MUIC Airline Business Economic NOV 16

Business Economics:Airline Industry Context

MUIC Class NOV 16Dr Narudh Cheramakara

Today’s LectureI – Airline Business the current state, the competition, the trendsII – The economic principle application of the aviation industry and its modus operandi

Objective- To exemplify how to apply economic theories to the real world business.

Mankiw’s 10 principles of economics1. People face tradeoffs2. The cost of something is what you give up to get it3. Rational people think at the margin4. People respond to incentives5. Trade can make everyone better off6. Markets are usually a good way to organize economic activity7. Governments can sometimes improve market outcomes8. A country's standard of living depends on its ability to produce

goods and services9. Prices rise when the government prints too much money10.Society faces a short-run tradeoff between Inflation and

unemployment.

Basic economic concepts- Scarcity - Demand- Supply- Elasticity of demand- Willingness to pay - Competitive advantage- Competition - Market

Power/Monopoly/Duopoly/Free market- Market failure - Business cycle

Part I: The History

History: The Beginning First Flight: 1903Oldest airline with continuing ops (95 years)Progress:WW I -> Air MailColonial powers: The golden age of flying boatWWII -> Long range passenger planesFast-paced development in technology https://www.youtube.com/watch?v=S4s2spL0O0Q&list=PLDF12C831C41E1B44&index=4

History: The Flying Public (60s-80s)• Safe and reliable• The Jet Age• Sexual Appeal• The Jumbo jets – Unit cost• The deregulation – Free competition• Oil crisis – cartel • The rise and fall of Concorde – Govt spending• The fall of British jets – Govt intervention• The charters – unit costhttps://www.youtube.com/watch?v=v9bVFkDhGPE

Contemporary History• The stagnation of techonology: Fuel efficiency • Market liberalisation• Airline Alliance – Economy of scale• E-ticket (reducing settlements)• Terrorism and Epidemic – external factors• Low cost era• The ME3• What’s next?

Nature of Airline industry

- Inflexible production- Regulatory-bound- No real competitive advantage: Similar instrument, limited airport choice, IT system, aircraftA320 (97M) B738 (93M)A358 (269M) B789 (257M)A380 (428M) B748 (367M)

- Economy of scale- External factors - Bloodbath: War FareWho holds the market power?

Cost Components

What are they?

Cost Components1) Aircraft: - Buy (Firmed/Option)- Lease; Wet /Dry/ ACMI- Sale and lease back (Air Asia/Lion Air)

Cost Components

2) Crew 3) Maintenance4) Insurance5) Fuel (61.8 USD/Barrel, 28 OCT): Hedging/ DL Case 6) Business operations (marketing, IT, personnel,rent etc)7) Landing/Navigation fees (weight-based)8) Inflight services** Currency and Fuel are extremely important!!

Before heading to the revenue side,

1)What are the types of passengers? 2) What are the characteristics?

Airline Passenger1) Business- Frequency- Flexibility - Benefits (FFPs, Comfort)- Company pays!!!!- Thai Gov’t, MPs (Freebies, VIP treatments, Front row)- Elasticity of demand:……………. Elastic or inelastic?

2) Leisure (+VFR)- Price- Self-paid- Strong seasonal fluctuation

- Changing buying behaviours: Travel agents (commission cuts) to direct sales -> Hugh effects on the travel industry

- Elastic or inelastic demand? Price sensitivity?

- Of the two, which group of passengers do airlines preferred? Why?

Deciding factors (Source: IATA)

What are the sources of revenues?

Revenue Components1) Ticket revenues:- Revenue Management : Response to demand- Leisure pax ->Price, Biz pax -> Flexibility, benefits (company pays) - Price Discrimination (Saturday night), date of travel, time of travel. –

Product differentiation (Flex tickets for biz) – King’s Funeral - Toying with Demand to maximise revenue

2) Ticket-related fees:- Change fee- Payment fee

3) Ancillary revenues: Inflight sales (mostly LCC), Hotels, Car rentals

4) Other revenues (mostly FSC): Maintenance, Ground handling, crew training, catering, cargo, Consultings (LH)

Airline TypesLegacy (Full Service Carrier: FSC)Low Cost Airline (LCC)Charter Airline: Cost structure similar to low cost airlines- What are the differences?

The changing landscape of Aviation Regulations: The Government’s Instrument

- Flag carrier as a national symbol- https://www.youtube.com/watch?v=0N3J6fE-0JI - https://www.youtube.com/watch?v=hbGuqmaDgLA- Flag carrier as a colonial power (KLM, British Airways, Air

France, TAP to Macau and Timor Leste)- Instrument of Economic/Transport developments- Old school- Protectionism

Type of Regulatory Obstacles - Traffic Rights (Flights/Capacity)- Foreign ownership- Fare control – Price Ceiling/Floor- 5th Freedom (Thailand-HK)- 7th Freedom (EU Case)- Cabotage (Domestic flight by foreign

airline)

Why?

Market liberalisation in ASEAN

Intra-ASEAN: Half-baked liberalisation

1) First Agreement

- 3rd, 4th, 5th, Freedoms to ASEAN capitalsExcept Philippines and IndonesiaPhilippines allows access to other cities as Manila is full in terms of CapacityIndonesian is heavily lobbied by its carrier to stay out of it: This undermines the purpose of openskies policy

2) 2nd Agreement3rd, 4th, 5th, freedoms to all ASEAN citiesExcept Brunei, Laos, Cambodia, Indonesia

- There remains the restriction on foreign ownership- No 7th freedom or cabotage (where as these provisions are available in the EU

liberalisation)

Airport BusinessWhat are the costs?

What are sources of revenues?

Airport Business- Natural Monopoly – Various Constraints- Generally owned or partly-owned by Gov’t- Capacity constraint (Land use issues,

noise problems)- Market for slot trading (worth millions of

pounds per slot pair at LHR)- Recent trend: Focus more on non-

aeronautical revenues, diversification, investment in other airports

Market liberalisation IIThailand Case- Liberalised domestic sector on main routes: 2001- Prior to that only one airline per route- No fare control- Restrictions still in places on small airport (only 2 airlines

can operate)

ASEAN-China - Free access- Chinese carriers have advantage over ASEAN carriers

Thailand: Market Overview

Thailand Overview- Jump-started by Openskies policy - TG used to dominate the market- The IPO Rush - Nok Air and Air Asia are leaders- Over-capacity- Strong seasonal demand- Fare war – Tail chasing game- Less defined market

Year Passengers Cargo (Tonnes) Aircraft Movements

1998 33,055,833 Not available 320,5961999 34,656,209 Not available 343,2752000 37,948,719 933,613 278,4722001 39,108,367 907,421 283,9802002 41,349,559 1,019,003 297,0242003 38,475,771 1,009,097 293,6522004 49,795,440 1,123,633 366,5702005 49,526,984 1,195,122 388,9142006 54,736,770 1,233,741 413,2932007 59,790,818 1,291,439 457,5472008 57,898,932 1,253,424 427,5192009 57,570,010 1,115,096 395,6922010 62,260,970 1,391,938 4339652011 71,462,504 1,405,803 494,0912012 82,544,477 1,438,355 571,4272015 106,789,914 1,390,605

Airline Price (baht)

Seat Allocation

FreeBaggage

Allowance

In-flight Meals

Frequent Flyer Points

THAI 1,648 20kg Thai Smile 1,650 20kg

Bangkok Airways 1,790 20kg Thai Air Asia 891 X X X X

Nok Air 1299 15kg X Lion Air 1010 15kg X X

Thai Airways International- Founded in 1960 with Assistance from SAS- Founding member of Star Alliance, the world’s

first- FSC, Network Carriers- Former largest player in Thailand- 2015 13 bn loss with 19m pax, 75 planes- Thai Smile/ Nok Air shareholdings: WHY? – Competitive advantage/ Cost

THAI: Troubles- Political influences (Fleet decisions, corruptions,

incompetent leaderships)- No clear strategy - Losing to LCCs on short hauls and ME3 on Long hauls- Strong union with unsustainable benefits - Unsuitable fleet - Unsuitable route: JNB (not fully utilising Star Alliance)- Failure to capitalise Thailand’s competitive advantage

(Labour, geographical, tourism, etc)- Do we still need a flag carrier????

Thai Smile Airways- Estd 2012- Positioned as “Premium LCC”- Regional carrier for TG- Wrong Positioning - Lack of strategy (stop-gap

measure)- 20 aircraft, mainly domestic

servives

Nok Air- Premium LCC- Aiming and elderly, business travellers,

frequent flyers- 12th Anniversary- 30% owned by TG, originally to fend off Air

Asia then lost track.- Largest domestic network- Regional Expansion: NEWS!- Fly and Ride/Ferry- 32 Aircraft- China Expansion- Strategy: B2B, other businesses, Implant

the brand to the travelling public

Nokscoot- Longhaul LCC- JV between Nok Air and

Scoot- Scoot itself is part of

Singapore Airlines

Bangkok Airways - Advertised as Asia’s Boutique Airlines- Samui and monopoly markets- Codeshare strategy- Failed Cambodian venture/Long haul ambition- Leisure-based airline - Victim of expansion outside niche market- Passengers often mistook Bangkok Airways as

an LCC

Thai Air Asia- First to exploit the market liberalisation- Foreign ownership question- LCC, no frills model- Catching first time flyer, deal seekers- Sensational promotion - Thai Air Asia X: Japan, Korea- 50 aircraft

Thai Lion Air - Part of Indonesian airline- Again, foreign ownership question- Eating both markets from Nok and Air Asia- Stir the market to prevent Thai carriers from going

to Indonesia - Fast growing: 24 aircraft- Dumping price (345 baht fare, etc)

30 busiest airports in the world

- 7/20 Airports are in ASEAN/China- None of ASEAN/China airports were listed in the top 20 in 2000

(The previous lists were dominated by hubs)

ASEAN Overview (1st week APR 2014)Carrier Seats (000)Lion Air 857

THAI 541

Air Asia 525

Garuda 471

Malaysia AL 461

Singapore AL 444

Vietnam AL 372

Cebu Pacific 333

Thai Air Asia 236

Sriwijaya 207

Airport Passengers (000)

Jakarta CGK 1400

Singapore 1371

Bangkok BKK 1237

KLIA 1134

Manila 824

Ho Chi Minh 482

Surabaya 452

Denpasa 381

Bangkok DMK 359

Makassa 330

ASEAN Carrier Financial Performance

ASEANThe rise of Indonesia- To become the 4th largest aviation market in the world

by 2040- Indonesia will enter the top ten around 2020 and attain

6th place by 2029. By 2034 it will be a market of 270 million passengers. (IATA)

- Largest populations- Rising middle class –Disposable income - Geographical Reasons - Lion Air: 495 aircraft on order!!!- Safety issues to be addressed

ASEANThe rise of Air Asia- Easyjet of Asia- Expanding strategyThailand, Indonesia (AWAir), Philippines (Zest), India, Japan (Failed JV with ANA) - 345 aircraft on order- Sale and lease back

strategy

Air Asia XMalaysiaThailand Indonesia

ASEANThe fall of Flag carriers

- Singapore Airline Status quo? (next page)- The two-front battle- ME3, the alliance non-believer (QR OW, EK

Alone + QF, EY buys) – Unfair competition

Singapore Airlines: The fading charm of Singapore Girls

- https://www.youtube.com/watch?v=RrI8DSCmRb4

- https://www.youtube.com/watch?v=ewzY-vXJAsU

- Singapore doesn’t need an airline- Investing in other segments- Demand for SIA is falling

ASEANLCC Long haul?- ASEAN is the largest region of longhaul LCC- Prone to failure as there are no real cost

advantage on long route- Air Asia X suffered heavily from EU markets

(Paris, London)- Norwegian uses legal advantage!!

ASEANSafety Concerns (Advert: Safe means unsafe)Indonesia https://www.youtube.com/watch?v=UC8ySY_GlUk – EU-Banned except Garuda, Air Asia, (Lion is on the banned list)- Philippines – EU-Banned except Phillippines Airlines and Cebu - Problems with oversights, infrastructures, training and safety cultures- Laos/Cambodia – Limited infrastructures/Badly-maintained equipment

(spares)- https://www.youtube.com/watch?v=-qyZFASOAe0

Failure to invest in infrastructures and training

From unprecedented growth

ASEANSafety ConcernsThailand v ICAO debacle (We normally have 1 accident once a decade)- Thai airlines are safe however the governing authority fails to meet the

international standards, not the airlines! (Department of Civil Aviation)- Thai DCA fails ICAO audit- The key failures (Qualification of examiners, document controls, lack of

training for examiners, ILS catIII, dangerous good- Korean/Japanese DCA threaten to ban Thai airlines to enter their space- However, the ban was never materialised - Political questions? - Far too much economic benefits from Thai tourists at stake!

Aviation Externalities: Suvarnabhumi

- Positive Impacts?- Negatives?

Aviation Externalities: Suvarnabhumi

d- Greenfield Project- Opened in 2006- 800 movements daily- First noise-related protest

Benefits- Rapid urbanisation: markets, shops,

businesses, opportunities- Improvement in transportation:

motorway, direct rail-link, buses- Business opportunities- Employment: Direct/Indirect

Aviation Externalities: Suvarnabhumi

Issues:

- Aircraft Noise: Sleep disturbance, stress, heart-related diseases - Local air pollution (33%) Global emission (66%)- Carbon emission from aviation is estimated at 3% (IPCC)- EU-ETS (2012) China along with US and Russia refused to join and the aviation sector has

been delayed since.- Waste- Flooding

- UK-APD (Used as money generator) / European Airlines has an advantage as a hub

Chinese Aviation IndustryCAAC: Civil Aviation Authority of China- Maintained airline monopoly in China

1949-1988- Unique in being a mixture of Soviet and

Western equipments- Broken up into different airlines in 1988

Chinese Aviation IndustryThe great consolidation (2001)

Airline Fleet size Consolidated Subsidiary

Air China (Star) 333 China Southwest Air China CargoShenzhen AirlinesShangdong AirlinesDalian Airlines Beijing Airlines

China Eastern (Skyteam)

388 China YunnanChina NorthwestGreatwall AL

China Cargo Airlines China UnitedShanghai Airlines

China Southern (Skyteam)

494 Zhongyuan ALChina Northern China Xinjiang

Xiamen AirlinesChongqing AirlinesSichuan Airlines

Chinese Aviation IndustryThe rise of Hainan Airline GroupFast expansion5-star airline Intercontinental routes139 aircraftSubsidiaries:- (China) Beijing Capital Airlines, Chang An Airlines, China Xinhua, Fuzhou Airlines, Heilongjian Airlines, Lucky Air, San XI Airlines- Hong Kong Airlines, Hong Kong Express, Zest

Chinese Market 1stQuarter

Q3 2015

10 Busiest Chinese Airports (2004)Airport Passengers (millions)

Beijing Capital 86.1

Guanzhou Baiyun 54.8

Shanghai Pudong 51.7

Shanghai Hongquao 40

Chengdu Shuangliu 37.8

Shenzhen Bao an 36.2

Kunming Changshui 32.2

Chonqing Jiangbei 29.2

Xian Xianyang 29.2

Hangzhou Xiaoshan 25.5

Chinese Aviation IndustryThe only LCC operator: Spring Airlines Owned by a tour company

Based in Shanghai Fleet size: 51

Chinese Aviation IndustryASEAN-China Traffic- B2B- Thailand + Malaysia and Singapore triangle - 5 million Chinese visit Thailand in 2014- Air Asia and Nok Air is aiming for the market- Must adapt to chinese payment and booking

system - Charter airlines from Thailand- Chinese mainline charter from China

Chinese Aviation IndustryCommercial Aircraft Development

The Y-10 707 reverse engineering

Chinese Aviation IndustryCommercial Aircraft DevelopmentSoviet Technology (An-24): Y7MA-60 – Landing accidents (1/4 written-off)

Chinese Aviation IndustryThe Western TechnologyEmbraer: ERJ-145, HarbinAirbus: A320 Family, TianjinMD 80, Shanghai

Chinese Aviation IndustryCommercial Aircraft Development: Home GrownARJ 21 (MD Fuselage, Antonov Wings)C919 – 737 and 320 Battle

TAHOMA(BOLD) 36P.QUESTIONS?