Japan's expanding LCCs drive growth but need cultivating; Spring Airlines and AirAsia re-entry loom

LCCs flew 17% of domestic passengers in Japan in 2013; 2014 capacity is 24%

The latest data from regulator MLIT is for the first three quarters of FY2013 (the year to 31-Mar-2014) and shows LCCs carried 17% of passengers. This is led by Skymark with a 7% total share, more than the combined 6% figure of Jetstar Japan, Peach and Vanilla Air. Grouping in Japan's "new entrant" carriers (including Skymark) that officially are LCCs but offer frills (unlike Jetstar Japan, Peach and Vanilla) brings the total to 17%. This figure is suppressed due to AirAsia Japan's cessation of services and slow build-up from its successor, Vanilla Air.

Share of domestic Japanese passengers by carrier: Apr-2013 to Dec-2013

Source: CAPA - Centre for Aviation and MLIT

While this 17% share is a solid proportion compared to the sub-5% LCC penetration rates as recent as 2009, this segment is still a fragmented market.

ANA accounts for 49% of domestic passengers while JAL (including subsidiary JTA) holds a 32% share. Comparing Jetstar Japan's 3% share or Peach's 2% share seems especially small. But it is these new LCCs that are growing, and in early 2014 they account for 24% of domestic seat capacity in Japan, a nearly unimaginable threshold a few years ago.

LCC Capacity Share (%) of Total Domestic Seats in Japan: 2001 - 2014*

* Year to Month indicated
Source: CAPA - Centre for Aviation with data provided by OAG

Japan's three new LCCs accounted for 43% of growth; the domestic market was up 9%

In the first nine months of FY2013 domestic passenger numbers are up 9% - an envious performance for many markets, but especially considering the limited economic growth and population challenges in Japan. This 9% growth figure follows an encouraging FY2012 where the market, with help from LCCs, grew for the first time in six years. But even with this growth, Japan's domestic market is well below is heyday. While it is important to keep a historical perspective, bygones are bygones. The new reality is Japan is growing again with much help from LCCs.

The LCCs are punching above their weight in terms of growth. Despite Jetstar Japan and Peach being a fraction of the size of JAL and ANA, Jetstar Japan carried almost as many new passengers in the first nine months of FY2013 as JAL did. Peach carried almost as many new passengers as ANA. So while the heavyweights retain their mighty position, the LCCs are sprouting quickly.

Additional domestic passengers carried by airline: Apr-2013 to Dec-2013

Source: CAPA - Centre for Aviation and MLIT

It is true LCCs tend to have faster growth in their early years. But there is medium- and long-term confidence of their future. A few more years of even moderate growth translates to tangible gains. Further, while ANA and JAL are in growth mode domestically, they predict medium- and long-term declines. Not only will the LCCs grow their position, ANA and JAL will decrease theirs - marginally, but still enough to continue to inch the domestic market towards using LCCs more.

See related report: LCCs help Japanese domestic market grow for first time in six years, but market situation still dire

Spring Airlines Japan will launch in Jun-2014 from Tokyo Narita

Despite the growth spurt, there may very well be future expansion constraints on existing LCCs. Jetstar Japan's parent Qantas Group is being increasingly conservative while Vanilla Air is bedding down from its transition.

Japan itself is still adjusting to LCCs. The no-frills concept is new and early poor on-time performance (standard for any other market, but low by Japan's exceptionally high standards - ANA was awarded the world's most punctual airline) has created a lasting negative impression that is only slowly being cast off.

Aside from the influx of three new LCCs, two new LCCs are on their way. The first is Spring Airlines Japan, a JV with China's Spring Airlines (China's largest and earliest LCC) that marks Spring's foray into the pan-Asia strategies of AirAsia and Jetstar (but potentially with a greater focus on the Chinese market). The carrier launches on 27-Jun-2014 with three domestic destinations served by three aircraft.

Spring is slightly modifying its logo by having a flower in the background of its standard green emblem, a "localisation" not seen as AirAsia, Jetstar and Tigerair groups have established new subsidiaries.

Spring Airlines Japan logo: Apr-2014

Source: Spring Airlines Japan

This is one known example so far of how Spring Airlines wants to localise its product, learning from AirAsia and Jetstar who, Spring believes, came in without locally-tailored solutions. Spring feels its North Asian, not Southeast Asian or Australian, heritage makes it better suited to the Japanese market.

While Spring has found great success in China, it continues to not only grow in China but innovate, requiring resources and attention. Spring will however need significant management bandwidth to operate two airlines. Japan will be unforgiving for any shortcomings, although the Chinese consumer also has high expectations - potentially more so than in Southeast Asia.

AirAsia Japan and Jetstar Japan promoted their existing brand presence in Japan (AirAsia via AirAsia X and Jetstar via Jetstar Australia services), but unaligned Peach was also able to secure a following despite being an entirely new airline. Spring Airlines has been operating between China and Japan, but how much this has done for its brand awareness - and loyalty - will become clearer in coming months.

Spring will operate 189-seat (maximum certified limit) 737-800s. This is a change from its all-A320 fleet in Japan.

The highly pragmatic Spring explains the selection as there is greater support in Japan for Boeing aircraft given the dominant position Boeing has enjoyed, although A320s are the choice of Jetstar Japan, Peach and Vanilla Air - and are increasingly common. Other likely factors are possibly Japanese passengers being more familiar and comfortable with Boeing aircraft (safety conservatism is exceptionally high) as well as Spring wanting to use aircraft from both manufacturers to ensure discounts. The airline has major long term expansion plans.

Spring announced its Japanese subsidiary in 2012 and will finally, after some delays, launch in Jun-2014 on three routes from a base at Tokyo Narita. Jetstar Japan and Vanilla Air are also based at Narita whereas Peach is based at Osaka Kansai. Jetstar Japan and Vanilla Air targeted major destinations initially, such as Sapporo and Fukuoka.

Spring Japan however is aiming for smaller destinations that are not trunk routes. Saga does not see competition from Narita while Spring's other two initial destinations - Hiroshima and Takamatsu - see limited competition (from both Narita and Haneda) of about 5-11 daily flights, compared to dozens that go for example from Tokyo to Sapporo (Japan's largest route). While these destinations may see less competition, they also see a potentially smaller travelling size. But arguably many of Japan's smaller destinations hold greater growth percentage opportunities by low air fare stimulation. As can be the case in other markets, trunk routes have lower yields than services to secondary cities.

Spring's launch fares are much lower (about half) than ANA or JAL's, but are there are no zero dollar fares. This also averts a negative fare war.

In selecting Saga and Takamatsu, Spring is also gaining scale as its Chinese AOC serves Saga and Takamatsu from Spring's Shanghai Pudong base. It is unclear what, if any, connecting opportunities will be available to reach Tokyo from Shanghai via Saga or Takamatsu on a Spring China-Spring Japan combination. Sprirrng serves the (much) greater Tokyo area with a service to Ibaraki.

Spring Airlines Japan launch summary: 03-Apr-2014

Route	Frequency	Launch	Competition from Narita	Competition from Haneda	Spring Japan launch fare (one-way incl. taxes)	Competitor's lowest fare (one-way incl. taxes)
Tokyo Narita-Hiroshima	2x daily	27-Jun-2014	ANA 2x daily CRJ	9x daily A320/767/777-200/787	JPY5690 (USD54.85)	ANA: JPY10690 (USD103.04)
Tokyo Narita-Saga	2x daily	27-Jun-2014	None	ANA 33x weekly A320/737/787	JPY5700 (USD54.94)	ANA: 10290 (USD99.07)
Tokyo Narita-Takamatsu	2x daily	27-Jun-2014	Jetstar Japan 2x daily A320	ANA 6x daily A320/767/787 JAL 7x daily 737-800	JPY5630 (USD54.20)	Jetstar Japan: JPY4590 (USD44.24) ANA: JPY10690 (USD103.04)

Source: CAPA - Centre for Aviation, companies and OAG
Note: Schedule and fare data for late Jun-2014. ANA Saga fares available only through Jun-2014; fare listed is for Jun-2014 travel.

JTB, Japan's largest travel agency, invested 5% in Spring Airlines Japan

Spring Japan says it has capital of JPY6 billion (USD57.8 million) with Spring China taking an unspecified ownership level. Japan caps foreign ownership at 49%. One local investor with a 5% share is JTB (others are undisclosed). While this is a small share, it comes from Japan's largest travel agency - a potentially powerful relationship in a market where travel agencies are still very common.

Another large agency, HIS, has a leading stake in Skymark as well as Thailand's Asia Atlantic Airways, which caters to the expanding Thailand-Japan market. JTB CEO Hiromi Tagawa told local outlets that its Spring Japan stake is modest and helps it secure seats for package tours, which it expects to increase in the lead up to the 2020 Olympics in Tokyo. Mr Tagawa does not believe ANA and JAL will contribute to market growth. ANA and JAL are increasingly focusing on the international market, and in the medium-term will decrease domestic capacity.

Domestic destinations are the initial focus for Spring Japan, which will later target international markets - especially China

Spring Japan expects to add two 737s in 2014 to end the year with five aircraft and then grow by five aircraft a year, ending 2017 with a fleet of 20 aircraft. While the carrier will continue expansion in the domestic market, Spring will also look at the international market, and in particular the China-Japan market. Spring Airlines with its Chinese AOC faces restrictions on the Chinese side of what China-Japan routes it can serve. A Japanese AOC averts this problem, making Spring's Japanese unit (along with Hainan's purchase of a French carrier) a new type of foreign JV.

See related report: Chinese airlines pioneer new international strategies: JVs to overcome internal limitations

The China-Japan market will be large for Spring - and potentially its largest - but Spring Japan is expected to serve other regional Asian destinations. This will help boost Japan's international LCC penetration rate, which as is often the case lags the domestic figure.

LCC Capacity Share (%) of Total International Seats to/from Japan: 2001 - 2014*

* Year to Month indicated
Source: CAPA - Centre for Aviation with data provided by OAG

See related reports:

• Spring Airlines moves to establish Japanese base while ANA sees cannibalisation from new LCCs
• Spring Airlines embarks on pan-Asian strategy with establishment of Japanese subsidiary

AirAsia Japan considers re-entry after ending its ANA affair; Toyko will not be its base

The AirAsia Group is planning to re-enter Japan. AirAsia originally launched Tokyo Narita-based AirAsia Japan in Aug-2012 in a 49%/51% joint-venture with All Nippon Airways. While ANA already had a minority interest in Osaka Kansai-based Peach Aviation, ANA saw fit to partner with AirAsia rather than have AirAsia partner with a competitor, namely Skymark. The driving logic was that it was better to cannibalise your business than let someone else do it.

AirAsia and ANA had early clashes of style and operating culture. AirAsia saw ANA as not practicing cost discipline while ANA saw AirAsia being unaware that what worked in Southeast Asia could not simply be transplanted in Japan; one sticking point for ANA was AirAsia's unwillingness to embrace local distribution methods unique to Japan. AirAsia Japan's performance consequently lagged Jetstar Japan's despite their very similar route networks. While ANA held a majority share, AirAsia was effectively trying to run the airline. With a different ownership profile, Peach foresaw the need to limit airline influence and intentionally kept ANA's involvement to a minority position. Likewise in Jetstar Japan, JAL has a minority share, although JAL and Jetstar Japan coordinate network development.

AirAsia and ANA in mid-2013 broke ties, with ANA buying out AirAsia's stake and the operation ending in Oct-2013, with aircraft returned to AirAsia and the airline no longer using the AirAsia brand. ANA re-launched the carrier in Dec-2013 as Vanilla Air.

Public details about AirAsia's re-entry are scant, but the carrier has said it will not base itself at Tokyo Narita. Nagoya could be a possibility: AirAsia Japan launched a base there prior to its dissolution, and AirAsia Group CEO Tony Fernandes praised Nagoya's willingness to welcome LCCs. Nagoya is also a 24-hour airport and is also the sole airport in the region, unlike in Osaka and Tokyo where the LCCs have gone to the more inconvenient airport (but where slots are available), putting them at some disadvantage.

AirAsia's local partner is believed to be a travel agency, which could have been an influence for JTB to invest in Spring Airline. AirAsia is unlikely to partner again with an airline, having learned from its time with ANA.

Japan could be home to five new LCCs, but it seems each will have their own niche

AirAsia Japan's re-entry would mean five new LCCs have started in Japan in three years. Japan is the third-largest domestic market in the world, and it seems the five LCCs are carving niches based on international or domestic focus and operating base.

Summary of Japan's new and proposed LCCs: 03-Apr-2014

Airline	Airline Affiliation	Primary Base	Fleet	Domestic/International ASK Split	Outlook
AirAsia Japan - proposed	Unknown but unlikely	TBC, not Tokyo Narita	TBC	TBC	TBC
Jetstar Japan	JAL	Tokyo Narita	18x A320	100% domestic	International services to be launched but domestic focus likely as JAL uses Jetstar Japan to catch-up to ANA
Peach	ANA	Osaka Kansai	12x A320	55% domestic, 45% international	More focused internationally
Spring Airlines Japan - proposed	None	Tokyo Narita	3x 737-800	Initially 100% domestic	Japan-China will be large market
Vanilla Air	ANA	Tokyo Narita	3x A320	54% domestic; 46% international	More focused internationally, especially leisure destinations

Source: CAPA - Centre for Aviation and companies

Consolidation will be necessary in Japan's market - but more likely with the older LCCs

But the reality of fragmentation, with a half-dozen odd airlines each having around a 2% market share each, means consolidation will become increasingly attractive - and necessary. ANA is still developing Vanilla Air and could decide it is better to have its other LCC, Peach, take over.

There is also opportunity for consolidation with Japan's longer-established LCCs, the new entrants. Kitakyushu based StarFlyer is cutting back growth and ANA has already enlarged its stake in StarFlyer. Solaseed's developments are scarcely notable while Air DO (not strictly a LCC) is closely aligned to ANA. Skymark has a clear independent future, but elsewhere inefficiencies prevail.

Consolidation of multiple carriers would be logical on paper, but as the saying goes, airlines never die in Japan. Pride and prestige ensures they continue to operate, even if effectively confined to the airline nursing home. As the market aligns more with global practice this may change, but the old inertial overhang is strong.

Summary of Japan's 'new entrant' LCCs: 03-Apr-2014

Carrier	Airline Affiliation	Primary Base	Fleet	Domestic/International Capacity Split	Outlook
Skymark	None	Tokyo Haneda	2x A330-300 31x 737-800	100% domestic	Expanding domestic position with all-premium economy A330s for use on trunk routes. Larger-capacity aircraft enables expansion at slot-restricted Tokyo Haneda. Lower operating cost should allow for lower density seating. Expanding internationally with A380s, initially to New York JFK and London. This carries high risk, especially without partners, but Skymark has tour agency backings.
Solaseed	ANA (only strategic)	Miyazaki (corporate), Tokyo Haneda (operating)	13x 737	100% domestic	Limited growth opportunities. Formerly known as Skynet Asia Airways.
StarFlyer	ANA (strategic, equity)	Kitakyushu (corporate), Tokyo Haneda (operating)	11x A320	100% domestic	Expansion on non-Tokyo Haneda routes has not been met with success. Further Haneda expansion unlikely in medium-term

Source: CAPA - Centre for Aviation and companies

See related reports:

• Japan's StarFlyer, struggling to expand its niche, will reduce its fleet and receive new management
• Air Do, product of Japan's quixotic airline market, likely to remain independent pending reform

Outlook: Japan's international aviation policy shows mixed results, but domestic is on growth path. Time to introduce more LCC-friendly conditions

While over-capacity and the potential need for consolidation may worry airlines, this is a very healthy scenario for Japan. After years of dragging its feet Japan welcomed LCCs with numerous reforms in hopes of boosting traffic - although many improvements still need to be made. Two years of solid growth is an excellent start, and the signs are there is more growth to come. Japan's domestic aviation policy towards LCCs is bearing fruit.

This contrasts to Japan's international aviation policy, still largely centred on increasing the number of international flights at convenient Tokyo Haneda Airport. Slots have been made available to Japanese and foreign carriers but so far they have mostly been used to shift existing flights from Narita to Haneda, the economic benefit of which is unclear but surely limited. The number of genuinely new services launched is underwhelming, and in any event they could equally have been launched at Narita.

The entrenched airlines - local and foreign - captured the Japanese government's attention with Haneda slots but have done little to return the favour.

Japan's LCCs will naturally continue to expand, including internationally, thereby bringing more leisure tourists in, boosting the tourism economy - a central objective. Here though there is still the dichotomy between aviation policy preferences and the support for a new form of industry with a greater consumer and economic impact profile.

So Japan's best economic objectives would be better served if they were to focus reform on initiatives that benefit LCCs. Efficiency is a tenet of LCCs, but many Japanese policies continue to stifle efficiency, disproportionately impacting LCCs that are already lean and keen to improve utilisation.

ANA and JAL each have ambitious international growth plans, but have effectively recognised that their future expansion opportunities are not at home. Yet Japan's domestic regulatory and operational conditions remain little changed, still much more suited to an older world, legacy environment.

Japan's LCCs however are clearly delivering results in the domestic market - and, increasingly - on short haul international routes. Whatever their future number and shape, they, like elsewhere in the world, need a collective voice and recognition of the economic drivers that they can become.