12-Sep-2014 12:37 PM

VietJet Air international expansion enters new phase with Cambodia and Russia

Analysis

VietJet Air is planning further expansion of its international network with Cambodia and Russia slated to become its fourth and fifth overseas markets. Vietnam's leading low-cost carrier is also looking at launching a connection product which will enable it to compete in the broader Russia-Southeast Asia and North Asia-Southeast Asia markets.

Russia will initially be served using VietJet's rapidly growing A320 fleet to access the Russian Far East city of Vladivostok. But VietJet has big ambitions for the Russian market using its anticipated future fleet of A330s.

The LCC sees huge potential in Russia as it is a large and fast growing source market for Vietnam's emerging tourism industry. VietJet's parent company also has Russian roots, which should make it easier from an access and local sales perspective.

VietJet Air has so far focused primarily on the domestic market

Vietjet Air launched in Dec-2011 and has quickly expanded in the domestic market, where it now serves 12 destinations and has about a one-third share of total capacity. International expansion has been slower than expected and the LCC currently only operates three international routes - Ho Chi Minh-Bangkok (launched in Feb-2013), Ho Chi Minh-Singapore (launched in May-2014) and Hanoi-Seoul (launched in Jul-2014).

But VietJet's international expansion is starting to pick up pace. This is partly a reflection of the relatively fewer opportunities in the domestic market now that VietJet is serving almost every domestic route which can support 180-seat A320s. It also reflects the huge opportunities in Vietnam's international market, which remains relatively underserved particularly from an LCC perspective.

Given its large order book and ambitious mindset it was always inevitable that VietJet would pursue more aggressive international expansion. It was sensible however for VietJet to first focus on the domestic market and wait until it had scale (it now operates 15 A320s) as well as a strong local brand before turning to more riskier international expansion.

VietJet plans Siem Reap service

VietJet has been evaluating several potential markets in Southeast Asia and North Asia. VietJet is close to confirming new destinations in both regions and stated on 8-Sep-2014 that "more destinations will soon be added, including a flight to Siem Reap in Cambodia".

Cambodia is a logical destination for VietJet as it is one of Vietnam's largest international markets but is not yet served by any LCCs. The Vietnam Airlines Group, which includes Cambodia Angkor Air, now dominates the Cambodia-Vietnam market, accounting for about 80% of total seat capacity between the two countries.

Vietnam to Cambodia capacity by carrier (one-way seats per week): 19-Sep-2011 to 8-Mar-2015

VietJet has not yet said which of its Vietnamese bases it would use to initially serve Siem Reap but eventually it likely will operate to Siem Reap from both Hanoi and Ho Chi Minh. Both are short flights but have relatively high demand as Siem Reap is a popular tourist destination for the Vietnamese emerging middle class.

VietJet should be able to significantly lower fares on the Hanoi-Siem Reap and Ho Chi Minh-Siem Reap routes, stimulating demand. Cambodia Angkor Air and Vietnam Airlines are the only carriers on the Ho Chi Minh-Siem Reap route, operating a combined six daily flights. Cambodian leisure carrier Skywings Asia competes on Hanoi-Siem Reap but operates only one daily flight on the route while Cambodia Angkor Air and Vietnam Airlines offer a combined 19 weekly flights.

Hanoi and Ho Chi Minh are the largest two international routes from Siem Reap based on current seat capacity. The lack of an LCC in either market makes it obviously attractive to VietJet.

VietJet to start pursuing transit markets including Russia-Siem Reap

Siem Reap has a very limited outbound market as it is almost entirely a tourist destination. But VietJet plans to tap into Siem Reap's emergence as a popular tourist destination in other markets such as Korea and Russia.

Currently VietJet is strictly a point to point operator. It does not offer a connection product or a sum of sectors option on its website booking engine. For example, passengers seeking to travel from Bangkok or Singapore to Seoul or a secondary destination in Vietnam need to buy separate tickets and self-connect.

But in the 8-Sep-2014 announcement VietJet mentioned offering Russian tourists connecting flights to Singapore, Thailand and Cambodia. VietJet could simply promote self-connections but more likely will look to join a growing number of Asian LCCs in offering a connection product.

A connection product would help VietJet generate sufficient traffic volumes and yields to support more international routes. Vietnam has become a big outbound market for several countries including Russia and Korea but feed would provide incremental traffic and help VietJet compete with flag carriers. Secondary destinations such as Vladivostok may not be viable on a pure point to point basis.

Vladivostok is a seemingly odd - but ideal - destination for VietJet

Vladivostok has emerged as VietJet's most likely initial Russian destination following the 6-Sep-2014 signing of a memorandum of understanding (MoU) between VietJet and Vladivostok Airport. VietJet said in its 8-Sep-2014 announcement that the MoU will "pave the way for the new-age airline to open direct flights from Vietnam to Vladivostok".

(VietJet has started referring to itself as a "new age airline," a phrase CAPA began using in 2012 to refer to new hybrid carriers. VietJet is continuing to hybridise as it starts to pursue connection traffic and looks at adding widebodies, most likely A330s, to supplement its narrowbody fleet.)

Vladivostok may seem like an odd choice but could be an ideal destination for VietJet to establish itself in the Russian market. As Vladivostok is located in far eastern Russia, it is within narrowbody range of Vietnam. This enables VietJet to accomplish its goal of serving Russia before it has to commit to A330s, which it has been looking to acquire for potential routes to major cities in western and central Russia.

Vladivostok is not a huge market - the city has a population of only about 600,000 and its airport has only about 90 scheduled international movements per week.

But the market should be big enough to support a narrowbody service to Vietnam - at least a low frequency service (two or three weekly flights) - when factoring in the stimulation effect of VietJet's low fares and connection opportunities beyond Vietnam.

VietJet to provide Vladivostok with its first link to Southeast Asia

VietJet is poised to become the first carrier offering non-stop services from Vladivostok to Southeast Asia. Currently Vladivostok has 11 international routes, all of which are to North Asia. Only one of these routes, Seoul, is served with at least one flight per day.

Vladivostok international capacity (seats) by country: 8-Sep-2014 to 14-Sep-2014

Korea is the biggest international market, accounting for almost 50% of international seat capacity at Vladivostok. Asiana and Korean Air both serve Vladivostok and are the main players in the Vladivostok-Southeast Asia market.

Of the eight international carriers serving Vladivostok four are Russian. They are for the most part unable to compete in the Vladivostok-Southeast Asia market except with very circuitous routings via eastern Russia. The other two foreign carriers in the Vladivostok market (besides Asiana and KAL) are North Korea's Air Koryo and China Southern. Air Koryo only carries point to point passengers while China Southern only serves Vladivostok from Yanji in northeast China, which is not connected with Southeast Asia.

As the first LCC serving Vladivostok, VietJet should able to significantly undercut the Korean carriers in one-stop markets such as Vladivostok-Siem Reap and also potentially offer faster connections than what is now available via Seoul. But the majority of passengers will be Russians heading to holiday in Vietnam.

Vladivostok international capacity share (% of seats) by carrier: 8-Sep-2014 to 14-Sep-2014

Vladivostok could be the first of several Russian destinations for VietJet

Russia is a large and fast-growing source market for Vietnam's tourism sector. Vietnam recorded over 240,000 Russian tourists in the first eight months of 2014, an increase of 28% compared to the same period in 2013.

Vietnamese beach destinations have particularly become popular holiday spots for Russians, including the resort city of Nha Trang. Nha Trang now handles non-stop flights from Russia, including two weekly scheduled flights from Moscow from Vietnam Airlines and seasonal charters from Russian carriers.

VietJet has looked at potentially operating A330 flights from Nha Trang to Russia to tap this market. But Hanoi is a more likely initial hub to serve the Russian market as it is closer to Russia and can be used for domestic connections (including Nha Trang and Phu Quoc, an island destination in southern Vietnam which is starting to gain popularity with Russians) as well as some international connections (potentially Siem Reap and Bangkok).

Hanoi is particularly a more practical option for Vladivostok and other potential destinations in southeast Russia. Vladivostok is about 3400km from Hanoi, or slightly over four hours by air. But it is about 4300km from Ho Chi Minh and about 4100km from Nha Trang, or over five hours by air and therefore requiring payload restrictions on a 180-seat A320.

Nha Trang could potentially support future VietJet A330 flights from large Russian cities such as Moscow. But for secondary Russian cities a link to a hub is more practical and less risky, with Hanoi being the most logical choice given its location in northern Vietnam.

VietJet can leverage experience of parent company in serving Russian market

Russia is not a typical market for Asian LCCs and traditionally Russian airlines, including charter operators, have dominated the Russia-Southeast Asia market. But VietJet has Russian ties; these should help it sell in the Russian market services to Vietnam, as well as connections beyond Vietnam. VietJet's parent is Sovico Holdings, a large Vietnamese conglomerate that was originally started in the former USSR before moving to Vietnam.

VietJet should be able to leverage Sovico's expertise and become a major player in the emerging Vietnam-Russia market. The Russian operation could become an important differentiator for VietJet in the increasingly competitive Southeast Asian LCC sector. It is unlikely other LCC groups - such as AirAsia, Lion and Jetstar - will enter the Russian market.

There are currently about 23,000 weekly non-stop scheduled seats between Russia and Southeast Asia (capacity increases significantly during peak periods). About a third of these are in the Russia-Vietnam market, which is currently served by SkyTeam partners Vietnam Airlines and Aeroflot with equal capacity shares.

Southeast Asia to Russia capacity by carrier (one-way seats per week): 19-Sep-2011 to 8-Mar-2015

VietJet adds a second daily flight on Ho Chi Minh-Bangkok

While Vietnam's international sector is primarily an inbound market, VietJet has until now focused its international operation on markets that have strong outbound demand such as Singapore, Thailand and Cambodia. This is a sensible approach as it has allowed VietJet in its early phases to rely mainly on Vietnamese point of sales, leveraging the strong brand it has quickly established in Vietnam.

But in order to continue its rapid growth trajectory VietJet over time will need to build up its brand overseas and capture a large portion of the inbound market. The Hanoi-Seoul route, which is still in the maturing phase as it has been operating less than three months, has provided VietJet with its first major test in the inbound market. Russia will likely be the second test but one that perhaps has less risk given the experience VietJet's owners have in the Russian market.

The Bangkok and Singapore routes also have provided an opportunity to establish a presence overseas and supplement outbound Vietnamese traffic with inbound passengers. VietJet is adding on 12-Sep-2014 a second daily flight on Ho Chi Minh-Bangkok Suvarnabhumi, a positive indicator the LCC has had success in its first international route despite intense competition. Ho Chi Minh-Bangkok becomes the first international route VietJet has served with more than one daily flight.

The increase from VietJet allows it to match the capacity provided by the only other LCC in the Ho Chi Minh-Bangkok market, Thai AirAsia. Thai AirAsia currently has two daily flights from Bangkok's other airport, Don Mueang. The Ho Chi Minh-Bangkok market is also served by Thai Airways, Vietnam Airlines and Turkish Airlines (all of which operate from Suvarnabhumi).

A second Thai LCC, Nok Air, has been preparing to launch services to both Ho Chi Minh and Hanoi and is expected to launch services to Vietnam in late 2014 or early 2015. VietJet's decision to add a second daily flight could in part be a strategic move to increase its presence ahead of Nok Air's entry.

The decision to add a second daily flight on Ho Chi Minh-Bangkok could also be a strategic move to help pave the way for the launch of its planned Thai affiliate, Thai VietJet. VietJet has been aiming to launch its Thai joint venture by the end of 2014 and initially allocated Thai VietJet three of the 10 A320s the group is slated to receive in 2014.

Thai VietJet is expected initially to operate domestic flights from Bangkok Suvarnabhumi, which could be timed to connect with VietJet's flights from Ho Chi Minh. VietJet could also potentially resume services from Hanoi to Bangkok, which it suspended earlier this year but may see a resurrection once market conditions in Thailand improve and VietJet has a local JV up and running that can provide feed and local marketing support.

VietJet needs international expansion and overseas JVs to fulfil its aircraft commitments and growth plans

While a launch date for Thai VietJet has not yet been set there are no indications the project has been dropped. VietJet could be waiting for a more stable political environment and an improvement in market conditions. VietJet clearly needs the Thai affiliate (or an affiliate in another Asian country) to support its ambitious aircraft commitments.

In Feb-2014 VietJet completed an order for 62 A320 family aircraft, including 42 A320neos, 14 A320ceos and six A321ceos. The first aircraft from this order are expected to be delivered in 4Q2014. VietJet has sourced its initial 15 A320s from leasing companies, including the five aircraft that have been added so far this year.

As CAPA has previously analysed, the group expects to end 2014 with a fleet of 20 A320s and add about 12 A320 family aircraft per annum starting in 2015. While there are still opportunities for growth in Vietnam, particularly in the international market, Vietnam is unlikely to be able to absorb all these aircraft.

VietJet begins an important phase as international expansion is accelerated

VietJet is entering a critical phase.

Its first three years have been highly successful, with the airline already carrying over seven million passengers (including three million in the first seven months of 2014) and becoming profitable.

But as it starts to spread its wings outside Vietnam - through expansion in Vietnam's international market as well through joint ventures - there will be bigger challenges and risks.

If VietJet plays its cards right the rewards could be huge. Entering the Russian market appears a clever strategy given its huge potential and VietJet's Russian ties. Cambodia is another logical new international market that is not yet served by any LCC.

But with any international expansion there are always risks. And VietJet will need to continue diversifying its network after Cambodia and Russia are launched. This is where VietJet could ultimately face its toughest tests.