Air Canada chief executive Robert Milton has given up on the pretext that a major, full-service network carrier can be financially viable in the domestic Canadian market, and is aiming to transform his airline into a primarily low-cost carrier (LCC).

The rapid emergence of Calgary-based LCC WestJet - profitable for six consecutive years and now operating flights on many of Air Canada's domestic long-haul routes - coupled with a fall in passenger numbers following 11 September 2001 - has led Air Canada to move towards a dramatic alteration of its product.

Over the past 18 months, the carrier has started a low-fares "sub-brand", Tango, and launched a Calgary-based low-cost subsidiary, Zip. The airline has already transferred about 20% of its domestic capacity to Tango and Zip, and plans to eventually double that figure. In addition, Milton wants to rework Air Canada's labour contracts to turn mainline Air Canada service into a far lower costing operation.

Air Canada, despite turning profits in the second and third quarters of 2002, posted a C$428 million ($288 million) loss for the full year. The airline is seeking C$650 million in concessions from its employees and is exploring selling off subsidiaries, such as regional Jazz. But Milton insists Air Canada made "radical improvements" in 2002 as it moved one-fifth of domestic capacity to low-fares operations.

"The next step is essentially to transform Air Canada into a low-cost carrier in its own right," he says. "If we had [WestJet's] work rules, pay scales, and so on we would drop C$1.3 billion to our bottom line. If you stop and reflect on this, if we had our competitor's labour cost structure, we would have made C$900 million last year.

"We cannot produce a product for $1 and sell it for 75¢ while our main domestic competitor can produce the same product at 50¢, and I'm confident our employees understand that reality."

Operating a fleet of 21 Boeing 737-200s and 16 737-700s, WestJet serves a network of 23 Canadian points. The airline is increasingly moving away from its once signature short-haul western Canadian routes and operating transcontinental flights to eastern Canadian destinations. The company wants to serve "every major Canadian city". Chief executive Clive Beddoe hints that transborder US expansion may only be 18 months away.

Beddoe asserts that Air Canada's network model is completely broken and that, facing stiff low-fares competition, it has little chance of returning to profitability, Zip and Tango notwithstanding.

One major advantage WestJet has over Air Canada is that its workforce is non-unionised. Pilots and other employees are given stock options as part of their compensation, as well as financial incentives based on how efficiently the airline operates. Beddoe says this allows WestJet to operate more efficiently because it is not constrained by union rules, and gives employees, particularly pilots, motivation to turn around aircraft quickly to minimise costly delays.

"High utilisation and a highly motivated workforce are the keys to running a low-cost airline," says Beddoe.

Smith concedes that "70% of controllable expenses are labour" and says Air Canada's unions have to face a new reality, or the airline will sink under the pressure of low-fares competition.

"This isn't the same game it was a few years ago," he adds. "A lot of people wish it could be the way it was. Unfortunately, it will never be the way it was. And those that understand and accept that will survive."

Milton wants all of Air Canada to look more like Zip, which launched in September 2002 from WestJet stronghold Calgary. After securing more favourable labour agreements than mainline Air Canada, Zip was able to start up with a much lower cost structure than its parent.

"Our cost structure is 30% to 40% less than mainline on an equivalent stage length," says Zip chief executive Steve Smith. "We have a whole different attitude and corporate culture here."

Zip operates a fleet of 11 737-200s, all leased from parent Air Canada, serving 10 Canadian cities. It hopes to eventually have a fleet of 20 737-200s. The airline is focusing on flights with a 2h duration or less, although it launched flights from London, Ontario, to three western cities - Abbotsford, Calgary, and Vancouver - on 2 March. But Smith says the London flights will be an exception to the carrier's western short-haul-centred operation.

Air Canada has not yet revealed financial figures for Zip, but claims satisfaction with the carrier even though its load factors are running at about 50% - unchanged from when Air Canada mainline operated the routes. Zip serves no food - not even pretzels or peanuts - and subcontracts maintenance and other operations to parent Air Canada to keep costs down. It also takes other low-cost measures, such as using its flight attendants to clean aircraft between flights, saving on the cost of cleaning crews and improving turn times, says Smith.

Beddoe is not convinced. He dismisses Zip as Air Canada "dressed in different colours".

"I don't think there's any doubt that Zip is losing millions of dollars a month for Air Canada," he says. "It's all substitution capacity right now. You had an Air Canada aircraft, now you've got a Zip aircraft. What's the difference?"

Beddoe adds: "Air Canada is operating the same aircraft, but painted a different colour. What they've got is a high-cost structure operating in a low-fares environment."

WestJet posted a year-on-year 41% increase in net earnings for 2002, jumping to C$51.8 million ($34.9 million). Beddoe asserts that LCCs now have firm control over the North American market.

"I think the major carriers are all finished," he says. "I don't see how they can survive. I think they'll all go through Chapter 11-type reorganisations, shrinkage, consolidation, a change of their labour rules and labour costs."

Source: Flight International