Never say never: Cathay Pacific enters budget market

Courtesy AFP

In 2015, Cathay Pacific together with Hong Kong Airlines opposed Qantas’ application to set up Jetstar Hong Kong Airways – co-owned with China Eastern Airlines and billionaire Stanley Ho’s Shun Tak Holdings Ltd. Cathay was particularly vehement about there being no room or need for budget travel in Hong Kong. The authorities were convinced and Jetstar HKG never took off.

Today, Cathay announced its decision to buy Hong Kong’s only budget carrier, Hong Kong Express Airways, for HK$4.93 billion (US$628 million). This expands Cathay’s stable of airlines to three, which includes regional carrier Cathay Dragon. It will boost Cathay’s market share to 50 per cent in Hong Kong.

A Cathay spokesperson said: “We intend to continue to operate Hong Kong Express as a stand-alone airline using the low-cost carrier business model.”

Now what caused Cathay to change its mind?

Cathay is not alone in facing stiff competition in the long-haul and premium market, from not only neighbouring rivals such as Singapore Airlines (SIA) but also Middle east carriers such as Dubai Airlines. Besides, Chinese carriers from mainland China are also fast expanding, flying direct and more services to Europe and North America.

At the same time, Cathay can no longer ignore the encroachment by the flourish of budget carriers in the region, particularly those operating out of mainland China. The Hong Kong authorities too may begin to realise how all this may be reducing Hong Kong International Airport’s hub status, particularly when limited options are resulting in Hong Kong being bypassed.

It could be a matter of timing. In 2017 Cathay reported its first annual net loss in eight years and introduced a three-year transformation program. It was later in that same year that Cathay CEO Rupert Hogg affirmed that Cathay had no plans to start a low-cost carrier. But the debt-ridden HNA Group which owns Hong Kong Express offers a timely opportunity not to be missed even as Cathay posted its first full year profit in 2018 of US$299 million.

The business climate can change fairly quickly, but unfortunately airlines may be slow in catching up with the changes because of the huge investment and lead time to implement many of the changes, apart from a host of other reasons, some of which could be largely circumstantial.

Many legacy airlines pooh-poohed the threat of budget airlines to their traditional market when it was first mooted, and as many of the carriers fell by the wayside before they could assert any impact.

SIA for one came on the scene later than most others, setting up Tigerair jointly with Ryanair, and then Scoot. Its strategy has changed yet again with the merger of Tigerair and Scoot, and now SIA is in the process of assimilating SilkAir into the parent airline.

One wonders if this is the path that Cathay may take should Hong Kong Express and Cathay Dragon find their services overlap as they expand.

Whatever the reading, it would be discreet to never say never. The question is always if so, when?

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Is there room for budget carriers in Hong Kong?

Cathay Pacific Airways has said there is no room for budget carriers in Hong Kong, following the announcement of a joint-venture between Qantas’ Jeststar and China Eastern Airlines, to be named Jetstar Hong Kong. Cathay has also made it clear that its subsidiary Dragonair is not a low-cost carrier but a regional airline. Now that Hong Kong Express is also diving into the budget market, will Cathay be proven wrong?

Courtesy Wikipedia Commons

Courtesy Wikipedia Commons

Inevitably the demise of Oasis Airlines in 2008 is often quoted to support Cathay’s argument, but there is a critical difference here: Oasis was a daring long-haul venture that could not be sustained by the traditional budget model, and at a time when fuel prices were spiralling. But there is no reason why both Jetstar and Hong Kong Express cannot succeed if they stick to regional routes within the 4 to 5 hours radius, although it is to be recognized that the competition can only get more intense – perhaps the real reason behind Cathay’s apparent skepticism.

Hong Kong Express, controlled by the HNA Group, already operates to regional destinations in mainland China, Taiwan and Southeast Asia. Its transformation into a low-cost operator means it already has an existing market and network to its advantage, while it plans to add destinations such as Kunming and Chongqing in China and Kota Kinabalu in Malaysia. Deputy CEO Designate Andrew Cowen said: “Some of our lowers fares will be 30% below the existing lowest fares in the market.” Now, Cathay and Dragonair should be concerned.

With the large and growing hinterland population of mainland China, the demand for seats is almost a given. While the budget market may have developed its own niche of travellers more concerned about stretching the dollar than with the frills and comfort of travel, increasingly as the aviation landscape changes with the vicissitudes of the global and regional economies, the choice of air travellers is fast becoming one of between airlines as to which offers the best value for money rather than strictly between budget and full service airlines.

Budget carriers no longer need to operate solely from exclusive budget airports to compete. In fact, being away from the main stream may limit its reach especially when the mode of some travellers may involve a mix of operators. Hong Kong, very much like Singapore for its land size, may not find it feasible to designate a separate airport for budget carriers. The solution may be a separate terminal within the same airport just so that budget operators, as they are so designated, may similarly avail themselves of “budget” facilities for lower ground costs. Even then, some budget carriers in Singapore were reluctant to be so isolated, and today Changi Airport has relocated budget carriers previously handled at the Budget Terminal to the main terminals as the facility makes way for the construction of an additional terminal to the airport’s existing three main terminals.

It may then be said that the Hong Kong authorities are not themselves sufficiently convinced of Hong Kong’s propensity to fan the budget airline growth, or that they somehow have not been encouraging enough the way that Singapore goes about spearheading that drive that has seen in recent years the budget business growing at a higher rate than legacy airlines. Hong Kong International Airport is an expensive airport, so it is said, and that in itself is not an inducement for potential budget operators. In spite of that, Jetstar and Hong Kong Express may yet have the clout to slowly shift the market, to the dismay, of course, of Cathay and Dragonair which realistically should not fear the competition.

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.

Cathay considers switch from OneWorld to Star Alliance: Is it a matter of choice?

Rumor is rife that Cathay Pacific Airways is considering switching from OneWorld to Star Alliance. The reason: Cathay objects to fellow members British Airways (BA)’s and Qantas’ support of the HNA Group’s Hainan Airlines joining OneWorld. The HNA Group has a 46 per cent stake in both Hong Kong Airlines and Hong Kong Express, which are Cathay’s competitors.

Cathay’s chief executive John Slosar (who took over the helm in March 2011) apparently once said he “cannot rule out” such a move.

Alliance membership is not cast in stone. Shanghai Airlines left Star Alliance in October last year to join SkyTeam, to be in the same stable as parent China Eastern Airlines. Star Alliance is courting Shenzhen Airlines, which is owned by member Air China. That makes OneWorld the only one of the three major airline alliances without any mainland China connections – something of a setback since China is one of the world’s fastest growing economies and airlines are looking to tapping its potential.

If Cathay switches, so too will Cathay-owned Dragonair.

Cathay’s change of heart is therefore no more than part and parcel of a business decision. It makes sense when Cathay is a stakeholder of Air China and has a 49 per cent stake in Air China Cargo, a joint venture set up by the two airlines. Cathay’s membership will also strengthen the Star Alliance, whose members include Singapore Airlines (SIA), United Continental, Lufthansa, Air Canada, Air New Zealand and All Nippon Airways (ANA). The strong list of possible replacements should allay any concern Cathay may have about losing the benefits of any existing tie-ups with OneWorld partners such as BA, Qantas, American Airlines and Japan Airlines.

Any further development now hinges on: (1) whether Cathay’s threat to leave OneWorld is strong enough for OneWorld to reassess its position, basically how important it is to the alliance to stake a vigorous presence in China (before it is too late) with the enrolment of Hainan Airlines vis-à-vis the benefits of a strong partnership with Cathay (better a strong than weak partner), (2) whether behind Cathay’s veiled threat, Cathay still prefers to remain in OneWorld, its predicament being a case of the push rather than pull factor, (3) whether Star Alliance member SIA has any objection to Cathay moving into the same house since both airlines are known to be keen rivals not only in the region but also for the long haul, and (4) whether Cathay itself also relishes that idea of co-existence.

Prior to the establishment of largely sectarian multi-airline groups – Star Alliance (1997), OneWorld (1999), SkyTeam (2000) – individual airlines have engaged in agreements of co-operation that include flight code-share, first preference for passenger transfers, station representation and joint use of common facilities such as CIP lounges. This practice has continued inside and outside of the alliances, even between rival group members. For example, Air Canada not only code-shares flights between Vancouver and Singapore with fellow Star Alliance members SIA and ANA but also with OneWorld member Cathay.

While any alliance is supposed to promote the collective interests of its members, the reality is that in the game of survival, the dominance of self-preservation is not easy to disguise. Qantas, hungry for a greater presence in China is likely to favor the candidacy of Hainan Airlines that together with Hong Kong Airlines and Hong Kong Express may complement its wider network including that of subsidiary Jetstar. If endorsed by OneWorld, it is up to Cathay to choose to go or to stay.

In the rival camp, SIA that openly champions competition is unlikely to make an issue of objecting to Cathay joining Star Alliance which includes regional competitor Thai Airways International. Viewed positively, there could not be a more formidable force than a partnership between Asia’s two most usccessful airlines to confront and check the growing competition posed by budget carriers in the region. So again it is up to Cathay to decide where it wants to belong. According to reliable sources, Cathay is more likely to switch camps than to compromise to stay in OneWorld. However, one wonders if it is really a matter of choice.

Yet in the end, it may matter little, considering how promiscuous alliance relationships have become and that membership is no protection against even intra-group, let alone inter-group, competition.