Terrie's Take 721 -- LCCs -- One Down, Two to Go, e-biz news from Japan

Terrie's Take terrie at mailman.japaninc.com
Mon Aug 5 06:50:30 JST 2013

* * * * * * * * * T E R R I E 'S T A K E * * * * * * *
A weekly roundup of news & information from Terrie Lloyd.

General Edition Sunday, Aug 04, 2013, Issue No. 721


- What's New -- LCCs -- One Down, Two to Go
- News -- Severity of Fukushima situation becoming clearer
- Upcoming Events
- Corrections/Feedback -- Softbank, not Yahoo JP has Alibaba shares
- Travel Picks -- Kushiro, Hokkaido and Todoroki Valley, Tokyo
- News Credits

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At the end of June, All Nippon Airlines (ANA) announced a net loss of
JPY6.6bn for the first quarter of the year -- even as demand for
international and foreign travel increased. Part of the loss was
attributable to the 787 Dreamliner groundings, part due to rising fuel
costs on the weaker yen, and part because of losses booked from its failed
joint venture with AirAsia.

The AirAsia failure has been interesting. The parting was reasonably
amicable, but apparently the two companies have been fighting for a while
about how to run the Japan business and this finally came to a head in
April-May (the joint venture dissolution was announced in June). During
April, seat occupancy fell to around 56%, an unsustainable level, and the
partners knew that something had to be done quickly. ANA wound up buying
out AirAsia's share.

According to the ANA side of the story, the partners fell out over
management differences, which in the Japanese media translated to AirAsia's
unwillingness to sell tickets through middlemen (tour agencies, convenience
stores, etc.) and the poor quality of the company's Japanese website. Given
that ANA had 67% of the j/v, though, this is not necessarily a good
reflection on ANA. On the AirAsia side, three factors were cited: ANA's
over-influence of AirAsia Japan management (they only have 38.7% of Peach,
which is much more successful), failure to follow proper cost-cutting
strategies, and poor marketing. No doubt, being stuck out at Narita airport
had a big role to play as well.

An excellent analysis of the break-up and what went wrong can be found at:

So it seems that while the AirAsia Japan operation suffered mainly from
human factors such as ANA's bureaucratic mindset and unwillingness to
implement workable marketing ideas, and from AirAsia's heavy-handed
management attitude, it also suffered from simple business failure -- high
costs versus low income. The cost-cutting side of things is a critical
contributor to success in the LCC business and as measured by Cost per
Available Seat Kilometer (CASK) flown, AirAsia is an expert in this area.
They had set Japan a CASK target of JPY5.3/km -- about half of what ANA
achieves -- and that expertise is now lost to ANA. What a waste for both

[Continued below...]

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[...Article continues]

Costs for an LCC seem to roughly fall under the following categories:
aircraft, fuel, maintenance, pilots, marketing and sales, and management
overheads. There isn't much that any LCC operating in Japan can do about
aircraft (which need to be relatively new or flyers won't fly in them) and
fuel costs, and so the AirAsia-ANA tussle would have mostly been about
maintenance, pilots, marketing, and management costs.

Maintenance costs are not only hard to contain in cost-heavy Japan, but
there is also a severe shortage of qualified staff in the labor market. We
wrote some time ago about airlines planning to send their aircraft abroad
for maintenance to get around this problem, but for pre-flight checks,
having local staff is unavoidable. Certain LCCs have tried to bring in
mechanics from abroad and get them to work alongside lesser experienced
locals, but this can backfire. JetStar got admonished late last year for
having two locally licenced engineers doing work that they wouldn't have
been qualified for per the airline's own internal rules.

Pilot and cabin crew costs can be somewhat contained through careful
business management and outsourcing. On the cabin crew side of things,
willing amateurs can be recruited and will be accepted by Japanese
consumers so long as they are given enough training to know how to smile at
the right time and generally be helpful. JetStar has proven that this is
possible, and while their crew don't get paid much, they seem happy enough
to be doing the job. Maybe some of them see it as a backdoor to crewing for
larger brands in the future.

The pilots on the other hand are a much more difficult proposition. Some
airlines are using foreign pilots since Japanese ones are in short supply.
We don't know if those pilots are resident in Japan, but the impression we
get from various recruiting and online discussion sites, that they are most
likely outsourced from a labor supplier and brought in for short periods
under a grey zone rule about foreign pilots working in Japan. If this is
the case, then it would help the airlines avoid training costs, cumulative
leave, and retirement benefits, as well as lowering salaries. This all adds
up and it must be tempting to keep using such services.

Outsourcing of pilots is not something new, and airlines all over the world
have been moving steadily towards third-party suppliers -- although in
Japan until the arrival of the LCCs it was an activity reserved for the
smaller operators like Skymark and Air Japan (ANA's charter flight
subsidiary). But now that we have a full-fledged domestic LCC movement
going on, pilot outsourcing and whether the practice is safe and legal is
going to hit the news again.

For example, one of the more controversial aspects of outsourcing pilots
involves basing them in another country, then flying them in for short
duties before flying them out again.

While this is an acceptable practice for international flights where you
have a pilot "working" cross-border by virtue of their job, they are at
least delivering the bulk of their services outside Japan. But with LCCs
making domestic flights only, suddenly the issues of residence, tax, and
social insurance become relevant. This is a prime area of conflict between
cost-cutters and those who want to follow the rule book. From what we can
see, this is a grey area that the immigration and aviation authorities seem
ready to overlook, but which the labor authorities are wanting reigned in.
We don't know if this became an issue for AirAsia Japan, though.

ANA's inexperience in domestic LCC operations may have doomed their
relationship with AirAsia, but they don't lack vision. At the same time as
they announced that they would relaunch AirAsia Japan in December (new
brand to be disclosed later this month) they also announced that they had
just bought a major US pilot training company called Pan Am Holdings. Given
that most pilot outsourcing companies start their personnel pipeline with
training of new pilots, our guess is that ANA is going to take this route
as well. This would allow them to place graduates with their various LCC
subsidiaries, then graduate them later to the main airline. Aer Lingus did
something similar with a company that is today one of the biggest suppliers
of pilot training and outsourcing -- CAE Parc Aviation.

Then there are the marketing costs. JetStar Japan has decided to go with
local wisdom, and do its marketing/selling through third parties, such as
convenience stores, as well as being online. Doing this no doubt causes
them to drop a significant amount of margin across the resellers, but we
imagine that JetStar sees this more as a start-up cost, and that once it
has educated a consumer as to the value it is offering, then the consumer
will be more likely to buy directly from the website after that. Web
incentives can help to further lock in loyalty. So it's strange to us that
AirAsia couldn't see its way to a similar strategy, especially since it has
such a close relationship with Expedia, one of the world's largest travel
websites. We can only guess that the other pressures in the Japan operation
were great enough that they just simply had had enough.


Food for thought -- Stagflation

What happens when you get inflation but no growth in the economy? It's
called Stagflation, and we believe it could be one possible outcome of
Abe's economic policies as they stand today. The Wikipedia definition of
Stagflation gives two likely causes and of the second, it says, "...both
stagflation and inflation can result from inappropriate macroeconomic
policies. For example, central banks can cause inflation by permitting
excessive growth of the money supply,[9] and the government can cause
stagnation by excessive regulation of goods markets and labour
markets.[10]" In our humble opinion, Abe's failure to restructure the
regulatory environment -- his so-called third arrow -- qualifies amply as a
probable root cause of Stagflation in the future.

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+++ NEWS

- Rakuten numbers suggest Abenomics is working...
- ...Or is it smoke and mirrors?
- Health premiums may double for 70-year olds
- Severity of Fukushima situation becoming clearer
- Government wheat prices up 19% in last 12 months

=> Rakuten numbers suggest Abenomics is working...

Rakuten's first half consolidated operating profit soared 26% according to
the company, to JPY47.5bn. The firm says that it had outstanding
performances for its brokerage and credit cards units. Online mall sales
were also up substantially. Rakuten's CEO said that the company was
enjoying substantial sales of products priced over JPY100,000, and
commented that, "We're feeling the benefits of Abenomics." (Source: TT
commentary from e.nikkei.com, Aug 03, 2013)


=> ...Or is it smoke and mirrors?

Before anyone starts singing the praises of Abenomics, a Nikkei-Macromill
survey has found that consumers may simply be buying big-ticket items
before the Consumption Tax rate goes up. The survey found that 59% of
respondents want to buy high-end consumer electronics, 28% want cars and
motorcycles, 24% want travel, and 19% want high-end apparel (such as
kimono), before the tax goes up to 8%. At the same time, people are
off-setting their spending by cutting back on entertainment, food, and
low-end apparel. ***Ed: In other words spending increases are being
"borrowed" from future spending. Sounds like a recipe for failure to us."
(Source: TT commentary from e.nikkei.com, Jul 30, 2013)


=> Health premiums may double for 70-year olds

The National Council on Social Security System Reform has issued a
recommendation that the government increase health care levies from the
current 10% to 20%, bringing the wealthiest part of Japanese society more
in line with the 30% levies made by those under 70. The paper also suggests
hitting old high-income earners with a tax on retirement income and
introducing health insurance premiums. Currently, neither exists for
oldies. Lastly, the paper brings up the need for raising the pension age
beyond the current target of 65 (to occur by 2025). ***Ed: Our take is that
within 12 years, the age for getting the national pension will no longer be
65 -- more likely around 70 or so.** (Source: TT commentary from mainichi.jp,
Aug 02, 2013)


=> Severity of Fukushima situation becoming clearer

Tokyo Electric Power Co. (TEPCO) has admitted in a report to the Nuclear
Regulation Agency (NRA) that at least 20trn-40trn Becquerels of Tritium
have leaked from the damaged Fukushima nuclear plant into the Pacific
Ocean. The utility is only just starting to come clean with the leakage,
and still hasn't said anything about Strontium levels, which have a much
longer half-life (28.78 years) than Tritium's 12 years. ***Ed: As we said
two weeks ago in TT-719, we think the core of at least one of the reactors
has partially or fully melted through its steel and concrete encasement,
and is emitting radiation in direct contact with the groundwater. It is
high time the government brings in outside experts to take over the
monitoring and strategizing for the plant. They need to do this without
delay.** (Source: TT commentary from japantimes.co.jp, Aug 03, 2013)


=> Government wheat prices up 19% in last 12 months

The government-set wholesale price of foreign wheat is about to go up 5% in
October, the third price rise in 12 months, and collectively, an overall
price increase of 19% over the rate set October 2012. Japan imports about
90% of its wheat, with 58% coming from the USA. Although the yen has risen
about 25% over the same 12-month period, global wheat prices overseas are
actually down 15% due to a supply glut. ***Ed: So WHO is making the money
here and why? Is the government expecting the yen to fall further and
getting the price rises done early..?** (Source: TT commentary from
bloomberg.com, Aug 02, 2013)


NOTE: Broken links
Some online news sources remove their articles after just a few days of
posting them, thus breaking our links -- we apologize for the inconvenience.




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=> No events announcements this week.



In this section we run comments and corrections submitted by readers. We
encourage you to spot our mistakes and amplify our points, by email, to
editors at terrie.com.

=> In Terrie's Take 719, when commenting on Masayoshi Son's bid for Sprint
and the assets he could muster, we incorrectly stated that Yahoo Japan owns
a 20% (36.7% on a voting rights basis) stake in Alibaba. In fact, Softbank
itself owns a 31.9% stake in the Chinese firm. Thanks to the reader who
pointed this out.



=> Kushiro's Fisherman's Wharf, Hokkaido

The cold marine air that moves in and around the port city of Kushiro and
mixes with warmer spring temperatures can create unpredictable weather
patterns. I awoke, climbed out of bed and pulled back the curtains on my
ninth floor hotel room overlooking the harbor to see, well, nothing. The
fog had rolled in and enveloped the city reducing visibility to less than
20 meters.

Lucky for me, my hotel (ANA Crowne Plaza Hotel Kushiro) is just a two
minute walk from a large fish market and shopping center -- the
Marine-Our-Oasis building (commonly referred to as MOO). It seemed
appropriate that I visit Kushiro?s version of fisherman's wharf on a foggy
morning. The weather pattern itself reminded me a lot of San Francisco, a
city known for its similar wharf-side tourist attractions and infamous cool
and foggy weather even in the middle of summer.


=> Todoroki Valley in Setagaya Ward, Tokyo
Get some relief from the heat!

Tokyo is very hot and humid during summer, mostly because of the large
numbers of skyscrapers and paved roads which absorb the heat. However, you
can escape with a visit to Todoroki Valley. Descending down towards the
river, you will notice a big drop in temperature. Todoroki Valley is
located near Todoroki Station on the Tokyu Oimachi Line in Setagaya ward.

In the middle of July, we hiked down the stairs located at Golf Bridge
(there used to be golf course here back in the 1930s), and it was so much
cooler at the bottom. This is largely due to the tall trees on both sides
of the Yazawa river blocking out the sky and the hot sun. I only felt
sunbeams streaming through leaves instead of strong direct sunlight. I've
heard that the temperature at the bottom is generally lower by 3-4 degrees.
It was like another world: I was surrounded by deep green trees, and was
able to breathe fresh and cool air. I enjoyed walking along the river and
listening to birds singing. Hard to believe it's in the middle of Tokyo...




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Written by: Terrie Lloyd (terrie.lloyd at japaninc.com)

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