Skymark’s A380 bubble bursts

September 1st 2014

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When a 51 word fax, written in English, arrived at Skymark Airlines’ Tokyo office on Sunday July 27, the airline’s president, Shinichi Nishikubo, knew his dream of flying the A380 on international routes was evaporating. He also knew the message threatened the survival of his airline. Read More »

The fax from Airbus headquarters in Toulouse informed the president of Japan’s third biggest airline that its order for six of the world’s largest passenger jets had been terminated and that the manufacturer would seek compensation.

Skymark’s A380 dream shattered by unrealistic ambitions

In a statement issued two days later, Airbus said: “Following discussions with Skymark Airlines and in light of the airline’s expressed intentions in respect of the A380, Airbus has, in accordance with its contractual rights, notified Skymark Airlines that the purchase order for the six A380s, signed in 2011, has been terminated. Airbus is reserving all its rights and remedies.”

Already weakened by its first loss in five years, Nishikubo and “Skymark was suddenly faced with a possible 70 billion yen (US$666.6 million) in “rights and remedies” from Airbus. Skymark’s total sales revenue last year was 86 billion yen, its best ever result, so a payment of 70 billion yen to Airbus is a huge burden.

Skymark went into survival mode. In mid-August it announced it would cut six routes from its 34-route domestic network from the end of next month, including the closure of its loss-making operations at Narita International Airport, a decision that will save about three billion yen a year. It has raised some of its fares by as much as 69%, despite the threat of losing out to a cheaper rival.

The carrier is focused on increasing its profitable services between Tokyo’s Haneda airport to key cities such as Sapporo and Fukuoka.

At press time, the airline was considering a step it has never had to take: approaching banks and other financial institutions for funding. There was “material uncertainly” about the carrier’s future, a company statement said.

So, what went wrong with Nishikubo’s A380 dream?

Back in 2010, when the order was first proposed to Airbus by Nishikubo, Skymark was in robust financial health. Born as an budget carrier in 1998, after Japan deregulated air fare price controls, Skymark was the first new airline in Japan for decades. Backed by Japanese travel giant, H.I.S. Travel, it struggled to survive. It was in crisis in 2003 when Nishikubo, a successful IT entrepreneur, bought out its debt and took over the carrier.

In a few years, he had turned Skymark into an efficient, money-making concern. He changed the fleet from B767s to smaller B737-800s, because they were better suited to short haul LCC operations, and concentrated on high demand domestic trunk routes out of Tokyo’s Haneda airport.

The strategy produced years of profits. By 2010, the airline had a load factor of 90% on the key trunk routes out of Haneda to Sapporo, Fukuoka, and Naha and it was turning a profit.

Nishikubo resisted launching international services for several years, but out of the blue, in late 2010, he revealed his ‘dream’ of introducing the A380 on major overseas routes, with Narita-London and Narita-New York as his first destinations.

The industry- and some Skymark managers - held their breath and wondered if he was serious. He admitted it seemed a crazy move, but the decision reinforced his reputation as an autocratic leader. He owned the airline and called the shots. As a result of his management style, he has been labelled the Michael O’Leary of Japan, after Ryanair’s famous CEO.

The order, initially for four aircraft and later increased to six, was signed in February 2011. Soon afterwards, Skymark announced another radical move. The airline would introduce the A330 on domestic trunk routes, configured with single class premium economy style seating - Green Seats - in a spacious 271-seat cabin. The fares were to be cheaper than at All Nippon Airways (ANA) and Japan Airlines (JAL).

Suddenly, Skymark was the focus of attention – and Japan’s premier Airbus customer. But Nishikubo did not hedge the currency cost, leaving Skymark vulnerable.

By coincidence rather than design, the aviation industry environment in Japan began to change. Influenced by foreign LCCs, which were being cleared for operations in Japan in greater numbers, Japanese investors did the unthinkable and launched budget carriers.

In 2011, three new ‘made-in-Japan’ LCCs announced they would start business in 2012. Nishikubo responded by expanding domestic regional services, rather developing his trunk route resources, a decision that did not turn out well.

A major mis-step was Skymark’s establishment of a base at Narita in October 2011, where two of the new LCCs, AirAsia Japan and Jetstar Japan, planned to start operations in 2012. Skymark had to tackle its cheaper competitors head on.

Skymark’s Narita overheads and its fares were higher than the LCCs. Passengers failed to materialize, load factors plunged. Losses mounted. In its 2013 fiscal year, Skymark carried fewer passengers than in the previous year.

Expanding regional routes cost Skymark dear. In 2009, the proportion of regional routes to Skymark’s total seat supply was only 15%, with the key trunk routes providing 85% of its business. Within three years, the ratio of regional seats to trunk routes had leapt to 65%.

Politics came into the picture. In late 2012, the Liberal Democratic Party returned to power and the new prime minister, Shinzo Abe, launched his “Abenomics” policy to boost the stagnant Japanese economy. A weaker yen was part of the strategy and this negatively impacted on the airline by driving up fuel and equipment prices, which was a serious blow to Skymark’s strategy.

With the Japanese yen 20% weaker than in 2011, the costs of preparing for the introduction of the A330 and the A380 escalated. Preparations included pilot training, as both types are new to the airline – and to Japan. Skymark’s training programmes were meticulously operated, but very expensive.

In the year ending this March 31, Skymark reported its first loss for five years, at 1.8 billion yen, on revenue of 85.9 billion yen. The first quarter of the present year, from April to June, recorded an operating loss of 5.7 billion yen.

In April, Skymark entered into discussions with Airbus, with the intention of renegotiating its orders with the Toulouse manufacturer. According to reports, the carrier had been asking for delays and reductions in the number of planes ordered.

It appears Airbus had decided to terminate the contract after concluding Skymark would not be able to meet the original payment terms for its ordered aircraft. The airline had paid Airbus 26 billion yen, but additional stipulated payments required by the contract had not been made.

Skymark rejected Airbus requests to join an alliance or form a partnership with another, bigger airline. The plan to introduce A330 aircraft with one-class premium economy seating on key domestic trunk routes finally got off the ground on June 14 on the Tokyo (Haneda) – Fukuoka line, but only after many postponements.

Critics of Skymark said the introduction of the A330 ‘premium service’ diverted investment and management attention from the A380 project. Plans to introduce a much-needed frequent Flyer Programme were shelved, while the A330 and A380 service preparations went ahead. At one point, Skymark also thought about increasing seat size and leg room on its 737-800 aircraft, but dropped that plan.

Inside the company, there was skepticism about the introduction of the A380. Financial issues apart, many managers believed it was an operational challenge to launch A380 services to New York so close to the commencement of the A330 domestic flights. In June, Skymark announced a six-month delay to the commencement of A380 flights because of cabin specification issues.

Skymark’s flight operations and technical departments had their hands full with the A330 launch and believed the A380 debut would inevitably have had to be postponed. The company simply didn’t have the in-house systems or organization to operate overseas scheduled flights, whatever the aircraft.

According to insiders, Nishikubo did not understand the difficulties of introducing a completely new aircraft into an airline. In addition, the Japanese regulatory authorities had no experience of the A330 and the A380. Skymark’s cost analysis of the A380, in particular, was insufficient. The planning section did not even know the fuel consumption.

So, will Skymark survive? Yoshihisa Akai, founder and chief analyst of think tank, Japan Aviation Management Research, is positive on the issue, but thinks the airline needs to go back to basics.

“Skymark bit off far more than it could chew with the A380 order. In addition to the financial issues, the idea to introduce such big aircraft in an unknown environment for the airline was reckless,’’ said Akai.

Usually, airlines launch international services after starting with domestic flights, moving from short to medium range services and later expanding to long range routes. Skymark’s ambitious plans raised doubts from the very beginning. Long range international operations need developing cockpit and cabin crew and the provision of maintenance and engineering support, said Akai.

“Operations apart, there’s the marketing aspect. An international airline needs good connections with other carriers such as alliance partners. But Skymark has no network,” he said.

On the A330 ‘Green seat’ domestic trunk route flights, Akai is skeptical. “Skymark is offering more spacious seats than its competitors, but that means the number of seats must be reduced,” he said. “To absorb the higher cost per seat, the ticket cost per passenger has to be increased. It depends on the fare range, but to be profitable with a 271-seat A330 cabin at current fare levels, it has to achieve a load factor above 80%. That’s a tall order,” he said.

“Skymark could solve its financial problems by forging links with other airlines, but to date they have maintained a ‘stand alone’ policy. They may wish to stay that way.”