Liberalisation means opportunities

Low cost penetration in Latin America remains low compared with other more mature markets. But that disparity is starting to change, as market access controls are relaxed and as entrepreneurs recognise the vacuum and rush to fill it.
LCCs in Latin America have proliferated during the past year, with four new LCCs taking to the skies. After LCCs blazed trails in Brazil and Mexico in the early to late 2000s, the model is moving to Central America, Peru and Chile. The latest generation of LCCs aims to capitalise on inherent stimulatory opportunities in a region where LCC penetration remains low.
But underneath the excitement generated by the crop of new LCCs emerging in Latin America, familiar obstacles remain - high taxes and airport costs. Additionally, some entrenched full service airlines are not resting on their laurels, crafting strategies to ensure they capture their share of passengers opting for air travel as the region embarks on an economic recovery and the middle class continues to gain strength.
Given those challenges, maintaining a low cost structure is crucial for new budget airlines to achieve longevity in the Latin American market.
More than a decade ago, Gol ushered in the low cost model in South America, aiming to stimulate air traffic growth among Brazil's growing middle class. Gol is now Brazil's largest domestic airline, holding a 34% domestic passenger share for 1H2017. The country's second LCC, Azul, captured 21% of Brazil's domestic passenger market during that time period.
VivaAerobus, along with Interjet and Volaris, ushered in a new low cost era in the Mexican market in the mid 2000s, challenging full service airlines Aeromexico and Mexicana, which is no longer in existence. Volaris and Interjet are now the second and third largest airlines in the Mexican market, holding domestic passenger market share of 28% and 21%, respectively, in 1H2017. Combined, Mexico's three LCCs represent 65% of the Mexican domestic market.
The Viva Group's ambition to spread its brand across Latin America tempered after the creation of VivaAerobus. VivaColombia launched operations in 2012, and since that time LCC investment firm Irelandia has bought out the share Mexican bus company IAMSA held in VivaColombia, and IAMSA, in turn, purchased Irelandia's stake in VivaAerobus.

Domestic passenger market share and annual growth rates*

Source: CAPA - Centre for Aviation, Brazil ANAC, Chile JAC, Mexico SCT, Peru DGAC
Nore: * Brazil and Mexico passenger market share by airline.

Five years after VivaColombia's launch, Irelandia settled on Peru for the next Viva franchise, and Viva Air Peru launched operations in May-2017. In mid-2017, the Viva Group (VivaColombia and Viva Peru) signed an MOU with Airbus for 50 aircraft, comprised of 35 A320neos and 15 A320ceos. Presently, Viva Air Peru operates two A320s subleased from VivaColombia.
Peru is an attractive region for an upstart LCC. The country's domestic market nearly tripled in size between 2007 and 2016 from 3.7 million passengers to 10.8 annual passengers, and its GDP growth inched toward 4% in 2016. The market is dominated by LATAM Airlines Group, with LATAM Airlines Peru holding a 58% market share for the first five months of 2017.
However, the Peruvian market was competitive prior to Viva Air Peru's launch, with Peruvian Airlines growing rapidly during the last couple of years. Peruvian along with the country's other smaller airlines LC Peru and Star Peru have worked to offer lower fares without adhering to the LCC model.
As of late Jul-2017, Viva Air Peru's network composition centred on major trunk routes from Lima where the upstart faced ample competition. With Viva Air Peru's market entry, up to six airlines operate on some of the country's trunk routes; but Viva believes it can drive 40% growth in the Peruvian market, and has declared competitors reduced fares by 70% after its launch.
The LATAM Group is in the midst of creating a new fare structure in response to LCC expansion in Latin America. Beginning in 2017, the company is offering unbundled fares in its six South American domestic markets (Argentina, Brazil, Chile, Colombia, Ecuador and Peru) that are roughly 20% cheaper. LATAM projects 50% passenger growth on domestic routes in its South American countries by 2020.
Viva Air Peru's debut and LATAM's competitive response are altering dynamics of the Peruvian market in a short period of time. With backing from the powerful Irelandia Group, Viva Air Peru has an arsenal to launch a formidable challenge to the status quo, and LATAM shows no sign of ceding its dominance.
For now, the Avianca Group has no plans to launch a counter attack against the LCC invasion in Latin America, and during the last year Avianca Peru has slid from Peru's second largest airline to third place. Peru's smaller airlines seem to carry the greatest risk for extinction against a wave of price matching that will last for the foreseeable future.
After establishing numerous LCCs in Europe, Asia and the Americas, LCC specialist Indigo Partners has now set its sights on South America. The company launched JetSMART in Chile during Jul-2017, the first LCC starting from scratch in the Southern Cone. Sky Airline, which has long held the position as Chile's second largest airline, has transitioned from a full service to a low cost airline during the last couple of years.
Chile's domestic market has also grown steadily during the last few years, with domestic passengers nearly doubling between 2010 and 2016 from 6 million to 12 million. LATAM and Sky have enjoyed a duopoly in Chile, reflected in LATAM Group's 71% passenger share for 1H2017 and Sky's 27% share.
JetSMART plans to operate up to 10 A320s in the market in the 2018 time period. Two major factors likely drove Indigo to settle on Chile for its foray into the lower South America - dominance by a single airline entity and Chile's status as one of the more liberalised markets in the region.
Indigo Managing Partner William Franke has concluded Chile provides a "nice, stable platform" for a new LCC.
Central America also welcomed a new LCC in 2017 with the launch of Volaris Costa Rica. At one point, Viva had outlined plans to establish its third airline in Costa Rica, but eventually concluded airport costs and taxes would be prohibitive to offering stimulatory fares.
Central America presents an interesting dichotomy for LCCs - high taxes and airport costs paired with attractive low market penetration by budget airlines.
Costa Rica along with Guatemala, Honduras, El Salvador and Nicaragua comprise the Central American Common Market (CACM) and have a single aviation market status; but governments of those countries have long complained about a lack of air service and high fares.
There are approximately 40 million inhabitants in the region, but less than half a million airline seats. The LCC penetration rate among the CACM countries along with Panama and Belize is roughly 8%.
Although CACM markets remain under-stimulated, the cost of doing business in the region appears to have driven low cost airlines away. Government taxes on international flights within Central America can reach up to USD50, but Volaris concludes it can offer lower base fares than competitors due to its cost structure. Volaris' unit costs excluding fuel for 3Q2017 were USD 5.1 cents, which is among the lowest of ultra low cost and low cost operators in the Americas.
Eventually, Volaris aims to deploy 18 to 22 Airbus narrowbodies at its Costa Rican subsidiary to operate on routes within the CACM, and from those countries to North America.
Volaris Costa Rica's initial debut of routes shows the opportunities present in Central America if the group can successfully keep its fares at a level to manage high taxes and fees while stimulating traffic. Three of Volaris Costa Rica's initial routes were monopoly markets operated by Latin American aviation group Avianca, which is the entity formed by 2010 merger between Colombia's Avianca and Central American airline group TACA.
Volaris' moves will be closely watched now that it has launched numerous routes through its new Costa Rican subsidiary to determine if it can sustain the ultra low cost model in one of the highest cost regions to conduct business.
Other Latin markets are emerging as potential fertile ground for aspiring low cost airlines. A new president elected nearly two years ago has ushered in a new liberalised era in Argentina, catching the attention of Norwegian Air Group. The company has established Norwegian Air Argentina with the goal of operating domestic service in Argentina and international flights from the country. Norwegian has ambitious plans for its operation in Argentina, targeting a fleet of 70 aircraft by its eighth year of operations - 50 Boeing 737s and 20 787s.
If Norwegian is successful, it would be the first airline group based outside Latin America to capitalise on the stimulatory opportunities available for low cost airlines. Norwegian executives have characterised Argentina as a hidden jewel. Average trips per capita in Argentina are roughly 0.50 compared with 0.58 for Brazil and 0.63 in the Mexican market (all figures are based on 2015 statistics compiled by LATAM Airlines Group). In a large country where very long haul bus services are common, the potential for low priced air travel would appear significant.
Elsewhere in Latin America, Copa Holdings capped off 2016 by transitioning the bulk of its Colombian operations to a new low cost brand, Wingo. Copa is adopting a different strategy from LATAM in counteracting LCC proliferation, opting to transition unprofitable routes to a specialist low cost operation Wingo, which unlike Copa Airlines mainline, operates 737s in a single class configuration.
Copa's impetus to create Wingo using Copa Colombia's operating certificate was to reverse losses on routes within Colombia and on international routes from the country. After VivaColombia entered the market in 2012, Copa opted to shrink its domestic Colombian operations, focusing on regional international routes from the country. Copa is also using Wingo to compete directly against VivaColombia on routes to Panama. Both Wingo and VivaColombia operate from Colombia to Panama's secondary airport Panama City Pacific. Obviously Panama City Tocumen remains Copa's mega hub, but Copa is using Wingo as a tool to combat the LCC threat in its home market.
With just four single-class, 142-seat Boeing 737 700s, Wingo represents a small portion of Copa Holdings' operations, about 3% of the company's revenues. But the establishment of Wingo marks a milestone; Copa has opted to adopt the multi-brand strategy to compete with existing and aspiring low cost airlines. If the Wingo experiment is successful, Copa could spread its low cost brand to other markets in Latin America.

Latin American LCC brands ranked by fleet size*

Source: CAPA Fleet Data base
Note: *As of end Jul-2017

For now, Copa seems satisfied with Wingo's early returns. In mid-2017 company executives stated Wingo had already reduced Copa Colombia's losses, and the obvious goal was to transition toward a break even result and eventually sustained profitability. "Otherwise, why do it?" stated Copa CEO Pedro Heilbron. He also acknowledges there is still a learning curve Copa needs to master with its LCC operations.
Indeed, all of the new LCCs that have emerged in Latin America during the last year need to gain a deeper understanding of their respective markets and the evolving competitive responses. LATAM and Copa have established specific strategies to combat the proliferation of LCCs in Latin America.
Avianca, which faces pricing pressure in its largest market from Wingo Colombia, VivaColombia and LATAM's new lower pricing tiers, believes it has the scale to compete with lower cost rivals, and, for now, does not foresee a need to create a separate low cost unit to combat the ever growing budget airline threat.
Although LCC expansion in Latin America is gaining considerable momentum, the collective size of the new entrants remains small. Combined, Wingo, JetSMART, Viva Air Peru and Volaris Costa Rica operated 10 aircraft at the end of Jul-2017. Even adding the total operating fleet of the Viva Group and Volaris, those companies along with the other new LCC entrants represented just 24% of the aircraft operated by the eight Latin American LCC brands.
(Volaris also has operations in Mexico and Viva has brands in Mexico, Colombia and Peru, although there is no coordination between Mexico's VivaAerobus and the Viva airlines operating in the other two countries).
But the possibilities for further expansion by upstart LCCs remain vast, especially given the range of new generation narrowbodies some of those airlines intend to operate. Armed with low cost and new aircraft, the new LCC entrants in Latin America have the potential to trigger market disruption that should ultimately benefit the region's air passenger growth. The larger rivals of the new LCC competitors are recognising their potential for disruption, and adopting strategies to capture their share of passengers stimulated by lower fares.
New upstarts are generating ample intrigue and interest; now they need to deliver on their promise of successfully executing the low cost model in some markets that have historically proven uninviting for budget operators.