04-Jul-2013 7:28 PM

South Africa’s Mango, the often forgotten budget airline subsidiary, starts to pursue faster growth

Analysis

South African Airways' (SAA) low-cost subsidiary Mango plans to pursue further expansion as it attempts to leverage its position in the domestic market, which has strengthened significantly over the last year. The carrier over the last year has completed the largest expansion phase in its seven-year history, exploiting consolidation in the South African market to increase market share and return to profitability.

The collapse of two LCC competitors in 2012 left Mango and Comair subsidiary Kulula as the only players in South Africa's dynamic LCC sector. A new carrier is expected to eventually enter the market, leading to another possible phase of over-capacity and irrational competition. But Mango is now well positioned to fend off any new competition and gain more global recognition as a successful example of a full-service airline group budget subsidiary.

Mango is still a tiny carrier with a low global profile. Its counterparts in Asia have received significantly more attention for pioneering the LCC subsidiary strategy. But Mango's hybrid model has quietly succeeded, providing the building blocks for growth and a bright outlook.

Mango launched in Nov-2006 as part of a new multi-brand strategy for the SAA Group, which at the time faced increasing LCC competition and recognised the huge opportunities at the bottom end of the market. Mango was the third LCC in South Africa, following the 2001 launch of Kulula and the 2004 launch of (now defunct) 1time.

Kulula and 1time were able to quickly capture over 20% of South Africa's domestic market. As in the case of most markets experiencing its first taste of LCCs, the market share gains came mainly at the expense of the flag carrier although the total size of the market also increased significantly as the introduction of low fares stimulated demand. South Africa's domestic market grew by about 50% in the three years prior to Mango's entry. Rapid growth continued in the first year after Mango's launch but has since slowed considerably.

Mango's expansion was very slow through its first five years

Mango's operation within a few weeks after its launch consisted of four 737-800s. But it was not until 2011 that the carrier added its fifth aircraft. The network was also stagnant until flights from Cape Town to Johannesburg's alternative airport Lanseria was added in Jun-2011. Lanseria became only the fifth airport served by Mango, an incredibly low figure for a LCC in its fifth year of operations.

Mango flew 1.5 million passengers in the year ending 31-Mar-2008 (FY2008), its first full fiscal year of operations. But traffic shrunk to 1.3 million in FY2009 and FY2010 and did not surpass the 1.5 million level until FY2012, when the fifth aircraft was finally added.

Mango annual passenger traffic: FY2008 to FY2012

Mango annual RPKs: FY2008 to FY2012

Three years of shrinkage or zero growth is very unusual in the LCC sector, particularly for a new LCC trying to establish a foothold in a competitive market. But the Mango management team preferred to focus initially on perfecting its model and patiently waited for the inevitable consolidation.

"The South African market has always been over-supplied," Mango CEO Nico Bezuidenhout recently told CAPA. "Normality has to prevail at some point. The market simply cannot stomach the over-supply situation indefinitely."

Mango was also confronted with unfavourable conditions, including a slow economy, rising fuel prices and intense competition. South Africa's economy shrunk in 2009 and grew by less than 3% in 2010.

Mr Bezuidenhout, who has led Mango since the pre-launch phase and also just completed a four-month term as interim CEO of parent SAA, said the strategy was "not necessarily to be conservative" but Mango management "always wanted to ensure growth on a stable platform." He added that the initial years were spent refining operations, processes and distribution networks.

Mango builds leading distribution network and adopts hybrid model

The distribution network was particularly important as Mango recognised it needed to pursue alternatives to attract first time fliers in Africa, where credit cards usage is not universal. Mango became the first and is still the only African carrier to accept store charge cards. It was also the first South African carrier to offer mobile bookings and claims to offer more distribution channels and payment options than any competitor. "Mango has the broadest distribution network on the African continent in terms of non traditional connections," Mr Bezuidenhout says.

Mango also has evolved by offering products geared at the business traveller. Its Mango Plus product provides lounge access, unlimited flight changes without fees as well as vouchers for on board food and drinks. In FY2012 it developed a travel management system to deliver inventories to corporate customers.

While Mango has adopted some components of the hybrid model, the carrier maintains a strict low-cost focus and, like most LCCs, will not hybridise if this is at all compromised. "Sometimes we misunderstand the concept of low-cost carriers," Mr Bezuidenhout said. "The concept of low cost carriers is about keeping simplicity. If you can implement a codeshare arrangement while keeping your cost structure true and keeping your process simplified why not? If you can offer a passenger a business class lounge without you incurring the overhead cost for it, without you running and managing lounges - or if you can offer on-board internet access without incurring the capital cost for doing so and still maintaining the lowest cost structure in the industry, the quickest turnaround times and the best on time performance - does that make you anything less of a purist LCC?"

Mango looks forward to two-way codeshares with SAA and new partnerships

Mango started codesharing with SAA in 2010, initially on Mango-operated flights between Cape Town and Durban. In Sep-2011 the codeshare was extended to include the new Cape Town-Lanseria route, which is not served by SAA. Passengers flying on the SAA code receive snacks and beverages and accrue SAA frequent flyer points. Harmonisation of baggage policies is not an issue as Mango offers all passengers 20kg of complimentary checked bags with an extra allowance of 10kg provided to Mango Plus passengers.

Mango expects to extend the SAA codeshare to more Mango routes and ultimately SAA-operated flights. Selling on SAA, or potentially other airlines, would allow Mango to leverage its investment in distribution channels, including retail sales. "It stands to reason that we would like to leverage our strength in distribution so that it may not be inconceivable for us to place our code on the likes of SAA or other carriers," Mr Bezuidenhout said.

He added that Mango would be limited to selling on SAA short and medium-haul flights within Africa because South African Civil Aviation Authority restrictions do not allow an airline to codeshare on a route operated by a partner carrier unless they can in theory operate the route with their own fleet. As Mango has no intentions of adding widebody aircraft, it will only be able to sell SAA-operated flights of up to six hours.

Mango has intentionally built its in-house reservation system to enable it to codeshare with other carriers. Like other LCCs, Mango only seeks light codeshares that do not have the complexity of traditional partnerships.

"We can't operate in the fullest traditional sense of codesharing because that interjects complexity," Mr Bezuidenhout explained. "It does require a give and take. It's difficult to get airlines that are set in their ways to adjust. But that is the basis on which we can accommodate codesharing. And we have found that some of the existing more well established LCCs take a similar point of view."

Mango sees opportunity to more than double domestic operation by 2017

Codeshares with foreign carriers serving South Africa could provide a new stream of passengers, boosting yields and unlocking additional opportunities for growth.

Mr Bezuidenhout said Mango has already seen a 44% increase in passenger levels on a year-over-year basis, based on traffic figures for early Jun-2013. This was driven by a 40% increase in capacity and a 4 point improvement in load factor. Mango is confident further growth can be pursued as it looks to leverage the position it has built up in its first seven years and its investment in alternative distribution channels.

While Mango plans to pursue opportunities internationally, there are still opportunities for further domestic growth. Mr Bezuidenhout believes Mango can grow its domestic operation to a fleet of 15 aircraft before reaching saturation. He expects Mango to reach the 15 aircraft level in "three to four years".

Mango currently has a fleet of six 737-800s with 186 seats in single class configuration and one wet-leased 737-300. It plans to end 2013 with a fleet of eight 737-800s as two more 737-800s are added and the wet-leased aircraft is returned.

Mango fleet: as of 4-Jul-2013

Mango added the wet-leased aircraft following the Nov-2012 suspension of services at 1time. The aircraft was used to launch services on 5-Dec-2012 to Port Elizabeth from Cape Town and Johannesburg OR Tambo International Airport. Port Elizabeth, which had been served by 1time, became the sixth airport and fifth city in Mango's scheduled network.

Mango's network: as of 4-Jul-2013

Mango expands as 1time exits

Mango also has been able to boost capacity on several existing routes after dry-leasing a sixth 737-800. Mango in Jun-2013 offered about 48,000 weekly seats in South Africa's domestic market, representing about a 40% increase compared to Jun-2012, according to CAPA and Innovata data.

The biggest capacity increase has occurred on Cape Town-Durban, where Mango has added nine weekly frequencies for a total of 30. 1time operated two to three daily flights between Cape Town and Durban. The SAA codeshare has helped Mango grow the market as SAA has not up-gauged from using 50-seat regional jets on its 18 weekly flights between Cape Town and Durban. Kulula also has not expanded beyond its one daily 737 frequency although Comair has expanded in the Cape Town-Durban market over the last year through its full-service British Airways brand, which currently provides 23 weekly 737 frequencies.

Mango now accounts for 51% of seat capacity in the Cape Town-Durban market, compared to 36% one year ago. 1time had a 25% share in Jul-2012. Cape Town-Durban is the only Mango route in which the carrier accounts for over 50% of capacity.

Cape Town to Durban capacity by carrier (one-way seats per week): 19-Sep-2011 to 22-Dec-2013

Cape Town-Durban is now Mango's third largest market after Johannesburg OR Tambo-Cape Town and Johannesburg OR Tambo-Durban. Mango currently operates 33 weekly return flights from Johannesburg OR Tambo to both Cape Town and Durban. Mango currently has a 13% share of seat capacity on Johannesburg OR Tambo-Cape Town and a 19% share on Johannesburg OR Tambo-Durban, according to CAPA and Innovata data.

Mango also offers 20 weekly flights from Johannesburg Lanseria to Cape Town. Port Elizabeth (PLZ) is currently served with one daily flight from Cape Town and four weekly flights from Johannesburg OR Tambo. Mango's only other route, Cape Town-Bloemfontein (CPT-BFN), is served with six weekly flights in each direction.

Mango routes ranked on one-way frequencies: 1-Jul-2013 to 7-Jul-2013

Rationality returns to South African domestic market

1time served all of Mango's current routes except Cape Town-Bloemfontein. A fourth LCC, Velvet Sky, also served all three routes in South Africa's 'Golden Triangle' of Johannesburg, Cape Town and Durban. Velvet Sky suspended operations in 1Q2012, just one year after its launch.

Prior to Velvet Sky's exit, the South African domestic market consisted of about 360,000 weekly seats, including about 250,000 in the Golden Triangle. Capacity is now at a more rationale 320,000 seat level.

South Africa domestic capacity by carrier (seat per week): 19-Sep-2011 to 22-Dec-2013

Mango currently accounts for about 15% of domestic capacity in South Africa while LCC rival Kulula accounts for about 25%, according to CAPA and Innovata data. SAA accounts for a leading 45% of domestic capacity, including flights operated by its regional partners, while the British Airways brand accounts for the remaining 15%.

South Africa domestic capacity share (% of seats) by carrier: 1-Jul-2013 to 7-Jul-2013

Mango and Kulula both have seen their market share increase but the total LCC penetration rate has decreased as a result of the exit of 1time and Velvet Sky. In early 2012 LCCs accounted for 46% of capacity in South Africa's domestic market, including 18% for Kulula, 13% for 1time, 10% for Mango and 5% for Velvet Sky.

A third LCC could struggle given limited size of South Africa's domestic market

While there is potential for rapid domestic growth in the medium to long term, the South African domestic market is not of the size where it can support four LCCs. Even sustaining three LCCs over the long term is questionable.

Countries with similarly sized domestic markets include Chile, New Zealand, Norway, Saudi Arabia and Vietnam. The domestic markets in New Zealand, Norway and Saudi Arabia are currently only served by one LCC. Vietnam is the only other market with two LCCs while Chile has the distinction of having the second largest domestic market in the world after Russia without any LCC service.

As a result pan-African LCC group fastjet will face challenges in trying to establish a presence in South Africa's domestic market as a planned third LCC. fastjet has been seeking to enter the market since 1time's collapse. fastjet initially looked at taking over 1time's operator certificate but shifted gears in May-2013 to establishing a joint venture carrier in partnership with a South African investment company and a South African charter carrier. But plans to launch the South African affiliate in mid-2013 were put on hold recently as fastjet decided to instead focus for now on launching international operations from its original base in Tanzania.

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fastjet is still planning to eventually establish a domestic operation in South Africa. But the repeated delays and postponements gives Mango and Kulula a further advantage as they have more time to cement their positions in the market. Both brands are strong and have first mover advantage over any third LCC which enters the market.

Mango returns to the black with 'very good' FY2013

While Mango and Kulula have the muscle to fight back at any new entrant, inevitably the intense competition that will result from the launch of fastjet or any other start-up will impact profitability.

Mango was back in the black in the fiscal year ending 31-Mar-2013 after two consecutive years in the red. The carrier does not release financials but parent SAA acknowledged unspecified losses at Mango in their annual reports for FY2011 and FY2012, following small profits in FY2009 and FY2010.

SAA has not yet reported its results for FY2013 but Mr Bezuidenhout told CAPA it was "a very good year for Mango" and unit revenues were up 39% compared to FY2012. He added: "I would like to say that not everything was fundamentally due to 1time's exit. Last year was a good year yes because, one, there was an exit in the market but, two, our on-board internet access got well adopted and, three, we expanded before 1time's exit."

Mango became in 2012 the first South African carrier to offer on-board internet access, which it believes gives it an important competitive advantage. The internet product has been particularly beneficial for Mango as all installation costs were covered by partners.

Mango to stick with 737-800 until about 2020

Mango is now investing in retrofitting its aircraft with new interiors and seats. The carrier is comfortable with making this investment as it expects to operate its current fleet of 737-800s until about 2020, at which point it expects to transition to the 737MAX or A320neo. The carrier plans to soon start evaluating both new types.

Mango's next two 737-800s are coming out of SAA's fleet, which is transitioning its narrowbody fleet to A320s. The carrier's last two and original four 737-800s also were previously operated by SAA.

While Mango could potentially grow its fleet to 16 aircraft if it takes all of the 737-800s being phased out by SAA it is not obligated to take ex-SAA aircraft as in most cases their leases are expiring. But so far Mango has been able to negotiate favourable lease rates with the owners of the aircraft, resulting in a significant reduction compared to what SAA had been paying. "We have to negotiate better rates. It's as simple as that," Mr Bezuidenhout said.

Mango has the right approach

Mango is relentlessly focused on keeping its costs low and well below SAA's bloated levels. This is a key component of the multi-brand strategy as the SAA Group continues to use Mango to compete against LCCs and grow with a focus primarily on leisure markets - for now domestically and over time internationally.

Mr Bezuidenhout points out that in setting up Mango in 2006 the SAA Group was careful not to repeat the mistakes in Europe and North America, where full-service carriers established new LCCs as divisions rather than independent subsidiaries, resulting in cost structures which were too similar to their parents. SAA instead took the more successful Jetstar-type approach that been used in recent years across the Asia-Pacific region. While Mango was established two years after Qantas launched Jetstar, which is widely viewed as the first successful example of the multi-brand model, SAA should be credited with recognising at a very early stage the benefits that a budget subsidiary could bring under the right strategy.

While Mango has pursued very slow expansion until relatively recently, the foundation is there for a successful budget carrier subsidiary. Perhaps the biggest roadblock to future success is SAA itself, as the flag carrier attempts to implement yet another new strategic plan aimed at reversing several years of losses and failed restructurings.

Part 2

This is the first part in a two-part series of reports on Mango. The second part, to be published later this week, will look at opportunities for Mango in the international market, including potential joint ventures in other African countries.