31-Jul-2013 10:16 AM

Spring Airlines and Juneyao Airlines enter cross-Strait market; market impact small - at first

Analysis

Juneyao Airlines and Spring Airlines will make advances with their forthcoming entry into the highly lucrative cross-Strait market between mainland China and Taiwan, where yields approach an astronomical USD30 cents/km for the one to two hour flights. While they are due to initially serve Kaohsiung, a Taiwanese port city, they should gain entry on the key Shanghai-Taipei route later in 2013. The two privately-owned airlines are the most prominent of the carriers that launched mid-last decade during a period of relative liberalisation. Being new carriers, they have lean bases unencumbered with legacy baggage. Spring also has the distinction of being China's largest LCC by some degree, and will be the first LCC on the cross-Strait market.

The two will be expected to offer lower fares than competitors, but not by much, at least on the Shanghai-Taipei route. Demand far exceeds current supply, tightly controlled by the respective governments since scheduled cross-Strait services recommenced in 2008 as relations between the two governments warmed. There is little incentive to offer cut-throat fares as might be expected in other markets. The routes should do well for Juneyao and Spring from a marketing and profitability perspective, but their limited frequency against a backdrop of high demand means competitors should have little to worry about for the medium term. In the long term, however, these short point-to-point routes seem perfect for LCCs, if airlines are willing to make a fundamental change to their business.

Summary

Juneyao Airlines and Spring Airlines are set to enter the highly lucrative cross-Strait market between mainland China and Taiwan.
The airlines will initially serve Kaohsiung, Taiwan's second-largest city, and later expand to the key Shanghai-Taipei route.
The cross-Strait market is tightly controlled by the respective governments, with limited frequency and high demand.
Juneyao and Spring are expected to offer lower fares than competitors, but the impact on existing carriers will be mild due to the limited capacity.
The entry into the cross-Strait market will enhance the brand image of Juneyao and Spring and reflect the warming acceptance of private carriers by the Chinese government.
The cross-Strait routes are ideal for low-cost carriers (LCCs), and there is potential for the development of LCC subsidiaries in mainland China and Taiwan.

Juneyao and Spring to enter cross-Strait market with service to Kaohsiung

The entry of Juneyao and Spring reflects their long-running heavy lobbying to the governments of mainland China and Taiwan. Signs became encouraging in mid-2013 as the carriers seemed confident of receiving approval, which should happen shortly in advance of an Aug-2013 launch. This will be a great achievement - but also raises complexities. Reflecting the tightness of the cross-Strait market, preliminary indications are that Juneyao and Spring will be able to serve cross-Strait routes in exchange for giving up landing slots at constrained Shanghai Pudong airport. The slots will be re-allocated to Taiwanese airlines so they can expand their cross-Strait presence.

Each government will have to agree to the overall number of weekly services and also ensure that there are appropriate landing slots for additional capacity to be implemented. A frequent complaint from governments and airlines is that bilateral agreements may accommodate growth but are not accompanied by landing slots - not just in China.

Local reports indicate Juneyao and Spring will each offer three times weekly services between Shanghai Pudong and the Taiwanese port town of Kaohsiung, which is also Taiwan's second-largest city. Capacity to Taiwan is almost entirely concentrated at Taipei. Kaohsiung is linked to Shanghai only via Shanghai Pudong and with two weekly flights on each China Airlines and EVA Air. China Airlines uses A330-300s while EVA Air uses 747-400s.

While Juneyao and Spring only have A320 family aircraft (Spring entirely A320s and Juneyao recently A321s as well), they will have a slight frequency advantage. They should also beat competitors on price, although it will not require a substantial discount to woo passengers but still be profitable: a three month advance-purchase ticket still carries a yield on EVA Air of USD17.2 cents per kilometre.

Reflecting the limitations on the cross-Strait market, this is little change in capacity over a 16 month period.

Shanghai to Kaohsiung International Airport (seats per week, one way): 19-Sep-2011 to 19-Jan-2014

More lucrative service to Taipei should come by the end of 2013

Later in 2013 Juneyao and Spring should enter the Shanghai Pudong-Taipei Taoyuan route, the largest cross-Strait route by far, although the service from Shanghai and Taipei's more convenient downtown airports, Hongqiao and Songshan respectively, is more lucrative.

Top 10 Routes between mainland China and Taiwan ranked on seat capacity: 29-Jul-2013 to 4-Aug-2013

Rank	Origin		Destination		Total Seats
1	PVG	Shanghai Pudong Airport	TPE	Taipei Taoyuan International Airport	13,557
2	PEK	Beijing Capital International Airport	TPE	Taipei Taoyuan International Airport	8,929
3	SHA	Shanghai Hongqiao Airport	TSA	Taipei Songshan Airport	7,333
4	CAN	Guangzhou Baiyun Airport	TPE	Taipei Taoyuan International Airport	5,556
5	SZX	Shenzhen Airport	TPE	Taipei Taoyuan International Airport	4,320
6	HGH	Hangzhou Airport	TPE	Taipei Taoyuan International Airport	3,637
7	WUX	Wuxi Airport	TPE	Taipei Taoyuan International Airport	2,266
8	CTU	Chengdu Airport	TPE	Taipei Taoyuan International Airport	1,937
9	PVG	Shanghai Pudong Airport	TSA	Taipei Songshan Airport	1,694
10	XMN	Xiamen Airport	TSA	Taipei Songshan Airport	1,664

There are no firm indications yet what the frequency may be - China's CAAC is supporting a daily flight subject to the Taiwanese side's approval - but once again Juneyao and Spring will be able to tap into pent-up demand with only modest fare discounts. The Shanghai-Taipei route carries a premium over the longer Kaohsiung sector. Yields for an advance purchase ticket on EVA Air are an enviable USD24.5 cents per km - but this is when booked from Taipei. Booking from the far more popular Shanghai side (the vast majority of passengers on cross-Strait flights are mainland Chinese) and the yield increases to a staggering USD28 cents per km.

Chinese carriers report yields based on region, with Taiwan part of the "regional" yield, which consistently out-performs the other regions. Also included in the regional grouping are Hong Kong and Macau, but the majority of capacity and revenue comes from Taiwan.

Air China, China Eastern and China Southern yield (RMB per RPK): 2012

	Air China	China Eastern	China Southern
Domestic	0.73; -1.58%	0.66; -4.39%	0.69; 1.5%
Regional	0.83; 27.13%	0.84; 4.00%	0.84; -4.5%
International	0.56; -1.75%	0.62; -1.09%	0.53; -5.4%
System Average	0.67; -0.87%	0.65; -4.17%	0.66; -1.5%

Individual visits from mainland China to Taiwan were recently approved, but the majority of bookings still come from tour groups.

Spring will have an advantage here as it has a related travel agency, the widely known brand Spring Travel. Spring has found that Spring Travel typically helps a route launch but over the long term as a route matures most bookings are from individual passengers. Juneyao, like most Chinese airlines, works with travel agencies.

Shanghai Hongqiao to Taipei Songshan Airport (seats per week, one way): 19-Sep-2011 to 19-Jan-2014

Shanghai Pudong to Taipei Taoyuan Airport (seats per week, one way): 19-Sep-2011 to 19-Jan-2014

Demand is high and supply tight - immediate competitive impacts should be mild

Juneyao and Spring will have a tidy operation in the cross-Strait market, but it will be small. With nearly 21,000 one-way seats a week between Shanghai and Taipei, the 2,000 return seats Spring and Juneyao will add (assuming a daily service) may be a 10% expansion but is still far short of meeting demand. Fellow cross-Strait operators will not lose sleep about Taipei, especially if the slot transfer proceeds and China Airlines and EVA Air gain more access. Yield decreases from the high USD20 cent levels are inevitable; this is still the honeymoon period for the market. (All signs point to continuing warm relations between mainland China and Taiwan, but a shift in politics - especially on the freely elected Taiwanese side - could alter this. However, it would be a serious popular setback for any government which caused a roll-back in direct cross-Strait flights.)

Perhaps of more concern to non-SkyTeam carriers in the market (mainly Air China and EVA Air) is what will eventuate out of the greater Chinese carriers' mini China alliance and how they can respond.

Juneyao and Spring's service to Kaohsiung may indicate to legacy incumbents how inefficient they are compared to their new generation rivals: Spring an LCC and Juneyao full-service but agile and efficient. The two mainland Chinese carriers could also show all carriers in the market the potential to sustainably link secondary cities.

No doubt Juneyao and Spring would in a heartbeat give up Kaohsiung for more Taipei access, but in the long-term there are numerous secondary city pairings that LCCs can excel on or have to themselves, as has occurred elsewhere in Asia and also the more mature markets of North America and Europe.

The entry of Juneyao and Spring would be encouraging as an indicator that airlines and regulators are willing to work together to expand trunk routes. While the cross-Strait market has been expanding, the focus in recent times has been on these secondary pairings, which have not seen the same demand, and sometimes are unprofitable.

Passengers currently taking cheap but circuitous connecting routings via Hong Kong and Macau may switch to Juneyao and Spring, further dampening traffic, albeit lightly, around the historical hubs for mainland China-Taiwan traffic.

Annual seat capacity in select Greater China markets: 2003 to 2012

Source: CAPA - Centre for Aviation & OAG

Serving cross-Strait routes will bolster the image of Juneyao and Spring

Serving cross-Strait routes will also be important for Juneyao and Spring from a brand perspective. At the Chinese consumer level, they are not seen as being of similar status to China Eastern or China Southern, let alone flag carrier Air China. This is for reasons beyond business model and smaller size. Introducing cross-Strait routes adds further credibility.

At the government level, it points to warming acceptance, or at least a recognition that this is a force that cannot be contained. While any Chinese airline by the nature of its existence has good government relations, private carriers do not match the state-owned companies' connections and influence. Earlier in 2013 Juneyao and Spring had aircraft deliveries held up so the government could limit short-term growth. This is in addition to Juneyao and Spring's growth plans already being curtailed to satisfy regulators.

The permission to serve cross-Strait routes follows a recent unusually glowing report from the Chinese government about Spring Airlines, noting its efficiency to the rest of the industry. There is a growing recognition in Beijing that a policy of providing a competitive buffer while the bigger, former state owned, airlines gradually become more efficient is not going to work. Efficient models like Spring and Juneyao are needed, to show the way.

China is officially encouraging the launch of more private carriers, but of course there is no free access. Even Juneyao and Spring's entry into the cross-Strait market is highly choreographed, but it does give some overdue weight to official policy.

Outlook: Beginnings of expansion in a Cross-Strait market ideal for LCCs

With mainland China and Taiwan capping the cross-Strait market based on weekly frequencies, not seats, this has unsurprisingly caused airlines to deploy their largest aircraft on precious few services.

China Airlines' Shanghai Pudong-Taipei Taoyuan route, upwards of four daily, is served exclusively by 747-400s. Its link between the more downtown airports of Shanghai Hongqiao and Taipei Songshan is on two daily flights flown by A330s, a down-gauge caused by airport limitations, not demand.

This concentration of capacity may be efficient - and better for the environment - but hardly caters to market principles that favour frequency and point to point service on some smaller city pairs.

Even when additional services are permitted on these trunk routes, the increases will still be small compared to demand, so airlines will continue to search for their largest available aircraft. With a flight time of one or two hours, cross-Strait routes can be effectively flown by aircraft otherwise on a layover between long-haul routes. But as the gap between demand and supply narrows, carriers are already gravitating away from large capacity aircraft to more medium-sized ones that can be deployed with greater versatility, perhaps shifting the economics of using the aircraft on a cross-Strait route. There are precedents in Japan, once the land of 747s, with All Nippon Airways and Japan Airlines decreasing the share of large widebodies while increasing the share of medium widebodies.

Once cross-Strait capacity nears equilibrium, with some flexibility from regulators and slots permitting, airlines would prefer to change a three weekly 747-400 service to a daily service on a lower-capacity aircraft. Then the cost advantage of a Juneyao or Spring will be felt more closely. The widebodies presently flown by incumbents offer seat unit scale, helping to offset the efficiency of Juneyao and Spring.

But an inevitable LCC subsidiary from mainland Chinese and Taiwanese airlines does not need to wait until the competitive impact is clearer. There are routes today that could either have greater profitability, or be brought to break-even/profitability, if flown by a lower-cost unit. Mainland Chinese and Taiwanese governments have been expanding routes on secondary city-pairs that simply lack the demand at current airline cost - or price - levels. But airlines still take up these routes, knowing that appeasing the government will bring them due rewards.

Yet LCC subsidiaries in mainland China and Taiwan are either nascent thoughts or sharply opposed, even though the short nature of many cross-Strait routes - an hour or two - is where LCCs perform best, as controllable costs take up a greater share of overall costs. Being efficient with controllable costs significantly lowers the overall cost - and the ability to reduce fares, in turn stimulating new demand.

In the current regulated environment there is even the potential to convert the present regional widebody operations to a low-cost unit, creating a low-cost widebody short-haul operation. Again Japan offers precedents with tightly configured domestic aircraft, with upwards of 550 seats. On the low-cost side, regional widebody flights are being trialled largely by Cebu Pacific and Scoot on selected routes (such as Manila-Singapore for Cebu and Singapore-Bangkok for Scoot) that complement their larger focus of medium/long-haul flights.

Mainland China and Taiwan have ideal geography and trunk routes for such a regional low-cost widebody operation. For now, Juneyao and Spring will quietly benefit from low-cost cross-Strait routes. But the small market noise they make is sure to resonate disproportionately to their scale.

LCC and New Age Airlines in North Asia Summit: 4/5 September in Seoul

Spring Airlines CEO Xiuzhi Zhang and Juneyao Airlines CEO Junjin Wang will speak at CAPA's second annual LCCs and New Age Airlines in North Asia Summit to be held in Seoul, 4/5 September. It is proudly hosted by Incheon International Airport Corporation and supported by Travelport, SITA, Sabre and Bombardier. Click here for full details.