Welcome to the cheap seats

China Eastern unveils a low-cost airline to take on Air China

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No frills, except the smiles: China’s latest budget airline will operate from Beijing

“Even if it is a stone, we’ll squeeze water and oil from it,” was the promise five years ago from Wang Zhenghua, founder of Spring Airlines, China’s best-known low-cost carrier (or LCC). That sounds like backbreaking work and it has certainly been slow going for a sector that has captured just a 5% share of flights in the domestic market, much less than LCCs have achieved in other parts of the world.

But there is now a sense that the pace might start to pick up after one of the leading carriers announced plans to convert a subsidiary into a low-cost operator.

China Eastern says that China United Airlines, which is Beijing-based, has been chosen to serve as its low-cost flagship. “We’ll see explosive growth of LCCs, especially in China,” China Eastern’s chairman Liu Shaoyong told reporters. “In Asia alone, they already account for a third of the market.”

Until last year only Spring Airlines was getting much traction from budget air travel in China, primarily because regulators wouldn’t grant operating licences to new entrants, especially those not controlled by the larger state-owned carriers.

There were a few indications that the mood might be changing, including Ruili Airlines, a regional carrier without major state backers, getting approvals to fly (see WiC210).

But more influential for the prospects of the LCC sector was the release of a glowing report by the aviation regulator – the CAAC – into Spring’s performance.

Among the highlights: a passenger load factor of 94% compared to the industry average of 76%; sales and distribution costs at a fifth of the rest of the industry, and management costs at less than half.

In short, the study confirmed that Spring, founded in 2004 but now operating a fleet of 40 Airbus A320s, was flying its planes more hours per day, at much higher efficiency than its peers, and making almost four times the margins for its shareholders.

Not only did that invite talk of an IPO for Spring (see WiC235), it also tapped into the mood of the moment in demonstrating how newer business models funded with private capital could deliver much better returns on investment.

Despite the findings, the announcement that China Eastern is developing a low-cost airline of its own represents a new departure. For one thing, the proposal is powered by rivalry between the three leading airlines – Air China, China Southern and China Eastern – in pitching China United as a potentially powerful operator from Beijing, which is the home hub of Air China. China United is already operating from Nanyuan, an airport with mixed civilian and military use only a few miles outside the city. But it has plans to move again when Beijing’s second international airport opens by the end of the decade. It also says it wants to grow capacity at another dual-use airport not far from China Southern’s home citadel of Guangzhou too. That makes it look like China Eastern is trying to take the fight to the home turf of both its larger rivals. If its state-owned brethren complain about this new state of affairs, it will claim that their experience will be little different to what it has to deal with at its own home base in Shanghai, where Spring has now established itself, and even flies on overseas routes to Japan, South Korea and Hong Kong.

A fundamental question is whether China Eastern can create a low-cost carrier on the Spring model, however. Positively, China United is already up-and-running with 26 Boeing 737s providing more than 130 flights a day. The airline will plan to scale up quickly too, because of its parent’s backing. As Time Weekly noted last week, it will expect to get many of the 80 new aircraft that China Eastern ordered from Boeing last month.

Bosses at both airlines are also saying all the right things about being able to drop their fares 20% lower than rivals in switching to all-economy class configurations, charging for seat selection and inflight meals, and selling tickets online rather than via travel agents.

The full service carriers are being drawn into the fray because they realise that they cannot ignore the low-cost threat. Under attack from high-speed rail on shorter routes, the state airlines are also vying with foreign LCCs on flights linking Chinese cities with international destinations in the region. AirAsia has outlined its own plans to boost capacity into China, for instance, and there was speculation in the domestic media last week that it has been talking to Spring about a potential tie-up, including investment in a new low-cost terminal at Hongqiao airport in Shanghai.

The counter argument is that the transition to lower cost operations is far from straightforward. Reducing expenses in areas like airport charges, maintenance costs and staff overheads (see WiC210 for more on how the main carriers have been battling to keep hold of their pilots) is difficult. Traditional (or ‘legacy’ carriers) are often thought to be the least likely to make the shift. The argument is that the low-cost mentality needs to be in the corporate DNA from the outset, and that it is almost impossible to introduce it at a later stage.

It was partially for these reasons that China Eastern partnered with JetStar, an international low-cost operator, in a venture in Hong Kong. Supposed to launch last year, it was pitched as a way for the Chinese carrier to build up know-how. But the airline’s progress has been blocked by objections from Hong Kong carrier Cathay Pacific on the grounds that it breaches provisions in the territory’s Basic Law (which stipulates a carrier must have its principal place of business in Hong Kong).

Back on the Chinese mainland many aviation analysts predict that a two-tier market will develop in which the LCCs get encouragement to fly on lesser-served routes, especially in poorer parts of the country, while the full-service carriers get a semblance of protection on flights between the major cities, where they make most of their money.

All of this presupposes that China’s airlines can overcome the wider problem of flight congestion – an issue beyond the CAAC’s control because it requires more airspace to be opened up by the military.

Until that happens flight delays will continue to plague the industry, creating the kind of frustration voiced by China United president Yao Weihui at an airline forum last November. “Airspace reform is so urgent,” he told the symposium. “We have to reform our systems. It is an institutional problem, not a technical problem.”

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