NO-FRILLER IN MANILA
Lance Gokongwei is an extremely busy man, but do not expect to find him playing golf or sampling fine wine in order to relax.
“Making money is the best way to relax,” the boyish-looking chief executive of Cebu Pacific says with a grin at the low-cost carrier’s office, adjacent to Manila’s Ninoy Aquino International Airport (NAIA). “I like running a business; I enjoy interacting with people. Work is not a chore at all.”
If Cebu Pacific’s success is any gauge, he must be very relaxed. The airline became the market leader in the Philippines in 2010, when it carried more passengers than flag carrier Philippine Airlines (PAL). It also raised $620 million in an initial public offering that year, a record for a low-cost carrier. It has ordered new aircraft and is holding its market share in a country where competition is growing rapidly.
The success has probably surpassed the expectations of his boss and father John Gokongwei, the third-richest man in the Philippines and chairman of Cebu Pacific’s parent company, JG Summit Holdings.
The 85-year-old bought Cebu Pacific in 1995 following a failed bid for a stake in PAL and it began operations a year later.
He called upon his only son, Lance – who was then 29 and had only graduated with degrees in engineering and finance from Pennsylvania University a few years previously – to create a viable competitor to PAL from scratch.
MOVE TO LOW-COST
With a fleet of Boeing 757s and McDonnell Douglas DC-9s, the airline started offering domestic services such as between Manila and Cebu, with fares pegged around 40% lower than PAL’s. Profits came and its market share grew to around 30%, but the SARS crisis of 2003 and rising fuel prices in 2004 and 2005 forced a rethink of its model. That led to Cebu Pacific’s eureka moment.
“With oil prices going up, we did not have a genuine cost advantage against PAL, who also started to match our ticket price,” says Gokongwei. “So we had the classic dilemma. Yes, we were a low-fare carrier, but we had to decide if we should become a full-service carrier or a proper low-cost carrier. Given our low-fare legacy, the answer was obvious.”
Using Ryanair and EasyJet as models, Gokongwei went to Airbus and ordered 10 A319s. Cebu Pacific then forced authorities to redevelop domestic airports and won rights to international destinations, while developing a marketing strategy aimed at making a fun and lively brand. By 2008, the airline had grown so fast that it decided to consolidate its domestic and international operations at a mothballed terminal in NAIA.
It unlocked a latent demand for air travel within an archipelago where an extensive network of ferries is still the main mode of transport. It tapped into the growing number of overseas Filipino workers and residents, offering them cheap fares, no-frills services and extensive connections. It has been a boon to the tourism industry, with both Filipinos and foreigners discovering more about the country’s natural beauty. Cebu Pacific is largely responsible for the Philippine airline market’s growth from 2 million passengers in 2005 to 12 million in 2011.
“We did not even get options when we first ordered the aircraft – I didn’t think it would grow so rapidly,” Gokongwei says with a chuckle. “In 2005, we rebranded and did all the things low-cost carriers were supposed to do – selling through the internet, doing a lot of yield management. What changed was that by going from being a low-fare carrier to a truly low-cost carrier, we were able to significantly stimulate the market.
“As a businessman, the lesson I learnt was that you can’t afford to be in the middle. You are either an ultra-efficient low-cost carrier, or a super-premium network carrier. There’s no room in the middle in this business.”
The success of the IPO vindicated the business model, says Gokongwei. “Look at unit cost, our safety performance, our productivity, our brand recognition. By all metrics, we are a tightly run airline and the market has recognised that. Unfortunately, we have no control over the most important cost driver – fuel. But the key is the solid execution of the costs you can control. This is a cyclical business and you need a strong balance sheet, and Cebu Pacific has that.”
That is an advantage amid the intensifying competition, which resulted in Cebu Pacific’s market share going down to around 45% last year from 48% in 2010. AirPhil Express, which is also owned by PAL’s main shareholder Lucio Tan, is adding aircraft and growing its network. Singapore’s Tiger Airways has a partnership with Seair and plans to take a stake in the carrier, while Malaysia’s AirAsia also plans to open a franchise in the country. A classic capacity crunch is looming, but Gokongwei is upbeat about his prospects.
“The question is if the other airlines can make enough money to clear their costs,” he points out. “When a lot of capacity comes in, yields are affected and margins are reduced. All I know is that I am making money in this high fuel environment and have a strong balance sheet.
“Of course, I hate it that my yields are not as good as I hoped, but that is part of the industry. But more importantly, you need a sustainable business model. I’m not in this for market share alone. There is more capacity put in than anticipated, but nobody would want to lose money permanently. Something has to give – all I know is that it is not gonna be me.”
Cebu Pacific’s strategy is to expand gradually. It will increase the frequency of existing services, with basic trunk routes set to grow by 10-15% in 2012. It could add some bases to allow early-morning domestic services or international flights from secondary cities.
It is facing competition on the international network from both domestic rivals and foreign carriers. Apart from the existing airlines in Southeast Asia, low-cost carriers are also starting up in Japan and South Korea – two of its most important markets.
While Gokongwei is confident that his airline’s “superior cost base, brand and management” would help it cope with the competition, there is frustration that the traffic rights are awarded in a way that favours the foreign carriers. Indonesia, Japan and Thailand, for example, have rebuffed Manila’s attempts to get more rights for its carriers. In some instances, Philippine carriers are unable to add services as they have used up all of their rights, but a renegotiation is not on the cards as the inbound rights are not utilised.
“Let me make it clear – we are totally supportive of open skies,” says Gokongwei. “We have been the underdog and I have spent the last 10 years trying to get rights for new cities. But it must be mutual or reciprocal. We are against specific provisions that allow the Philippines to award rights to a foreign carrier without requiring the same rights for the Philippines.”
PROBLEMS WITH INFRASTRUCTURE
In the Philippine airline industry, executives can often appear frustrated with the short-term thinking that accompanies government policy. In part, that is because the country’s presidents are limited to one six-year term and heads of national agencies tend to change with them. As a result, there is little impetus to ensure that infrastructure is developed with long-term benefits in mind.
One example is the plans for an airport for Manila. The redevelopment of NAIA has been in limbo for years, and the government only approved funds for the refurbishment of the main terminal after it was voted as the world’s worst in a prominent survey. A proposal to shut down NAIA and to redevelop Clark airport as Manila’s main hub has been mooted. Yet Clark is 100km from downtown Manila with no high-speed rail links, and it could take several hours to reach the central business district, depending on the traffic.
Gokongwei is not a subscriber to the “build Clark and shut Manila down” camp. Both are needed if there is a “long-term view of the growth of the Philippine economy”, he says.
Attention must also be paid to the airports outside Manila, where Cebu Pacific has been responsible for much of the growth over the last few years. Instead of new airports, the existing ones could do with increases in passenger-handling capacity, night-landing capability and the number of trained personnel, he says.
Another priority is to get the Civil Aviation Authority of the Philippines (CAAP) off ICAOs “significant safety concern” list. Philippine carriers remain on the US Federal Aviation Administration and the European Union blacklist despite efforts by both Cebu Pacific and Philippine Airlines to prove that their safety standards stand up to international norms. That appears to cut little ice with ICAO.
“We are audited all the time, says Gokongwei. “We have a lot of corporate clients and they want us to be audited before they allow their guys to fly. We even offered to have ourselves audited, similar to Indonesia where the regulator did not meet the standards as well. But there does not seem to be any impetus for that and we are focused on getting the CAAP upgraded, hopefully in 2012.”
In the meantime, Gokongwei is focused on the airline’s long-term plans. It has 24 A320s and eight ATR 72-500s on order as well as 30 A321neos due from 2015 to 2021. The A321neos will expand the airline’s network reach even further, but it could also add widebodies to launch long-haul low-cost services.
“Long-haul low-cost is viable only if you are selective about the routes: point-to-point markets that are underserved,” he says. “The Middle East has 2.5 million Filipinos and the USA four million, for example. People can’t fly there directly. We would do this only if we can achieve a sustainable unit cost advantage and make money for our shareholders. A completely different team must be in charge; you will confuse the management otherwise.”
Over the last few years, Gokongwei has gradually taken himself away from day-to-day operations at Cebu Pacific. He will eventually take over at the helm of JG Summit Holdings, where he is president and chief operating officer, and give up his current position at Cebu Pacific.
But he is proud that he met his father’s expectations by creating a success out of Cebu Pacific, and making it “approachable and affordable” for “every Juan” who wanted to fly – as the airline’s tagline puts it.
“I’ve never gotten a compliment from my dad – as long as I get my bonus, I am fine!” he laughs. “But seriously, he is proud of what we have done.
“Strategy is always important in business but in the airline business, it is particularly important. You make such large capital investments three, four, five years ahead of execution, without actually generating any revenue, in a world where sometimes you can’t even see beyond next month.
“You must have a clear state of mind, a long-term vision,” he adds. “At Cebu Pacific, we have that for sure.”