Air Canada wins approval for low-cost carrier but now faces the challenge of defining the operation

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Air Canada wins approval for low-cost carrier but now faces the challenge of defining the operation

Air Canada’s plans to create a new low-cost subsidiary to better compete in leisure markets is far from a foolproof scheme to wipe away the legacy cost elements that management believes make Air Canada mainline uncompetitive on various levels. The airline faces the danger of disrupting those markets with additional capacity those routes are unlikely to absorb. In its planned slow ramp-up, the new carrier will also likely create upfront costs that might not be recovered until the low-cost carrier reaches full scale, which will further pressure Air Canada’s costs in the short-term.

Other than touting the establishment of the low-cost carrier as a significant growth platform to allow Air Canada to compete in the crucial low-cost space, few details have emerged about the new airline. Air Canada has not stated if it will seek a separate operating certificate for the carrier, if there will be a separate management structure, estimated aircraft utilisation levels, seat density or how network planning and optimisation between the two carriers will be carried out.

Air Canada has a five-tiered fare structure ranging from its non-rufundable "Tango" fares to its "Executive Class Flexible" offering, but the carrier has not disclosed if its new low-cost unit would offer a single fare class. The carrier is either keeping its vision for the carrier at arm's length, or still determining how to craft the structure of the new airline to make a positive contribution to its business strategy.

A new contract recently imposed on Air Canada’s pilots by a federal arbitrator allows the carrier to move forward with the establishment of a low-cost subsidiary. The airline tabled its interest in launching a LCC over a year ago, but opposition from pilots and subsequent acrimonious negotiations between pilots and management left the establishment of the new subsidiary on ice. Now that the arbitrator has sided with Air Canada and ruled the carrier's contract should be imposed on pilots, Air Canada has the authority to create a low-cost carrier with a lower pilot pay scale.

Federal mediators also imposed contracts on Air Canada’s mechanics and baggage handlers in Jun-2012. Attempting to launch a low-cost carrier in 2013 against the backdrop of significantly low employee morale creates a distinct disadvantage for Air Canada’s low-cost aspirations.

See related article: Air Canada touts continuing transformation as 2Q2012 losses widen

Air Canada’s management remains bullish on the potential created by the establishment of a low-cost carrier in allowing the airline to jumpstart stagnant growth. Company CEO Calin Rovinescu argues that Air Canada’s cumulative growth since 2007 has been less than 7% while the rest of the industry has moved forward to capture leisure markets. With the lower cost structure of the new low-cost carrier, Mr Rovinescu believes Air Canada can enjoy the success other airlines have achieved by operating in that space.

Hybrid fleet of wide and narrowbody aircraft
One definitive detail Air Canada has disclosed is the fleet composition of the new carrier – 30 A319s and 20 Boeing 767 – sourced from the mainline fleet. Carrier management has explained those aircraft have lease expirations during the next 24 to 36 months, arguing that transferring them over to the yet-to-be-defined low-cost carrier represents pure growth for the Air Canada group. But it is not clear if those aircraft will be replaced in the mainline fleet. If not, Air Canada will merely be transferring existing capacity to a lower-cost base operation, which could grow independently if it is more lean.

Such a move would not be unprecedented with Delta transferring capacity to Song and United to Ted, although both units are now gone. The Qantas Group had a similar experience with its LCC, Jetstar. More recently Iberia has transferred routes to lower-cost base Iberia Express with the division standing apart from Iberia mainline primarily on salary and productivity differences from staff.

Air Canada actual and planned fleet: 30-Jun-2012

Source: Air Canada

Air Canada begins taking delivery of its first of 38 Boeing 787s on order that are designed for 767 replacements in 2014, and recently stated it is studying its mainline future narrowbody needs. As part of that examination Air Canada will likely opt to dispose of its sub-fleet of Embraer jets that consists of 15 E175s and 45 E190s. The new pilot agreement includes job security for cabin crew operating those aircraft.

Air Canada does plan some obvious product distinction between mainline and the new LCC. That could entail a pure low-cost, bare-bones strategy where every frill beyond the seat has a price, or Air Canada could evolve toward the hybrid, medium frills model sweeping the low-cost space. Iberia's low-fare arm Iberia Express has purposefully billed itself neither as hybrid or low-cost carrier, and the Express operation is closely linked to mainline's frequent flyer programme, and tied to Iberia's long-haul network planning.

See related articles:

JetBlue continues to see benefits and growth opportunities from its hybrid business model
Iberia Express launches as Europe's latest salvo to bring short-haul model to profitability
Air Canada's low-cost operation will encompass both long and short-to-medium-haul flying, which results in questions arising over the fate of the Executive class featuring lie-flat seats that is currently present on the carrier's 767-300 aircraft. Longer-haul, low-cost operators that Air Canada has studied, including Qantas' Jetstar and Singapore Airlines' new low-cost offshoot Scoot, offer a business class on their longer-haul flights operated with Airbus A330s and Boeing 777s, but the the offerings reflect more of a regional business class (no lie-flat or angled-flat seat) than the business class offerings from full-service carriers that are growing in sophistication. AirAsia X, however, does offer a lie-flat seat. Cebu Pacific, which will operate A330s in 2013, plans to have only economy seats. If Air Canada opts for a pure low-cost model, it could operate the 767s in a single-class configuration, which was similar to the strategy of low-cost trans-Atlantic carrier Zoom, which ceased operations in 2008. Zoom did offer a premium economy seating option on its long-haul flights to Europe.

Seating configurations for Air Canada's Boeing 767-300s/300ERs spans roughly four configurations. In the highest-density configuration the carrier offers 260 seat split between 18 seats in Executive class and 242 in economy. The other 767 configurations include a 247 seat version split between 223 economy seats and 24 in Executive class, 211 featuring 24 in Executive and 187 in economy and a 191-seat aircraft with 25 Executive class seats and and 166 in economy. The 767-300's maximum capacity is 290 or 299 depending on exit door configuration, according to Boeing. So Air Canada could see considerable density increases.

The A319s targeted for Air Canada's low-cost operation will likely need to undergo an interior overhaul as the current two-class configuration on some of the aircraft featuring 14 seats in Executive class and 106 in economy is a less dense seating capacity than the 145-seat max of the A319 model (with a single pair of overwing exits). The 132-seat single class configuration of the carrier's A319s is fewer than the 145-seats featured on the A319s operated by ultra low-cost carrier Spirit Airlines. If Air Canada is seeking to build a true low-cost model, then additional seats are necessary to ensure overall lower unit costs. A denser seat configuration is especially necessary for the lower-yielding leisure markets to the US and Caribbean that Air Canada is targeting for its new low-cost carrier.

Is the leisure market the most viable market to optimise growth?
In addition to other details, specific routes for Air Canada's new low-cost carrier for the moment are undisclosed. The carrier's management has indicated the carrier would operate to sun destinations in the US and Caribbean and long-haul flights to Europe using a fleet of 30 A319 narrowbodies and 20 767s. Mr Rovinescu also indicated that some leisure routes currently operated by Air Canada are “better served outside mainline”. Presumably he means that a portion of the leisure markets would be transferred over to the new carrier whose cost base would make the routes more viable.

A look at some of the changes Air Canada is making to its winter 2012-2013 schedule could provide clues to its approach in handing over routes to its new low-cost arm. According to Airline Route the carrier is replacing 93-seat E190s with A319s on a single weekly flight from Calgary to Los Cabos, on one of three weekly flights from Halifax to Orlando and on two of three weekly services from Ottawa to Orlando.

On a single weekly flight each from Montreal to Cayo Largo, Cozumel and Holgiun, Air Canada is replacing its 146-seat A320s with A319s. Other routes where the carrier is replacing A320s with A319s include three daily flights from Toronto to Miami, one weekly flight from Winnipeg to Cancun, two weekly flights from Toronto to Santa Clara, one daily flight from Toronto to Punta Cana, a single weekly flight from Toronto to Puerto Plata, a daily service from Toronto to Nassau, one of two weekly flights between Toronto and Cayo Coco and one of three weekly flights from Toronto to Antigua (a route being launched by WestJet).

At the same time Air Canada during the upcoming 2012-2013 winter season is exiting the crowded Vancouver-Calgary market, which is also served by WestJet, Sunwing and Air Transat. Prior to the planned Dec-2012 suspension, Air Canada is operating Boeing 767-300s on the pairing. The route could be possibly be resurrected under a low-cost structure that allows Air Canada to be more competitive.


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