The Japanese connection on US airlines in the Philippines

The Need for Stop-over in Japan

April 13, 2009

In the 90's United Airlines used to grace the Philippine skies by flying to the mainland US via Japan and Guam but because of the new aviation treaty between Japan and the United States of America in 1998 it removed United's fifth freedom right because the Philippines has only one flag carrier. But for United Japan was the most lucrative Asian route with plenty of premium passengers. And bless with its geography, Japanese hub in the Asia Pacific region is essential for its survival.

As previously agreed by the American and Japanese governments, only three (3) carriers has fifth freedom rights out of Japan, namely Northwest Airlines, United Airlines and Federal Express per 1952 aviation treaty. The beyond rights or flying right to third country destination covers only three U.S. carriers to supposedly compete in the Japanese market on a level playing field with their counterparts, with Japan solely represented by Japan Airlines (JAL). These airlines are known as "incumbent" carriers in the industry. While American, Delta and Continental Airlines were considered outsiders with limited rights to Japan.

PAN AM is the first international airline in the Philippines having started operations in 1942 followed by British Cathay Pacific and Qantas in 1947 and Northwest Airlines in 1952. Currently, Northwest is the oldest operating international airline in the Philippines.

Northwest has been an incumbent airline since the agreement's inception because it had been flying to Japan before the execution of the treaty. United gained incumbent rights when it purchased Pan Am's entire Pacific division in 1985. Federal Express received incumbent rights by acquiring the privileges from the cargo carrier Flying Tigers in 1989. United Airlines entry to the Philippines started with the end of Pan Am's Pacific operations.

But in 1985, The Japanese Transport Ministry views United Airlines entry as a "new" carrier in Japan, despite the facts that the 33 Pan Am routes already exist and that United is flying trans-Pacific routes between Seattle- Portland, Tokyo and Hong Kong. For the Japanese government, the rights granted under the 1952 treaty to Pan Am died wit h it.

The fate of United Airlines' $750 million purchase of the Pan American World Airways Pacific division, which was considered as the biggest airline deal in hi story, now hinges on the willingness of the American government to negotiate new terms with Japan or risk losing its airlines hub in Tokyo. A settlement was reached in January 1986 putting numerical limit on the number of flights using fifth freedom rights out of Narita to be limited to 50% to what is granted by the Japanese government to third country destinations from the former parity. The Japanese government position was also bolstered by the fact that Narita's landing and take-off slot is so scarce that they have to regulate number of flights and type of aircraft allowed at the airport.

In February 1986, United got the green light to fly to Asia taking Pan Am routes to Taipei, Singapore, Bangkok, Seoul, Manila, Beijing, Australia an d New Zealand. The Philippines granted landing permission in 1987 with reservations for simila r rights out of Tokyo for the United States. Twenty Eight years later, that right to fly from Tokyo to the US still evades the Philippines and so is the American's request for open skies.

The United States has approached smaller countries in the Asian market like the Philippines in hopes of pressuring Japan into agreeing to negotiate an open skies agreement. The underlying goals of open skies agreements with the smaller Asian nations include not only providing better air service to Asia, but also sending a warning signal to Japan that it may lose its prominent hub status as other countries become accessible to U.S. carriers.

But the Philippine carrier, Philippine Airlines has problems of its own which it wants the government to protect. The government response of further suspension of treaty with the US ended in 1994 and the last remaining hope of Philippine airlines to balance US carriers domination is the Japanese treaty.

Still, Japan is pivotal to the entire Asian aviation market, and it is aware that it has a great deal of leverage from the fact that Japan's gross domestic product remains greater than the combined value of all the countries with whom the United States has reached open skies agreements.

Northwest would have wanted direct flights but management decisions call for it to follow the "hub and spoke system" of operations because it was the most efficient, so the theory said so, until chapter 11 went their way, as the story goes.

The US-Japan aviation market is the largest aviation market in the world in terms of revenue generating almost $10 billion in annual sales based on 1995 figures. Japan knew this and wants to protect its own interest too.

The market is particularly lucrative because these flights are "among the longest-haul routes in the world," and US airlines can get top prices for their services. In 1995 alone, U.S. carriers dominated their competitors in the U.S.-Japan market. U.S. carriers held about sixty-three percent of the passenger market and fifty-three percent of the cargo market.

Japan alone represents more than sixty percent of the traffic between the U.S. mainland and Asia, or five million passengers a year.

United Airlines officials in 1995 publicly stated that Japan was essential to their Asia routes because many of the destinations which can be served efficiently through Tokyo are "either too distant or have insufficient demand to serve nonstop from the United States". United received most of its premium passengers with its connecting stop in Japan.

The U.S. incumbent carriers have leveraged their rights in the Japanese and Asian markets, making them some of the more highly utilized carriers in the region. Similarly, United and Northwest dominate the routes between the United States and Japan. Together, the two U.S. carriers fly more than 85% of American passengers in the U.S.-Japan aviation market. The same story goes with its onward connections to the Philippines with Philippine Airlines accounting the balance of over 20%.

Both Northwest and United Airlines derived most of its substantial profit in Asia Pacific region. Northwest Airlines, which operates 245 flights per week between the United States and Japan, provides more flights between the two countries than any other airline. Northwest derives an estimated 30% of its revenue from its flights between the United States and Asia. It is also estimated that twenty-five percent of Northwest's operating profit comes from flights between the United States and countries in the Pacific Rim.

In addition, Northwest's freight capacity to Asia "substantially exceeds" that of any other U.S. carrier. The airline operates eight Boeing 747s exclusively in the Pacific cargo market, and it also carries cargo on its passenger flights. Northwest reportedly gets about ten percent of its overall revenue from cargo, a high percentage for a U.S. passenger carrier.

In 1997, US Transportation Department officials, who were in the middle of aviation negotiations, publicly stated that the failure to reach a consensus on aviation trade policy had created a "strained relationship" between the the US and Japan. Of particular concern to U.S. airlines and U.S. government officials was Japan's refusal to approve additional services for incumbent carriers through Japan to other destinations in Asia, particularly the Philippines.

The disagreements threatened U.S. airline plans to use Japan as a "launching pad" to serve the growing Asian market. According to some U.S. airline officials, Japan's refusal to give limited beyond rights now seriously threatened airline expansion. To U.S. airlines, these beyond rights were "vital" to their Asian operations.

The Japan-U.S. aviation disputes of the mid-1990s resulted from differing views as to the purpose and intent of the 1952 agreement. Specifically, Japan interpreted the agreement as allowing for restrictions on U.S. incumbent carrier access, while the United States interpreted it as offering unconditional flight rights. Furthermore, Japan saw the agreement as providing an unfair advantage to U.S. carriers, given the new market conditions that had developed in the forty years since the agreement was signed, and complained that the United States was violating the underlying intentions of the agreement.

To protect Japanese-based airlines from U.S. competition, Japanese officials had steadfastly refused to negotiate a full-fledged open skies agreement with the United States. Hiromichi Toya, Japan's Vice Transport Minister for International Affairs, stated his government's aversion to the U.S. position after the September, 1997 negotiations: "It is obvious that we cannot accept any proposal that would commit us to open skies. It would be difficult to continue talks if we would be forced to accept a proposal like that."

Instead of open skies, Japan had been seeking "equality" in any agreement. To the Japanese negotiators, equality meant that each country should have the same number of carriers with liberal access to each other's market.

Essentially, the Japanese version of equality meant that only two carriers would have open access to the Japanese market, and in exchange, both Japanese carriers--ANA and JAL--would have open access to the U.S. market. U.S. negotiators found this approach unworkable. Deputy Assistant Secretary of Transportation Murphy outlined the U.S. view on Japan's approach to aviation negotiations: "This approach would essentially give Japan's international airline industry unrestricted access to the US market while excluding a major portion of the US industry from liberal access to Japan.

Its worthy to note that the same strategy was applied by the Philippine government in re-negotiating open skies agreement with the United States in 1994 but to no avail. It was thought to be a fair agreement as only Philippine Airlines was the sole airline for the Philippines. Where Japan succeeded, the Philippines has failed for one main reason, bargaining position. US carriers are dependent on Japanese aviation market while PAL is dependent on its transpacific flight.

To the Japanese, the "equality" approach to negotiations made sense and was reasonable. Japanese officials believed that the 1952 plan clearly created an "imbalance" in favor of the United States. To the Japanese, the United States had two airlines with essentially unrestricted access to the Japanese market, while Japan had only one air carrier with the same rights to the U.S. market. To Japan, that did not represent fair trade.

To Japan, the U.S. market share is the direct result of an unfair advantage acquired under the 1952 agreement. Japanese officials are also quick to point out that "open skies" policy is not completely open because the United States does not allow foreign carriers to establish hubs at U.S. destinations such as Los Angeles or San Francisco.

Its worthy to emphasize that the Philippines, particularly Philippine Airlines, had interpreted its own open skies with the United States that way. For example, PAL wanted to establish a Los Angeles hub for points in New York, Chicago, Seattle, Houston, and Washington airports but US doesn't allow it so.

In 1993, the fifteen-member Orient Airlines Association (now Association of Asia Pacific Airlines) recommended that Asian governments negotiate "fairer agreements which provide a level playing field" to help Asian carriers who compete against U.S. airlines.

In 1995, specific disputes kick-started aviation negotiations between the United States and Japan. After Japan refused to allow Federal Express to expand its service from Japan to its Philippines hub at Subic Bay, the U.S. government threatened sanctions. To head off an aviation trade war, the two parties engaged in negotiations and reached a limited agreement that would allow Federal Express to begin full operations to the Philippines in exchange for six additional weekly cargo flights by Nippon Cargo Airlines (NCA) and JAL to Chicago.

At a 1995 Asian-Pacific industry meeting, JAL's Director of International Public Relations Geoff Tudor blamed the United States for aviation tensions around the world. The JAL official went on to say that the U.S. carriers "flagrantly abused" their beyond traffic rights and that the U.S. airlines "are resented in Asia, not because they are in the market at all, but because they are greedy, and take too much.

During the September 1997 meetings, Japanese negotiators refused to accept a full transition to open skies, so the United States retreated "from its original position" and proposed that both sides agree to a four-year deal with a transition to open skies when the interim deal expired. This four-year transition to open skies was not accepted outright, and the two nations failed to reach an agreement on whether open skies would ever be implemented.

Northwest and United both stressed that the United States should settle for nothing less than open skies. However, United Airlines defected from the Northwest camp and joined supporters of an interim agreement that would partially open access to the Japanese market. United announced that it was now seeking a "result-oriented" strategy that would allow for code-sharing and other airline alliances. Northwest executive publicly accused American and United of "selling out" in return for alliances with Japanese airlines and being "bought off" by Japan.

In January, 1998, the United States and Japan reached a compromise four-year framework agreement. The pact guaranteed incumbent carriers the same rights they had acquired under the 1952 agreement. The allowance for code-sharing agreements, one of the last major stumbling blocks to an agreement, took a creative solution. At the United States' request, Japan readily agreed to allow for all alliances between U.S. and Japanese carriers.

As a matter of fact, United Airlines termination of service to the Philippines was not at all related to 1998 agreement but due to its financial difficulty made more difficult by 2001 attack on the World Trade Center. Eventually, it filed for Chapter 11 Bankruptcy protection in December 2002. Even Northwest was forced to merged with rival Delta Airlines to survive in the airline industry in 2008.

But it saved United Airlines status and operations in Japan by cutting cost, and that is pulling the plug to Manila, one of its unprofitable route. It finally closed its door to the Philippines on February 20, 1998, ending Pan Am's legacy to the country.

Written with notes from Derek Lick.

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