PAUL SEIDENMAN / SAN FRANCISCO
Restructured Air Canada emerges from bankruptcy protection this year, but can it beat the low-cost operators in a depressed economy?
The Canadian airline industry is in a state of flux. Although it has yet to emerge from bankruptcy, national carrier Air Canada is facing growing competition from low-fare rivals Canjet, Jetsgo, and WestJet leading to a protracted fare war. Some blame a struggling, cash-strapped Air Canada - a charge strongly denied by the airline's president and chief executive Robert Milton.
"We have not been the price leader, but a follower, responding dollar for dollar to our low-cost competitors," Milton says. "At the same time, we have not added capacity, but reduced it."
Air Canada's capacity in the year up to June was down by nearly 11%, with revenue passenger kilometres showing a decline of 14.8% for the same period. Along with its competitors, the airline, which filed for bankruptcy on 1 April, has been buffeted by the outbreak of the SARS virus in Asia and in Toronto, its major domestic and international hub. The Iraq war and an overall decline in travel have also contributed to the carrier's problems.
The airline is projecting emergence from bankruptcy as a restructured carrier during the fourth quarter of this year. Considerable progress has already been made in saving C$1.1 billion ($795 million) on labour costs through new agreements with airline unions. Modified lease terms have also been renegotiated with nearly all of Air Canada's aircraft leasing firms, including General Electric Capital Aircraft Services (GECAS) - its largest lessor. The GECAS leases encompass 106 aircraft operated by the mainline carrier and its regional subsidiary, Air Canada Jazz. Air Canada's mainline fleet totals 227 aircraft, of which all but nine are leased. Fifty-one of the 100 aircraft operated by Jazz belong to leasing firms.
In addition to better terms, the recently concluded agreement with GECAS will provide a secured loan of C$575 million as part of a previously announced requirement by Air Canada for C$1.35 billion in bankruptcy exit financing. GECAS has also agreed to provide the airline with an additional C$1.285 billion to finance up to 43 regional airliners.
Milton reports that Air Canada will emerge from the restructuring process as a slightly smaller carrier capacity terms, but positioned to build upon a new cost structure. To reduce capacity, the airline plans to dispose of its three remaining Boeing 747-400s by the end of 2004 and, further ahead, its 24 Boeing 737-200s and 767-200s, although it is considering retaining some of the latter for all-cargo services.
Leasing deals
The post-restructuring fleet will include Airbus A319s, A320s and A321s, A330s, A340s and Boeing 767-300s. "We are also looking at 100-seat aircraft," says Milton. Boeing 717s, Airbus A318s, Bombardier CRJ900s and Embraer 190s are being considered for high-frequency, shuttle-type operations in the mainline fleet, and possibly for Jazz, with selection set for year-end, along with a possible order for 70-seat aircraft for Jazz.
The 100-seat aircraft purchase could be made in conjunction with Air Canada's Star Alliance partners Austrian Airlines, Lufthansa and SAS. "It would be the first significant acquisition by multiple purchasers of a common specification airliner, which would drive down the costs for each of us," he says.
Air Canada's Tango fare product, aimed at providing "highly affordable, simplified travel" began services in October 2001 with a fleet of six A320s serving 34 Canadian destinations. The airline stresses that Tango is not a low cost carrier, rather a brand of service which enables Air Canada to expand and contract according to market demands. "For Tango, we added more seats to our A320s and introduced a totally online and electronic ticket distribution system," Milton explains. "To keep costs down, we have a separate charge for all value-added items including food, beverages and seat assignments, as well as for booking a seat by phone." The Tango fare offering will eventually become available through Air Canada's domestic and international network
Tango has given Air Canada the flexibility to respond to market conditions, says Milton, as aircraft can be reconfigured overnight, according to market requirements. He brushes aside comparisons with similar co-branding failures in the USA, such as Continental Lite, Delta Express, MetroJet and Shuttle By United. "Other operations were established before internet ticket booking and distribution became a cost-effective way of marketing."
Air Canada has also established Zip, a separately certificated, low-fare subsidiary. Based in Calgary, rival WestJet's backyard, Zip took flight in June of last year and operates 50 mostly short-haul daily flights to 10 Canadian destinations. The airline's fleet of 13 737-200s could increase to as much as 20, Milton says.
Niche growth
On the international side, Milton says Air Canada's new lower-cost structure is stimulating growth into niches that would have previously have been economically prohibitive. The new daily non-stop Toronto-Delhi service, operating with an A340 and starting next month, will be the first and only non-stop service between North America and India. Capacity is also being rebuilt on transpacific routes, which suffered during the SARS scare.
Air Canada's only serious domestic rival is Calgary-based WestJet. According to chairman and chief executive Clive Beddoe, WestJet now claims a 25-27% share of Canada's domestic revenue passenger kilometres. The airline, which started in 1996 with just three 737-200s and 220 employees, now provides coast-to-coast service in Canada, flying an all-737 fleet of 42 aircraft and employing 3,500 staff. WestJet now flies charters into the USA, mainly to Las Vegas and other leisure destinations.
As Beddoe explains, the airline based its business plan on that of successful Southwest Airlines in the USA. "We took the Southwest model and adapted it to the Canadian market," he says. "Southwest operates high-frequency services within many markets but, in Canada, there isn't the population to justify high frequencies in most places. The real challenge was to operate an airline with a low cost structure in lower density markets."
Beddoe adds that the company's decision to operate a single fleet type, specifically the 737 family - as is the case with Southwest - has been a key component of WestJet's success. The fleet is composed of 21 737-200s, and 21 New Generation 737-700s. "With the addition of the 737-700, we have an aircraft family that is equally adaptable to short- and long-haul markets," he says.
All 21 737-200s will be gone by 2008, with the 737-700 as the replacement model - for now. "When the fleet was planned, we considered the 737-600 for some markets, and our contract with Boeing permits us to substitute the -600 for any of the -700s on order," Beddoe says. "We are also considering the 737-800, but no final decisions have been made on either the -600 or -800."
WestJet was also the launch customer for the Aviation Partners 737 blended winglet modification, which will be applied to all of the carrier's 737-700s, out of the factory and through retrofits. The modification is expected to result in a 4-5% fuel burn improvement, depending on stage length.
Beddoe says that, while the present pricing environment has had an impact on WestJet, the carrier's costs have continued to decline, especially as the new, morefuel-efficient 737-700s have entered the fleet. "They are providing an offset to a good portion of the revenue erosion resulting from the aggressive price-cutting practices in the Canadian air travel market today," he says.
Low-cost challenge
WestJet's current cost per available seat kilometre is about C¢8 (¢5). Beddoe reports that, without the burden of Canada's heavy fuel taxes, those costs could be further reduced.
"In Canada, fuel taxes are about 30% higher than in the USA," he says. "Disallow that, and we would be at US¢7.5 per available seat mile [¢4.6/km] for a 630nm [1,170km] stage length - which is about our average. Fuel represents about 20% of our costs. Still, as new aircraft are delivered, we will continue to focus on cost reduction."
Although it is a lower-cost carrier, WestJet is being challenged in some markets by Tango, and recent start-up Zip. Beddoe does not seem especially worried.
"Tango is gradually shrinking, and we see it as much less significant than it was a year ago. We are, however, waiting to see what will happen with Zip Air, which we believe was established solely to undermine us, especially in the eastern part of the country," says Beddoe.
Unlike Air Canada, WestJet experienced minimal impact from the SARS outbreak in Toronto, since most of its flights to the Toronto area use Hamilton airport, to which it has 24 daily flights. WestJet has served Toronto Pearson International since 2002, but with just seven daily flights.
Halifax-based CanJet, which was started in June 2002 by Canada's IMP Group, operates six 120-seat 737-200 Advanced aircraft on a route system that is heavily centred on Canada's Atlantic provinces. Serving seven Canadian destinations, CanJet also flies a seasonal service to Florida's St Petersburg-Clearwater International Airport from Halifax.
Julie Gossen, the company's executive vice-president and chief operating officer, says CanJet was established as an alternative to the high-fare environment that prevailed in eastern Canada. With an average stage length of 830-880km, Gossen says: "We had to offer an airline service at a low enough fare that would entice people to fly instead of drive. By offering good service at a low price, especially in this part of Canada, we feel we have filled a niche."
Because the airline is privately owned, Gossen does not cite any financial or operating statistics, but she stresses that the carrier has been successful. "We took delivery of our sixth aircraft in May, and the fleet will be expanded as new opportunities come along."
From its Montreal base, Jetsgo has spent the last year challenging Air Canada and WestJet with a fleet of 10 160-seat Boeing MD-83s. Founded in June last year, the airline serves 17 Canadian cities, along with Fort Lauderdale and New York Newark. President and chief executive Michel Leblanc claims that his airline is the lowest-cost carrier in Canada. Because Jetsgo is privately held, Leblanc does not wish to disclose figures.
With a specific catchment area centred at Toronto - Air Canada's hub - Jetsgo's business plan, Leblanc explains, was based on a perceived demand for a discount airline serving the eastern Canadian market.
"WestJet flies into parts of eastern Canada, but it does not really provide a low-cost discount service to the extent that was needed," he says. "You also have Air Canada, which is not a low-cost carrier. The routes we selected were based on the combination of consumer demand and the range of the MD-83, which has been very successful in our operation.
"We selected the MD-83 because we had a requirement for a 150- to 180-seat capacity aircraft that could fly Toronto-Vancouver, non-stop, fully loaded. After 11 September, more MD-83s, which have extremely low unit costs, suddenly became available, as many of its operators cut services."
New routes
Leblanc says that, while Jetsgo provides a low-frequency service in key Canadian markets, he wants to add secondary markets, and open new transborder routes. For example, the US resort city Las Vegas will be added in September, followed by new services to Florida.
"We have been able to hold our own and even expand despite the predatory pricing going on with the Canadian airlines today," Leblanc says. "At the end of our first year, our load factors have been about 75%, and we are profitable."
One of the carrier's cost-control measures was implementation of web-based booking. "That is a major component of our low-cost structure, and we finished the year with more than 90% of our bookings accomplished on the web. We actually projected about 35% the first year," Leblanc says.
The development of the low-cost market in Canada has meant that competition is tougher than ever. The unusual nature of the market, with a relatively low population, most of it concentrated in cities along the US border, means that survival, as ever, will be the preserve of the fittest and most adaptable.
Source: Flight International
