Airline Industry in the Philippines

Introduction

In Asia, one of the first countries to embrace air transport is the Philippines. Founded in February 26, 1941, Philippine Airlines made Asia’s oldest carriers and oldest operating under its current name. The airline’s first flight was made on March 15, 1941 with a single Beech Model 18 NPC-54 aircraft, which started its daily services between Manila and Baguio, later to expand with larger aircraft such as the DC-3 and Vickers Viscount. Today, despite the numerous challenges faced, the Philippine Airline Industry still survives with more than 50 destinations within the Philippines and around the world.

This paper aims to show the Market Structure and Outlook of the Airline Industry in the Philippines. Likewise, Porter’s 5 Forces as well as the Threats and Opportunities for the Airline Industry are presented. The top 2 Airlines companies which are the Philippine Airlines and Cebu Pacific, are illustrated to provide more insights as to the strengths, challenges and competition in the industry. Recommendations for improvement are also being given by the end of this paper.

Market Structure

For 22 years, Philippines Airlines, being the first air transport company was able to dominate the country’s domestic airline industry. The monopoly created control over the domestic flight schedules, number of routes served, flight frequencies and fare. Moreover, it also resulted inefficiency in the quality of service, since it was not tailored to the demand. The airline was not concern to keep its service to certain standards to keep and attract even more customers since it knows that passengers had no alternatives. Left with no choice, travellers have to contend themselves of what PAL has to offer.

Today, domestic air transport industry has evolved into oligopolistic structure. The liberalization under Executive Order 219 signalled the entry of new airlines in the industry. The bigger players, as defined by the size of their fleet and aircrafts (Philippine Airlines, Cebu Pacific, and Air Philippines) are concentrating on the major trunk lines where traffic demand is heavier while smaller airlines (Zest Air and South East Asian Airlines) are flying the secondary or tertiary/rural routes where traffic demand is lighter.

In contrast, except for the number of sectors, much of the secondary and tertiary routes were now slowly being penetrated by two of the major players (Cebu Pacific and Philippine Airlines) with the launching of their new small fleet. The presence of big carriers in secondary and tertiary routes could kill small carriers flying the said routes. Competition comes in terms of comfort that a passenger obtains by flying bigger airline and lower fare. Because the cost spread for bigger airlines is higher, they could charge lower airfare than smaller airlines.

Cebu Pacific is providing PAL stiff competition in major trunk lines. In 2007, Gokongwei said Cebu Pacific had a 43 percent share of the domestic market while Philippine Airlines had 39 percent and Air Philippines, 11 percent. Last year, CebuPac had a load factor of 83 percent compared to PAL’s 79 percent and Air Philippines’ 73 percent.

The entry of new players resulted in intensive competition in the business. Competition opens the air industry to travellers who previously could not afford to travel by air by giving promotional and discounted fares. Furthermore, it provides passengers a wide range of choices on departure schedules, facilities and service quality.

The Industry: Porter’s 5 Forces

The growth in the domestic airline industry is fast but the competition has been fierce for the last few years. The Porters 5 forces model is a good representation of our analysis because it stresses the risks of entry by potential competitors, bargaining power of buyers, threat of substitutes, bargaining power of suppliers, and the effects of rivalry within the industry.

Threat of New Entrants

Regulatory Barriers

The Government does not allow foreign carrier to fly the country’s domestic routes, thus limit the domestic market to domestic airlines.

Brand Loyalty

In the airline industry, passengers are concerned about safety, reliability, service and punctuality.

Economies of traffic density

This refers to the fall in average unit cost as the number of passengers traveling on a particular route increases. This is achieved if an airline adds flights in a route or seats on existing flights. If the incumbent airline is realizing economies of density in a route, potential entrants are deterred from entry by the choices available to them. That is, entry can be made either on a small scale but with a significant cost disadvantage or on a large scale that is likely to depress airfares significantly (Warren et. al., 1998).

Incumbent airlines possess some advantages that would prevent potential entrants from achieving economies of density. One, incumbent airlines generally have established interlining agreements1 with other airlines that could feed connecting traffic into the route at issue. There are significant reductions in transfer costs available for passengers who prefer interline travel. Potential entrants would therefore have difficulty attracting this kind of passengers without interlining arrangements. But making interlining arrangements could also prove difficult and could put the potential entrants at a cost disadvantage. This would require potential entrants to either duplicate the incumbent’s existing arrangement or hire existing airlines who can provide feeder services. Most likely, those who can provide feeder services are already committed to the incumbent airline and hence, would only be willing to shift loyalty if offered a higher price (Warren, et. al., 1998).

Frequent Flyer Program

The existing frequent flyer program of the major players in the airline industry (Philippine Airlines: Mabuhay Miles) can also act as entry barrier to potential entrants since these programs build passenger’s loyalty to the airline offering them. Study shows that travelers particularly business travelers always chose their flights in order to accumulate FTP mileage points. These FTP points can eventually be converted into free airline tickets or seat upgrade. Thus, potential entrants would have difficulty pulling the existing clients who are already a member of the carrier’s FTP.

Use of CRS (Computer Reservation Systems)

The use of Computer Reservation Systems has also the potential to close out potential players from the market of ticket sales. The CRS is a device that can be used to save time and cost in handling the growing number of flight reservations. With the existence of CSR, travel agencies can easily view the seat allocation as well as the prices available of the certain airline. About 75 percent of flights made through CRS are made from the first screen page of the CRS (Hanlon, 1996). Thus, airlines displaying their seat availability on the first screen of the page can be a vital source of competition.

Bargaining Power of Customers

Despite the Global crisis, the Airline Industry is trying to stay afloat and profitable. The trend in the Domestic Airline industry has changed over the years. The consumers demanded a more competitive industry by seeing lower prices. This cause the airline to charge prices according to the current demand of the passengers.

Threat of Substitute Products

The source of competition in the airline industry is coming not only in the industry itself but also from the alternative modes of transportation such as water and land. The shipping industry is one of the major competitors of the air transport industry in providing transport services in the southern part of the country. Currently, shipping companies are also offering discounted and promotional fare to remain competitive in the growing market of the airline industry.

Another substitute for air travel in the business segment is teleconferencing. It enables to establish meeting rooms wherein participants can sit in different geographic locations. Thus, business travelers have an option not to travel.

Bargaining Power of Suppliers

Labor Costs

Labor is the largest single expense of the airline companies. The Airline workers who belong to one of a dozen labor unions have strong power in negotiation with the airlines since most of them belong to labor unions.

Fuel Costs

Next to Labor, fuel Cost is the second highest expense in the airline operations. Prices of fuel tend to fluctuate on a monthly basis. The increase in the cost of jet fuel will also increase the operating cost. Thus, monitoring the prices of fuel in the world market is crucial.

Competitive Rivalry within an industry

The airline industry in the Philippines is highly competitive. Though there are only few players, all are basically offering the same product. As a result, companies generally earn low returns because the cost of competition is high.

Currently, major airline companies namely Philippine Airlines and Cebu Pacific are slowly dominating the secondary and tertiary routes. Last year, the two airlines bought new smaller fleet to cater to the demand of the growing market in the cities with small airports. The entry of these airlines can serve as a major threat to small players like Zest Air and Seair who are previously capturing majority of the passengers. Moreover, since CEB and PAL have larger aircrafts, the spread of cost is bigger. Hence, they have more ability to charge lower airfare compared to the latter.

Aside from the domestic routes, Cebu Pacific and Philippine Airlines are competing head to head in the international destinations. Cebu Pacific is increasing its passenger traffic in the international scene with the launching of new routes and buying more aircrafts. The potential merger of Zest Air and Seair can strengthen the competition within the industry. They plan to purchase additional aircraft to enter into the international market and to streamline the redundant domestic destinations to cut down the costs.

External Threats and Market Opportunities

External Threats

Fuel Price

The current threat in the airline industry is the fuel price. The increase in the jet fuel cost makes the airline cut in the domestic passenger fares. At Present, the fuel surcharge being imposed to the travelers is a temporary relief granted to the airlines to help them recover losses they incur from higher jet fuel prices.

Government Intervention

The implementation of open skies policy can have an adverse effect on the operations of local airline companies. Under the open skies policy, national carrier would have the right to fly over a country without landing, to stop in a country for refueling or maintenance without transferring passengers or cargo, and to carry it from one country to another and vice-versa. There was no limitation on airline designation,that even non-flag carriers can fly there from multiple designations. (www.fingad.com). Granting access rights to foreign airlines has no clear guarantee that governments of the participating foreign carriers would also grant the same concessions to Philippine carriers.

Market Opportunities

Low Fare Concept

The Domestic Airline industry faces imminent competition and price wars among the domestic players. Passengers are slowly accepting the concept of the low cost carriers. To adapt to the demand of the traveling public which is low cost and high quality airline, the industry players are continuously reducing its regular fares. Passengers can now enjoy all year round discounted fare by planning and buying their tickets ahead of time. The advance booking is a major boost for any airline as it allows them to better forecast passenger volume and maximize revenues on a per flight concept. More importantly, the new low fare concept will able to capture a good fraction of the alternative sea transportation market, therefore, further growing their base market.

Tourism as a complimentary Industry

• Complimentary industry like tourism will increase the demand for airline service. A high volume of tourist arrivals means a high probability of tourists taking the air as a mode of transportation to explore the available tourist spots in the country. The increasing passenger traffic in cities like Busuanga and Caticlan can be attributed to the growing number of tourists.

Airline companies locally are starting to build partnership with hotels and resorts creating tour packages to cater to the demand of both local and foreign tourists.

Philippine’s Airline Companies

Philippine Airlines

Company Background

Philippine Airlines (PAL) is the flag carrier of the Philippines. Founded in 1941 by a group of businessmen led by Andres Soriano, it became the first airline in Asia. With a long and distinguished history spanning over sixty years, PAL deeply involved itself in shaping the course of historic events and nation building. With its every takeoff and touchdown, PAL planted the seed of growth.

PAL has become one of the most respected airlines around the world with a young and modern fleet of 47 diverse aircraft and a route network that spans 31 foreign cities and 30 domestic points.

Strengths and Challenges

Experience

With more than 60 years of industry experience, PAL has the capability to adapt to any situation or circumstances that they may face.

Market Leadership

Philippine Airlines has long been the market leader of the industry. However, since the deregulation of the industry, it has lost its leadership in the domestic market but it has remained to be the country’s leader in international flights. This might be short-lived as its local competitors are now eyeing the international routes.

Fare and Quality of Service

Fierce competition has left PAL to improve on its services and slash fares to keep up with other local airlines. It began to embrace the electronic business by improving its website and adding new features such as online booking.

Mabuhay Miles

Mabuhay Miles is the Philippine Airlines frequent flyer program. It was established in 2002 by merging all existing PAL frequent flyer programs namely, PALsmiles, the Mabuhay Club and the Flying Sportsman. In line with this, Mabuhay Miles members earn miles that can be redeemed at face value on most Philippine Airlines-operated flights, as well as on code-shared routes of partner airlines. With this Mabuhay Miles program, members can enjoy free trips, travel award ticket or service class upgrade award.

Cebu Pacific

Company Background

Cebu Pacific (CEB), a subsidiary of the Gokongwei’s JG Summit Holdings, is the low fare leader in the Philippines. Launched in 1996, it became the country’s leading domestic carrier with the most number of flights and routes. It now flies to more than 30 domestic points and 15 Asian Cities.

CEB now operates the youngest fleet in the country with 21 Airbus and seven ATR 72-500 aircrafts.

Strengths and Challenges

Lowest Fares

CEB offers the lowest year round fare for all its domestic and international destinations. Even in difficult economic condition, it continuous to be the pioneer in creative pricing strategies as it manages to offer the lowest fare in every route it operates.

Innovation & Creativity

Considered as a young airline company, it was able to propel itself to be the country’s leading domestic carrier through its innovation and creativity. Customers are treated with a unique upbeat flying experience with CEB, as this is the only domestic carrier that offers fun in the skies with its games on board popularly known as “FunFlights” together with its entertaining in-flight magazine - Smile.

Electronic Services

By taking advantage of electronic commerce, CEB was the first to introduce the E-ticketing service, prepaid excess baggage, and seat selection in the country. It has also used email alerts to announce low fare promos to customers.

Partnerships

CEB has partnered with various destination hotels, car rental service, travel insurance, and entertainment ticketing service, to provide its passengers a more convenient travel experience.

Market Outlook

Throughout the world, the air transport industry experienced radical changes since the 1980’s to meet the emergence of air traffic as a result of the ever-increasing integration of economies. From government owned or supported to independent, for-profit public companies, has been the pattern of ownership. To increase the efficiency of the industry, reforms were made through deregulation and liberalization towards decreasing restrictions on competition.

The overall trend of demand to the Airline Industry has been consistently increasing. It can be seen that there would be more competition and greater pricing freedom. This will result in lower fares and sometimes dramatic spurts in traffic growth. The industry has been observed to be repeating in its financial performance. Four or five years of poor earnings proceed five or six years of improvement. But profitability even in the good years is generally low. In times of profit, the airlines will lease new generations of airplanes and upgrade services in response to higher demand.

The entry of five new players in the industry, namely, Cebu Pacific Air, Air Philippines, Asian Spirit, Mindanao Express and Grand International Airways resulted to a strong and tough competition in the domestic flights. As the new airlines grow, PAL suffered a significant decline in market shares. Air Philippines and Cebu Pacific are currently PAL’s stiff competition in terms of the domestic flights.

However, even with the increased competition in the domestic air industry, this gave travellers lower airfares. The outcome is the rapid growth in domestic travel. PAL, however, still charges the highest fare. This picture shows that competition in the industry enables the more efficient, low-cost airlines to operate at fares lower than pre-competition days and yet continued to be profitable.

There would be only a small number of big efficient airlines in the long run to survive, should a financial problem in the industry occurs. The Airlines with continued losses could force them to withdraw or exit from the industry or merge with those profitable.

When it comes to flying international, PAL has remained recognized as the country’s flag carrier. Nevertheless, the absence of competition results to poor performance and growth. This could be seen in the lack of ability of PAL to take advantage of the opportunities in the country’s air services agreements (ASAs). Based on the Philippine APEC study centre network (PASCN), during 1996, PAL used only 61 percent of the country’s traffic rights per week compared to 81 percent for the foreign airlines flying in the country. The unused entitlements is an indication that there are opportunities for PAL and other Philippine-based carriers to operate additional international services without the government requesting for greater capacity under existing ASAs.

Merger and acquisition is also an area for competition in the Airline Industry. Though domestic traffic in the country is relatively minute, there is a limit to the number of airlines that would make an efficient domestic airline industry. Considering that only two of the airlines are currently profitable, the intense competition in the industry could lead the airlines into merger and consolidation. Similarly, merger and consolidation could be a fast solution to the problem of local ownership requirement and huge capital requirement of the new entrants to be able to fly international routes. Still, a defined policy on mergers and consolidation should be established so as not to result in reduced service, less competition and decreased efficiency. It should always keep in mind that these mergers and consolidation are done for the interests of the travelling public.

Overall, the market outlook for the Airline industry is one of strong growth. Forecasts suggest that passenger numbers will double up by 2010. For airline companies, the future will confront many challenges. Those companies that would be successful are those that continuously manage their costs and improve their products, hence protecting their strong presence & reputation in the aviation market.

Recommendations

Though is it apparent that the Airline industry is continually growing, the Philippine Airline companies as well as the government should always think of ways to improve and sustain the industry. Philippines as we all know is an archipelago and the most efficient way to travel would be by Air, domestically and especially internationally. They may benchmark this with other countries with the same archipelagic setting. Improving the Airline industry would entail growth to other economic areas, more importantly on Tourism.

On the domestic side, there are areas in the Philippines where travel by Air is still not viable, though necessary. Airline companies do not venture to these locations due to financial constraints. The government should act upon this to enable growth to that location. They may provide incentives to encourage these companies to fly to that location, like reduced taxes. However, if the government will provide incentives, the policy of that should be designed not to reduce competition and efficiency. Again, the policies should always be for the benefit of the Travellers.

Competition between the Airline companies is also a way to make improvements to the industry in which the government has the major role to facilitate competition. Of course, if there is competition, these companies would not be complacent and would constantly think of ways to improve their service in order to continue being profitable. Airlines could invest heavily in the quality of service that they offer, both on the ground and in the air. They can enhance their Ticketless travel, new interactive entertainment systems, and more comfortable seating. When these Airline companies are able to make outstanding services and product enhancements, these will attract foreign investments, trade and tourism.

On the International setting, improvements to the Airline industry could be in way of tourism, since it is only by air transportation that foreigners can come efficiently to the Philippines. The government should advertise well the country in order to catch attention of tourists.

Additional aircrafts and routes is also a medium in the improvement of the industry. Given that there are increased demands for air transportation currently, these additions would definitely enhance traffic, to facilitate more destinations and passengers. Though acquiring additional assets involves a lot of money, these acquisitions will be for the benefit of the company in the long term. New aircraft entails improved technology where enhanced safety comes along with it. For that reason, customer satisfaction and retention can be achieved.

Improving the airports could help tremendously in the progress of the Airline industry. Though this will take a lot of effort, time and money, this improvement would definitely contribute so much to the advancement of the industry. With a much efficient airport, there would be fewer delays in flight and much less congestion on the air traffic. This would provide more flights as well as create more jobs not only to the Airplane staff, but also to the ground operations including those in construction and maintenance.

Air fares have a major effect on the Airline Industry. Definitely, lower airfares would encourage more people to take the opportunity to travel, especially to visit their love ones. So the more passengers there are, demand will increase as well, creating more transactions and business to these airline companies. But then, the Airline companies should retain the airworthiness of the aircraft so people would not be frightened of travelling by air. Sustaining the integrity and reliability of the aircraft, at the same time having a reasonably low fare would certainly drive up the market for the airline industry.

In general, what’s still important for the Airline Industry is to maintain its principles of providing quality service to travellers. As the definition goes, Airline Industry is composed of Organizations providing aviation services to cargo and passengers.

References

Austria M S. The state of competition and market structure of the Philippine air transport industry. PASCN Discussion Paper No. 2000-12. PASCN Discussion Paper Series 2000. Philippine Institute for Development Studies.

Department of Transportation and Communications, Civil Aeronautics Board, 2009. Data & Statistics of Airlines International and Domestic Pax.

Hanlon, Pat, 1996. Global Airlines, Competition in a Transnational Industry, Butterworth-Heinemann, Great Britain.

Warren,Tony, Tamms, Vanessa and Findlay, Christopher, 1999. Beyond the Bilateral
System: Competition Policy and Trade in International Aviation Services, PECC Trade Policy Forum, Auckland.

www.philippineairlines.com

www.cebupacificair.com

www.wikipedia.org

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The Philippine Airline Industry

References: Austria M S. The state of competition and market structure of the Philippine air transport industry. PASCN Discussion Paper No. 2000-12. PASCN Discussion Paper Series 2000. Philippine Institute for Development Studies. Department of Transportation and Communications, Civil Aeronautics Board, 2009. Data & Statistics of Airlines International and Domestic Pax. Hanlon, Pat, 1996. Global Airlines, Competition in a Transnational Industry, Butterworth-Heinemann, Great Britain. Warren,Tony, Tamms, Vanessa and Findlay, Christopher, 1999. Beyond the Bilateral System: Competition Policy and Trade in International Aviation Services, PECC Trade Policy Forum, Auckland. www.philippineairlines.com www.cebupacificair.com www.wikipedia.org ----------------------- The Philippine Airline Industry