German air superiority

Deutschland uber alles: Kong selected German carrier as his benchmark

Perhaps he’s keen on lederhosen. Or maybe a fan of Oktoberfest.

Back in November last year, in an interview with Flight Global magazine, Air China chairman Kong Dong drew up a short list of the top airlines that he hoped Air China would soon join. But fast-forward five months, and the contenders have been whittled down to one.

And the winner is… Lufthansa. The Germans are the ones to follow, Kong told Chinese Entrepreneur magazine. His job was to “know the gap” with Lufthansa’s model.

As it turned out, the 2009 financial results were much better ones for Air China, and marked a solid recovery from a year earlier. Total revenue fell slightly. But expenses fell a lot faster, allowing it to announce a record profit.

A large chunk of the improvement was related to changes in the valuation of fuel hedging contracts (the same ones that laid the carrier low in 2008). But the truer foundation of the recovery was in the domestic market, where passenger numbers surged, helping to offset tougher times internationally.

In fact, domestic routes generated twice the revenue of foreign ones. Yields were better at home too (meaning the airline was able to charge more per mile flown by passengers on trips within China than for those travelling to and from overseas destinations).

But back to that comparison with Lufthansa: why would Kong choose to talk teutonic in outlining his Air China vision for 2015?

His admiration seems reserved mostly for the way that the Lufthansa Group has bulked up, swallowing an assortment of regional feeder carriers, as well as larger airlines like SWISS, Austrian Airlines and British-based bmi.

Lufthansa also sits astride a range of aviation-related businesses, including a powerful cargo division, a respected aircraft maintenance arm and various airline catering, logistics and IT operations. That fits with Chinese government pleas that state-owned enterprises concentrate their efforts on the industries that they know best, and don’t fritter money away elsewhere. But the real attraction in the Lufthansa line-up is its “multi-hub, multi-brand” message – the kind of airline system that Kong is looking to imitate.

How does this fit with Air China’s current condition? Certainly, aspiring to the Lufthansa model will appeal to its sense of self-worth. As we have discussed previously in WiC, the Chinese aviation scene is split primarily between three carriers; China Eastern, China Southern and Air China itself. Each has an extensive fleet, an expansive domestic network (and a growing international one), as well as a hub airport in which it is market leader.

That is the competitive backdrop. But while Air China is careful not to sound condescending, it considers itself first among equals as far as its state-owned peers are concerned. Take its public pronouncements of acceptance when its rivals seem to get the best of the industry bailouts (they need the help the most, naturally). Or its reminders that it is still the only one of the three permitted to display the Chinese flag on its tail fin. It remains the carrier of choice on overseas travel for the party leadership too.

That sense of superiority makes for some super-charged ambitions, as well as a strong competitive position at home. Air China dominates Beijing (and its brand new airport), with more than half of flights flown through the city. It controls subsidiaries in casino-enclave Macau, and in the northern outposts of Shandong province. Last year, it set about getting entrenched elsewhere in central China with a new Hubei subsidiary. It also announced plans to base several aircraft at Pudong airport in Shanghai, and this year added a new cargo joint venture – with Hong Kong’s Cathay Pacific – also out of Shanghai.

That all sounds like a supersized strategy, and some in the industry grumble that it is a vision with little space for competition, especially from privately-run airlines.

It is a charge that Kong rejects; state-owned airlines and private carriers “both breathe under the same blue sky” is how he explains it to China Entrepreneur magazine. But that sky has been looking a lot less settled for at least two carriers recently (Shenzhen Airlines and East Star) which have both come under Air China control after bruising takeover battles (see WiCs 12 and 42).

Of course, at this point it is worth asking how Cathay Pacific feels about the Lufthansa love-in. After all Air China forged a cross-shareholding deal with the Hong Kong carrier in 2006. Kong has since raised his stake in Cathay to only a fraction below levels that would trigger a mandatory bid.

The arrangement has often been presented as one in which Cathay gets to extend its reach into the world’s most attractive aviation opportunity, while Air China looks to pick up more of its partner’s management and operational pedigree.

Further, Cathay is consistently recognised as one of the world’s best-run airlines. So it might be wondering why it seems to have been gazumped by the Germans as the airline to emulate.

The plainer truth is that it is unlikely to be too bothered. As Cathay’s CEO told WiC (in issue 38), the Air China partnership is paying dividends for his own airline, not least in enabling wholly-owned subsidiary Dragonair access to the Chinese market that most foreign carriers would kill for. The new cargo joint venture serves both partners rather well too. For transpacific and north Asian shipments originating in central and northern China, for instance, it makes less sense to send freight through Hong Kong. Shanghai also looks good as a secondary cargo hub for both carriers, given its location close to the manufacturing heartland of the Yangzte River Delta.

Of course, it will also allow Air China to muscle in on China Eastern’s home territory, just as the takeover of Shenzhen Airlines sees it knock on China Southern’s back door in Guangdong.

Not that everything has been golden for the Germans recently. Lufthansa reported another series of losses this week, plagued by striking pilots and Icelandic ash. But with a majority share out of Beijing, a stake in Hong Kong’s ‘flag’ carrier, and various subsidiaries now establishing themselves in other Chinese provinces, the outline of Air China’s own ‘multi-hub, multi-brand strategy’ becomes a lot clearer.

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