At a Glance
- Continuous growth of intra-regional RPKs thanks in part to increasing affordability of air travel and growth of middle-classes.
- The rapid capacity expansion has caused doubts over wether the airline industry can generate healthy and sustainable financial performance due to over-capacity and intense competition.
- Earning downgrades are widespread, as fuel costs begin to rise in tandem with falling airfares causing profit margins to shrink rapidly.
- Governments are seeking to increase connectivity, offering incentives for carriers willing to expand into lower-frequency routes.
A Time of Strong Volume Growth
Intra-regional RPKs grew at 8.2% CAGR over the past 10 years – a trend that is set to continue, underpinned not only by increasing affordability and broadening air networks, but mainly by a combination of a massive capacity inflow in the system and the need to stimulate traffic and populate the ever-expanding fleets.
The Indian market has been topping the month-on-month growth in the last two years, with an RPK growth rate exceeding 20%. The airline industry in the member states of the South Asian Association for Regional Cooperation (SAARC), led by India, is projected to grow by 9.0% CAGR by 2036 – the fastest growing region in terms of RPKs – followed by China with a projected RPK growth rate of 6.4% annually over the next 20 years. This growth will place the two countries, along with Japan and Indonesia, among the ten largest passenger markets in the world by 2036. While it is clear that Asian airlines will experience strong RPK growth of 5.7% annually by 2036, doubts remain if the airline industry can generate healthy and sustainable financial performance due to over-capacity and intense competition.
Profitability for Airlines
The region’s airlines usually derive their strength from a single aircraft fleet type and large aircraft orders for economies of scale benefits. Although the center of airlines’ strategy is a leaner cost structure, industry pricing has been falling as an adverse result. Notwithstanding the weak revenue environment, the recent plunge in the price of oil improved the industry’s returns. However, while fuel costs are on the rise again, airfares remain on a downward trend, resulting in continued earnings downgrades in the airline industry. The expected outcome is profit-destroying competition. The profitability in the region has been volatile, with carriers resorting to predatory pricing to capture market share. The thorny concern of overcapacity must be addressed sooner rather than later.
2016 Fleet in Service vs Backlog (Narrow-body Aircraft Only)Source: Ascend
Countries like India, Indonesia, Malaysia, the Philippines and Vietnam have emerged over the last decade among the fastest growing in the airline industry. Although passenger traffic growth has kept pace with capacity growth, yields (especially on the intra-regional front) have been pressured downwards. The rapid traffic expansion has primarily been driven by the spreading out of LCCs, which already account for as much as 60% of seat capacity offered in the region (twice the market share held worldwide by LCCs) and has increased three-fold over the last 10 years, by approximately 20% annually.
While competition demands constant emphasis on cost leadership and productivity improvements, it also calls for a new mindset: from a share-driven market strategy to a commitment to strong earnings and return on invested capital. Risk management is critical, via, among other ways, ongoing capital investment in fleets.
Given the focus on larger narrow-body aircraft, the mismatch between market demand and aircraft capacity threaten airlines’ ability to expand the network in the lower density markets.
In the last five years, the major driver of growth has been additional frequencies on existing routes. Since a large-capacity aircraft is the engine of growth, the natural focus of expansion has been in the highest density markets. Higher frequencies in previously served routes represented nearly 70% of the capacity added, measured in terms of available seat-kilometer (ASK), since 2012. Not surprisingly, frequency in new markets was responsible for only 20% of the growth in the same period, followed by higher sectors flown and seat densification, each accounting for 5% of the growth in the same period.
Capacity Added (ASK Breakdown)Source: Innovata, Embraer
Right-sizing: A New Strategy
As opportunities to explore trunk routes are limited, low-density markets will become more relevant in networks. Right-sized aircraft offers a new strategic mindset, as it calls for a shift in focus from competing to creating new market space and seeking out untapped opportunities to exploring low and mid-density markets, where yields are up to 10% stronger than the average.
Air Travel and the Economy
The quality and range of air services available will be increasingly major contributing factors not only to airlines’ earnings, but also to the region’s socio-economic development.
In this context, China and India have recently announced new policies to boost connectivity by offering concessions to airlines incentivizing them to fly on certain regional routes. Chinese start-up airlines are set to exploit the opportunity to grow from small and mid-sized cities with government incentives for 100-seat aircraft, while the Regional Connectivity Scheme envisaged by India’s DGCA has just come into effect in order to connect under-served (and even unserved) airports. Access to air travel will increase twice as fast in second and third-tier cities. Routes to such airports will need to be opened by high-performance, right-sized regional aircraft that can connect to the nearest metro area.