19-Mar-2015 6:10 PM

Thai Smile needs to focus on feeder role at Bangkok Suvarnabhumi as Thai Airways restructures

Analysis

Thai Airways regional subsidiary Thai Smile could be approaching a critical juncture as its parent pursues a major restructuring. Thai Smile could be used to take over Thai's unprofitable regional routes but the group also has been using the subsidiary to expand in point to point markets as competition with LCCs intensifies.

Thai Smile has made several strategic U-turns since its 2011 conception and now has dual roles, serving as a feeder for Thai Airways at Bangkok's main international gateway Suvarnabhumi while competing against LCCs on point to point domestic routes from Bangkok's original airport Don Mueang. The roles are somewhat contradictory and not easy to balance. Ultimately the group may need to adjust its multi-brand strategy and refocus Thai Smile, which has generally lacked the cost structure to compete effectively at the bottom end of the market.

Thai Smile's fleet will grow to 20 A320s by the end of 2015. The group has no additional narrowbody commitments for 2016 or beyond. Further fleet growth is possible, particularly if Thai Smile is used to take over more Thai Airways routes, but is hardly guaranteed and could hinge on further changes to its business model.

This is the first in a series of analysis reports on the Thai market and the outlook for 2015. Subsequent instalments will look at Thai Airways itself, boutique full service carrier Bangkok Airways and Thailand's fast-growing LCC sector.

Thai Smile has evolved significantly since its establishment

The Thai Airways Group initially decided in May-2011 to establish a new regional carrier, recognising the need for a lower-cost option as LCC competition was rapidly intensifying in Thailand's domestic and short-haul international markets. The group immediately committed to acquiring 11 A320s for the new airline, adding commitments for nine more A320s in early 2012 for a total of 20 aircraft.

After contemplating an LCC model during the pre-launch phase the group settled on a hybrid regional low-cost model. The original business plan envisioned Thai Smile focusing primarily on routes of two hours or less with A320s in all-economy configuration. But Thai Smile adjusted its business plan prior to its Jul-2012 launch, moving upmarket by deciding to offer a premium product. As a result Thai Smile's A320s were configured with a flexible business class cabin similar to the product major European full service carriers have been offering for several years in their short-haul market.

The Smile Plus product was introduced to provide a more suitable option for premium passengers connecting from Thai Airways flights, particularly as Thai Smile decided to pursue medium-haul routes along with domestic and short-haul international routes within Southeast Asia. Bangkok-Macau, which is about a three hour flight, was Thai Smile's first route. Thai Smile subsequently launched several four hour routes to South Asia.

Economy class passengers have always been offered complimentary drinks, snacks or meals, seat assignments and checked bags as Thai Smile was keen to follow the model used by SIA Group regional subsidiary SilkAir. Like SilkAir, Thai Smile has lower unit costs than its parent airline but much higher unit costs than LCCs. With both airlines the priority has been to provide a seamless product for passengers connecting from the parent airline.

See related reports (in chronological order):

Thai Smile's network strategy also has evolved

In the international market, Thai Smile has dropped several routes to South Asia and is now focusing entirely on Bangkok after a failed experiment with point to point international routes from Phuket. While its South Asia routes have been handed back to Thai Airways or dropped entirely, it continues to operate a handful of international routes within Southeast Asia that were original Thai mainline markets. It also has launched a handful of regional international routes within Southeast Asia and to Greater China that are new to the group.

In the domestic market Thai Smile has similarly taken over several Thai Airways routes. But in a strategic shift it also launched in Aug-2014 three point to point domestic routes and 10 daily flights from Don Mueang. In these three markets (Bangkok Don Mueang to Chiang Mai, Phuket and Khon Kaen) Thai Smile is competing entirely against LCCs, including Thai Airways LCC affiliate Nok Air.

As CAPA previously highlighted, the partial move to Don Mueang is not logical as it resulted in a split hub for Thai Smile and in a relatively small airline having two seemingly contradictory roles. The domestic point to point role is more suitable for Nok as the LCC has a cost structure that can compete more effectively against Thai AirAsia and Thai Lion Air.

The domestic market at Don Mueang, which is a more convenient airport for most Bangkok residents, has been growing rapidly. Domestic traffic at Don Mueang increased by a staggering 39% in 2014 to 15.6 million passengers, driven primarily by expansion at Nok, Thai Lion and Thai AirAsia. But all of Thailand's domestic operators were unprofitable in 2014 as overcapacity resulted in a significant decrease in yields.

Competition in Thailand's domestic market is expected to intensify even further in 2015 as Thai Lion continues to expand rapidly and as Thai VietJet Air launches services. Thai Smile is eager to participate in the growth at Don Mueang but it generally lacks the cost structure to compete effectively against LCCs.

Thai Smile seeks to expand Don Mueang point to point domestic operation

For now Thai Smile is committed to the Don Mueang market and is looking at expanding its presence at the airport. While Thai Smile is no longer looking at moving its existing international routes to Don Mueang, which was under consideration in 2H2014, it does see an opportunity to link Don Mueang with more domestic destinations that are served by Thai Airways from Suvarnabhumi.

For example Thai Smile is now looking at moving its Krabi service to Don Mueang. Both Thai Smile and Thai Airways currently serve the Suvarnabhumi-Krabi route but Thai Smile believes the Thai Airways flights in this market are sufficient to serve the connection market.

Thai for example operates two widebody frequencies to Krabi which are timed for connecting flights to and from Europe, which is a large and growing market for Krabi. Thai Airways already operates all of the group's flights from Suvarnabhumi to Chiang Mai and Phuket, giving Thai Smile the opportunity to serve these markets from Don Mueang without compromising on Thai Airways' ability to offer domestic connections to international passengers.

Hat Yai is another possible destination that could be served from Don Mueang. Like Krabi, Hat Yai is currently served from Suvarnabhumi by both Thai Airways and Thai Smile.

Thai Smile currently operates a total of 10 domestic routes, including six from Suvarnabhumi, three from Don Mueang and one point to point route connecting Chiang Mai with Phuket. Thai Smile plans to add an 11th domestic route on 5-May-2015, when it takes over from Thai Airways on the Suvarnabhumi-Khon Kaen route. The withdrawal from Khon Kaen will leave Thai Airways with only five domestic routes (Suvarnabhumi to Chiang Mai, Hat Yai, Krabi, Phuket and Samui) including the two that are served with a combination of Thai and Thai Smile services (Hat Yai and Krabi).

Thai Smile domestic operation: current northern winter schedule

The other four domestic routes Thai Smile operates from Suvarnabhumi are no longer served by Thai Airways - Chiang Rai, Surat Thani, Udon Thani and Ubon Ratchathani. All of these routes will need to be maintained as part of Thai Smile's feeder role, although it is also possible that it launches services to these destinations from Don Mueang to serve the point to point market.

Thai Smile adds its own marketing function

As it entered the domestic point to point market Thai Smile also has added a marketing function. Initially the airline relied entirely on Thai Airways for sales, marketing and distribution. Thai Smile was purely an operator with Thai Airways controlling its inventory and fares.

Thai Smile is now doing its own sales and marketing in the domestic market, including setting fares. Thai Airways however also sells on Thai Smile domestic flights, including to connecting passengers originating in international markets.

Thai Smile is also now doing its own marketing on some international routes that rely heavily on local sales such as Macau. On routes that consists mostly of passengers originating in overseas markets Thai Smile continues to rely entirely on Thai Airways. For example a majority of its passengers on the Bangkok-Phnom Penh route originate in Europe.

As Thai already has a well established brand and distribution network in the European market it makes no sense for Thai Smile to set up its own point of sales in Europe. But in Thailand the situation is different as Thai Smile has been able to establish its own brand and a lower cost distribution network that relies more on direct sales than Thai Airways.

Thai Smile routes that are sold independently of Thai Airways

Thai Smile believes there is room for a full service airline at Don Mueang

Thai Smile is also considering launching international point to point routes from Don Mueang including Singapore. While Singapore is well served by Thai Airways from Suvarnabhumi and by LCCs from Don Mueang, Thai Smile sees a potential niche for a full service/hybrid carrier from Don Mueang as some passengers in Thailand do not want to fly with an LCC but view Suvarnabhumi, where all Thai Airways and Bangkok Airways flights operate, as inconvenient. Thai Smile also believes it can keep its costs low enough to compete with LCCs.

Thai Smile points out that it has kept the costs of its Don Mueang operation to a minimum by having only 18 employees at the airport while outsourcing most functions. While there is still a significant cost gap between Thai Smile and LCCs, it is working to narrow this gap and is adapting by learning from the LCCs while still providing a higher level of service.

Thai Smile recognises its Don Mueang operation has resulted in some overlap and cannibalisation with Nok Air. But Thai Smile believes if it does not maintain and expand its Don Mueang operation it will leave a void that will mainly be filled by other competitors.

By not launching services at Don Mueang in an earlier phase of its development, Thai Smile thinks it created an opening for start-ups, particularly Thai Lion. Ceding the Don Mueang market entirely to LCCs is no longer viewed as an option for the Thai Airways Group.

But ultimately the Don Mueang operation could prove to be a distraction. Focusing on one role and one hub would be logical. Thai Smile has relatively limited resources that could be better put to use on feeder routes at Suvarnabhumi, particularly as its parent restructures.

Thai Smile is not planning to expand its fleet beyond 20 aircraft - for now

The Thai Airways Group's current fleet plan does not envision more than 20 A320s. The group has not committed to any additional A320s beyond the initial 20 aircraft that it ordered and agreed to lease in 2011 and early 2012.

Thai Smile CEO Woranate Laprabang told CAPA recently that there are currently no plans to acquire more A320s. He said any decision on more aircraft will not be made until after Thai Airways completes its restructuring.

The group has so far taken 18 of the 20 A320s on order. This includes five A320s that are temporarily under the Thai Airways air operator's certificate (AOC) but will be moved to Thai Smile's AOC by the end of 2015.

Thai Smile fleet: as of 19-Mar-2015

Aircraft	In Service	In Storage	On Order*
Total:	18	0	2
Airbus A320-200	18	0	2

The group was forced to put some of the A320s under Thai Airways in 2014 after Thai Smile, which was originally a Thai Airways unit flying under the TG code, secured its own AOC but was unable to secure its own traffic rights. In order for Thai to maintain A320 services on some international routes the Thai Airways AOC had to be used as foreign authorities did not yet approve Thai Smile as an operator.

Thai Smile has since been working towards securing the required authorities and Mr Laprabang is confident all the routes can be transferred back to Thai Smile from the start of the northern winter schedule in late Oct-2015. This transfer is largely cosmetic as most of the services that have been temporarily operated under the Thai Airways AOC have continued to have the Thai Smile product, including Thai Smile flight attendants.

In addition to the 10 Thai Smile-operated domestic routes, the group's A320 fleet is currently used on nine international routes from Suvarnabhumi - Changsha and Chongqing in China, Gaya in India, Luang Prabang and Vientiane in Laos, Macau, Mandalay in Myanmar, Penang in Malaysia and Phnom Penh in Cambodia. Some of these flights are operated with the five aircraft under the Thai Airways AOC for regulatory reasons but will transition to the Thai Smile AOC in the coming months.

Thai Smile to pursue international expansion as fleet grows and utilisation improves

The fleet under the Thai Smile AOC will grow from the current 13 aircraft to 20 by the end of the year. In addition to the five aircraft being transferred from Thai Airways, Thai Smile will be taking the last two aircraft from the original commitment. Mr Laprabang said these last two A320s are slated to be delivered in Sep-2015 and Nov-2015.

Thai Smile expects to use the two additional aircraft to take over more Thai Airways international routes which will likely be dropped by the parent as part of its upcoming network restructuring. Thai Smile also will have an opportunity to expand capacity by improving average aircraft utilisation rates, which is currently less than eight hours per day.

There are several regional Thai Airways routes which Thai Smile could take over. These include routes which Thai Smile previously operated but are now again being operated with Thai Airways widebody aircraft including Bangkok to Colombo and Hyderabad. There are also a few marginal or unprofitable regional routes which have always been operated with Thai Airways widebody aircraft.

Given the group is now in restructuring mode route transfers are more likely at this stage than totally new routes. The group has used Thai Smile over the last three years to open new routes, some of which have been successful while others quickly proved to be unsustainable including Bangkok to Ahmedabad and Phuket to Delhi and Mumbai.

Thai Smile should focus on feeding Thai Airways

Thai Smile for now is also planning to maintain and potentially grow its point to point operation. But as Thai Airways restructures, growing the feeder operation should take priority. Ultimately the group may need to re-examine its two-brand strategy and focus Thai Smile on domestic and international feeder routes from the Suvarnabhumi hub.

Thai has several widebody short-haul flights which could be more sustainable with Thai Smile A320s. In some cases this does not represent entire routes but frequencies during off peak hours which are more suitable for A320s while peak hour flights can be maintained with widebody aircraft.

Downgauging to A320s is generally a better option than cutting widebody flights or routes entirely. (Thai Airways currently has an all-widebody fleet except two 737-400s, which it expects to retain for at least the next two years for the Bangkok-Samui route. Eventually Thai Smile could acquire A319s and take over services to Samui, which is unable to accommodate A320s due to runway restrictions.)

Thai Airways needs a clearer multi-brand strategy

As Thai Airways restructures it should also look closely at its relationship with Nok and Nok's new long-haul joint venture carrier NokScoot. The sale of Thai's approximately 39% stake in Nok has been raised as a possibility as the group looks to raise capital. But Thai Airways should not be considering a sale of its stake in Nok and, if anything, should be looking to increase its investment and role in the short-haul LCC, similar to SIA's move in late 2014 to increase its stake and role in Tigerair.

Nok is the more appropriate brand for the point to point market and growing the Thai Airways' Group market share at Don Mueang. Thai should view Nok as its response to the intensifying competition from LCCs. Instead it currently sees Nok as a completely separate and independent LCC.

Using Thai Smile in the sector Nok now competes in does not make sense. Thai Smile should be focusing on its feeder role, particularly given the challenges Thai Airways currently faces.

Thai Smile has had many twists and turns since it was first conceived four years ago. It is time for the group to decide on a coherent strategy for its regional subsidiary once and for all.

With the right strategy and focus there will be growth opportunities for Thai Smile well beyond the 20 aircraft currently planned. But the decisions made in the coming months at Thai Smile - and at the Thai Airways Group overall - will be critical for its future outlook and sustainability.