Global Competition

A determination by Beijing to turn the country into a global aviation power has turned a spotlight on the international prospects of China’s carriers. Typical of Chinese thinking, long-term goals are being set. “By 2030, China is set to achieve the historical transformation from a big aviation nation into a strong aviation nation,” China’s Civil Aviation Administration minister Li Jiaxiang said earlier this year. So Beijing’s ambitions are clear and high, but to succeed the country’s airlines will have to address outdated business models that do not best position them to compete effectively in the international market.

Chinese carriers have achieved impressive financial performances over the past few years, especially in 2010 when domestic carriers posted a record high net income of CNY35 billion ($5.5 billion), almost five times the CNY7.4 billion net income reported in 2009.

But at least some of this success was due to favorable economic conditions and political support from Beijing rather than to management improvements. The detailed figures tell the whole story. Chinese carriers collected CNY19.36 billion in fuel surcharges during the first 11 months of 2010 and enjoyed an exchange gain of CNY3.47 billion in the same period. They also received CNY2.69 billion in various government subsidies last year.

However, CAAC and China’s domestic carriers are aware that more must be done to  sustain long-term growth as set out in CAAC’s 12th Five-Year Plan for Civil Aviation Industry (2011—2015). Based on this plan, CAAC expects domestic airlines’ annual growth rates of passenger boardings and cargo traffic to slow down in 2015. Passenger growth is anticipated to be 11%, or 450 million boardings, while cargo growth is estimated at 10%, or 9 million tones. The average annual growth rate for both passenger boardings and cargo traffic in the previous plan, for the period 2005-2010, was 15.6%.

According to CAAC, Chinese carriers transported 139 million passengers in the first half of this year, up 9.8% over the previous year. Passengers carried on domestic routes rose 10% while international boardings increased 8.2%. Average load factor improved 2.5 points to 81.3%. Cargo traffic dropped 0.4% to 2.66 million tonnes. Cargo traffic on domestic routes increased by 1.4%, but international routes dropped 3.8%.

And growth is still on the agenda for the future. Most industry analysts believe that the increase in domestic consumers’ disposable income that triggered China’s airline positive results in 2010 will continue. One downside to this, however, is that Chinese carriers have relied mainly on this fast-growing domestic market demand, stimulated by a booming Chinese economy, to sustain their consecutive annual growth tracks rather than put in place business practices that would increase their international competitiveness.

What CAAC is mindful of in its latest plan is an anticipated shortage of airspace and pilots—structural issues it believes will slow down the growth rate of domestic airlines. Even more important, in CAAC’s view, is the imperative to transform the outdated business models used by Chinese carriers. According to the plan, the regulator is committed to attaching “more importance to growth quality rather than growth rate.”

 “Chinese carriers can’t catch up with the growing trend of accelerating international air transport liberalization because of their collective weak international competitiveness,” CAAC minister Li Jiaxiang said. According to the CAAC, Chinese carriers collectively took a 45.3% share of the international market in terms of passenger traffic in 2005, but this figure dropped one percentage point to 44% in 2010. The percentage share for cargo traffic, meanwhile, rose to 32% in 2010 from 23.9% in 2005. That’s an improvement, but it’s still less than a third of the market.

Understandably, perhaps, Chinese carriers have been reluctant to invest in loss-making international routes while the domestic market has been so lucrative.

But this may change as domestic carriers face increasingly fierce competitive pressure from the rapid development of domestic high speed rail services that cover parts of eastern, central and southern China, the golden business areas for these carriers. It is hard to believe that Chinese carriers can maintain their profit tracks if they do nothing to enhance their international competitiveness.

Fighting Within 

Li Jiaxiang also points to something he calls “disorderly competition” as a reason why Chinese carriers’ international competitiveness is undermined. China’s big three—Beijing-based Air China (CA), Guangzhou-based China Southern Airlines (CZ) and Shanghai-based China Eastern Airlines (MU) have been content to dominate their  respective hubs but are also keen to grow their presence at each other’s hub cities.

Beijing, the second biggest city in China in terms of gross domestic product, is the most lucrative single market for passenger transport in China owing to its geographical location as a convenient transfer point for passengers traveling to and from Europe and the US and its capital-city status.

So it is not surprising that CZ, which faces fierce competitive pressure from Hong Kong-based Cathay Pacific Airways (CX) and its Dragonair subsidiary, is accelerating efforts to gain a deeper foothold in Beijing. Reports indicate that CZ is seeking approval to operate between Beijing and New York or Paris Charles de Gaulle using Airbus A380s, the first of which arrived in September.

Additionally, CZ signed a cooperation agreement with the government in May that paves the way for the Guangzhou-based carrier to enhance its position at the new Beijing Daxing airport, which is projected to open in 2016. CZ noted that over the next 10 years, it plans to locate about 200 aircraft—Airbus A330s and A380s—at the new airport.

China Eastern chairman Liu Shaoyong, meanwhile, has said that MU will allocate 50 aircraft to Beijing PEK to raise its profile there over the next several years.

And while CZ and MU are working to challenge CA’s position in Beijing, CA is eyeing a potential bigger footprint at China’s business capital of Shanghai, which is home to MU. CA chairman Kong Dong told ATWthat the carrier will pursue its strategy of building Shanghai Pudong as its international gateway over the next five years. First, however, it must overcome slot shortage at the airport, which is dominated by MU, especially since its merger with Shanghai Airlines (FM) last year.

“Shanghai is quite an important market for us. We will allocate more long-haul aircraft to open more international routes and boost flight frequencies starting from Shanghai in the next five years and of course we will continue to work on getting more slots,” Kong said.

Over the next five years, the carrier expects to take delivery of 59 long-haul aircraft comprising 19 Boeing 777s, 10 A330s, 10 Airbus A350s, 15 Boeing 787-9s and five Boeing 747-8s, which Kong said will be a part of the fleet renewal but will also support international expansion on routes to Europe and the US from Beijing and Shanghai.

But China’s big three carriers’ efforts to grow their presence at each other’s hub cities has met with regulatory disapproval. “So far there is no Chinese carrier that can successfully operate two domestic hubs. Domestic airlines should focus on their own operating base to avoid scattered capacity allocation and disorderly competition,” Li Jiaxiang said.

Li Jiaxiang added that a carrier can’t say it successfully operates a hub airport unless it has at least a 45% share of the market. CA has a 42% share of passenger traffic at its Beijing hub—with transfer traffic accounting for 20%; MU has a 38% share of its Shanghai (Pudong) hub—with transfer traffic 17%; while CZ has a 52% share of its Guangzhou hub—but transfer traffic share is only 8%.

Growing Cargo 

Weak air cargo competitiveness is another issue Chinese carriers must address before turning China’s “strong aviation nation” dream into reality. According to CAAC, domestic carriers collectively held less than a one-third share in the international cargo market last year.

Kong shrugs off these competitive pressures, but says that “our target is to grab a one-third share of the Chinese cargo market.”

Joint venture arrangements with foreign airlines are one way that China’s carriers can grow their international cargo presence. CA and CX launched their joint venture cargo operation in May, consolidating the two carriers’ airfreight divisions. CA owns a 51% stake in the consolidated cargo carrier while CX holds 25% and also funded an offshore trust through a loan that holds 24%.

Air China Cargo’s fleet will comprise 12 Boeing 747-400 freighters and its base will be in Shanghai, which CA said would “satisfy the market demands of the Yangtze River Delta, which makes up two-thirds of Air China’s service area. The cooperation will help Air China Cargo reach all-round global development.”

Shanghai is the biggest and most lucrative cargo market in China, but it is dominated by FedEx, UPS and DHL.

Similarly, Shanghai-based MU is seeking to strengthen its cargo business through the relaunch of China Cargo Airlines (CK) in June. The new carrier has registered capital of CNY3 billion. MU holds a 51% stake in it; China Ocean Shipping Co. owns 17%; Eva Airways controls 16%; and Singapore Cargo Airlines has 16%.CK is also based in Shanghai and will operate 18 freighters comprising five Boeing 747-400Fs, four 777Fs, four Boeing MD-11Fs, two 757-200Fs and three Airbus A300-600Fs. It is scheduled to introduce two new 777Fs this year. MU MD Ma Xulun said the 747-400F and 777F would become the cargo venture’s main fleet types by 2015.

CZ chairman Si Xianmin, meanwhile, revealed in June that the airline was in discussions with fellow Skyteam member carriers, widely speculated to be Korean Air and China Airlines, on the possibility of establishing a new cargo joint venture this year. China Southern was scheduled to launch a cargo joint venture with Air France-KLM in 2008, but the deal fell through amid the European financial crisis.

Last year, CZ shifted its cargo base from Guangzhou to Shanghai, where it operates a freighter fleet of seven aircraft, comprising two 747Fs and five 777Fs, on international routes to Los Angeles, Chicago O’Hare, Amsterdam, Vienna and Frankfurt. It is expected to accelerate its expansion plans after reaching an agreement with Boeing to buy six 777F.

But industry analysts point out that simply chasing market share and launching cargo joint venture deals will not provide enough of a solution. Chinese carriers must also invest in new software and logistics so that they can adjust and fully integrate their cargo route networks, broaden sales channels and improve customer service.

As China’s carriers plan for the next decade, it seems likely that depending on domestic growth alone will not be enough; they will need business strategies that extend their new-found success to international markets.