Airline Weekly March 26th, 2018
The cover story this week is focused on the proliferation of many LCCs (low-cost carriers) in Latin America. LCCs have come into prominence as a favorable business model over the past few decades and are distinguished by offering tickets that come without traditional services and products. This allows the base ticket prices to be lower, but relies on cost optimizations in other areas and the purchase of non-flight ancillary products. LCCs have succeeded in Europe, India, East Asia and other areas in the face of doubt stemming from uncertainty about consumer responsiveness to the basic service and competition from state-owned airlines amongst many other potential issues - many LCCs have large operating margins in the double-digits, such as Ryanair, Spirit, JetBlue, AirAsia and IndiGo. Latin America is beginning to see a large uptick in the number of airlines entering the LCC product space, but new entrants have a challenging road ahead that differs greatly from the obstacles faced in other parts of the world.
Latin America is an attractive market for existing long-haul carriers and new entrants looking to build out an LCC model. South of the equator, Latin America gives a nice seasonal balance in the winter months to smooth out revenue for current LCCs that service mainly destinations in the northern hemisphere. There hasn’t been much mature competition yet, but current players such as Gol and Azul (both out of Brazil) posted double digit operating margins in the past year. Argentina has also deregulated its airline sector which has ushered in new players.
However, there are many issues that face Latin American players who wish to offer an LCC product.
Geography
LCCs realize most of their advantage for short-haul frequent routes. As routes get longer, cost differentials with non-LCCs begin to narrow and the frequency of flights decreases. Unfortunately, the geography of Latin America is unsuited for shorthaul-heavy routes as most of South America is covered in Amazon rain forest and the Andes mountain range. This restricts inter-South American traffic and also elongates flights due to flight patterns. The large distances between economic and population centers of Latin America have impeded growth, leading to less demand for airline service. Additionally, Latin America is a great distance from Asia and Europe and even most of northern North America, diminishing the attractiveness for potential overseas tourism.
Mexico is better positioned when it comes to geography in its proximity to the United States and more flyable terrain. It also recently signed an open skies agreement with the United States, spurring competition for international flights for both Mexican and US airlines. However, carriers must deal with the high fees and stiff negotiations levied by privatized airports, specially those run by ASUR. Airline carriers such as VivaColombia have moved planes out of airports as a negotiating tactic and is threatening to continue this practice in the face of high fees.
Incumbent competition
Traditional carriers smell an opportunity in the LCC space, and are primed to take advantage of their incumbent position. Aeroméxico has adopted some strategies often used by LCCs such as adding basic economy prices and expanded the ancillary products it sells. It also a footing in the most popular Latin American airport (MEX in Mexico City) where LCCs have a difficult time gaining access to. It has also signed a cross-border JV joint venture with Delta. Avianca, out of Colombia, looks to consolidate even further to increase its holding and expand with Avianca-branded affiliates in other Latin American countries. LATAM is introducing LCC-like products and may start an exclusively LCC unit. Larger carriers have also been able to influence some regulation preventing competitive prices in places such as Argentina. Armed with capital and presence, these incumbents hope to stomp out the incoming LCC tenderfoots by offering competitive products.
Everything else
Countries don’t have particularly strong economies, and have some of the highest crime rates in the world which cap tourism. There is a lack of open-skies agreements. The politics of the area are in a bit of disarray with large charges of corruption and many upcoming elections which have uncertain results, specifically in Brazil and Colombia and Peru, whose president resigned with potential impeachment imminent. Pricing is not exclusively set by market forces either - in Argentina, LCCs have to deal with restrictions on how low prices can be set due to restrictions espoused by labor unions and non-LCC airlines. For example, the lowest fare in Argentina is estimated to be eight to ten times higher than the lowest fare in Chile by Sky Airline. Credit cards are not as ubiquitous as in other markets, stifling consumer purchases. Strong labor unions have been burdensome and played a hand in keeping inconvenient regulations in play.
It is yet to be seen if the LCC strategy is tenable in the Latin American market. There are many LCC newcomers and veterans following the LCC model attempting to gain a foothold in a largely untapped market. However, they must deal with awkward geography, unsteady airline regulation, economies and politics, and overcome entrenched competition.
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