Full service airlines could become endangered unless they adopt new strategies for sustainability

But, in most cases, the longer established full service "flag" carriers are not sharing in the new growth or the prosperity. They are struggling to maintain size and profitability. They are now being forced to evolve new strategies to remain relevant and sustainable in the long term. However, although they may be down it is much too early to count them out.

A combination of rapid economic expansion and new airline types (and government attitudes) has pushed the region into becoming the fastest growing in the world. And that is not likely to change in the foreseeable future. There will be hiccups, but on most long-term projections, the region will dominate world aviation by the middle of the next decade.

Despite these hiccups, Asia is still growing right now. Traffic numbers across the region are in many cases increasing by high single-digit figures. The sheer economic momentum of the region will ensure that growth occurs, despite occasional slowdowns. In aviation, that growth is helped by the availability of lower fares and the proliferation of new airlines and new city pairs.

As a key indicator of what the future holds, aircraft orders are among the best. They compress the thinking and planning of the industry into formal commitments to spend large amounts of money. That means there has been a certain amount of due diligence applied to the forecasting of demand. Although in a fast evolving market like this one, there is a very significant element of "strategic" ordering too, aimed at opening the way to claiming market share among the emerging growth. In terms of trade alone, this represents a significant amount, where each of the 2500 aircraft, with engines, is going to cost somewhere in the vicinity of USD100 million. The maths is not hard.

The first diagram on the following page is astonishing in what it indicates. In Asia Pacific, where the existing fleet is much smaller than either Europe or North America, the number of orders is almost equal to the total of the other two regions combined!

Asia's dominance will arise partly from the sheer economic power and growth of the region - but also from the proliferation of new entrant airlines. As these airlines emerge they are bringing with them many mutations of older versions, so that today there are things happening in Asia Pacific that do not or cannot occur elsewhere.

Single-aisle aircraft orders: Oct-2014 Source: CAPA Fleet Database Widebody aircraft orders: Oct-2014 Source: CAPA Fleet Database

But amid this expansionism, Asia's full service network airlines are stagnating. The great bulk of these orders comes from LCCs. Most full service carriers have scarcely grown since the global financial crisis. This is an important phenomenon. It tends to get lost in the flurry of LCC new entrants and route expansions. It is a vital development because it will reshape the future, in terms of "flag carriers" and of the nature of the airline models that will replace them.

LCC evolution is changing the entire airline system. So, as the weight of LCC entry impacts on the full service airlines, the previously simple LCC point to point model is evolving into something more complex. This in some aspects resembles the full service model, but in new ways - and from a much lower cost base.

Liberalisation is reshaping traffic flows and opening up new city pairs. Much of this evolution is being made possible by the more flexible, liberal policies being adopted by governments. In some cases this means simply not opposing change, rather than actively adopting the new regime as a formal policy. They are happy to do so as they see the immediate benefits that new air services bring to regional development. Their willingness to accept the changes - particularly with cross-border joint ventures - has been a vital feature of the new environment.

As most of the markets concerned are international - an area still governed by archaic regulation - the attitudes of governments towards these changes are vital too. At least for the time being, most jurisdictions are relatively flexible when it comes to accepting new forms of airline, most notably the many cross-border joint ventures.

Only in this new and more relaxed regulatory atmosphere have the new pan-Asian LCCs been able to emerge and expand - notably the independent AirAsia, as well as some full service airline affiliates such as Jetstar, Tiger and Scoot.

Independents Lion Air and Cebu Pacific are close behind and new aspirants , notablyVietJet are also promising to follow their lead. IndiGo in India is also coming over the horizon. In China, Spring Airlines is adopting the same expansive strategy - and there will soon be a host of other Chinese LCCs entering the market. That now is why most of the massive order book for short-haul aircraft is destined for a handful of these LCCs.

With this expansion of capacity, demand will not always be in balance. And there will be market turbulence - which means mergers, alliances, failures; in short all the things that happen in a normal international business.

The Asian airline explosion is not limited to short-haul either. The region is by far the biggest buyer of long-haul widebody (twin-aisle) aircraft; taken together with the Middle East/Gulf carrier orders, it becomes even more obvious how the world aviation order is going to change. Widebody aircraft are typically only used by the big full service network airlines, mostly in Europe and North America. Now the old order is changing - and it is easy to see why the older airlines are resisting these new forces.

And - perhaps surprisingly for many - most of those widebody orders too are from LCCs. In this case it is the so-called long-haul low-cost airlines. And they are most attracted to the new wave of A350s, 787s and, most recently the new A330neos, for which AirAsia X was the lead order. Scoot and Jetstar also have A350s and 787s either in service or on order.

The long-haul low-cost model is - with the main exception of Norwegian - unique to Asia. It has prospered on north-south sectors of up to eight hours. But as more effective aircraft types become available and as fuel prices (50%+ of costs) come down, longer ranges become more viable models. Watch this space.

Asia Pacific airlines: cost per available seat kilometre (CASK, USc) versus average passenger trip length (km) 2013*

Source: CAPA - Centre for Aviation & company reports
*Nearest financial year to calendar 2013
Note: Vertical axis does not start at zero, StarFlyer not included in LCC trend line

Against this surge in growth, the full service airlines are finding it hard to compete. They are simply stagnating, as low profitability forces them to rein in capacity growth. Premium travel is not growing as it used to (and has only just got back to the sort of pre-GFC 2008 levels); and the other main source of revenue that LCCs usually don't compete for, cargo, has been very subdued in the past five years.

As a result, the main Asian FSCs' capacity growth - measured in available seat kilometres (ASKs) - have remained static, as they seek to avoid financial losses.

Their cost bases are too high to compete effectively for lower yielding passengers. So, unless they can generate higher yields, the necessary option is to reduce or limit flying.

The pressure to contain expansion comes from weak financial results. Most logical and commercial organisations in these circumstances cut back loss-making areas and so the large full service airlines have, in the face of losses, done so.

As is obvious from this diagram (where the profit margin is on the vertical scale and airline size on the horizontal), the full service airlines in Southeast Asia notably have all floundered.

Malaysia Airlines was the standout exception to that rule in 2013/2014 and expanded rapidly; the largely government owned airline suffered heavy financial losses and was recently delisted, now undergoing restructuring and downsizing.

In the past, this sort of setback would have provoked a backlash from the established airlines, but for now at least protectionism is painted in a lighter hue.

In this more liberal climate, there is light at the end of the tunnel, even for the FSCs - provided they are able to adapt effectively to the new circumstances.

Asia Pacific airline profits FY2013 Source: CAPA - Centre for Aviation & company reports

There is, however, an outlet for the longer established airlines - and most are pursuing it. Instead of expanding in their main brands, FSCs are establishing low-cost subsidiaries to grow for them. As the parent cannot reduce costs sufficiently - and often doesn't want to risk corrupting a valuable brand by discount marketing - creating a low-cost arm to cater to the low-price market is the chosen method.

The only standout in this respect is Cathay Pacific and, although it does operate a lower cost regional feeder, Dragonair, its protected position at capacity constrained Hong Kong Airport has allowed it to resist establishing its own LCC.

Yet the most strategically significant development - among a host of innovative change - in the Asia Pacific LCC movement has occurred more recently. It involves connecting, or transfer, passengers. This type of operation is at the heart of the full service network airlines' profile and if LCCs are in a position to intervene at that level, armed with lower costs and streamlined airport procedures, their threat to established practices grows steeply.

Passengers on LCCs have frequently "self-connected" between flights in the past - buying two tickets back to back and effectively flying two separate services. But this was inconvenient, and more valuable passengers would not accept the risk of missed connections or the hassle involved in double check-in.

Meanwhile, LCCs could not afford to add cost to their operation by providing the reservation and operational complexity that FSCs were locked into.

The evolution of air transport in the Asia Pacific region Source: CAPA - Centre for Aviation

Over the past year, long-haul LCC AirAsia X has broken through this barrier at its Kuala Lumpur hub. It has two advantages in this regard: the new and purpose built Terminal known as KLIA2; and the high level of connectivity potentially offered by its short-haul cousin, AirAsia. For FSCs this has usually meant their building "banks" of flights which radiate in and out of a hub at specific times of the day. The volume and frequency of service offered by AirAsia means that natural banks exist which are almost as effective.

The low-cost operator AirAsia X has become a hub carrier! And it won't be the last. Others are watching carefully.

The ability to connect traffic flows has obvious benefits - most notably the potential to "feed" traffic from several points onto a single flight. This is doubly important for a long-haul low-cost operation, operating typically much larger aircraft. Here, the absence of feeder traffic limits the available pool of passengers, so that the service must rely on pure end-to-end passenger flows. As a result, only a limited number of city pairs can be linked.

That is one major reason why no other "long-haul low-cost" airlines have survived. So it is the more remarkable that AirAsia X has managed to evolve a new format.

In 2011, about one fifth of AirAsia X's passengers self-connected, onto another airline, or to another of its own flights. That proportion has changed little in the meantime; but the important trend is a major increase in "fly-thru"- a process that is in many ways very similar to the conventional connectivity previously only associated with full service airlines.

In total, this means that, in 2014, more than half of all of AirAsia X's passengers were transfer passengers. This is, remarkably, higher than the proportions often achieved by traditional full service airlines.

In other words, the writing is on the wall that there is potential for long-haul low-cost + short-haul low-cost to assume more than just dominance of short-haul operations. This potentially goes to the heart of the hub carrier system that has formed so much of the basis for airline operations in Asia.

But it would be grossly premature to suggest that the day of national flag carriers is over. Far from it - although they will have to be far smarter than they used to be in the old protected marketplace. Most have already made the strategic shift to recognising that they need to use lower cost brands to complement their high profile presence. Implementing the new plans is by no means straightforward.

Take Singapore Airlines for example: its "group" of airlines is spearheaded by the familiar SIA brand. Its regional feeder, SilkAir, is now well established and has its own role as well as connecting into SIA at the Changi hub.

Then there is its wholly owned long-haul low-cost operation, Scoot, as well as part-owned short-haul LCC, Tigerair. Both of these airlines also have cross-border joint ventures in other Southeast Asian countries. And SIA also has a substantial minority investment in the full service Virgin Australia, with whom it shares ownership of the Australian based Tigerair Australia.

This is only a beginning - and already it is obvious that juggling all of these balls, many of which overlap competitively, is no simple task. There is as yet no road map for this type of operation. It is indeed a new world.

All of this is good for the consumer, for the economy, for tourism, regional development, improving communications ... the list goes on.

Most notably for aviation entities, it is airports and regional communities that stand to benefit enormously as this evolving system rolls out. It will be turbulent and in some ways destructive. In contrast with the past, airlines will actually fail, but many will prevail. We are only at the beginning of this major new aviation market and the potential upside over the next decade defies belief, especially as China unfolds its wings beyond its home territory.