Analysis of the asia pacific airline industry

There are many industries that the world has come to heavily rely on as globalization has become more widespread. The idea of national and continental boundaries being a limitation has gradually been overtaken by the innovations of mankind over the past few decades. The inventor of the airplane; Orville Wright is quoted as saying in 1908; “No airship will ever fly from New York to Paris. That seems to me to be impossible…the airship will always be a special messenger, never a load-carrier” (Smithsonian Education, 2010). What he could not have imagined was that a century later his invention would be at the centre of the globalisation movement taking place and that the airplanes would be the core of an industry which directly facilitates economic growth, world trade, international investment and tourism (Doganis, 2000).

The International Air Transport Association (IATA) forecasts international air travel to grow by an average of 6.6% a year to the end of the decade and over 5% a year from 2000 to 2010 (Stanford University; 2010). These rates correlate with the levels of profitability that have been noted over the past five years as illustrated in Figure-1, showing that the level of profitability in the industry has been steadily growing over the past 5 years.

Figure-1: IATA, 2010

The Asia Pacific Airline Industry

The most dynamic growth is centred on the Asia Pacific region, where fast-growing trade and investment are coupled with rising domestic prosperity. Home to more than 4 billion people and driven by two of the largest dynamic economies; India and China, the Asia-Pacific region carries more than 25% of global passenger traffic annually (IATA Annual Report, 2010).

According to IATA CEO Giovanni Bisignani, as of April 2010 the Asia Pacific region was deemed to be the world’s largest aviation market (IATA Annual Report 2010). High rates of economic growth in the emerging markets within the Asia Pacific have led to the rapid expansion of aviation industries serving Asia and The Pacific (Sumner et al. 1995). The Asia Pacific airline industry witnessed a boom in the 1990’s that can only be termed as remarkable especially when compared to the performance of other airline markets such as the USA and Europe (Sumner et al. 1995).

The dynamic nature of this region places it as an area of economic interest and analysis. This paper will give an economic analysis which will present arguments of how the airline industry functions and the plausible economic justifications for the massive growth that has been seen in the Asia Pacific airline industry. To present a concise analysis we will focus on three major commercial airlines in the region namely; Cathay Pacific, Singapore Airlines and All Nippon Airways as well as three market leaders in the Low Cost Carriers Sector (LCCs) namely; Cebu Pacific Air, Tiger Airways and Air Asia.

2. Asia Pacific Airline Industry: A Competitive Analysis

Airline services categorized as low cost carriers or LCC’s emerged in the airline industry in the South-East Asia region following deregulation in the early 2000’s and Air Asia pioneered low cost travelling (Arifin et al. 2010). Arifin et al. (2010) further highlight that as the number of LCC’s has grown; these airlines have begun to compete with one another in addition to the full service airlines. A competitive analysis of the Asia Pacific airline industry is therefore two-fold; firstly analysis on the basis of the competition between LCC’s themselves and secondly between LCC’s and full service airlines.

Perfect Competition – The competition of LCC’s

Airline services regardless of whether they are full service or LCC’s are made up of a very complex mix of tangibles and intangibles and these elements are keys in determining the level of competition between the different airlines (Gursoy et al. 2005). The Asia market airline deregulation opened up the market, as new airlines were permitted to enter all domestic routes (Forsyth, 1998). As the number of LCC’s grew, these airlines begun to compete with one another in addition to the full service airlines (Arifin et al. 2010). The LCC market is characterized by key qualities which make it heavily linked to the perfectly competitive market structure.

Firstly the market is characterized by the existence of many players in the market. As highlighted above the deregulation of the market led to the massive entry into the market by LCC’s. The previously limited market suddenly expanded as more players entered the market. Deregulation created a more concentrated airline market, as it lowered the average airfare and has increased competition on many routes (Wang, 2005).

Secondly, in a perfectly contestable market, the threat of entry is said to be sufficient enough to induce competitive pricing (Wang C, 2005). Directly linked with deregulation the Asia Pacific airline market has seen many low cost airlines coming into the market. Wang (2005) highlights that in 2007, 61,000 flights and 9.2 million seats in the Asia pacific airline industry were accounted to LCC’s (Figure-2). As a result, the LCC market now accounts for 14% of all flights and all seats within Asia/Pacific.

Figure-2

Thirdly, LCC’s offer what has been termed the ‘no frills product’, For example, Air Asia’s fares are significantly low as their service targets the customers who will do without the frills of meals, frequent flyer miles or airport lounges in exchange for fares up to 80% lower than those currently offered with equivalent convenience by full service carriers (Jiang, 2007).

The saturated market is prompted by LCC’s which identified a need in the market for airline service with no frills and low cost which allows passengers to travel from one destination to the next at very low prices. The airlines identified the opportunity to offer a low cost product which would in turn yield high rates of profitability. In the Asia Pacific airline industry competition is in the short run where the many sellers (airlines) who through cost cutting realize massive profits. In the competitive market for low cost airlines, airlines are earning abnormal profits due to their strategic business plan characterized by low operating costs and low prices (Forsyth, 2008). This is driven by the LCC business model (table-3) which by its very nature hinges on cost advantages that are centered on three key aspects namely; a simple product, positioning of the product and low operating costs (Doganis R, 2002).

THE LCC BUSINESS MODEL

Simple Product

•No in-flight meals

• Planes with only a single class

• No seat assignment

Positioning

• Non-business passengers price-conscious passengers

• Short-haul point to point traffic with high frequencies

• Aggressive marketing

• Secondary airports

• Competition with all transport carriers

Low Operating Costs

• Low wages

• Low airport fees

• Low costs for maintenance, cockpit training – due to homogeneous fleet

• Short ground waits due to simple boarding processes

• No air freight, short cleaning times, high percentage of online sales

Table-1: LCC Business Model. (Wong, 2009)

As long as the price exceeds average variable cost, all airlines will stay in the market, offering the same amount of capacity (Forsyth, 2008). The sustainability of LCC’s in the Asia Pacific market is based on the fact that they strategically cut their variable and fixed costs by way of low wages; low airport fees; low costs for maintenance, cockpit training and standby crews due to homogeneous fleet; high resource productivity: short ground waits due to simple boarding processes, no air freight, no hub services, short cleaning times; and high percentage of online sales (Wong, 2009). For example Air Asia has optimized costs by operating a faster turnaround time, improving aircraft utilization and crew efficiency, providing a ‘no frills’ service, using one type of aircraft to save training costs, all of which result in savings which are passed back to consumers in the form of low fares (Jiang, 2007).

Monopolistic Competition – LCC’s vs. Full Service Airlines

On the other hand, a competitive analysis exists between LCC’s and full service airlines. The Asia Pacific market is characterized not only by LCC’s but also by full service carriers which have a different business model to LCC’s. Monopolistic markets contain many sellers but not quite to the extent of a perfectly competitive market (Vasigh et al. 2008). Vasigh et al. (2008), further highlights that each firm in the market therefore produces a small fraction of the industry.

The main difference between a perfectly competitive market and a monopolistically competitive market is that in perfect competition markets sell homogenous products; while in monopolistic competition companies sell heterogeneous products with close substitutes (Vasigh et al. 2008). Firms in a monopolistic market therefore sell products that are more or less similar and they have the power to set their own prices. The logic is that the more differentiated your product the more control you have over the price. For example full service airlines such as Cathay Pacific and Singapore airlines charge much more than LCC’s such as Air Asia and Cebu Air over the same distances. The key element of the monopolistically competitive airline market is the fact that a differentiated product is offered. The differentiated product is on the basis of differentiation of the service product and differentiation on the basis of price.

Differentiation by service

The airline industry is predominantly a service industry and the competitiveness of airlines especially in the commercial aviation industry is heavily reliant on the quality and efficiency of the service provided by the specific airline. At the centre of the airline industry is a traveller who wants to fly from for example India to China. Airlines must successfully identify their most important customers and establish deep relationships with them that are established through service which creates a brand. What can be noted is that this factor of value is more important in the commercial airline industry than in the low cost airline industry. For example; Jiang (2007) highlights that Air Asia’s fares are significantly lower than those of other operators, as they target guests who will do without the frills of in-flight meals, frequent flyer miles and reclining seats.

A customer using this airline would have contracted to the no frills flight that does not possess the comforts and the quality of service provided by an airline such as Cathay Pacific. In contrast Cathay Pacific provides excellent high quality in-flight services. These services include; cabin services, in-flight catering, entertainments, and communication services (Cathay Pacific, 2010). Table-2 below highlights that comparative view of in-flight products and services between LCC’s and full service airlines as adapted from information gathered from the various airline websites. It is clear those low cost carriers optimised costs by providing a ‘no frills’ service, using one type of aircraft to save training costs, all of which result in savings which are passed back to consumers in the form of low fares. The opportunity cost however is that LCC customers do receive benefits such as in flight meals, more than one class, in flight entertainments and internet services.

Airlines

In-Flight Meals

More than one class

In-flight entertainment

Internet, Wi-Fi

Air Asia

X

X

X

X

Cebu Pacific

X

✔

X

X

Tiger Airways

X

X

X

X

Singapore Air

✔

✔

✔

✔

ANA

✔

✔

✔

X

Cathay Pacific

✔

✔

✔

✔

Table-2: Comparative view of products and services between LCC’s and full service airlines

It can be noted in the Table-2 above, LCC’s, do not provide service options of a high standard as compared to the high level service that is provided by Commercial Airlines. Passenger behavior to flight choice has dynamic pattern in each passenger group. The dynamic pattern of the passenger behavior includes the choice flight by various passenger preferences and service is a key factor.

Differentiation by Price

Frequent airline flyers know that a ticket to any destination can be purchased at any one of a large range of prices to fly a given route. Full service airlines have fares that vary with time of travel, whether peak or off peak, with class of travel – whether first, business or economy, with length of stay at destination and a whole host of other factors (Doganis, 2002). In full service airlines, the variation between fares can be such that it is possible for two passengers sitting next to each other on the same flight and enjoying exactly the same quality of in-flight service, to find that one is paying very much more than the other (Hanlon, 1999).

3. Interaction between Airlines

The airline Industry in the Asia-Pacific is highly competitive and it is characterized by specific interaction between airlines. There are different factors which found airline interaction namely; flight schedule/frequency, origin-destination route, airfare, passenger travel demand, new entrants, flight frequency (Chaug-Ing and Yuh-Horng, 2005).

Figure-3: Competitive interaction between airlines

Interaction based on flight frequency

When one airline increases frequency for a single or multi destination, competitors are likely to follow suit in order to maintain their market share. In practice, it often happens that the increase in frequency involves a directly proportional increase in capacity (O’Connor, 1995). However, it is unlikely that competitor will decrease frequency in the event of one airline doing the same as it may not affect the market share and so as the competition (Chaug-Ing and Yuh-Horng, 2005). Air Asia’s high frequency service ensures guest convenience is met. The airline practices a quick turnaround of 25 minutes, which is the fastest in the region, resulting in high aircraft utilization, lower costs and greater airline and staff productivity (Jiang, 2007)

Interaction based on airfare

In the early years of the Asia Pacific Airline industry there was only one class of passenger and the air mode was an expensive way to travel (O’Connor, 1995). In the perfectly competitive and monopolistic market that now exists airfare plays a pivotal role in determining supply and demand in the industry. An airline may likely to follow the airfare reduction decision of competitor to maintain market share (Chaug-Ing and Yuh-Horng, 2005). Below table-3 is a comparison of how airfare prices over the same distance have gone down since the introduction of LCCs’.

AIRLINE

FARE BEFORE ENTRY

(Singapore $)

FARE AFTER ENTRY

(Singapore $)

Air Asia

–

18.93

Malaysian Airlines

220

26.00

Tiger Airways

–

42.00

Singapore Airlines

220

156.00

Table-3: Asia pacific airline airfares before and after the entry of LCC’s (Air Asia, 2010)

Interaction based on demand

In a situation where there is increased demand in travel because of particular occasion (summer vacation or Christmas or sector becomes popular), some airlines increase the frequency and reduce airfare anticipating more passengers and more revenue. On the other hand, when demand falls airlines tend to decrease frequency and increase airfare. This may or may not impact the competing airlines because it might have market share which may not require frequency or airfare decrease (Chaug-Ing and Yuh-Horng, 2005).

Destination

As a customer plans their journey, they look for an airline which flies to the destination or the nearest destination to the intended destination.

Cathay Pacific

Singapore Airline

ANA

Cebu Pacific

Tiger Airways

Air Asia

Destinations

120

98

79

50

37

75

Countries

38

39

15

11

10

22

Table-4: Flying Destinations

A Customer will choose an airline which gives wider options to choose from. In our analysis (table-4 above), we found that Cathay Pacific and Air Asia are giving good value by flying to more than 120 and 75 destinations worldwide. It could be argued that this a key factor in their popularity and success.

4. Conclusion

Asia Pacific Airlines – Winners and Losers & Value provider

In conclusion it is important to observe key factors that may enable an assessment of who are the winners and the losers in the market. The two main business aims of the airlines are to make profit and to increase market share. Table-5 below shows compiled data (Passenger flown by Airline, Revenue, Profit or Loss and market share) for selected airlines as gathered from the Airlines financial statements for the year 2010. The market share and net profit during Jan-Jun 2010 period, clearly state that Cathay Pacific is first and ANA last in the commercial airline category, whereas Air Asia is ahead and Tiger Airways last in the low-cost airline category.

Airlines

(Jan-Jun)

2010

Passengers

(000)

Revenue

(US$ Million)

Profit/Loss

Market

Share (%)

Cathay Pacific

12954

5337

882

2.62

Singapore Airlines

8084

6800

268

1.64

All Nippon Airline

2189

7600

-339

0.44

Cebu Pacific

5219

322.2

68.4

1.06

Tiger Airways

2853

285

24.2

0.58

Air Asia

7578

914

87.8

1.53

APAC (Total)

494272

Table-5: Source – Air Transport World & data from Respected Airlines as per ref. list

Figure-4: illustrated from table-5

Figure-5: illustrated from table-5

There are different reasons for failure and success. For example Cathay Pacific maintained a positive profit margin of US$ 882 million during first quarter of the 2010 where many other airlines struggled. In the LCC category, Air Asia had a profit margin of US$ 87.8 million. While on the other hand, ANA struggled to make a profit and had a loss of US$ 339 million in first half of 2010.

It can be deduced that the emergence and growth of no frills, low-cost carriers have radically altered the nature of competition within the industry. With targeted markets and networks, low-cost carriers nearly halve turnaround times, increase aircraft utilisation, reduce congestion, and significantly improve their productivity; and still are in compliance with safety regulations. The issue that however remains and that will be revealed with time is whether the Low Cost Carrier Business model is sustainable in the long run.