08-Feb-2016 7:10 PM

Emirates Airline: The strategy reshapes in 2016 – partnerships, China growth, smaller widebodies

Analysis

It is a truism that Emirates Airline has been a gamechanger. But that is not just in size, but in its comprehensive precision. This is an operation that plans and consistently delivers. In its own words: growth hinges not just on internal capability, but in the capacity of its home airport; the output of factories in Everett and Toulouse; and the willingness of ministries to grant more traffic rights. Consequently it is surprising that a year ago there were few indications 2016 would be as momentous as it appears likely to be: the beginning of the next phase of Emirates' growth.

First in this phase is the internal change in strategy and mindset: to be more receptive to partnerships. There is commercial value in this strategy, but also a recognition of a changing world where bilateral alliances are taking on a more prominent role - including Qatar's oneworld alliance membership and Etihad's equity network. Emirates said it will look for more major partnerships along the lines of its expansive Qantas deal; it has since forged a much smaller deal with Malaysia Airlines, and a deeper South African Airways partnership could be next.

Summary

Emirates is becoming more receptive to partnerships, aiming to form major partnerships similar to its Qantas deal.
The airline is experiencing a change in strategy and mindset, recognizing the value of bilateral alliances in a changing world.
Emirates is planning to expand its presence in China, with new flights to Yinchuan and Zhengzhou, and potentially more destinations in the future.
The airline is considering an order for medium-sized widebody aircraft (A350s or 787s) to access thinner markets and replace its existing medium-sized widebody fleet.
The growth of Emirates in China is seen as a significant development, as Gulf carriers have been underrepresented in the Chinese market.
Despite some skepticism about the future growth of Gulf carriers, Emirates continues to demonstrate its foresight and proactive investment in the aviation industry.

Second are long-overdue traffic right additions from mainland China, where Emirates has fewer daily flights across the whole country (5) than to Bangkok alone (6). Its first two new points, Yinchuan and Zhengzhou, may not seem lucrative, but other new flights will be.

Third is Emirates' well-publicised order for A350s or 787s, medium sized widebodies that will allow it to access even more markets.

The combination implies a break from Emirates' largely go-at-it-alone strategy using A380s or "smaller" 777-300ERs, where India was the main source market in an emerging economy. The result is a more regionally pervasive Emirates. For many airlines, this will intensify competition that they already struggle to contend with. For a select few, a partnership could be on offer.

Emirates is becoming more receptive to partnerships

Prior to the Qantas-Emirates partnership announced in Sep-2012, Emirates' partnerships were relatively confined in scope and quantity. The Qantas-Emirates partnership had considerable breadth: Qantas would operate through Emirates' Dubai hub and there would be revenue sharing and extensive codesharing from both parties on overlapping markets, as well as behind/beyond gateways.

The impact of the Qantas deal was heightened by Emirates stating merely days later that it wanted a deep partnership with American Airlines. The message then, and since then, has been that Emirates would seek partnerships where it made sense, and where value could be extracted.

What has changed in recent months is an expansion of the parameters to define value. Emirates has thus far been unsuccessful in wooing Qantas' partner American Airlines, but it has formed smaller partnerships.

The one with TAAG in Angola is perhaps the smallest, while Malaysia Airlines is larger. A second pitch at South African Airways would bring Emirates closer to the South African market, its 10th largest based on seats. The Qantas partnership covers Emirates' fourth largest market, Australia, while American Airlines would have covered the US, the third largest.

Emirates Airlines seat capacity by country: 28-Dec-2015 to 3-Jan-2016

Malaysia is not one of Emirates' 10 largest markets, but this Southeast Asian region where Emirates will gain better access is one of its largest regions.

Emirates seat capacity by region: 28-Dec-2015 to 3-Jan-2016

The TAAG partnership could, at first blush, be seen to be Emirates dabbling with very small partnerships. The Angolan market - at least prior to the downturn - was small but lucrative. The partnership developments in Malaysia and potentially South Africa show that Emirates is looking to make friends in markets of importance, but going beyond its handful of key markets (Australia, US) where its previous major partnership efforts were concentrated.

Commercial value and competitors mean that Emirates is changing its stance

"Go big or go home" - this is an apt description for Emirates. It tends not to do anything in a small way. It would rather wait and kick off with a strong start than begin with a small presence.

This certainly applies to its routes, where less than daily service is unusual; Etihad and Qatar are less concerned by having only a few frequencies a week. It also extends to marketing, where Emirates may be quiet for a period, but will then deliver its pointed Jennifer Aniston commercial, which nearly instantly made headlines. Emirates launched social media with full force rather than dabbling in it.

The Qantas partnership was big, and an American Airlines one would have been too, but Emirates is increasingly bowing to flexibility, finding it can benefit from smaller partnerships while not deviating from its business. This is not necessarily a sign that Emirates was wrong in the past but rather it can be agile, and as it enters maturity, at 30 years old, it can think about Life differently.

There are also external factors as its competitors develop and grow partnership strategies, with most of these occurring in recent years. Qatar Airways is taking the traditional partnership path of bilateral agreements and alliance membership (as is the "fourth" Gulf carrier, Turkish Airlines). Etihad Airways is acquiring typically distressed carriers for strategic and sovereign reasons, forming codeshare partnerships with a number of other carriers.

Forgoing the opportunity to join the oneworld alliance, allowing Qatar Airways to enter, may be a regret for Emirates. Emirates has watched with surprise - and a degree of annoyance - as Etihad's acquisition portfolio grew, and as codeshare partners rapidly increased to be far more than Emirates' partners. Partnership revenue for 2014 accounted for USD1.1 billion, or 24%, of Etihad's passenger revenue.

Forming smaller partnerships may bring benefits to Emirates, and it also now keeps those partners out of Etihad's reach. Prior to the extensive Emirates partnership announcement, Malaysia Airlines partnered with Etihad. (The future of the Malaysia-Etihad partnership is unclear.)

South African Airways had been seeking a Gulf partner and was weighing offers from Etihad and Emirates. Emirates' initial offer was limited since it did not think that Etihad was a viable option for SAA, and thus that SAA would not choose Etihad. But SAA did indeed choose Etihad, and launched services to Etihad's Abu Dhabi hub. This has resulted in Emirates coming back to SAA with a far more competitive offering.

An overview of Emirates' existing partnerships

There is no overarching matrix to justify Emirates' current major partnership portfolio (and wish list). Although value is of course the end objective, there are multiple nuances along the way. Below is a brief description of the individual motivations.

Qantas

The landmark Qantas partnership is what started much alliance/partnership change - at Emirates specifically and globally. Crucially, Qantas shifted its European stopover hub from Singapore to Dubai and gained access to Emirates' far wider European, and beyond, network. Emirates saw the Qantas partnership as a necessity since Qantas, despite a far more limited network and forced backtracking through London, was able to have a yield advantage over Emirates because of its local presence and frequent flyer programme. Flying to a Gulf partner's hub has been a feature of some of Etihad's closer partnerships, while beyond flying has not proven as popular.

American Airlines

An American Airlines partnership has not materialised, despite the desire, and attempts from Emirates. Similarly to the relationship with Qantas, Emirates wants access to American's customer base, which includes the world's largest frequent flyer programme, AAdvantage. American in fact has a longstanding codeshare with Etihad, and formed a codeshare with Qatar following Qatar's entry to oneworld. American has expanded its Etihad and Qatar partnerships several times since the US Big 3 airlines issued their White Paper against Gulf carriers.

Malaysia Airlines

The Malaysia-Emirates partnership follows from Etihad's interest in Malaysia. Malaysia has been restructuring and cutting its long haul network, particularly to Europe. The Emirates partnership was announced at the same time Malaysia announced that it would end service to Amsterdam and Paris, leaving London as its only online European market. Malaysia is also closing its daily service to Dubai, leaving all Dubai-Kuala Lumpur capacity flown by Emirates. The deal will likely see Emirates place more passengers onto Malaysia's regional Asian network than Malaysia places passengers onto Emirates. The Southeast Asia access that Malaysia will provide to Emirates supplements Emirates' existing Jetstar Asia partnership.

See related reports:

South African Airways

SAA was Emirates' first codeshare partner and the relationship was largely limited until SAA was able to end services to Beijing and Mumbai (two routes deemed strategic by its government owners). SAA sought a Gulf hub partner to facilitate offline access to China and India. SAA solicited both Emirates and Etihad, initially forming a large partnership with Etihad. The Etihad partnership may fade as Emirates - originally believing SAA would not partner with Etihad - has brought to the table a far more comprehensive partnership. While this would be smaller in size than Emirates-Qantas, it could go deeper into procurement, including aircraft purchasing, a feature of Etihad's partner network.

See related reports:

TAAG

Announced in Oct-2014, the Emirates-TAAG partnership is a small, market-specific partnership covering Angola, where access is limited but the yields are high. Emirates will manage the carrier, and appoint some management, but will not place equity. A lack of ownership stakes is one large difference between Emirates' major partners and Etihad's.

Alaska Airlines, Copa and JetBlue

These three are market-specific partnerships. The partners do not fly to Dubai or cooperate on any long haul routes (having none) although JetBlue does codeshare on Emirates' network.

JetBlue provides access at JFK, which Emirates has been able to grow because of the feed to/from JetBlue (similar to Emirates-Jetstar Asia in Singapore). JetBlue also contributes in other Emirates destinations, including Boston and Orlando.

Alaska is a growing partnership to cover Seattle and the Pacific Northwest, as well as parts of Canada, where Emirates cannot secure more traffic rights, and the partnership has seen Emirates grow Seattle capacity.

Copa is a new partnership and takes form in 2016 as Emirates plans to commence service to Copa's Panama City hub (Dubai-Panama City will become the world's longest route). Copa will provide access to Central and South America, markets that are either too thin for non-stop service, or have operational challenges that preclude non-stop service. Codeshare flights on Copa have taken longer than expected and delayed Emirates' Panama City launch.

Emirates is finally growing in China: Yinchuan and Zhengzhou are the next destinations

Gulf carriers are underrepresented in China. Where Gulf carriers have such small presences - not just in China but also in Canada and Korea - it is because of bilateral restrictions. There has been little change in the number of average daily Gulf carrier flights into mainland China between 2012 (11) and 2015 (12).

To put this in perspective, in 2005 Gulf carriers had more flights into China (1.9 a day on average) than the US (1.1 a day). With the benefit of open skies, Gulf carrier flights into the US are growing from 1.1 to 32 in 2016. The China market, once larger than the US for Gulf carriers, is now one third the size. Over a 10-year period, there has been larger frequency growth to China than India, but this is from a low base.

Looking at changes since 2012, Gulf carriers' Indian flights have increased 34% compared to their Chinese flights growing 17%. Protectionist-inclined India is the well-cited bane of Gulf carriers, but in perspective China appears generous. In recent years India has moved away from being the Gulf carriers' main source of bilateral antagonism; Canada, China and Korea have joined the mix.

Gulf carriers' flights into China have plateaued in recent years. This is in contrast to European and US carriers accelerating growth.

Average daily flights into China from airlines based in Europe and the US compared with Emirates/Etihad/Qatar: 2005-2016

Emirates has not increased its China flights since 2009, which followed a period of introducing a new daily service to Guangzhou and then a second daily service to each Beijing and Shanghai. Guangzhou's addition in 2008 was the last new point in China.

In comparison, Etihad added Chengdu in 2011, while Qatar added Chongqing in 2011, and then Chengdu and Hangzhou in 2013.

Average daily flights to China from Emirates, Etihad and Qatar: 2005-2016

Although Emirates is the largest Gulf carrier in China by seat capacity (and, to a lesser extent, frequency) it is Qatar that has the widest destination footprint, with six points in 2015 compared with Emirates' three. Although Qatar's may be wider in terms of points, Emirates' double daily to Beijing and Shanghai are surely more valuable than additional points.

Emirates has been able to upgauge Beijing and Shanghai to A380, but in the murky world of bilateral negotiations it has not been able to upgauge Guangzhou or add new points. Emirates has not grown frequency since 2008, and bilateral negotiations, including those in 2013, have produced no growth outcomes.

China to Middle East (seats per week, one way): 2011-2015

Local versus national aviation aspirations constantly play out in China: locally, each city or region wants its own airline. Nationally, the CAAC would prefer consolidation. With Gulf carriers, there are plenty of Chinese cities, of various sizes, that lobby Gulf carriers for service. Some could plausibly receive Gulf service but have been unable to persuade the central government to grant more traffic rights. A common refrain is that Gulf carriers are welcome to serve new Chinese cities, but to do so they would have to remove a frequency from their existing network, namely Beijing and Shanghai, which they would certainly not do.

After six years of no frequency increases, there has been a bilateral breakthrough. The exact details and reasons remain publicly unclear, but it is understood to be momentous. Emirates has announced a new four per week service to Yinchuan and Zhengzhou, with Zhengzhou tagged in both directions with Yinchuan.

Yinchuan is the capital of China-Arab relations and already has two weekly flights to Dubai by Sichuan Airlines; the service originates in Chengdu, Sichuan Airlines' hub. Although load factors may be strong, yields are weak. China is ramping up efforts to develop its national strategies of "One Belt, One Road" and the "Maritime Silk Road".

Conveniently for the Gulf carriers, their homes are part of this geography. Many of their connecting markets have no viable connections to/from China other than a Gulf hub. Emirates in particular has pursued this strategy, noting its current and potential role in China's strategies.

This is in addition to China's longer-running effort to develop a larger presence on the African continent, which presents only limited opportunities for Chinese carriers. China-Africa is a large traffic flow for Gulf carriers; Emirates says 22% of its China passengers connect to Africa.

See related reports:

Emirates' facilitation of China's Belt and Road Links: Dec-2015

Destinations served by Emirates and Chinese carriers along the Belt and Road route: Dec-2015

In short, it was time for China to match speech with actions.

There are likely to be other factors too. One could be a deliberate effort to have Chinese carriers improve their proposition; historically, the CAAC has intentionally allowed foreign competition that in the short term diluted the strength of local carriers - but then cajoled them to be more competitive, with long term benefits. Gulf carrier competition could be more palatable amid efforts to introduce some transparency in Chinese aviation, and to remove corruption.

As China experiences bilateral antagonism with European nations and the US, granting Gulf carriers traffic rights could be seen as leverage, even though Gulf carriers have limited overlap in China with European carriers and hardly any with US carriers (connections via the Gulf are too circuitous). There are still Europe connections on Gulf carriers' Chinese flights.

The China-Europe market has become more competitive following significant growth, especially from secondary markets where flights are sustained through subsidies and tour operators. Low fuel costs currently enable the China-Europe non-stop services to continue, but an increase could see them taper off until more demand builds.

In a scenario where higher fuel prices would force them off some of these secondary routes, Gulf carriers have advantages sustaining their secondary China routes since they are shorter than a Europe-China flight. A secondary flight between Europe and China is more demanding to make profitable, given limited connections and very limited premium demand. Gulf carriers will be able to rely on the rest of their network, and while they may also find limited premium demand, that will impact a six or seven hour flight, not a 10 hour flight.

Zhengzhou has no Gulf carrier service, or in fact any intercontinental passenger flights. Cargo services are plentiful: Zhengzhou is a major manufacturing city, including for Foxconn, Apple's main contractor. The high output of consumer electronics requires air freight. Henan province, of which Zhengzhou is the capital, has invested in Luxembourg freight operator Cargolux.

Cargolux flies to Zhengzhou, and beyond to points in Asia and North America, giving it access to the lucrative Asia-North America freight lane. China Southern operates direct from Zhengzhou to Los Angeles , while there are other freight services, including 747s from Cathay Pacific.

See related reports:

Yinchuan and Zhengzhou are not primary or even secondary markets for Emirates. Yinchuan has political significance while the Zhengzhou tag will help pump cargo into the 777-200LR's spacious belly, more so with potentially light passenger loads. The routes are a sign of commitment to China's national aviation development and long term opportunities. More immediately, they are expected to be followed with service to additional Chinese cities.

Those additional points are expected to be more familiar secondary cities, such as the ones that European carriers are serving, and Chinese carriers are increasingly launching intercontinental service from.

Emirates has not stated any China growth plans beyond Yinchuan and Zhengzhou, but it is not far-fetched to think that in a short time Emirates could double its number of China flights. Even then opportunities will be missed due to restrictions, protectionism (limiting A380 service) and slots. Overall, this is still a very welcome, and overdue, start.

A350/787 order will allow Emirates to reach thinner markets

In the pipeline for some years has been an order for medium-sized widebodies. Their need was apparent some time ago: Emirates ordered A350s and then cancelled them as specifications changed. Emirates has said it expects to make a decision in 2016 between the A350 and 787 for its medium-sized widebody needs.

The use for a medium-size widebody aircraft is evident. Looking at the composition of the fleets of the three Gulf network carriers, Emirates is heavily reliant on large and very large aircraft, A380 and 777-300ER, which make up 79% of its fleet. A comparison with Etihad and Qatar is skewed, since Emirates does not operate narrowbody aircraft.

737 operator FlyDubai fulfills many of the Dubai market's narrowbody aircraft needs. Although not directly affiliated with Emirates, it has the same shareholder. Flydubai is arguably close to being the narrowbody operation of Emirates. Even if FlyDubai's narrowbody fleet is included with Emirates', Emirates' large and very large aircraft represent 65% of the combined fleet, compared with 34% at Etihad, and 25% at Qatar. While Etihad and Qatar may have differences between them, they are closer to each other than to Emirates.

Emirates (including/excluding FlyDubai), Etihad and Qatar fleet by aircraft type: 21-Dec-2015

Looking only at widebody aircraft across the three airlines, medium sized widebodies make up 21% of Emirates' fleet compared with 51% at Etihad, and 63% at Qatar.

Emirates, Etihad and Qatar widebody fleet by aircraft type: 21-Dec-2015

The large scale of Emirates' operation can only partially justify such a significant reliance on large aircraft. Emirates has more 777-300ERs and A380s than Etihad and Qatar have passenger aircraft in their entire fleet.

Emirates has almost as many widebody passenger aircraft as Etihad's and Qatar's combined. This significant number of large aircraft enables feed across a network where approximately 80% of traffic is connecting; it takes an A380 to feed an A380.

Nevertheless, there are thinner markets that currently cannot be accessed with one of these large aircraft, even if there is such significant feed elsewhere on the network to try to support the destination. There are also destinations currently served by large aircraft that would be better served by a smaller widebody, in line with a small downgauging trend observed at other airlines (from 747-400 to 777-300ER, from 777-200ER to 787). Finally, a smaller widebody will replace Emirates' existing medium-sized widebody aircraft (mostly A330s) that are in need of replacement.

Outlook: sceptics ask if Gulf growth is ending, but a different era is beginning

For the Gulf carriers China brings a welcome change to aeropolitical matters. Canada, India and Korea are still notable challenges. Despite the noise around US carriers requesting a revision to US-UAE/Qatar open skies, change seems unlikely. Europe's new aviation policy promises later commentary on "fair competition". Like the US talk, this may also not go anywhere, but unlike the situation in the US, traffic rights are already restricted in key markets (notably France and Germany).

2016 will see Emirates further roll out its two-class A380 service. Bangkok, Copenhagen and Kuala Lumpur were initially announced and have been followed with Birmingham, Prague and Taipei. There are sceptics (even within Emirates) of this A380 sub-fleet, to say nothing of those who have long questioned the role of the A380. Emirates may demonstrate it can find sufficient markets for 15 two-class A380s. Alternatively it may find there are more opportunities and grow the sub-fleet. Still within the aircraft realm, Emirates has flagged 2016 for the unveiling of its new business and first class cabins. The design and style, it quietly concedes, are due for an update.

A calm Dubai Airshow in Nov-2015, coupled with financials showing, some argued, lower benefit from reduced fuel prices compared with peers or passing too many of the savings onto consumers, provoked some industry observers to ask if the Gulf carriers had passed their prime. This could hardly be the case. The outcomes of the 2013 Dubai Airshow were unlikely to be outstripped in 2015. With the existing aircraft backlog there is not need for significant growth. And there is no rule that aircraft orders have to be announced at airshows (Gulf carriers in 2015 announced top-up orders, but not at the Dubai Airshow).

There are many reasons for varying financial performance: revenues are down as the dollar strengthens, fuel savings have been passed on to consumers, and Gulf carriers have "strategic" (market share) priorities at present that need time to mature. Qatar will at last achieve its long overdue sought for growth to Australia and the US, and Etihad is looking to bed down developments after its significant acquisitions of Alitalia and Jet Airways. The opening of Etihad's new Abu Dhabi terminal in late 2017 is increasingly within reach.

See related reports:

Foresight, proactive investment and facilitating aviation growth continue to define the strategies of the UAE and Qatar. As Gulf carriers enter new phases and become stronger and smarter, many competitors will still fail to grasp the fundamentals. The standard claim of needing to protect the status quo has in some cases helped delay the inevitable, but market forces and strategic ingenuity are chipping away at the old order.

Emirates Airline: The strategy reshapes in 2016 – partnerships, China growth, smaller widebodies

Emirates is becoming more receptive to partnerships

Commercial value and competitors mean that Emirates is changing its stance

An overview of Emirates' existing partnerships

Qantas

American Airlines

Malaysia Airlines

South African Airways

TAAG

Alaska Airlines, Copa and JetBlue

Emirates is finally growing in China: Yinchuan and Zhengzhou are the next destinations

A350/787 order will allow Emirates to reach thinner markets

Outlook: sceptics ask if Gulf growth is ending, but a different era is beginning

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