The Middle East and budget aviation were writ large last month when the world’s air industry met at the venerable Le Bourget airfield near Paris. The circle of Gulf-based full service carriers (FSCs) from Emirates and Qatar Airways to Etihad committed to important orders for new wide-bodied jets needed to carry out their various long-haul network expansions — and with their large-scale orders delivered equally important good news to brighten the mood among executives and employees of the large plane manufacturing duo, Boeing and Airbus.
Right next to the region’s big names and their prominent aspirations to rank higher among the world’s long-haul carriers, the Middle East’s emerging low-cost carriers (LCCs) added a splash to the aviation news circus with sizeable orders and buying plans in their market segment: single-aisle aircraft.
Jazeera Air, the new Kuwait-headquartered budget airline, on the first day of the Paris Air Show committed to buying 30 new A320 planes from Airbus, expanding its order volume to 40 aircraft. Sharjah-based Air Arabia, while not signing any contract in Le Bourget, said it wants to buy 34 new jets from Boeing or Airbus by the end of the third quarter of 2007, also in the single-aisle category.
Budget airlines poised for expansion
More than any marketing statement or regional aviation report from an investment bank, the new orders by the two operating Arab LCCs manifest how confident the discount carriers are in their rapid expansion. Estimates by aviation analysts put the (discounted) cost for 30 A320s at around $1.4 billion.
This means that Jazeera, which only in April could announce that its first full year of operations in 2006 resulted in black figures with a profit of $8.7 million, will spend in the range of $2 billion on its fleet purchases in the next few years. Air Arabia, which is slightly more seasoned with a three-year operational track record, also could spend more than $2 billion on new aircraft.
In unit numbers, the two carriers are looking to boost their fleets by multiples in the coming eight years, from Air Arabia’s current nine to 52 by 2015 and from Jazeera’s five to 45 planes that will serve the budget airline passenger demand within the Middle East and to neighboring regions, especially the Indian subcontinent.
The surge of Gulf-based LCCs marks a departure from a past in which the Middle East was a desert-like space for air travel. With poor options for intra-regional travel and fractious regional networks, it was ruled solely by opulently staffed flagship carriers whose service levels were usually directly inverse to their employee count.
The budget flight business model, while not at all new in the airline industry, has matured greatly in the past 15 years with the first success stories in the United States and Europe where LCCs could benefit from market segmentation and introduction of open-skies policies.
In the Middle East, the voracious growth of LCCs is linked to the boom economies in the Gulf region and the hunger for labor. As oil prices peak and GCC countries use this money to diversify their economies, more expatriate workers from Lebanon, Egypt, other regional countries, and Asia move to the Gulf for work. With the decent salaries expatriates make, they are able to return to their home countries, making this group a focal consumer base that FSCs and LCCs compete over.
“In the Middle East [LCCs] target workers in the GCC that want to go home,” Eric Chang, Senior Associate for The National Investor (TNI), a UAE investment company, told Executive in a phone interview.
The region’s discount flying market is still in its infancy. The LCCs’ share of the market is under-penetrated compared to Europe and America where 2006 market penetration was 23% and 27% respectively. In comparison, the Middle East’s LCC market share was 1.4% according to the Official Airline Guide (OAG).
By providing flights for half the cost due to their ‘no frills’ model, which cuts operational costs by 63%, LCCs are gaining ground. Unlike FSCs, in-flight meals are not offered, special VIP lounges are not available and all seats are economy class, providing more seats and thus tickets to be sold.
For travelers who last month could find a roundtrip flight this summer between Beirut and the UAE below $350, according to price quotations on Air Arabia’s web site, the concept would have been appealing.
Room for more
Passenger traffic for Jazeera in 2005 was 500,000 and increased by 20% to 600,000 in 2006. Air Arabia’s 2005 traffic reached 1,132,900 passengers, increasing to 1,600,000 in 2006 — a 41.2% surge.
Jazeera is building a second hub in Dubai to complement its existing Kuwaiti one, which will up the ante for Air Arabia as it is based in Sharjah.
Two new arrivals that latched onto the LCC market came out of Saudi Arabia this year, Nas Air and Sama Airlines. Both plan to focus on providing low-cost flights within Saudi Arabia and cautiously speak of building up their domestic aviation market before advancing into the market regionally.
As the Middle Eastern aviation industry will grow by 6.4% every year until 2015 according to the International Civil Aviation Organization (ICAO), there is room for more LCCs and FSCs to emerge. The OAG pegged the 2006 LCC market share at 0.8% — almost doubling this year to 1.4%.
The numbers will soon increase as Air Arabia and Jazeera expand their routes, while Nas Air and Sama Airlines are making their first steps in serving the Saudi domestic market since February and March of this year.
Rethinking the strategy
The strong LCC growth is making FSCs rethink their business strategies. “Conventional airlines feel the pressure from LCCs and are trying to narrow down their ticket costs,” said Kareem Murad, Senior Research Associate for Shuaa Capital, an UAE investment bank.
Emirates Airline is the first to show signs of trepidation over LCCs. Emirates’ vice chairman, Maurice Flanagan, in April hinted to the press that the airline may open an LCC unit in the coming years to complement their regular FSC service.
The scramble to grab a share in the Middle East’s LCC market marks a shift in the aviation industry’s consumer base. TNI, in a March report, largely attributes the industry’s growth to the swelling middle class fuelled by GCC petrodollars being invested to diversify the economy and create jobs.
Investors see potential in LCCs, too. In March, Air Arabia listed an IPO of 55% of its shares with equity of $713 million, which was quickly oversubscribed. Though less successful, Jazeera Airways launched its IPO in 2006, offering 70% of its shares with an equity offering of $24 million.
“The success of the IPO reflects the belief of the investors in LCCs and their business model,” said Murad.
Budget travel has an additional bonus in the fact that cost-consciousness is increasingly understood to be smart and vastly different from “cheap.” This has created a segmentation of air travel also in the business realm where LCC business-class-only carriers Silverjet (UK) and Maxjet Airways (US) have opened successful routes between Europe and the US East Coast. According to recent reports, both business-only LCCs are considering routes to Dubai. The companies will offer tickets for roughly half the cost of an FSC business class ticket and the same price as an FSC economy class ticket.
But the lack of Middle Eastern open-skies agreements hinders LCC growth, making inter-regional air travel more costly than in Europe and providing fewer flight choices. For LCCs to continue growing, they must pressure governments to liberalize their skies as FSC customers can swallow high prices, as opposed to LCC consumers.
In May 2006, 17 states from the Arab Civil Aviation Commission signed open-skies agreements, but “the full and proper implementation of liberalized policies has not yet been adopted by most countries,” says Murad. “However, several countries are holding the grants of permits for use of their skies and hubs until they begin restructuring their own national carriers.”
As the steep discounts for aircraft purchase orders at the Paris Air Show — estimates speak of 40% price reductions against list prices for large orders — demonstrate, LCCs encounter a supportive environment within the international aviation industry and the regional budget airlines appear to have chosen a good time to enter the market.
But they will have to succeed in the long term in a new phase of passenger air transportation that is leaving behind the old business paradigm of economizing by cramming as many human sardines as possible into a tube subdivided into 20 to 50 rows of pain and a few rows of pleasure.
Air carriers are looking at years of a tight cost environment of high oil prices to which most recently also ecological concerns over limitless travel growth have been added. In the end, customers will judge by comfort, price, and social — which is largely environmental — acceptability of the carrier when they get on a plane.
