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JAL: Against the clock

Things appeared to be looking up for Japan Airlines (JAL), Asia’s largest airline group, in 2004. Its finances were getting back in order after huge losses in 2003 and it was winning back domestic market share ceded to rival All Nippon Airways (ANA). Last year, however, was one that JAL would want to forget – and problems that arose early in the year are still shaking the carrier’s confidence.

JAL has for the past decade suffered financial mood swings, typically reporting profits one year followed by losses a year later. But it seemed it was on course to finding the formula for consistent profitability with its takeover of rival Japan Air System (JAS), which began late in 2001 and for which the integration of operations was completed early in 2004.

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At the time of the takeover announcement in November 2001, JAL insisted that the deal would help it find a better balance between revenues from domestic and international services and help it compete more effectively against ANA on the more stable domestic front. JAL’s domestic market share in terms of passenger numbers would rise from 25% to around the same as ANA’s 49% share.

Before the merger, JAL earned only around 30% of its passenger revenue from domestic operations and around 70% from more volatile international operations. The carrier promised that the merger would bring that to a roughly 50:50 mix. That promise has become a reality, which helped the carrier return to profitability for the year to March 2005. In May of the same year it confidently forecast profits for the year to March 2006, but soon after things began to fall apart.

High fuel prices

JAL’s financial position has been deteriorating as costs have risen due to higher fuel prices and as bad publicity from safety-related issues has caused demand to fall. Over the same period ANA has done remarkably well in turning itself around and is now in a strong financial position, having just posted its first-ever profits from international operations and continuing to strengthen its domestic structure.

So while ANA was reporting profits for the first half to 30 September, JAL reported that it fell unexpectedly into the red in the same period and revised its earnings forecast, changing it to a warning that a net loss for the full fiscal year to 31 March 2006 of ¥47 billion ($410 million) was expected.

Fuel costs are a clear factor behind these woes, but they are not the only culprit, as revenue has come in below expectations. JAL estimates that adverse publicity from its safety-related troubles will cost it ¥32 billion this financial year – ¥20 billion from lost domestic revenue and ¥12 billion from lost international revenue.

Many analysts now believe it is clear that JAL moved too slowly to implement change after completing its merger with JAS, which was in reality a takeover of the smaller airline. They say JAL has been too conservative for fear of offending the former JAS management, for example, and has acted too slowly in cutting employee costs, failed to simplify a complex, convoluted corporate structure quickly enough and has been slow in rationalising and modernising its mixed and ageing fleet.

For its part, JAL notes that it has been affected by many external events since its announcement of the JAS deal that have forced it to throw many of its forecasts out of the window. There was terrorism on the Indonesian resort island of Bali, for example, as well as war in Iraq, SARS, unexpectedly high fuel costs and political troubles between Japan and China that cut into demand on those traditionally strong sectors.

But JAL also insists that many of the cost-cutting gains it promised when it announced the JAS merger have become reality. It has cut the number of staff working in airline operations by nearly 18%, for example, to 19,029 from 23,119 employed before merger. This was achieved all through natural attrition.

However, JAL officials will probably admit that they are now in a race against the clock. The airline desperately needs to get things right by 2009, when everything changes in the ­Japanese aviation market. That year a fourth runway is due to open at the busy Tokyo Haneda airport, which will increase capacity by more than 40% and give competitors many more opportunities to take on the incumbent carriers. International services will also be allowed from the airport, which is by far Asia’s busiest, despite the fact that it handles almost entirely domestic services.

At Tokyo’s Narita International airport, meanwhile, an extension of the second runway to 2,500m (8,200ft) from 2,180m is going forward, which will also allow for an increase in capacity – and give competitors the 
opportunity to expand their operations there too.

One big problem is that in Japan things often do not move quickly when it comes to change. The many years of infrastructure limitations preventing new players from becoming real competitors probably left JAL too complacent. The carrier admits that there is no more room for complacency, given the changes that will be seen in the local environment in 2009, and it insists it will have its financial house in order by then.

JAL is not only the largest airline in Japan, it is also by far the biggest in Asia. As a result, its problems get much more attention than they probably deserve. That happened through much of 2005 on the safety front, and it has badly dented the airline’s confidence.

Problems first arose in March, when JAL was issued highly unusual public reprimands from the Ministry of Land, Infrastructure and Transport. The first was for an incident in which JAL failed to report for some time that one of its aircraft began a take-off run without air traffic control approval. It was also reprimanded for using the wrong parts on the landing gear of a Boeing 747 freighter, and for other operational incidents that would probably have been considered minor in other countries. More problems have come to light over the past six months and now even the most minor incident attracts much media attention.

Days after the first problems were highlighted in March, JAL named company veteran Toshiyuki Shinmachi chief executive-designate to take over from long-serving Isao Kaneko. Kaneko’s retirement was expected in part because his health was not good, and the initial plan was for him to step down formally in June.

Taking responsibility

But days later, as the media spotlight on its safety woes intensified, Kaneko announced that he would step down nearly three months earlier than planned to “take responsibility” for the operational incidents. Other top-level management changes were also announced at the time that included demotions of high-ranking officials. This was followed in May by an announcement that Kaneko would retire from the airline’s board and would step aside as chairman. In many ways it was a sad corporate ending for Kaneko, who joined JAL in 1960 and was until then credited with overseeing improvements to the airline’s balance sheet and implementing badly needed cost-cutting measures.

But often in Japan the only way a company can move forward is after someone has taken responsibility for problems. And what Kaneko did was considered necessary for JAL to be able to say that under the leadership of new chief executive Shinmachi it could move forward with a fresh attitude.

Shinmachi is now firmly in charge, but he faces considerable challenges. JAL said last year that a key part of its restructuring will include cuts to employee salaries of around 10% and that it hoped they would take effect by January. It acknowledges now, however, that it has had to push back its targets as agreement has yet to be reached with employees, many of whom are opposed to the cuts. One of JAL’s admitted problems is that it has too many unions – 10 in total, since JAS staff inherited through the merger brought their own labour groups into the fold.

But JAL says it is working aggressively to cut costs in other areas, including accelerating the retirement of older aircraft. For example its last 30 747-200/300s are now to be retired by the 2009 fiscal year, rather than the 2012 fiscal year as originally planned.

In the 2007 and 2008 fiscal years, JAL also plans to expand the number of routes it serves with aircraft smaller than the 747 and 777 to address changes in the marketplace. At the same time it is looking at outsourcing more maintenance operations to lower-wage countries like China, such as those of its Boeing MD-80/90s.

“The new plans…are aimed at creating an airline group with enhanced customer appeal and a stronger corporate base in time for 2009, a crucial year for Japan’s aviation industry,” the carrier says. “That year will see the expansion of Tokyo’s predominantly domestic Haneda airport with more international services and the extension of Narita airport’s second runway enabling more arrivals and departures there, all adding up to a major business chance for JAL’s future growth.”

JAL is also focusing heavily on turning around its loss-making international operations and recently unveiled a new wave of network cuts, which are in addition to service suspensions made in October. It will also be transferring even more flying to lower-cost international subsidiary JALways.

The planned cuts are designed to return JAL’s international passenger business to profitability in the 2006 fiscal year to 31 March 2007.

It says about 10% of its international flying in terms of available seat kilometres is being cut, by dropping some routes, including Tokyo-Las Vegas-Los Angeles-Tokyo; Osaka-Los Angeles; Komatsu-Seoul and Hiroshima-Seoul. Service cuts from secondary destinations in Japan have been the most difficult to push through, as this can be highly political. It is also reducing services on several other international routes and reducing the size of aircraft used on others.

The cuts will make up part of JAL’s latest corporate plan, which is revised every year and has traditionally covered the following three years. This time it will cover four years, however, to enable it to run through the important period when the new airport capacity is added to the marketplace.

Merging divisions

Another major part of the restructuring will see JAL’s three main operating divisions merged into a single entity by October this year. The airline says it needs to streamline its corporate structure, which it admits became too convoluted following the merger with JAS. The integration led to the establishment of airline operating divisions JAL International and JAL Domestic, as well as passenger sales company JAL Sales, all of which fall under the JAL Corporation holding company.

JAL says its finalised plans call for the holding company to be retained, but “slimmed down as much as possible to speed up decision-making and the transmission of information”. JAL International, which handles international passenger operations and cargo operations, will form “the nucleus of the integration” of the operating companies. JAL Sales is to transfer its ticket sales activities to JAL International on 1 April, while JAL Domestic is to be folded into JAL International from October.

“As a result of this unification, Japan Airlines International and Japan Airlines Domestic will integrate their personnel and wage systems, achieving greater work efficiency due to the removal of intra-group trading, procedures and adjustments among the integrated companies,” the carrier said in announcing the rationalisation plans.

“The purpose of the integration is to speed up decision-making and to streamline management, emphasising better communications between head offices and service branches,” it adds.

Another major shift in JAL’s thinking has been to finally accept that it should join a multilateral alliance. In October it announced that it would join oneworld within two years, after completing membership formalities, thereby becoming the alliance’s largest member when measured in terms of group revenues.

JAL had long been courted by oneworld as a future member, but repeatedly said it was not interested in joining a multilateral grouping – and until then was the only one among the 20 biggest IATA member airlines not to have joined or sought membership of one of the three key airline groupings. It has codeshare and frequent-flyer programme ties to members of all the major alliance groupings and says it intends to maintain existing bilateral agreements. It is considered likely that it will officially become a oneworld member in April 2007.

JAL senior vice-president corporate planning Fumio Tsuchiya says the main goal of the extensive restructuring initiatives planned for the next few years is to “build a robust management framework, a business structure that can produce profits even in the face of factors such as rising fuel costs or slowing demand”.

Tsuchiya says JAL is “extremely optimistic about reaching these targets” – of a return to profitability in its international passenger business in fiscal year 2006 and a consolidated operating profit of ¥100 billion in 2007.

JAL is again expressing confidence about its future, calling the changes that are coming in the market “business opportunities” rather than challenges. There are many who question whether its change programme will be aggressive enough this time, but in the eyes of Asia’s largest airline group, it has no choice but to get it right. With the local operating environment set for such major change, time is no longer on its side. ■


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