The previous chapters of this book outline the characteristics of low-cost carriers (LCCs), their impact on markets, the transferability of their framework to emerging markets, and opportunities and challenges for LCC development in the East African Community (EAC) market—with the objective of examining the role of LCCs in the development of air services in lesser-developed countries and emerging markets. The implied narrower question can be more simply formulated as: “Is the introduction of LCCs into a thin and underdeveloped air service environment the solution to foster growth of air transportation?”
Based on our analysis, the short answer would probably be no. LCCs can only survive and become a catalyst for air transport growth when certain conditions are in place. In essence, the air transport market needs to achieve a certain degree of maturity, become at least partially liberalized, enjoy relatively good governance allowing for undistorted competition, and have a critical mass within a country’s population which has sufficient purchasing power to utilize air services. The existence of a significant middle class is particularly crucial for building a market in which LCCs can achieve the highest possible utilization of assets in order to drive costs down. In both the cases of South Africa and Mexico, a substantial middle class was present, which stimulated demand for air travel.
Although developing markets with little traffic and limited economic growth may currently not be suitable for this business model, there are a considerable number of ways to foster the sustainable development of air transport, make air services more affordable for the population, and pave the way for the future development of LCCs. Some of these measures are outlined below.
One of the key factors in developing air transport is to enable market access and foster competition. LCCs have emerged only when the air transport sector was liberalized and deregulated. As the case studies of Mexico and South Africa show, open competition against key players, such as a state-owned carrier, is necessary to bring down fares and attract new customers. Many developing countries, however, still have a dominant national carrier, be it a state-owned or private carrier, which enjoys anticompetitive advantages.
The first step in liberalizing air service markets is to define a sector policy that is conducive to creating competition. This is of special importance where a dominant national carrier depends on a protected market, and artificially keeps fares high. In order to gain political support for liberalization, it is important to examine the advantages of liberalizing the market, and communicate the expected outcome in terms of economic development to the public. Too often, protecting employment through inefficient dominant carriers is the official or implied reason to oppose the introduction of competition, which could pose a challenge to established players. However, the benefits of increased air services on the tourism sector (to name one example) are rarely clear. They can result in gains in terms of employment, as compared to airline jobs alone.
Enabling market access has to be achieved in an open and transparent manner. This requires the establishment of regulations and laws that set clear requirements for new market entrants. Such regulation must foster an environment without limitations, such as the number of participants or exclusive rights for a given air carrier. Furthermore, any existing market distortions, such as direct or indirect subsidies to select carriers—as well as exclusive rights to serve certain routes—must be eliminated. At the same time, certain subsidies that are granted to fulfill a public service route to remote destinations should be maintained, but only if they are granted following a competitive bidding process and reviewed regularly.
Many developing countries are small, and a large part of their population often cannot afford air travel. The development of air service markets in these countries depends primarily on establishing a competitive international network. As elaborated in chapter 4, access to international or regional markets is traditionally defined and regulated on a bilateral basis. Liberalizing traffic on routes involving more than one government is more challenging than simply opening up the domestic market. Nevertheless, several initiatives to liberalize international air services have been implemented on a bilateral or multilateral basis. On a bilateral basis, many countries have agreed to very liberal air service agreements (ASAs), which do not restrict frequency or capacity of flights and allow for the free setting of airfares. A further step for any government is to establish a so-called “open skies” agreement with another country or a group of countries, for example, as members of a regional economic community (such as the Association of Southeast Asian Nations [ASEAN]). Another effective and rather simple procedure is the adherence to an existing open sky policy agreement, such as the Yamoussoukro Decision in Africa.
It is important that the signing of any liberal ASA, open skies, or multilateral agreement—or even the establishment of a fully liberalized economic environment which includes air services—be implemented and maintained on a transparent and sustainable basis. Too often, governments have announced and even signed important bilateral or multilateral agreements on air services, only to have slow or no implementation for years to come (for example, the Yamoussoukro Decision).
International partners, as well as the industry (for example, aircraft manufacturers), can play an important role in initiating, supporting, and monitoring the process of international liberalization of air services. Support for liberalizing international air services can range from technical advice on existing bilateral air service agreements to fostering the establishment of a regional liberalized air service market. The latter includes the example of the pan-African liberalization of air services, which was initiated by the United Nations Economic Commission for Africa (UNECA), when it actively engaged African countries to agree to the Yamoussoukro Declaration in 1999 (UNECA 1988).
Liberalization of air services is not a one-time event, but rather an ongoing policy that must be monitored and adjusted. Regions that have been, on paper (by treaty), liberalized often have some countries unilaterally depart from their liberal policy and restrict their services. In many cases, such as the West African Economic and Monetary Union, no effective monitoring or compliance body exists that could intervene and correct violations against market liberalization. Institutions, such as regional or global development banks, should initiate policy discussions at high levels of the regional economic communities concerned in order to support adherence to agreed liberalization.
Finally, the private sector, represented by trade organizations such as the International Air Transport Association (IATA) or major industries, such as aircraft manufacturers, must influence decision makers at every opportunity to move toward and maintain a liberal policy when it comes to international air service agreements.
Air transport services, in general, and LCCs, in particular, rely on adequate infrastructure that can handle capacity in a cost-effective and safe manner. As discussed in chapter 4, the sector needs airport infrastructure that can meet traffic demand in terms of capacity and quality, while complying with relevant safety and security standards. In terms of air traffic management, air traffic control infrastructure, which can ensure safety and efficiently manage traffic at peak hours, is critical. Many emerging countries lack adequate airport and air traffic infrastructure. Often these countries do not have sufficient traffic to warrant the modernization of aging airports or communications, navigation, and surveillance (CNS) systems. However, there is a group of emerging states that have seen rapid air traffic growth, while airport or CNS infrastructure lags behind.
In many developing countries, the capacity of airport infrastructure, whether airside or landside, is often not the primary challenge. Whereas at smaller airports, the necessary airside investments, such as tarmac surfacing and the acquisition of boarding bridges, may be required, most airports in developing countries have the necessary capacity to absorb additional traffic. Oftentimes a preliminary measure to handle growing traffic can be simply achieved by working with carriers to schedule traffic more evenly throughout the day. In addition, economic measures such as peak or congestion pricing of airport usage can be temporary solutions before investment in additional infrastructure is undertaken. Nevertheless, both measures have their limits given that carriers depend on many high volume destinations at certain times during the day (for example, early morning or evening).
Similarly, landside infrastructure investments are often not urgent as passengers can be processed temporarily in less adequate environments. LCCs in particular do not need any special amenities or services; basic and efficient installations are sufficient. However, effective maintenance is essential for both landside and airside infrastructure in developing countries. It is crucial in prolonging the infrastructure life cycle and ensuring safe as well as efficient operations.
Yet, oftentimes, the focus of the responsible airport operator is solely on the upkeep of the country’s primary entry airport, with little investment or maintenance being made at secondary or regional airports, which are important for domestic and regional traffic development. Even in cases where investments are made, these may not be prioritized correctly due to political or other commercial interests. Political support for a new modern terminal building may be much stronger, rather than for a potentially more urgent airside project or maintenance program, such as an additional taxiway, runway extension, or the hiring of additional maintenance staff. In order to assess the necessary investments in airport infrastructure, an accurate demand forecast and development of an airport master plan is fundamental. Only in this manner can a sustainable airport system be developed and maintained.
Air traffic control installations need to provide reliable CNS services, which allow aircraft to arrive safely and without delay at their destination. However, many lesser-developed countries lack reliable basic services, which can result in constant delays and longer holds on the ground and in the air. Poor communication systems and the lack of positive surveillance installations, such as radar, result in many additional operational procedures, which could otherwise be shortened or eliminated altogether. Examples of such unnecessary procedures include large separations of traffic, as well as the requirement to fly so-called standard arrival and departure routes, or a full approach procedure instead of being directly vectored for a final approach. In addition to delays, poor CNS infrastructure poses a safety challenge, which may hinder development of air services when authorities or carriers limit traffic for safety concerns.
Nevertheless, air traffic installations are comparatively less costly than airport infrastructure. Modern communication systems, even when integrated into satellite-supported networks, cost much less than a new terminal at a major airport. In addition, modern surveillance technologies, such as automatic dependence surveillance systems (ADS-B/C), allow for air traffic surveillance infrastructure at a fraction of the cost of traditional radar-based systems.
Air navigation service providers (ANSPs) need to establish safe and efficient procedures, maintain a high level of reliability, and secure operational maintenance of physical infrastructure. In order to support the development of air traffic, investments in installations and procedures, as well as in maintenance, need to be secured by good management of revenues. Similar to the case of developing airport infrastructure, an assessment of the existing system and a long-term development program need to be prepared. A follow-up implementation program, which includes ongoing maintenance and renovation of the system, would also be required. Like airports, ANSPs need to be corporatized as public or private entities, and must be supervised and regulated by an authority. What is important is that improvements of air navigation services are harmonized on a regional basis in order to avoid disruptions and delays. Coordination between ANSPs is key in achieving this.
Both airports and air traffic control infrastructure require good management in terms of operations and resource allocation. Airport management, in particular, sets many requirements for the seamless handling of arriving and departing aircraft, while safety and security standards are maintained at all times. Many emerging countries experience a lack of adequate staff with necessary technical or managerial skills. The resulting mismanagement can mean delays, waste of resources, or safety and security infringements. Good airport management depends on hiring skilled staff, providing good training, and ensuring constant supervision. The best way to implement good standards is to have airports managed as independent entities, whether as a state-owned entity or as a private sector venture. In addition, airports need to be supervised by a regulatory body, which ensures safe and secure operations, and which may set certain economic boundaries, primarily on usage fees for aircraft and passengers.
The financing of aircraft or airport infrastructure poses a particular challenge in many developing countries. The lack of hard currency resources in banks, as well as the perceived or apparent emerging country risk, makes it difficult to finance aircraft or infrastructure locally or by foreign direct investment. This is especially the case in countries with thin traffic, low airport utilization, and a restrictive market policy—all of which prevent a competitive environment.
Aircraft financing depends on a business environment that is conducive to private sector development, which allows companies to freely invest and retrieve funds, and which provides a mechanism for securing and recovering assets in distress. The creation of such a business environment spans over many sectors and public entities of a given country. Emerging countries must take development measures that include regulatory provisions for free capital flows, good governance, as well as laws and institutional mechanisms for asset recovery. For example, an effective bankruptcy procedure, the possibility to cease aircraft operating internationally facilitated by the Cape Town Convention, or a definition of responsibilities with sanctions of the board and management of a company, are relatively easy measures to implement.
Aircraft financing can be provided by a variety of sources and should be complemented, where needed, by international development agencies such as the International Finance Corporation (IFC). However, additional provisions, such as granting an air operator certificate for an aircraft registered in a foreign country, are requirements that need to be in place. One of the most promising initiatives to facilitate foreign direct investments in air carriers, however, is to allow a majority stake for foreign ownership. Despite the fact that most countries have legal requirements that aircraft or air carriers be majority and publicly-owned, a number of smaller nations never adhered to such limitations. Portugal, and countries that were former Portuguese colonies, typically do not limit foreign ownership in aircraft or air carriers. This allowed for the creation of Air Corridor, a foreign-held carrier in Mozambique. Indeed, it is also the reason that all fractional aircraft ownership operations in Europe are conducted by a Portuguese entity with aircraft registered in Portugal.1
The scope and feasibility of airport infrastructure financing depends on many factors. First, the dimension and elements to be financed need to be determined. This could range from a simple terminal or a runway, to an entire airport. Second, the source of funds and economic feasibility need to be analyzed. Large airports with several million passengers can usually be financed by commercial banks, and repayment from operational income is relatively secure.
Many airports in emerging countries are on the other side of the spectrum, and struggle to achieve the traffic required for commercial financing. These airports are generally in the public domain, and in many cases their financing and maintenance is provided by the public sector. In between these two extremes, there are is an array of possible financing mechanisms, which range from public funding and ownership, to an entire private airport. In many growing airports around the world, public-private partnerships (PPPs) have become interesting solutions for development. However, they require a certain level of traffic to become financially viable, as well as respective regulation and sufficient governance to attract outside investors.
The sustainable development of air transport services requires a predictable and stable regulatory environment that sets standards to ensure safety and security. If this is not in place, long-term development of any airline operation is at risk and the traveling public will consequently be reluctant to use air services. Furthermore, financing and insuring aircraft becomes a considerable challenge.
Safety and security requires a regulatory framework that complies with international standards, and which is enforced by an effective civil aviation regulatory entity. In addition, some safety and security measures need financing for equipment, construction, or for training staff of supervisory entities. Most importantly, however, the establishment and maintenance of a sustainable safety and security environment depends on political stability and good governance.
Ensuring safety and security is a priority within all sector operations and entities. For example, airlines need to introduce safety management systems, and should regularly be subject to audits by trade organizations, such as the IATA Operational Safety Audit (IOSA).2 A similar audit program for airports is currently being implemented by Airports Council International (ACI). Nevertheless, the main responsibility to regulate, enforce, and supervise the air transport sector lies with respective civil aviation regulatory bodies, in most countries, the civil aviation authority (CAA).
As highlighted in chapter 4, the International Civil Aviation Organization (ICAO) is mandated with conducting an audit of the supervisory capacity of a CAA in terms of safety and security. Their audit results provide a good measurement of compliance and oversight with respect to international safety and security standards. However, the establishment of a compliant oversight regime in less-developed countries can entail the creation of an entirely new regulatory and legal framework, the recruitment and training of inspectors, and the preparation of various tools, such as technical libraries, information systems, and inspectors’ handbooks and manuals. Many smaller countries do not have the necessary skills or funding, and need support.
Support for establishing the safety and security oversight mechanism can come in various forms. Countries with sufficient income from the sector, for example, through overflight and passenger fees, can use these funds to finance the improvements at the CAA. In this case, development partners may assist by providing policy and technical advice. However, many poorer and/or smaller nations lack the financial and human capacity to provide effective oversight. Regional safety oversight organizations (RSOOs) can prove more viable in such cases. The World Bank, for example, has successfully supported the development of RSOOs in both West and Central Africa, as well as in the South Pacific.
Support should be conditioned on the establishment of good governance. This can be achieved by being fully transparent on financial matters of the sector (for example, by publishing airport income and use of funds), or by disclosing ICAO audit reports on the CAA. It can also be achieved through the release of information on sanctions pertaining to sector participants (for example, imposing a fine on an operator). Development partners can also condition their support to achieving measurable results with respect to safety or security improvements. In this context, the World Bank conditioned the release of a tranche of a Development Policy Loan for Guatemala on the certification of the country by the U.S. Federal Aviation Administration for complying with ICAO standards.3
Air transportation is a capital-intensive industry with small profit margins. In fact, according to IATA, the global airline industry has been only marginally profitable in 2012, achieving a net profit of US$2.56 billion with revenues of US$228.56 billion (Pearce 2013). Furthermore, for decades, the industry was unable to provide a positive return for investors when profits are compared with the weighted average cost of capital (WACC).4 These poor returns include some factors that cannot be controlled by the carrier’s management, such as a sudden increase in fuel costs. Carriers therefore constantly struggle to keep operational costs as low as possible in order to achieve a positive operational result.
At the same time, aviation has always been an easy target to levy charges, fees, and taxes. Indeed, aviation is a soft target where charges are easy to collect given that only a handful of companies need to remit them. In addition, the voting public often does not know the real amount of taxes paid, as these are mostly embedded in the overall ticket price. Finally, in most countries the traveling public does not have a vocal advocate who lobbies against high charges on air travel, even if these exceed 50 percent of the overall ticket price.
Charging reasonably for services received and costs incurred is a complex issue. User fees for airport usage, including security screening, have increased significantly over the past decade. Airports argue that it is necessary to invest in costly infrastructure for anticipated growth in passengers. In addition, security-related investments and the cost of services have skyrocketed since the terrorist events of September 11, 2001.
The development of sustainable air transport services depends on the affordability of air travel. This is especially true for emerging and developing countries, where income per capita is significantly lower and price sensitivity consequently much higher. In markets where air travel has reached high penetration with large economies of scale permitting low airfares, disposable income is often used to visit friends and families in remote destinations or for tourism. This type of “leisure” travel has become the backbone for most LCCs around the globe. Excessive taxation can act as a major deterrent in such countries.
Therefore, charges for air transport services should be kept at a reasonable level and only cover the cost for services received. However, the determination of reasonable levels of charges can be a challenge, especially in developing countries where passenger numbers are low and where costs of airport usage need to be borne by fewer passengers than in countries with major hubs. In addition, according to Article 15 of the Chicago Convention, there should not be any discrimination between national and foreign carriers. Nevertheless, in many developing countries that operate a national carrier, market distortions and discrimination of carriers can be observed. These may range from simple discounts on airport charges for a carrier to the direct usage of air traffic income paid by foreign operators to settle fees owed by the national carrier to foreign air service providers.
The sustainable development of air transport services depends on reasonable, equitable, and cost-based levies. These charges need to be determined in a transparent manner, preferably in consultation with all concerned stakeholders. They also need to be accessible to the traveling public through detailed ticket prices, as well as listings on official websites. At the same time, governments in emerging markets need to refrain from using the sector as an easy provider for hard currency, and understand that the overall economic benefits of developing aviation services far outweigh the income from such charges. Development support by international organizations should focus on various economic and developmental aspects when advising governments on how to determine taxes and levies on the sector.
This chapter has outlined some of the most significant challenges and possible solutions for developing countries to grow their air transport market in a sustainable manner and to pave the way for future LCC entrance. As table 6.1 outlines in more detail, the support of development partners in fostering fair competition, providing guidance on adequate safety and security standards, as well as on reasonable taxation and good governance, is crucial to ensuring the sustainable growth of the air transport industry in developing countries. Once these elements are in place, LCCs can be introduced by the private sector, and will commence to catalyze the market further. As such, LCCs are not the solution for initiation, but the catalyst for growth—LCCs are the turbocharger, but they can only become effective once the engine is running smoothly.
Table 6.1 Challenges and Measures for the Development of Sustainable Air Transport Markets in Developing Countries
Challenge |
Enabling measures |
Support by development partners |
Open up access to markets against dominant national carriers (whether state-owned or private) |
Privatization of state-owned carrier, granting access to private operators. |
Privatization advice; define liberal air transport policy and legal and regulatory changes; study economic impact of opening up access. |
Foster a competitive environment |
Regulation and laws supporting an open and competitive environment. |
Technical support to develop and implement a regulatory environment conducive to competition. |
Remove market distortions |
Review all direct and indirect subsidies to air carriers to eliminate such distortions, except in cases where a public service obligation is granted on a competitive basis. |
Assistance in reviewing and defining which subsidies are to be eliminated, and which should be designated as a public service obligation. |
Access to international markets |
Negotiate and agree to liberal ASA or open skies agreements or adhere to an open multilateral agreement or to an established open market. |
Examination of existing ASAs, and analysis of market potential for liberalization; support for the negotiation of liberal or open skies agreement; initiate, support, and monitor the establishment of liberalized air service areas within existing economic organizations. |
Airport infrastructure |
Airport infrastructure development planning based on (a) demand forecast, (b) analysis of existing infrastructure, and (c) compliance with safety and security standards. |
Technical support for the preparation of an airport master plan, be it on an airport level (case-by-case) or for a national airport(s) master plan, and effective maintenance plans. |
Air traffic control infrastructure |
Assessment of existing CNS system, and identification of gaps or inefficiencies in service provision; preparation of a CNS development program. |
Technical support for the assessment of current CNS systems, and of a development program. |
Airport and air traffic control management |
Establish independent entities for airport and air traffic service providers; establish an independent regulatory oversight authority; ensure good governance and best practice. |
Policy and regulatory advice to establish airport and ANSP entities, as well as to establish regulatory oversight; support on governance and best practice in airport and ANSP provision. |
Aircraft financing environment |
Establish a private and financial sector that is conducive to domestic and foreign private investment. |
Policy and technical support to introduce measures to improve the business environment, including finance/ownership regulation. |
Labor force |
Provide training for civil aviation authorities, airport staff, air traffic controllers and other relevant staff. |
Financing for CAA; airport and airline staff training based on detailed training needs; assessments and training plans. |
Aircraft financing |
Provision of financing by loans or equity investments. |
Direct funding in air carriers through equity or by loans; provision of guarantees for foreign direct investments (for example, political risk). |
Airport infrastructure financing |
Public or private financing of airport infrastructure by loans or equity investments; facilitation of PPPs through management or concession agreements. |
Financing of airport infrastructure works or provision of guarantees for foreign direct investments; establishing regulatory framework for PPPs; advisory services for financing concession agreements in PPPs. |
ICAO-compliant safety and security regime |
Establishing a regulatory and legal framework; creation of an independent CAA; preparation of inspection materials and training of CAA staff; infrastructure investments in safety and security. |
Technical support to assess, determine, and implement safety and security systems for effective oversight; financing of regulatory reform, CAA staff, and required infrastructure improvements. |
Taxes and charges on the air transport sector render air travel unnecessarily expensive |
Transparent and holistic approach when determining the level of charges. |
Technical support to assess and determine levies on air transport services. |
Note: ASA = air services agreement; ANSP = air navigation service provider; CAA = civil aviation authority; CNS = communications, navigation, and surveillance; ICAO = International Civil Aviation Organization; PPP = public-private partnerships.
In terms of the focus for development of the air transport sector and the role of international development partners, the priorities remain the same. Many basic requirements for LCCs to successfully operate in a given market are the same as for traditional air carriers that need to operate on a sustainable basis without being supported by the public sector. Development partners can assist the sector by providing relevant guidance on policies, regulations, laws, and oversight.
1. In fractional ownership programs, customers buy a share of an aircraft, rather than an entire plane. The price is prorated from the market price of a full aircraft. Owners then have guaranteed access (for example, 50–400 hours annually depending on share size) to that aircraft. Fractional owners pay a monthly maintenance fee and an hourly operating fee. European fractional ownership programs have owners of many different nationalities, which is not an issue in Portugal where there are no nationality requirements to own an aircraft.
2. The IATA Operational Safety Audit (IOSA) program is an internationally recognized and accepted evaluation system designed to assess the operational management and control systems of an airline. IOSA uses internationally recognized quality audit principles and is designed to conduct audits in a standardized and consistent manner.
3. The World Bank project is Second Broad Based Growth Development Policy Loan (P094897, 2006).
4. The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all of its security holders to finance its assets.
Pearce, B. 2013. Profitability and the Air Transport Value Chain. Economics Briefing 10, International Air Transport Association. http://www.iata.org/whatwedo/Documents/economics/Profitability-and-the-air-transport-value-chain-final.pdf.
UNECA (United Nations Economic Commission for Africa). 1988. Declaration of Yamoussoukro on a New African Air Transport Policy. Côte d’Ivoire: UNECA.