Air Asia and the growth of Low-Cost Airlines models in Asia Pacific Examined

By Soumyajyoti Basu

The global airline industry is being driven by Low-Cost Carriers (LCCs). The revenue pie of Low-Cost airlines is expected to grow at a whopping 8% over the next 10 years.

Globally, budget carriers are known to follow a simple product portfolio; that is to carry people to their destination at the minimum cost. This product is delivered through a supposedly simple business model of carefully monitoring, planning and minimising the cost of the services.

However the operational strategies of the LCCs are changing, getting more innovative & sometimes radical. In the Asia Pacific region, Air Asia has certainly been the pioneer of the low cost model.

The success of Air Asia lies in carefully choosing the strategies that has worked with European & American low-cost carriers and adapting them to suit Asia Pacific consumer preferences.

The first quarter results published by Air Asia can be scrutinised to reveal these strategies and how effective they have been. This would also be a good benchmark to understand the dynamics of the Asia Pacific airline industry. The performance of Air Asia should not be studied in isolation.

While a good result was anticipated, the details provide some interesting insights and are harbinger to the quarters to come.

LCC Performance Examined

During the recession, the net profit of top LCCs across the world combined was around US$1 billion while legacy carriers suffered. This trend of LCCs providing better financial results is continuing. Increases in revenue and PAT by 10%, passenger carried by 17% and Load Factor by 4% are some of the key highlights of the excellent last quarter performance of Air Asia.

This increase in revenue was achieved at a time when the average fare was reduced by 13% over the last year. This shows that, post-recession, the average traveler in the Asia Pacific region has continued to remain price elastic.

Superior revenue management is one of the key success factors for Air Asia, though it would be futile to expect the reduction trend to continue.

The super dynamic nature of air-travel will require a close eye on the macro-economic factors and the trend of business travel that would set the prices in the coming quarters. Moreover, there has already been an indication from Air Asia that certain routes will be seeing an upward revision of air fares. This trend might actually signal a change in the strategy from LCCs. Fare structures including profit margins would be extremely route specific.

Product unbundling is turning out to be the most lucrative way for the LCCs to generate greater revenue. The increased ancillary revenue is a reflection of this product unbundling. Ancillary revenue contributed to 16% of the overall income of Air Asia. While for some this might look as a shift for the airline from its core activity, this speaks volumes about the superior operational strategy of the airline.

Although ancillary activities will help airlines to effectively capture excess revenue from passengers who are willing to pay for additional service and comfort, it is tricky to set the right price for the right passengers and Air Asia is doing great in this regard.

This also makes the pricing mechanism more transparent to the customer. While the bulk of current ancillary is coming from on-board food and baggage, there are a multitude of other opportunities available such as priority boarding, check-in, and credit card booking.

There is also a genuine effort by LCCs to start consolidating the market through efforts of code-sharing. Air Asia has paired up with Jetstar, a practice which has been common among the legacy carriers but hitherto unheard off among the LCCs.  Moreover, we might also soon be seeing code-sharing agreements between legacy and low cost carriers, something that would definitely bring a sea-change in the airline industry.

Still, there are major problems in this direction as different airlines have different operational philosophy in reaching their low cost goals. Harmonising these philosophies would be a challenge in itself.

Little less rosy

Although everything is definitely rosy for LCCs overall, the picture becomes a little gloomy when one looks at the profit from the core operations in the case of Air Asia.

The Earnings Before Interest, Taxes, Depreciation, Amortisation and Rent (EBITDAR) for Air Asia Malaysia has actually reduced by 17% when the airline industry was expected to do well.

The reason for less profitability is the increase in costs driven by the sharp increase in fuel price. While there was a 26% overall increase in Cost per Available Seat Kilometer (CASK), the figure becomes 12% when we leave out fuel.  This is a trend that is expected to continue.

While aviation fuel price levels seen in May 2008 might not be imminent, airlines across the globe would do well to hedge their risks at this moment. The bigger cause of concern would be the increase in 12% in CASK excluding fuel, a figure which is substantial. This increase is mainly because of a 14% jump in staff costs per average seat kilometer – a surprising fact given that over the years the general trend have been reduction in staff CASK, something that is achieved through increased staff productivity – and a substantial increase in the overheads.

It would be interesting to understand the reason behind the increase in these two cost heads. The global shortage of airline human resource could point a general trend in this direction, a reversal trend that might not go well with the low cost model.

A quick comparison among airlines within the Asia Pacific region would provide a clearer picture in terms of operational performance. While Air Asia registered a 17% increase in Revenue Passenger Kilometers (RPK), the overall increase in the APAC region is 12%. Although at the same time MAS registered a growth of 29%, this was the result of a weaker base year for the legacy carrier. However, when taken into account the operating margin of Air Asia which stands at 34% compared to 8% of MAS, Air Asia is still doing exceedingly well comparatively.

There is also a strategy being followed by the carriers in the form of setting up sister airlines concentrating in catering to a specific market. Air Asia has been successful with this model. In fact, Thai Air Asia is perhaps the brightest spot of the last quarter performance. An increase in 109% in Profit After Tax (PAT) and 30% in EBITDAR year-on-year provides an excellent opportunity for the soon to be declared IPO of the carrier and better fund raising.

Given the aggressive policies of the group, this will help in further strategising the arm. Moreover, the 25% increase in passenger carried while making just 2% reduction in average sales price means there is a different dynamics in play in the region.

The Indonesian arm has a different reason to cheer: being profitable for the first time. This would however require some more time before reaching conviction. Though there is a Y-O-Y growth, both passenger load factor and capacity in the region has seen a fall over the past quarters. Next quarter results for the region would be an interesting look.

Overall, the LCC model is here to stay; this is the model that will drive innovation in the airline industry. Fuel price would be the point of concern in the coming quarters. Although, revenue will keep on increasing, how the costs hold up will define profitability. Furthermore, fuel prices are not expected to increase too much from here. Hence, it is expected that the coming quarters will be more profitable.

Currently in the Asia Pacific LCC dynamics, it has been studied that the model is constrained by the political regulations in the area, unlike in Europe. This constraint will slowly be removed in coming times thus making LCCs more profitable and allowing further strategisation in their operations.

One Response to “Aerospace & Aviation: LCCs Under The Microscope”

1. spy camera says:

   November 17, 2011 at 12:09 am

   Informative and precise…

   Its hard to find informative and accurate info but here I found…

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