25-Jan-2013 7:45 PM

Quiet achiever Dragonair aligns with owner Cathay Pacific in recognition of its growing stature

Analysis

Dragonair has taken a backseat in the public limelight since Cathay Pacific acquired the carrier in 2006, despite Dragonair accounting for about a quarter of the group's passengers and its network into mainland China - the largest of any foreign carrier - being a key asset driver.

Dragonair had been allowed to be the less sophisticated brand in a bid to preserve the status of Cathay, but Dragonair will now grow the closest it has ever been to Cathay as it embarks on what will likely be another record year of passenger growth and destinations served.

A new aircraft interiors programme, its first in a decade, will see Dragonair adopt Cathay's interior and service elements while a new staff uniform will be more similar to Cathay's than previous iterations. Driving the change and multi-million dollar investment is a series of messages that Dragonair needs to piggyback off Cathay's high-end premium reputation.

Summary

Dragonair, a subsidiary of Cathay Pacific, is undergoing a major rebranding and upgrading of its product to align more closely with Cathay Pacific's premium reputation.
The new interiors program will see Dragonair adopt Cathay Pacific's interior and service elements, including new staff uniforms.
Dragonair's focus on becoming a premium carrier is driven by increasing competition from low-cost carriers and the need to differentiate itself in the market.
The rebranding aims to position Dragonair as a premium carrier and set it apart from regional competitors such as Hong Kong Airlines.
The new product will feature high-end interiors, including personal in-flight entertainment screens and power ports at every seat.
The rebranding is part of Cathay Pacific's strategy to ensure a consistent premium experience across its network and maintain its market position against competitors.

Sixth freedom competition is increasing, necessitating short-haul flights connecting to long-haul ones see no loss of service. Notably, regional competitor Hong Kong Airlines has had a more sophisticated look than the old Dragonair.

Finally, as LCCs are set to rapidly increase in Hong Kong, Dragonair needs to differentiate itself now more than ever as a premium carrier. The implication for the industry is if other short-haul units - like Singapore Airlines' SilkAir, Thai Airways' Thai Smile - must grow closer to their parents too.

Dragonair, installing high-end interiors, takes the fight to competitors

While Cathay Pacific has rightfully earned a reputation as one of the world's leading premium carriers, its wholly-owned Dragonair subsidiary has been less developed and sophisticated. This was the not the path Dragonair intended. Last decade prior to Cathay's 2006 takeover of the Hong Kong-based regional operator, Dragonair had planned to refresh its brand but after the takeover the programme was scrapped in a bid to maintain differentiation between the two brands.

Dragonair and Cathay do overlap services in some cities, namely Beijing and Shanghai, but elsewhere Dragonair tends to serve cities like Chiang Mai that have a more leisure focus that better suits Dragonair's slightly lower operating cost, as well as narrowbody aircraft. Dragonair has A320s and A321s in addition to A330s while Cathay is an all-widebody operator. The second component of Dragonair's network is services to mainland China, the heart of its network and where its brand recognition is high.

Dragonair ranks behind the big three in seats operated to/from the mainland.

Top 20 Airlines ranked on international seats to/from mainland China: 21-Jan-2013 to 27-Jan-2013

Rank	Airline		Total Seats
1	MU	China Eastern Airlines	267,159
2	CA	Air China	216,497
3	CZ	China Southern Airlines	191,292
4	KA	Dragonair*	158,492
5	OZ	Asiana Airlines*	77,152
6	KE	Korean Air*	73,868
7	NH	All Nippon Airways*	58,692
8	HX	Hong Kong Airlines*	41,610
9	JL	Japan Airlines*	39,298
10	SQ	Singapore Airlines*	37,710
11	CI	China Airlines*	35,598
12	TG	Thai Airways*	35,160
13	UA	United Airlines*	31,892
14	FM	Shanghai Airlines	31,676
15	NX	Air Macau*	31,528
16	BR	EVA Air*	30,556
17	MF	Xiamen Airlines	30,260
18	EK	Emirates*	28,480
19	HU	Hainan Airlines	25,614
20	MH	Malaysia Airlines*	22,830

With a regional focus, Dragonair's product has matched traditional standards, like narrowbody aircraft having no in-seat in-flight entertainment and business class seats being old-school style recliner chairs. This will change with Dragonair's new product, which will be installed first on an A330 for service entry in Mar-2013 while the entire fleet (which numbered 38 at the end of 2012) will be refreshed by the end of 2014.

Dragonair CEO Patrick Yeung, speaking at the product launch in Hong Kong on 24-Jan-2013, declined to put a cost on the project. Mr Yeung, however, confirmed the cost would obviously be well above that spent at the last product refresh, at the time around HKD175 million (USD22.5 million), reflecting the higher cost of the new product as well as Dragonair's enlarged fleet. The larger Cathay Pacific group had been spending approximately HKD3 billion (USD387 million) on various product and service enhancements.

The re-vamped product at Dragonair is in both business and economy classes. The new products are the same as those featured on Cathay Pacific with exception made to tweaks to accommodate narrowbody aircraft. But the intention is that a Dragonair A330 will match a regionally-configured Cathay Pacific A330.

Dragonair is even adopting Cathay's seat cover colour choice and menu design to further drive the consistency between the carriers. That means all seats, even economy class on narrowbodies, will have personal IFE screens with access to a content library featuring over 100 movies, 500 TV shows, 888 CDs, 22 radio station and 15 video games - far more content than could be consumed on the short-haul flights.

Business class seats will move from manually-controlled recliner seats to motor-powered seats that go into a "lazy-Z" position (but not lie-flat). The business seats will also have a shell, ensuring passengers reclining do not interfere with those in the rows behind them.

Dragonair new business class seat summary: Jan-2013

	Current Business Class	New Business Class
Seat pitch	42"- 45" (depending on aircraft type)	45"-47" (depending on aircraft type)
Seat width	20"	21"
Seat recline angle	Not available	36 degrees
Leg rest recline angle	Not available	60 degrees
PTV	9" monitor (on selected aircraft)	12.1" touch-screen monitor
Meal table dimension	17" W 11" D	20.3" W 14.5" D
Headrest movement	4-way movement	6-way movement
Entertainment system	Broadcasting system (on selected aircraft)	Audio Video On Demand
Multi-port connector	Not available	iPhone/iPod/iPad port and USB port
PC Power to each seat	Some aircraft	All aircraft

Dragonair new economy class seat summary: Jan-2013

	Current Economy Class	New Economy Class
Seat pitch	30"-32" (depending on aircraft type)	30"- 32" (depending on aircraft type)
Seat width	17.75"	18.1"
Recline	Up to 6"	Up to 6"
Meal table	Single piece meal table	Bi-fold meal table with integrated cup holder that is stable and robust to ensure no liquid spillage
PTV monitor size	7" monitor on selected aircraft	9" touch screen monitor
Entertainment system	Broadcasting system (on selected aircraft)	Audio Video On Demand
In-seat power outlet	Selected rows and shared basis on selected aircraft	One in-seat outlet for each passenger
Multi-port connector	Not available	iPhone/iPod/iPad port and USB port
Extra personal storage space	Not available	Extra space for passenger to stow personal amenities such as mobile phone and glasses
Living space	Not applicable	Living space enhanced by smaller underseat equipment boxes

Cathay Pacific regional business class seat to also be used on Dragonair: Jan-2013

The new business class seat from Recaro will add notable weight compared to the older version whereas the weight gain in economy class seats will be minimal: while IFE screens and powerports, with all associated cabling, are being added, the previous seats were heavy whereas the new version (the Webber 5751) are lighter, offsetting the weight from the IFE.

There are also cost synergies from using the Cathay product. Additionally, the Dragonair IFE, branded as Studio KA, is a clone of Cathay's Panasonic ex2 system, Studio CX.

Dragonair must set itself apart as a premium airline, as Cathay has done

The interiors may be some of the best on regional and/or short-haul aircraft and represent a steep improvement for Dragonair. This is important for multiple strategic reasons.

Whereas before there were elements of ambiguity about Dragonair, differentiation has been established. It is now clearly a premium carrier and clearly in a different category from Jetstar or Spring Airlines, both of which have their eyes on the Hong Kong market. Previously there had been questions about whether Dragonair was a LCC.

Shanghai-based Spring Airlines until late-2012 had linked Hong Kong with three mainland Chinese cities while a major push in late-2012 saw Spring's presence established in four more cities. There will undoubtedly be further growth and Spring has even raised the possibility of having a Hong Kong base to tap into other markets.

Australia's Jetstar Group intends to launch a local LCC affiliate in Hong Kong in mid-2013 in partnership with China Eastern. The proposed Jetstar Hong Kong will target the mainland China market as well as North Asia and Southeast Asia, Dragonair's markets.

Jetstar and Spring plan to stimulate travel by offering lower fares, a pattern which globally has forced full-service incumbents to justify themselves and their higher prices to the market. Dragonair's new interiors - modern IFE and powerports at every seat, plush seats with adjustable head rests - will set it apart from the LCCs, whereas before the differentiation was less.

Competition from other carriers is a driver as well. In Dragonair's backyard Hong Kong Airlines and sister carrier Hong Kong Express have built itself on being a modern regional carrier with new aircraft (its A330s have IFE at every seat while A320s and 737s do not). The contrast in hard product between venerable Dragonair and fledging Hong Kong Airlines was stark. Dragonair's re-vamp will address that and even position it ahead of Hong Kong Airlines in some areas, enabling Dragonair to better justify its asking for a yield premium over Hong Kong Airlines - and that is before considering frequency and loyalty programmes, amongst other drivers.

There is greater regional competition, and while mainland Chinese carriers for example are making leaps in the product and experience on widebody aircraft, narrowbody aircraft are relatively untouched with innovation, but this will undoubtedly change with the carriers already studying if in-seat IFE should be incorporated at every seat and how they can deploy more premium widebody aircraft to Hong Kong as China Eastern has done. Strategic initiatives like a codeshare partnership between Hong Kong Airlines and China Eastern gives the two carriers greater scale against Cathay and Dragonair and its equity partner Air China, reducing gaps that may exist between their proposition and that of Cathay and Dragonair. The re-vamped Dragonair interiors will help slide it up the premium scale and establish greater differentiation.

Finally there is a need for Cathay to ensure a consistent premium experience across its network, and in particular when a Dragonair passenger connects to a long-haul Cathay Pacific service, a core market for the airlines. Between 2006-2012 premium traffic accounted for approximately one-third of passenger revenue, but during the 2009 slowdown tipped to 20% (it has since returned).

On certain routes, such as to the US and Australia, premium traffic can account for 40-50% of passenger revenue. (Cathay excludes premium economy from its "premium" calculations.) Long-haul routes make up nine of Cathay's 10 largest routes by ASKs.

Cathay Pacific top 10 international routes ranked on ASKs: 21-Jan-2013 to 27-Jan-2013

While the philosophy for airlines in the past has been to look at each flight individually and adjust service according to duration, Cathay and Dragonair are taking a holistic view. While Cathay and Dragonair do not disclose transit traffic, a reasonable estimate is that half of passengers connect. A two hour Dragonair flight may thus be part of a significantly longer itinerary in which extra comfort on short sectors would be appreciated and could attract a yield premium, as the Middle East network carriers have typically done, deploying long-haul aircraft on short sectors or outfitting narrowbody aircraft with premium features.

Cathay has been able to offer premium aircraft on short-haul routes by using them during layovers, but this has limited practice and is not extended to Dragonair.

The Middle East carriers are very much part of the changing sixth freedom environment, although they do not serve as many points in China as Dragonair does (they do, however, have partners). This means they have been able to offer a more consistent premium product across the entire journey than Cathay and Dragonair. North Asian carriers like Asiana and Korean Air in South Korea as well as All Nippon Airways and Japan Airlines in Japan have been targeting the Chinese market effectively, adding to the pressure felt from Cathay's long-time competitor Singapore Airlines. A more premium product on short-haul routes will further set Dragonair apart.

The clear path of Dragonair becoming a premium carrier further highlights the need for Cathay Pacific to have a dedicated low-cost operation.

2013 set to be another record year for Dragonair

The alignment with Cathay comes as Dragonair celebrates 2012 being a record year. Dragonair opened its largest ever number of routes (eight), grew its fleet to its largest point with 38 aircraft (in 2012 it received four A320s and two A330s) and carried a record 7.8 million passengers - a rare statement given Cathay and Dragonair report combined traffic figures.

2013 will likely be another record year for passengers carried as Dragonair has already announced four new routes: China's Wenzhou and Zhengzhou (bringing mainland China destinations to 22), Myanmar's Yangon and Vietnam's Da Nang. Dragonair may eclipse last year's record of new cities opened: in addition to the four already planned destinations, two in Southeast Asia are in the pipeline - and this is only January. Announced fleet growth is so far confined to one A330, but this will likely grow as the year progresses. Dragonair so far intends to hire 100 additional cabin crew and 14 pilots while Cathay looks to reduce cabin crew count via early retirement.

Dragonair in 2012 also saw a 7ppt improvement in its load factor and achieved an average 60% load factor on its eight new routes, with destinations Jeju (South Korea) and Chiang Mai (Thailand) outperforming the others.

Dragonair seat capacity by region: 21-Jan-2013 to 27-Jan-2013

While the group is planning a 1.6% reduction in capacity for 2013 compared to 2012, this is mainly driven by Cathay replacing 747-400s with more fuel-efficient but lower-capacity 777-300ERs. This continues the marginal growth Cathay planned for 2012, dropping mainline capacity growth from 7% to 2% while increasing regional Dragonair growth from 7.3% to 9.2%.

Cathay did not break down growth between Cathay mainline and Dragonair, but based on CAPA's OAG data, Dragonair will grow about 4.5% year-over-year in 1H2013 while Cathay mainline will shrink about 4.4%.

Dragonair is also doing light experimentation with fares and distribution via its weekly "Fanfares" sale promotion done in conjunction with Cathay. But Mr Yeung adopts a different tone on the topic of fare reform - such as unbundling and offering multiple economy fares, as some full-service carriers have done to counter LCCs - saying Dragonair is firmly focused on the premium market and will undertake initiatives to further that position. But he also notes Dragonair must respond to what the market wants and evolves to wanting.

See related articles:

Dragonair top 10 routes by seat capacity: 21-Jan-2013 to 27-Jan-2013

Competition drives changes - will others, like SIA/SilkAir, follow?

Dragonair has likely set a short-haul precedent for peers to follow, but to what extent remains to be seen. The closest comparison to the Cathay-Dragonair relationship is between Singapore Airlines and its wholly-owned regional unit SilkAir. While SilkAir like Dragonair is a full-service carrier, it is not as premium as its big sister. As SilkAir overlaps with Dragonair around secondary Southeast Asian cities and in mainland China, SIA may find that it needs to develop SilkAir too in order to offer a more premium experience across the entire journey.

This would be an expensive undertaking and one that carriers would try to resist, but premium carriers are constantly trying to outdo each other with products, much to the benefit of passengers and interior firms.

There are some concerns in these strategies. The first is if brands mesh together this raises the question of whether it is worthwhile maintaining separate ones. Time works against brand alignment; although carriers today may be large, given future growth it may be better to consolidate brands sooner rather than later. As brands become similar, passengers will be more inclined to overlook the separation points, expecting that if a Dragonair aircraft looks like a Cathay one that other service points on Cathay be available on Dragonair too.

Blending models has its concerns, not least the respective pay scales

One issue if closer integration between SIA and SilkAir occurs is for example loyalty programmes; SilkAir is only a partner of SIA and not SIA's fellow Star Alliance members.

There is a more important issue: a similar proposition can be posed by staff, who can argue that if a subsidiary is effectively the same as the parent, then staff (often paid less on a subsidiary and/or with higher productivity requirements) should be treated the same as those at the parent. This equation is the same on a worldwide scale.

Qantas in Jan-2013 saw the end of a bitter battle between management and staff for pilots at LCC unit Jetstar to be employed under Qantas contracts. Iberia staff have protested the same about Iberia Express. Cathay has had run-ins with its unions - a strike was averted days before Christmas 2012 - and wages are a frequent discussion in the local press. At the product launch Mr Yeung was pointedly asked if Dragonair staff are paid the same as those at Cathay.