Air Battles of the Andes: small country airlines seek to sum markets to compete with the megacarriers. (Trade Lanes).

Enrique Cueto, chief executive of LanChile, doesn't even like to set up subsidiary airlines. "Why should we need to look for a partner and create a company in each country? You don't get the best synergies this way," he says.

Yet he and Federico Bloch, head of Grupo Taca, have spread their airlines through ore of Latin America this way than any other carrier in the region. The reasons are simple: Nations do not let foreign airlines carry their domestic passengers and will only let them service international routes under a bilateral agreement. These airlines, based in small Latin countries, also need to amass size through cross-border deals to compete with the world's megacarriers.

The strategy of choice is to buy or build an airline in a neighboring country. Then the related airlines operate hubs in both countries. Using this technique, El Salvador-based Grupo Taca has become an alliance of six airlines with local feeders in Central America and Cuba plus Taca Peru. LanChile has been less prolific but equally effective with LanPeru and, until recently, a close affiliation with Ecuatoriana de Aviacion.

Brazil's VASP, owned by Wagner Canhedo, tried this same approach in Ecuador and Bolivia but failed. Ecuatoriana, its former partner, is now in receivership, while Lloyd Aereo Boliviano (LAB) floundered under VASP control until Ernesto Asbun, a Bolivian businessman, bought it out. LAB is now poised to expand on its own. Peru's AeroContinente is the only other Latin airline that has aggressively tried to follow this growth-throughsubsidiaries model.

These strategies have started a battle of surrogates up and down the spine of the Andes from Chile to Ecuador: three major airlines--LanChile, Grupo Taca, and AeroContinente--seeking advantage over the other two. So far AeroContinente's efforts have been rebuffed, Cueto and Bloch are facing off in Ecuador.

Carlos Morales, AeroContinente's president, is fighting fiercely against hard-ball tactics and, rightly or wrongly, his airline's own reputation. In the late 1990s, AeroContinente destroyed its Peruvian rivals with low fares they could not match. Sore losers claimed that Fernando Zevallos, AeroContinente's owner, was subsidizing low fares with drug trafficking. Investigation of those charges by the U.S. and Peruvian officials yielded nothing--and Zevallos has long since sold his stake in the airline to other family members.

When AeroContinente launched a subsidiary in Chile two years ago, local authorities launched the first of three investigations into the Peruvian carrier. First it was alleged predatory pricing, a charge dropped after lengthy proceedings. Then it was alleged money laundering and links to drugs. As part of the court battle, a Chilean court grounded AeroContinente in Chile, arrested its officers and seized its assets. Thirty seven days later, higher courts reversed and the case was closed. The airline, after having lost its entire market share, was allowed to fly again.

No sympathy at home. Still clawing its way back, AeroContinente finally succumbed in June to safety violation claims in Chile. Local authorities grounded it again and revoked its license. As a result, the Chilean subsidiary went into bankruptcy. The only thing AeroContinente has left in Chile now is a US$1 billion lawsuit against the government.

The Zevallos family sought sympathy back home for the way Chile treated their subsidiary. They explained how Chilean authorities had waged what they called a two-year campaign against AeroContinente, how both predatory pricing and money laundering charges had evaporated after costly proceedings, and how, according to them, the safety charges were also trumped up.

Through diplomatic channels, Peruvian officials asked Chilean authorities to respond to AeroContinente's allegations. Peru filed a protest, but it did not find enough evidence in Chile's reply to justify action against LanPeru, LanChile's Peruvian subsidiary.

During a recent visit to Santiago, Peru's Transport Minister Luis Chang Reyes told local reporters, "Retaliation is not a valid reason to ground an airline."

Thus, AeroContinente's foray into Chile and its attempt to roll back LanChile's entry into Peru both failed. The battle then shifted north, to Ecuador.

Ecuador has lacked a functioning flag carrier since Ecuatoriana's aircraft were repossessed two years ago. LanChile stepped into that breach with a combination of wetleases (leasing its jets with crews to Ecuatoriana to operate Ecuatoriana flights) and code shares (designating a flight operated by LanChile as both a LanChile and Ecuatoriana flight). Thus, LanChile effectively provided air service for Ecuador to the United States.

LanChile never had any interest in owning Ecuatoriana. Buying a debt-ridden airline already in receivership is a waste of money, Cueto says, because it simply pays off old debts. "If you are going to use fresh money to pay that debt, you don't have the money to do anything else," he says.

So LanChile was content to use Ecuatoriana's name and route rights until government officials found a longer-term solution.

Canhedo's wake. Fresh from defeat in Chile, AeroContinente President Carlos Morales saw a chance to upset LanChile's cozy alliance in Ecuador. AeroContinente officials flew to Quito with a surprising $7.1 million offer to buy 70% of Ecuatoriana and assume its $35 million in debts. Here was a potential white knight. Ecuatoriana could wipe its slate clean and relaunch with an experienced new partner. True, that partner was not Ecuadoran, but neither was LanChile nor Ecuatoriana's previous partner, Wagner Canhedo, the head of Brazil's VASP.

But there were legal issues about Canhedo's shares, and Ecuador was not willing to confront them. Antonio Pere, executive director of Ecuador's National Council of Modernization, explained that the government lacked authority to sell those shares, so it would have to reject AeroContinente's offer.

That reasoning itself is debatable, but then the national council of civil aviation further clouded the issue. In mid-2002 it revoked Ecuatoriana's license and awarded all its routes to LanChile for the next 12 months. Joaquin Martinez Amador, council president, did not explain what warranted pulling Ecuatoriana's license when it had not flown for two years. He only said that Ecuatoriana's debts were mounting, and that it needed to restructure. But both had been true for two years.

For the unprecedented award of routes to a foreign airline, Martinez explained that Ecuador needed LanChile to serve the United States until Ecuatoriana could recover and take its own routes back.

Observers were still trying to fathom what was behind these decisions when Grupo Taca resurfaced. Several years ago Federico Bloch had declared an interest in Ecuador, but nothing came of it. Bloch has never said it, but LanChile's alliance with Ecuatoriana started around the same time and probably dissuaded him.

AeroContinente's bid for Ecuatoriana apparently prodded Bloch to dust off his Ecuador plan. Grupo Taca has now applied for and obtained authority to fly from Quito to San Salvador and the United States. Taca Ecuador, as the new airline will be called, still needs an operating license, but with that Grupo Taca will have more hubs in more countries than any other Latin American airline.

Cueto has responded in kind. LanChile has now obtained Quito's approval to ply the Ecuadoran-U.S. routes under the name LanEcuador. Because of geography, LanChile has always been interested in the long-range, north-south routes, and LanEcuador would fit that pattern.

Authorities in Quito appear poised to give operating licenses to both Taca Ecuador and LanEcuador. Smaller Ecuadoran airlines--TAME, Lineas Aereas Nacionales del Ecuador (Aerolane) and VIP--also want part of the action.

Still, no one is counting AeroContinente out. It's back with a new proposal to operate Ecuatoriana's routes on at least an interim basis. It is also talking about entry through TAME or one of Ecuador's smaller airlines. AeroContinente has Little so far to show for its effort, but Carlos Morales is anything but a quitter. Setbacks are harder to live down than old rumors.