Isao Kaneko became president of Japan Airlines the same day its shareholders approved a US$894 million write-off against capital reserves - the largest in Japan's corporate history. Kaneko succeeded Akira Kondo, who resigned as president to take responsibility for the unprecedented loss. It hardly seemed the occasion for the new man to say, 'I'm rather optimistic at this point.'

But he did. And he meant it. Consequently one has the suspicion that this labour lawyer and former senior managing director, who is too smart to fool himself, knows something that no one else does. The question is whether it's real or based on some spin from in-house forecasters who thought it best, given the need for shareholder approval, to sound reassuring.

There is certainly much to worry about. Before the write off the airline itself had accumulated $334 million in losses since 1991. Problem debts and over-valuations of some associated hotels and resorts had reached another $560 million. Never before had a Japanese corporation found it necessary to write off so much against its capital reserves. Eitaro Itoyama, JAL's largest shareholder with 3 per cent, said in early June that he would vote against it, adding that JAL's salvation lies in foreign capital and managers.

Moody's Investor Services and Standard & Poor's both recently lowered JAL's credit rating. This was Moody's second downgrade in a year, and it dropped JAL's long-term debt rating to only two notches above junk bonds. 'JAL has been barely profitable since 1992 due to the combined factors of slow revenue growth, downward pressure on yields, both in the international and domestic markets, its unprofitable non-air businesses, and the heavy burden of costs and expenses,' said Moody's.

To that it could have added S&P's concerns over increased competition resulting from the recent Japan-US bilateral and the expected opening of a second runway at Tokyo/Narita airport. Over 40 foreign airlines want more flights when Narita expands in the next two to three years. Both rating agencies could also have mentioned that Japan's current airport congestion may insulate JAL from overseas competition, but it also retards its growth. JAL cannot add flights to new or expanding markets without dropping others. Japanese slots are a zero sum game.

The list of JAL's problems actually is much longer. Japan's stagnant economy depresses traffic. JAL depends on Japanese passengers for 80 per cent of its traffic, yet they are staying home by the thousands. Prime Minister Hashimoto's plan to stimulate Japan's economy with $180 billion in tax rebates and public works contracts is a last ditch effort to stave off recession.

Devaluation of the yen has not been as quick or painful as other Asian currencies, yet the yen's value has slid almost 1 per cent every month over the last 15 months. It plunged sharply after reports in May that US Treasury Secretary Robert Rubin is prepared to allow the dollar to rise as high as 150 yen if that's what it takes to help Japan's economy. At presstime it seemed the yen was sliding toward that level, which would be its lowest in 12 years. But while a weaker yen cuts JAL's traditionally high costs, it also deters outbound traffic and raises dollar-denominated fuel and aircraft acquisition expenses.

The latter is of major concern. In the last half of this year JAL has four Boeing 747-400s, three 777-300s and two 737-400s earmarked for delivery. Next year three more 777s, a 767 and two more 737s are due. JAL has options on 10 more 777s and 10 MD-11s. The net effect of confirmed deliveries and retirements will boost JAL's fleet from 146 to 153 jets by April 2000. With more competition around the corner, JAL may need even more to match its rivals. The alternative is to concede market share, and Kaneko is unwilling to do that. Asked whether he will match foreign capacity to protect JAL's market share, he replies: 'Oh yes, we have to.'

Worse, as expenses rise, revenue is also falling. Asia's crisis, Japan's doldrums, and the weaker yen conspired during the financial year ending March 31 to cut JAL's overseas traffic - its first drop since the Gulf War. Only a 7.5 per cent rise in domestic passengers allowed the airline to show a net annual increase in passengers. But yields suffered as more passengers produced 7 per cent less operating revenue than the year before.

Deregulation of domestic skies was part of the reason for that. Gradually the Ministry of Transport is allowing Japan's airlines to charge less than it costs to take the train. Ironically, because of new Nozomi bullet trains and the distance of airports from most city centers, the train is often faster.

Several startup airlines have already emerged. As domestic deregulation expands over the next several years, incumbents can expect more challenges. So far, the limited number of slots granted to startups at Haneda, Tokyo's domestic airport, is all that has kept competition in check. That could change when Haneda adds its 'new B' runway in about two years, boosting annual slots by 25,000.

JAL's final two headaches are the fall-out effect of Asia's crisis and the airline's continuing high cost of labour. A recent report by The Asia Foundation confirms that the result of the currency crisis in Indonesia, the Philippines, Malaysia, Thailand and South Korea has spread. Hong Kong and Singapore have been 'seriously affected.' The only Asian economies still growing at respectable rates, says the Foundation, are China, Vietnam and Taiwan.

Albert Hofman, analyst for a regional investment bank, points to the wave of Asian credit downgrades and warns that countries in the region are pulling each other into a downward spiral. Given the number of bank and corporate downgrades in Japan, he told the Australian Financial Review, 'You have to wonder if, in this climate, the AAA rating for Japan itself is sustainable.' If Japan's sovereign rating drops, is JAL in for another hit?

Finally, there is the problem of what to do about the high cost of Japanese labour. Given the strength of labour unions and the abhorrence most Japanese feel towards laying people off, the problem of cost competitiveness looms like Kamakura's Buddha over Japanese carriers. All Nippon Airways lost $30 million in April when its pilots went on strike because it tried to lower their 65 hours per month flight guarantee to a closer level to what they actually fly.

Faced with this list of problems, how can the president of Japan's largest airline voice any confidence? How can he dispute the collective judgment of the credit rating agencies and many economists? In short, how can Isao Kaneko be optimistic?

Kaneko does not claim to have answers for all of these issues but it soon becomes clear that he has thought carefully about them. Where he can make a direct difference Kaneko seems ready to implement change.

'Most Japanese companies traditionally make decisions bottom up. On daily operations where the policy is already established, we will delegate line management,' Kaneko says. 'But for big policies, I'd like to reverse that. I feel strategic decisions have to be made from the top down.'

The big write-off was a top-down decision. For the first time in years, JAL had the earnings to help absorb the blow. The airline itself showed a non-consolidated profit of $60.6 million - only its third in seven years and its biggest since 1990. With more competition and lower yields on the horizon, JAL's top management decided this was the year to write off all accumulated losses and problem debts.

Says Kaneko, 'We had to choose the right timing.' Rather than drag the write off out over a period of years, he explains, 'We decided to concentrate on core business - air transportation - rather than use our resources for subsidiaries, such as hotels and resorts. We needed to start from scratch in 1998.'

Neither Kaneko nor most of JAL's shareholders were moved by main stockholder Itoyama's call for more foreign capital. Japanese law limits foreign ownership to 30 per cent and no one seriously thinks a new offering would attract much foreign interest at this stage.

Kaneko does not dispute predictions that JAL will face more competition under the revised Japan-US bilateral. His predecessor was a vocal critic of that accord, which he claimed gave the US too much in exchange for elevating All Nippon to the largely symbolic status of an incumbent. Kaneko shows less interest in rearguing that issue than in exercising rights granted by the new accord. Thus, JAL has added capacity on the busiest transpacific routes, and plans a new service to Las Vegas in October.

So far, Asia's slowdown has discouraged US incumbent carriers from exercising their expanded fifth freedom rights beyond Japan, while JAL is already moving to exploit its new US fifth freedoms into Latin America. It is adding more flights to Sao Paulo and expects to start Los Angeles-Mexico City. JAL also foresees tying into the extensive Latin network of its codeshare partner, American Airlines. For now, however, Kaneko sees the benefit of that alliance mainly in North America: 'We will take advantage of our codeshare with American Airlines to spread our routes all over the US.'

Kaneko holds the same two-sided view about a second Narita runway. It will create more competition, but it will also end the zero sum game where he must decide which flight to sacrifice so he has slots to start a new one.

Kaneko also sees Narita's expansion as a historic opportunity to correct an old imbalance. With charts to illustrate his point, he shows how Japanese carriers collectively have fewer of Narita's slots than other major carriers at their own gateways.

Japanese carriers only have 36 per cent of Narita's slots compared to French airlines' control of 51 per cent of all slots at Paris/Charles de Gaulle, he says. At Los Angeles, US carriers control 46 per cent; at Frankfurt, German carriers have 43 per cent; Singapore Airlines has 42 per cent at Changi; British carriers 41 per cent at London/Heathrow, and so on. To make matters worse, says Kaneko, US carriers have almost the same amount at their hubs. He warms quickly to this point: 'When the new runway opens we have to discuss not just the new openings, but the whole division from scratch. I think we have to discuss what [overall] percentage must be used by Japanese carriers.'

Slots also dominate JAL's plan to boost its 25 per cent domestic market share which Kaneko wants to lift to one third. Startups can mount challenges only by offering sufficient frequencies but fared poorly in last year's slot allocation at Tokyo/Haneda. That means new entrants pose their greatest threat at secondary airports where more slots are available. JAL is targeting its own low cost subsidiary - known as JAL Express or simply 'JEX'- in precisely these areas. With its launch in July, JEX will initially take over only two of JAL's 51 domestic routes, operating from Osaka/Itami to Miyazaki and Kagoshima. Kaneko says, 'We will phase it in, especially for markets suitable for the smaller [737-400] airplanes. For the time being we don't plan to use 737s at such slot-restricted airports as Haneda.'

JEX is one answer to high labour costs. Since JAL trains all pilots ab initio and decides which aircraft they will fly, it does not differentiate pay by aircraft size. 'So our big airplane cost is not so high,' Kaneko claims, comparing it to widebody rates for other international airlines. 'But our small airplane cost is very high. So we have to separate the companies to make a separate pay scale.'

This parallels the approach JAL took with Japan Air Charters, or 'JAZ.' JAZ flies its own charters but also wet leases aircraft to JAL. The formula: create a separate company, offer separate pay scales, turn operations over to it, and avoid JAL's high employee costs. The unions don't like it, but under Japanese law unions only represent employees at one company. Thus, pilots at JEX or JAZ would need to form separate unions from JAL pilots, even though JEX and JAZ are JAL subsidiaries.

Kaneko's response to other concerns pretty much follows the 'survival manual' being adopted by other Asian carriers facing the same problems. That reads as follows: exploit the yen's weakness, boost outbound cargo and promote inbound tourism. Also use your codeshare partner to stimulate US-originating traffic. Within Asia, boost flights to fast-growing Vietnam and China. Elsewhere, cut regional flights and shift capacity to the US, Latin America, and Europe. Form maintenance joint ventures. Lease more of your aircraft for fleet flexibility and to cut dollar-denominated debt. About the only measures JAL has not taken are the sale of aircraft and order deferrals.

Kaneko is especially upbeat on labour costs, perhaps reflecting his recent role as senior vice president for human resources. He disagrees with critics who claim JAL has been too cautious about addressing high labour cost, with too much emphasis on early retirement, attrition and outsourcing, and not enough on layoffs.

'The industrial society of Japan is very concerned about stable employment. Few companies lay off people, even when they have a deep deficit. We have been successful in reducing our employment step-by-step, starting in 1992,' says Kaneko. 'The purpose of this restructuring is to decrease the cost of labour, not just a head count,' he stresses. He says JAL's labour unit cost was highest in 1991, and has been steadily declining since then. Kaneko claims, 'We have had a 45 per cent decrease over six years.'

Kaneko concedes this does not include the cost of outsourcing but says JAL's unit costs are now similar to other carriers such as Northwest Airlines, United, British Airways or Cathay Pacific. For the sake of comparing JAL's unit cost with other airlines who still use their own employees, 'maybe we have to add three to four yen,' Kaneko concedes, but adds 'still our cost of labour is comparable to theirs'. JAL has already negotiated the phase-in over four years of a 10 per cent roll back in flight crew pay. Talks with unions continue. But the flying hour guarantee that sparked the strike at All Nippon is a non-issue at JAL. 'We have the same 65 hour guarantee,' says Kaneko, 'but most of our pilots are flying across the Pacific or trans-Siberia, so they are normally above 65 hours.'

However, Kaneko is still worried about the cost of pensions. JAL's pension plan assumed investments would grow 5.5 per cent annually, but they currently are only earning 3 per cent. 'We will have to make up the deficit from profits,' Kaneko admits, adding that this will be easier now that the company has written off past losses.

But the big question remains Japan's economy and how it will affect air travel. Consumer spending accounts for 60 per cent of gross domestic product but the Japanese are hording their money. Kaneko opines, 'I think consumers are ready to spend for consumption, like travelling and so on. But they are not confident about the future.' He criticises Tokyo for not going far enough with its fiscal stimulation plan and wants to see more tax reduction and reform. Still, his optimism prevails: 'I think economic growth will improve by the summer or autumn.'

Economists are divided on this, but Kaneko is in good company. The Organisation for Economic Development and Cooperation, after assessing Japan's fiscal stimulation package, has revised its forecast for Japan's growth from zero to between 1.5 and 2 per cent. That is close to JAL's own prediction for a 2 per cent growth in revenue this year. This may not warrant dancing in the streets yet, but it could be grounds for modest optimism.

Source: Airline Business