Aeromexico and Mexicana: On a collision course?

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From his penthouse office Manuel Borja watches as a steady stream of aircraft bank to the left when passing Mexicana's headquarters on their approach to Mexico City International. It is early evening and one of Mexicana's newly acquired Boeing 767-200s, arriving from Sao Paulo, is followed by a new Airbus A330, arriving from Madrid. "They are saying 'hail to the chief,'" Borja jokes.

Borja, who took over as Grupo Mexicana's chief executive in mid-2007, can see from his office window how rapidly the carrier has changed. Four additional widebodies, which Mexicana has used to launch Sao Paulo and the first two transatlantic routes in its 87-year history, are just the icing on the cake. Mexicana also recently concluded lease deals covering 25 Boeing 717s for low-cost unit Mexicana Click and 13 Bombardier CRJ200s for new regional unit Mexicana Link. In case four new aircraft types, launching transatlantic operations and starting a new airline wasn't enough, the carrier has also been preparing to join oneworld in May. To this end, Mexicana has just overhauled its IT systems.

It may seem like too much at once given today's economic climate but Borja says these pieces have been part of Grupo Mexicana's long-term strategy since hotel chain Grupo Posadas acquired the airline from government holding company Cintra in 2005."What you're seeing today is a reflection of several years' work," he says.

But Andres Conesa,chief executive at rival Aeromexico since it was sold to a consortium led by Citigroup arm Banamex in 2007 and whoheaded Cintra when it owned both carriers, claims Mexicana's launch of regional and transatlantic operations represents a strategy shift. "Why are they changing? Why do they want to become like Aeromexico?" he asks. "They are really trying to mimic us. I guess they see us above and they want to reach us."

Borja responds: "Our plan and roadmap isn't based on what Aeromexico is doing. At one time both companies were owned by the same company. We're now competitors."

Aeromexico and Mexicana have historically complemented each other, even before Cintra took over both carriers in 1996. Aeromexico was always the only Mexican carrier serving Europe and Brazil while Mexicana controlled Canada, Argentina and most of Central America. The US was split with one or the other controlling most markets. Only a few US destinations - namely Las Vegas, Los Angeles, New York and Chicago - were seen as big enough to support both carriers.

Aeromexico and Mexicana for years operated under an understanding that nearly every international market, and several domestic markets, were too small for two carriers. To facilitate transfers within their largely complementary networks, the duo had a comprehensive codeshare and frequent flier link-up, which remained in place until the second half of last year. "It was a nice equilibrium that worked. It's a shame it was lost," Conesa says.

While it seems Mexicana has been preparing for outright war against Aeromexico since it was privatised, Conesa claims today's super-competitive environment was not an inevitable outcome of the decision to split Cintra - a decision he proposed and executed after securing government approval. "Cintra was divided in 2005 - it was three or four years that the model remained," Conesa says. "There were some changes but not the situation that we have today in which basically we are competing in every market."

While in recent months Mexicana has expanded into Europe, added Sao Paulo and launched several regional routes, Aeromexico since February has added four Mexicana international markets - Denver, Montreal, San Francisco and Toronto. Aeromexico also plans to begin serving this year nine new domestic destinations already served by Click or Mexicana regional partner Aeromar. "Obviously if you are going to fly the markets we were only flying, I'm going to fly the markets you were only flying," Conesa says.

Retaliatory Behaviour

This kind of retaliatory behaviour can only have one outcome, according to some of Mexico's other key airline industry figures. "Both can't survive as they are now - competing in all the domestic and international markets," says Interjet chief executive Jose Luis Garza. He predicts Aeromexico or Mexicana will fail "if not this year, then next year" but says "which one will win, I don't know".

Aeromar chief financial officer Ami Lindenberg believes the status quo cannot continue but is willing to publicly pick a winner: "Mexicana has worked very hard to restructure and has a good three-year strategy. Aeromexico has sufficient internal problems and is entering into battle with Interjet in Interjet destinations, Mexicana in Mexicana destinations and Aeromar in Aeromar destinations. To enter into war against all airlines in the industry at one time on all routes is irresponsible."

Lindenberg points out that Aeromar and Mexicana are the only two carriers in Mexico now co-operating. "The best way to overcome crisis is to forge an alliance," he says. "No one else in the Mexican market is working together. Everyone is against everyone and everyone will lose because they are working in a lose-lose concept."

Conesa agrees: "In Mexico today you don't have co-operation except Aeromar and Mexicana. That needs to change. You need to have more co-operation. It doesn't necessarily mean mergers and acquisitions. It can mean other types of commercial agreements."

Grupo Posadas has long advocated a merger, having initially expressed interest in also acquiring Aeromexico before it was sold to the Banamex consortium. The government at the time refused to endorse the concept, insisting the two carriers should have separate owners for competition reasons. Last year competition authorities changed their tune and indicated they would no longer oppose a merger given the rapid rise of the country's low-cost sector, but Aeromexico's owners have since refused to entertain the idea.

Mexico's undersecretary of transportation, Humberto Trevino, says: "I don't see a merger soon. Their plan is to survive this complicated period.I suppose they are doing the right thing right now. They keep trying to get their best market share. I don't see anything changing in the next few months." He explains that while "the situation has changed with the competition authorities" and the government would no longer block a merger, "we don't promote mergers".

Business Focus

Both carriers claim they are focused on executing their own business plans and are not concerned about what the other is doing. "On our side we tend to focus on what we can do and not what others can," Borja says. "We're very clear on what we want. We want to set our future, not react to what everyone else is doing."But while he says he does not want to talk about the competition, Borja unprompted brags about how Grupo Mexicana now carries twice as many international passengers asAeromexico (see chart p46)and 1.5 million more annual passengers overall.

Conesa also says he does not want to talk about the competition, but points to Grupo Aeromexico having more RPKs, higher revenues and a larger share of the domestic market (see chart p46) "according to official figures".

He though is critical of Mexicana's strategy, saying it is trying to do everything. "You have to concentrate on what you do and, for example, what we have been doing is having this large, good and profitable long-haul service complemented with a feeder in Mexico. Going into an LCC business would be deviating from that model."

Instead of creating a low-cost carrier, he says Aeromexico has been using Aeromexico Connect to expand domestically. The former Aerolitoral unit will grow from 34 to 46 regional jets this year, helping Aeromexico expand its domestic network from 37 to 48 destinations this year.

Conesa says 50-seat jets have allowed it to link Mexico City with regional cities twice per day while Mexicana, using larger aircraft, offers one frequency on the same routes: "If you look at our network we have the largest coverage in the country and what we call the AM/PM service that takes you there and back on the same day. That's the strategy we're following and it's been very successful."

Mexicana's domestic strategy involves using Click to operate all but the largest of its domestic routes. Click was launched as a low-cost carrier in 2005, just prior to the opening of the domestic market, but Borja says Mexicana now sees Click as a regional. He says over the last two years Click has assumed from Mexicana several routes to regional business centres that attract high portions of business travellers and passengers heading to destinations beyond Mexico. As a result "Click has more and more connectivity".

In response to the changing passenger mix, Mexicana decided to include a business class cabin in Click's new fleet of 717s. Click's 25 Fokker 100s, which will be replaced over the next two years, are all-economy. "By introducing the 717 we're improving our product. It is a better airplane at the same operating cost. This will benefit our customer and we'll protect our revenues at these difficult times," Borja says. "You may see it as offensive move; we see it as a defensive move."

Borja calls Link a feeder carrier and says it takes on an important new role in the group which was previously unfilled because Mexicana did not have any aircraft with fewer than 100 seats. Link, which launched services in March, will operate many routes previously served by ALMA before it ceased operations last November. Borja is confident Mexicana can make these routes work because it will feed Mexicana's secondary hubs in Guadalajara and later Monterrey. Link will not operate at Mexico City, where most of Aeromexico's regional jets are now based.

"There was a void in the market and we believe we can profit from this space," Borja says. "We won't leave space for someone else. Again, it's a way to protect our revenues."

Borja adds that Link, like Click, features a low cost base because administrative and other services are provided centrally. Grupo Mexicana's five units - mainline, Click, Link, loyalty and maintenance - share services and are led by the same management team.

Reducing Mexicana's historically high cost base has been a focus for Borja since his days as chief financial offer in 2006. "We needed some changes to face new [low-cost] competition. What worked three years ago doesn't today. Fortunately we realised that three years ago," he says. "We've been working on ways to be more cost effective - to give a better service to our client but also to be lower cost."

Despite the intense competition and gloomy economy, Borja is confident Mexicana will not only survive but turn the corner and post its first profit at a group level this year. "That's our budget and goal," he says. "This year we'll probably be 99% there in reshaping the company. The next step will be to grow. We want sustainable growth. The only way for sustainable growth is profitability."

Borja addswhile Mexicana mainline continues to operate in the red and its new long-haul operation is not budgeted for profit until next year, Click is already profitable and "all our numbers including start-up costs show Link will be cash flow positive this year".

Grupo Aeromexico also believes it can meet its goal of becoming profitable in 2009. "We're confident we can comply with the objective of being in the black for the year," Conesa says.

But is it really possible for any Mexican carrier to be profitable this year given the intense competition and economic downturn? Garza says only if there is more consolidation and market conditions start to improve in the second half. Last year three scheduled carriers collapsed and at least one of the eight remaining players may not survive 2009. "It's a crazy time," Garza says. "I think we're at the beginning of the last chapter."

For more on the fast evolving Mexican airline market, see our in-depth feature