Competition grows in the budget airlines sector

10 November 2009

The Gulf’s aviation sector is becoming increasingly crowded, with Kuwait’s Jazeera Airways and Flydubai the latest firms to join Sharjah’s Air Arabia in offering cheap flights to regional travellers

As the region’s first low-cost carrier, Sharjah-based Air Arabia has had a head start on its rivals. Formed in 2003, it has now been operating for six years, considerably longer than most of its competitors.

For Air Arabia, the concept of ‘first mover advantage’ has paid off. In 2008, it was one of the most profitable airlines in the world, reporting AED510m ($138m) net profits for the year despite the global aviation industry being on its knees due to the financial downturn.

Key facts

149 - Number of aircraft on order from the Gulf’s five largest carriers

11 - Number of routes opened by Air Arabia this year

Source: MEED

Air Arabia’s formula is a simple one: it keeps its costs down. It minimises overheads by eschewing in-flight catering, charging for inflight entertainment and automating ticket processing. It operates a new fleet of just one type of aircraft, rather than leasing different, older aircraft, and therefore reduces the costs of training and minimises maintenance overheads. It seeks the lowest landing fees by operating from smaller airports, such as Sharjah rather than Dubai, using cheaper night-time slots and minimising turnaround times.

By restricting flights to only short or medium-haul routes, it keeps cabin crew costs to a minimum. In short, it has adopted the strategy successfully deployed by Western low-cost carriers such as Easyjet and Ryanair, allowing it to offer its customers highly competitive fares.

Hybrid model

In its first year of operations, Air Arabia broke even, an impressive feat for such an asset-intensive business. This allowed it to embark on rapid expansion and it now runs a fleet of 19 aircraft, up from the original three, and flies to 61 destinations.

Air Arabia’s $138m net profit for 2008 was the result of an 85 per cent load factor, the highest capacity utilisation of all the low-cost carriers. This performance has been carried over into the first half of 2009, with profits rising by 21 per cent to AED193m compared with the same period last year, while the load factor has dropped only slightly, to 80 per cent in the six months to the end of June.

The opening in May of its operations in Casablanca, it second regional hub, has underpinned this growth. Air Arabia also added 11 new routes to its network between January and the end of August, against the seven new routes it added in 2008.

Positive results have given the company confidence in the future. It has 41 aircraft on order and is continually expanding its operations. In early 2010, it plans to open a third regional hub, in Egypt, following Sharjah and Casablanca. With this multi-hub model, it hopes to add at least four new destinations to its network each year.

So has Air Arabia established the benchmark model for the region? Kuwait’s Jazeera Airways, under Stefan Pichler, chief executive officer (CEO), is determined to tackle the market its own way. “I do not believe in the low-cost carrier buzzword,” says Pichler. “We are in the airline industry. My main competitors are not just the other low-fare airlines, they are all those that operate on the short-haul regional network.”

This mindset is reflected in the company’s hybrid approach, which blends traits of the low-cost carriers with those of traditional firms. Rather than opting for only offering economy seats, Jazeera’s eight A320s each have 12 premium and 147 economy seats, which allows for a multiple fare structure, unlike the simple, one-class tariff structure offered by typical low-cost carriers.

“There are a lot of smaller players, but you cannot sustainably run an airline with just two or three planes”

Stefan Pichler, CEO, Jazeera Airways

Pichler argues that Jazeera is a “consumer champion, because it operates in a multi-market, multi-class segment and soon we will be multi-hub as well”.

The airline is still in the process of establishing a second operational hub, which Pichler says will not be in the Gulf but in North Africa. This is a region that is currently undersupplied by low-cost carriers, he says.

Although, unlike Air Arabia, Jazeera failed to make a profit in its first year of operations, it has done so each full-year since, posting a net profit of KD4.48m ($15.5m) in 2008. However, Jazeera recorded losses of KD2.2m in the first half of this year, although Pichler insists the company will be profitable over the year as a whole.

The latest entrant to the low-cost carrier club is Flydubai. Just five months after its launch in June, the airline has already taken delivery of its fifth aircraft and has 49 on order. When the final aircraft is delivered in 2015, its fleet will have just six fewer aircraft than Air Arabia’s.

Flydubai has also adopted Air Arabia’s simple business model. “Flydubai aims to make travel a little less complex, a little less stressful and a little less expensive,” says Ghaith al-Ghaith, CEO of Flydubai.

Al-Ghaith says the airline offers a basic fare package, to which customers can tack on extras for an additional fee. “Why should you pay for a meal if you do not want to eat one?” he says. “And why should you pay for baggage if you are only travelling with a briefcase?”

Although it initially targeted intra-regional leisure and business travellers, in September Flydubai expanded its network into India and Africa, to destinations including Lucknow and Djibouti, to capture some of the large market in migrant labour flows.

Crowded market

The new carrier has one significant advantage over its rivals: it operates out of Dubai International airport’s Terminal 2. Dubai is the regional air passenger hub, with far more travellers flying into the emirate every year than any other destination in the Gulf.

Indeed, excluding Saudi destinations, which have unusual traffic patterns because of the annual Hajj pilgrimage, passenger arrivals into Dubai, at 37.4 million in 2008, exceeded the total of all other Gulf destinations put together.

Flydubai therefore has a huge competitive advantage over its rivals. The airline’s government backing also means it will be difficult for any other low-cost carrier to operate out of Dubai, effectively shutting out the competition.

Such is the company’s belief in the strength of its Dubai location that Al-Ghaith says Fly-dubai has no current plans to operate out of anywhere other than Dubai. Given Dubai’s advantages, it is surprising that a low-cost carrier did not capitalise on this opportunity earlier.

Flydubai shares its ownership with Dubai’s flag carrier Emirates Airline. The Emirates board, noting the expansion of other low-cost carriers in the region from 2003 onwards, clearly decided that if the low-cost carrier market was going to put pressure on the premium market, then it was better off grabbing some of it itself.

This model is typical of other flag carriers around the world. Faced with increased competition from low-cost carriers, larger carriers have set up low-cost subsidiaries. Pichler says that by passing costs onto the low-cost carrier platform, larger carriers do not saddle themselves with debt, yet ultimately benefit from their offspring’s success.

The larger premium carriers will face stiffening competition from the low-cost carriers, through their pricing and multi-hub strategies, which will force the flag carriers to adapt in an ever more competitive market. The Gulf aviation marketplace is becoming increasingly crowded, leading to over-capacity and reduced load factors. “The industry will certainly see consolidation,” says Pichler. “There are a lot of smaller players, but you cannot sustainably run an airline with just two or three planes.

But it will not just be the larger carriers swallowing up the smaller ones. Jazeera itself has moved from owning aircraft to leasing them, providing it with cash for acquisitions. “Jazeera is always looking for opportunities to build shareholder value,” says Pichler.

“Flydubai aims to make travel less complex. Why pay for baggage if you are only travelling with a briefcase?”

Ghaith al-Ghaith, CEO, Flydubai

This would allow it to expand rapidly, not only through the acquisition of assets, but also by acquiring additional hubs.

But expansion in the low-cost carrier market will also come through natural growth in the industry and wider economy. Real gross domestic product (GDP) growth in the Middle East and North Africa region is forecast by the International Monetary Fund to pick up from 1.1 per cent this year to an average of 4.6 per cent over the next three years. Given that the Gulf is expected to be one of the regions that recovers fastest, passenger traffic into the GCC should continue to rise. Pichler foresees low-cost carriers’ share of the regional aviation market growing from 5 per cent to 15 per cent in the next four to five years. But he also says GCC low-cost carriers will have difficulty attaining the same market share as in the EU and US because of the lack of an open-skies agreement.

The market share of low-cost carriers in the West is more than 20 per cent, owing to the liberalised regulatory regimes. In March last year, the EU and US open-skies agreement came into effect, allowing any EU airline and US airline to fly between any point in the EU and any point in the US.

But in the Middle East, despite the evidence from the EU that deregulation increases competitiveness and stimulates the market, it has been slow to materialise. Regional governments still block swathes of airspace for military traffic. Since the region’s transport ministers signed an open-skies memorandum in 2004, only six states out of 22 have ratified the agreement due to fears over the impact of deregulation on their airlines’ profitability.

The price of oil is also a volatile variable that can dent profitability. Typically, a carrier can allocate a third or more of its total expenditure to fuel costs, meaning that the price of oil has a significant bearing on a company’s balance sheet. Volatility in the oil market in recent years also makes it difficult for carriers to know whether or not to hedge against price fluctuations.

However, the fact that most Gulf-based low-cost carriers made a profit last year, when the oil price reached record highs of $147 a barrel in July, shows that it is a robust industry.

Low-cost aviation in the Gulf also has considerable potential for growth due to rising economic prosperity and growing populations. But Air Arabia no longer has the market to itself. Its first-mover advantage has now been whittled away and, in Jazeera and Flydubai, it has some cash-rich, aggressive competitors.

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