Jetstar Hong Kong stirs up a storm

JETSTAR Hong Kong, a new budget joint venture of equal partnership between Qantas and China Eastern Airlines, is stirring up a storm – and not quite in a tea-cup considering the market potential of 450 million passengers by 2015. The carrier is expected to commence operations in mid-2013.

The announcement drew mixed reaction from aviation analysts. Some of them think Qantas made a strategic move in penetrating the lucrative Asian market, following failed talks with Malaysia Airlines to set up a premium carrier to be based in the region. However, Qantas chief Alan Joyce insisted that it was not the end of the road for that project. “We are still in dialogue with both the Singaporeans and Malaysians but nothing is happening in the short term,” said Mr Joyce. “It’s more of a long-term issue.” By that, he meant a likely delay of two to three years.

The RedQ project got on to a rough start when it was announced a year ago as part of the Qantas restructuring to rescue the Australian flag carrier from further losses – it lost A$200 (US$207) – incurred by its international operations. Qantas flies less than 20% of Australia’s international passengers compared to a market share of 65% for domestic travel. Asia became its Holy Grail. Unfortunately, disruptive labor action in protest for fear of the loss of jobs at home put the brakes on the project. What started with a big bang simmered down to a proposal for a joint-venture instead. Singapore and Kuala Lumpur were identified as the possible Asian base, and Malaysia Airlines – which is also muddling in red ink – the only known interest in the partnership so far.

Mr Joyce explained that the project was put on hold “because the requisite traffic rights couldn’t be secured in Singapore while Malaysian Air (sic) is going through a restructuring plan of its own, so that reaching an accord with Qantas proved too ‘complex’.” It is to be seen as a matter of timing. Interestingly, Mr Joyce mentioned difficulties with Singapore, which is a strong supporter of open skies and where Qantas already enjoys hubbing privileges. While Jetstar Hong Kong – a budget carrier – is not a replacement for RedQ, would Qantas face similar impediments even though it had inked an understanding with China Eastern?

According to aviation consultant Andrew Pyne who had held senior positions at Cathay Pacific, Viva Macau (as CEO) and Avianova (as founding CEO), the deal is far from being final, in case we missed the fine print that reads “subject to regulatory approval”. In his opinion, neither Qantas nor China Eastern which is “controlled in effect from Sydney and from Shanghai can be said to have its principal place of business in Hong Kong” and therefore does not comply with Hong Kong’s Basic Law. This means the law would have to be tweaked to legitimize the union, but with pressure from Beijing, this is not likely to be an insurmountable hurdle.

But if that came about, Mr Pyne opined that two things could happen, both of which undesirable for Hong Kong. First, there would be a long line of other airlines wanting to operate from Hong Kong, which would end up being “a flag of convenience”. A bad thing? That would depend on the Hong Kong administration’s objectives, priorities and vision of growth – it has already given the green light for a third runway to be constructed at the Hong Kong International Airport (HKIA). Uncontrollable? Not quite.

Second, Cathay Pacific would probably look for a new home elsewhere. It could, but would it? Besides, it is unimaginable that the region’s most successful airline should be so ruffled by a new budget carrier on the same turf or be so terrified of the competition it poses that it should shake out of the territory where together with subsidiary Dragonair it has 50% total capacity share compared to 5% for all low cost carriers (LCC) at HKIA. Jetstar Asia on its own manages only 0.5%.

Yet there is suggestion that Cathay Pacific is not quite happy about Jetstar Hong Kong setting up base at HKIA – manifested in renewed speculation that it would withdraw from OneWorld (of which Qantas is a member) and consider joining Star Alliance. But it is really much ado about nothing if you consider that China Eastern is a member of the Sky Team, and not OneWorld.

A more pertinent question to ask is whether Jetstar Hong Kong would do much better than the average LCC at HKIA, and in particular for Qantas whether the new budget joint-venture was strategically the right move in its Asian plan, which looks set to employ the Jetstar branding as the growth vehicle. The Jetstar brand – including services within Australia and New Zealand – already connects eight cities in mainland China in a network of almost 60 destinations served by some 3,000 weekly flights. Besides Jetstar Asia that operates out of Singapore, Jetstar Japan in partnership with Japan Airlines and Mitsubishi Corporation will commence domestic services out of Tokyo’s Narita Airport in July. Jetstar Pacific in joint venture with Vietnam Airlines will follow on a date yet to be finalized.

However, the less optimistic group of analysts doubt that the Jetstar Hong Kong would work as hyped for Qantas (and China Eastern). They think that Hong Kong is just not the right market for budget travel. The volume out of HKIA is much too small and the yield very low especially if the target is the leisure market. For now, the options seem limited as destination rights are strictly rationed by the Chinese authorities. Cathay Pacific has said it would not follow in the footsteps of regional rivals such as Singapore Airlines and Japan Airlines in setting up budget offshoots. It is already complemented by subsidiary Dragonair that operates shorter regional routes. But Qantas chief Joyce had this to say: “Cathay will always be talking down (LCC opportunities) because it is in its interests to do so.”

Both Qantas and China Eastern are confident that Jetstar Hong Kong – which is eyeing the market beyond Hong Kong – would turn in a profit within three years. China Eastern chairman Liu Shaoyong estimated a market share of 6 to 7%. All this despite high fuel costs that have increasingly become the bane of LCC operations. Mr Liu said the costs would be offset by high aircraft utilisation and through surcharges. That, of course, would be premised upon a growing market and the elasticity of the demand vis-a-vis costs.

Jetstar CEO Bruce Buchanan said costs would be kept low, as much as 50% compared to full-service airlines, and fares would similarly be as much as 50% below what the latter are charging. By charging low fares, Mr Bachman has latched on to the promise of the theoretical economic model that it will generate new demand – the first principle of the budget business. Ceteris paribus, you may add, and given that the economy will fully recover and strengthen then on. He has also placed his bet on compensation by ancillary revenue, a new and convenient source of income that many airlines have begun to adopt. Jetstar is said to be amongst the cohort of high ancillary revenue earners.

Mr Joyce said Hong Kong Jetstar would enjoy “first-mover” advantage, but sceptics are apt to cite how two other airlines namely Hong Kong Airlines and Hong Kong Express are still struggling with a 60% load factor despite charging fares that are said to be 50% lower compared to full-service airlines. Both airlines are backed by Chinese conglomerate HNA Group and garner a combined 5% market share. Besides fuel costs, operations at HKIA do not come cheap for LCCs, particularly in the absence of a low-cost budget terminal.

Whatever the outcome, the storm stirred up by Jetstar Hong Kong has surfaced a few hard realities. First, Qantas is determined – almost desperate – to spread its wings far and wide over Asia, eyeing in particular the huge potential of China. Jetstar Hong Kong may not have been ideally timed, but it is a significant stepping stone if its sceptics are proven wrong. Mr Joyce is waiting in the wings to celebrate the fortune that China’s “booming middle class” would bring when the floodgates finally open fully, a key part of his bruised five-year plan to restructure Qantas. The Australian carrier badly needs a new lease of life.

Second, while still commanding a very strong presence in Hong Kong – and no reason to believe this would change any time soon – Cathay Pacific may have to brace itself to have to fight even more tenaciously to uphold its dominance. Elsewhere in the region, a visible shift in the market is taking place. In Singapore, LCCs have increased their market share to 27% and are continuing to grow, while flag carrier Singapore Airlines has seen its share reduced to 33%. In Australia, LLCs have a market share of 43% compared to Qantas’ share of 37%. The competition has broken down the barriers of segmentation. No doubt, the competition will intensify.

Third, Hong Kong may be undergoing policy changes in the wider China context. Past encumbrances may make way for new opportunities. Things can change.

And, lastly, the jury is still out on which way the wind will blow.

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About David Leo
David Leo has more than 30 years of aviation experience, having served in senior management in one of the world's best airlines and airports. He continues to maintain a keen interest in the business, writes freelance and provides consultancy services in the field.

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