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Top>Opinion>Challenges for Aviation Reorganization toward Upcoming Full-Scale Liberalization: JAL Revitalization and Responses to the Open Sky


Eiji Shiomi

Eiji Shiomi [Profile]

Challenges for Aviation Reorganization toward Upcoming Full-Scale Liberalization:

JAL Revitalization and Responses to the Open Sky

Eiji Shiomi
Professor of Transportation Economics, Public Economics, Physical Distribution and Logistics, Faculty of Economics, Chuo University

1. Faltering decisions on the revitalization plan

The revitalization plan for Japan Airlines (JAL) has not been finalized yet. As a result of a series of discussions, the failed JAL is going to be restored through pre-arranged, pre-package-style early revitalization measures—applied for the first time in Japan—in lieu of traditional corporate rehabilitation processes. While some argue that these measures will not lead to fundamental revitalization, implementing such measures should be considered as vital in order to maintain public services and the continuity of flights, given that it is impossible to find alternative services immediately. It has already been three months since JAL filed a petition with the Tokyo District Court for protection under the Corporate Rehabilitation Law and Enterprise Turnaround Initiative Corporation (ETIC) and a judgment was rendered to provide such assistance to them. Initially, a draft of the revitalization plan was supposed to be submitted to the court in June. The parties concerned are engaged in ongoing negotiations, however, regarding how JAL should be restructured. Whereas JAL and their trustee ETIC developed a revitalization plan that incorporates reduction in the operational size and reform of the organization, their bank syndicate and the Ministry of Land, Infrastructure, Transport and Tourism requested further restructuring. Moreover, JAL still holds unstable business structures that will not help improve operational income. All of these factors have resulted in a two-month delay in submitting the draft.

Based on this situation, I will discuss below what drove JAL into bankruptcy, how and in what direction JAL should be revitalized, and what issues need to be addressed amid a market environment in the Asian aviation industry where full-scale liberalization is imminent.

2. Causes of the JAL bankruptcy

While the causes of the JAL bankruptcy involve multiple factors related to the management structure, they can be summed up in the following three points: (1) Its aviation business was largely dependent on international routes that had high volatility and unstable profitability; (2) limited productivity improvements and restructuring failed to compensate for these shortcomings of international flights; and (3) some business models and traits of the company were not well suited to the competitive market environment. The recent international aviation market has been strongly impacted by risk factors in the short and medium term. SARS and the series of terrorist attacks substantially decreased income for every major international aviation company. The world financial crisis that was triggered by the Lehman Shock also exacerbated their decline in profits. These factors had a direct impact on businesses because aviation services are instantaneous goods, whose production cannot be adjusted though inventory. The situation is compounded by the cumulative burdens of fixed costs for network deployment as a means of competition strategies. In order to survive in the international market, aviation companies need to be equipped with strategies and corporate structures that enable them to address these risks. JAL lacked such structures and organizations as well as adequate levels of productivity.

Since the privatization in 1987, JAL had not accomplished the level of governance appropriate for a private-sector company nor did they centralize their decision-making processes. These inward-looking organizational structures delayed responses to the market, resulting in a vicious circle. They also failed to concentrate investment that was required for improving income, leading to an avoidance of identifying and cutting unprofitable parts of their business. These failures are reflected by lagging updates of aircraft equipment, which involve many interconnected cost factors. As a result, troubles have occurred frequently, cost burdens aggregated, service levels deteriorated, and eventually profits further declined.

3. Challenges for revitalization and improvements in competitiveness

Given the public assistance of as much as 1 trillion yen in total, the size of business must be properly re-designed to ensure economic feasibility of each flight. The key is improving productivity. Such improvement would require establishing specific numerical targets and operational environments that allow sharing information on productivity within the company as a whole—from field to the management. At this moment, however, they have not been sufficiently established. It has been pointed out that Japanese major aviation companies entail extremely high unit costs for their flight operations, which are about 1.5 times more than those of other Asian major airline companies, and approximately 5 times larger than those of AirAsia, a typical Low-Cost Carrier (LCC). Amid the progress of the Open Sky negotiation and other rapid movement toward the liberalization of aviation in Asia, an important issue would be to narrow this gap as much as possible. On the other hand, the corporate structure is urgently required to have flexibility enough to address drastic changes of the management environment. Lacking ample historical data, flight operation plans should incorporate effective implementation of system management for optimizing passenger revenue according to downsized equipment and management for optimal assignment of devices. As for the operation of international routes facing severe business environments, some maintain that it is appropriate to integrate them into those of All Nippon Airways (ANA) in the future. I believe, however, that the Japanese duopoly system of international flights consisting of two aviation companies should be maintained in order to retain the effects of competition. In the first place, any governmental intervention toward such integration is unjustifiable, and it should be avoided—given the process through which international flights were divided into multiple air carriers in the 1980s—as maintaining the competitive order within the industry is crucial.

In terms of policy, the airport system must be reformed. Exorbitant airport charges including landing fees and taxes and public fees such as the aviation fuel tax have hindered competition. The airport charge structures should be modified so that they can flexibly adapt to downsized equipment that will be common in the near future. The aviation fuel tax also has to be revised because the tax's primary purpose is deployment of airport networks, which have already been established. In addition, while the airport charges are ultimately shifted to passenger airfares, passengers cannot know in the portion of their payment that is equivalent to the charges under the current system. I maintain that the rate structures need to be changed for more balanced and transparent cost-benefit relationships. One option would be accelerated introduction of air facility charges. Above all, the overall operational and financial systems of airports, which are maintained through pooled funds under the special account for airport improvement, have caused weak governance and inefficiency in airport operations.

4. What styles of airport operation are called for?

A characteristic of Japanese airport operations is that the main area, the terminals, and the parking lots are operated separately in airports around the country under the special account for airport improvement, except for the Narita, Chubu, and Kansai International Airports. In contrast, it is common overseas that the operation of those facilities is consolidated in each airport. Separate operation would be irrational in terms of externality and economies of the scale of those facilities. Last year, a special project in the Aviation Policy Research Association—of which I am chairperson—estimated and reported in briefings, symposiums, and documents of the income-expenditure balances for airports nationwide, assuming that those facilities are operated in an integrated fashion. Such estimation had not been attempted before that. It is necessary that this kind of investigation be continued in order to categorize airports by size or profitability based on the number of annual users and to transform the style of airport operation into ones based on privatization or private resource mobilization. Public airports which are indispensable in daily life would additionally demand public support or other measures. Clearly distinguished from these, other airports with extremely low use and profitability should be potentially shut down or liquidated. These airport system reforms and operation styles must be fundamental and rapid, otherwise Japanese aviation companies will continue to lose their competitiveness and be left behind the wave of aviation liberalization throughout the world.

Eiji Shiomi
Professor of Transportation Economics, Public Economics, Physical Distribution and Logistics, Faculty of Economics, Chuo University
Professor Shiomi was born in 1947 in Fukuoka Prefecture. He received his doctoral degree in Economics from Kobe University and is currently a Professor at the Faculty of Economics in Chuo University. He graduated from the master's course at the Graduate School of Commerce in Waseda University and left school at the time limit for obtaining credits for the doctoral course at the Graduate School of Economics in Kyushu University. He has been a visiting scholar at University of British Columbia from 1993 to 1995. He specializes in Transportation Economics and Public Economics. Professor Shiomi's major publications include Studies on the United States Aviation Policy [Beikoku Koukuu Seisaku no Kenkyu], Theories of the Modern Logistics System [Gendai Butsuryu Sisutemu Ron] and many other books and articles. He has been President for The Japan Society of Research and Information or Public and Co-operative Economy (Japan-CIERIEC) and is currently Vice President for The Japan Society of Transportation Economics. He also serves as a member of many committees and research projects related to national and local governments.