This article first appeared in The Edge Malaysia Weekly on December 18, 2017 - December 24, 2017

JAPAN Airlines (JAL) expects to see growing passenger demand between Southeast Asia and the US, driven by rising incomes and population growth in this region. The Japanese airline has targeted 5% annual growth in its international capacity from the fiscal years ending March 2017 to 2020.

“We are at an advantage as an airline in Japan because, geographically, this is an important connecting point between Southeast Asia and the US. If I say Hong Kong, it makes more sense to fly direct to the US. When I say Southeast Asia, it is down south — Vietnam, Malaysia and Thailand — it is too far to fly direct so it makes sense to make a connection at a convenient airport in Japan,” Norikazu Saito, JAL’s director, senior managing executive office for finance & accounting, tells The Edge in an interview in Tokyo.

He notes that various forecasts see the number of passengers travelling between these two geographic areas growing at the highest level of 5% to 6% per annum.

The airline’s focus on Southeast Asia and the US forms part of its medium-term management plan for FY2017 to FY2020, whereby its profitability targets are to achieve an operating margin of 10% or above each fiscal year and return on invested capital of 9% or above by FY2020.

Aside from rising demand for travel between Southeast Asia and the US, JAL is banking on additional capacity arising from the Tokyo Olympic Games in 2020.

“There will be additional capacity and landing slots available for international operations in Haneda [Airport], so we would like to capture these business opportunities as well,” Saito says, adding that although JAL’s target of 5% annual growth in international capacity is higher than its actual growth in the past five years, it is in line with market expectations. “It’s not too ambitious, just an adequate rate of growth into the future. So we will be adding fleet and routes.”

JAL emerged from bankruptcy in March 2011, after 14 months of corporate reorganisation proceedings under the Corporate Reorganisation Act, and was relisted on the Tokyo Stock Exchange on Sept 19, 2012.

Saddled with US$25 billion of debt, it filed for financial assistance from the Enterprise Turnaround Initiative Corporation of Japan (ETIC) and petitioned for reorganisation proceedings on Jan 19, 2010. In the reorganisation, its business shrank 60% as unprofitable routes were cut. The number of companies within the group was halved and staff numbers fell 40%, resulting in a 20% drop in personnel costs.

A new corporate policy was established and the JAL Philosophy was adopted and the “amoeba” management system was introduced.

As a result, operating income for FY2011 reached ¥204.9 billion, allowing JAL to repay the financial support from ETIC in full.

Its initial public offering in 2012 raised US$8.5 billion and was the world’s second largest that year, after Facebook’s US$16 billion IPO.

JAL has remained profitable since, posting operating income of ¥170.3 billion in FY2016 (for year ended March 31, 2017).

“The business model we used to pursue was economies of scale — the widespread belief was the bigger the better. The more capacity we have, the more efficient we can be. But that model was not successful. That model was vulnerable to risk events such as war, terrorist attacks and economic crises like the ones triggered by the Lehman shocks. When those events occurred, we saw a sharp drop in demand and we had such a high level of fixed costs that it was very difficult to recover,” recalls Saito, who has been with JAL since 1980.

“The management style we have now is to pursue efficiency and profitability. We believe in having an adequate network of routes but we are also very prudent in opening new routes. We do a careful study beforehand and make sure it is going to be profitable.”

Saito also credits the contribution of Kazuo Inamori, founder of electronics firm Kyocera Corp, who at 77 years old was brought in as chairman of JAL in 2010. He retired in 2013.

“He taught us the profitability management model that works very efficiently at JAL now — each department has its own income statement so each department will be able to always realise and be aware of the profit it is making and the contribution to the entire organisation,” he says.

In a monthly management meeting, each department reports on its performance in comparison to its earlier plan. The plans are reviewed and revised as necessary.

“So we are very flexible to changing environments. The leader of each department is required to maximise profit but is also encouraged to make long-term value enhancements,” Saito explains, adding that the process is not confined to the top management. “Everyone participates, every young person.”

Saito attributes JAL’s consistent profit track record to the quality of its products and services, as well as its disciplined approach to capacity expansion.

“First and foremost, our product was well received by customers, of superb quality both in terms of hardware — our Sky Suite is probably one of the best in the world — and software: the quality and level of service we provide. For example, we rank No 1 in terms of on-time performance worldwide,” he says.

Since emerging from bankruptcy, Saito says, JAL has been cautious and prudent in growing its capacity, resulting in moderate capacity growth. As at March 31, it had a fleet of 230 aircraft.

Its load factor on its international routes was 80.3% in FY2016, compared with 70% about five years ago. The load factor for its domestic routes has risen to 70% from 60% earlier.

“So we have utilisation of capacity. Those things turn into a much higher unit price per passenger compared with our competitor. [We have] fewer seats on the aircraft that give wider space for each customer, and comfort. There is a risk in doing that, because if you cannot sell the products at a higher price, you end up bearing the cost without charging a high enough price. But we are able to do this because of the quality of service we are providing,” Saito explains.

Instead of going down the low-cost route, JAL went up market after the restructuring by offering wider seats, better food and service, among other things. It launched the JAL Sky Suite in 2013 soon after its listing. The business class Sky Suite seats are wider and offer comfort and privacy to passengers.

“There was a big debate within the company, whether to go for wider seat and higher price or smaller seat with a discount price,” he says.

In the end, while other airlines might be tempted to fill their planes with many seats and offer a lower fare, JAL was confident it could capture high-yield business travellers who are willing to pay a reasonable price for comfort.

“We wanted to have passengers feeling comfortable on our aircraft and we were very confident to provide super quality services. It’s a bit of challenge but we were also confident to charge an appropriate level of airfare for passengers to enjoy a bigger space, and it’s been working well.”

During JAL’s reorganisation, its competitors, including Japan’s low-cost carriers, had the opportunity to expand. When it emerged from bankruptcy, it was seen as a challenge for JAL to move into the LCC segment. Nevertheless, it took up a 33% stake in Jetstar Japan.

Saito says the move was driven by its desire to have a foothold in the business, even though it is not to JAL’s competitive advantage.

“We also have a code share agreement with Jetstar Japan so passengers carried by Jetstar Japan can be transferred to JAL on international routes.”

LCCs thrive on short-haul routes but struggle with long-haul flights. Hence, Saito does not see LCCs encroaching into JAL’s space.

“In conclusion, LCCs and full-service carriers like JAL are co-existing nicely and [they are] not posing a competitive threat to us. Our travellers are business people and even the leisure traveller, who is willing to pay for comfort and quality and other services,” he says.

Although JAL achieved its targets — operating margin of 10% or above for five consecutive years and an equity ratio of 50% or above by FY2016 — as set out under its medium-term management plan for FY2012 to FY2016, it was off the mark in its target of zero accidents for five years as one aircraft accident occurred in FY2016. As for customer satisfaction, JAL fell short of its target for domestic flights.

Under the management plan, it has identified two growth drivers. First, to improve its services and routes via the expansion of international routes operated with JAL Sky Suite-configured aircraft. The second growth driver is the expansion of its airline-related businesses such as airport handling and aircraft maintenance, as well as in the travel agency and credit card sectors.

JAL has targeted a revenue increase of 10% and 30% respectively in its core and new business domains in FY2020 compared with FY2016.

Saito is confident JAL’s performance can be sustained as it is in a better position to withstand external shocks now than it was previously.

“Also, the demand structure is changing in a positive way. We have a very stable stream of Japanese customers but, on top of that, we have a fast-growing number of people from overseas flying to Japan. The number of inbound passengers is growing at a more than double-digit percentage each year. It is helping us a lot to diversify the risk as well,” he concludes.

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