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The evolving long-haul low-cost network airline model: AirAsia X and the new LCC connectivity

At the Farnborough Airshow on 15-Jul-2014, AirAsia X became the launch airline customer for the new A330-900neo, with 50 commitments. That is an important order – but it is made doubly special because AirAsia X is a long-haul low-cost airline, a model that is consistently written off by industry experts. 

What makes the story most significant for the purposes of this discussion about airline business models  – and more challenging as the industry goes through its gentle process of disruption – is that AirAsia X has also very quickly become a network airline.

Nearly half of its passengers through its Kuala Lumpur hub are transfer traffic; and that percentage is growing steadily. Many full service hub operators do not manage that level of connectivity.

This is a slightly amended version of a report that first appeared in CAPA's Airline Leader, Issue 23, 2014.

To learn more about this cutting edge model and to meet all of Asia's key aviation players, sign up now to be part of CAPA's three day Asia Aviation Summit and LCC Congress, plus a full day of corporate travel at Singapore's Capella Sentosa 13-15 October, 2014: http://centreforaviation.com/events/upcoming/

Note: since this Airline Leader report was published, AirAsia X has reported its 2Q2104 results. CAPA's report on this can be found at:

AirAsia X records 2Q2014 loss as Australia underperforms. But long-term prospects are still bright

 

AirAsia X, the long-haul sister of AirAsia, the region's most successful LCC

To achieve this level of connectivity, it helps in no small part that the AirAsia X Group is affiliated with short-haul LCC group AirAsia, which also has a hub at Kuala Lumpur, with high frequency point-to-point services. This creates a whole additional dimension to the model, and one that acquires further breadth as each airline establishes complementary cross-border joint venture companies.

Then there is also the important feature that Kuala Lumpur International Airport has effectively constructed a purpose-built hybrid terminal (KLIA2) which facilitates a lower cost and efficient transfer process that works with LCC operations. The development involved extensive cooperation between airport operator and the airlines, notably AirAsia.

While this was not always a comfortable development partnership, it too offers a precedent, both of process and of outcome in this new, low-cost connectivity model.

AirAsia X was established in 2007 and listed in Jul-2013

by a consortium including Tony Fernandes’ Aero Ventures and the Virgin Group. An IPO on the Kuala Lumpur stock exchange in Jul-2013 raised USD300 million but the stock has yet to be proven a good short-term investment due primarily to losses over the last year and intense competition in the Asian marketplace.

In 2014, the group is adding 40% to its capacity. The group’s fleet of 22 aircraft in Jul-2014 compares with only 12 at the beginning of 2013. AirAsia X will likely surpass the 100-aircraft market early next decade, which would make it a significant force regionally – and globally.

AirAsia X has the world’s lowest airline costs, at a non-fuel USD1.9 cents per ASK (add in fuel and its costs double). And, like many low-cost operators AirAsia X is no longer a simple “pure” LCC model. It is hybridising; its A330s now include some near lie-flat seating, it uses airport lounges, offers a loyalty programme and has expanded its distribution channels to embrace GDSs – but it remains very LCC in achieving 17 hours a day utilisation and deriving 25% of its revenues from ancillaries. And, even where full service-style features are added, they are each done with a low cost twist, such as a fee for lounge use.

The evolution is perfectly logical in so many ways. It is the convergence of the well-tested full service network model, combined with the fundamental concepts of low-cost airline operation. 

The more traditional function of feeding the hub, so the long-haul larger capacity aircraft does not leave with empty seats, is an essential part of network operations. Then add to this an ingrained low-cost culture, extended aircraft utilisation, a simple product with active use of ancillary potential and the basis for servicing 85-90% of the market cheaply is established. 

All of these features are compatible with, if not essential to, long-haul operations. Also, complementing the flexibility provided by a new style hybrid KLIA2 terminal, AirAsia X improved the sophistication of its pricing model. Instead of leaving it to online connecting customers to buy two separate sectors – with the resulting sum-of-sectors pricing – the airline began offering O&D pricing, allowing it to ensure competitiveness with the competition, direct and indirect, on end to end city pairs.

KLIA2 is an excellent example of a key airline and the airport operator creating a tailor made entity

By working together, Kuala Lumpur International Airport and the AirAsia group are generating mutual benefits. That is not to say in this case that the process hae been straightforward. The new terminal, KLIA2, was delivered late and over budget – but how many new airport facilities do not conform to that formula! Here though there were mitigating influences.

KLIA2 was initially conceived as little more than a larger replacement for the dedicated low-cost terminal built in 2006, two generations ago in the short evolution of low-cost airline operations in Asia (it closed in May-2014, after being drastically over capacity almost from the day it opened, as AirAsia’s growth confounded the market).

However, the massive and unpredictable metamorphosis of low-cost airline operations during planning and construction meant there were constant pressures to adjust the specialised processing facilities. Already AirAsia was asking for a system that would deliver a quality experience (at no cost!), but cater specifically for travellers who may have two tickets and want to avoid having to perform CIQ formalities and re-check in, perhaps with bags to collect as well. As time passed and the market changed, this aspect of the LCC’s operations became increasingly vital. 

At the same time, long-haul AirAsia X’s Australia services were growing – the airline is now the fourth largest foreign operator to Australia, by seats flown – so the demand for connections grew in parallel. Today’s outcome is an airport terminal which is compatible with both full service and LCC needs.

The transfer facilities were designed mainly by Malaysia Airports Berhad (MAHB) but with extensive inputs from its airline customers. As the profile evolved, MAHB made an assumption in the design that about 50% of passengers would be transfers though, interestingly, the airlines wanted an even higher percentage than that to be catered for.

When opened on 2-May-2014, KLIA2 included transfer capability for domestic-to-domestic, domestic-to-international, international-to-domestic, and international-to-international, applicable to both intra- and inter- airline services.

As can be expected, developing this game-changing model has not been free from setbacks

All of AirAsia X’s scheduled flying is on A330s, but it still has two A340s, leased from Air Canada when fuel was a lot less expensive and now used for ad hoc charters. It was these aircraft that once ventured all the way to London and Paris, routes that had to be dropped as fuel prices rose, punishing the four engined jet. 

For the same reason a planned route to the US west coast was dropped, as were potential other European services; and an 11.5 hour Christchurch, New Zealand service was suspended after 12 months’ operation, along with demand problems associated with the severe earthquake in that city. 

The importance of the transfer traffic model became more intense as a result of the high price of fuel – and, consequently, reduced its cost advantage over full service airlines. Long-haul low-cost is inevitably highly sensitive to fluctuations in energy prices. Offering lower prices on long-haul sectors, with only limited potential for leveraging premium seating sales, means the yield profile is also intentionally low. The model depends largely on stimulating traffic, as well as diverting it, so raising prices is not always a viable solution.

In other words, fuel prices have also helped define the long-haul LCC comfort zone; based on the current A330 fleet economics this reaches up to about 8 hour sectors, possibly 10 in some circumstances.

So what was originally a relatively casual need for on-carriage on low priced airlines became an essential ingredient of this evolving operation as it adjusted to fuel accounting for half of its costs.

But the European services also suffered from a lack of local connectivity. Despite operating initially into Stansted and later Gatwick, both of which have LCC operations, this was not the right foundation for an originating eastbound traffic feed. This was a mistake that will not quickly be repeated.

Today, most of AirAsia X’s connections still interline onto the short-haul AirAsia. This is unsurprising, as the latter operates a third of the KLIA capacity, on a par with flag carrier Malaysia Airlines. But as its route network expands, AirAsia X is growing its on-line connectivity at a faster rate.

There is another string to the AirAsia X long-haul strategy: cross-border joint ventures

These are another specific adaptation to the massive opportunities presented by the Asian economic explosion. Following the lead of its AirAsia antecedent (and several others since), as well as learning some lessons from all of their mistakes, the long-haul LCC has established JVs in Thailand and Indonesia – with undoubtedly more unannounced plans in the portfolio.

This cross-border competence allows AirAsia X, on the one hand, to benefit from AirAsia’s domestic and short-haul international operations – mimicking its collaboration at home in KLIA – enabling it to link into its overall operations. In the process this offers AirAsia X extensive additional long-haul operating options, exploiting the third country’s bilateral rights. When the A330neos enter into service, the long-haul opportunities become legion, as AirAsia X has multiple potential national hubs to work from, all able to be fed by short-haul and domestic traffic.

Growing the operation has exponential potential within the AirAsia Group

The latent opportunities for the various arms of each airline to work synergistically expand as each new JV is established. It is unlikely to be a coincidence that the first cross-border JV that AirAsia X established was in Thailand. That was also the first cross-border JV for sister group AirAsia and is the destination of many Australians, flying via Kuala Lumpur as much of the direct capacity between the two countries has been withdrawn. 

They connect onto AirAsia for the 90-minute or so onward flights, and will continue to do so, as the division of responsibilities works along practical lines, where the short-haul operator provides a more efficient product. Then AirAsia also operates domestically in Thailand, using its Thai AirAsia JV vehicle, creating the ability to feed the Bangkok hub.

But Thailand also is the beneficiary of strong inbound growth from Chinese tourism, as well as experiencing strong Japanese market growth. So, until China permits foreign airline establishment, Thailand offers a sound base for AirAsia X to access that market, both end to end and connecting over Bangkok; half of its total capacity is already allocated to North Asia and the China market is only going to grow – and grow. Thai AirAsia X will focus on eastern and northern China, which is more than four hours’ flying time from Bangkok while short-haul Thai AirAsia will continue to grow in southern, central and western China.

(Although China is undergoing a frugality campaign which has affected conspicuous tourism, the impact of that is likely to be diluted in the short term; and there is also the conflicting goal that China needs to expand its air travel to meet five-year plan targets. It can only do this by encouraging airline activity – which in turn means stimulating passenger growth.)

The arrival of A330-900neos will expand AirAsia X’s potential stage length opportunities

It will also improve the economics of the existing profile. AirAsia X CEO Azran Osman-Rani is on the record as saying “we can triple our growth over the next three years without a new country or market”, so while Europe and other markets may become viable with the new equipment, these longer routes are perhaps more an investment in opportunity scope, rather than a targeted plan.

To learn more about this cutting edge model and to meet all of Asia's key aviation players, sign up now to be part of CAPA's three day Asia Aviation Summit and LCC Congress, plus a full day of corporate travel at Singapore's Capella Sentosa 13-15 October, 2014: http://centreforaviation.com/events/upcoming/

That may not be a bad strategy in its own right. AirAsia X is inevitably on the radar of airlines looking for partnership options in the new environment. Having previously focused on combating the likes of Ryanair and easyJet at home, the major European network airlines are now actively looking around for long-haul solutions as they realise their existing cost bases are not going to be sustainable as new entrants appear, or as yield margins are eroded.

This long-haul challenge is in no small part due to the discomfort caused by the intrusion of the Gulf airlines into their longstanding hub markets. Emirates, Etihad and Qatar Airways are themselves long-haul low-cost models which have disrupted the market by establishing powerful networks. The Gulf carriers are essentially long-haul to long-haul precedents for this emerging AirAsia X connectivity model; they have shown that it can be wickedly successful.

(Turkish Airlines, the “fourth Gulf carrier”, is different again, more a short-haul to long-haul classic network model; but its success has also been in achieving low-cost expansion.)

AirAsia X is not alone in seeing the potential of this connectivity strategy

Singapore Airlines’ part subsidiary Tigerair, now sees it as a must-do for survival. Tigerair is a short-haul LCC, but if a pending application with the Singapore competition authority is approved, it will be able to cooperate in a similar way with SIA’s wholly owned long-haul low-cost subsidiary, Scoot.

During reporting of its (very weak) financial results for the Jun-2014 quarter, new Tigerair Group CEO Lee Lik Hsin was clearly aware of the virtues of the Malaysian model. He said: “We need to market ourselves more like a network carrier rather than a point to point carrier,” stressing that in order to grow, Singapore based Tigerair cannot rely entirely on local traffic. Increased transfer traffic should also help Tigerair to boost falling yields and eventually enable it to resume expansion in Singapore. 

This is not simply an issue for airlines. Singapore’s Changi Airport needs LCC transfer traffic to drive a new era of growth in what is otherwise a relatively mature market. Growing at only 1% in 1H2014, Changi is currently lagging far behind neighbouring Kuala Lumpur’s double digit expansion, led largely by the AirAsia Group. The nexus between airline and airport strategies is ever more important.

The other long-haul low-cost operators in Asia Pacific have different profiles

Qantas subsidiary Jetstar International for example, the Australian based long-haul arm of the domestic LCC, does not possess the advantage of geographic centrality, so has to rely on the Australian end of the market for its feed – from both Jetstar and Qantas. This has not so far been a major impediment, as Australian outbound has been strong; but that does not satisfy longer term needs to be able to feed both ends of its longer sectors. So, while Jetstar establishes locally in several markets with cross-border JVs, these should progressively help service their Australian based sibling. 

Jetstar appears with minority interests in Japan with Jetstar Japan, a JV with JAL and local parties; in Vietnam as Jetstar Pacific with Vietnam Airlines; in Singapore, with local investors, as Jetstar Asia and potentially in Hong Kong with China Eastern and local parties. Each of these is a short-haul venture and has the potential for “joining the dots”, like AirAsia.

Cebu Pacific has also established a long-haul operation – but it does not yet have the cross-border profile of its regional competitors.

The newest Asian long-haul LCC intriguingly brings together subsidiaries of two longstanding full service competitors. NokScoot is a long-haul low-cost JV between SIA’s Scoot and Thai Airways’s part-owned Nok Air; its hub at Bangkok Don Mueang will also be effectively fed by Nok and Scoot, which is moving its Singapore-Bangkok service from Suvarnabhumi to Don Mueang on 1-Sep-2014 as Nok and Scoot also start to interline with each other.

There are other LCC connectivity-based models emerging too

There is for example Norwegian Air Shuttle group’s 787 operation from Stockholm to Bangkok and to the US not to be confused with Norwegian Air International which will operate an ambitious roster of services to the US from London Gatwick and Dublin, with “plans for” Africa and South America, as well as Asia. 

Norwegian is a powerful force in the European LCC market, notably in Scandinavia and these services benefit directly from its ability to deliver short-haul feed to the long-haul operation – although there is not yet the level of connectivity which AirAsia X has compiled with AirAsia.

The LCC-LCC short-to-long-haul connectivity model contains a level of group complexity

But in these still-early days, it appears to offer a viable formula, with long-term sustainability. The essential concept, of imitating the tried and tested network hub operation, logically should work effectively with a lower cost halo across the operation. AirAsia X has achieved remarkable results in a very short time and has massive ambitions for expansion. 

It is certainly something that has attracted attention from more than other LCCs; Lufthansa has, in its recent public pronouncements, made clear that the group is seriously studying options for imitating some aspects at least of a long-haul LCC. With no clear long-haul strategy to follow its holding pattern against the Gulf carriers, and no helpful partner, Lufthansa needs new options. It would be most surprising if its long-haul LCC plans were merely to establish a glorified charter operation, especially given its deep understanding of hub operations.

And airports should review their potential in supporting this new direction...

Then there is the airports’ operational dimension in this new formulation; they may be well advised also to look at how they can attract new business by reformulating their own operating systems too.

With the added layer of cross-border establishment, already evident in Asia and more recently in Europe, an even more complex, but proportionately more effective model is making its presence loudly felt.

Others will seek to emulate AirAsia X, learning from its achievements and its mistakes. This is clearly no mere mythical model; it has an entirely logical foundation and its success will lie in effective implementation (and a bit of luck). 

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