China approves more start-up airlines but they risk being starved of scale in a fragmented market
Eleven airlines during the past year have announced their intention to launch in China's domestic market. Increasingly, they are being approved (three so far) by regulator CAAC after a few years of a policy that technically forbade new entrants - although there were exceptions, allowing some new airlines to launch.
The new airlines fulfil the objective of creating growth and inviting private capital into the aviation industry as the state grows weary of its large investments across numerous sectors. Space will have to be created for these new airlines in China's ecosystem where 79% of seats are flown by state-owned carriers or their subsidiaries and affiliates. A full 94% of capacity is flown by airlines part of either the Big 3 – Air China, China Eastern or China Southern – or HNA Group. That leaves just 6% of capacity for independent airlines. So the incumbents are not facing an immediate threat, especially as the new airlines are not being based in first-tier cities.
But the additional airlines come as China already has an over-supply of airlines, despite the enormous potential for growth. The fragmentation means few can gain scale and synergies. That situation could be exacerbated by further airline approvals - yet liberalisation is undoubtedly where the system needs to head, creating a dilemma for the CAAC.
This report provides a look at the new airlines likely to enter China's domestic market and what their entry means. This is a follow-up to a previously published report providing an outlook on China's aviation market after forthcoming reforms.
China's policy towards new airlines has been opaque
China has gained attention in recent months over policy to lift its ban on approving new airlines. But in recent years new airlines have been approved and launched.
China had a brief period of liberalisation early last decade. This most notably saw the entry of Spring Airlines and Juneyao Airlines, today two of the leading independents. In 2007 the CAAC said it would not accept applications for new airlines until 2010. This was affirmed in 2008 with the clarification that not even subsidiary airlines would be approved, and this was mentioned again in late 2010.
The about-face in policy was the result of a few factors, including weak financial performance at some carriers as well as operational incidents and questions about safety. Safety is an extremely sensitive topic for China, still conscious of its poor record up until well into the 1990s. Responses to any incident are as a result frequently excessive, albeit effective in ensuring a recently very safe system. Against this environment, state-owned carriers posted significant losses during the global financial crisis, so the CAAC adopted the approach of stability before expansion. (The state-owned carriers quickly recovered, with some considerable financial support from Beijing.)
The caveat was that airlines which had submitted an application before the ban could still be approved, and many were. Such approvals during this period included Joy Air and Tibet Airlines. Approved airlines were often associated with an existing player (Air China, in the case of Tibet Airlines and China Eastern for Joy Air) and were focused on regional markets, which meshed well with China's objective to facilitate economic growth in hinterland areas.
In Mar-2011 CAAC Director General Li Jiaxiang was quoted as saying new applications – including from private airlines – would be accepted, but there would be no more than three approvals a year. Late 2012 and early 2013 saw a quickening of pace as additional new airlines announced intent to launch or received preliminary approval. Local reports from state media outlets also spoke of greater liberalisation and finally signalled that the "ban" would be lifted. But by this point, any official regulatory change would merely reflect what had become the status quo.
Provinces have a high degree of autonomy – and they each want their own airline
It can be questioned how much growth the existing aviation industry wants. Airlines do not shy away from saying that their rapid growth has been operationally exhausting and it is difficult to bring efficiency with so much focus on volume growth. But there are pressures from above for aviation to fuel economic growth. Hence China has explicitly said its many new airports should not be evaluated on profitability – most are loss-making – but holistically, since the airports bring people and services in that fuel growth in other sectors.
Another factor amid the zchigh growth and new airlines is that China's provinces have a high degree of autonomy from the central government. The impact is twofold. First, provinces can argue that when they are a major backer of a proposed new airline, the decision to launch should be theirs as they bear the financial risk. In these cases it is hard for the central government to intervene.
Second, the succession of one-off approvals started to create a repeating cycle in that a province sees that another province's airline was approved, so argues its local airline should also be approved. Some argue this process has now got out of hand, with the extreme example being Sichuan Airlines, which broke from its initial regional focus to serve Vancouver and Melbourne. Some stepping in appears to have occurred as Sichuan's plans to fly to Europe are on hold.
Provinces are not to be entirely blamed. Indeed, they might even be rewarded: unlike most governments elsewhere in the world, they see how beneficial aviation is to a local economy and want to support it. Some provinces have even gone a step further and are planning entire aviation development zones. (Meanwhile the UK struggles with a third Heathrow runway!). Provincial thinking is not dissimilar to the process among Dubai, Abu Dhabi or Sharjah. But the provinces have yet to master those regions' execution, although it is early days in China.
Airlines in China are like others elsewhere in the world in that they are a source of pride. Plenty of foreign governments have struggled and still do with supporting a local airline out of nationalistic pride. So the result is that provinces generally want their own uniquely branded and independent airline. The CAAC has forthrightly maintained that new airlines should consider partnerships with existing airlines for the purpose of knowledge transfer, introducing some efficiency, and keeping the airlines within the family. Approval announcements specify the "source of professional and technical personnel" (English translation), even when the airline is entirely owned, in the case of Ruili receiving staff from China Eastern and Sichuan Airlines. Sometimes an existing airline will not want to enter a market but is lobbied; or alternatively wants to enter a market but has to take the market's local investors.
The winds are changing. One provincial government found its returns were far better spent on supporting an efficient privately owned airline than the inefficient one it had directly backed and put its name to.
The trend extends beyond airlines. Local governments can subsidise a new route or an existing one but effectively receive branding rights that help with marketing. So support from Wuhan means, for example, China Eastern promotes a "Wuhan-San Francisco" service that is actually an existing flight from Wuhan to Shanghai and a separate one from Shanghai to San Francisco. The Shanghai stopover is a detail often lost.
11 airlines are in start-up phase in China's domestic market
Over the past year or so 11 airlines are known to have planned to launch, subject to approval. (This excludes a previously announced planned carrier in inner Mongolia from Air China.) Five of the 11 startups are part of the private HNA Group. Of the others, one is affiliated via Air China (via Shandong Airlines), one with China Eastern (via Joy Air), one with Okay Airways, two are entirely private and one is an LCC from existing full-service carrier Juneyao Airlines.
The main four airline groups – Air China, China Eastern, China Southern and HNA – continue to add new brands, but now the independent airlines are doing so as well. Previously airlines like Okay and Juneyao existed just as themselves, but now plan to add brands. In Juneyao's case, it is adding a LCC to its full-service/hybrid mainstay operation, so a different brand is clearly warranted. It seems Okay's airlines could fall under the same brand, but like different branding would better enable it to take advantage of specific local incentives. Spring Airlines has established a Japanese unit, the first of likely additional carriers as part of its pan-Asian strategy.
As of Oct-2013, three start-ups are known to have been approved. What follows is the best available information about the start-ups.
Summary of proposed new Chinese airlines: Oct-2013
|HNA in May-2013 announced it would seek to launch Chang'an and four other proposed new airlines. However, Chang'an was an existing airline integrated into the larger HNA Group. As recently as 1H2013 HNA has reported separate financials for its Chang'an unit. It is unclear what the development plan is.
|Fuzhou Airlines was announced in mid-2012 as a proposed start-up carrier to be based in its name city of Fuzhou in Fujian province. The carrier is a cooperation between HNA Group and the Fujian provincial government and will operate as a subsidiary of Hainan Airlines. Fuzhou Airlines plans to operate services within Southern China and will compete with Xiamen Airlines, which has a 50% market share in Fuzhou and is a subsidiary of China Southern. In May-2013 Hainan said it was still awaiting government approval.
|Another HNA-affiliated start-up, Guangxi Airlines plans to be based on Tianjin Airlines’ Nanning branch, which is also a subsidiary of Hainan Airlines. The carrier is set to further improve Tianjin Airlines' regional network, or may expand into South Asia.
|Hefei Airlines is a joint venture between Hefei Municipal Government and Joy AirAviation Holding, which is partially owned by China Eastern. Hefei Airlines plans to launch scheduled services by year-end 2013 with three aircraft. By 2020, the carrier plans to operate a fleet of 30 aircraft serving 50-70 routes including international services. Hefei has been delayed, initially expecting to launch by the end of 2012. Then it was to be established in Jun-2013. In Aug-2013 the carrier said it expected to submit its application shortly. Hefei reportedly wanted to purchase Airbus narrowbody aircraft to tackle thicker routes, but Joy Air part-owner AVIC wanted Hefei to focus on regional routes and use the aircraft AVIC manufactures in Xi'an.
|Likely to be in Harbin
|Heilongjiang Airlines is a proposed Chinese start-up to be launched as a JV between HNA Group and China’s Heilongjiang Provincial Government after signing a strategic cooperation agreement in Mar-2013. The carrier will focus on expanding services in China’s northeast. Heilongjiang Airlines may be based on the operating model of Capital Airlines, focussed on regional routes and charter travel as its main business.
|Qingdao Airlines is a Chinese start-up established by Air China, Nanshan Group and the Qingdao Municipal Government. The carrier received CAAC approval around May-2013/Jun-2013, a speedy timeframe as Qingdao government only publicly stated in Oct-2012 its desire to have a local airline. Qingdao Airlines is being sponsored by Shandong Airlines, which is partially owned by Air China. Air China's indirect ownership likely helped the process along. The airline plans to launch in 1H2014 with leased A320 equipment, possibly numbering five in the short-term. Qingdao Airlines inSep-2013 announced an order for a total of 23 A320 family aircraft, including five A320ceo and 18 A320neo with the first delivery expected in 2016.
|CNY600 million (USD93.8 million), 100% owned by Yunnan Jingcheng Group
|Kunming and Mangshi
|Ruili Airlines is a Chinese start-up planning to launch services from Kunming Changshui International Airport by Apr-2014. It received CAAC approval in May-2013. The new carrier will be 100% owned by Yunnan Jingcheng Group and plans to utilise Boeing 737-700/737-800 equipment. CEO Dong Lecheng said the start-up carrier will launch 10 routes including Mangshi-Kunming, Mangshi-Beijing, Mangshi-Shanghai and Mangshi-Guangzhou. In Aug-2013 Ruili Airlines and Boeing signed a purchase agreement for 14 Boeing 737 aircraft including eight 737-700s and six 737-800s. The carrier also signed purchase agreement with Air Berlin for two 737-700s in 2013 and two 737-800s in 2014. By 2020, the carrier plans to expand its fleet to 45 aircraft. Although privately owned, flight inspectors to come from China Eastern Airlines Yunnan while management staff will also be recruited from China Eastern Yunnan. Technicians from Sichuan Airlines Group and Civil Aviation Flight University of China.
|Urumqi Airlines is a proposed Chinese start-up which is a JV between the Urumqi municipal government and HNA Group. Urumqi Airlines plans to take over Hainan Airlines’ operation at Urumqi which includes seven Boeing 737-800s based at the airport. Urumqi Airlines will also expand internationally from Urumqi to Central Asia, Europe and the Middle East. Hainan Airlines is expected to be the controlling stakeholder in the start-up although the ownership structure has not been decided.
|Zhejiang Loong Airlines is a Chinese start-up based in Hangzhou. The carrier signed an MoU for 20 A320 family aircraft, including 11 A320ceo and nine A320neo in Sep-2013. Zhejiang Loong Airlines plans to launch services in 2013 following approval by the CAAC for passenger flights. Zhejiang Loong is, according to recent reports, the re-branded name of CDI Cargo Airlines, which operates three 737-300Fs from Hangzhou. Destinations reportedly include Chengdu, Chongqing, Shenzhen and Xi'an while regional (Hong Kong/Macau/Taiwan) and international operations are hoped to commenced in three to five years time.
|(Unspecified – LCC)
|Shanghai-based private carrier Juneyao, which launched during last decade's liberalisation wave, has reportedly received preliminary approval to operate a Shanghai-headquarted, Guangzhou-based LCC. Rival Shanghai carrier Spring follows the LCC model (Juneyao is full-service) and plans to have a base in nearby Shenzhen.
|(Unspecified – regional carrier)
Okay Airways is a privately owned carrier unaffiliated with others. It is based in Tianjin and follows the regional model, although its fleet of eight MA60s is complemented by 11 larger passenger 737-800s, with additional 737 variants on order. In mid-2012 Okay said it submitted an application to base a regional affiliate at Harbin in Heilongjiang province. In Aug-2013 Okay said it had filed an application to launch a regional carrier in 2014, but it was not made clear if this was new, a revised or the same application as 2012. The announcement that HNA and Heilongjiang provincial government agreed to form Heilongjiang Airlines appears to conflict with Okay's initial plan to have a carrier in the same province. HNA may have decided no to go with Okay. Okay said new affiliates would have separate branding and be part of its effort for a country-wide regional carrier network. Okay has spoken of eventually operating over 100 MA60s.
89% of domestic seats are affiliated with the Big 3 or Hainan
These new carriers may be entering a crowded market, but it is not a diverse market. Most carriers are affiliated with one of the Big 3 or Hainan Airlines. Sichuan Airlines even has all three of the Big 3 as shareholders (in varying amounts). 89% of domestic seat capacity in early Oct-2013 is flown by the Big 3, Hainan or an airline to which they are the single airline shareholder (so this excludes Sichuan Airlines and its subsidiary Hebei Airlines, which account for a further 5% of the market). So truly independent and unaffiliated airlines account for only 6% of China's domestic seat capacity. That number may grow with the launch of new carriers, but even a double-digit share of the market will be an accomplishment in the near future.
Seat share of China's domestic market: 07-Oct-2013 to 13-Oct-2013
Most of these start-ups will be in growing areas that, unlike Beijing and Shanghai and even Hangzhou, do not face slot limitations. So there is not a concern they will be a large competitor for a scarce resource. But the carriers will of course eventually want a service or two to the main cities, and then they will compete for slots. The impact on air traffic control is mixed as some carriers will fly in less dense areas while others may be based in a third tier city but will have to share corridors with flights going to first and second tier cities.
The bigger concern is a lack of efficiency from a management perspective (see next section.)
Cross-ownership and partnership amongst Chinese carriers: Oct-2013
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Limited presence means little scale, making efficiency elusive
Most of these start-ups are starting small but plan to amass dozens of aircraft. Even if that vision is realised, the existing main carriers will be even larger than they are know. That translates - at least in theory - to more opportunity for scale and efficiency. The start-ups may very well not reach their aspirational size, either due to their own causes or to the imposition of state limitations; Spring is significantly below its planned size due to limits on the aircraft it is allowed to import.
The CAAC has been frank in saying there is short supply of management resources in the country. Duplicating management across airlines will not be efficient. Promoting separate brands will be costly, and in some areas could be better achieved if a local operation were part of a larger branded entity. For carriers that have ties to an incumbent, the ownership varies – in value and impact; 40-60% ownership from an incumbent is typical. Many carriers have their own distinct operation; it would not be easy to tell they were part of another airline. But Dalian Airlines for example is so integrated into Air China that Dalian flies under Air China's CA code and so is not accounted for (amongst others) in the pie chart above.
Outlook: Expansion, consolidation, expansion – more consolidation next?
This is the academic argument for consolidation. But the wishes of provinces, combined with their influence, keep the airlines apart. It will only be if losses start mounting that there would be calls for reform. There will hopefully be incremental efficiency gains as the overall industry improves, but it is difficult to see sweeping change.
It does appear that new airlines will continue to be approved, and the CAAC could use the safety card to push for closer integration with China's main airlines. But the risk is the existing airlines, already stretched and in need of time and resources to make their own improvements, will be further challenged.
The CAAC's dilemma is based around the risk that extended protection of the major three while they consolidate their position may not achieve that goal. Instead they will remain inefficient in a comfortably protected environment and, in doing so, fail to respond effectively to consumer needs and national communication goals.
It is not easy to plot the right path amid these varying considerations. But the CAAC can at least be fairly certain that there remains a great deal of market expansion potential and, in those circumstances, there is much greater room for experimentation; and errors are quickly overtaken.