Untapped opportunities remain for low-cost airlines beyond the main domestic markets

But even before economic weakness began permeating, the Latin American low-cost sector was concentrated in only three countries - Brazil, Colombia and Mexico. LCCs accounted for 51% of domestic RPKs in the region's largest market, Brazil, in 1H2014 while LCCs accounted for 54% of domestic passengers in the second largest domestic market, Mexico. But the LCC penetration rate in the region's third largest domestic market, Colombia, is still below 10%. Meanwhile LCCs have not yet started to penetrate any other domestic market. Argentina, Chile and Peru are the only domestic markets in the world's top 30 that are currently not served by any LCCs.

Latin American LCC capacity share by carrier: Aug-2014

Source: CAPA - Centre for Aviation & OAG
Note: includes capacity with Latin America and the Caribbean provided only by local LCCs in late Aug-2014

LCCs have also barely penetrated the intra-Latin America international market, where they still account for less than 10% of capacity. There are currently only about 50,000 weekly international LCC seats, the equivalent of about 20 daily return flights, within Latin America (excluding the Caribbean) although most of the markets are within narrowbody range. Not surprisingly this is a market still characterised by high fares.

Progress has been disappointingly slow. The average LCC penetration rate within Latin America (excluding the Caribbean) is only marginally higher than the rate three years ago. Other emerging markets such as Asia have experienced rapid LCC growth, while Latin America's LCC sector has essentially been stalled.

Other emerging markets see frequent LCC launches; Latin America has not had any start-up activity since 2012, when VivaColombia joined Mexico's VivaAerobus as the second Viva affiliate. The Viva Group, which is backed by LCC investment firm Irelandia, has surprisingly not yet made a move in any other markets despite several years of studies.

There are only six low-cost carriers in Latin America - Azul and Gol from Brazil; Interjet, VivaAerobus and Volaris from Mexico; and VivaColombia. Azul and Gol are now the largest, which is hardly surprising given that Brazil is by far the largest domestic market in the region and is the fourth largest domestic market in the world.

The grouping has posted mixed results during the past couple of years, driven in part by the region's slowing economy. In 2013, Volaris joined Gol with a public listing on the New York Stock Exchange. Azul, Interjet and VivaAerobus have also been preparing initial public offerings but have had to put them on the backburner because of the challenging market conditions.

In spite of the economic overhang in Latin America, each of the region's low-cost carriers is creating nuances within their respective businesses in order to remain viable. The most ambitious is Azul's plans to launch international service to the US in late 2014. After its launch, Azul will become the first long-haul LCC in the Americas, a gamble that could have significant implications for Azul and its competitors.

LCC capacity share (% of total seats) within Latin America: 2001 to 8M2014

Source: CAPA - Centre for Aviation & OAG
Note: Central America includes Mexico but excludes the Caribbean

In announcing its plans to acquire six second-hand Airbus A330-200s and five new A350-900s, Azul took the bold move of skipping over narrowbody aircraft and instead creating a new long-haul, low-cost operation that could, if successful, bring about a new dimension of competitive pressure for the country's largest airlines,TAM and Gol. Presently Azul operates a fleet of Embraer 190/195 jets and ATR 42/72 turboprops. As of Aug-2014 a couple of A330s had joined the airline's fleet in preparation for a Dec-2014 launch from the airline's base at Sao Paulo alternative airport Campinas Viracopos to Fort Lauderdale and Orlando. Azul intends to add service from Campinas to New York JFK during 2015.

It is a bold strategy shift for Azul, which remains a young airline after its debut in 2008. Through its own aggressive growth and by acquiring small Brazilian regional airline TRIP, Azul has risen to become Brazil's third largest domestic airline with a 17% market share for 1H2014 (based on RPKs). Gol accounted for a 36% share, giving LCCs a 51% share of domestic RPKs.

With the addition of the A330s, followed by A350s due for delivery beginning in early 2017, Azul will remain the only low-cost carrier in the Americas that does not operate narrowbody aircraft. It has opted to bypass expanding its low-cost brand on regional routes within Latin America and instead launch service to the US.

It is a curious move given the LCC penetration rate on regional international routes within Latin America is still in the low single digits. The US is the largest international market from Brazil, making Brazil attractive to potential long-haul LCCs. But Brazil's second and fourth largest international markets, Argentina and Chile, are easily within narrowbody range.

Making the leap from operating turboprops and regional jets to widebodies is a significant undertaking for Azul. The airline is also charting new territory with its planned configuration for the Airbus widebodies, which will feature a business class with lie-flat seats, economy seats with extra legroom and standard economy seats. Azul's Embraer jets and ATR turboprops are in a single class configuration although it does offer an extra legroom product.

In order for the project to achieve success, Azul needs to offer fares below that of TAM and US carriers, which have pursued ambitious expansion in Brazil over the last couple of years as the market has opened up. Competing against Gol should be easier as it serves Miami and Orlando with a one-stop narrowbody product via the Dominican Republic, which puts it at a competitive disadvantage.

Azul will ultimately also need to forge partnerships to maximise the value of its overall offering. Azul's first three US destinations - Fort Lauderdale, Orlando and New York JFK - are all hubs for JetBlue, which was founded by Azul chairman David Neeleman. If Azul and JetBlue are able to forge a formal partnership - so far there have been no talks - Azul could market JetBlue's network from Fort Lauderdale, while JetBlue could almost instantaneously offer service throughout Brazil from Azul's base in Campinas.

Campinas is strategically located in Sao Paulo state, and the Sao Paulo metropolitan area is the largest source market in Brazil. Campinas is located roughly 100km from Brazil's major international gateway Sao Paulo Guarulhos. The region's other airport, Sao Paulo Congonhas, only handles domestic flights.

Azul maintains a roughly 84% seat share at Campinas, and by possibly leveraging partnerships with US airlines - it has an interline and reciprocal frequent flyer agreement with United - the carrier has an opportunity to position its long-haul product to both connecting and O&D passengers.

Azul's strategy to leverage its extensive network throughout Brazil - it serves over 100 domestic destinations, more than any other Brazilian carrier - to target travellers to and from the US is unchartered territory for an LCC. It is a strategy fraught with risk, the most glaring is funding the expansion. The airline opted not to participate in an initial public offering in 2013 after market conditions weakened. Based on information disclosed by Azul, it recorded annual losses from 2010 to 2012. Azul's long-haul ambitions are a high stakes gamble for the company. But if the airline achieves success with its long-haul low-cost project, it could quickly propel Azul into a much more powerful position within the Americas.

Once Azul enters the market, Gol will face a tough new competitive force on US flights.

Some of Azul's competitors are already attempting to dampen the prospects of its long-haul aspirations. In Jul-2014, Gol added flights from Azul's Campinas stronghold to Miami with a stopover in Santo Domingo in the Dominican Republic. The new Campinas option joins flights from Sao Paulo Guarulhos and Rio de Janeiro to Miami and Orlando via Santo Domingo, which were launched in late 2012.

Gol uses Santo Domingo as a scissor hub for Brazil-US flights. It operates one daily flight to both Miami and Orlando, with one flight originating in Guarulhos and one flight originating in Rio de Janeiro or Campinas, depending on the day. When it began operating the new four weekly Campinas flights, Gol reduced Rio de Janeiro-Santo Domingo from daily to three weekly.

Gol decided to reenter the US in 2012 as part of a strategy to focus more on the international market. Gol operated Boeing 767 widebodies to Miami in 2008 following its acquisition of former Brazilian flag carrier Varig. But that route and other long-haul services were dropped after only a year due to huge losses.

Gol's decision to resume services to the US as well to other Latin American cities such as Santiago is part of an attempt to diversify its business and improve its financial performance, which has suffered as market conditions in Brazil have weakened. Gol recorded annual losses in 2011, 2012 and 2013, and at the beginning of 2014 estimated it had shrank domestic capacity in Brazil by 12% during the last two years.

Gol has stated that in 2013, international services represented approximately 8% of its USD395 million in revenues. The airline has set a target for international services to represent 17% of its revenues in three years. During 1H2014, Gol's international capacity increased 4% and its traffic in international markets jumped 24%. The improvement in its international load factor, which suffered as the airline added capacity in 2013, is an encouraging sign.

Azul's planned service to the US could slow Gol's momentum in international markets as Gol's one-stop service may increasingly become unattractive to Azul's direct flights, especially if the price differential between the two offerings is not significant. In essence, as Azul debuts new flights to the US, Gol's niche could be compromised, and it could find itself weighing the acquisition of widebodies and the associated costs and complexity of operating those aircraft, or exiting the US market.

But Gol's all 737 fleet allows for a simpler and more efficient operation. While the 737 is hardly the ideal aircraft for the Brazil-US market, Gol is alone in connecting Brazil with several international markets within South America and the Caribbean.

The opportunities for LCCs to continue penetrating Brazil's international market are huge. While LCCs have accounted for more than half of domestic in Brazil since 2009, they still comprise less than 10% of international seats in the Brazilian market. This figure will surely rise as a result of expansion from both Azul and Gol - even with Brazil's two LCC giants adopting radically different strategies in pursuing international opportunities.

Brazil international LCC capacity share (% of seats): 2001 to 8M2014

Source: CAPA - Centre for Aviation & OAG

After a quiet 2013, VivaColombia springs to growth in 2014. VivaColombia's debut in the Colombian market during 2012 was the first attempt in Latin America at the cross-border LCC model pioneered in Asia. VivaColombia is the sister airline to Mexican LCC VivaAerobus. Both companies are partially owned by Irelandia and Mexican bus company IAMSA, which at one point appeared to be poised to establish other Viva affiliates in Latin America.

In 1H2014, VivaColombia captured an almost 10% share of the domestic market. The airline has resumed expansion this year after keeping its fleet flat at only five aircraft in 2013.

VivaColombia's expansion in 1H2014 included the addition of Bogota as a new base joining its main base in Medellin. With the new base, VivaColombia introduced service from Bogota to Pereira, Santa Marta, San Andres and Monteri. Those routes joined VivaColombia's existing routes from Bogota to Cali, Cartagena, Medellin, Barranquilla and Bucaramanga.

Initially, VivaColombia opted to avoid having a large presence at Bogota, Colombia's largest airport, concluding the facility was too congested and expensive for its pure low-cost model. But Bogota is largely un-penetrated by LCCs, which account for less than 2% of the airport's seats. Given Bogota's position as Colombia's largest airport, the country's economic strength and a growing middle class, the stimulative opportunities in Bogota are too favourable for VivaColombia to pass up.

During 2014, VivaColombia is also taking the important strategic step of introducing international service within Latin America. The carrier launched flights on 1-Aug-2014 from Bogota and Medellin to Panama City Pacific International airport, which has lower operating costs than Panama's main airport, Tocumen International. VivaColombia has unveiled plans to launch Quito in Oct-2014, followed by Lima in Nov-2014. Both destinations will initially be served from Bogota.

Low-cost airlines have virtually no presence in Panama, Ecuador and Peru, with the LCC penetration rate in all three countries less than 1%. The four international routes targeted by VivaColombia are all strongholds of Avianca and in some cases also Copa or LAN.

Copa, whose subsidiary Copa Colombia largely operates on international routes from Colombia, believes VivaColombia's entry into the Panamanian market will cause little disruption. Copa CEO Pedro Heilbron recently concluded that his airline and VivaColombia serve different market needs. VivaColombia is a point-to-point airline and Copa's strength is leveraging Tocumen as a transit point for other destinations throughout Latin and North America.

There is an opportunity for VivaColombia to leverage the solid local Colombia-Panama market. Even as the distance from its new routes between Colombia and Panama is relatively short, the unpenetrable jungle geography of the Panama Isthmus means that flying is the only viable option for travel between the two countries. There are also large local markets between Colombia and Ecuador and Peru. In announcing Lima, VivaColombia stated that there are 51,000 monthly passengers in the Bogota-Lima market and its entry should grow the market to 70,000 monthly passengers.

VivaColombia appears to have achieved some success in executing its traffic stimulation strategy in the Colombian domestic market. But Colombia's largest airline, Avianca, still enjoys a 60% market share within the country and has continued to grow its domestic traffic at about a 6% rate.

LCCs account for only about 7% of international capacity in Colombia. Almost all of this capacity is flown by US low-cost airlines JetBlue and Spirit, which combined operate about 50 weekly flights to Colombia. Mexico's Interjet also operates one daily frequency from Mexico City.

VivaColombia has a huge opportunity to stimulate demand on international routes within South America. If successful in markets such as Ecuador and Peru, VivaColombia's shareholders may even be persuaded to finally launch a third franchise.

VivaColombia has not yet had any coordination or cooperation with its older Mexican sister carrier, VivaAerobus. It is not clear if that will change in the short term, as each airline seems to be pursuing opportunities to grow both domestically and internationally in their respective home markets without examining the benefits of a tie-up. With such potential upside in the growth of travel among the middle classes in Mexico and Colombia, at some point it would seem logical for the two airlines to work together more closely to ensue the Viva group is well positioned in Latin America over the long term.

VivaAerobus plans to expand its US transborder footprint in 2014. For now, VivaAerobus is focusing its international operation on the US market. The LCC recently unveiled plans to introduce service in late 2014 from Monterrey to San Antonio and from Guadalajara and Cancun to Houston. It is also planning to resume service from Monterrey to Las Vegas after exiting the market in early 2013. VivaAerobus only operates one international route, Monterrey-Houston, although previously it had forays in several other US markets including Austin, Chicago, Miami, Orlando and Las Vegas.

VivaAerobus is making another attempt to expand its presence in the US-Mexico transborder market, as demand in the domestic Mexican market has become weaker and pricing traction has evaporated. Both Aeromexico and Volaris have been battling weak domestic yields for the better part of a year, and have opted to deploy the bulk of their capacity growth to international markets, where pricing is more healthy. VivaAerobus appears to be adopting the same tactic.

VivaAerobus' overall growth during the last couple of years has been slower than its Mexican LCC counterparts. VivaAerobus recorded 4% domestic passenger growth in 2013 compared with 21% for Volaris and 16% for Interjet. In 1H2014, VivaAerobus' domestic passenger traffic shrunk by 1% while Interjet recorded 4% growth and Volaris grew by 11%.

However, in 2Q2014, VivaAerobus began an ambitious fleet renewal and expansion programme after taking delivery of its batch of A320s. The A320s will likely support the international expansion given their fuel efficiency improvement over VivaAerobus' fleet of 18 737-300s. The A320s are also configured with 32 more seats than the carrier's 737-300s. In late 2013, VivaAerobus placed an order for 52 Airbus narrowbodies (12 A320neos and 40 A320neos) and intends to complete its transition to an all Airbus fleet by the end of 2016. It has also leased several A320neos.

VivaAerobus will face competition from United on its new service from Houston to Cancun and Guadalajara. The LCC has the advantage of tapping its point of sale ability in Mexico and stimulating traffic as it will likely offer lower fares than United. VivaAerobus adds an interesting layer to the competitive dynamic on the routes from Monterrey to San Antonio and Las Vegas. Those routes are served by Aeromexico and Interjet. Aeromexico is a full service airline while Interjet is more of a hybrid LCC, offering roomier pitch than VivaAerobus or Volaris with leather seating. Interjet targets more corporate passengers than its Mexican LCC peers.

Mexico international LCC capacity share (% of seats): 2001 to 8M2014

Source: CAPA - Centre for Aviation & OAG

With VivaAerobus offering a pure low-cost product, perhaps it can also stimulate traffic. But it competed with Aeromexico and Interjet prior to ending Monterrey-Las Vegas in Jan-2013 - as well as in some of its other earlier US routes - so success is far from a given.

The Mexico-US market is highly competitive and served by several US LCCs as well as all three Mexican LCCs. Mexico's international market has a much higher LCC penetration rate, about 22% more, than any other Latin American market. But this is driven almost entirely by transborder routes. Mexico's international LCC penetrate rate was only about 7% five years ago - before Volaris and Interjet launched international services (US LCCs have also expanded in Mexico in recent years).

All of Volaris' and VivaAerobus' international capacity is in the US market, as is more than half of Interjet's international capacity. North American LCCs have about 130,000 weekly international seats to Latin America but nearly all of this capacity is allocated to Mexico and the Caribbean.

Even as each of Latin America's LCCs is undertaking various changes and expansion during 2014, the region as a whole remains under-penetrated by the low cost business model. The continued lack of penetration in the intra-Latin American international market and in medium size domestic markets is particularly puzzling.

The recent international moves by VivaColombia and Azul are encouraging but represent very small initial steps in bringing up the international LCC penetration rates. Much more needs to be done by Latin America's LCC sector in response to the latent demand among the region's burgeoning middle class.

Perhaps potential upstarts for now are waiting on the sidelines, opting to observe the impending moves by Azul and VivaColombia before committing the resources to compete with Latin America's powerful airline groups LATAM, Avianca and Copa. It is now up to Azul and VivaColombia to prove that increased competition is healthy, and more importantly, profitable.