Budget carriers revolutionizing Asian skies amid Malaysia tragedy

Shortly after Tony Fernandes was packed off to a prestigious boarding school on the outskirts of London at the age of 12, he called his mother back in Malaysia, hoping to return home for the Christmas holidays.

“She said ‘It’s too expensive,’” Mr. Fernandes recalls. “And I said, ‘One day, I want to make this possible.’”

After finishing a degree at the London School of Economics, the ebullient Mr. Fernandes flew through the upper echelons of the music industry, working for Richard Branson’s Virgin Group before becoming the regional director for Warner Music in Southeast Asia.

The disastrous AOL-Time Warner merger eventually gave him the impetus he needed to make a career change and pursue his childhood dream. Mr. Fernandes sold his stock, returned to Malaysia and went about building a hugely successful budget airline – AirAsia Bhd.– in Kuala Lumpur.

In the process, he also started a revolution in the skies above Southeast Asia.

Dozens of low-cost competitors have followed him to cash in on the burgeoning middle class in the countries that make up the Association of Southeast Asian Nations (ASEAN). They are putting pressure on full-service flag carriers – such as beleaguered Malaysia Airlines, which has lost two planes in unrelated tragedies over the past four months – that have had to lower fares to compete.

The low-cost carriers’ success connecting the island nations of the region has been a boon to manufacturers, however, who have signed record orders for new jets from regional airlines, some of which are entering a new phase as they push into longer-haul routes.

Even with the intense competition, and some rumblings of overcapacity, the region’s airline industry looks set to continue its surging growth.

The rise of AirAsia

It was just a few months after the terrorist attacks of Sept. 11, 2001, when Mr. Fernandes bought his airline for next to nothing.

In December, 2001, he and some investors banded together to buy a struggling airline called AirAsia from the Malaysian government. It came with 250 staff, two aging Boeing 737s that flew six routes to two destinations – and $11-million (U.S.) in debt.

“We were jumping for joy,” Mr. Fernandes says during a long interview at his open-concept office in Kuala Lumpur. “Everybody else pooh-poohed the whole thing and said, ‘Look at these idiots. They don’t know anything about airlines. And they went and bought an airline just after 9/11, when nobody is flying.’”

Mimicking European discount airlines, the executives planned to sell seats on the plane and make passengers pay for everything else, including food. But the night before their first flight, Mr. Fernandes got a call and realized they didn’t have any food to sell on their flight.

“I said let’s go to [the supermarket] Carrefour,” Mr. Fernandes says. “And so we went and bought bottles of Coke, sandwiches. To think of those days, it’s amazing.”

Today, AirAsia has a fleet of nearly 160 aircraft, with operating subsidiaries or joint ventures in Indonesia, Thailand, India, the Philippines and Japan. It operates nearly 50 per cent of Malaysia’s international and domestic flights, 26 per cent of Indonesia’s international flights, and 29 per cent of Thailand’s domestic flights. The Kuala Lumpur airport now has a dedicated terminal – KLIA2 – for low-cost flights.

Mr. Fernandes, whose wealth is estimated to be about $650-million (U.S.), gets his surname from the Goan heritage of his father, but seems to have picked up his entrepreneurial flair from Sir Richard Branson, his one-time boss.

He once insisted an executive from the aircraft manufacturer Airbus Group NV get on the dance floor at a bar in France before he would sign an agreement for a huge new order of jets, and then he had the document sealed with a kiss from a flight attendant wearing red lipstick.

After purchasing a Formula-1 team, he and his friend Sir Richard once made a famous bet: Whoever’s F-1 team lost would have to dress up as a flight attendant on the other’s airline. Mr. Branson lost and – dressed in the red outfit worn by female AirAsia cabin crew, wearing bright red lipstick, but still sporting his goatee – served a joyous Mr. Fernandes a meal on an AirAsia flight from Australia to Kuala Lumpur. All the proceeds from the flight went to charity.

Pranks aside, Mr. Fernandes’s expansion plan has been serious, targeted and successful. With AirAsia X, Mr. Fernandes is pushing beyond cheap short-haul flights and into low-cost, longer-haul journeys, connecting passengers across China, Australia, India and the Middle East – and funnelling them through his ASEAN network to tropical paradises like Phuket and Bali.

Mr. Fernandes says that when he started, only 4 per cent of Malaysians had flown; today, that number is nearly 40 per cent. When he renewed his passport last year, he says the head of Malaysia’s immigration department came down to say hello – and point out that he had to double his work force to keep up with the number of Malaysians now wanting passports.

That trend is playing out elsewhere in a region where dense population centres are separated by large bodies of water – not just between countries but within sprawling archipelagic nations like the Philippines and Indonesia, which have populations of about 97 million and 250 million, respectively.

“Currently there are about 23 low-cost carriers in ASEAN and more are coming,” Mr. Fernandes says. “We think it’s healthy. We think the region can easily have double the number of low-cost carriers, simply because of the population and the geography.”

A fast-growing market

In Southeast Asia, partly thanks to AirAsia, the skies are getting crowded.

Fuelled mainly by a growing middle class of more than 500 million people and its thriving low-cost airlines, the Asia-Pacific region is now one of the world’s fastest growing aviation markets.

Between 2012 and 2013, every country in Southeast Asia – with the exception of tiny Brunei – posted double-digit year-over-year growth in passenger traffic.

Myanmar, which has only recently opened its borders after a long period of military rule, led all countries with 77 per cent year-over-year growth in weekly international seat capacity. Laos and Cambodia both saw 28-per-cent growth, according to the Sydney-based Centre for Aviation consultancy, while Indonesia saw 29-per-cent growth. Though Thailand’s renewed political instability has dampened its outlook, Malaysia, Vietnam and the Philippines all saw strong growth, helping keep average growth in the region at nearly 20 per cent.

The Centre for Aviation noted that this growth has come from Southeast Asia becoming wealthier, not more populous: During that same period, the region’s population grew by only 6 per cent. At the same time, “intense [low-cost carrier] competition has reduced fares in many markets, stimulating demand, particularly among the region’s new middle class,” the organization said in a report.

Asia’s rise in economic and demographic terms is unparalleled and is set to become an even greater force in the global economy. By 2020, Ernst Young estimates that the Asia-Pacific region will have 1.7 billion people who qualify as middle class, a figure that is expected to rise to 3.2 billion by 2030 – when the region will have two-thirds of the global middle class.

The ASEAN nations have struggled to integrate their economies and make it easier for businesses to operate across the entire region, but have made strides in recent years, particularly as low-cost carriers pushed for liberalization through the region’s open skies framework. ASEAN countries already have a combined population of more than 625 million and a collective gross domestic product of roughly $2.3-trillion.

Low-cost carriers, pushing and tapping into this growth, now account for about 50 per cent of air travel in the region.

That has been a boon for Western manufacturers of airplanes. Asian airlines have placed record orders for new aircraft from Boeing Co. and Airbus SAS: Regional low-cost airlines now have more than 1,500 new aircraft on order.

AirAsia, in 2012, became Airbus’s single largest customer when it placed a $9.4-billion order for 100 aircraft. The budget airline currently has about 400 aircraft on order, to be delivered by 2026. In mid-July, Mr. Fernandes got a kiss on his cheek from Airbus CEO Fabrice Brégier at the Farnborough International Air Show after pledging to buy 50 widebody A330-900neo airliners for AirAsia X.

But AirAsia’s numbers are actually dwarfed by Indonesia’s Lion Air Group – a key competitor – which has roughly 550 aircraft on order. Although its present day fleet is smaller than AirAsia’s, Lion Air is growing faster, as AirAsia eyes more international flights. Smaller low-cost carriers such as VietJet Air and Tiger Airways (Tigerair) are also expanding. Analysts expect the fleets of the major Southeast Asian low-cost carriers to triple over the next decade.

But even with all the growth, particularly in low-cost but long-haul flights, there are some signs of overcapacity. In March, Tigerair – owned by a consortium that includes Singapore Airlines – cancelled an order for nine A320 aircraft it had placed with Airbus, giving it more financial flexibility in a crowded market, even as it maintained its plan to purchase 37 A320 aircraft by 2018.

No frills, big profits?

The business model for low-cost airlines, pioneered by companies such as Ryanair Ltd. and easyJet PLC in Europe, is not exactly a secret: Keep operations lean, utilize each plane as efficiently as possible, keep frills to a minimum, make passengers pay for every perk and – most important – keep ticket prices low. Mr. Fernandes travelled to London’s Luton airport to observe and film easyJet’s operations before he started AirAsia.

Ultralow-cost airlines thrive in high-density areas with short-haul flights, which makes them difficult to operate profitably in places such as Canada, but make them ideal in Asia, Europe and even in the United States.

While full-service airlines will charge high prices to bundle in meals and give generous baggage allowances, almost nothing is provided free with lower-cost carriers – as any who have flown them will know. For AirAsia, that means no lounges, no paper tickets and no refunds. It means they also charge passengers who want to select their own seats, and often fly out of secondary airports to save money and shave turnaround times.

“What low-cost airlines do is get passengers on the plane and make money on them from ancillary services – and that’s everything from paying for excess baggage to food to services in and after the flight, like hotel add-ons and sporting or concert tickets,” says Dany Bolduc, who ran this division within AirAsia for two years under Mr. Fernandes.

One of the keys to this efficiency has been the Airbus A320 family of jets, an ultraefficient, single-aisle plane prized by many low-cost airlines, such as AirAsia and also Indigo, which uses the aircraft to fly short-haul routes between Indian cities from its hub at New Delhi’s Indira Gandhi airport. Many low-cost carriers use these jets exclusively, because using just one type of plane for an entire fleet allows low-cost carriers to cut costs on pilot training, engineering and maintenance, as well as enabling a rapid turnaround on the ground.

Budget airlines, such as AirAsia, mainly operate without large unions. Mr. Fernandes said his company and employees don’t need one, and he has encouraged an open environment where employees can speak to him directly. He said he once ordered new uniforms for baggage handlers, and then got a text saying they were uncomfortable to work in. The baggage handlers asked Mr. Fernandes, who complained that the uniforms had cost him a fortune, to load a flight from Indonesia. He agreed. The uniforms were changed. He sees this as a more efficient labour relations model that helps him keep down his costs, which keep ticket prices low – and passengers flying.

“I’ll always remember something Tony said in a financial review meeting, ‘Listen, cost will always win,’” Mr. Bolduc says. “For the most part, the low-cost airlines, it’s more or less the same experience [as full-service airlines]. You just don’t get the food. But it doesn’t really matter on short-haul flights. The low-cost carrier model for long-distance flights, typically over four or five hours, the economics are more challenging.”

The explosive growth in low-cost airlines – and particularly the fierce competition from AirAsia – makes the two tragedies that recently struck Malaysia Airline System Bhd. cut that much deeper.

Flying out of Kuala Lumpur, the home base of AirAsia, Malaysia’s national airline first lost track of flight MH370 en route to Beijing four months ago. While crews were still searching for the presumed wreckage, another flight, MH17, en route from Amsterdam to Kuala Lumpur, was shot from the skies above rebel-held eastern Ukraine, likely by a surface-to-air missile.

These catastrophes, however tragic, have simply highlighted long-standing difficulties at the struggling carrier, which is majority owned by the state-run investment fund Khazanah Nasional Bhd. The airline’s shares have declined roughly 30 per cent this year, and in its most recent quarter in June, Malaysia Airlines said it carried 3.1 per cent fewer passengers than the year before.

Mohshin Aziz, an analyst with Maybank Investment bank in Kuala Lumpur, says the company has an aging and inefficient fleet that is expensive to operate, and a “bloated” unionized work force that keeps costs high. Despite a “history of underinvesting in its business,” the company had been reducing operating costs.

“The whole region is getting really competitive,” Mr. Aziz says. “Then the MH370 incident happened in March and that just completely put a spanner in their plans. They had to discount their ticket prices even more, and their costs soared rather than improved. [Given] this second incident, I think they’ll have to discount their ticket prices again.”

He estimates that the company is losing about $1.6-million a day, could run out of capital soon, and needs to radically restructure away from international flights to concentrate on the domestic Malaysian market. , where it is still well-liked But he said there will likely be no return to the glory days when Malaysia Airlines, Cathay Pacific and Singapore Airlines unquestionably ruled the skies over Southeast Asia.

“They used to say we can get back to the flagship [carrier] years. The past is the past,” Mr. Aziz says. “Competition is one of the key issues.”

Competition everywhere

Malaysia Airlines is just one of the region’s major carriers under pressure.

Singapore Airlines Ltd. said profit fell 71 per cent in the second quarter ended June 30, as it struggled to eke out profit while selling fares under pressure from discount carriers.

But Singapore Airlines has joined a number of other full-service airlines that have fought back by launching their own discount subsidiaries – such as Australia’s Qantas Airways Ltd., which launched Jetstar – seeking to cash in on the growth of the middle class without hemorrhaging market share to low-cost carriers.

Indonesia’s flagship carrier Garuda’s share price has also been under pressure as discount carrier Lion Air made inroads. But starting in 2001, Garuda’s discount airline Citilink has battled back, flying Indonesians domestically between the thousands of islands that make up the archipelago nation – and in June, the airline reported that domestic passenger numbers were up 10.5 per cent year-over-year for the group, with Citilink up more than 28 per cent; international passengers, though, were down 1.5 per cent.

“For us the strategy has been very clear, we see both markets growing,” says Erik Meijer, Garuda’s executive vice-president of marketing and sales. “And so we go for this dual strategy. We see some people travel domestically on Citilink and then connect in Jakarta for international flights.”

Although Mr. Meijer sees competition continuing to increase in the region – where Indonesia’s Lion Air is expanding rapidly and accounts for about 37 per cent of the region’s seat capacity – he is optimistic. Garuda bought 27 aircraft this year and 26 last year, bringing the carrier’s fleet to a total of around 130.

“The growth of the middle class, it’s very big,” he says. “We’re seeing a few developments happen at the same time. We see the growth of the middle class in Indonesia, which is a significant force in the region. And we see that the group of people flying is also growing rapidly. And the growth of the networks with other carriers is growing rapidly. The critical mass keeps on shifting forward as more airlines keep adding routes and destinations.”

For Mr. Fernandes, AirAsia X has allowed him to expand his network well beyond Southeast Asia – one day, perhaps, it might even reach back around the world and link Malaysia to where he once studied as a child.

“Having ASEAN as the base, we can now look to Northeast Asia and South Asia – so that’s China, Japan, Korea, India and west Asia, or the Middle East as they call it, although that’s not a very attractive market right now,“ Mr. Fernandes says. “But once you go there, let’s say Dubai or Abu Dahbi or something, from there you’re within seven hours of Europe, of London.”

Budget carriers revolutionizing Asian skies amid Malaysia tragedy