The liberalization of ASEAN’s aviation sector will be a major catalyst for the region’s economic growth by 2030 - Liow Tiong Lai, Malaysian Minister of Transport
The Malaysian Minister of Transport’s thoughts are backed by strong arguments as aviation plays a vital role in developing business, trade, sales, innovation, investments and tourism, all facilitating economic growth. With South East Asia being one of the most dynamic areas in the world, a boost in tourism and trade should have astonishing effects and bring countless opportunities - and challenges - for all aviation players. Latest news indicate that the Single Aviation Market (SAM) is due to be signed by this year.
South East Asia Aviation Market
The Association of South East Asian Nations (ASEAN) is a political and economical organization gathering ten countries and about 9 percent of the world’s population or 625 million people. Taken as a whole, ASEAN would rank 7th in terms of GDP, before Brazil and India.
ASEAN’s core countries are Indonesia, Thailand, Malaysia, The Philippines, Singapore and Vietnam and are home to the biggest airlines in the region. Among them are rather large full service carriers (FSCs), most being under restructuring, like Garuda Indonesia followed by Singapore Airlines as ASEAN’s biggest. But ASEAN's aviation market is being dominated by low cost carriers (LCCs), the major being Air Asia Group and Lion Air Group, both on their way to reach a milestone of 50 million passengers carried per year.
Despite ASEAN's capacity growth shrinking from 30% in 2013 to 13% in 2014 in light of overcapacity concerns, LLCs account for about 60 per cent of the market and are growing faster than their full service carrier counterparts. Even if astonishing growth rates might get lower as markets get more mature, Southeast Asian carriers account for 15% of global aircraft orders (almost 2000 airplanes). In other words, nobody plans to leave the battlefield, no matter how large the cake will grow, and airlines have faith in their ability to grow and compete even beyond their borders.
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Contrary to Europe and the US where LLCs mostly emerged after full liberalization (in 1978 with the Airline Deregulation Act in the US, and in 1997 in Europe), ASEAN airlines’ ability to expand beyond their borders is still very much government-regulated. A major step was taken in 2008, when airlines based in a country member of ASEAN were granted the right to fly between the region’s capitals without restrictions. And in January 2011, this right was extended. Airlines of any of the ten countries were granted the right to continue to an extra destination of the country’s capital they are flying to (fifth freedom).
For airlines, it was not enough. To fulfill their desire of expansion in other countries, foreign airlines had no choice but to create local companies in joint venture with local partners, and to gain a national airline operating certificate (AOC) in the respective country. This allowed competition to develop even more rapidly, as shown for instance by Malindo, Indonesia’s Lion Air subsidiary in Malaysia which launched in March 2013. Malindo claims a 10%-market share on the Malaysian domestic market (versus 45% for rival AirAsia and 38% for Malaysia Airlines), where it operates 13 domestic routes and 13 international routes. Thus, despite various forms of protectionism observed in the past, airlines have been able to significantly expand beyond their borders. For Air Asia, which initiated this trend, international operations are now larger than its historical activity in Malaysia.
But this has come at the price of enormous complexity. Presently, there are 24 LLCs in Southeast Asia, 8 of which are affiliated to AirAsia and operate in more than 17 hubs in five countries. With a single aviation market, these local entities would no longer be needed, nor would be a local partner and AOC. Carriers could be more agile, hence opening new routes. As an example, the number of routes between Japan and Taiwan increased 5 times since an open skies agreement between Japan and Taiwan was signed three years ago, and in the European Union, the number of routes have been multiplied by more than five in twenty years of deregulation.
New ASEAN Competition
Beyond the opportunity of reuniting all local subsidiaries with their parent company with full ownership, an opened market will open doors for mergers and acquisition. This already started in the Philippines with the purchase of Tigerair Philippines by Cebu Pacific. Similarly, the strongest carriers in the region could take the lead and grab the opportunity to become bigger through external growth. But there aren't many. One can count less than five profitable LCCs in the region (for 24 actors), and barely ten FSCs (roughly 40 players). Some like AirAsia, which has only its Malaysian and Thai subsidiaries profitable, initiated a paradigm shift from growth to profitability. FSCs like Thai Airways are also undergoing cost cuts, while others are working hard to develop their low cost subsidiaries (currently six in the region). To say the least the airline industry in the region is not in its best health to welcome an increased level of competition. Yet, with liberalization, the possibility given to carriers to open new routes, and to easily switch planes to their most profitable markets, could help raise profitability and diminish fears of overcapacity. There are also underpenetrated markets like Myanmar. It has a low cost penetration rate of 27% and the country’s tourism is booming, which make it an easier market to conquer. The extra competition will not come without opportunities for the region’s carriers, even though the outcome (with airlines that could as well be stronger, even more aggressive and reluctant to cut capacity as fuel costs slump) will be interesting to watch.
An airline industry massively losing money is not the only matter to monitor as the Single Aviation Market arrives. Infrastructure use, including airport, runway, or air traffic systems capacity will feel a more intense pressure, while being extremely saturated in some countries already like in Indonesia. Lack of safety will be a worse bottleneck than national regulation and protectionism now.
Recently, Air Asia CEO repeatedly said that a change in mindset regarding infrastructure management in ASEAN is needed urgently. Tony Fernandes reminded everyone that his airline attempted to invest in infrastructure several times over the past years, but was always blocked by authorities. The creation of regional aviation regulatory bodies could help make things move forward, otherwise airport space and slots could be used as traffic rights, as Jetstar CEO recently warned.
ASEAN and Asia aviation in general are already among the world’s most competitive markets with 75% of the routes operated by more than three carriers. Besides enhancing direct competition and making air travel more affordable, open skies agreement deals in the past have enabled a huge increase in terms of city pairs flights. This is key to unlock new markets, and LLCs will probably fiercely want their slice of the cake. LLCs play a vital role in allowing a growing part of these countries’ middle class to fly. While most LLCs are losing money, the demand will stay strong: 7.7% on average for the coming 20 years.
With a single sky market, airlines can strategically choose their operational bases, and increase competition between national infrastructure providers. All in all, this matters a lot in this deal: with a single market comes the need for all the ASEAN countries to collaborate.
Hopefully, there will be a regional answer to current infrastructure problems. And other outcomes, such as the opening of bilateral negotiations to increase competition on long haul markets (which stand far behind competition levels seen on the regional market) will follow.
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