12-Jan-2013 3:00 AM

Sriwijaya attempts to maintain its position as Indonesia’s third largest airline as market explodes

Analysis

Sriwijaya Air is seeking to renew its fleet, expand its network and launch a new full-service subsidiary in a bid to maintain its position as the third largest airline in Indonesia's fast-growing market. The low-profile airline group, which is already one of the 30 largest in Asia, has big ambitions to expand domestically and to a lesser extent internationally with new Boeing 737-800s and Embraer E190s in two-class configuration. But the group plans to stay away from the faster-growing Indonesian budget airline sector and, in a rather odd strategy, have two full-service brands with one positioned at the premium end and one in the middle.

Sriwijaya risks getting squeezed out as much larger Lion and Garuda pursue rapid expansion in both the budget and full-service sectors while the Indonesian affiliates of AirAsia and Tiger grow rapidly at the low end of the market. But within Indonesia's large group of second tier full-service carriers, Sriwijaya has the strongest position and stands to benefit in the likely event of consolidation.

Summary

Sriwijaya Air plans to renew its fleet and expand its network to maintain its position as the third largest airline in Indonesia.
The airline aims to stay away from the budget airline sector and focus on two full-service brands, one positioned at the premium end and one in the middle.
Sriwijaya Air has been growing rapidly since its launch in 2003, doubling in size since 2008 and nearly tripling in size since 2006.
The airline is primarily a domestic operator, serving 40 domestic destinations and only two international destinations.
Sriwijaya Air faces competition from larger airlines such as Lion and Garuda, as well as budget carriers like AirAsia and Tiger.
Sriwijaya Air plans to launch a new full-service subsidiary called Nam Air, positioned at the top end of the market with a two-class product.

Sriwijaya is primarily a domestic operator, serving 40 domestic destinations and only two international destinations - Singapore and Penang in Malaysia. Sriwijaya currently operates a fleet of slightly over 30 aircraft, primarily 737-300/400/500 Classics although it began leasing second-hand 737-800s in 2012. The carrier is planning to take delivery of at least 45 aircraft over the next several years consisting of additional 737-800s and Embraer 190s.

With the additional aircraft, Sriwijaya is targeting annual growth of about 15%, which is roughly in line with the overall growth expected in Indonesia's domestic market. The carrier has been growing at a rapid clip since launching in 2003, more than doubling in size since 2008 and nearly tripling in size since 2006.

Sriwijaya annual passenger traffic: 2006 to 2011

Annual passenger traffic for Indonesia's leading carriers: 2006 to 2011

Sriwijaya passes Batavia but could be passed by Indonesia AirAsia and Citilink

In 2011 Sriwijaya surpassed Batavia as Indonesia's third largest overall carrier as it transported 7.4 million domestic passengers and just under 200,000 international passengers, according to Indonesian DGAC data. Sriwijaya further widened the gap with Batavia in 2012 as Sriwijaya continued to grow rapidly while Batavia, which has run into financial difficulties, has been shrinking. Through the first nine months of 2012, Sriwijaya's passenger traffic reportedly grew by 11%.

Indonesia's fourth largest carrier, Indonesia AirAsia, is still significantly smaller than Sriwijaya but is closing the gap with Sriwijaya and has ambitions to become one of Indonesia's three largest players. Indonesia AirAsia recorded 13% passenger traffic growth through the first three quarters of 2012 to 4.2 million and is planning to accelerate expansion in 2013 as its fleet expands by 39% from 23 to 32 aircraft.

Citilink, which transitioned in 2012 from a Garuda unit to subsidiary and now has its own operating certificate, is also growing rapidly and could overtake Sriwijaya as Indonesia's third largest carrier as early as 2013. Citilink, which plans to have a fleet of at least 75 aircraft by the end of 2015, aims to carry 10 million passengers in 2013. Citilink transported only 1.9 million passengers through the first three quarters of 2012.

Citilink, Indonesia AirAsia as well as Lion Air and Tiger affiliate Mandala are planning much faster growth than Sriwijaya but these carriers are targeting the budget end of the market. Sriwijaya is intentionally staying away from the budget end, believing that the market could quickly become oversaturated and competition could become irrational given the expansion of these four well-funded carriers.

Indonesia's full-service airline sector becomes increasingly competitive

Rapid growth is also expected at the full-service end of the market, which is being targeted by Sriwijaya, Garuda, new Lion Air subsidiary Batik Air, Batavia as well as several smaller Indonesian carriers. While growth will likely be faster at the budget end of the market as Indonesia's middle class expands, resulting in a much larger segment of Indonesia's 240 million people having the discretionary income to afford flying, there are also opportunities at the middle and top of the market. Indonesia overall represents tremendous growth opportunities for all types of carriers, with domestic passenger traffic projected to triple from 60 million in 2011 to 180 million in 2021.

Garuda is now the market leader in the full-service segment, with domestic traffic of 10.3 million passengers in the first three quarters of 2012, representing growth of 16% over the same period of 2011. Sriwijaya is well positioned as the second largest carrier at this end of the market and is keen to maintain this position as other carriers enter.

Lion Air's new full-service subsidiary Batik Air poses the biggest threat. Batik plans to launch services in May-2013 with 737-900ERs in two-class configuration. Batik plans to have an initial fleet of 10 737-900ERs and has the backing to rapidly expand and potentially quickly overtake Sriwijaya as a larger full-service carrier.

Lion Air has over 300 737s on order and the flexibility to shift aircraft between its various brands. The Lion Air Group also includes regional subsidiary Wings Air, which primarily operates turboprops, and new Malaysian joint venture Malindo which also plans to launch in 2013. Lion is slated to receive 36 737-900ERs in 2013, with most of the aircraft expected to be allocated to Batik and Malindo as it focuses growth on its two new operations.

While the launch of Batik is seen widely as a move to counter rival Garuda's decision to take on Lion at the budget end of the market using Citilink, Batik could have an even bigger impact on Sriwijaya. Garuda is in a relatively stronger position as the carrier has a loyal customer base, including in the corporate sector, and a strong network of agents. Sriwijaya also has a strong network of agents but will inevitably feel the pressure as Batik launches services on several of its routes.

Sriwijaya, which traditionally has been considered a middle market carrier, is responding to the threat by trying to move upmarket. Like Batavia and other Indonesian middle market carriers, Sriwijaya has traditionally provided frills including food and beverages but with an all-economy product. Sriwijaya, however, introduced a business class cabin in early 2012 and has been retrofitting some of its 737 Classics. In addition, all of its newly acquired 737-800s are being delivered in two-class configuration.

Sriwijaya plans to moves further upmarket with Nam

Sriwijaya aims to further upmarket by launching a new full-service subsidiary, Nam Air. The group has begun the process of applying for a new operating certificate for Nam Air, which is expected to launch in 2H2013.

Nam Air will be positioned at the very top end of the market with a two-class product that includes hot meals in both classes (while Sriwijaya will serve snacks). The intention is for the two brands to operate side by side on trunk and potentially some regional routes where there is high demand for premium services.

Positioning of Indonesia's major airline brands

Sriwijaya's two-brand strategy is unusual as most full-service airline groups use a second brand for regional services or the budget market. The differentiation between Sriwijaya and Nam appears to be small, which could cause consumer confusion.

Sriwijaya could be applying for the second operators' certificate to give it flexibility in case it later decides to enter the budget market. The second certificate could also be used to launch a regional operation. As Sriwijaya is a privately owned company with often a shifting strategy, Nam could end up being shelved or launching as something different.

While Sriwijaya's new fleet of E190s have reportedly been allocated to Nam, a Sriwijaya source says the tentative plan for Nam includes both E190s and 737-800s. As a deal for E190 still has not been concluded Nam could launch with 737-800s, assuming the group goes ahead and establishes the second brand.

The smallest aircraft in Sriwijaya's fleet is currently 737-500s and the airline has been intending since mid-2011 to order E190s. Sriwijaya and Embraer originally announced an order "subject to final documentation" at the 2011 Paris Air Show for 20 E190s plus 10 purchase rights.

But the order was never finalised and the Sriwijaya source says the original deposit was returned to the carrier in 2012. But Sriwijaya has begun negotiating a potential new order with Embraer and still hopes to start taking delivery of E190s by the end of 2013. Embraer has the available delivery slots to provide Sriwijaya's E190s in 2013 and remains keen to enter the Indonesian market, having lost a campaign against the Bombardier CRJ900 in 2011 to Garuda.

Sriwijaya starts renewing fleet with 737-800s

Sriwijaya took its first second-hand 737-800 in Apr-2012 as part of a plan to lease 10 737-800s. Five 737-800s were slated for delivery in 2012 with another batch of five for 2013. The initial batch of 737-800s, as well as the acquisition in 2012 of an additional batch of 737-500s, has allowed the carrier to phase out its ageing 737-200 fleet. The additional 737-500s are in two-class configuration and are equipped with winglets, providing for better operating economics.

The carrier also has been negotiating an order for up to 20 new 737-800s directly from Boeing. The Sriwijaya source says these aircraft will likely be delivered from 2016.

Sriwijaya will need to follow through on its promises to order new aircraft to stay competitive in Indonesia's dynamic full-service market. While the used 737-800s and additional 737-500 represent a major improvement, Sriwijaya is competing with airlines offering modern products on brand new aircraft.

The E190s are also important for the carrier to improve its regional network. Sriwijaya originally intended to base its E190s at four of its regional bases - Balikipapan, Makassar, Surabaya and Medan. As part of its network model, Sriwijaya operates short sectors from these bases with passengers connecting onto its trunk routes. The E190 allows the carrier to increase its frequency and improve its product on several short-haul sectors as well as open new longer point-to-point regional routes utilising the E190's range.

Sriwijaya keen to expand in eastern Indonesia

Indonesia's secondary cities are growing rapidly, leading to increasing demand for air services at both the budget and full-service ends. Garuda is now expanding in regional markets, including opening new routes, using its dual-class CRJ900s. Sriwijaya needs the E190 to respond to this new competitive threat and keep up with growing demand for a full-service product on regional routes.

The range of the E190 could particularly be used to open up new thin routes in the more remote eastern part of Indonesia, which has seen very rapid economic growth. Sriwijaya in 2012 focused much of its capacity expansion on east Indonesia, using its newly acquired 737-800s to increase capacity on existing routes and adding two destinations in the easternmost province of Papau, Biak and Jayapura. Sriwijaya began serving both destinations in 2Q2012 and in Dec-2012 expanded its Jayapura operation from one to three daily flights and its Biak operation from three weekly flights to daily.

More growth in east Indonesia is likely in 2013 as several Indonesian carriers look to expand in the more remote eastern part of the country. Citilink and Indonesia AirAsia, which currently only operate to western and central Indonesia, also plan to extend their networks to the east in 2013.

The new fleet of E190s and 737-800s would also allow Sriwijaya to stay ahead of smaller but ambitious full-service carriers. While Batavia has been struggling, several smaller Indonesian full-service regional carriers are aiming to enter larger routes as they take larger aircraft. For example, Kartika Airlines has ordered 30 Sukhoi Superjet 100 while Sky Aviation has ordered 12 of the type.

Both Kartika and Sky plan to start taking delivery of the Superjet 100 in 2013 and use the new type in eastern Indonesia. Sky plans to place into service its first Superjet in Feb-2013 from Makassar to Sorong and Jayapura in Papua, routes which are currently served by Sriwijaya. Sky expects to have five Superjet 100s in operation by the end of 2013.

The opportunities in Indonesia's full-service market also attracted a new entry in 2012 in Pacific Royale. The carrier launched services in Jun-2012 using Fokker 50 turboprops on regional routes. Pacific Royale's initial business plan envisioned operating A320s on trunk routes with Fokker 50s operating as regional feeders throughout Indonesia.

Pacific Royale, however, was unable to secure leases on A320s as intended and quickly encountered problems with its regional operation. The airline suspended operations in Oct-2012 and its three Fokker 50s were grounded. The carrier has been working on a re-launch plan focusing entirely on trunk routes with A320s while retaining the full-service model. But even if it succeeds in re-launching, Pacific Royale, like other smaller Indonesian carriers, will face an uphill battle in trying to become a meaningful player in a crowded market.

Government-owned Merpati, Indonesia's sixth largest carrier, also has ambitions to enter more trunk routes and renew its fleet with 12 737-800s and 20 regional jets. Merpati has a higher chance of survival than most other second-tier carriers, as it enjoys government backing and is needed to provide a social service to remote areas of the country with its turboprop fleet. But Merpati will likely struggle outside of subsidised regional routes and it will be challenging for the carrier to secure the funding, or achieve partial privatisation, that is required to expand.

Indonesia's full-service market has huge potential but competition will be fierce

While Indonesia's market will likely remain fragmented, with several smaller regional operators required, given the country's vast geography, the trunk routes could see consolidation. There are already seven airlines competing on some trunk routes and this could swell to as many as 10 in 2013.

Indonesia's domestic market is huge but likely could be supported by a few big players along with several small regional carriers. As the Lion and Garuda groups get bigger and bigger, it will become challenging for others.

Indonesia's much smaller international market will also likely only support a small group of carriers. Eight Indonesian carriers currently operate international services but four have very small international networks - Batavia, Sriwijaya, Wings and Merpati. Sriwijaya has ambitions for a larger international network as it expands its 737-800 fleet, including Kuala Lumpur in Malaysia, Perth in Australia and Shenzhen in China. But its focus is predominately domestic and international services will be challenging given it does not have a strong brand overseas. Indonesia AirAsia has been able to become Indonesia's largest international carrier by leveraging the strong AirAsia brand while Garuda is now investing significantly in increasing its international profile through such initiatives as entering the SkyTeam global alliance and sponsorship of the Liverpool Football Club.

Sriwijaya captured only a 2.3% share of Indonesia's international market in 2011, making it the fifth largest carrier after Indonesia AirAsia, Garuda, Lion and Batavia. In comparison, Sriwijaya captured a 12.3% share of Indonesia's domestic market in 2011, smaller than only the powerful Lion (44.8% share) and Garuda (22.8% share) groups.

Indonesia domestic market share (% of passengers carried) by airline group: 2011

Indonesia international market share* (% of passengers carried) by carrier: 2011

Even if it only remains a small international operator, Sriwijaya should be able to secure its future by simply maintaining its 12% share of the domestic market. But maintaining that 12% share, which would give Sriwijaya a base of about 12 million annual passengers in 2015 and about 20 million annual passengers by the end of the decade, will be challenging. There will be room for a few niche players but not necessarily for a medium-size group in a market where powerful and well-backed groups such as Lion, Garuda and AirAsia are competing.

This is the fourth and final article in a series of articles on Indonesian carriers. For the first three articles in this series see: