HNA Group: four airlines form U-FLY Alliance, world's first LCC grouping, showing HNA consolidation


China's HNA Group was expansive even before the deals it has made over the past year, where it acquired stakes in various companies including Brazilian airline Azul, the lessor Avolon, the ground handler Swissport and the ride-sharing service Uber. The group became wider but still fragmented, with the companies hardly stitching together to deliver synergies, or at least to avoid competitive overlap.

That will start to change with four HNA airlines forming the world's first LCC alliance, the U-FLY alliance. They operated 67 aircraft at the end of 2015 and project a fleet exceeding 218 by the end of 2020.

U-FLY will be beneficial for HNA. The airlines – HK Express and three from mainland China: Lucky Air, Urumqi Air and West Air – will work together for revenue and cost synergies. In the long term this cooperative action will hopefully spread across the HNA group and integrate it more effectively. The alliance's objective is to "build U-FLY to span the globe, similarly to existing full service airline alliances", and it reflects the ambition and high aspirations that often characterise Chinese aviation. The existing global alliances have attractions that are structurally different to passengers and prospective airline members. U-FLY is likely to provide some cohesion to various HNA LCC brands. Other LCC groups – AirAsia, Jetstar, Viva and FastJet – already benefit from the power of a single brand structure.

U-FLY established with four HNA carriers, but alliance seeks non-HNA members

The U-FLY alliance was announced on 18-Jan-2016 in Hong Kong. Hong Kong is the home of HK Express, whose CEO Andrew Cowen will also fulfil the role of U-FLY CEO. The U-FLY board comprises a representative from the four founding carriers, with a chairman rotating from the group (the current chairman is HK Express' appointment to the board, Ma Zhimin).

Despite the heavy presence of HK Express, the directive for the alliance has more likely come from within mainland China and the HNA Group. Hong Kong would have denoted a more international feel to the alliance, and HK Express is the most international and visible of the four founding carriers, although it is the second smallest.

U-FLY Alliance summary: 18-Jan-2016

Besides HK Express, the other three members are mainland Chinese units affiliated with the HNA Group. West Air has been the most successful at transitioning from being a full service to a low cost carrier. Lucky Air and Urumqi Air are still in the transition phase.

Urumqi Air commenced service only in Aug-2014, one of a number of recent start-ups in mainland China following changes to allow new entrants. This is a period of change in the mainland market as carriers consider the low cost model and how applicable it could be to their future business. As other HNA carriers define their future, and select the LCC model, they could be expected to join the U-FLY alliance.

Launch of U-FLY Alliance: 18-Jan-2016

The U-FLY alliance carriers the slogan "U fly the world". For now, the carriers do not serve any destination outside Asia, and most flights are within Northeast Asia. 88% of their joint flights in Jan-2016 are within the domestic mainland Chinese market, according to CAPA's combined schedules analyser tool.

U-FLY Alliance network: 18-Jan-2016

Based on available system seat capacity, the alliance's five largest bases are Kunming, Chongqing, Hong Kong, Zhengzhou and Jinghong.

Combined global top 10 hubs/bases/stations/focus cities for U-FLY Alliance ranked on seat capacity: 18-Jan-2016 to 24-Jan-2016

U-FLY is constructing an LCC brand the way AirAsia, Jetstar and others did: from birth

U-FLY is careful to distance itself from its HNA origins. The HNA name and logo do not appear on any marketing information, and the official announcement about the alliance completely excludes any mention of HNA. U-FLY wants to promote itself as an LCC alliance, and not a grouping of HNA airlines. U-FLY wants to expand the alliance to include carriers from outside HNA and it welcomes "other independent" LCCs to join, which implies the existing members are independent despite their HNA affiliation. .

Mr Cowen wants two to three additional airlines to join the alliance in 2016, and says discussions have been under way with undisclosed HNA and non-HNA members. Outside HNA, prospective members would likely be smaller carriers. An LCC like AirAsia is focused on building its brand and network, leading Mr Cowen’s remark on potential U-FLY membership: "We wouldn't expect them to be part of it."

There are opportunities for the alliance to evolve. Many of the details of the customer proposition await later announcement. For now U-FLY is essentially offering a comprehensive brand to smaller LCCs and trying to create group benefits on the revenue and cost side. Existing LCC brands (AirAsia, Jetstar) benefit from group scale (which they can opt-out of: Jetstar Pacific sources its own aircraft rather than from the group). U-FLY could deliver benefits to the grouping as a 96-aircraft airline (their forecast size at the end of 2016) rather than four fragmented carriers.

The alliance may find more success with cost synergies than passenger-facing revenue and brand opportunities. Although the existing HNA umbrella should see them already realise efficiencies, in practice this has not played out and many opportunities are missed. The alliance could help focus the efforts.

Other LCCs groups have been a brand since birth. The AirAsia and Jetstar families (as well as those outside Asia, such as Latin America's Viva Group) comprise airlines with their own licences in multiple jurisdictions, but operating under a common brand. Permission from various regulators to operate as a largely unified brand has been a significant contributor to the individual businesses. (In limited cases have airlines been prevented from using a foreign brand.) The multi-JV model unified under a brand arguably stands out as one of the most defining developments in Asian aviation.

U-FLY Alliance board and CEO: 18-Jan-2016

Autonomy in China has prohibited the formation of a large multi-hub LCC

The branded JV model was necessary to overcome each market's foreign ownership restrictions, a situation unlike Europe's common market.

China is different. In theory it should replicate a large domestic market like the US, where there is a single regulator and a single set of laws, and thus one large single-licence LCC could operate in the way that Southwest and JetBlue, among others, do.

But Chinese aviation remains highly regional. Although it is a single country each province, and often city, has a high degree of autonomy in deciding what airlines can and cannot be based at the city or fly there. There is also widespread desire to have a local airline serve the region's interests, and with a name that promotes the home.

The result is the spread of domestic carriers, as seen at HNA. Experience says that HNA would surely have preferred a single airline and brand, or perhaps now two: one full service and one low cost. But without having Urumqi Airlines and Fuzhou Airlines flying as separate brands with local ownership, HNA would have been unlikely to gain as large a footprint in those markets as it can by having a local carrier. HNA has also operated outside the alliance sphere; the state-owned carriers, members of Star and SkyTeam, would have lobbied to prevent HNA carriers from joining an alliance.

Thus, from a unique background U-FLY is born. Had the carriers been unified from the start under a single brand, or even a single operating licence, there would have been far less impetus to form an alliance. Without multiple brands, the operation of a single carrier would have been confined.

Spring Airlines, the country's largest and most successful LCC, ended 2015 with 52 A320s. The three mainland founding members of U-FLY ended 2015 with 54 aircraft, all narrowbodies. Spring remains heavily focused on its Shanghai base, with a much smaller presence at Shijiazhuang (one fifth the size of its Shanghai presence).

The three mainland U-FLY carriers count six bases, giving a wider spread than Spring. Spring of course has the holy grail of a base at Shanghai, a very prominent area in size, income, and business travel. Others would trade for Shanghai in a heartbeat. Under protectionist restrictions on how many aircraft Spring could add every year, Spring naturally focused growth on its blue chip home, rather than a spread of hubs.

Looking at Spring's largest airports, it has roundly 197,000 weekly seats to/from Shanghai (Pudong and Hongqiao, PVG and SHA on the chart below). Its second largest city, Shijiazhuang, had 38,000 weekly seats.

Spring Airlines top 10 hubs/bases/stations/focus cities: 18-Jan-2016 to 24-Jan-2016

The spread of hubs at JetBlue and Southwest is not so stark. There are hubs half the size of the main hub, or larger, especially at Southwest.

JetBlue Airways' top 10 hubs/bases/stations/focus cities: 18-Jan-2016 to 24-Jan-2016

Southwest Airlines' top 10 hubs/bases/stations/focus cities: 18-Jan-2016 to 24-Jan-2016

It is perhaps interesting that an alliance move from HNA concerns low cost and not full service carriers. An LCC alliance may be more relevant for the current atmosphere. LCCs have become a hot topic in China having been finally blessed by the regulator and promoted as a model of efficiency, now after years of being somewhere along the spectrum of ignored and shunned. Awareness of LCCs within China is growing as the outbound international Chinese market surges.

An LCC alliance has not yet been attempted, giving HNA some bragging rights. It also gives some freedom, since there is no benchmark to measure U-FLY against; Chinese full service carriers are worried about how they are perceived compared with foreign full service carriers. Keeping flagship brand Hainan Airlines outside a new alliance keeps it neutral to work with other carriers, and also possibly to join an existing global alliance that would deliver far greater benefits than one of its own making.

As an initiative for greater cooperation within the HNA Group, an LCC alliance would not have been one of the biggest opportunities, but is certainly a place to start.

U-FLY members to promote connections, seamless booking, and consistent customer experience

U-FLY is planning a gradual roll out of alliance functions throughout 2016. Details are short, but general items have a feeling of a full service alliance and include, according to U-FLY:

Network expansion

Alignment of route networks to support easy interline connections for U

Increased choice as further independent LCCs join U-FLY

Easy booking

Build of seamless multi-airline booking capability for U

Website, app, contact centre, travel agents

Consistent customer experience

Alignment of all customer “touch points” for U

Brand, standards, airport check-in transfers

Product enhancement

growing choice of U-FLY products typically enjoyed with other alliances, but always offered with low fares

To name a few challenges: alliance signs and stickers may come cheap, but it could be costly, and sacrifice efficiency, to have network alignment supporting connections that will likely be low-yielding and low volume. As each carrier grows ancillary options (enabled through various IT solutions), alignment may prove difficult, and potentially more hassle than it is worth.

IT integration will be a significant challenge, made more difficult owing to TravelSky platform

The lurking challenge in alliances and partnerships is IT integration that enables airlines to align. IT will be a challenge to U-FLY.

The founding carriers are split across several systems. HK Express cut over from TravelSky to Navitaire, which has a proven partnership platform for LCCs. However, the three mainland members (Lucky, Urumqi and West) use TravelSky, and are unlikely to cut over. TravelSky is not a flexible nor robust platform – exactly why HK Express left it.

The alliance will need to link between Navitaire and TravelSky, but also the various plug-ins and other add-ons that TravelSky users have added to work around TravelSky's limitations. West Air is understood to have particularly excelled at transforming its IT to support its change to the LCC model. U-FLY says it will conduct IT integration in 1H2016.

As there is no frequent flyer programme, or at least not yet, the U-FLY alliance IT will be far from being as comprehensive as those at the full service global alliances (and there are other reasons), but supporting connections and other partnerships will be onerous enough.

Global alliances benefit long haul transfer traffic and frequent flyers. This lacks in the LCC rubric for now

To consider the potential of a low cost alliance, comparison with the objectives of a full service alliance is useful. To passengers, global alliances essentially deliver recognition and benefits when leaving an airline's online network, often on a journey where possible flight (airline/alliance) combinations are numerous. The recognition and benefits usually focus on perks during the experience (lounge access, more luggage allowance), as well as those associated with frequent flyer points.

So far these are missing from the U-FLY platform, making it unclear why a passenger would choose the alliance over another option, especially when LCCs have price – lowest in the market – as their main selling point. U-FLY says it is considering a loyalty programme.

The need for a short-haul alliance might be questioned. Short haul travel tends to be less competitive since the shorter distances introduce fewer intermediate connections. Those making a three or four hour trip – on a time-constrained weekend getaway, for example – would be less willing to add a connection, requiring an extra three or four hours, than those travelling to another continent. Mr Cowen says that less than 10% of HK Express passengers are connecting within the airline, although the carrier's network is largely Northeast Asia focused, which reduces connecting opportunities.

To prospective alliance members, alliances allow an airline to extend its virtual network and make patronage more sticky (in part, as the frequent flyer programme becomes more valuable). Alliances also promote traffic growth as other members feed the new carrier, often (but not always) from a long haul flight to a short haul flight. As noted above, short haul to short haul connections are not terribly lucrative. In an LCC context, they are likely to be on the fringe and not on major traffic corridors.

About half of AirAsia’s passengers connect to other AirAsia-branded flights, but this is coming from long haul AirAsia X services, not flights in the short haul space.

See related reports:

U-FLY gives the example of passengers connecting between Hong Kong and southwest mainland China via Kunming, with HK Express operating between Hong Kong and Kunming, while West Air and Lucky Air operate beyond Kunming. There are some tourist attractions beyond Kunming, and they can be accessed by road as well; overall the flight segment is thin.

U-FLY partnership from Hong Kong to Southwest China: 18-Jan-2016

There was also the example of connecting between Chengdu and Chongqing to Japan and Korea. This involved taking West Air or Lucky Air to Shenzhen, switching airports to Hong Kong, and then taking HK Express.

Besides the inconvenience of switching airports (and the potential immigration formalities), Chengdu-Osaka is 30% more circuitous on distance alone via Shenzhen/Hong Kong than it is non-stop. Non-stop international flights from China, including those on LCCs, are rapidly growing. The founding LCC members should already be experiencing high point-to-point demand and resulting high yields. Connecting itineraries can entail a high price and customer inconvenience, or in fact, a steep yield hit for the sake of promoting transfer traffic.

In the long term, HK Express regards the alliance as a potential hedge: excess capacity at times could be handled by partners, with either more connections sold or HK Express leasing aircraft to other carriers (although HK Express could theoretically sub-lease without an alliance). Mr Cowen considers this type of hedge an alternative to a banking hedge.

There may be occasional day and time combinations, or very niche markets that other carriers do not compete in, where connections make financial sense but these would be small, and remain so even with China's (and Asia's) traffic growth.

That reframes the question whether a whole alliance, as opposed to bilateral partnerships, is necessary. Even if the alliance can deliver incremental profits, it could reasonably be conjectured whether participating and managing the alliance is a distraction for the carriers, and whether management bandwidth would be better spent on projects core to the carrier that would deliver stronger results.

U-FLY partnership from Western China to Northeast Asia: 18-Jan-2016

U-FLY arrives as partnerships morph: Star's LCC platform, Etihad's Partners, easyJet/Ryanair feeder roles

Unusual origins have produced a problem resulting in an unusual solution. The nuances of Chinese domestic airline licensing and support have created a fragmented group, with the result – an alliance. Although the origins may not be replicated in another market, or at least not to such a degree, the outcome remains unchanged - there is now an LCC alliance.

Effectiveness will be watched. The three mainland Chinese airlines had a joint fleet larger than Spring, but even if an alliance tag had been added to them, their joint recognition would have been far lower than just Spring Airlines.

Spring has the advantage of being affiliated with one of China's major cities, and for having a successful and long-running marketing campaign. Its overall size boosts its profile, whereas size fragments the U-FLY members.

Drawing on the experience at oneworld, SkyTeam and Star, alliance membership can boost an airline brand but not by multiples, and the alliance brand does not become more distinct than the individual airline brands. Awareness of the U-FLY alliance will be less, since customers have fewer interactions with it; it is when passengers fly on a partner airline and receive benefits that the alliance brand stands out. Merely having a connecting flight does not connote a partnership.

There is the larger matter of LCC cooperation; if it makes sense, it can be profitable and can be implemented.

Locally, Spring Airlines has been seeking international partners but is still facilitating the necessary IT links. If the U-FLY alliance can work among themselves, and across two IT platforms, supplementary IT links become less painful. Spring may need to accelerate its strategy, although the absence of the U-FLY members in Spring's Shanghai home means that Spring is unlikely to lose prospective partners.

Regionally, there have been quiet partnerships. The Jetstar Group accepts full service connecting passengers, including from AF-KLM, Emirates, Jet Airways and Lufthansa. One of the more reclusive full service airlines, Singapore Airlines partners with its LCC, Scoot.

See related reports:

Globally, JetBlue has a number of international partners, although it is increasingly diverging from the pure low cost model (in terms of service). EasyJet and Ryanair are assessing the potential of being feeders for full service airlines. The LCC Norwegian is interested in a partnership with AirAsia, with CEO Bjørn Kjos saying, as reported in Dagens Næringsliv: "It’s a perfect match...If we should cooperate with anyone, it would have to be them."

AirAsia and also Spring bring an aura of experience and internationalisation that many find lacking at Chinese airlines, although that is changing. The potential of Chinese service from LCCs based outside Asia – not just Norwegian but also Eurowings – is uncertain. For short haul LCC partnerships, the balance might be skewed.

Prospective LCC members may favour an alternative LCC programme, such as that from Star Alliance. The opportunity for connections between airlines is greater on long haul flights than short haul, and Star is positioning its offering to feed long haul passengers to regional LCCs, although not all LCCs may be invited to partake.

Although not an alliance per se, Etihad's "Partners" offering represents yet another grouping of carriers. For now, Partners is not dissimilar to U-FLY, in that the genesis was airlines with a common shareholder but different brands. The full service and long haul nature of Partners positions it differently from the opportunity at U-FLY. (It is curious to wonder whether Partners or U-FLY will be the first to receive a member outside Etihad/HNA ownership).

See related reports:

U-FLY's greatest potential – and worry to competitors – is to effect change at HNA

It is probably not without coincidence that the first multi-LCC partnership, or even alliance, occurs among airlines with a common shareholding, and now together, they demonstrate the benefits from working together.

Yet with each having its own objectives, the U-FLY airlines are presented with the greater challenge of bringing together two LCCs that lack commonality, and have no parent nudging the children to play along. Market-specific bilateral partnerships with LCCs are likely to grow, especially as long haul flights become more common. An alliance may prove too prescriptive for independent airlines. Some LCCs may retort that they already have their own alliance – their organic size.

There are many ways for the U-FLY alliance to evolve. The three staple and significant global alliances date back no earlier than Star's formation, in May-1997. That was four months before the KLM-Northwest JV, aviation's first JV, now with superiority over global alliances. Yet the greatest impact from U-FLY is likely to be close to home at HNA. Its unified global fleet makes it one of the world's largest carriers, with businesses stretching across the aviation, tourism and travel chain.

The best case scenario is one that is highly infectious and contagious: that HNA LCC cooperation spreads across the group. The ramifications of a more integrated group spanning multiple businesses are far greater than the benefits of LCC cooperation. U-FLY will be worth following, if not for itself, then certainly for its impacts across HNA.

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