31-Dec-2012 8:00 AM

Eight North Asian low-cost airline trends to watch in 2013

Analysis

It certainly took North Asia some years to have momentum for low-cost airlines that was anything like booming Southeast Asia. 2012 delivered on that with three new LCCs launching in Japan and plans underfoot in Hong Kong for Jetstar Hong Kong as well as a possible transformation of Hong Kong Express into a LCC. While elsewhere the region may not have gone as far as producing LCCs, there is active discussion of having LCCs and the reforms needed to welcome and support them.

Talk is strongest in Taiwan, which has seen considerable growth from LCCs in North and Southeast Asia. South Korea is considering how and when its LCCs can become better competitors, shedding some of the comforts they have been unwilling to charge passengers. Japan will see growth, from existing LCCs and new ones, a challenge for incumbents. Reforms in China may enable LCCs in the future to launch, while all LCCs are watching how to be hybrid and chase yields. These are eight North Asian LCC topics to watch for in 2013.

South Korea: will stagnating LCCs see a revitalisation?

The first LCC North Asia push was in South Korea, a result of the entry of Jeju Air mid-last decade. The carrier became South Korea's only third airline. A launch on domestic services where sectors are short allowed its service to be simple, leaving the carrier with a mixed identity, although it gradually saw itself as a LCC.

Jeju Air's success prompted responses from Asiana and Korean Air, which launched Air Busan and Jin Air, while entrants like T'way and Eastar Jet entered. All are LCCs, but are so-called "Korean-style" LCC where baggage and light refreshments, amongst other perks, are still offered. Respect in Korean society is high and there has been hesitation to introduce ancillaries for fear of upsetting passengers.

The Korean-style LCC format has had varying success on profitability, with the off-shoots and large Jeju Air reporting more success than T'way and Eastar Jet, which at times have had a dim outlook. (737 operator T'way was born from defunct turboprop carrier Hansung Airlines.) A clearer attitude about market positioning, with resulting implications to follow appropriate revenue streams (ancillaries) would have helped years ago, but now must become the focus.

Peach Aviation and AirAsia Japan, two of Japan's three new LCCs in 2012, are serving South Korea with their full ancillary works. The third new Japanese LCC, Jetstar Japan, will very likely enter Korea when it launches international services in 2013. Japan-Korea is a key market for the Korean LCCs, so they must be able to compete effectively. That will mean having a lower cost base (in theory, given Korea's lower labour cost, they could undercut a Japanese competitor) and pursuing ancillaries.

The pressure is not from Japan alone. The South Korean market has exposure to Malaysia's AirAsia X and Philippine LCCs Cebu Pacific and Zest. Scoot, from Singapore, would like to serve Korea but there is no room in the Singapore-South Korea bilateral.

South Korea LCC capacity (seats) by carrier: 31-Dec-2012 to 6-Jan-2013

The Korean LCCs are realising their position needs to change, although the view varies by carrier. Jeju Air, which has received a new CEO, Kyu Nam Choi, wants to actively pursue ancillaries and make Jeju more competitive given the pressure, but is unsure how the market will respond. "Competing with the Jetstar and AirAsias of the world is very concerning," Mr Choi said.

As CAPA previously wrote:

Resistance to break the status quo of service on Korean carriers reflects larger Korean society where leadership - in technology, for instance - is strong but innovation is not. Once other countries test the waters - Japanese companies in televisions - Korean companies adopt. Samsung, through what a court has judged infringement of Apple patents, doubled its smartphone marketshare in a year.

That basic evolution looks likely to be replicated in Korean aviation. Knowledge of LCC CASK nuances may not be rife, but perhaps unlike other sectors, Korean LCCs want to change. Holding them back is self-restraint as they caution of evolving ahead of what they see as market acceptance, which could cause the huge dishonour of losing face.

"We get tempted to apply that bare bones model to our structure but we think it may be better for us to wait. Instead of us leading the public, we would like the public to get accustomed to the LCC model in different scales," Mr Choi said.

The concern is that Korean LCCs are losing their advantage in making changes and will instead have to do so under duress. It remains to be seen what domino affect will occur: an independent LCC like Jeju making changes could see the other independents, Eastar and T'way, respond more quickly than the off-shoots of Air Busan and Jin Air.

Foreign entrance seems unlikely. T'way, which has been on the market for some time, attracted interest from AirAsia in a bid to establish AirAsia Korea, but the deal did not pan out, likely to the frustration of AirAsia. Instead Yearimdang Publishing on 18-Dec-2012 acquired 73.2% of T'way Airlines shares for KRW7 billion (USD6.5 million), increasing its stake from 9.6%.

Singapore-based Tiger Airways Group in 2008 tried to launch Tiger Airways Incheon (based at Incheon airport) but the plan got scuttled amongst fears bordering on xenophobia. Established LCC brands increasingly prefer to start from scratch rather than take on an existing operation and its baggage. Until there is a sharp change in the political climate in Seoul for new and foreign start-ups, other pan-Asian LCCs (busy with ventures elsewhere) will likely stay away, perhaps less by choice than force.

Taiwan: absent of indigenous LCCs but filled with talk of them, will any form?

LCC fervor has hit Taiwan, largely a result of TransAsia. The carrier is agile and young and has the potential to be a hybrid or possibly adapt a dual-brand strategy of making itself a full-service carrier and having a LCC. The discussion has not always been focused, as TransAsia suggested all Taiwanese carriers partner on a single LCC, although this statement may have been made more to get discussion rolling than as a serious proposal.

If so, it has worked as Taipei has accelerated plans to support a low-cost carrier terminal. Taipei had considered converting the present terminal building into a LCCT once terminal three is completed around 2018. Now the airport holds the view it could use an old hotel building as a LCCT on a considerably shorter timeframe.

The government has also stepped in, saying it would support indigenous low-cost carriers, although there are some details that await clarity. Further initiatives across the sector will be needed, too. EVA Air in 2012 mulled over transforming regional carrier Uni Air into a LCC but ultimately decided against the concept. The global suggestion is that taking costs out is an exceptionally difficult task, one that few airlines have succeeded in doing.

The preference is to start from scratch. China Airlines earlier in 2012 had opposed LCCs on the grounds the environment was not right with regards to regulatory support and matters like LCCTs. But with that now changing, the carrier will need to make room for evaluating LCCs at the same time it pursues significant change at its full-service operation.

As foreign LCCs continue to expand in Taiwan, the pressure on the local carriers will continue to mount. Scoot in Sep/Oct-2012 launched services to Taipei from its Singapore base as well as Tokyo Narita, making it the largest LCC serving Taiwan. For now the LCC penetration rate in Taiwan remains the lowest in all of Asia - just 5%. Change is inevitable and 2013 could be the year.

Taiwan LCC capacity (seats) by carrier: 31-Dec-2012 to 6-Jan-2013

Hong Kong: how do the first LCCs enter - and what does Cathay do in response?

Hong Kong, like Taiwan, was virgin LCC territory - and not only that, but largely dominated by Cathay Pacific. But change is now happening, and quickly.

Jetstar Hong Kong aims to launch services in mid-2013, Hong Kong Airlines is mulling over a transformation to Hong Kong Express to make it a LCC, and mainland Chinese budget carrier Spring will have a larger presence, either with routes on its existing Chinese AOC or perhaps a new Hong Kong AOC. There may even be more entrants in due course.

Jetstar Hong Kong faces lobbying against it from Cathay Pacific. The final decision on its approval may very well come down not to Hong Kong authorities but those in Beijing. The relationship between Hong Kong and the mainland is still one of pushes and pulls, and Cathay is hoping its influence, and that from Air China (its equity and strategic partner) will sway the decision.

Air China has an additional vested interest in particular as Jetstar Hong Kong is a joint venture between Australia's Jetstar and China Eastern, Air China's deepest competitor. The situation is fluid in Beijing, however, with a changeover in the CAAC likely. The CAAC has been aligned to Air China's interest following the carrier's chairman moving to the CAAC, but balance may be on the cards with the next administrator to come from China Eastern. But an even higher figure could be swayed by Air China and Cathay.

If and when Jetstar Hong Kong secures approval, routes are for the picking, with yields high and competition little. Slots are becoming crowded, limiting efficiency, but there is opportunity.

Some of that opportunity, however, lost momentum with Spring Airlines in Nov-2012 announcing a fairly aggressive initial expansion to the Hong Kong market by linking the city with four new mainland ones. Some were to be initial Jetstar Hong Kong destinations. Spring's fares (including luggage, which is standard for the carrier) are well below 50% the rates offered by Dragonair, Hong Kong Airlines and mainland carriers.

While Spring will need to see yield growth to be profitable, the low entry fares are a stark reminder of what new competition can do. Some routes on high-cost carriers were under pressure before Spring's entry as they relied on some transfer traffic, especially from Taiwan, that is increasingly going into mainland China on direct routes.

Spring is now the sixth largest LCC in the Hong Kong market, where LCCs account for just 6% of total capacity.

Hong Kong LCC capacity (seats) by carrier: 31-Dec-2012 to 6-Jan-2013

Hong Kong Airlines in 2011 announced that in 2012 it would transform its Hong Kong Express brand into a dedicated LCC. Under the plan Hong Kong Express would replace its 737-800s with A320s. Those plans did not eventuate but the carrier in local reports in late-2012 said the plan is once again on, this time for 2013.

Should it pan out, Hong Kong Airlines will need to dedicate resources to thoughtfully construct a LCC at the same time it is undergoing significant growth of its own. The experience of itself, and that of part-owner Hainan Airlines in China, is in full-service carriers, not low-cost, so there will be a learning curve to experience at the same time developed LCCs like Jetstar Hong Kong and Spring are on its doorstep.

None of these moves bode well for Cathay Pacific, which is seeing its long-haul network come under its own pressure as other carriers grow in that space. Cathay has taken a decidedly anti-LCC view, although deep down this may be more a result of the carrier prematurely and boldly taking that view a decade ago and feeling it cannot back down from it. Cathay Pacific's wholly-owned subsidiary Dragonair does offer lower costs but it is still a full-service legacy carrier. Change is needed.

Japan: as three new LCCs expand, how does Skymark adapt, and what is the impact on ANA and JAL?

The impact from LCCs on their full-service counterparts is a universal one, and in Asia will be playing out prominently in Japan as legacy carriers All Nippon Airways and Japan Airlines adjust to LCCs being on their doorstep, even if they partially own the LCCs. While Japan had seen new entrants sometimes styled as LCCs, in absence of a better term, they have not been fully low-cost.

Skymark is making the biggest initiatives of the lot, which also includes Starflyer and Solaseed, which are closer to hybrids or even full-service carriers, but it faces its own strategic decisions. Its plan to launch full-service long-haul A380 services will require feed and a different service and strategy mindset than a low-cost operation. Skymark has secured a footing in Japan, but the new LCCs are aggressive.

There have been upsets. Jetstar Japan has had to slow down expansion after it did not follow internal maintenance procedures, which were more encompassing than Japan's basic procedures, which it did follow. The decision to hold on expansion was mutual, and avoided Japan's notably conservative regulators having to hand down a decision. The news received more attention that perhaps warranted, owing to the Australian media's fixation on slamming airlines, especially the low-cost ones talkative unions do not like.

AirAsia Japan in Dec-2012 underwent a CEO changeover. While details are limited, there are hints the career ANA executive did not bode well with the younger and agile AirAsia (ANA and AirAsia own stakes in AirAsia Japan). JV relationships always carry risk, especially when the cultures mixing are so different.

Going forward, it remains to be seen how the push and pull at AirAsia Japan occurs between AirAsia and ANA. Jetstar Japan is firmly in the hands of Jetstar, which investors welcome, not wanting a stereotypical legacy carrier interfering with a sensitive operation like a LCC. Peach has noted one of its first decisions was to ensure ANA did not have a majority stake.

Hiccups are to be expected, but the growth potential is still strong. Jetstar Japan will open a base at Osaka Kansai, its second, while AirAsia Japan is likely to select Nagoya as its second. As the carriers spread and plot substantial growth, they will be carving different sections of the country, but the overwhelming impact is what that will do to their legacy incumbents. JAL is preparing to decrease domestic capacity, seeing it being eaten up by LCCs, which ANA is slowly coming to terms with too, but the carriers are perhaps not prepared to recognise the changes that will be needed after they unleashed LCCs.

See related articles:

Japan LCC capacity (seats) by carrier: 31-Dec-2012 to 6-Jan-2013

Japan: how will Spring Airlines fit in with a subsidiary based at Tokyo?

Markets are seldom calm, and amidst the seismic changes occurring in Japan with the existing LCCs, Spring Airlines is planning to establish in Japan its first foreign base. The carrier lags on a first mover advantage, and is not as developed in LCC tactics as AirAsia and Jetstar. But overall there is still huge latent demand Spring could tap into with the right strategy. While AirAsia Japan, Jetstar Japan and Peach are so far flying to and from major cities, Spring will likely be based at Tokyo Narita and serve secondary Japanese cities, which can lower costs but is a concept not yet fully embraced by the Japanese.

As CAPA previously wrote:

The Japanese base will enable Spring to more easily serve other Chinese cities. "If we can set up a company in Japan that can pick up passengers from China, that would be good for us," Spring CFO Johnny Lau said at CAPA's Financing the Asian Revolution in Macau on 7-Sep-2012. In addition to any Chinese regulatory issues (outside of sheer air rights; China and Japan recently agreed to an open skies agreement) on further international expansion, flights on Spring's Chinese AOC from cities other than in its bases/focus cities -Shenyangand Shijiazhuang - could require a branch company to be established, adding costs.

While a Japanese affiliate will have higher costs on China-Japan routes than Spring's Chinese AOC, the affiliate may be the only way to access those markets. Additionally, while Spring is lean compared to Chinese legacy carriers, government restrictions - such as personnel structure - have prevented Spring from achieving as much efficiency as it would like or would be possible in other markets; it averages approximately 160 staff per aircraft. So Spring may not be as low-cost on the labour side as one would assume for a Chinese carrier (plus salaries are rising across the board at Chinese carriers, often with double-digit increases).

Mr Lau said Spring will also have a domestic network. This is partially due to the regulatory time required to be approved for international services, with China typically taking longer than other countries. The short and medium term focus for the Japanese subsidiary will be domestic services and flights to China with Mr Lau saying that after a few years the Japanese AOC will also consider international flights to countries other than China. A launch date is not set yet, but the ownership of the affiliate will include a minority shareholding from Spring (as is common elsewhere, majority foreign ownership is not permitted) with the remaining held from non-airline Japanese companies. AirAsia Japan and Peach Aviation have ownership ties to ANA while Jetstar Japan has ownership ties to JAL.

Spring has discussed a Japanese affiliate for over a year but no longer holds a first move advantage. "We are one year late in Japan but that may not be bad," Mr Lau said.

Discussions of brands amongst the Japanese LCCs, in operation and formation, is high. Each claims an advantage over the other, but it will be some time before trends emerge.

See related articles:

China: what is next for Spring Airlines, evolving and moving away from 'LCC' connotation?

Spring Airlines is effectively China's own LCC and by its own calculation punches above its weight. It is agile and efficient, especially when compared to its bloated legacy peers that have been weighed down with mergers and bureaucracy. Yet being a private carrier has seen it, like others (Hainan and Juneyao) receive no favouritism or be downright disadvantaged: Spring lobbied hard and long for permission to serve the trunk Beijing-Shanghai route, and when it was given permission it was only for one flight a day at off-peak hours.

Spring is also finding the term "LCC" may not bode well with Chinese authorities, perhaps on grounds of suspicion that LCCs globally are associated with being disruptive forces that prompt deep and fast re-thinks at legacy peers.

Independent of that, Spring has moved away from a bare-bones LCC model, quickly hybridising as it pursues yields. That is allowing it to style itself as a value carrier, further moving away from the LCC phrase. Besides new routes to Hong Kong and a base in Japan, Spring is interested in establishing a base at Kunming in China's southwest, a hotbed of growth potential, especially to South and Southeast Asia.

China LCC capacity (seats) by carrier: 31-Dec-2012 to 6-Jan-2013

China: will reforms enable more LCCs to launch?

China is seen as the endgame for LCC operations in Asia. A vast domestic market, it also supports international sectors in markets from North Asia to Southeast to West Asia. While Air China has studied LCCs and stated it wants more LCC experience, and has likely had some discussions with Tiger Airways, the regulatory mood is unlikely to be one not conducive to mainland LCCs, unless it is Air China doing the asking.

Like in Taiwan, but more deeply so, significant change will be needed in China to not only support LCCs but to ensure legacy carriers can compete against them. As CAPA's strategy journal Airline Leader wrote:

A further important ingredient of balanced supply and demand is the CAAC's domestic fare regulation. It has set a price of RMB75 cents (USD12.0 cents) per one-way kilometre, with carriers allowed to charge upwards of 25% more or 45% less, giving a range of USD6.6-15.0 cents per kilometre. As evidenced by the Big 3's domestic yields, average fares fall slightly under the target price.

The CAAC in 2012 quietly suggested it would end domestic fare regulation, something it has already done so internationally. Deregulation would likely have a greater impact in the long-term than short-term, as Chinese carriers could fully hone revenue management practices, which would benefit their international markets. With domestic load factors - previously relatively low - hovering around 80%, stimulation opportunities would not be great, except perhaps for quieter periods.

Fare deregulation could deliver to the domestic market the behaviour passengers are coming to expect from foreign low-cost carriers that set rock-bottom launch fares or special sale fares. Critically, Spring Airlines, the only notable domestic LCC, would gain experience with this - as would full-service carriers, who will one day have to contend with greater domestic LCC competition.

...

If LCCs are to become an effective force in China, economic regulatory overhaul and streamlining is needed in many important areas to allow greater efficiencies:

• Removal of price controls
• Management ability to streamline staff
• Loosening aircraft acquisition (and de-coupling purchases from China's grand five-year plans, which do not align to airframe manufacturers' backlogs)
• Breaking TravelSky's GDS monopoly on domestic carriers (regulations have loosened for foreign carriers)
• Airport fees
• Low-cost facilities
• Route applications, among many others

See related articles:

Hybridity: how do all LCCs evolve, and in doing so, chase yields and higher profitability?

Irrespective of market, LCCs are evolving, and typically becoming hybrid operations as they move away from being dogmatic about cost at all expense to instead see how they can be more profitable. A decade ago a LCC codesharing or having lie-flat beds would have seemed contrary (and to some, it still does) but these are just some of the evolving moves occurring. The advanced carriers will look for new opportunities while those that are more simple will look to join the crowd.

There is no textbook to hybridity, but a number of carriers are closely watching plans from Lufthansa - perceived to be one of the best when it comes to analysis and keeping its house in order - to transform its wholly-owned low-cost subsidiary Germanwings. Besides implications for LCCs, the move may spark momentum for carriers to change their full-service operation, with implications on a new scale for LCCs.

See related articles:

Outlook: Themes of opportunity and change

Asia has yet to have calm years and, aside from a few and brief periods, lack of growth opportunities. Growth abounds in North Asia and many LCCs are positioning to take it up. They will require change, sometimes wilfully to pursue better yields, and other times to accommodate partners or governments.

The story is overall upbeat and exciting for them, but for legacy incumbents the challenges are bigger and the responses, so far, fewer.

Eight North Asian low-cost airline trends to watch in 2013

South Korea: will stagnating LCCs see a revitalisation?

Taiwan: absent of indigenous LCCs but filled with talk of them, will any form?

Hong Kong: how do the first LCCs enter - and what does Cathay do in response?

Japan: as three new LCCs expand, how does Skymark adapt, and what is the impact on ANA and JAL?

Japan: how will Spring Airlines fit in with a subsidiary based at Tokyo?

China: what is next for Spring Airlines, evolving and moving away from 'LCC' connotation?

China: will reforms enable more LCCs to launch?

Hybridity: how do all LCCs evolve, and in doing so, chase yields and higher profitability?

Outlook: Themes of opportunity and change

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