09-Apr-2013 9:00 AM

Scoot selects Nanjing, capping a busy first year of operations for the Singapore Airlines subsidiary

Analysis

Singapore Airlines' (SIA) low-cost long-haul subsidiary Scoot has completed the last phase of its initial network development, announcing on 8-Apr-2013 the selection of Nanjing as its 11th destination and fourth in mainland China. Scoot will be the only foreign LCC at Nanjing, which like most secondary cities in China is underserved from an international perspective.

Singapore-Nanjing will be launched on 3-Jun-2013 and give Scoot a total of eight routes by its first year anniversary on 4-Jun-2013. After celebrating its first year anniversary the start-up is expected to take a hiatus from fleet and network and expansion for at least 18 months. The hiatus will allow the carrier to focus on improving profitability as its initial network and business model beds down.

The hiatus also gives Scoot ample time to prepare for the delivery of the first of at least 20 787s in late 2014. The 787 will usher in a new era of growth and improved profitability for the carrier. But while Scoot waits for its mix of 787-9s and 787-8s, competitors could pursue faster expansion, leaving Scoot with a smaller slice of Asia's emerging low-cost medium/long-haul market.

Summary

Scoot, Singapore Airlines' low-cost long-haul subsidiary, has announced Nanjing as its 11th destination and fourth in mainland China.
Scoot will be the only foreign low-cost carrier at Nanjing, which is underserved from an international perspective.
Scoot's strategy in mainland China has been to launch services to secondary cities not already served by other SIA Group carriers.
Nanjing is a classic example of a market that could potentially only be viable under a low-cost operating model.
Scoot will have a two-year hiatus from fleet and network expansion to focus on improving profitability and prepare for the delivery of its first 787s in late 2014.
Scoot's market share in Singapore is expected to fall over the next two years as other carriers expand, giving it only a 2% share of the market in early 2015.

Nanjing further supports the Scoot and SIA Group network strategy for China

In mainland China, Scoot's strategy has been to launch services to secondary cities which are not already served by other SIA Group carriers. While SIA and regional full-service subsidiary SilkAir already serve 10 destinations in mainland China, making SIA one of the largest foreign carrier groups in the Chinese market, there are still dozens of potential Chinese cities which are large enough to support service to Singapore.

Scoot has been used in its first year as a vehicle to access Chinese cities in northeast China that are generally too far from Singapore for SilkAir, which only operates narrowbody aircraft, and do not have sufficient business demand to support regular service from SIA. China has a huge number of large and fast growing secondary cities with an equally fast growing segment of residents which are starting to travel abroad. Singapore is a popular destination for Chinese tourists and a common destination for their first trip outside greater China. Scoot with its low fares is better positioned than SIA and SilkAir to tap into this sector of the market.

Nanjing, which will initially be served with three weekly flights, is a classic example of a market that could potentially only be viable under a low-cost operating model. SIA served Nanjing for several years but dropped the market in Mar-2010 due to insufficient demand.

China Eastern now serves the Singapore-Nanjing market but operates the route with A320 narrowbodies and has strong local distribution channels in China. Scoot will compete with China Eastern, particularly tour groups originating in Nanjing, but will be able to undercut China Eastern on fares, stimulating demand. China Eastern downgraded its Singapore-Nanjing service from daily to four weekly flights in Apr-2012, leaving an opening for Scoot.

While the route Singapore-Nanjing is technically within the range of a narrowbody, at over five hours it is too long for short-haul LCCs such as SIA affiliate Tiger and not ideal for SilkAir. Scoot's low-cost product should be a good match for the market. As Scoot now interlines with SIA, SilkAir and Tiger it will also be able to provide Nanjing passengers with a much wider range of connections beyond Singapore than China Eastern.

Scoot makes China a priority

China has been a priority for Scoot from the beginning and would have been the carrier's first market if it were not for onerous Chinese regulatory requirements. Scoot instead made Gold Coast and Sydney in Australia its first routes followed by Bangkok, a short-haul route which was added to improve aircraft utilisation and offer a one-stop product in the large Australia-Thailand market.

Tianjin, which was launched on 23-Aug-2012 and is served with four weekly flights, was Scoot's first mainland China destination and fourth overall. Qingdao and Shenyang were launched on 11-Jan-2013 and are served with three weekly flights on a Singapore-Qingdao-Shenyang-Qingdao-Singapore routing.

Scoot's routes: as of its first anniversary on 4-Jun-2013

Route	Frequency	Launch date	Scoot's capacity share^	Competitors from SIN
Singapore-Sydney	Daily	4-Jun-2013	16%	SIA, Qantas, British Airways
Singapore-Gold Coast	5x weekly	12-Jun-2012	100%	N/A
Singapore-Bangkok	Daily	05-Jul-2012	6%	SIA, Thai, Tiger, AirAsia, Jetstar, Cathay, MAI
Singapore-Tianjin	4x weekly	23-Aug-2012	100%	N/A
Singapore-Taipei-Tokyo Narita*	Daily	18-Sep-2012	20%	SIA, CAL, Jetstar, EVA, TransAsia, Tiger
Singapore-Qingdao-Sheyang	3x weekly	11-Jan-2013	100%	N/A
Singapore-Taipei-Seoul	3x weekly	29-May-2013	20%	SIA, CAL, Jetstar, EVA, TransAsia, Tiger
Singapore-Nanjing	3x weekly	3-Jun-2013	66%	China Eastern

Tianjin, Qingdao, Shenyang and Nanjing are all similarly sized cities in northeast China. (Nanjing is the furthest south, located on the banks of the Yangtze River, which is considered by some to be the north-south divide for China.)

Nanjing has a population of about eight million. Shenyang also has a municipality population of about eight million while Dalian has about nine million and Tianjin approximately 13 million. As is the case with most of Scoot's Chinese destinations, Nanjing is also a tourist destination in its own right as it is one of China's four ancient capitals.

Scoot is only interested in mainland Chinese cities that are not yet served by SIA

Northeast China has been targeted as southern China is within range of Tiger, which currently serves Guangzhou, Shenzhen and Haikou in southeast China. Guangzhou is also served by SIA and Shenzhen is also served by SilkAir.

Tiger would also be the logical LCC brand for southwestern destinations such as Chengdu and Kunming. SilkAir now serves these two destinations.

While the SIA Group has been intentionally staying away from using Scoot in existing SIA (or SilkAir) destinations, the approach is different at Tiger as Tiger is only 33% owned by SIA and therefore unlike Scoot does not consult with SIA in network planning. The SIA Group has taken the view that it is important to separate the brands in mainland China. But in other markets the approach is different and Scoot already operates alongside SIA in Bangkok, Sydney and Taipei (Tiger also serves Bangkok and Taipei).

There are opportunities in northwest China for Scoot such as Xian but such routes are riskier given they are not established destinations from Singapore. Airport issues also have prevented Scoot from considering some mainland Chinese destinations. While most of China's secondary cities have airports which were constructed with runways long enough to support widebodies, many currently do have any widebody service and are not capable of handling widebodies. This is not an issue in Nanjing, which already has widebody service from Lufthansa, Dragonair and China Eastern.

Lufthansa currently serves Nanjing with three weekly flights from Frankfurt, providing the city's only service outside the Asia-Pacific region. Lufthansa and Asiana are currently the only carriers from outside greater China serving Nanjing.

Nanjing international capacity (seats) by carrier: 8-Apr-2013 to 14-Apr-2013

Nanjing has very little capacity outside greater China

Cathay Pacific subsidiary Dragonair and Hong Kong Airlines are the largest two foreign carriers serving Nanjing. Hong Kong is by far the largest international destination from Nanjing, accounting for almost 14,000 or 36% of the airport's approximately 38,000 international weekly seats. China Eastern also serves the Nanjing-Hong Kong market but with one daily flight compared to the two daily frequencies from both Dragonair and Hong Kong Airlines.

Taipei is Nanjing's second largest international destination, with service from China Eastern and three Taiwanese carriers. Another city in greater China, Macau, is the fourth largest destination but is currently only served by Air Macau.

Overall greater China accounts for 65% of Nanjing's international capacity. Nanjing only has about 13,000 weekly international seats outside greater China. Only about 3% of Nanjing's total seat capacity is now allocated to markets outside greater China. Southeast Asia is particularly under-served, with only about 3,800 weekly seats.

Nanjing international capacity share (% of sets) by region: 8-Apr-2013 to 14-Apr-2013

Southeast Asia only has double the capacity of Australia, which is served by China Eastern with three weekly flights to Sydney. China Eastern launched Nanjing-Sydney service in Dec-2012 with A330-300s, giving Nanjing its second longest route after Frankfurt.

Nanjing arriving international seat share (% of seats): 8-Apr-2013 to 14-Apr-2013

While Scoot will only initially serve Nanjing with three weekly flights, its 402-seat 777-200s will boost the Southeast Asia figure by 64% to about 5,200 weekly return seats. Scoot's entrance will also push up Singapore in the Nanjing top 10 international route rankings from the seventh position to the third position, making it bigger than Seoul and the largest destination outside greater China. Seoul is currently served with one daily flight from both Asiana and China Eastern.

Nanjing top 10 international destinations based on capacity (seats): 8-Apr-2013 to 14-Apr-2013

There is huge potential in Nanjing-Southeast Asia market

Inevitably Nanjing's capacity to Southeast Asia will increase as demand grows, attracting more Southeast Asian carriers. Incredibly Scoot will be the only Southeast Asian carrier serving Nanjing. Lion Air subsidiary Wings Air served Nanjing from Bali but dropped the route in Feb-2013, just over one year after launching the service, according to Innovata.

Nanjing is a potential candidate for schedule service from several Southeast Asian carriers including Malaysia's AirAsia X, Malaysia Airlines, Thai Smile and Thai AirAsia.

Bangkok is currently the largest destination in Southeast Asia from Nanjing with 1,600 weekly seats generated from China Eastern's five weekly flights on the route. Bangkok-Nanjing is less than a four hour flight, making it a viable short-haul LCC route for Thai AirAsia, which has been pursuing rapid expansion in mainland China over the last year. Thai Smile, which operates A320s and is studying potential mainland Chinese routes not served by parent Thai Airways, could also potentially serve Nanjing.

Kuala Lumpur, which is currently not served by any carrier from Nanjing, is also a possibility. AirAsia X is looking at additional mainland Chinese routes for 2013 as it takes seven additional A330s for the remainder of 2013. Scoot's selection of Nanjing could persuade AirAsia X to also serve the market.

In addition to Bangkok and Singapore, China Eastern also operates seasonal low-frequency flights from Nanjing to three other Southeast Asian destinations - Phnom Penh and Siem Reap in Cambodia and Da Nang in central Vietnam.

Scoot to be the only international LCC in Nanjing

Scoot will also have the distinction of being the first carrier with international LCC services. Less than 3% of total seat capacity at Nanjing comes from LCCs, which puts it behind China's overall already low 5% LCC penetration rate.

Three Chinese LCCs currently serve Nanjing - China West Air, Lucky Air and Spring Airlines. China West and Spring each operate only one domestic route at Nanjing while Lucky has two domestic routes. All four domestic LCC routes from Nanjing are served with just one daily flight.

Like other Chinese secondary cities, there are huge opportunities in the Nanjing market to stimulate demand through more low-cost services. In addition to Southeast Asian LCCs, Spring could potentially start international services at Nanjing as China's largest LCC continues to expand its international network. Nanjing is also a potential destination for Jetstar Hong Kong, which launched services in mid-2013, and any of Japan's new trio of LCCs. Nanjing is now linked by China Eastern with Osaka Kansai and Tokyo Narita, both of which now serve as bases for two Japanese LCCs.

For Scoot, North Asia has emerged as the carrier's biggest market. Currently 53% of the carrier's seat capacity is allocated to the North Asia market. This will grow to 61% in Jul-2013 as all of Scoot's expansion in the northern hemisphere summer 2013 season will be to North Asia.

Scoot capacity (seats by region): 8-Apr-2013 to 15-Apr-2013

Scoot's other new summer 2013 route is Singapore-Taipei-Seoul Incheon, which was announced on 21-Mar-2013 and will be served with three weekly flights commencing 29-May-2013. The two new routes are made possible by the delivery of a fifth 777.

Scoot to wait until 787s before pursuing further expansion

As previously reported by CAPA, Scoot has decided against taking delivery of additional 777s and will hold off further expansion until its first 787 is delivered. Scoot's original fleet plan included 14 777s, including six aircraft by the end of 2013, eight by the end of 2014, 11 by the end of 2015 and 14 by the end of 2016. But the opportunity to take over SIA's order for 20 787s prompted a re-think shortly after Scoot launched services.

Scoot is better off waiting for the more efficient 787s instead of investing in retrofitting additional 777s, particularly as it would get less than two years of use out of any additional 777s. The 777 is also not seen as the ideal aircraft for low-cost long-haul operations given its large size. Even the 787-9, the type SIA originally ordered, is seen as slightly too large for some Scoot routes. As a result Scoot has switched 10 of the 20 aircraft ordered to the smaller 787-8.

Scoot will use its first batch of 787s, which are expected to be -9s and will arrive in late 2014 and early 2015, to phase out its 777-200s. That means Scoot's fleet is not likely to reach six aircraft until 2Q2015.

Even when it finally adds its sixth aircraft Scoot could look to expand capacity to existing destinations rather than open a new route. Scoot will be three years old in Jun-2015 and some of its non-daily routes should be mature enough for frequency increases. Qingdao and Shenyang could also be split into separate flights as the current routing is not ideal because Scoot is unable to pick up passengers between the two cities. (Scoot initially planned to operate a triangle routing but could not get approval for such a routing, prompting a costly six-week delay in launching the service and leading to the less efficient tag routing.)

Not expanding for two years is not the ideal scenario for a start-up. But it will give Scoot the opportunity to improve its profitability and tweak its model. While the carrier has enjoyed relatively high load factors on most of its routes, yields have been low as promotional prices are almost always available. Scoot throughout its first year of operations seems to have taken the strategy of filling up seats rather than pursuing higher yields. As CAPA reported in Jan-2013:

Scoot passed the 500,000 passenger milestone on 14-Jan-2013, which according to CAPA calculations means the carrier has had an average load factor of 78% since its launch. But the carrier's yields have been very low as very low promotional style fares have been consistently offered on all its routes.

The low yields are not surprising as the carrier has been focused on building exposure during its start-up phase. But profitability with such an approach is virtually impossible, particularly given the economics of the 777-200.

The transition to 787s in late 2014 and early 2015 will immediately improve Scoot's operating costs. By that point, Scoot will have several robust partnerships in place, giving it the volumes and type of traffic to raise yields, particularly as the 787s are smaller. ... The introduction of 787s, combined with a large group of partners, changes the dynamics significantly. Scoot is unlikely to be profitable until both these components are fully in place and the carrier is operating a fleet of several 787s.

The real test for Scoot will not come until the fiscal year beginning Apr-2015, when the carrier should have the fleet, network and strategy to start making positive contributions to the SIA Group. Having a likely initial loss-making period of three years is rather long but SIA Group has the financial backing to withstand three years of losses at Scoot and be patient as the new carrier slowly implements its business model.

Scoot will lose market share as it waits for 787

The two-year hiatus in expansion will come at the expense of market share. Scoot has quickly built up a 2% share of seat capacity in Singapore, which will grow to almost 2.5% by early Jul-2013 - not a bad slice for a one year old carrier, particularly given the large size of Singapore's market and the fact that all but one of its routes are medium/long-haul. But Scoot's market share in Singapore will likely fall over the next two years as other carriers expand, giving it only a 2% share of the market in early 2015 - a very small slice of a home market for a carrier that will be at that point almost three years old.

Scoot will likely remain the largest long-haul LCC in Singapore because Jetstar, which currently bases three A330s in Singapore, is also not expected to grow its widebody fleet over the next couple of years as it focuses on replacing its A330-200s with 787-8s. But Southeast Asia's other existing low-cost long-haul carrier, AirAsia X, is growing rapidly and committed to taking 14 additional A330s over the next two years, giving it a fleet of 23 aircraft by the end of 2014, at which point Scoot will have only five aircraft.

Scoot will eventually pursue rapid expansion from 2Q2015 to early 2017 as its fleet quadruples from five to 20 aircraft. Such a rapid ramp up after two years of no expansion could prove to be overly ambitious. But it is hard to know what market conditions will look like two to four years from now and how the competitive landscape will unfold. It is likely there will be new long-haul low-cost carriers in Asia, joining Scoot, Jetstar, AirAsia X and soon Cebu Pacific.

Scoot has been in the spotlight over the last year as SIA's bold experiment with the still emerging low-cost long-haul model has generated significant attention, putting Scoot's every move under the microscope. Scoot will not likely receive as much attention over its second year. The spotlight will return in its third year when the 787s are delivered. In the meantime Scoot will have an opportunity to build up its partnership base and work on other possible areas of weakness such as revenue management.

Appendix

CAPA's complete coverage of Scoot includes the following analysis articles, in chronological order: