Air Canada's chief executive Robert Milton outlines his future strategy as the group prepares to emerge from bankruptcy

At the time of its 2000 takeover of rival Canadian Airlines, the public worried about the muscle Air Canada would flex in the domestic market. Now, as the merged group plans its late 2003 emergence from bankruptcy, the flag carrier is focusing its attentions on the US market.

Seeing more opportunities south of the border than at home, Air Canada plans to exploit its geographic advantage in ways US carriers will find hard to match. Building Toronto and Vancouver into sixth freedom hubs is a top priority to attract more North Atlantic and North Pacific traffic onto Air Canada to and from the USA. Meanwhile, the revitalised airline will cut domestic capacity and settle for half the intra-Canada traffic. The local market is 'mature', in the words of Robert Milton, Air Canada's chief executive.

'Lean and mean' is often used to describe a company that successfully restructures, but a better label for Air Canada might be 'lean and opportunistic'. Its new business plan recognises the reality that there is more growth and profit in trans-border and international routes than in a domestic market seemingly increasingly dominated by a drive for lower fares.

'I couldn't care less' about domestic market share, Milton declares. This comes from the head of an airline that has been hauled before the competition bureau twice for predatory conduct. Yet, perhaps mellowed by the restructuring process, Milton adds: 'You will not see us grow in the domestic market.'

Overseas focus

This focus on US and overseas opportunities rather than those within Canada has much to do with the restructured company's fleet plan. Ever since its takeover of Canadian, Air Canada has tried to bring coherence to its fleet. In the past two years it has disposed of five types: McDonnell Douglas DC-9s and DC-10s, Fokker F28s, ATR-42s, and Beech 1900s. By next summer the last Boeing 747 and 737 will fly away, to be followed shortly by the BAe 146s.

In their place will come about 20 more 50-seat regional jets, and at least another 85 new 70 to 100-seat jets. The carrier already has 35 50-seaters, but the larger regional jets will be completely new to the fleet. With a $950 million financing commitment from General Electric Capital, the first order could come before year's end.

That will leave the Airbus A330 and 340 as well as the Boeing 767 for overseas flights, A320s for North American services and at least 140 regional jets over the next six years for routes with maximum lengths of 3,000km (2,000 miles). With 10 more 50-seaters next year and the first 25 of the larger regional jets in the next two years, Air Canada plans to launch what Milton calls 'the next level of fragmentation of the industry'.

Regional jets and point-to-point discount carriers, Milton says, 'are fragmenting market after market and creating more profitable direct service, which undermine the hub structure of the big airlines'.

Although Toronto will shrink as a domestic hub, it was never that big - by US standards - given that most of Canada's population lives in a thin east-west band along the Canada-USA border. As far as hubs go, Montreal, Halifax, and Calgary are even smaller. Watch, Milton predicts, for 'more and more bypassing of hubs [within Canada] with nonstops on appropriately gauged aircraft'.

That is precisely what he plans to do in the USA with new regional jets. 'It's what we did initially with the 50-seat regionals,' says Milton. 'We went very successfully behind US hubs: behind Detroit into the Ohio valley; behind Chicago into Milwaukee and Kansas City and St Louis. We really undercut the US hubs. With the 70-100 seaters, I see us getting in behind the east coast, into secondary markets in California, and doing the next round of what we did with the 50 seaters.'

The route map shows how extensively Air Canada has already penetrated secondary US cities with its direct flights to Toronto, which in the evening are timed to connect with transatlantic operations. Now, this principle is being enhanced in Toronto and rolled out in the western USA over Vancouver, which is several hours closer to Asia than nearly all US Pacific Coast gateways. That makes any US city west of the Mississippi River a potential spoke to the Vancouver hub.Even with a 6% drop in capacity and no plans for domestic growth, the airline also expects to be a stronger competitor within Canada. Thanks to restructuring, it has brought its costs near enough to local rivals so that, for the first time, it can compete with them on price on a sustainable basis.

Air Canada's annual cost savings from restructuring are impressive: C$1.1 billion on labour ($830 million); over C$600 million on aircraft leases; C$300-350 million from vendors; and C$250 million in reduced interest. Final numbers are not out yet, but restructuring will have erased close to C$13 billion in debt and cut Air Canada's annual operating costs about 20%. 'We will have the most attractive balance sheet in the business,' Milton says.

As a result, the new Air Canada will look and behave differently in its home market. Tango, its pioneering low-cost unit, will disappear as an airline. Instead, Air Canada will offer 'Tango fares' on its main line. Customers equated Tango with low fares and Air Canada with higher fares. But with the new Air Canada's lower costs, its costs are consistent with Tango's fares. 'We don't need Tango anymore,' the chief executive explains. 'Tango will become a brand offering on Air Canada, but it will not be painted on any aircraft.

Discount competition

The new Air Canada is radically lowering its costs, making it better able to compete on price with its discount rivals, WestJet, CanJet, and Jetsgo, but it will not be a discount airline itself. 'We will not trivialise the product,' Milton says.

Except on inflight meals, Air Canada will continue to offer all attributes of a full-service carrier Ð dual class seating, frequent flyer points, interlining, baggage check-through, advance seat assignments, lounge access, Star alliance benefits and so on. Whether the 70-100 seat regional jets will also have dual-class seating is 'still open to discussion', but likely. 'Particularly as we continue our focus on the international network, it is still relevant,' Milton says. 'It also gives us an edge on our domestic competitors.'

On meals, he says that Air Canada is simply going the way of the industry by moving toward food sales on shorter flights. 'People don't choose an airline because of meals,' he adds. But he also foresees the day when passengers will select and order their meals via the Internet at the same time they book their flights. 'We were pioneers on the use of kiosks for check-in,' he says. 'We will continue to look for any technological advance that simplifies things for the customer.'

That includes online ticket sales, which represented only 6% of all bookings last year. It will be near 20% this year, with a target of 37% by the end of 2004. Before then, Air Canada, United, and Lufthansa will have picked a new Star Alliance global distribution system that, according to Milton, will bring dramatic cost reductions.

The new Air Canada's unit costs will still not be as low as main domestic rival WestJet's on comparable-sized aircraft, but Milton seems unworried about this, for at least two reasons.

First, Zip, Air Canada's other discount unit will, unlike Tango, continue to fly. Its costs are as low as WestJet's, according to Milton, who sees it as the discount unit within Air Canada that can compete head-to-head with all discount rivals. At present, Zip is small. But Milton says: 'Zip will grow to up to 20 aircraft and its network will expand wherever it makes the most sense - probably all of Canada.'

Revenue advantage

Second, even though Air Canada's unit costs remain higher than WestJet's for comparable-sized aircraft, Air Canada's yield is also higher. Business class is a big reason, but 20% of Air Canada's domestic capacity is also behind or beyond gateway feed for international flights. These are generally more lucrative seats than those sold to other domestic passengers. By contrast, none of Air Canada's discount rivals carry a significant number of passengers connecting with international flights. Hence, for the first time in history, the new Air Canada has a net revenue advantage over its domestic rivals.

It also has a service advantage. Even Zip passengers earn frequent flyer points as well as Star Alliance benefits, the advantages of interlining and access to airport lounges. Mainline Air Canada passengers add the other benefits of a full-service airline. At comparable fares to those offered by discount rivals, Milton argues that these added values amount to a big plus for Air Canada.

'It becomes a sweetened products offer,' he says. 'we're the only guy who will offer you the Caribbean or Hawaii or Japan, and a shuttle product for business as well. We will continue to be the guy who can offer all of these things, with the foundation of AeroPlan, our frequent flyer programme. To the extent it's sustainable and profitable, we won't compromise the product. We need some differentiation from our rivals.'

Several big issues remain before the flag carrier can emerge from court protection - most relating to the tug of war between old creditors and new investors. Unresolved pension issues could also be troublesome. But these battles, bruising as they may be, are unlikely to affect the final shape of the new Air Canada. Both finalists for major equity investment say they are satisfied with the airline's business plan, corporate structure and senior management.

The challenge most likely to mar the prospects for a rosy future is the threat that sustained profits, starting next year, will prompt union demands to claw back some or all of the concessions they made in lowered pay, relaxed work rules and fewer staff. Those concessions were for six years, but that has never stopped unions arguing that changed conditions justify earlier renegotiation.

'Yes, time heals everything and you start to forget,' Milton says, 'but I would like to believe that, more than ever before, employees have realised how important it is in their own best interests to be working for a company that is cost-competitive and in a position to be profitable. ' In an effort to stem forgetfulness, Milton adds that the concession deals include profit sharing. 'Hopefully that will change behaviour, but the United experiment demonstrated that it doesn't always work that way.'

Milton is fully aware of Air Canada's significant transformation. 'At a recent IATA board meeting', he recalls, 'I said to the board that we have to wake up and realise that around this board table we have what are viewed by most as the greatest airlines in the world, but all of whom, without exception, are losing a fortune. And there is not here among us a single low-cost carrier, which are exclusively the profitable airlines of the world. The change in this industry is profound and it is not reversible.'

The restructuring effort he is overseeing shows that Air Canada's chief executive, at least, intends to learn from that lesson.


Source: Airline Business