Fasten your seatbelts: cutting costs, TAM Airlines follows low-cost Gol's model to cater to Brazil's growing airline business.

Lucas Oliveira arrives with his parents at the check-in counter at an airport in Congonhas, Sao Paulo prior to departing for Florianopolis. in Santa Catarina state. The airline employee checks the boy's document to find it's his 10th birthday He shares the information with a tall, agitated man, who runs to a microphone to inform the hundred passengers in line that it's Lucas' birthday and asks that everyone join in singing "Happy Birthday." It's that kind of spirit that has helped Gol Linhas Aereas Inteligentes, a Brazilian low-cost airline, to conquer 22% of the domestic market since its startup in January 2001.

The man at the microphone, Wandrey Passetto, is Gol's airport director. He moves among 19 fully staffed counters in an area he calls "the war zone" Going by the nickname Xando. Passetto is the brains behind Gol's combination of party atmosphere and efficiency at the check-in counters. "This is the moment of truth. The employees have to be quick, happy and do everything. Gol's style is the style of the future" says Xando.

For rival TAM Linhas Aereas, the future has already begun. The domestic leader, TAM controls 35% of the market. It nevertheless has faced up to the task of battling stiff and innovative competition from Gol, an advance by regional airline OceanAir and the whatever crisis that could be provoked by its longtime, yet ailing, competitor Varig. TAM earned more than US$103 million during the nine-month period ending in September 2004. a 236% gain over results posted during the same time in 2003. "We are experiencing a very favorable market for worldwide air transportation and very strong growth in the domestic Brazilian market," says Marco Antonio Bologna, president of TAM.

To cut costs, Bologna did not shy away from studying his sudden competitor, Gol. "We even copied some parts of it" he says, Competition between a company that is restructuring, such as TAM. and another under construction, like Gol, could help both companies fly higher in the future, Bologna asserts. "We are the major competitors, the big players fighting over the domestic market," he says. While TAM has made headway in cutting costs, Gol has raised the number of flights and routes it provides.

Both companies aim to grow and to do so by learning from the good examples set by all of their competitors, yet not stray from their own business models: TAM focuses on the executive traveler while Gol, because of its low fares, tends to appeal to ordinary individuals. "You want to kill TAM's character? Then do this: Get rid of the red carpet at the airport.

The day that happens is the day TAM is done for," says Bologna. The way in which TAM relates to its customers is based on high levels of service geared to executives with direct flights and a larger number of destinations. The low-cost business model, on the other hand, competes more on price than on convenient departures, TAM's goal is to offer better service at a price that is only slightly higher than that of its rival. The company lowered fares to 25% more than Gol's average prices, then to 12%. The airline's plan is to keep cutting costs until the difference is down to single digits.

Lessons learned. Bologna says he hasn't forgotten the effect that the Sept. 11 terrorist attacks had on passenger traffic, oil prices and security costs, but he points out that all of these factors also accelerated changes that were a long time coming. "New concepts were already being introduced to the market, independent of September 11: The low-cost, low-fare model, which showed a new way for airlines to operate at lower costs, to enter the market with competitive prices and slowly catching up to traditional airlines, which had to undergo a process of adjustment and reengineering." TAM was just taking on that tough task soon after preparing itself for a domestic air travel boom--expected between 2001 and 2003--that never took place. The company meanwhile took delivery of 39 new Airbus aircraft, in retrospect an expensive choice given the immediate decline in air travel after the attack on the United States.

After spending some time in the red, TAM started on a tough restructuring plan at the beginning of 2003. Cuts to the employee roster were deep, including firing nearly 200 pilots and co-pilots. "We cut back on a valuable, hard-to-replace workforce in which we had invested strongly in terms of training. But it was necessary. We had no other way out[ says Buy Amparo, technical and operational vice president at TAM. A pilot, for example, spends nearly five months training to meet TAM's specifications, while equipment costs, mainly flight simulators, cost the company between US$15,000 and $20,000 per team of pilot and copilot.

Layoffs aside, the company dramatically cut its domestic routes, suspended some international routes and implemented a code-sharing plan with Varig to maximize its use of flight schedules. The year 2003 was a year of great change, Bologna says, and TAM moved from posting losses to making money. "In 2004, we had to diligently continue our search for efficiencies, and the great challenge for 2005 is to maintain leadership, irrefutably so, in the domestic market," he says.

Amparo breathes a sigh of relief now that hiring has begun again. "All the copilots laid off are now back on board, If we continue growing at this pace, in 2005 we will begin to bring back the pilots," he says. To keep costs down and to be able to face its competitors with greater efficiency, TAM is investing in infrastructure, including opening a technology center in Sao Carlos, in the interior of Silo Paulo state. The center will do all of the major maintenance work on the Airbus and Fokker aircraft in the fleet, which in the past was done outside Brazil. "Sao Carlos can service Brazilian and foreign aircraft, like those owned by LanChile, which has the same kind of aircraft that we do, the [Airbus] 320," says Amparo. The 4.6 million-square-meter complex will require a $35 million investment during the next five years. Last year, the company cut costs by $5.5 million, plus an additional $4 million by buying parts made in Brazil.

Bologna's take on the numbers back up his optimistic forecasts for TAM. "There are 180 million Brazilians, 34 million of which fly each year and close to 12 million flying three times in the period, if 24 million people started flying, the Brazilian market would double," he says.

Besides flying cheap, Gol has bet an improving Brazilian economy will make it grow even more. It has reason to celebrate. Last year, the airline flew its 20-millionth passenger, of which 5.2 million traveled in the first quarter alone. In terms of capacity, Brazils third-largest airline flew its planes 71% full during the first eight months of 2004, compared to the 65% average for the entire sector. Net income was $34 million for the third quarter of 2004, which brought year-on-year earnings at the time to $91.4 million, more than double earnings by September 2003. The company is neck-and-neck with Irish carrier Byan Air for the title of most profitable airline in the world.

Gol bet on the low-cost model early, when it was something new in Brazil. For Tarcisio Gargioni, vice president of marketing, research and services at Gol, the formula is simple: "Make it easy to buy, demystify the glamour of flying, price, reliable planes, good service with a smile and simplicity." Backed by this philosophy and the slogan 'Anyone Can Fly," Gol reports that 9% of its passengers are flying for the first time in their lives. "This is a democratization process. Through research, we found that these people really wanted to fly but they are afraid of the unknown," Gargioni says.

To keep cost down, 74% of the company's passenger sales are made on the Internet. The company works with 25 Boeing 737-700 or 737-800 aircraft and has another 18 due for delivery in 2009, as well as the option to acquire another 24. "In 2006 and 2007, we could renew the fleet, if the market grows and we have the opportunity to fly to new destinations, these 24 options could become firm orders." says Gargioni.

Gol seems to be in quite a hurry to grow. In 2004 the airline lofted a successful initial public offering on the Sao Paulo and New York stock exchanges and drew up plans to go international in 2007, beginning with two daily flights from Sao Paulo to Buenos Aires. Gol expects to offer travel across South America in the same way it serves its 30 destinations in Brazil from Sao Paulo to Manaus, which is not much of a stretch considering the distances it would have to fly abroad are the same as those it already flies inside Brazil's borders. "We believe that it is possible to fly around South America with the same model under which we operate in Brazil," says Gargioni.

New breed, Cutting cost to the bone is the hallmark of another new breed of Brazilian carriers, known as regional airlines. Launched in March 2002 to cater mainly to the oil-related businesses in Bacia de Campos, OceanAir is already the fastest-growing regional airline in the country. A unit of Brazilian conglomerate Grupo Sinergy, it services more than 30 cities in 10 states with passenger growth up a reported 230% from January to April 2004 compared with the same period a year earlier. The growing economy and the reduction in coverage area, once dominated by the larger carriers, has opened the doors to regional airlines. Since Brazil is bigger than the continental United States in landmass, there are great opportunities for start-up airlines to serve routes to the interior.

OceanAir's owners are still building their business, but it is nevertheless bringing in $2.5 million a month in revenues on 1,000 passengers a day. The fleet consists of 10 turboprop aircraft, manufactured by Brazilian plane-maker Embraer and Germany's Fokker, catering to a market in which 50% of the runways aren't big enough for a modern jet to land. For that reason, OceanAir has signed operating agreements with TAM and Gol. "We bring passengers from the interior to a large capital to make their connections. Our goal is to provide service to areas that were in one way or another abandoned by other companies," says Jorge Vianna, OceanAir vice president. The regional airline's formula also calls for crossing borders. In November, OceanAir announced it would take a 75% stake in Colombian carrier Avianca (the other 25% stake stayed in the hands of the National Federation of Coffee Growers of Colombia).

In the deal, OceanAir assumed Avianca's $220 million in restructured debt and capitalized the company to $63 million. Upon closing the deal, OceanAir could then connect the northern Brazilian cities of Recife and Salvador with international destinations such as New York by flying through Bogota. "Avianca's plan includes the possibility of doing this from the northeast to Bogota. The northeastern market lacks international flights. Code-sharing is also possible," says Vianna. Independent of Avianca, the region north of the Bio-Sfio Paulo axis has become a priority for OceanAir. "It's an attractive market. The distances are great and the aircraft is an important means of transportation" Vianna says.

Turbulence. Despite the optimistic forecast, such success stories usually are hard to come by in the Brazilian airline market. Vasp suffered serious problems with heavy debt, delayed salary payments and an ailing fleet. At the end of last year, the carrier's share of the domestic market fell to just 1.39% and some creditors have called on the company to declare bankruptcy. Nevertheless, the most emblematic example of the changes taking place in the Brazilian airline business has been the case of Varig.

A traditional airline, it has struggled under the weight of serious accumulated debts following Sept. 11, a devaluated Brazilian real and high fuel prices. Weighed down with debts nearing $1.8 billion, Varig is struggling to regain domestic routes and to defend its first place spot in international flights even as Gol and a reinvigorated TAM tighten their grip on lucrative routes.

The president of the national airline employees' union, the Sindicato Nacional dos Aeronautas, Graziella Baggio, says Brazilian President Luiz Inacio Lula da Silva's decision to step in to save the company is the right one: "President Lula has publicly declared it necessary to find a way to keep Varig operating. It's a national resource and a business with 75 years of history that can't be written off."

The Brazilian government is committed to saving Varig, and at press time the method most likely to occur seemed to be an official intervention in the company. One idea is to remove the Rubem Berta Foundation, Varig's controlling entity, and take charge of the airline, guaranteeing jobs and existing flights while creating a new, healthy--yet not state-run--airline, called "Super Varig." Yet Varig's reported net profit of $91.7 million during the third quarter of 2004 barely enabled it to begin paying down accumulated losses of more than $100 million reported during the January-September period of last year.

Some in the government believe that Varig could be profitable, yet they recognize that the airline's debts are nearly impossible to pay. Executives at TAM and Gol declined to comment on Varig's problems. Behind the scenes, the two companies are quietly negotiating with the government the possibility of taking control of Varig's national and international market share without taking on its overwhelming debts. Other pending items for Varig include the airline's employees pension fund and mileage credits owed to thousands of Varig frequent-fliers. On top of these unknowns, internal disputes rage inside the government itself over the best course for the former airline giant, a sure sign that progress will be slow at best. The battle to save Varig could turn out to be a long flight with many stops along the way.

CARLOS ADESE

SAO PAULO