Low-cost airlines struggling to gain altitude in battle for Asian skies

Alongside the runway at Alice Springs Airport sits one of the world's newest aircraft "boneyards".

Since the first small plane arrived at the storage yard in June, a Qantas Boeing 767, four Tigerair Singapore aircraft and a Boeing 737 from another small airline have parked up.

From the air, the planes sit on their hard stands like mosquitoes in the desert.

The arrival of the Qantas jet at Asia Pacific Aircraft Storage's 110-hectare site in the parched land of central Australia over the last week fits with the airline's plan to retire its fleet of Boeing 767s by the end of the year. The white kangaroo on the tail of the 767 has been painted over.

Once the centerpiece of Qantas' domestic fleet, the last 767s will end up at Alice Springs or Victorville, the world's largest plane parking yard at the edge of the Mojave Desert in California. They are likely to find new owners, a better fate than many 747 jumbos. Once dubbed the "Queen of the Skies", many 747s will be broken up for scrap because of a weak second-hand market for the aircraft.

While the Qantas planes are at the end of their working lives for a full-service airline, the four Tigerair Singapore planes – two 180-seat Airbus A320s and two smaller A319s – are relatively young in aviation terms.

A further eight could be lined up alongside them over the coming months, depending on whether Tigerair can sub-lease the surplus planes to another airline.

Until they were parked at Alice, they shuttled passengers between cities in South-East Asia. Some are from Tigerair's offshoot in the Philippines, which was recently sold to that country's largest airline, Cebu Pacific.

Tigerair's decision to ground planes in the red centre serves as a stark reminder of the battle under way in South-East Asia between budget airlines. Qantas's budget offshoot in Singapore, Jetstar Asia, is among scores of low-cost carriers in the region bleeding red ink.

Put simply, there are too many airlines flying in South-East Asia to meet demand, even in a region boasting some of the fastest-growing economies on the planet. Seat capacity on routes in South-East Asia has increased by a third in just three years, according to analysts at investment bank CIMB.

Asian airlines have endured tough periods before, usually because of external events such as the Asian financial crisis in 1997 or the outbreak of severe acute respiratory syndrome, or SARS, in 2003.

"But this is different because it seems this time what has precipitated the problem is a lot of carriers buying a lot of aircraft and putting them into the market at the same time, particularly no-frills carriers," says Rod Eddington, a former chief executive of British Airways and Hong Kong's flag carrier, Cathay Pacific. "This is clearly a tough time and the operating numbers for the airlines reflect that."

When Geoff Dixon unveiled Jetstar Asia in Singapore in September 2004, the then Qantas chief executive declared that "this is going to be a very, very substantial airline".

A decade later, Qantas has put the brakes on the expansion of the Singapore airline, the first of four Jetstar-branded carriers it has set up in Asia as part of joint ventures with local investors.

Jetstar Asia's fleet has increased by only one plane a year for the past two years, leaving it with 18 single-aisle A320s – the same size as Jetstar Japan which began flying just two years ago. The Singapore-based airline's losses blew out to $40 million last financial year, from a $2.2 million profit previously, due to what Jetstar Group chief executive Jayne Hrdlicka described as an "unprecedented level of capacity".

While budget airlines and their shareholders are nursing their wounds, travelers have benefited from the surplus flights. Airlines are having to discount fares heavily to fill their planes.

Flight Center estimates fares from Australia to destinations such as Phuket in Thailand, Kuala Lumpur and Singapore are about 5 per cent cheaper than this time last year. "From an affordability perspective, it is fair to say that they have never been cheaper," a spokesman said.

The glut in flights has left budget airlines such as Tigerair Singapore little choice but to ground planes in far-flung corners of the globe – or to slow or cancel orders for new aircraft from manufacturers – while they await a pick-up in demand. Tiger's losses doubled in the first quarter to $S65 million ($58 million), part of which was due to the shutdown of a budget airline in Indonesia that bore its name.

The grounding of planes for any length of time runs contrary to a low-cost airline's business model. With them reaping less from their passengers, they need to sweat their assets more than their full-service counterparts. That means budget airlines need to turn planes around quickly at airports to ensure they spend as many hours as possible flying their lower-yielding travelers between cities.

Planes also need to be at least 80 per cent full, or they can quickly be tipped into loss-making territory. After all, an airline's biggest expense – jet fuel – is no cheaper for a budget carrier than their full-service equivalent.

In the rush to break into Asia's markets to tap an apparent gold mine, budget carriers have broken what many full-service airline executives once believed was a cardinal rule. That was to do their utmost to ensure they did not take delivery of new planes until they had secured air-traffic rights and landing slots at airports. Otherwise, airlines end up taking delivery of expensive assets without the ability to generate revenue from them.

Further north, Jetstar Hong Kong serves as a reminder of the consequences of breaking that rule. The joint venture between Qantas, China Eastern and Pansy Ho's Shun Tak has been forced to sell six of its nine-strong fleet because it is still to gain regulatory approval more than a year after it had planned to launch flights.

In South-East Asia, the development of many airports such as those in Jakarta and Manila has also failed to keep pace with the rapid increase in flights, leaving airlines fighting for landing slots, especially at peak times.

The big question remains how long it will take before the supply-demand imbalance ends. The concern is that a number of airlines such as Indonesia's privately owned Lion Air and Malaysia's AirAsia have a huge number of planes on order. Between them, Lion Air and AirAsia have ordered more than 800 aircraft.

Andrew Orchard, an aviation analyst in Hong Kong for CIMB, says low-cost carriers have indicated they will reduce capacity by leasing aircraft they are due to take delivery of to other airlines.

"But any measure that they make will be quite temporary and I'm not convinced they have altered their mindset. They are taking a wait-and-see approach," he says.

Azran Osman-Rani, the chief executive of Malaysia's AirAsia X, agrees competition is the most intense it has been in South-East Asia but remains predictably optimistic about the long-term outlook.

"It is a short term, one to three-year crunch, before demand catches up to capacity," he says.

"When you look at in the context of population and economic development, then demand will very quickly catch up to this excess capacity."

As budget airlines in South-East Asia fight for survival, the former cable television executive highlights the importance of remaining number one or two in the market.

"Once you start to get to a point of industry maturity, where you have [low-cost carriers] reaching 50 percent of the total market, it becomes very, very difficult for people who have a much lower market share – for people who are number three, four or five," Osman-Rani says.

"That's why when you look at some of the South-East Asian airlines, or affiliates of airlines that have closed down, it has typically been at least number three or one-third the size of the incumbents."

Smaller players such as Tigerair Mandala in Indonesia have raised the white flag because they have been unable to close the gap with market leaders such as Lion Air in a capital-intensive business.

Like other industries such as retail banking, an airline that has a wider footprint in the market than its competitors has a large economic advantage over its rivals.

Osman-Rani says airlines need to hold their nerve during the capacity crunch because the the size of the population in Asia with disposable incomes is growing fast and demand for flying will catch up with supply.

Regulatory barriers have long limited airlines' ability to spread their wings in Asia. Airlines such as Qantas, Tigerair and AirAsia have circumvented the ownership restrictions in countries by teaming up with investors to launch low-cost airlines such as Jetstar Asia.

South-East Asian governments have long targeted next year for a relaxation of the restrictions on airlines flying on routes within the region. However, the test will be whether all countries who are members of the Association of South-East Asian Nations – or at least the major nations – ratify, sign and implement what is known as "open skies". It promises much but many within the aviation industry remain cautious.

"There is not going to be an overnight wave of the wand for an open market but the framework is there with the ASEAN open skies," Osman-Rani says. "Once you have access to the routes, then that is the main way the market can really become a lot more efficient provided we address the problem of airport bottlenecks. Until the infrastructure bottle necks are addressed, the market is going to be very imperfect."

South-East Asia has seen phenomenal growth in budget airlines over the last decade. For every passenger flying on a full-service airline within South-East Asia, another flies on a low-cost carrier.

In comparison, only about one out of every four passengers flies from the region to destinations elsewhere in the world such as Australia on budget airlines. It is this segment of the market – long-haul flying to and from South-East Asia– that airlines such as AirAsia X and Singapore Airline's Scoot are targeting for growth as they eat into the underbellies of full-service airlines on the routes.

After several years of growth on routes to Australia, AirAsia X will focus on digesting the capacity between its hub in Kuala Lumpur and Sydney, Melbourne and the Gold Coast before it boosts capacity further. However, its affiliates such as Indonesia AirAsia X and Thai AirAsia X are set to lead the expansion of services on routes to and from Australia. 

"Where the expansion is probably going to come from is probably our other hubs. We have invested in Indonesia AirAsia X and Thai AirAsia X – they could be the ones where we continue our expansion into Australia from those hubs rather than KL," Osman-Rani says.

In the wrestle for market share, it may in fact be full-service airlines that give more ground as they have in Europe over the past decade to budget airlines on short-haul routes.

CIMB expects Malaysia Airlines, which had expanded aggressively in recent years, to cut flights throughout Asia as it seeks to turn its fortunes around following the loss of two Boeing 777 aircraft this year. The disappearance of Malaysia Airlines' flight 370 in March resulted in Chinese tourists avoiding traveling to South-East Asian countries  such as Malaysia and Singapore in droves.

Orchard agrees low-cost carriers recognize they need scale to survive. "They are all trying to be one of the few survivors, and the only way you can do that is build up your network. It is a case where the biggest and fittest survive, and it will be a case where a few guys pull back or go under.

"I don't think you will see it play out right away – it will happen over a number of years. The market has expanded very, very quickly."

Others remain optimistic about the outlook in Asia.

"There will be casualties but it will be just the weak ones that are weeded out," an executive at an Asian aircraft leasing company says. "The averages can be deceptive and I don't paint the airlines all with the same brush. We have got population on our side, we have rising disposable incomes and a number of countries are crossing the threshold in moving more into consumption-driven markets."

However, Eddington has a note of caution for airlines searching for a rich new vein of revenue in Asia.

"People are mesmerized by the size of the market and the growing middle class but that doesn't mean that airlines that get started are going to be profitable. There are a lot of airlines that have got started and most of them have lost a substantial amount of money," he says.

"Your passengers can disappear quite quickly. The low-cost carrier market basically targets people who are discretionary spenders. Those who follow [the dominant players] thinking it's an easy game are often doomed for disappointment."

A slight wobble in an economy can lead to risk-averse consumers closing their wallets. The Tigerair Singapore planes sitting idle in the red center of Australia serve as a reminder that the road to riches in Asia is full of hidden dangers.

Read more: http://www.smh.com.au