Questions and Answers on Low Cost Airline Developments in Asia

The Centre for Asia Pacific Aviation, a major aviation consultancy in Asia and organiser of the China & North Asia Low Cost Airline Symposium on 26-27 April in Macau - has released  the following new Question & Answer (Q&A) update on Low Cost Airlines (LCAs) development in the North Asian region:

Q - Why would carriers in North Asia be interested in low cost airlines?

A- There are several reasons.

First, LCAs from outside the region, including AirAsia, are looking at establishing operations in China/North Asia. Their interest has been fanned by the pace of aviation liberalisation in the region, such as the recent open skies agreements between Hong Kong-Malaysia and China-Thailand. New low cost entrants have obvious competitive implications for local airlines. It’s a matter of weeks - not years - before an established low cost airline announces plans to launch low cost services to the region.

Second, in the past lower input costs have enabled carriers from this region to compete very effectively on international routes. As the global carriers of Europe and North America are restructured, often under the impetus generated by low cost operations in their home markets and with some assistance from more liberal aviation rules, they will become increasingly efficient and competitive. Lower costs will not provide the region’s carriers with the competitive cushion they have had in the past, and they will be obliged to seek their own operational efficiencies and savings in overheads.

Third, several major carriers in North Asia must reduce their costs on domestic services to tackle impending competition from high speed rail operations and eliminate losses on domestic services.

Q - How are North Asian airlines responding to these changes?

A- This week, four Taiwanese carriers announced that they are considering a joint no-frills domestic service, to compete with the introduction of high-speed rail services in Taiwan in October 2004. The new rail service will cut the journey from Taipei and Kaohsiung from around six hours to one-and-a-half hours.

Likewise, a new express rail link will open in Korea in April 2004, which is expected to drive down domestic air travel by as much as 30%. To claw back some of these traffic losses, Korean Air, Asiana Airlines and other entrants have to offer more competitively priced domestic services.

This needs a lower operating cost base. Korean Air is considering cutting the number of frequencies on Seoul-Pusan (up to 30 daily services) and Seoul-Taegu (20 daily services) as the new rail link takes effect from next month.

In Japan, domestic carriers have been waging a running battle with bullet train operators for years. In September last year, Japan’s carriers cut domestic fares by well over 20% on some services in response to price cuts for coupon tickets launched by Central Japan Railway Co.

The prospect of increased international low cost competition and new domestic express rail operations provide compelling reasons for carriers in this region to consider substantially lowering their cost structures.

Q - Which parts of Asia provide the biggest untapped opportunities for LCAs?

A- All the indicators point to China becoming the next big thing for the growth of low cost airline services – and the rapid rate of developments suggests it will happen by 2005 or 2006 – as regulation of the aviation sector eases and demand for air travel explodes. Economic and industry environments in China are fast reaching a stage where low cost airline development is both inevitable and desirable, and the government has shown a willingness to consider its role in the future of international and domestic aviation.

The really exciting question, though, is what this will do for Japan and South Korea? These are potential huge markets for LCAs, with surprisingly low propensities to travel. Japan, in particular, with average GDP per head of around US$31,300 in 2002 had only 130 air travellers per 1,000 population. South Korea, with average GDP/head of US$9,918 did a little better in the traveller stakes (150 per 1,000 people in the year). But, compare these figures with Australia (US$20,220 per head and 176travellers per 1,000 population), New Zealand (US$14,800 and 327/1,000 travellers) or Taiwan (US12,455 and 333 travellers/1,000).

The implication is that these are substantial untapped markets which, with the introduction of low fare international services even within the region, could really take off. Any moves towards a more open aviation market in China could well trigger a softening of the regulatory Japan and South Korea, with a potential explosion in international air traffic.

The urban and industrial geography and the increasing interdependence of North Asian states and cities lend themselves to rapid growth if the regulatory environment allows. Japan, in particular, has a plethora of airports and runways capable of handling international narrow body jet services (over 50 civil airports with sealed runways exceeding 2,000 metres), and the regional populations and business base to support services between them and international destinations across Asia.

China may be the catalyst, then, but over the next five to ten years, many of the benefits of aviation development may come from the development of a more liberal, low cost airline environment in Japan and South Korea.

Q - Will Chinese authorities allow LCA entrants?

A- If nothing else, the prospects for China to steal a march in the LCA sector will encourage them to move in this direction. For example, the likely entry of low-cost international services to destinations such as Macau will apply pressure for change within China and throughout the region, at a time when consolidation of the three airline groupings in the country is almost complete.

The emergence of LCAs could see Air China, China Southern and China Eastern adopt low-cost operations or regional subsidiaries – a move which would address the current mismatch between aircraft type and capacity and thin demand associated with secondary airports. Another possible outcome is the development of a “second tier” of the airline industry in China involving non-aligned secondary airlines concentrating on low cost services.

Q - Who would benefit from LCAs coming to China and North Asia?

A- Travellers will be the big winners, with lower fares and a larger range of destinations on offer. Business travellers and leisure travellers in the region stand to benefit – and travel companies may have to find ways to participate in the revolution which will account for much of the growth in the region.

But this does not go far enough. Travellers generate business, increasing consumption, generating demand in new places for new products, and lifting the level of business being done. Even for leisure travellers, lower fares may mean more to spend at the destination. Any real reduction in the cost of air travel (and air freight) as a result of the expansion of LCAs will reduce the costs of business, improve productivity and lift output generally. This is especially true as the economies of North Asia become more integrated, with growing trade, tourism and investment flows among them.

In addition, the World Travel and tourism Council estimated in 2003 that travel and tourism directly and indirectly contributed over 10% to China’s economy, 9% to Japan, 8% to South Korea, and 5% to Taiwan. Any boost to aviation from the introduction of LCAs will clearly feed straight through into economic growth in these countries.

The arrival of a low-cost airline culture in North Asia could revolutionise travel in the region – to the benefit of the travel sector as a whole and national economies. It is timely to consider just what form this might take, how current industry members, including government, should react, and who the main players in this next phase of aviation development will be.

Q - Are low cost airlines a threat to national carriers?

A- The coming generation of LCAs in Asia represents a remarkable opportunity for national carriers - once they are able to emerge from the state of denial into which many have retreated.

The new low cost, point to point thinking is already helping make complacent airlines much more efficient – which, by reducing their costs and prices and improving the airlines’ customer targeting, will help them stimulate traffic growth well above forecast levels.

LCAs clearly are a catalytic force in the push for regional liberalisation. They are sure to become increasingly influential in terms of both airline restructuring and the formation and pursuit of an effective government aviation policy.

But the major airlines are still in the “box seat”.

In the special nature of the Asia Pacific market, still dominated by government regulation on international routes, the majors can make the running by establishing their own low cost subsidiaries.

In this, they have perhaps a year’s head start over their independent competitors. The flag carriers will have first bite at the international routes available under bilaterals, they should have no difficulty in raising adequate funding, they can often rely on the parent airline’s infrastructure (including aircraft and services), and they do not have to face the usual public doubts affecting independent start-ups. 

But they must heed the lesson of the LCA: the issue is not simply one of driving down input costs. It also requires the creation of a culture of efficiency and the continuous pursuit of productivity gains, while still responding to market demands.

Q - Are LCAs driving other reforms?

A- The emergence of low cost airlines in Asia will greatly accelerate moves to harmonise aviation policies across the region.

We are confident governments will see that change is essential and important reforms will take place in a very short period of time The critical mass being generated by this process will short circuit what would otherwise be a 10 year timetable – compressing it into perhaps two or three years.

Regional cooperation in trade and tourism, improved access to sub-regional markets and higher levels of political stability have sharpened the focus on aviation reform.

No longer is it sufficient to equate the national interest solely with that of national airlines. Other sectors of the economy, such as tourism, airport operators and trade are, correctly, demanding a closer role in the development of national transportation strategies.

The challenge for the negotiators lies in the complexity of the regulatory environment and the difficulties implicit in making the transition from outcomes based on the sectoral interests of airlines to those reflecting national economic interests.

To ensure that the economic benefits that will derive from LCAs (Low Cost Airlines) stimulating demand and growing new market segments, policy planners must ensure that the bilateral system is used as a positive instrument of reform, not as a means of protecting vested interests or inefficient airlines.

Q - What does this all mean for airports?

A- Already there are moves in the region to privatise and corporatise airports, to lead to better utilisation of capital and more effective funding of capital works, among other things. Liberalising airlines and allowing new entrants will help to ensure that these objectives can be met.

It will do this first by generating a lot more traffic. By its nature, low fare point-to-point traffic can make more diverse use of airports. It may fill in the shoulder periods for trunk and hub airports with high commuting peaks, and lift traffic levels generally for struggling secondary airports. This leads to better use of capital and extends the life of existing assets.

In addition, a lift in the number of travellers raises the prospects for non-aeronautical revenue, which is becoming more important for airports in the new corporatised and competitive environment. Anecdotal evidence indicates that LCA travellers do not spend less than their full service counterparts at airports, although their spending patterns may differ. And the more of them that come in from overseas, the better for airport concessionaires.

More airline traffic means also more opportunities for their suppliers and for airfreight businesses.

Existing airports may have to change the way they work with airlines, and work to provide the different sorts of services that LCAs require without undermining their level of service to (and revenue from) full service airlines. They will have to be innovative and perhaps aggressive to do this.

There are a number of airports that could provide exploit a range of new markets and new opportunities associated with LCAs, within China, across North Asia and between North and South East Asia, exploiting the LCA model. One of the big issues over the coming years will be which ones do this most successfully? And how will individual airports be able to make the most of a rapidly changing market?

Q - How can industry and government find out more about the LCA revolution?

A- The Centre is holding the second of three Asia Pacific Low Cost Airline symposiums in Macau on April 26 and 27. The third will be in New Delhi on 5-6 July. The symposiums include presentations and panels from industry leaders focusing on all aspects of LCAs – which are probably most significant development in Asian aviation for a considerable time.

The first Low Cost Airline Symposium in Singapore last month attracted 260 delegates from Australia, Asia, Europe and the US. Representatives of government, airlines, airports, tourism groups and investors attended the landmark summit at the Raffles City Convention Centre.