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    Recorded at CAPA Latin America Aviation & LCCs Summit, 11-Sep-2018

    Overview Of LCC Development In Latin America

    The LCC sector undoubtedly is confronted with the greatest global expansion opportunity in Latin America as hundreds of millions of people enter the middle class across the region. Huge new travel markets await. Across the region, second tier cities are emerging that offer great promise to LCCs as flag carriers defend their traditional hubs. But how do the region’s fledgling LCCs stay true to their business model of high efficiency? How can they drive the next step change in unit cost (CASK) reduction? Will it be driven by new aircraft technology, better supplier deals, greater operational flexibility or a combination of these? The LCC sector undoubtedly is confronted with the greatest global expansion opportunity in Latin America as hundreds of millions of people enter the middle class across the region. Huge new travel markets await. Across the region, second tier cities are emerging that offer great promise to LCCs as flag carriers defend their traditional hubs.
     
    Today, LCCs operate the majority of seats in the two largest domestic air travel markets of Brazil and Mexico and have a growing presence in Chile and Colombia. Yet LCCs also face inherent difficulties in achieving meaningful growth in this region, because of factors such as long distances between large O & D markets (where sector time is often in excess of 3.5 hours), relatively thin markets, high charges and taxes, regulatory inhibition and lack of secondary airports.
     
    Given such constraints, how do the region’s fledgling LCCs stay true to their business model of high efficiency? How can they drive the next step change in unit cost (CASK) reduction? Will it be driven by new aircraft technology, better supplier deals, greater operational flexibility or a combination of these?
     
    CAPA – Centre for Aviation, Senior Analyst, Lori Ranson

    Transcript

    Lori Ranson:Thank you, John, and good morning, everyone. I'm just going to take a few minutes to sort of set the stage for some of today's discussion about the growth of LCCs and ULCCs here in Latin America. So it's probably worth just a brief look, a brief history lesson at the rise of LCCs. Over the last 2 decades. Brazil's Gol was the first among the low-cost airlines to debut during that time, and now it's roughly 14 years old, and it's the leading domestic airline in Brazil. Then Mexico became a hotbed of LCC activity. Volaris, Viva Aerobus, and Interjet all launched service within a 2-year period in the mid-2000s. And Mexicana's exit from the market was a prime opportunity for some of those airlines to accelerate their growth. Azul made its debut in 2008, and in 2012 it acquired regional airline Trip, and then GOL purchased rival Webjet. That capped off some consolidation in the LCC space just as Avianca and TACA and LAN and TAM were forming 2 create Avianca and LATAM Airlines Group. So today, GOL and Azul are Brazil's first and third largest airlines measured by market share, and low-cost airlines in Brazil control 57% of the country's domestic seats. And in Mexico, LCCs control about 66% of of the domestic seats. Both Azul and GOL have transitioned to a more hybrid-like model. They're growing their business traveler base, and they're offering certain products to attract corporate customers. The lifting of restrictions in Brazil on airlines to charge for checked bags has allowed a certain level of product segmentation, and both airlines are also working to leverage their leading positions within the country to forge partnerships And as we all know, Azul is also working to create a JV with United. Volaris and Viva adhere more to a pure LCC model, and that's taken off in South America during the last couple years with JetSmart in Chile, Fly Bondi in Argentina, and Viva Air Peru all making a push to spread that model in this region. And now with Sky and JetSmart's entry into the Chilean market, LCCs control about 37% of the country's domestic seats. So this rapid growth in ULCCs and LCCs is obviously driven by the opportunity for traffic stimulation, and as we've seen over the last day or so, the best way to measure that is by trips per capita. So this is a slide from LATAM Airlines Group that shows trips per capita for various countries in 2017. And if you look at Latin America's largest markets, Brazil, Mexico, and Colombia, TPC in those countries is just a fraction of what it is in the US. So now Argentina and Peru are emerging frontiers for LCCs, and Chile Sky is working to establish a new Peruvian airline. And Viva Air Peru is working to garner a double-digit market share in the country's domestic market. Fly Bondi launched in Argentina this year. Norwegian is still working to launch operations, and JetSmart plans to launch flights from Chile to Argentina and is also considering domestic operations in the country. FlyCana is working to bring the ULCC model to the Caribbean from its base in the Dominican Republic. So there's no shortage of low-cost ambition in Latin America, but the obvious question is, what's the staying power of these upstarts? Full-service airline competitors aren't resting on their laurels. LATAM has created a new pricing structure in its domestic market to compete and isn't ruling out creating its own LCC. And those new airlines face the same challenges as some of the incumbents. keeping their costs in check in an environment where taxes loom large and departure taxes from some airports are higher than average airfares. Low-cost airlines need to maintain certain cost levels to effectively stimulate traffic. And what are those cost levels? Volaris calculated its unit cost excluding fuel in 2017 was 4.7 cents, and it estimated CASK for its rival Viva Aerobus was about 5 cents. Some airlines operating here have a CASK below 4.4 cents. So is CASK of 5 cents or below the benchmark for Latin America's LCCs versus 6 cents in the United States where stage lengths are longer? There's no magic formula to get cost in check. It's a combination of many elements. Fleet efficiency, aircraft utilization, and maintenance and supplier contracts. So this slide shows average fleet age for some of the LCCs here in the region, and the total for those is about 9.9 years. That drives a certain level of efficiency, and these airlines listed here have hundreds of airline— aircraft on order. And so that's going to drive their costs down as well. And Viva and Sky in particular are starting their refleeting programs, so that's going to create some cost efficiency for those 2 airlines. And these aspiring pan-regional LCC groups like Viva, JetSmart, and Volaris have an opportunity to use their scale to negotiate favorable maintenance contracts to further drive their costs down. But we have to ask ourselves, what are the other cost levers LCC can pull? Can they push employee productivity to new highs? Does it encompass streamlining internal systems and processes? Is it new distribution technology? Low-cost operators know no stone can go unturned, and all airlines in this region and globally have a laser focus on cost. Thank you, Lori. And just kind of turning to the market potential, it's a bit too early to draw any major conclusions about how the new entrants in Chile and Peru are changing market dynamics, but there's been solid passenger growth in both of those countries. So Chile's domestic passenger levels jumped 16.8% from January to July of this year, and LATAM and Sky remain the dominant airlines. They have passenger shares of about 62% and 25%, and JetSmart's share was about 12%. But there's some yield pressure in Chile, and it seems like fares are likely to keep falling next year in 2019. Peru's domestic passenger levels grew about 12% during the first half of this year, and the country's 2 largest airlines, LATAM Peru and Peruvian, maintained their first and second place share And Viva's market share was about 5%. So in markets where LCCs have opted to launch operations, passenger levels are definitely growing. It seems like fares are falling, and that's obviously good for customers. But the big picture takeaway for discussion right now is the ULCC era is here in full force in Latin America. The model is going to grow and spread rapidly across the region. In the coming years. Thank you.

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