28-Feb-2013 2:45 PM

Airlines' tangled alliances evolve: British Airways-Cathay Pacific codeshare to Australia - for now

Analysis

Implications continue to emerge from the Sep-2012 landmark Emirates-Qantas alliance, the latest development being a codeshare covering Australia for British Airways and Cathay Pacific. Although the two are members of the oneworld alliance and at first blush may be considered partners, they had the most minimal of ties, owing to significant competition between them.

That competitive situation still exists but other factors have changed: BA's once deep partner Qantas is now a competitor, aligned with Emirates, and is establishing a Jetstar franchise on Cathay's home turf in Hong Kong. BA and Cathay are united by a common enemy - not the first occasion this reasoning has spawned an alliance - but also other factors. BA has lost its Australian network access and Cathay fits in; meanwhile Cathay will be receptive to feed to sustain its positioning after China Southern and Singapore Airlines have made large capacity increases in Australia.

Alliances are evolving, and this partnership will surely change - or go extinct - as BA becomes more familiar with new oneworld members Malaysia Airlines and Qatar Airways, with whom it will have more in common than it does with Cathay.

Summary

British Airways and Cathay Pacific have formed a codeshare agreement to cover Australia, despite being competitors in the past.
The alliance was driven by the common enemy of Qantas and Emirates, as well as the need for both airlines to sustain their positioning in the face of increased competition in Australia.
The codeshare covers Cathay's services from Hong Kong to major Australian cities, subject to regulatory approval.
British Airways lost its Australian network access after the Qantas-Emirates alliance, making the partnership with Cathay Pacific a strategic move.
The dissolution of the joint service agreement between Qantas and British Airways led to BA ending Asia-Europe codeshares, while Qantas will only have Finnair available for transit to Europe via Asia.
The partnership between British Airways and Cathay Pacific may not be long-term, as BA explores deeper partnerships with other oneworld members like Qatar Airways and Malaysia Airlines.

The proposed codeshare covers Cathay's services from Hong Kong to Adelaide, Brisbane, Melbourne, Perth and Sydney, subject to Australian regulatory approval (but some city pairs are already available for sale). BA has double daily London-Hong Kong services, one with a 747-400 and the other a 777-200, which becomes a 747-400 service from Apr-2013. BA has spoken of Hong Kong being one of the first markets for its forthcoming A380s. Slots are scarce at Heathrow and limited at Hong Kong; BA's two services depart Hong Kong within 30 minutes of each other.

Despite oneworld ties, British Airways has historically not had a partnership with Cathay Pacific

Mere membership in the oneworld alliance was the extent of what united British Airways and Cathay Pacific. While the global marketing alliances conjure an image of integration and cooperation, they can be far from that. oneworld has always been the loosest of the three; in comparison Star Alliance has orderly Lufthansa to promote cooperation, although this can be limited: Singapore Airlines has limited codeshares and partners. The most basic of alliance cooperation is the mandated frequent flyer and lounge reciprocity, passenger-facing initiatives that hardly touch an airline's strategic plans, and this is what BA and Cathay had.

The encompassing frequent flyer earning and redemption options that global marketing alliances offer is a significant driver of what is keeping Qantas and Cathay in the oneworld alliance. The frequent flyer component is so critical that unaligned airlines have developed partnership strategies to enhance their reach: Etihad and Virgin Australia have expansive alliances, and Emirates has done a deal with easyJet.

Driving the limit of partnership between BA and Cathay was competition: BA and Cathay competed in the key point-to-point market of Hong Kong to London and any cooperation would have drawn the likely prohibitive scrutiny of regulators. They also competed in connecting markets, although, like many carriers, they had a basic interline relationship. Also a factor was the general high independent stance of Cathay, like SIA (although SIA is beginning to embrace deep partnerships).

British Airways' position changed after the Qantas-Emirates alliance

The status quo changed with the Sep-2012 announcement that Qantas would partner with Emirates, dropping its nearly two-decade-old joint service agreement with British Airways. The breakup was largely mutual.

The Europe-Australia market had fundamentally changed with the entry of Middle East network carriers. Emirates alone in Sep-2012 offered one-stop service from Australia to 30 European destinations. Qantas offered two - London Heathrow and Frankfurt - while other destinations had to be reached via backtracking through Heathrow. The power of these Middle East network carriers was displayed far earlier in Aug-2010 when Virgin Blue (now Virgin Australia) partnered with Etihad Airways, an alliance that slowly increased pressure on Qantas.

BA meanwhile was no longer enamoured with low-yielding Australia, slashing its own capacity to a single daily 747-400 service to Sydney. It too was lured by the hub power of Middle East network carriers, and was instrumental in signing Qatar Airways up for membership in the oneworld alliance. Although Qatar will be in the same alliance as Cathay and Qantas, it is the personal relationship between BA CEO Willie Walsh and Qatar CEO Akbar Al Baker that cemented Qatar's ascension into oneworld. Qatar will likely have its deepest partnership with BA, to unfold in due course.

With the dissolution of the JSA, Qantas immediately had a new partner - Emirates - while BA did not. BA did have preliminary options, and those continue to evolve today. A deeper partnership between BA and Qatar could include Australia, but Qatar's footprint is light: it serves only Melbourne and Perth; Etihad also serves Brisbane and Sydney (but not Perth) while Emirates also serves Adelaide, Brisbane and Sydney with multiple frequencies. In the medium-term BA could shift its London-Singapore-Sydney service via Doha, but the two will still have a lighter footprint than Emirates and Etihad.

Malaysia Airlines is a new ingredient in the mix

Malaysia Airlines, which joined oneworld in Jan-2013, was also waiting in the wings. MAS serves Adelaide, Brisbane, Melbourne, Perth and Sydney. This option would have required BA to launch services to Kuala Lumpur, which BA has said it is interested in (without a firm timeline) following its acquisition of bmi and its precious Heathrow slots. But the option is not smooth.

MAS has gone through numerous restructures in recent years and strategy has been fluid as it changes course on many occasions, a frustration to one-time hopeful partner Qantas (which sponsored MAS' entry into oneworld). More recently MAS has opened double daily A380 service to Kuala Lumpur and London Heathrow, creating over-capacity, as MAS is short of sustainable markets for its A380.

Although BA might be interested in MAS' Australia network from Kuala Lumpur, it is not keen to become deeply involved while MAS still seeks a strategy for selling its increased capacity between London and KL. Prior to the dissolution of the JSA, which relied on Singapore as the primary Australia-Europe gateway, Mr Walsh saw potential for Kuala Lumpur to rival Bangkok as a secondary transit point.

Australia international seat capacity by carrier: 25-Feb-2013 to 03-Mar-2013

BA in mid-2012 expressed interest to partner with China Southern (oneworld has no mainland Chinese member of its own), which could have theoretically included China Southern's growing Australia network, but this has not materialised (as in Kuala Lumpur, BA does not fly to China Southern's hub at Guangzhou, a stumbling block).

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Partnering with Cathay gives BA an associate in a city it already serves (Hong Kong) as well as the ability to maintain the full range of connections across Australia it used to have with Qantas. Whereas MAS, Qatar and a number of other partners would have a limited offering to Australia, a point underscored in BA's statement about the new partnership: "Our new code share with Cathay Pacific will allow British Airways to serve all major Australian cities."

Operationally, geography has a minor role; transferring from London to Sydney in Hong Kong is 157km shorter than through Singapore. BA flights arrive into Hong Kong at 14:20 and 16:40, the latter facilitating connections on Cathay to Melbourne and Sydney within about 2.5 hours while Brisbane and Perth have a wait of about six hours, and Adelaide seven.

British Airways pulled back Qantas codeshare

At the time of the Sep-2012 announcement of the Emirates-Qantas partnership, Qantas said that while the JSA with BA would be wound up, it would seek to maintain codeshares with BA from Asia to Europe, facilitating additional transfer options. BA, however, has reportedly not wanted to help Qantas to Europe. BA's Asia-London flights will no longer be available for a Qantas codeshare. Qantas currently has its code on BA's Hong Kong-London double daily flights, daily Bangkok-London flight and one of BA's two Singapore-London flights. The codeshares end on 31-Mar-2013, the day of the JSA's dissolution. Qantas says its passengers wanting to transit to Europe via Asia will only have Finnair available.

BA, however, is willing to place its code on Qantas services from Asia to Australia as well as domestic Australian flights that feed BA's London-Singapore-Sydney service. While Qantas will shift Sydney-Singapore-London and Melbourne-Singapore-London services to transit in Dubai, it will offer flights to Singapore that terminate there (rather than continue onwards).

Qantas did the same after pulling down Bangkok-London and Hong Kong-London services in Mar-2012. Although the dedicated Australia-Singapore capacity (A330s and 747s) will be less than the A380s that continued onwards to Europe, Qantas will have more seats dedicated to Asia, as previously around 85% of Singapore-Europe services commenced their journey in Australia, leaving few seats Qantas needed to sell between Australia and Asia.

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The pressure is on Qantas to make its Asian services sustainable. It will re-time flights to make the arrival in Asia more conducive to an Asian business day (flights currently arrive late, good for onward connections to Europe but not for those ending their journey in Asia), a move that has already been greeted favourably by the market. Partnering with Emirates' few Australia-Asia services (continuing to Dubai but with fifth freedom rights) will add scale. But Qantas still lacks major onward feed from Asia to accommodate Australian traffic.

Some interline arrangements, such as with Jet Airways and Dragonair, will help, but are no match for the local networks Cathay, SIA and Thai Airways have in their hubs. Jetstar Asia, based in Singapore, can offer some feed, but Qantas is not upbeat on its potential, at least for the premium segments. So while Qantas may seek retaliation against BA ending Asia-Europe codeshares, commercially Qantas welcomes BA's feed. Qantas is in greater need of Asia-Australia feed than BA is of Asia-Europe.

Sample dates for travel from London to Melbourne and Sydney (Adelaide and Brisbane do not appear to load yet on British Airways' site) show that sometimes a Qantas connecting service from Singapore is the cheapest option while other times it is a Cathay flight from Hong Kong for economy and premium economy. Business class varies less and is often cheaper on a Qantas codeshare than on Cathay. Services to Perth, the final Australian port Cathay serves, are only sometimes loaded on BA's site, making comparisons difficult.

The fluctuation between partner airlines and thus hubs indicates BA will still be able to take advantages of different local nuances, constructing a cheaper itinerary via another hub and partner when high demand prices out an alternative hub and partner.

Cathay Pacific has been impacted by a changing Australia market

As British Airways experienced change between Europe and Australia, so too had Cathay - and for longer. A once healthy network linking Australia to Europe was under pressure from the Middle East network carriers as well.

The Qantas-Emirates alliance linked two of Cathay's fiercest competitors. Singapore Airlines and Thai Airways have more capacity into Hong Kong than either Emirates or Qantas, but the latter two are symbolically large competitors and also compete with Cathay for overlapping connecting traffic. (And Cathay is not pleased with - ie fighting hard to prevent - Qantas establishing in Hong Kong a franchise of its low-cost carrier Jetstar, Jetstar Hong Kong.)

Hong Kong seat capacity by carrier: 25-Feb-2013 to 03-Mar-2013

The scenario is similar at Singapore Airlines, the second-largest foreign carrier in Australia. SIA and Cathay have had to spool up Australia-Asia connections (where the Middle East carriers largely do not compete) after relying so heavily on Australia-Europe. At the same time as they warmed to these markets, China Southern appeared on the scene, targeting the Australia market for flights to China, Asia and beyond to Europe and even North America. China Southern in 2009 had seven flights a week into Australia/New Zealand and by 2015 wants 55; it is now half-way there. Asia, and China in particular, had been healthy staples for Cathay and SIA.

Further pressure on Australia will materialise when Air India finally commences long-awaited Australian services with the 787. So incremental feed from BA is welcome.

Generally, additional passengers are always welcomed. Not only does their fare typically go straight to the bottom line after the operating carrier fills its own quota, feed from partners offers the opportunity to have more high-yielding passengers. Yet Cathay is not desperate to improve load factors. Australia and Hong Kong do not have an open skies agreement and almost all capacity under the bilateral is used up by Cathay, effectively blocking expansion. (Additional flights are permitted if routed through a second-tier Australian city.) While Cathay was constrained, SIA - which benefits from the Australia-Singapore open skies agreement - expanded, as did Emirates. Negotiations to expand Australia-Hong Kong bilateral broke down in 2011.

As Hong Kong carriers (Cathay) have nearly used up capacity while Australian carriers (Qantas) have ample room, Australia is understood to have requested fifth freedom rights from Hong Kong in absence of needing capacity growth. With Hong Kong typically not handing these rights out, negotiations broke down. Hong Kong is wary of giving Qantas (who essentially lobbied Australia to request greater fifth freedom access) fifth freedom rights, which could allow it greater competition with Cathay.

Cathay in 2012 recorded a 77.3% load factor on Australian services, according to the Australia's BITRE. SIA recorded an 80.3% load factor and Emirates 79.1% in 2012. It is not unheard of for Cathay to off-load passengers in order to carry more freight, meaning that while load factors may show room for some improvement, the network is already stretched.

British Airways unlikely to stay with Cathay in the long-term as alliances dance

The BA-Cathay deal is less a marriage of love than of convenience, and there may very well be a divorce in the long-term, or at least a de-emphasis of the new deal. As Qatar Airways, or even MAS, come into focus, that partnership may be more viable as the cooperation between BA and Qatar would be deeper and on more favourable commercial terms. A future partner will also be eager to capture BA's feed that will go to Cathay. Cathay for its part would rather transport a passenger from Europe to Australia on as much of its metal as possible rather than taking them from Hong Kong to Australia, the shorter sector. Cathay's drive will be heightened with its introduction of a fifth daily Hong Kong-London service in the northern summer (facilitated by acquiring Air New Zealand's slot).

As Cathay looks to make the service year-round, it will be further disinclined to help its direct competitor's flights (including with possible A380s) by providing onward feed if it can carry the passenger the entire way.

Alliances will continue to shift, and a breakup of the BA-Cathay deal, although tidy and logical now, would not be surprising. Nor would it be the biggest breakup to possibly come. As alliances become deeper and the revenue flows larger, demand can increase for an airline to be less promiscuous and more loyal to a certain member, or members. It is a part of the continuing story of alliances shifting from abstract bloc-based groupings to that of the ego-centric model.

It will continue to be an exciting time for partnerships, but also a complicated and volatile one too.