Star Alliance considers new platform for low-cost airlines, targeting Brazil's Azul & India's IndiGo

SkyTeam was the first alliance to open up to LCCs

SkyTeam in 2012 became the first and so far only alliance to unveil plans for a hybrid/LCC partnership platform. The SkyTeam offering does not constitute membership in the alliance but provides an option for members to affiliate and partner with a selected LCC.

See related report: SkyTeam plans new partnership platform to attract hybrids and LCCs, especially in Brazil and India

SkyTeam plans to soon start trialling its LCC partnership platform with Canada's WestJet in Vancouver. SkyTeam Connect is designed to facilitate connections with several members in a particular market. The intention is not for the affiliated LCC to work with all members but only those carriers interested in participating - typically members which serve the selected market.

All six SkyTeam carriers that serve Vancouver are participating. If successful, the product could be extended to other Canadian hub airports. But it is not expected to include the entire WestJet network.

With Canada's only main full-service carrier, Air Canada, in Star, there are limited options for offline connections for airlines outside Star. WestJet is a logical candidate for an alliance's LCC platform as it has hybridised and has already started codesharing or interlining with several foreign carriers, recognising the opportunities to work with non-Star carriers and improve yields.

SkyTeam Connect is not exclusive so WestJet can also continue to work with oneworld members and unaligned carriers. It could even potentially become affiliated with oneworld if the alliance decides to follow SkyTeam and now Star in developing its own LCC/hybrid platform.

The new Star platform will likely be similar to SkyTeam Connect. The idea is to bring in as partners LCCs and hybrid carriers which are not interested in joining the alliance but would add value by providing connections and feed.

LCCs offer an enticing alternative to alliances in select markets

LCCs from medium sized markets that have only one main full-service carrier can be attractive options for alliances that are looking to improve their coverage. LCCs that are not owned by the full-service carrier and have a model open to partnerships are particularly good candidates, as is the case with WestJet.

Besides Canada, other similarly sized markets served by one dominant full-service carrier along with LCCs include Mexico and Turkey. In Mexico, Aeromexico is a SkyTeam member while the country's two largest LCCs, Interjet and Volaris, are open to partnerships. The third Mexican LCC, VivaAerobus, follows a purer model. In Turkey, Turkish Airlines is in Star while Pegasus is the main independent LCC and is bigger than Turkish's LCC unit AnadoluJet. Turkey has several other carriers but they are all very small.

Australia's market is of similar size but the dynamic is different in that there are two large full-service players, oneworld member Qantas and independent Virgin Australia, which already works with several airlines outside oneworld. Australia's main LCC, Jetstar, is also owned by a full-service carrier in Qantas. (Smaller LCC Tiger Australia is also now majority owned by Virgin Australia.)

In the case of Jetstar, a LCC/hybrid platform could be used potentially by the market's leading alliance to further expand coverage as Jetstar operates some domestic routes Qantas cannot viably serve. Jetstar also has franchises in international markets, such as Vietnam and Singapore, where oneworld has relatively limited coverage.

LCC subsidiaries provide one option

With LCC subsidiaries of FSCs becoming increasingly common, this could be seen as one driver behind the move towards alliances introducing LCC/hybrid platforms. There are currently 16 alliance members with LCC subsidiaries or affiliates: Iberia, Japan Airlines and Qantas in oneworld; Air France, Alitalia, KLM, Korean Air and Vietnam Airlines in SkyTeam; and Air Canada, All Nippon Airways, Asiana, Lufthansa, Singapore Airlines, South African Airways, Thai Airways and Turkish Airlines in Star. South Africa's Comair, which operates a BA franchise in South Africa and is a oneworld affiliate, also has a separate LCC unit.

In addition pending oneworld member SriLankan and pending SkyTeam member Garuda Indonesia have LCC subsidiaries. SkyTeam current members Aeroflot and Kenya Airways are in the process of establishing an LCC subsidiary. As a result there will be at least 20 alliance members with LCC subsidiaries or affiliates by the end of 2014. This list will surely grow over the next few years, making an LCC option increasingly attractive to the alliances, particularly those LCC subsidiaries which are used by the parent to operate different routes.

But independent LCCs and hybrid carriers are the main targets for both the SkyTeam and Star LCC platforms. Perhaps this is because LCC subsidiaries of members do not really have to be courted. They can simply decide to participate although in many cases their parents could decide to keep them outside the alliance entirely in order to fully differentiate their low-cost and full-service products.

Brazil has emerged as a key battleground for global alliances

Independent LCCs in Brazil and India are the main targets, rather than LCC subsidiaries or smaller medium size markets such as Mexico. Brazil is the world's seventh largest aviation market while India is the ninth largest, based on current system-wide seat capacity.

Both are important growth markets with expanding operations from foreign carriers. But as both countries have several large and fast-growing secondary cities, domestic connections are required to provide a global alliance with sufficient coverage.

SkyTeam over the last two years has been actively courting Gol, which already works with several SkyTeam members including Aerolineas Argentinas, Aeromexico, Air France, Delta and KLM. Delta, which has had a minority stake in Gol since late 2011, has been leading the recruitment efforts.

SkyTeam's preference would be to bring Gol in as a full member. But as Gol has continued to remain neutral about alliance membership, the new SkyTeam Connect platform provides a potential option as it would facilitate more connections with SkyTeam members without requiring Gol to join as a member.

Gol captured a 35% share of Brazil's domestic passenger market in the first nine months of 2013, according to Brazil ANAC data. It has a small but growing international operation but it is the domestic connections which mainly interests SkyTeam.

Brazil domestic market share (% of RPKs flown): Jan to Sep-2013

Source: CAPA - Centre for Aviation & Brazil's ANAC

Gol currently serves about 50 domestic destinations. Gol's largest base is Sao Paulo Guarulhos, where it has about 283,000 weekly seats including 255,000 domestic seats. Seven SkyTeam carriers currently serve Guarulhos.

TAM is the largest carrier in Brazil with a 40% share of the domestic market in the first nine months of 2013. Guarulhos is also its largest base with about 316,000 weekly seats including 235,000 domestic seats.

TAM has 44 domestic destinations and is also the main Brazilian international carrier with about 21% of international seat capacity in Brazil compared to only 9% for Gol. About 70% of international capacity in Brazil is controlled by foreign carriers, most of which require domestic connections to sustain their Brazilian operations given the vast size of the country.

TAM is leaving Star on 30-Mar-2014 and entering oneworld on 31-Mar-2014. The decision to switch alliances came in Mar-2013, nine months after it completed its landmark merger with LAN. All of LAN's subsidiaries and affiliates are in oneworld.

See related reports:

• Pressure mounts on Star and SkyTeam to secure Brazilian members as TAM confirms switch to oneworld
• LAN Colombia expands oneworld market share in Latin America but TAM is the much bigger prize

Avianca Brazil works towards joining Star

Star has been working on bringing in Avianca Brazil as a new member. Colombia-based Avianca joined Star in Jun-2012 along with its sister carriers in Central America and Peru. But Avianca Brazil was not initially accepted into Star in 2010 due to an objection by TAM, which is now moot given the decision by TAM to exit Star.

Avianca Brazil has a separate ownership structure than Avianca, TACA, TACA Peru and LACSA (also known as TACA Costa Rica), all of which are part of publicly traded Avianca Holdings. But there is some common ownership with Synergy Aerospace, which is controlled by the Efromovich brothers, being the largest shareholder in Avianca Holdings and owning all of Avianca Brazil. (Ecuador-based AeroGal is also part of Avianca Holdings but has also not yet joined Star although it is expected to join in 2014.)

Avianca Brazil has begun working on becoming a member, upgrading its IT system and starting the process of meeting all the membership requirements. Although Star has not yet announced Avianca Brazil as a new member the carrier is well down the path to membership under an accelerated programme designed to give the more than one dozen Star carriers serving Brazil some interim coverage after TAM exits the alliance.

It is not possible for Avianca Brazil to complete the process of joining by the end of Mar-2014. But the carrier could potentially join Star as early as late 2014 and provide some unofficial coverage for Star, providing some benefits to the alliance's tier passengers, from the end of Mar-2014.

Azul provides intriguing and potentially supplementary but also controversial option

Star in the meantime has also begun courting Azul. The alliance believes Azul could add benefit even if Avianca Brazil also joins as a full member. Azul and Avianca Brazil combined would not provide the coverage TAM is providing but Star sees the duo providing better coverage than relying entirely on Avianca Brazil, which only has a 7% share of the Brazilian domestic market.

But some members of Star prefer not to offer an LCC partnership option, believing such a product could water down Star's offering to passengers. These members believe LCCs should only be allowed in if they chose to become members and fully meet Star's membership requirements. They think it is unfair for LCCs to enjoy a lot of the main benefits of membership, including feed, without having to invest in membership and meet the membership requirements. These members believe if an LCC does not want to join they should simply forge bilateral partnerships with Star members and not offer a special alternative platform.

Avianca Brazil obviously would prefer to be the only Star member or affiliate in Brazil. But some carriers would prefer a dual solution with both Avianca Brazil and Azul.

Avianca Brazil would provide sufficient coverage at Guarulhos

Azul is a bigger carrier, accounting for a 17% share of Brazil's domestic market compared to 7% for Avianca Brazil. Azul has a much larger network, with 100 domestic destinations compared to 24 for Avianca Brazil, according to Innovata data. Neither currently operates any international services.

While Azul overall is much larger, both carriers have similarly sized operations at Sao Paulo Guarulhos, which is the main international gateway to Brazil and is served by 13 Star carriers (excluding TAM, TAM Paraguay and US Airways as they are in the process of leaving Star).

Azul currently has 11 routes from Guarulhos, which it inherited from its 2012 merger with Brazilian regional hybrid carrier TRIP. Avianca Brazil also has 12 from Sao Paulo Guarulhos. Azul currently has about 52,000 weekly seats at Guarulhos while Avianca Brazil has about 49,000.

Sao Paulo Guarulhos domestic capacity share (% of seats) by carrier: 28-Oct-2013 to 3-Nov-2013

Source: CAPA - Centre for Aviation & Innovata

Azul currently holds about 10% of slots at Guarulhos compared to about 8% for Avianca Brazil. Azul has more frequencies as it operates Embraer E-jets and ATR 72s while Avianca Brazil operates primarily A320 family aircraft. (Avianca Brazil is in the process of retiring its Fokker 100s.)

Sao Paulo Guarulhos system-wide slot share (% of movements) by carrier: 28-Oct-2013 to 3-Nov-2013

Source: CAPA - Centre for Aviation & Innovata

The Avianca Brazil and Azul networks are somewhat complementary as each provides six destinations not served by the other. On the overlapping destinations, which include some of Brazil's biggest trunk routes - such as Brasilia, Porto Alegre, Rio de Janeiro Santos Dumont, Salvador and Recife - the two carriers combined would potentially offer Star a bigger range of connection options than if only one of the carriers was part of Star.

Avianca Brazil operates longer routes from Guarulhos than Azul, including five routes of at least three hours. Azul has just one route from Guarulhos over three hours (Recife).

Avianca Brazil would provide better coverage at Galeao

Avianca Brazil has a larger and more relevant operation than Azul at Rio de Janeiro Galeao, which is the second largest Brazilian gateway. Six Star carriers currently serve Galeao, accounting for about 23% of international seat capacity at the airport (excludes TAM, TAM Paraguay and US Airways).

Avianca Brazil has 17,000 seats at Galeao, a relatively small figure but it is spread across seven destinations, including Guarulhos. Azul has about 11,000 seats at Galeao but only has one route, linking Galeao with Sao Paulo alternative airport Campinas.

Rio de Janeiro Galeao domestic capacity share (% of seats) by carrier: 28-Oct-2013 to 3-Nov-2013

Source: CAPA - Centre for Aviation & Innovata

Azul's largest base is Campinas, which is only served by one Star member (excluding TAM), TAP Portugal. Its second largest base is Belo Horizonte Tancredo, which is served by only two Star members (Copa and TAP; again excludes TAM).

Rio de Janeiro Santos Dumont, a city centre domestic-only airport, is Azul's third largest base. Guarulhos is the carrier's fourth largest base.

Azul 10 hubs/bases/stations based on capacity (seats): 28-Oct-2013 to 2-Nov-2013

Source: CAPA - Centre for Aviation & Innovata

Guarulhos is Avianca Brazil's largest base. Salvador and Brasilia are the carrier's second and third largest bases. TAP Portugal serves both while Copa also serves Brasilia. Galeao is Avianca Brazil's seventh largest base based on current seat capacity.

Avianca Brazil to 10 hubs/bases/stations based on capacity (seats): 28-Oct-2013 to 2-Nov-2013

Source: CAPA - Centre for Aviation & Innovata

Azul currently does not yet have any interlines or codeshares. But the carrier is not a pure LCC and has been following a hybrid model similar to JetBlue (Azul is "blue" in Portuguese and both carriers were founded by David Neeleman). Azul will logically look to forge partnerships in future as JetBlue has done in recent years. Star therefore could be an attractive option.

But as a full-service carrier the Avianca Brazil product would be a better fit for Star. Avianca Brazil would provide connectivity to Star members to all the top cities in Brazil. Adding Azul would bring a bigger network but only a small portion of this network would be able to potentially provide feed to Star carriers.

Azul would provide more total volume for Star but Avianca Brazil would be able to provide more feed at the two main gateways and offer a product closer to the standards of Star's members. Adding Azul could also irritate one of Star's existing members in Avianca as the Colombia-based group has invested heavily in joining Star.

India presents a more intriguing option

Star would arguably gain sufficient coverage in Brazil from Avianca Brazil. The LCC platform could open up a more valuable opportunity in India as Star does not have any near-term full-service solution for the critical Indian market like it does for Brazil with Avianca Brazil.

Star has been hoping to secure India's largest private carrier, Jet Airways, as a member since it suspended Air India's induction into the alliance in Aug-2011 after the airline was judged as not having met the threshold requirements for membership after more than three years of preparation. Jet was also interested in Star for several years but had been blocked from joining by the Indian Government, which initially ruled that Jet could only join if Air India was first accepted. Air India has recently seriously re-activated its bid to join Star Alliance however the outcome of these efforts remains uncertain.

Jet is now also reconsidering its options following Etihad's acquisition of a 24% stake in the carrier. Etihad prefers an independent strategy and has developed its own alliance that has emerged as an alternative to the global alliances although some of its partners are aligned.

Singapore Airlines' new Indian joint venture carrier could be another option for Star. But the carrier is planning to only launch services in 2014 and it would be some time before it develops a sufficient network and scale and even considers alliance options.

See related report: Singapore Airlines-Tata joint venture proposal would be a big boost for SIA - and AirAsia?

In the meantime Star is keen to bring in IndiGo as a partner carrier under its new model or platform for LCCs. IndiGo is India's largest domestic carrier, transporting a 30% share of passengers in Sep-2013. Jet accounted for a 19% share and 25% when including its LCC subsidiary JetLite while another LCC and potential option for alliances, SpiceJet, accounted for a 17% share.

India domestic market share (% of passengers transported) by carrier: Sep-2013

Source: CAPA - Centre for Aviation & Indian DGAC

IndiGo currently serves 29 domestic and five international destinations, according to Innovata data. Its main bases are the primary international gateways of Delhi and Mumbai.

IndiGo top 10 hubs/bases/stations based on capacity (seats): 28-Oct-2013 to 2-Nov-2013

Source: CAPA - Centre for Aviation & Innovata

IndiGo unlikely to opt for Star partnership

But IndiGo has so far maintained a relatively pure LCC model and not yet pursued partnerships. Star began talks with IndiGo before its recent initiative to develop an LCC platform but acknowledged the carrier is not, at least at this stage, looking at membership. IndiGo's independent approach is serving it well for now, it continues to grow rapidly and profitably. And with trips per capita in India still extremely low, even by the standards of other emerging markets, the carrier believes that there is plenty of growth that can be tapped without the need to add complexities and costs to its business model through partnerships and alliances.

Alliance membership has been ruled out for now, but whether the LCC platform represents a more attractive option for IndiGo remains to be seen. The airline would need to be convinced that the benefits it can derive from the arrangement outweigh the costs and management distraction associated with integrating with the Star LCC platform. IndiGo has in the past been courted by several carriers interested in a codeshare or interline arrangement but to date the propositions have not proved to be sufficiently attractive. With passenger and revenue growth running in the strong double digits, IndiGo is for now likely to focus on sticking with the model it knows best.

Having an LCC and hybrid platform could also open up opportunities for other carriers which previously looked at Star but decided against membership, including Shanghai-based hybrid carrier Juneyao. While Star now has two members in China with Air China and Shenzhen it has been keen to increase its presence in Shanghai since Shanghai Airlines left Star in 2010. Shanghai Airlines later joined its new parent China Eastern in SkyTeam.

LCCs provide an opportunity for global alliances to increase their market shares

Introducing an LCC alternative may not be ideal as it falls short of the normal alliance product and standards. Undoubtedly some members will be against the concept, but it does open up the doors to better coverage in some key markets that otherwise would not be possible by only offering full membership.

LCCs now control about 26% of the world's seat capacity, offering more capacity than unaligned full-service carriers. Tapping such a large and growing sector is important, particularly as LCCs hybridize and start to work more with full-service carriers.

Global capacity share (% of seats) by alliance: 28-Oct-2013 to 2-Nov-2013

Source: CAPA - Centre for Aviation & Innovata

Inevitably alliance members will pursue more partnerships with LCCs. There are already dozens of such examples. By having a common platform at the alliance level, these types of partnerships are facilitated to their mutual benefit. But it may not be for everyone and the global alliances will need to pick their LCC partners carefully.

Global alliances need to try to increase their relevance in the new world order, where strong partnerships outside the alliances such as Qantas-Emirates have become more common and have started to diminish the value that global alliances bring. Offering an LCC platform could help them improve their relevance and bring value to some members. But it could also end up leading to more internal strife among members.