12-Nov-2012 3:24 PM

Air New Zealand-Cathay Pacific partnership has implications across Asia and for SIA & China Southern

Analysis

Air New Zealand's securing of a rare partnership from highly independent Cathay Pacific touches on much more than the niche Hong Kong-New Zealand market. There are far broader implications for networks and global alliances.

Asian carriers have usually taken a quite distinctive approach to global alliance participation and operation than their European peers. Indeed, Cathay and Singapore Airlines (SIA) take some of the largest hands-off approaches to alliances and, when it comes to partnering, can be deeply conservative. While this may have worked in the slow days of last decade, there is new competition and, as the Gulf carriers disturb the old equilibrium, it can be a scary world for long-haul carriers to confront alone.

Singapore Airlines is signalling a shift with baby steps for alliances, while the outlook at Cathay remains essentially solitary. This deal was heavy on influence from ANZ, which had struggled to serve the Chinese market effectively while also contending with a rising China Southern as a formidable force, a carrier competing with Cathay as well. And ANZ previously received little love from Star partner SIA, also a staunch Cathay competitor.

The outcome is a very tidy deal for Cathay and ANZ, but one that will undoubtedly spark ramifications - and see the emergence of Hong Kong Airlines as a viable partner.

Summary

Air New Zealand and Cathay Pacific have formed a partnership, which will see them codesharing on each other's Hong Kong-Auckland services.
The deal benefits Air New Zealand, as it gains network access to mainland China and India, two major markets where it previously did not have viable connecting opportunities.
The partnership may spark further alliances and partnerships in the region, as airlines look to compete with the growing influence of Gulf carriers and navigate the changing dynamics of the aviation industry.
Air New Zealand's withdrawal from the Hong Kong-London route will result in a decrease in capacity on the route by 17%.
Hong Kong Airlines may re-enter the Hong Kong-London market, taking advantage of the reduced capacity and offering a more suitable configuration for the market.
The partnership between Air New Zealand and Cathay Pacific is a significant move in the region, as it challenges the traditional approach of Asian carriers to global alliances and partnerships.

The agreement, which secured New Zealand regulatory approval (effective 12-Dec-2012) prior to being made public, will have Air New Zealand and Cathay Pacific codesharing on each other's Hong Kong-Auckland services. It is no coincidence that Air New Zealand from 04-Mar-2013 will pull off the Hong Kong-London route, where Cathay competes and which ANZ had been looking to restructure for some time (ANZ says the move is "separate"). The exit may deliver further impetus for Hong Kong Airlines to re-enter the Hong Kong-London market, but with a more suitable economy and business class configuration rather than its all-business class experiment earlier in 2012.

ANZ and Cathay also have unspecified commercial arrangements for onward connections, but the deal clearly benefits ANZ, which gains network access to mainland China and India, two major markets where SIA has been cleaning up and in which ANZ did not have viable connecting opportunities. The deal does not include onward codeshares.

China typically blocks third-country codeshares on foreign carriers serving the mainland (Cathay and Dragonair, based in Hong Kong, are not considered mainland Chinese), and ANZ joins a list of carriers that would like to codeshare on a foreign carrier serving the mainland. The carriers hint that expansion of the alliance is likely.

While ANZ has not disclosed the future for the London Heathrow slots it is foregoing, it has said the freed-up fleet capacity will be redeployed to Los Angeles and San Francisco. North America has been stable, and in May-2012 saw the exit of Qantas' Auckland-Los Angeles service. ANZ in recent months had already scheduled extra capacity to North America.

Air New Zealand had been looking to improve Chinese connections

China has proved a difficult market for end of line carriers. Until a 2012 revision, the New Zealand-China bilateral permitted a daily service from each country. ANZ served Auckland-Shanghai four times weekly and Auckland-Beijing twice weekly before deciding in Mar-2012 to concentrate on Shanghai and eventually build capacity to a daily service.

Likewise, Qantas ended Sydney-Beijing flights to maintain Sydney-Shanghai links. Virgin Australia has so far favoured long-haul services to Asia on partner Singapore Airlines, which can offer a number of connecting opportunities from its Changi hub.

Part of ANZ's China restructure included an emphasis to build connections across mainland China. This seemed challenging given ANZ's sole mainland destination was to be Shanghai, where fellow Star Alliance carrier Air China has only a fraction of capacity.

Shanghai Pudong Airport domestic seat capacity: 12-Nov-2012 to 18-Nov-2012

Shanghai Hongqiao Airport domestic seat capacity: 12-Nov-2012 to 18-Nov-2012

The largest carrier in Shanghai is China Eastern, which has no Oceanic/Pacific partner in SkyTeam but is cosying up to Qantas in the form of their joint venture to establish Jetstar Hong Kong, as well as possible future synergies between their mainline operations. ANZ likely found no dance partner in Shanghai. Services from Auckland to Beijing, where ANZ could perhaps work with Star Alliance partner Air China, would have come at the expense of circuitous connections as well as missing out on the business demand for direct services to Shanghai, China's financial centre.

Competition was increasing with mainland Chinese carriers

Further pressuring ANZ was growing mainland Chinese presence in its home market. China Southern commenced Guangzhou-Auckland services in Apr-2011 and went daily in Nov-2011, reaching the bilateral's capacity limit. New Zealand swiftly expanded access, giving Chinese carriers the rights for up to three daily services. But ANZ was left feeling miffed; although it is an ardent supporter of tourism into New Zealand, it saw that Chinese carriers would quickly be able to use their capacity allotment while it would struggle, even in the medium-term, to have three daily services to mainland China.

Its outlook is proving correct, with Auckland Airport in Nov-2012 saying it expects China Southern to increase services to double daily in the near future. China Southern's efforts to have double daily services to Australia (Melbourne and Sydney) proved too much too soon and the carrier has scaled back. But it has an advantage in New Zealand since there is little competition; in contrast, Air China and China Eastern each serve Melbourne and Shanghai.

China Southern's presence in Auckland was not one merely of seats but a serious competitor looking to tap into sixth freedom traffic and significantly undercut prices, provoking the need for ANZ to remain competitive.

Singapore Airlines was not a viable partner, and now ANZ shakes up Asian alliances with oneworld's Cathay

ANZ had at one time tried to partner with SIA, but the relationship was too difficult to work out. SIA, until recently, had been hands-off when it comes to partnerships, preferring to access markets on its own metal and ensure brand and experience consistency. ANZ, in switching from the use of a Singapore connection on a Hong Kong-London service, had hoped to waive the Star Alliance flag on the market and receive traffic on the premium-heavy market from Star carriers instead of their carrying it via their own hubs, but saw little interest, especially from SIA.

With SIA effectively a competitor, selecting Cathay was based both on opportunity and process of elimination. It may help that Cathay is 29.99% owned by Star's Air China, but even then with Cathay in oneworld this is an alliance shake-up. Cathay has always had cool feelings towards oneworld partner Qantas, mainly because of their heavy overlap and undoubted regulatory rejection if they tried a tie-up (ditto for Cathay and oneworld's British Airways). Also, Qantas is working with China Eastern to establish Jetstar Hong Kong right on Cathay's home turf, although Cathay is aggressively insisting, publicly at least, the proposed carrier will have no impact on its business.

The new generation partnerships

The push of new generation partnerships - deep ones outside alliance lines - in Asia-Pacific was quietly spearheaded by independent Virgin Australia, whose burgeoning virtual long-haul network was one impetus for competitor Qantas to pursue the grandest of the global shakeups in the form of a deep partnership with Emirates. Europe has been home for some time to Gulf carrier advancements, and now America appears to be a target with Emirates courting American Airlines. It was only time for the dominos to fall in Asia - and it is perhaps the most conservative of them all, SIA, which has made the baby steps.

As CAPA previous wrote:

With limited growth likely in the long-haul market, the SIA Group will continue to look for new partnerships to expand its network virtually. Mr Goh has been actively pursuing partnerships over the last two years outside the Star Alliance as part of a strategy to fill in gaps in its network and compete better against partnerships forged by rival carriers such as Emirates-Qantas.

Since Mr Goh became CEO he has forged five partnerships with unaligned carriers - Gol, JetBlue, Transaero, Virgin America and Virgin Australia. While they are interline rather than codeshare partnerships, the deals with Gol, JetBlue and Virgin America are significant because they represent the first time SIA has worked with foreign low-cost carriers.

New Zealand, as an inbound driven market and with a small population base, has always been a difficult market for Cathay to serve consistently. As a result Cathay's presence on the Auckland-Hong Kong route is highly seasonal, offering daily frequency year round, moving to double daily over the peak summer period when it accounts for about 65% of capacity against its sole competitor ANZ. For the rest of the year the two share the capacity roughly equally.

Auckland International Airport to Hong Kong International Airport capacity share (seats per week, one way): 19-Sep-2011 to 05-May-2013

Hong Kong Airlines has partnership opportunities as battle lines are drawn around greater China

The Cathay-ANZ deal will not go unnoticed. Rather it will accelerate other alliance moves. Lines are being drawn around Asia and China in particular. Cathay is with Air China and now Air New Zealand too. China Eastern and Qantas, competitors to Air China and Cathay, are nudging up. China Eastern is also with Hong Kong Airlines, a competitor to Cathay.

So the scenario emerges of two camps: Air China-Cathay and The Rest. Air China and Cathay make a powerful combination. Cathay is the region's stalwart and Air China has Beijing's backing and enjoys favouritism. Not all in The Rest may get along, but they will need to tackle Air China-Cathay before their own internal competitive pressures. Time will tell if there will be a third faction.

An anchor member, or members, for The Rest may not emerge soon, but there is considerable opportunity for Hong Kong Airlines. Its base in its namesake city is typically served by anybody who seeks the title of a global carrier. With Cathay closed off and Hong Kong Airlines having no allegiance ties (although oneworld could be favoured in due time if Cathay leaves, say to join Air China in Star), its door is open to most everyone.

It has the potential to use its regional Asia, and China in particular, network, to be the Hong Kong-based partner many carriers could only dream of having in Cathay. Hong Kong Airlines, if it can set its own agenda and receive backing from owner and main influencer Hainan Airlines, could do to the region what Etihad and Virgin Australia have done elsewhere. It has internal housekeeping to tend to, but it is not difficult to see a long list of potential suitors. The question, perhaps, is who will be its first main partner.

Air New Zealand's Hong Kong-London service had been a challenge; now capacity on the route drops 17%

ANZ's decision to withdraw from Hong Kong-London concludes a year-long review to stem long-haul losses and focus more strongly on serving the Pacific Rim. It launched Hong Kong-London services in 2006 with a daily offering before consistently reducing the operation to five weekly flights in Sep-2009, with occasional increases over peak periods.

Auckland-Hong Kong-London complemented Auckland-Los Angeles-London. ANZ CEO Rob Fyfe told CAPA in Oct-2011 that Hong Kong-London only under-performed Los Angeles-London at certain times of the year; it was not consistently doing worse. But ANZ has since determined - undoubtedly with the influence of the Cathay deal - to pull off Hong Kong-London. ANZ deputy CEO Norm Thompson told Aviation Week that Hong Kong-London had a 10% higher operating cost due to factors including Hong Kong landing fees and Russia overflight charges. Additionally, Los Angeles-London attained a higher yield, partially due to ANZ deploying 777-300ERs with more premium products rather than its older 777-200ERs (although these are due for retrofit later this decade). The -300ER for example includes the SkyCouch in economy, which adds little cost but offers large yield upticks.

ANZ's withdrawal will remove approximately 2,000 one-way seats per week between Hong Kong and London.

Hong Kong International Airport to London (all airports) (seats per week, one way): 19-Sep-2011 to 28-Apr-2013

The Hong Kong-London market over a year will shrink from five carriers offering approximately 20,000 one-way weekly seats to three carriers offering approximately 17,000 one-way seats, a decrease of 17%. Qantas in Mar-2012 withdrew its daily Hong Kong-London service as part of its long-haul restructure that saw all European flights transit via a single point in Singapore (Qantas' Bangkok-London service was also withdrawn and from 2013 Singapore-London services will transit through Dubai).

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However, this may not be the final story of the market, as changing factors could see Hong Kong Airlines re-enter the market.

Hong Kong International Airport to London (all airports) (seats per week, one way): 19-Sep-2011 to 28-Apr-2013

ANZ's withdrawal from London could pave the way for Hong Kong Airlines to re-enter

Air New Zealand's withdrawal from Hong Kong-London could be further impetus for Hong Kong Airlines to re-enter the market. The carrier operated between Hong Kong and London Gatwick for about six months in 2012, eventually ending services due to low yields and load factors. Its problem was not a weak market but the wrong configuration: it operated the Hong Kong-London service with all-premium A330s featuring lie-flat business class beds and recliner-style business class seats.

There is significant diversion of traffic between Hong Kong and London via hubs elsewhere in Asia, the Middle East and Europe. In 2011 the UK CAA reported there were 1.4 million passengers travelling between London and Hong Kong, but in that year there were only 1.1 million available O&D seats in the market. Assuming a load factor of 85% of available O&D seats, one-third of the total Hong Kong-London market makes a connection en route.

This is a significant pool to take from considering there are upwards of eight daily widebody flights (four on Cathay Pacific, two on British Airways and one each from Air New Zealand and Virgin Atlantic). Additionally, British Airways has spoken of Hong Kong being one of its first A380 markets while Virgin Atlantic would consider a double daily service if slots permitted.

Hong Kong-London passenger enplanements and available O&D seats: 2002 to 2012*

Hong Kong Airlines does have some disadvantages against its well-developed legacy competitors. It is a young airline with an embryonic corporate base as well as a limited frequent flyer programme. But even if these factors remain as they are, the option of more direct O&D seats at or below the price of sixth freedom carriers would see it gain traffic. Ongoing improvements to its corporate retention and frequent flyer programme could further enhance its position. Its biggest advantage may be that it is full service without a legacy cost base; its brief all-premium service showed the staunchest of frequent flyer programme loyalists would forgo miles/points in a global programme if a cheaper itinerary for the company could be attained without having to increase travel time by making a connection.

Hong Kong Airlines' service was compared to Oasis Hong Kong. Oasis operated between Hong Kong and London with 747-400s in a mixed configuration before shutting down. The comparison is made to suggest a folly, but according to those familiar with the situation, Oasis was profitable between Hong Kong and London but collapsed due to sagging trans-Pacific performance as well as internal shareholder disagreements. With a connecting network (Oasis had none), a more efficient aircraft (like the A330 Hong Kong Airlines used) and a suitable configuration (Oasis used 747s from Singapore Airlines that had old and weighty seats, IFE and galleys), there is potential - especially now with one more competitor reducing capacity, even if some capacity, like with Qantas, originated from other ports and was only transiting through Hong Kong.

The biggest challenge to Hong Kong Airlines may not be recognising the opportunity but rather the style of its management, which borrows heavily from mainland Hainan Airlines part-owners. The modus operandi of typical Chinese companies is to quickly eliminate problems - like unprofitable routes - and move on rather than acknowledge the problem and work to find a solution, such as re-entering with a different configuration, which would acknowledge what the market long saw: the non-sustainability of all-premium flights. Removal of all-premium flights from an industry stalwart, Singapore Airlines, may provide a confidence boost that Hong Kong Airlines was not alone in this undertaking that is no longer compatible in the current demand and fuel price environment.

Another strategic partnership for ANZ - and the first of more strategic partnerships at Cathay?

ANZ has shown itself to be a flexible and fluid alliance player, shifting Japanese partners from oneworld's JAL to fellow Star carrier ANA, partnering with independents Etihad, Virgin Atlantic and Virgin Australia. So the Cathay partnership provides another notch in its belt, but with extra weight since Cathay is in oneworld, the home of ANZ's largest competitor, Qantas.

Cathay is more rigid in its position, and even SIA is showing this is not the way to be. Heavy exposure to costly and competitive long-haul traffic carries a financial burden, as Cathay found when posting a rare first half loss in Aug-2012. And just as Qantas found, an airline that becomes too formidable will unite disparate carriers under a common enemy to respond.

This is the direction Cathay needs to be heading and with the right partners its already impressive platform could become much more powerful. Along with codeshare gains, improved interlines and shifting frequent flyer alliance out of the ANZ deal, there is the opportunity for Cathay to feel out these new wave of partnerships, and eventually plot some of its own.