LAN chief executive Enrique Cueto, who has long campaigned for more open markets in Latin America, has made his carrier a consistent money maker in a region where well-run airlines used to be the exception rather than the rule
If you can't break down barriers, just go over or around them and build there. That is the approach taken by Enrique Cueto, chief executive of LAN, the highly profitable carrier that used to be known as LAN Chile. Long an advocate for truly Open Skies within Latin America, Cueto has for years pushed for eliminating state and national obstacles to airline control and investment. In that regard he is in many ways some distance ahead of the governments and indeed the airline managements of the region.
"Some day we will see real consolidation in Latin America, but many barriers remain"
Chief Executive, LAN
Cueto, impatient for policy to catch up with commercial reality, has set up three cross-border subsidiaries, starting in Peru and moving on to Ecuador and Argentina. His strategy is to take the strong LAN brand into new markets across the region. The Peruvian venture found fertile ground in a nation that had limited competition, and where the national carrier had ceased operation in 1999. The Ecuadorian unit soon followed. Cueto says: "When you are able to offer on-time service on clean planes with safety and reliability, people do not care who owns the airline."
As LAN grew it dropped the "Chile" from its title and simply became LAN. Some said that LAN stood for Latin American Network, but Cueto says: "No, it's just our name." But it is a name that is becoming better known throughout the continent. The airline has repeatedly won awards for its passenger service, both domestically and internationally, and it is one of the top places where young Chileans want to work.
LAN now has a strong degree of regional diversification, matched by its global diversification. It is spread throughout the globe, and so is less vulnerable to regional shocks, downturns and trends. In Europe, most of its flights are to and through Madrid, where it operates in co-operation with Iberia on flights to most European destinations, such as London Heathrow, Milan and Paris. It also flies to Frankfurt with a stop in Madrid. In Oceania, it serves New Zealand and from there Australia, with a linkup to fellow oneworld carrier Qantas for more routes. Its North American routes, which Cueto says "are really profitable", are to Miami, New York, Los Angeles, and Toronto. It plans Washington Dulles flights sometime next year.
In balance with this geographic diversity, LAN depends on cargo almost as much it does on passenger services, and cargo has its own patterns that separate it from passenger whims and wants. In fact, cargo is very close to Cueto's heart: "We were just a couple of cargo guys when we came here and took over LAN," he says of his 1993 entry to the company along with his brother, Ignacio, and their team.
Central to the efforts at LAN is the belief that Cueto quietly espouses: "A differentiated value proposition, built around a clear customer focus and high standards of safety and reliability and on-time performance."
While Cueto is quiet, he is extremely ambitious and focused, and indeed his goal is to make LAN the leading global carrier in and to Latin America. Since late 2001, when he was first featured on the cover of Airline Business, the carrier has grown dramatically, with a compound annual growth rate of about 20%. Operating revenues have increased steadily from $1.4 billion and are on track to exceed $4 billion in 2008.
This is despite the 2001 terror attacks, SARS, the oil price shock, the Argentine fiscal crisis and other forces that have made the rest of the world's airlines at best unsteady. LAN's net income has grown from $11 million in 2001 to $308 million at the net level for 2007. LAN had a margin of 11.7% for 2007 at the operating level, putting it in the top 10 of the globe's most profitable carriers last year. Only Panama's Copa, with an 18.4% margin, joined this illustrious group from Latin America.
LAN reinvests this money to keep its fleet new and upgraded, even as it waits for its new Boeing 787s, which are delayed by two years, says Cueto. It will have 32 of the 787s by 2018, by which time it will have added five more Airbus A340s to the five it now has. While it is waiting for deliveries, LAN will have added winglets to the Boeing 767 fleet by the end of this decade.
In May, LAN retired its last Boeing 737, favouring Airbus A320-family aircraft for regional flights. "We ordered the 'bus back when (former Airbus chief Jean) Pierson had the company, and I think he was just very eager to get into the region, so he made us a good offer. The Airbus is a good plane and so is the Boeing, but we went with Airbus."
The company also refurbished its Boeing 767 fleet with both a new premium class and an upgraded economy class. LAN's Premium Business replaced separate first and business classes. It features lie-flat seats in staggered pairs, as well as an advanced in-flight entertainment system. In economy, the aircraft have new ergonomically designed seats as well as individual screens offering the same in-flight entertainment selections. This required an investment of about $80 million.
On regional flights, it has created a new product called Business Express on the Airbuses - with just 12 seats each it offers 50% more space than in economy. The BusEx class was first offered on flights linking the capital cities of Lima, Quito, Bogotá and Caracas. It will be on most short-haul routes by the end of this year.
Like most Latin American airlines, the old LAN Chile was a stepchild of the state, starting local flights in 1929, beginning service to the US in 1958 and to Europe in 1970. By 1983, it was a limited-liability company and in 1989 the state sold 51% of its equity to domestic investors and to SAS. In 1994, the company went into the hands of local investors, who control 98.7% of its shares. It was listed on the New York Stock Exchange in 1997, but less than 10% of shares trade on the "Big Board" in the form of American Depositary Rights. But Cueto says the New York listing was beneficial because its reporting requirements "certainly give us some discipline". They do more than that, says Bobby Booth, the Miami-based AvMan consultant: "Cueto's transparency is the result of the fact that LAN is one of four Latin airlines that is listed on the NYSE. It was the first and it's a model. The carrier has been consistently profitable since he went there." The Cueto family controls about a third of the company. Enrique's younger brother, Ignacio, took over as general manager for the airline in early 2006 after working his way up the ladder on both the cargo and passenger sides.
In part, LAN's admirable position stems from its place in the strong Chilean economy. The nation, although suffering from some inflation, has a vibrant economy in which tourism plays only a part, and Cueto notes that the country has always been amenable to privatisation and foreign investment. Chile has awarded concessions to private enterprise to operate its telephone and electricity industries, and is the rare exception in Latin America to have a network of privately-funded, privately-operated toll roads - which are run under concession by foreign operators. The airport in Santiago is privatised, but under the control of Chilean investors.
Fuel hedging has helped LAN maintain its status as one of the few carriers in the world with investment grade ratings. It was fuel-hedged 54% for the second half of 2008, and 2009 hedges start at 30% but Cueto says this could always be raised beyond the 10% rate for the year's second, third and fourth quarters. LAN has no significant long-term debt except, Cueto notes, some aircraft debt.
The subsidiaries are profitable and operate with some autonomy, says Cueto, "because they have to be aware of local markets and local conditions, so there is a limited network effect. But we are developing networks." LAN Peru's hub at Lima is what Cueto calls "the nerve centre of our Latin network". LAN Peru operates flights to Madrid as well as Miami, as does LAN Ecuador. The Argentine market is growing more slowly.
Technology is a key to the development of the network effect and its benefits, with the carrier moving toward full implementation of a revenue management system dubbed Real Origination and Destination Solution. "This way we can tell if an individual seat from say Santiago to Miami should be sold on a nonstop or a direct flight or on a flight over one of the subsidiary hubs," Cueto explains. The project interprets data that comes through various global distribution systems along with internal sales data. Cueto says that "one of my goals is to make us one of the world's top five airlines in terms of revenue management".
One essential key to LAN's strength is its cargo. Unlike most major carriers, air freight is not an after-thought or an add-on to passenger service, but, Cueto says, a starting point. The LAN cargo operation is headquartered in Miami, the cargo hub of the Americas, and in the first half of this year was responsible for 35% of the LAN group's operating revenues. It is in a way even more diversified than the group's passenger business, with 45% of its capacity devoted to Miami, Brazil and Mexico and almost 15% of the airline's available space on routes from Los Angeles to Brazil and Mexico. The break-even load factor on routes served by passenger/cargo "combi" flights is 63% - but would be 74% without cargo. One-third of overall revenues come from cargo, which is a greater portion than other world carriers such as Korean Air (29%), Cathay Pacific (22%) or Air France-KLM (12%). The dedicated freighters flew about 72% full in the year's first half.
Of course, cargo markets are highly susceptible to currency fluctuations, but the weakened US dollar has increased southbound loads as US exports stayed strong in the first half of the year. Northbound, commodities are the staples of the business, with Chilean seafood and wine both growing in volume.
In July, aviation authorities in Colombia - Latin America's largest source of cargo exports to the US, at 200,000 tonnes a year - approved a plan by LAN to set up a subsidiary there, to begin operations in the first quarter of 2009. By then, LAN should have received the first two of its new Boeing 777 freighters, of which it has four coming by 2018. It has already begun cargo operations in Central America, with service between Miami and both Guatemala and Costa Rica starting in September.
The Colombian market is one that Cueto would like to get into more deeply, but he faces barriers. Although LAN serves Bogota, the Colombian government has not been as welcoming as some others and the nation has at least one strong domestic competitor, Avianca, plus a growing Aerorepublica, now owned by Panama's Copa. But the cargo operation is a foothold.
"Of course we'd like to enter the Colombian market, just as we'd like to enter the Brazilian and the Venezuelan markets," Cueto says, noting that LAN signed a codeshare pact with Brazil's TAM last year. "It hasn't brought in that much so far." The pact was extended to LAN Peru in early 2008. But TAM's entry into the Star Alliance in October of 2008 may change that eventually.
In Argentina, the situation is also fluid to say the least. There, the Congress has moved towards re-nationalising the flag carrier, Aerolineas Argentinas, and this, Cueto says, could create competition. LAN Argentina, the newest of the subsidiaries, has a market share of about 27% and its 10 Airbus A320s serve 11 domestic destinations. It added two cities in the second half of 2008 and was able to raise fares by 35% over the year to compensate for inflation.
LAN Ecuador plans domestic operations in the first quarter of 2009 and should have nine destinations in the year's first half. LAN Peru, the first affiliate, was started in 1999 and has a domestic market share of more than 85% of the nation's 3.9 million passengers. In Ecuador, it has a 24% international share of the 2.8 million-passenger market, while in Argentina, the market is about 7.5 million annual passengers.
Cueto does not worry himself about low-cost carrier competition. "We are the low-cost carrier in our markets," he says, noting a new fare scheme that lowered the lowest fares and will drive growth of 50% between 2006 and 2008. Even as fares go lower in many domestic routes, passenger yields are up by 17% to 10.3 cents in the year's first half on a 10% increase in capacity. Booth, the Miami consultant, thinks that LAN will be able to set up more subsidiaries in the near future.
One goal is more transpacific service, but Cueto says: "This really depends on when Boeing delivers the 787. We are now facing two-year delays in getting the first of our Dreamliners, from 2011 to 2013. So we are putting winglets on our 767s. We won't be able to go to Japan because of the ETOPS rules but we will be able to go more places."
Enrique Cueto likes to say that when he went to LAN Airlines, he was essentially "just a cargo guy". While this is said partly in jest, it has much truth. From 1983 to 1993, he was chief executive of Fast Air, the Chilean cargo airline, and it was on Fast that he based his 2001 creation of LAN Cargo. Also involved in the development of the cargo division was Ladeco, once a major air cargo carrier. Ladeco is an acronym meaning Copper Airlines, after one of Chile's leading exports.
The blending of these two predecessors into LAN Cargo took place after Cueto, now 49, joined LAN in 1994 and became chief executive. His younger brother Ignacio also served at Fast, where he was chief executive between 1993 and 1995. Ignacio, now 44, was also at Ladeco.
Cueto is a very low-key personality and a man who does not seek the spotlight. His staff describe him as "very private" and will only say that he is married and has children.
LAN chief executive Enrique Cueto is active beyond Chile, having a seat on the governing board of the oneworld airline alliance as well as a seat on the IATA board of governors. Cueto is also active in ALTA, the Latin American airline executives group, and has become a major voice within the industry, both regionally and internationally, for liberalisation. He won the association's Federico Bloch memorial award in 2004 for his leadership and his impassioned advocacy of liberalisation.
On liberalisation and consolidation, Cueto says: "In some countries with a very limited domestic market, there are three airlines competing. This does not make sense economically. Some day, we will see real consolidation in Latin America, but many regulatory and cultural barriers remain, making this difficult."
While on airport fees, which can be as much as 30% of the price of a ticket, he says: "We don't need high-profile prestige products such as a boarding bridge at a little regional airport in the northern part of Chile where it rains once every 10 years. But we had to invest and buy tractors so we could adapt to this irrationality. Airlines are getting wiser about cost-cutting but airports are not."
On customer service: "Winning customer loyalty through good service is the only way to reach sustainable profits." And on local competition in Chile from carriers such as Air Comet, Cueto expresses little concern: "We'll have to see what they do, but I am not worried about the competition."