plants collectively turning out about 1.5 million vehicles a year. They are some of the industries that have been lured to Kitakyushu since the mid-2000s, cementing a relationship between expanded economic activity and the necessity of aviation for both a local airport and airline. The recent depreciation of the Japanese yen should calm fears Kitakyushu would lose any cost advantages.

StarFlyer received much encouragement from the local government, to say the least. Local officials were strongly encouraged to use StarFlyer out of Kitakyushu rather than other carriers or those at more distant Fukuoka. StarFlyer is the largest carrier at Kitakyushu.

With major companies having plants at Kitakyushu but corporate offices in Tokyo, there were natural traffic flows that StarFlyer was able to pick up; StarFlyer says 70% of Kitakyushu passengers are travelling on business, aided by its corporate travel programme and monthly invoicing. JAL competes with StarFlyer between Kitakyushu and Haneda while ANA has no services of its own, preferring instead to codeshare on StarFlyer. Haneda is the sole domestic destination from Kitakyushu, and until the Jul-2012 introduction of Kitakyushu-Busan services was the only passenger service (although others had come and gone, like South Korea's Jeju Air).

StarFlyer has a shuttle service to Tokyo Haneda, operating 12 daily services on its 150-seat A320s. It also has four daily Haneda-Osaka Kansai and five daily Haneda-Fukuoka services in addition to its two Kitakyushu-Busan services, a total of 23 daily flights – more than half between Kitakyushu and Haneda. As StarFlyer gained attraction in the corporate market for its Kitakyushu-Haneda shuttle, it was able to spread to the country's trunk routes of Osaka Kansai and Fukuoka, although not the largest route in the country, Tokyo-Sapporo.

StarFlyer's domestic route network is from cities in western Japan to Tokyo Haneda.

Top 20 domestic Japanese routes ranked on seat capacity: 21-Jan-2013 to 27-Jan-2013

Rank Origin Destination Total Seats
1 HND Tokyo Haneda Airport CTS Sapporo Chitose Airport 232,375
2 FUK Fukuoka Airport HND Tokyo Haneda Airport 190,158
3 ITM Osaka Itami Airport HND Tokyo Haneda Airport 119,993
4 HND Tokyo Haneda Airport OKA Okinawa Naha Airport 102,504
5 KOJ Kagoshima Airport HND Tokyo Haneda Airport 65,934
6 HND Tokyo Haneda Airport KMJ Kumamoto Airport 65,437
7 HND Tokyo Haneda Airport KKJ Kitakyushu Kokura Airport 56,994
8 KMI Miyazaki Airport HND Tokyo Haneda Airport 52,008
9 HND Tokyo Haneda Airport HIJ Hiroshima International Airport 51,640
10 KIX Osaka Kansai International Airport CTS Sapporo Chitose Airport 48,010
11 HND Tokyo Haneda Airport NGS Nagasaki Airport 44,048
12 FUK Fukuoka Airport OKA Okinawa Naha Airport 42,228
13 HND Tokyo Haneda Airport KMQ Komatsu Airport 41,926
14 MYJ Matsuyama Airport HND Tokyo Haneda Airport 40,985
15 OIT Oita Airport HND Tokyo Haneda Airport 39,996
16 KIX Osaka Kansai International Airport OKA Okinawa Naha Airport 38,796
17 TAK Takamatsu Airport HND Tokyo Haneda Airport 37,576
18 KIX Osaka Kansai International Airport HND Tokyo Haneda Airport 35,935
19 OKA Okinawa Naha Airport ISG Ishigaki Airport 34,100

StarFlyer's leading utilisation rate is helped as offshore Kitakyushu is one of Japan's few 24-hour airports (others are Nagoya, Osaka Kansai, Sapporo and Tokyo Haneda, while Naha in Okinawa faces some restrictions due to the US military presence there). StarFlyer has flights arriving into Kitakyushu at 23:45 and 00:45 as well as departing Kitakyushu at 05:30. The opportunity to maximise time in Tokyo further enhances StarFlyer's position for the corporate market.

StarFlyer top 10 system hubs/bases/stations by seat capacity: 21-Jan-2013 to 27-Jan-2013

With more Haneda slots, StarFlyer will expand existing destinations and look for new ones

Prior to the Haneda slot expansion, StarFlyer wanted to increase frequencies on its existing routes, seeing potential to even double its Fukuoka services from five daily to 10. Since the expansion StarFlyer has affirmed that view but not yet given details of the frequency increases, but saying they would occur from Haneda to Kitakyushu and Fukuoka, although expansion to Osaka Kansai is yet to be determined.

The carrier also intends to evaluate other domestic routes. StarFlyer would prefer to serve any new route at least twice a day, requiring two slots of its five new ones, leaving little wiggle room for much expansion – or foregoing new routes to focus on existing ones. Routes are point-to-point; connections are not offered (and given that routes are concentrated in Japan's west, would be far from efficient).

System-wide services will increase, under the company's current management plan, from the present 23 a day (with nine aircraft) to 33 (and 10 aircraft) in FY2013, 39 (and 11 aircraft) in FY2014 and 42 (and 12 aircraft) in FY2015. This schedule will very likely be accelerated.

StarFlyer's A320s had been leased but in Dec-2012 the carrier took delivery of its first directly purchased aircraft. In addition to fleet growth, StarFlyer will replace some older leased aircraft with direct purchases.

Note: Since this report was first published, StarFlyer announced details of its 2013 summer schedules including the following operational changes, effective 31-Mar-2013 through to 26-Oct-2013:

  • Tokyo Haneda-Fukuoka: Increasing from five to 10 times daily;
  • Tokyo Haneda-Osaka Kansai: Increasing from four to five times daily;
  • Kitakyushu-Guam: Charter service scheduled for launch in 1H2013. The carrier will operate 50 services p/a

StarFlyer's expansion into international services

StarFlyer is also considering international services, but this is not a key driver for the carrier. Japan's domestic market is a very profitable one, and more so than international services – at least for now, as LCCs are still relatively at bay. The vast majority of StarFlyer's capacity will remain in the domestic market, the carrier intends.

StarFlyer does not intend to acquire aircraft besides A320s, limiting it operationally to North Asia and the northern parts of Southeast Asia. China, Hong Kong, South Korea and Taiwan are the carrier's main focus, offering large markets but also corporate-heavy routes. Beijing and Shanghai would be ideal for StarFlyer's proposition, but the limited slots makes the possibility impossible in the medium-term unless StarFlyer were to use midnight-hour slots at Beijing and Shanghai, which its corporate travellers would not favour.

Secondary Chinese cities are a possibility but demand is weaker and the carrier does not have price as a stimulant the way AirAsia Japan and Spring plan to do.

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Taipei's convenient downtown airport is equally restricted, but the city is not ruled out entirely. Hong Kong is a quiet favourite and the carrier has experience running charters in the past. StarFlyer also plans to run charter services to Guam later in 2013, and previously had charter services to Hong Kong and Seoul Incheon before introducing its first scheduled international service, to Busan, Korea's second-largest city. Busan and Kitakyushu are directly opposite each other across the Korea Strait, a flight distance of 243km. That makes the service a low-risk introduction, but StarFlyer is not seeing immediate success.

Sale fares between Kitakyushu and Busan were offered for JPY17,000 (USD191) return, although day trip promotional fares were even lower at JPY6,000 (USD68). The carrier says that, at an undisclosed high load factor, fares of JPY17,000 will make the service profitable. But StarFlyer's average domestic load factor is around 70% and it is aiming for 65% to Busan, making profitability elusive. History does not provide confidence: South Korean LCC Jeju Air suspended services to Kitakyushu from Seoul, which has a larger population although it is farther than Busan and was served only three times a week. StarFlyer is targeting business travellers and day-trippers (shopping in Korea is a popular holiday) with double daily return services.

Short of a favourable corporate contract out of Kitakyushu, Tokyo Haneda is all but the preferred airport for international services. As in the domestic market, routes will be designed for target point-to-point traffic rather than connections. Other points in StarFlyer's network like Fukuoka and Osaka Kansai are unlikely to see international service, as are unserved points like Sapporo or Naha in Okinawa (which, with more southerly geography could access more parts of Asia).

StarFlyer is studying cargo potential for international services

Although LCCs make the bulk of revenue from passengers, cargo is becoming a larger source of revenue as carriers take advantage of large networks, high frequency and low costs. AirAsia, Jetstar and Scoot all offer cargo services. Although not a LCC, StarFlyer is taking a page out of their book by evaluating what future, if any, cargo could have on international operations.

StarFlyer is limited, however, in that its A320s do not have a loading system for container cargo, which the carrier says enables it only to carry bulk cargo, the profitability of which it has yet to determine. It has limited cargo operations across its domestic network.

StarFlyer's relationship with ANA is vague, but to StarFlyer's advantage

One of StarFlyer's largest corporate developments came on 14-Dec-2012 when ANA agreed to take over US-based fund Doll Capital Management's (DCM) 16.61% stake in StarFlyer, increasing ANA's shareholding in the carrier to 17.97%, making it the largest shareholder. ANA's involvement with StarFlyer dates back to 2005 when they agreed to a business partnership (StarFlyer uses ANA's reservation system, but is looking to migrate off it) and 2007 when codeshare services commenced.

The rationale for ANA's move is not clear, but likely grounded in two events: one, DCM wanted to sell its maturing stake and two, ANA is flush with funds following a Jul-2012 equity issue of JPY176 billion (USD1.9 billion). While ANA said the equity issue was to fund purchases of forthcoming 787s, some in the market suspect ANA wanted to steal the limelight – and any floating cash – from rival JAL, preparing to re-list on the Tokyo Stock Exchange.

ANA's ambiguity was further clear with its surprise announcement it would use the cash to fund purchases of foreign carriers to give it access to new markets. The partial acquisition of a domestic carrier, however, represents ANA's second reversal of strategy, frustrating the market as it ponders if ANA simply does not know what to do with its extra funds gained at the expense of existing shareholder dilution.

ANA's additional stake in StarFlyer costs approximately JPY2.47 billion (USD27.8 million), representing a mere 1.4% of its fresh funds, so a relatively small purchase. The upside, however, is not clear. StarFlyer has varying profitability. It posted a net 1HFY2012 profit of JPY172 million (USD2.2 million; a 1.4% net margin) with forecasts for a net FY2013 profit of JPY569 million (USD7.2 million; a 2.2% net margin). Its most recent full year results, through 31-Mar-2012, saw the carrier post a JPY966.7 million (USD12.2 million) net profit, a 4.3% net margin, indicating deterioration since then.

Recouping the investment could take time, excluding the likelihood of mounting pressure impacting the bottom line. StarFlyer is aiming for a 10% operating margin in 2014 or 2015, which for now will require a remarkable improvement – ambitious by most standards in aviation. 

ANA codeshares on StarFlyer's Haneda-Kitakyushu and Haneda-Kansai services, but not to Fukuoka or Busan. That could now change. StarFlyer does not codeshare on ANA's services. Outside of codeshares, strategic potential is limited.

StarFlyer uses ANA's reservation system but is looking to move off the clunky and expensive system. ANA has 20 A320s, offering some maintenance and spare part synergies.

ANA is the largest carrier in the domestic market and is looking to grow its presence while minimising direct capacity additions. StarFlyer may help achieve that on limited trunk routes where independent Skymark, for example, is nudging in.

The relationship has been to StarFlyer's gain. Immediately following the codeshare, StarFlyer's average load factor went from 59% to over 70%, the carrier says. Its Kitakyushu-Haneda route has seen frequency increases at the expense of load factors, now below 70%. Its Haneda-Fukuoka route in mid-2012 had a load factor of over 70% and was the highest, second only to Skymark (and that is without the ANA codeshare on that route).

Japanese carriers have not been efficient, permitting domestic load factors to dip below 60% in the off-season. The new LCCs are looking to exploit this with higher load factors, presenting a further challenge to StarFlyer as expansion on existing routes may come at the expense of load factors.

Japan regulates the amount of seats a carrier can make available for codeshares: 50% on secondary routes and 25% for trunk routes. StarFlyer's routes are considered trunk ones, and about 20% of StarFlyer's Haneda-Kitakyushu passengers are on ANA codeshares. ANA takes an undisclosed proportion of block seats from StarFlyer, but likely around the 25% threshold, so local reports of the MLIT possibly lifting codeshare seats available on trunk routes from 25% to 50% are welcomed.

StarFlyer monthly passenger numbers: Jan-2010 through Jul-2012

Partnering with other airlines could be in the mix

StarFlyer is open to partnerships and in 2012 announced a tentative relationship with proposed ATR start-up LINK that intends to serve regional markets in western Japan. StarFlyer is also open to international partnerships, but these will not be major drivers of traffic the way the ANA codeshare was. StarFlyer's network is small and as such has little to offer a larger international carrier.

The carrier is not actively thinking about a role in global marketing alliances.

With more competition from LCCs and FSCs, can StarFlyer maintain its position?

StarFlyer, like other established carriers in Japan, has two sets of competition: LCCs in the long-term, and peers in the short-term.

The near universal rebuttal from incumbent carriers in Japan about cannibalisation from the new LCCs is that they do not have access to Tokyo Haneda airport. This is true. AirAsia Japan and Jetstar Japan are based at Tokyo Narita while Peach is based at Osaka Kansai and does not serve the Tokyo area at all.

But the caveat is that Tokyo Haneda will see significant slot expansion later this decade, and while the LCCs are not commenting on opportunities to serve Haneda – that is too far out – it is definitely not ruled out. It will require only a few services for LCCs and their low-cost bases to challenge legacy operators, as LCCs have done in others markets throughout the world: JetBlue to Los Angeles, easyJet to Milan and Tiger to Sydney. But even before then there is risk. There is the possibility that some passengers – albeit not likely corporate ones – will use Narita if fares are significantly lower than at Haneda. The LCCs are partnering with transportation companies to make more affordable and convenient trips from Tokyo city to Narita airport, further enhancing their appeal.

Belt-tightening at companies could woo a LCC, or even lower-cost incumbent carrier like Skymark, into StarFlyer's den at Kitakyushu. Fleets at AirAsia Japan, Jetstar Japan and Peach are presently in the single digits, but the mood is their long-term growth is limited not by demand but aircraft availability.

StarFlyer's more immediate concern is not from LCCs (provided none enter Kitakyushu). Its strength is the Haneda-Kitakyushu service, where it has sizeable corporate traffic, but StarFlyer cannot subsist on that alone. As it grows elsewhere (provided it gains enough Haneda slots to close the gap with competitors) it will meet larger competition and expose itself to possibly being displaced. ANA may code with StarFlyer to Kitakyushu, but not to Fukuoka, StarFlyer's second-largest route.

With Skymark having a network far wider than StarFlyer and yields 25% lower, it is not difficult to see a future of passengers trading off the boutique and highly-branded experience of StarFlyer for the more functional Skymark, itself looking to become more efficient and step up competition with A330s that will likely be used in the domestic market. Flights in Japan are short (the longest trunk route, from Fukuoka to Sapporo, is only 1,415km), and the global evidence is LCCs take greater market share the shorter the sectors.

Incumbents including StarFlyer may be comfortable in the medium-term, but the long-term is likely to see greater change, as is ANA's stake in StarFlyer. JAL, Skymark and even Solaseed may find StarFlyer's niche in Kitakyushu too cosy and introduce greater competition. International services without a partner or corporate client could be less than positive.

StarFlyer has its own frequent flyer programme (Star Link, including credit card points) to fall back on, but this is not a deep cushion. A massive structural change – a smaller carrier like Skymark joining SkyTeam, which does not have any Japanese carrier, or international tie-ups involving the smaller Japanese carriers – could greatly shift prospects as the market re-evaluates its loyalty.

StarFlyer has found a niche, but one not based on having the lowest costs (unlike US peer JetBlue, relatively speaking). That limits potential compared to the LCCs, which are either bigger than it or on their way to surpass it, or the mega carriers like ANA and JAL that wield power via marketing and frequent flyer programmes.

No carrier has yet put forward a plan of how it will counter seemingly inevitable extensive cannibalisation from LCCs, or a more competitive Skymark or any global partnerships in the wing, all of which could be other game changers for the market.

A long-term path forward may not be clear for StarFlyer, but it is not alone in a once-solid established market now undergoing significant change.


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