10-Nov-2014 1:24 PM

North Asian LCCs challenged by liberalisation and pilot shortage but optimistic on partnerships

Analysis

2014 marked a turning point in North Asia, as the Sep-2014 launch of Tigerair Taiwan meant each of North Asia's key markets had an LCC, catching up to Southeast East Asia. Not only have LCCs have been more prolific in Southeast Asia, it has only been much more recently that North Asia received LCC activity. CAPA's recent Aviation Summit and LCC Congress explored the theme of where North Asia's LCCs are, the challenges they face and the outlook they project.

A panel featuring executives from Jeju Air, Tigerair Taiwan and Vanilla Air discussed cost challenges, including in some markets the lack of pilot availability as well as the overall high cost of expatriate pilots, especially in China.

Liberalisation is also a limiting factor, and one that has held back the growth of North Asian LCCs; the penetration rate of LCCs in North Asia is greatly lower than in Southeast Asia. Although lagging in organic reach compared to counterparts in Southeast Asia, these North Asian LCCs were optimistic about the ability to form partnerships.

Summary

North Asia's LCC market has been slower to develop compared to Southeast Asia, but is now catching up with the launch of Tigerair Taiwan in 2014.
The challenges faced by North Asian LCCs include high costs, limited pilot availability, and restrictive bilateral agreements.
Partnerships are becoming more common among North Asian LCCs, with a focus on hub cooperation and partnerships with parent airlines.
Tigerair Taiwan, a joint venture between Tigerair and China Airlines, aims to leverage its partnership to offer multi-destination itineraries.
Jeju Air, Korea's largest LCC, is looking to build more aggressive partnerships, particularly on its Seoul Incheon-Saipan route.
Liberalization and greater market access are crucial for the growth of North Asian LCCs, but challenges remain in accessing markets like China and Japan.

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Hub role and subsidiary nature drive partnerships at North Asia's LCCs

LCCs at first typically shunned partnerships. This has been changing, with the more mature markets of North America and Europe having the examples of WestJet and JetBlue accepting interlines and some codeshares while Vueling codeshares and interlines. The partnership activity in North Asia is notable as it is occurring at an earlier stage of development, and it also takes on a different role.

The partnerships discussed by the panel centred around cooperation at prominent hubs to feed flights from multiple carriers, and also partnerships with a parent airline.

These broadly reflect the nuances of LCCs in North Asia where they are often subsidiaries of a full-service airline, frequently based in large hubs, flying to primary cities. Europe and North America's LCC explosion has been due largely to flying between secondary points. Southeast Asia sees more secondary city flying by LCCs, but North Asia's LCCs are still focusing on primary city flying, in part because there is still growth to unlock in primary cities. By flying from primary cities, LCCs reckon they can offer access to the range of carriers serving that hub, often with high frequency.

The Door Opens to LCCs in China and North Asia

Tigerair Taiwan was born out of a partnership, and that origin is shaping its development, a joint-venture between Singapore's Tigerair group and Taiwan's China Airlines.

Tigerair Taiwan's first route was between Taipei and Singapore, an appealing and low-risk route. Demand is high and Tigerair Taiwan can achieve low start-up costs by tapping into some of the existing Tigerair infrastructure (from ground staff to internet bookings). As the hub of Tigerair (Singapore), Tigerair Taiwan can also promote connections beyond Singapore.

Tigerair Taiwan CEO Kwan Yue predicted that Asian travellers will increasingly seek multi-destination itineraries. Tigerair Taiwan's partnership with Tigerair (Singapore) can facilitate the necessary transfers. This also can work in the other direction: Tigerair (Singapore) can put passengers on Tigerair Taiwan flights to North Asian points beyond Taipei.

As Tigerair Taiwan settles down from its Sep-2014 launch, there will likely be greater integration with China Airlines. This begins to depend on the regulatory environment, but China Airlines would be interested in having Tigerair Taiwan take over some lower-yielding routes as well as enter routes it has been unable to.

Seoul Incheon, where Jeju has most of its international flights, is a hub that has become a popular destination for Chinese tourists, both those looking to visit an ever-popular Seoul but also those using Seoul as a hub for other Asian points and intercontinental services. Jeju is Korea's largest LCC, a feat given it is independent whereas major competitors are subsidiaries: Jin Air (part of Korean Air's parent company) and Air Busan (Asiana).

Jeju Air top 10 hubs/bases/stations for international flights: 3-Nov-2014 to 9-Nov-2014

Jeju Air's Ken Choi said he wants to "build more aggressive partnerships". Although open to simple marketing arrangements, codeshares are also the objective. He sees potential on Jeju's recently-inaugurated Seoul Incheon-Saipan route, a leisure destination seeing growing interest from the Chinese market. China is seeing an increase in the number of privately-owned airlines as well as LCCs.

It will take a few years before China permits the start-ups to fly internationally, but when they do Seoul is likely to be a top pick. The LCCs may not be able to offer a service to Saipan (or other Jeju points) but could partner with Jeju to access those markets.

Japan's LCCs have some of the largest partnerships in North Asia

Jeju Air is one of North Asia's longest standing LCCs (along with Spring Airlines), with its origins dating back to the middle of the last decade.

Vanilla Air meanwhile is one of the youngest, having launched in Dec-2013. Vanilla Air has a partnership with its 100% owner All Nippon Airways that allows ANA frequent flyers to redeem miles for tickets on Vanilla Air. Vanilla Air Executive Vice President - Operations Hiroshi Kitahara remarked the partnership enables greater award availability, especially to those looking for a leisure trip. Later in Vanilla Air's development the carrier may serve points ANA and its partners do not, thereby increasing the range of destinations for ANA frequent flyers.

Although not stated, the partnership may also help boost load factors at Vanilla Air and also provide a way for the Japanese market (still sceptical of LCCs) to sample Vanilla Air, and hopefully return to the carrier.

ANA also owns a minority interest in Peach Aviation. One of the region's most successful startups, Peach has not collaborated with other airlines. On the other end of the spectrum, Jetstar Japan has wider partnerships. It too offers redemption options for Japan Airlines, which has a partial stake in Jetstar Japan. JAL also codeshares on Jetstar Japan and in Oct-2014 American Airlines applied to codeshare on Jetstar Japan.

JAL's domestic operation in Tokyo is at Haneda airport whereas JAL's long-haul operation still has a large presence at Narita. Jetstar Japan is based at Narita so allows JAL, and its JV partner American Airlines, to access domestic Japanese points for feed.

Japan Airlines top 10 hubs/bases/stations for domestic flights: 3-Nov-2014 to 9-Nov-2014

In some Jetstar Japan markets, JAL does not serve the destination while in other markets Jetstar Japan has a higher frequency than JAL. JAL's Narita flights basically exist to provide long-haul feed. A successful partnership could allow JAL to decrease its domestic operation at Narita, which is small but costly.

Vanilla's Mr Kitahara was however cautious about expanding into more complex partnerships at this stage.

Asia is cultivating a new type of a partnership: leasing

Clyde & Co Global Head of Aviation Finance Paul Jebely observed on the panel that a more common (but still young) partnership in Asia compared to other regions is that of airlines sub-leasing aircraft to other airlines. Airlines have long done this, and Norwegian is looking to have a role, but the difference is the scale and formality Asian airlines are bringing.

The most notable example is Transportation Partners, the leasing unit affiliated with Indonesia's Lion Air. Transportation Partners placed two 737-800s with Chinese start-up 9 Air/Jiu Yuan. Tigerair is leasing aircraft to IndiGo while there has been activity at AirAsia and Jetstar, although this is less formal and not with a dedicated leasing unit.

Spring Airlines in Nov-2014 disclosed to Bloomberg its intention to establish a leasing unit in Shanghai. Spring mentioned it had discussions with prospective sub-lessors in China and outside, but Spring's primary objective is to reduce its own costs by having the leasing unit be based in Shanghai's free-trade zone. Spring in the past has had aircraft deliveries held up by Chinese regulators that wanted to moderate growth. Any medium- or long-term delay in the future could mean Spring could sub-lease the aircraft rather than delay its delivery.

(This could ease pressure on Airbus, but alternatively might irk it; Airbus and Boeing have given a cool reception to airlines as lessors, effectively a new stream of competition.) Having a leasing unit gives Spring confidence it could place aircraft it is not allowed to take and could help with long-term planning. For example, the more comfortable position of having alternatives could possibly see Spring order aircraft in larger numbers, and thereby receive a larger discount.

Greater liberalisation in North Asia will facilitate growth

The LCCs all saw a need for greater liberalisation in order to grow. For traffic within North Asia, LCCs account for only 11% of available seats compared to 59% within Southeast Asia. Even if there are differences in market characteristics, there are still clearly opportunities for LCCs to grow in North Asia.

LCC Capacity Share (%) of Total Seats within South East Asia: 2001 - 2014*

LCC Capacity Share (%) of Total Seats within North East Asia: 2001 - 2014*

To no surprise, the three LCCs saw difficulty in accessing the China market. Vanilla's Mr Kitahara said Vanilla was very interested in China but "it takes a long time to get into negotiation". Further, Vanilla's interest is mainly in the large cities of Beijing and Shanghai, where daytime slots are restricted, leaving less than ideal nighttime slots. International services are the most appealing to Vanilla Air, echoing a view from Peach. Mr Kitahara noted some destinations like Guam are of interest to Vanilla but it must wait for ETOPS approval.

Tigerair Taiwan is restricted by bilaterals but Mr Yue is encouraged that Taiwan is taking steps to re-negotiate air service agreements.

Taiwan's regulator had been trying to encourage establishment of local LCCs after seeing so many foreign LCCs enter and expand in Taiwan. LCCs account for 8% of international seats to/from Taiwan, almost exclusively from foreign carriers (Tigerair Taiwan's presence is still very small). Taiwan it seems is progressing from a stage of calling for local LCCs to now supporting their growth, but exactly how supportive the regulator will be is a topic Tigerair is watching.

Taiwan international seat capacity by type of carrier: 3-Nov-2014 to 9-Nov-2014

Mr Choi of Jeju Air remarked that it has only been recently that South Korea has started to support Jeju Air, for example helping Jeju with MRO facilities as well as counter space at airports. But Mr Choi was disappointed that when the China-Korea air service agreement made more seats available, it was heavyweights Korean Air and Asiana that benefitted the most. Jeju had "very high hope" LCCs would benefit, Mr Choi said, but the outcome reaffirmed the view that for governments, "the scope is still focused on full-service carriers".

However, that expansion was smaller than all the Korean carriers hoped for. As can be seen on the graph below, Asiana and Korean Air had only a slightly larger northern summer peak than in past years. Mr Choi said liberalisation was the "burning question" for China.

South Korea to China (seats per week, one way): 19-Sep-2011 to 19-Apr-2015

In addition to China, Mr Choi said Jeju faces bilateral constraints to the Philippines, Tokyo Haneda airport and Taipei Songshan airport. China is a huge opportunity in the long-term for Jeju, and aside from China, the constraints Jeju faces are not that bad compared to other carriers. This is important as international is Jeju's largest opportunity. Mr Choi said over 60% of Jeju's revenue was from international services.

Mr Choi noted Jeju has been able to curry government favour by supporting smaller Korean cities with air service. Jeju Air accounts for 7% of all seats to/from/within Korea, but at Cheongju accounts for 20% and at Daegu 17%.

Cheongju airport share of system seat capacity by carrier: 3-Nov-2014 to 9-Nov-2014

Daegu airport share of system seat capacity by carrier: 3-Nov-2014 to 9-Nov-2014

Mr Jebely noted without specifics that there are ways for carriers to get around traffic right restrictions. Indeed, Korean carriers and especially LCCs did this in China by offering numerous "charter" services. However, China has begun to view these flights as de facto scheduled flights and curtailed them by establishing a narrower scope for what could be a charter flight, such as by limiting how many flights could be offered and how long the charter period could be.

Even if the shackles are cut, pilot recruitment challenges growth

If traffic rights and government support were not an issue, there would still be growth constraints because of challenges of pilot recruitment. However, this is not evenly spread. Mr Yue was not concerned, believing Tigerair Taiwan could attract Taiwanese pilots who have been flying abroad and want to return home for a local base. Mr Yue however was concerned that pilots seeking simply the highest salary would go to mainland China, where there is large demand, primarily for captains. That demand is pushing up salaries and benefits that mean other regions have to try to match.

Mr Choi said pilot recruitment is a "major limitation factor for Korean LCCs". Jeju however has some cushion to rest on as some time ago it launched a training programme to fast-track intakes it recruits from Korea and overseas. Mr Choi said approximately 30% of Jeju's pilots are retired from full-service airlines while 70% have been "nurtured" by Jeju Air. Overall, Jeju's foreign pilot contingent is small.

Vanilla's Mr Kitahara was less upbeat, remarking of the pilot situation: "I'm not optimistic". Vanilla, and other Japanese airlines, have had to reduce their schedules due to pilot shortages. Vanilla has some pilots who used to fly for the self-defence force. There are efforts to boost productivity. Vanilla's pilots fly for about 80 hours a month compared to 50-60 at ANA, Mr Kitahara said. He thinks Japan should consider raising the pilot retirement age to 70 from 64, although Japan has indicated it would only consider raising retirement ages by one to two years at a time. Mr Kitahara said in the medium- to long-term Vanilla could benefit from parent owner ANA's partnership with the Pan Am flight academy.

Mr Kitahara also wanted Japan to loosen some regulations that are excessively conservative by any comparison, a common refrain from Japanese carriers. He also wants the Tokyo Narita curfew lifted but has no expectations that will occur.

It seems the message is to pick your battles while innovating where you can.

Growth is occurring but only slowly and remains constrained on many fronts

Factors holding back LCC penetration to any similar levels achieved in southeast Asia are many and complex. Of no small importance is the still-prevailing preference given to long established airlines in many government policies. The fact that many of the LCCs are also subsidiaries or part-subsidiaries of those flag carriers means that their expansion is often muted and envisaged as only complementary operations to the mainine carrier. This is changing as airports, tourism bodies and consumers add pressure to deliver air fares that will stimulate growth, but it still requires significant redirections in mindset.

Associated with this are the conservative and neo-protectionist attitudes entrenched in bilateral agreements and the slow process of change that allows new entry and expanded service. Japan, and to a lesser extent, Korea have moved rapidly to open up market access over recent years; Japan in particular, seeking a massive increase in inbound tourism, is evidence of what can occur where the policy focus shifts from protecting flag carriers to stimulating air travel.

Skills are also a constraint - not just pilots, but management skills too. As China undoubtedly will expand its LCC new entrants in the next couple of years, the shortage of skilled managers who understand the key features of LCCs threatens successful operating. And complementary understanding at airport and government level is also important, if facilities are going to be available to enable such features as fast turnarounds and limited handling costs.

But these markets are so big and the growing tide so strong that it is impossible to imagine that LCCs will continue at today's low level of penetration. Expansion is accelerating and as the home grown LCCs expand, so they will begin to enter the same markets that their southeast Asian counterparts are operating. Meanwhile, the model is becoming more variegated and partnerships are proliferating. Altogether a challenging mix, but one that carries with it massive economic and social change.