By Massoud A. Derhally
Well-run low-cost carriers in the Gulf are thriving, but governments need to relax rules over airport infrastructure and open skies to allow them to truly take off
In good times, when market indices are on the rise, and IPOs and the size of bonuses are the talk of the town, people like to travel. When times are bad, as they have been economically speaking for the bulk of the past five and a half years, cost cutting is the name of the game. That has invariably, in the present climate, helped drive the growth of low-cost carriers (LCCs) globally.
The industry benchmark of budget travel is Southwest Airlines, now in operation for 42 years and the world’s largest low-cost airline, carrying more than 100 million passengers annually. Ireland’s Ryanair, which has a market cap of $12.5bn, is Europe’s largest budget carrier, carrying about 80 million people, followed by EasyJet which recently has joined the UK’s FTSE100 index.
Though late to arrive in the Arab world, regional and local budget airlines have revolutionised the travel market in the Middle East and North Africa region. They have managed to stay afloat and grow during the credit crunch of the past few years, in the wake of high oil prices and a downturn in the aviation industry. Only two, Saudi Arabia’s Sama Airlines and Bahrain Air, have stopped operating because of mounting costs and an inability to maintain constantly high load factors.
Air Arabia, the Sharjah-based carrier that was the first to come to the market, understood the need to keep fares as low as possible. It had to maintain high load factors, maximise aircraft utilisation and staff efficiency and look to creating non-aeronautical revenue streams as it lured passengers away from legacy carriers. Since its inception in 2003, the airline has posted an average growth rate of about fifteen percent over the past ten years. In 2012, it carried 5.3 million passengers, achieved a 82 percent load factor and posted a net profit of $116m, a 55 percent gain from the previous year.
Kuwaiti rival Jazeera Airways reported a 2012 net profit of $49.3m last year, carrying just over a million passengers, while Dubai government-controlled Flydubai recorded a profit of $41m, its first, and carried over 5 million people.
Last month, the International Air Transport Association (IATA) said the outlook for the financial performance of the global aviation industry for 2013 had improved on the back of expected stronger revenues. The Geneva-based organisation now expects airlines to produce a combined net post-tax profit margin of 1.6 percent and a net post-tax profit of $10.6bn (up from the previously projected $8.4 bn).
Airlines in the Middle East are expected to post a profit of $1.4bn, a 55 percent increase from 2012. The region’s performance is projected to better European carriers by about 75 percent this year, 133 percent more than rivals in Latin America and far outpacing African carriers, which are forecast to post only a $100m profit in 2013. Only Asia and North America are forecast to outperform the Arab world.
Arab airlines are expected to add 12.8 percent in capacity in 2013 and this will be outpaced by demand growth of 13.7 percent, according to IATA.
As Emirates, Qatar Airways and Etihad continue to grow expanding their networks, feeding traffic into their hubs in Dubai, Doha and Abu Dhabi, the no-frills segment of the market is the future of aviation in the region and has room to grow and mature.
Air Arabia has set up multiple hubs and expects to have as many as 55 planes in operation by 2015, while Flydubai may order as many as 50 of Boeing’s 737 MAX or Airbus’ A320neo planes.
“If you look at markets like Asia, Europe, North America and even Brazil all these markets have taken 20 to 25 years to develop the low-cost market,” says Saj Ahmad, chief analyst at StrategicAero Research.com. “Air Arabia has only been around for ten years so we’re still going to be in early stages of maturity. Low-cost airlines are changing the landscape and schematics of the way people fly. The more players you have coming into the GCC the more diversity and options there will be.”
Given the changing demographics and growth in the region, it’s palpable that low-cost airlines are here to stay and legacy carriers can only ignore them at their peril.
“With the absence of train systems, road systems and difficult borders between the countries, that indicates to me that travel needs are going to be there and it’s going to grow as the prosperity continues to progress in the Arab world,” says Air Arabia CEO Adel Ali.
Arab carriers and low-cost airlines could draw lessons from Turkish Airlines, the third-largest airline in Europe by passenger traffic, which is expanding aggressively and methodically exploiting Istanbul’s position as a hub that links Europe with the Middle East, Asia and Africa. As part of its expansion strategy, the carrier is maximising the use of its short- to medium-range narrow-body jets that make up about 80 percent of the fleet, pushing aircraft like Boeing’s 737, the manufacturer’s bestselling jetliner, to its longest range of seven hours. That means Turkish Airlines can use its aircraft more efficiently.
“The market is still growing, it’s not yet matured. It’s certainly not saturated at all and there’s plenty of avenues for growth,” says Ahmad.
Ahmad believes it’s probable that the aviation market in the Arab world will see the entry of a Qatar Airways Lite or Etihad Express at some point in the coming five years. A key consideration for such legacy carriers is not to make the same mistakes of peers in Europe and the US. British Airways, KLM, Continental and Delta tried and failed to operate budget airline units only to then sell them off or shut them down. So far the independent running of Flydubai has proven to be successful.
“Certainly for Qatar Airways it’s more important than Etihad,” says Ahmad. “The real challenge for Qatar Airways now is to get into their new airport, which is delayed. Within the next five years they’re going to have no option but to launch.”
However, growth depends on a number of variables, including the relaxing of government protectionist regulations, according to industry players and analysts.
“The region is growing from an economic point of view very quickly,” says Tim Coombs, managing director of Aviation Economics. “So organic growth is going to take place as a result of strong economies. There are some markets that have not been fully liberalised yet. This is probably because of governments want to protect national flag carriers who haven’t necessarily opened their markets entirely to low-cost airlines.”
Dubai’s airport handled 57.7 million passengers in 2012, a thirteen percent increase on the previous year, ranking it as the world’s third-busiest hub. The emirate’s aviation sector is expected to contribute approximately $45bn in revenues to the emirate’s GDP by 2020. Assuming the price per barrel of oil stays at around $112, growth in the GCC will be about 3.5 percent this year from 5.7 percent, according to Moody’s Investors Service. GDP growth in non-oil importing MENA countries will be rise to about 2.6 percent in 2013.
In Europe a key element to consider for budget carriers has been secondary airports and avoiding head-to-head competition at airports where big full-service airlines operate, and where landing fees and associated infrastructure costs are high. EasyJet and Ryanair are able operate to and from airports that may be as much as 30 miles outside a city centre, in locations where the likes of Lufthansa, British Airways, Air France would tend to avoid.
That has largely been possible because Europe has 130 secondary airports and because military airfields were converted or privatised. Having the secondary infrastructure means more jobs, more investment and an increase in the flow of people travelling. Having secondary airports can decrease congestion and see the utilisation of otherwise defunct airfields.
“In Europe, a lot of the airports have been very aggressive in terms of their pricing policy to attract low-cost airlines. They have been able to do so because they were privately owned or they found ways to provide subsidies in terms of marketing support or tourism agencies that have underpinned discounts that airlines have been receiving in terms of aeronautical charges at airports,” says Coombs.
In the Arab world, the story has been markedly different even as the likes of Air Arabia and Flydubai embark on ambitious growth plans. From the Gulf across to North Africa there are hardly more than 20 secondary airports, and in many instances — according to the largest discount airlines in the region — they’re more expensive than primary facilities.
“Most of the secondary airports, with a few exceptions, they’re actually more expensive than the primary airports to operate to,” says Ali of Air Arabia. “They cost more in handling, landing, the fuel cost is higher and that’s one of the policies that gets applied to protect the national carriers who operate from the main airport and also to protect the domestic market. Therefore they make the secondary airport much more expensive to discourage people from travelling to.”
Ali points to India as a prime example of how he’d like to see the landscape change. Ten years ago, when Air Arabia began operating, India had four international airports. Today, the carrier flies to fourteen destinations in the country.
“The easy part is for us to grow or for another player to come in because where there is demand you provide the supply,” says Ali when asked if he’d like to see additional players enter the market.
“The reality for the market is to naturalise… before we go into new players or expanding businesses; there has to be a complete change in the aero-political requirement that exists,” adds Ali.
“Unless agreements get implemented to have a true open sky in the Arab world, there is no point in having new players or lots of planes. There needs to be lots of secondary airports, and primary airport infrastructure has to be improved, in addition to open skies.”
As more players enter the market, like Turkey’s Pegasus, Hungary’s Wizzair and India’s Spicejet, changes in the traditional low-cost model will only be natural with the gradual introduction of a menu of choices, entertainment and premium pricing for seat allocation.
Some of these elements have already been introduced by Flydubai and Jazeera. The differentiating factor among competitors at the end of the day will be price transparency, the strength of branding and whether it makes sense commercially for the individual operator to modify their own business model.
“This is a service industry and in a service industry you make sure you meet the customer’s needs, and those change every year and season as things develop and technology develops,” Ali says, adding, “For any airline to progress and continue to operate successfully you have to always manage your cost dynamics.”
If the changes take place, Ali believes the market could mirror that of the US.
“We should have something similar to America. The low-cost future is very prosperous in the Middle East. Things will only move forward they don’t move backwards,” he says.