June 7 (Bloomberg) -- All Nippon Airways Co., Asia's second- largest airline, is preparing to set up a new, low-cost carrier flying Boeing Co. 737 planes, to compete more effectively with rivals such as Japan Airlines System Corp. on shorter routes.

``We have done the study, we have established a task force to set up the company and it's at the stage before the company is set up,'' President Yoji Ohashi said in an interview during a conference of the Star Alliance airline group in Singapore. ``It's something I think that we have to do, and something that we should do as quickly as we can,'' he said, without elaborating on when the new unit will start operations.

All Nippon is following two of its Star Alliance partners, Singapore Airlines Ltd. and Thai Airways International Pcl, in setting up a discount unit. Full-service airlines are trying to find more effective ways to compete with low-cost start-ups as travel demand recovers from a slump caused by concerns about terrorism and the SARS virus, and jet fuel prices hit record highs, threatening to stifle profits industrywide this year.

``By operating a classic low-cost airline model, you could reap the benefits of what is a massive potential market, particularly the short-haul international market'' to destinations such as China and Korea, said Peter Harbison, managing director of the Sydney-based Centre for Asia-Pacific Aviation in an interview in Singapore.

The new unit will offer cost savings from using a fleet comprising a single aircraft type and will have lower personnel costs than Tokyo-based All Nippon, Ohashi said.

``In terms of pilot remuneration, for example, we are hoping to make it half the cost,'' he said. ``Of course, that's something we are in the process of negotiating.''

All Nippon shares rose as much as 1.2 percent to 340 yen as of 10 a.m. in Tokyo.

New Company?

The department preparing to set up the new unit is now part of All Nippon's regional subsidiary Air Nippon Co. ``Whether it will be kept with Air Nippon or whether it will be set up as a completely different company, we don't know yet,'' Ohashi said.

Kyodo News Service reported in April that All Nippon plans to set up a discount carrier this year to fly between regional airports in Japan. The unit will probably be based in Fukuoka, the report said, citing unidentified company executives.

``There's something like 40 airports at regional points in Japan which are capable of accepting the right kind of aircraft,'' the Centre for Asia-Pacific Aviation's Harbison said. ``Round Fukuoka you've got 20 million people who really aren't serviced internationally in any serious way. The potential's enormous.''

Next-Generation 737

``We are not able to say when it's going to be set up or when it will begin operations,'' Ohashi said. ``The aircraft used will be the Next-Generation 737, which will be introduced from next year,'' he said.

All Nippon Airways last year placed an order worth as much as $2.48 billion for 45 Next-Generation 737-700 planes, planning to save as much as 6 billion yen ($54 million) a year in costs by rationalizing its fleet to one type of single-aisle aircraft from two now. The airline now operates a mix of Airbus SAS A320s and older Boeing 737s in its single-aisle fleet.

The department preparing to set up the low-cost operation is now examining whether the new unit will require an order for more 737s, or whether the existing order will be enough to cover the group's needs.

Airport Charges

The unit may face difficulties following the low-cost business model used by carriers such as Dublin-based Ryanair Holdings Plc, because of a lack of smaller, cheaper airports near Japan's main population centers, Ohashi said. Tokyo's Haneda airport, which caters mainly to domestic flights, is Japan's busiest hub and has among the highest landing fees in the world.

Separately, All Nippon expects to post its first-ever profit on international routes this business year, ending March 31, 2005, thanks to increased demand on Chinese, European and U.S. routes, airline spokesman Shinichi Shinkawa said in an interview.

``This year is the year we are planning to make a profit for the first time'' on overseas flights, Shinkawa said. ``China is the key to our international profitability.''

The effect of the SARS epidemic on international travel demand had ``almost gone'' by the fourth quarter of the last business year, he said. Demand on European and U.S. routes is ``coming back very strongly,'' especially for business travel, he said.

All Nippon's international passenger numbers in April surged 63 percent to 301,790 as traffic recovered from SARS, while domestic passenger numbers increased 3.6 percent to 3.31 million. Demand in the month was helped by a longer-than-usual ``Golden Week'' holiday in Japan, encouraging leisure travel.

The airline filled 71 percent of its available seats on international flights in the month.

To contact the reporter on this story: Andrzej Jeziorski in Singapore at ajeziorski@bloomberg.net.

Last Updated: June 6, 2004 21:02 EDT