Fit to survive

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LanChile is determined to flourish in the an unpredictable economic climate that has already claimed two airlines

David Learmount/SANTIAGO DE CHILE

Latin American airlines are punch drunk. They have been successively hit by precarious home economies, a diving Brazilian currency, the Asia-Pacific economic crisis and a wave of powerful US carriers surging into their liberalising marketplace.

Despite this, LanChile's chief executive Enrique Cueto (left) has the confidence of one who sees all the long-term indicators pointing upward.

The airline's profits halved to $31 million in last year's economic downturn. Cueto predicts similar profits for 1999, which he accepts will be "a very bad year". The US Federal Aviation Administration, however, projects the average annual growth rate in Latin America at 6.5% to 2010 - about two percentage points above forecast growth for North America and Europe.

Nevertheless, sustaining confidence is difficult in the current Latin American economy. Three years ago, Venezuela lost its flag carrier VIASA. In Peru, Chile's northern neighbour, AeroPeru has been grounded by debt since March and its independent competitor Faucett Airlines folded in 1997. Meanwhile, Brazil's Varig, South America's largest airline, has struggled to survive since the nation's economic crisis and currency collapse last year.

There may be a shortage of capital in Latin American air transport, but no shortage of enterprise. LanChile, via its 49%-owned LanPeru, is bidding for the space left by the defunct national carriers.

LanPeru, starting with three of LanChile's Boeing 737-200s in a livery derived from its Chilean partner, launched Peru domestic services in early July, serving six destinations. The majority LanPeru shareholder (51%) is local enterprise Peruval and the airline's president is businessman Lorenzo Souza, with whom Cueto had been negotiating for about a year to get the new enterprise airborne.

Chile has good traffic rights with Peru, Cueto points out, emphasising that his airline runs daily non-stop Lima-Los Angeles and Lima-New York schedules. Meanwhile, the dormant AeroPeru has received offers from dominant local carrier Aero Continente and USA-based Air Power to help it get airborne again. LanChile and US major Continental Airlines have withdrawn bids for holdings in AeroPeru and Aero Continente and LanChile are bidding to take up AeroPeru's dormant right to operate the Lima-Miami route.

A series of accidents in the past five years gave Peruvian airlines a poor safety reputation, Cueto says, hitting Peru's tourist trade hard, according to Cueto. The country badly needs more direct services linking it with the USA, he says, and LanChile aims for a share in this, perhaps realising part of the predicted consolidation of air services in Latin America.

Latin American airlines "will consolidate quickly", says Federico Bloch, group chief executive of Grupo TACA, Central America's most powerful recent airline union outside Mexico. He is working to prove the truth of his own forecast: Grupo TACA comprises carriers from Guatemala, Honduras, Nicaragua, Panama and Costa Rica, allied to American Airlines, and the group is at work on starting TransAm in Peru. Bloch has a clear image of the South American air transport industry's vulnerablity: "I think in 10 years' time there will be only a handful of carriers in Latin America."

Gustavo Lenis, chief executive of Colombia's main carrier Avianca, is more precise about the underlying problem: "All airlines in Latin America need more capital."

Cueto maintains that it is impossible to compete on equal terms with the US carriers, so alliances with them are essential. Just before LanChile joined the American Airlines/British Airways-led oneworld alliance, Bloch said that a carrier can bring only one of two offerings to an alliance: money or market dominance.

According to Bloch's thesis, the US carrier is expected to bring the money, so a Latin American partner must bring market dominance in its arena. Even before LanChile had teamed with American via oneworld, Cueto had established codeshare arrangements and a common frequent-flier programme (FFP) with the US carrier. Tying its LanPass FFP into American's AAdvantage, says Cueto, has proved a moneyspinner for LanChile with American Airlines passengers.

Distance protects Chile from the full blast of US airline competition, Cueto says. While for a US airline it takes only a single widebody aircraft to serve the major cities in Central America or the north of South America daily, Santiago is 12h from most of the USA. That means a daily service requires two widebodies - twice the hardware investment for any single route from the USA to Santiago.

Conversely, this makes LanChile's partnership more attractive to American. By July the alliance should have stimulated enough demand for LanChile to operate three 767-300s weekly from Buenos Aires to Santiago, then non-stop to Los Angeles, as well as the existing daily Santiago-Lima-LA schedule.

The flexibility factor

Cueto's airline has been profitable every year since its restructure in 1994, when the carrier's extensive Miami, USA-hubbed cargo operation was integrated with the main line business at Chile's capital, Santiago. He attributes this success largely to a policy of being flexible in reacting to markets, and to LanChile earning one-third of its income in cargo, meaning that the airline is more diversified than the average. Of the total freight that LanChile carries each year, two-thirds is moved via its long-established Miami cargo hub. Cueto points out that, through Miami, LanChile links the USA to "all the major cities of South America", not just to Chile. As well as LanChile's two cargo 767s and four McDonnell Douglas DC-8-71Fs, the airline also uses Atlas Air Boeing cargo 747-200s and -400s.

The flexibility, he says, comes from being private while many competitors are state-controlled. "We have a good mix of management and shareholders who are very near the operation," he says, adding for clarification that a third of LanChile's equity is owned by his family. The result, he says, is that management is free to react quickly to market changes. Chile's government does not interfere with the airline's management. "This is a country which believes in the open market and competition," Cueto insists. "We are fighting for an open skies agreement with the USA, Argentina and Peru."

The USA wants open skies, says Cueto, but Chile will only agree if LanChile's request for alliance with American Airlines is granted without reservation. The greatest resistance to open skies, he says, comes from Europe.

The need for flexibility also governs LanChile's fleet acquisition policy, resulting in a judicious mix of ownership and operating leases. Costs are kept down by operating only three types, across passenger and cargo operations: 737-200s (12), 767s (12 -300ERs, two 767-300s), and the four DC-8-71Fs in the cargo operation. To replace the ageing 737s, LanChile has 11 Airbus Industrie A319s and nine A320s on firm order for delivery starting toward the end of 2000, with options on nine more A319s and 11 A320s. Some of these will go to replace the 737-200s in the fleet of LanChile's domestic subsidiary Ladeco (below).

He calculates the market is ready for the increase in aircraft size from the 737-200 to the A320 series, adding that the first Airbus will be used on cross-border regional routes in Latin America such as Lima in Peru and Buenos Aires in Argentina. Later deliveries will operate on domestic routes. The A320 order was negotiated in conjunction with fellow South American airlines TAM (Brazil) and TACA (El Salvador).

Independently, however, LanChile has ordered seven Airbus A340s for delivery starting in August 2000, with options on seven more, although the airline has not officially confirmed the order yet. Cueto emphasises the need for longer-range widebodies to enable non-stop Santiago-Europe flights with a full payload. At present, the 767s must stage through Sao Paulo, Brazil. On the Pacific side, LanChile links into the Qantas network at Tahiti, from which it continues to Auckland, New Zealand and Sydney in Australia. Any Pacific expansion would be co-ordinated with Qantas, a oneworld partner, says Cueto.

Among LanChile's markets, the USA, Peru, Spain and Argentina are still strong, although yields have dropped as international competition has increased. Cueto says Argentina and Peru are the main South American markets in which LanChile aims for development.

Recent indicators look positive: LanChile's May on May freight figures show a 35% rise, to 133 million tonne/km. May passenger traffic was up by 16% with a 9% capacity increase, raising the load factor by four points to 59%.

The airline saw its best growth in international traffic, up by almost 27%, although yields were down by 15%, partly because of fewer premium passengers and partly because of a fares drop, says Cueto. He maintains that the main effect of the Asian economic crisis on the rest of the world is that airline capacity withdrawn from Asia-Pacific was dumped elsewhere.

Meanwhile, domestic revenue passenger kilometres dived by 14% and the carrier cut domestic capacity by 15% to compensate. Before last year, Cueto says, LanChile's domestic business was growing at 20% a year, "but now it is not growing".

But Cueto says that, among the cross-border regional routes, only those to Brazil show "negative growth", and any Brazilian recovery is still over the horizon.

LanChile seems well prepared for the Latin American battle, arming itself with flexibility, aggressive expansion, high quality and its reputation for safety.