Yield pressure for China Southern Airlines as it deploys A380 to Sydney
While China Southern's announcement to serve Sydney from Oct-2013 with the A380 may be good for Australia at large, for China Southern there are limited upsides besides strategic ambition and slowly ending its negative perception from not being able to use the A380 in international markets.
The carrier will replace one A330 Sydney service with the A380, generating a 41% increase in capacity, which will likely make the service loss-making for some time. Sharper increases will occur in the premium cabins, where daily business class seats will rise from 48 to 100 and first class from four to eight.
The increase in capacity will occur in an already over-saturated Australia/NZ-Asia market, which is seeing increased capacity from AirAsia X, Air New Zealand, Emirates, Qantas, Scoot and Singapore Airlines.
From their delivery in 2011 until Oct-2012, China Southern's A380s were confined to domestic routes as well as a regional service between Hong Kong and Beijing. Delays were due to crew training and route approvals.
China Southern in Oct-2012 commenced daily Guangzhou-Los Angeles services with the A380 and still awaits, optimistically, permission to operate the A380 from Beijing to Paris, on which Air China has sole designation. China Southern would like to operate the service in partnership with Air China while Air China prefers a wet-lease that cuts China Southern out of the picture. China Southern would want to extend the relationship to Beijing-Frankfurt and/or Beijing-New York on the A380.
China Southern has received all five of the A380s it has ordered. Guangzhou-Los Angeles requires under 1.5 frames and Guangzhou-Sydney less than one aircraft. Two daily long-haul services to Europe (such as Frankfurt and Paris) would maximise the fleet while adding in New York would leave almost no room for error.
China Southern has dithered about having an operational spare, but on a fleet of five aircraft, this would come at great expense. Although doubts are high about China Southern's ability to finalise an arrangement with Air China, if the routes do go ahead China Southern could always use the Guangzhou-Sydney service as a spare and substitute A330s or 777-200s more readily than on a European service. The operation would be tight.
China Southern has domestic Chinese network – but also international connections
China Southern says it has re-timed 80 flights to facilitate better international connections, which in 2012 numbered approximately 370,000 – a significant increase from the 30,000 in 2009. Some routes see transfer rates upwards of 70%.
Australian, European, Japanese and Korean routes see about 50% of passengers transfer to China Southern's domestic network. Of China Southern's Australian routes, its more developed services to Melbourne and Sydney are "very good" according to China Southern president Tan Wan Geng but others require more effort. China Southern had closed reservations for its new Perth service, leading the industry to believe it would be shut down, but later re-opened the flight, saying it was committed to the Perth market.
Mr Tan in Mar-2013 said he recently had statistics pulled up about one of China Southern's Guangzhou-Los Angeles A380 flights. 55% of passengers on the service were connecting. While such a figure is comparable to large sixth freedom carriers like Cathay Pacific and Singapore Airlines, China Southern is still evolving into a formidable opponent.
On that flight, 53 passengers – accounting for around 10-15% of total loading – originated in Manila. The Philippines is hungry for services to the United States as Philippine Airlines is unable to expand its capacity until it regains FAA Category 1 status. Once it does, this market could soften for China Southern, highlighting the sometimes volatile nature of securing traffic sources for sixth freedom operations.
Up-gauge to A380 brings 41% increase in Sydney capacity – 1,554 more seats each week
China Southern's Apr-2013 capacity sees it deploy a daily A330-200 (with no first class) and a daily A330-300 from Guangzhou to Sydney for a total of 3,794 weekly one-way seats. China Southern commenced operating on the Guangzhou-Sydney sector in 2000.
From the middle of the last decade until 2010 the service flew on average only four times per week. That changed in Oct-2010 with China Southern embarking on an international capacity expansion drive: the carrier is the largest in China (indeed, all of Asia) but almost all of its capacity was in the domestic market and it lagged behind Air China and China Eastern. Whereas Air China focused international services to Europe and North America and China Eastern to North Asia, China Southern set its sights on Australia and New Zealand with plans to have 55 weekly flights by 2015.
China Southern's Sydney service went daily on a regular basis in 2010 and later that year went double daily (for more than a few weeks at a time, as had occurred in past years during China's busy but short national holidays).
China Southern Guangzhou-Sydney weekly capacity and frequency: 2004-2013
Deploying the A380 to Sydney will result in a 41% increase over Apr-2013 capacity levels with the addition of 1,554 weekly one-way seats for a total of 5,348. This would represent since 2010 – just three years ago – a capacity increase of 185%. It is not as high as if China Southern paired the A380 with the larger A330-300 instead of A330-200. That may change with schedules and China Southern's need for the longer-range of the A330-200 to be deployed on longer sectors than Guangzhou-Sydney.
China Southern Guangzhou-Sydney forecast weekly capacity and frequency with addition of A380: 2004-2013F
China Southern theoretically could have replaced its two daily A330 services with the single A380 flight. That would have delivered more favourable capacity (indeed, a slight decline as the A330s offer a combined 542 seats to the A380's 506) but at the expense of frequency.
A daily service would also reduce connecting opportunities. China Southern's morning departures from Australia arrive in Guangzhou in the early evening and connect to flights to Amsterdam and Paris, which depart Guangzhou around midnight. The evening departures from Australia arrive in Guangzhou in the morning, allowing passengers a full range of domestic and regional connections, as well as long-haul flights that depart in the afternoon before the overnight flights from Australia arrive.
Moscow departs at around 14:00 while London, which China Southern is heavily marketing under the "Canton Route" banner, departs most days around 09:00. Having a single daily flight would require China Southern to choose some markets over others. (This may not necessarily be financially problematic as most long-haul flights for Chinese carriers are unprofitable. But China Southern has stated its long-term ambition and is willing to endure short-term losses to cement its position early.)
China Southern in each direction has a daylight and overnight flight with the overnight services being more popular. But being unwilling (understandably) to have a nearly 12 hour layover in Sydney for each service, the Guangzhou overnight departure and Sydney daylight departure will receive the A380. Flights are about 20 minutes longer from Sydney to Guangzhou than Guangzhou to Sydney, according to China Southern's schedules.
China Southern Sydney capacity change scenarios: Apr-2013
|Apr-2013: 1x A330-200 and 1x A330-300||392||98||48||4||542|
|Oct-2013: 1x A380 and 1x A330-200||536||120||100||8||764|
|1x A380 and 1x A330-300||560||118||100||12||790|
Reducing the two services to one would have seen a 6.6% decrease in overall capacity. But it would be a split story with economy/premium economy (there is little differentiation between the two on China Southern, unlike at other airlines) decreasing from 490 seats on the two A330s to 422 on the A380.
Business class would increase from 48 seats across the two A330s to 76 on the A380, a 58% increase. First class would increase 100% from four to eight seats. While there has been a trend of airlines favouring premium cabins, China Southern has shown difficulty building awareness in the premium and corporate segments whereas in economy it can win seats by offering cheap fares.
Business class typically requires a more holistic offering. China Southern and its peers have made leaps and bounds in hard product on aircraft, but elsewhere – soft service, lounges, frequent flyer – the offering is still maturing. As premium service – and premium yields – ramp up, favouring premium cabins over economy may not be wise, further evidenced by China Southern's consideration of removing first class due to poor performance.
Deploying the A380 to Sydney alongside an A330 will require a shift in China Southern's marketing as business class rises in importance, going from 9% of the carrier's Sydney capacity to 13-15% at the expense of economy. Total number of business class will increase from 48 a day to a staggering 100.
China Southern Sydney capacity ratio change scenarios: Apr-2013
|Apr-2013: 1x A330-200 and 1x A330-300||72%||18%||9%||1%|
|1x A380 and 1x A330-200||70%||16%||13%||1%|
|1x A380 and 1x A330-300||71%||15%||13%||2%|
While Chinese carriers are just about maximising their use of the China-Australia bilateral, this is primarily based on allotment and not active use owing to Chinese carriers sharply increasing capacity over the limited Chinese New Year period and then quickly decreasing capacity. China Southern under the bilateral should be able to up-gauge to the A380 and keep its other Sydney service as this would equate to about 10,000 seats, which is slightly under the 10,200 seats China Southern used during the 2013 Chinese New Year period.
Australia to China capacity by carrier (seats per week, one way): 19-Sep-2011 to 13-Oct-2013
If there are any bilateral constraints, China Southern should only need to flag its interest to Chinese authorities. Australia is open to expanding the Chinese bilateral, and eventually moving to an open skies arrangement, but awaits China, which has more pressing matters to tend to first.
See related article: Australia must negotiate expanded bilateral agreements, particularly with China
A380 deployment to Sydney will further pressure weak international yields
The A380's time with China Southern has not been a profitable one, with 2012 losses reportedly to the tune of RMB150-200 million (USD24-32 million) for a fleet that averaged just three frames over the course of 2012. Nor has China Southern's long-haul expansion been met with profitability.
Although long-haul is a general challenge for Chinese carriers, the impact of China Southern's aggressive expansion into Europe and Australia is clear on its international yields, which declined 7% in 1H2012 and 5.4% for the full year. Not only were these the largest drops, but China Southern's international yields are the lowest of any domestic/regional/international yield from China's Big Three carriers.
Air China, China Eastern and China Southern yield (per passenger kilometre in RMB) summary: 1H2012 vs 1H2011
|Carrier||Domestic Yield||YoY change||Regional Yield||YoY||International Yield||YoY Change|
Air China, China Eastern and China Southern yield (per passenger kilometre in RMB) summary: FY2012 vs FY2011
|Carrier||Domestic Yield||YoY change||Regional Yield||YoY||International Yield||YoY Change|
China Southern takes a long-term view on international profitability, believing medium-term financial pain is the tradeoff to secure its position in what will be a more competitive market in the future. Competitors may be tempted to pass this off as government subsidisation, but irrespective of drivers the impact for other carriers is their own yields being pressured. This will be examined in the second part of this analysis.
China Southern has waited in vain for right deployment of A380s
China Southern had hoped to deploy its A380s on routes from Beijing, which were always going to require lengthy and difficult regulatory approval. The carrier waited to get its network right (in its ideal world) rather than make short-term network decisions it would later change. Although perhaps admirable, this has come at a financial cost and reflects poorly on the regulatory environment in China: the government approves aircraft purchases, so it seems quixotic to approve the aircraft without giving it sufficient routes.
As CAPA previously wrote:
China Southern's A380s have become a financial burden in the approximately 18 months since the carrier introduced the type. The fleet, which numbered four at the end of 2012 (a fifth was delivered in early 2013), is reported to have accumulated RMB150-200 million (USD24-32 million) of losses in 2012 as a result of China Southern facing route restrictions. China Southern quantified 1H2012 losses as under RMB100 million (USD16 million) but, amidst considerable attention from the public and financial markets, would not confirm reports out of China specifying full year losses.
China Southern's A380s in 2012 flew only on domestic and Beijing-Hong Kong routes until Oct-2012 when a daily Guangzhou-Los Angeles service started. Although international long-haul routes challenge Chinese carriers for profitability, China Southern would likely incur fewer losses from deploying A380s on international rather than domestic routes owing to higher relative yields, reduced depreciation, as well as lower landing fees and maintenance from the aircraft having fewer daily cycles.
In Aug-2012 China Southern said it was finalising plans with Air China to cooperate between Beijing and Paris, a route where Beijing grants Air China exclusive access. Under China's "one route, one airline" policy, long-haul routes are allocated to a single domestic carrier. The rationale is to have domestic carriers compete against international ones rather than amongst themselves. Even in the domestic market carriers try – with some government support – to establish mini fiefdoms. (Exceptions to this policy are often made for Air China, the flag carrier, which is allowed to operate some long-haul routes from Shanghai alongside China Eastern, which is not allowed to operate reciprocal routes alongside Air China out of Beijing.)
See related article: China Southern's A380 problems may not be solved by possible Air China partnership
China Southern's A380 challenge is representative of the larger state of long-haul services from Chinese carriers. As CAPA previously wrote:
The challenge for China Southern and other Chinese carriers is balancing the long-term objective of being significant international carriers, including in sixth freedom markets, with the short-term profitability objectives. A larger future tomorrow means building the network today, but doing so challenges short-term financials. As Mr Tan conceded of Chinese carriers: "If you wish to make a profit from long-haul routes, it's still very difficult."
China Southern and others are operating loss-making routes, but with the vision they will, one day, be profitable. They are not, as a Singapore Airlines manager once said, "profit-neutral", evidenced by China Southern's push to minimise losses rather than deploy aircraft where it might attract the greatest amount of attention.
On the larger subject of route profitability, Mr Tan asked analysts not to consider route-by-route analysis as "we have to rely on the network". The suggestion was that passengers on one loss-making sector feeding into a profitable sector made a positive gain. It is a valid point for some carriers and has been used in Europe to justify loss-making short-haul services as they feed profitable long-haul services. (A distinguished former Cathay Pacific network planner once said, only partly tongue in cheek, of the then-highly profitable carrier that it did not have a single route that made money.) But in China the profitability flow is in reverse: international services have high losses to feed passengers on either more loss-making international services or short domestic routes which can seldom recoup the cost of the international segment. Holistic perceptions are also asked for in other matters, such as the Chinese Government arguing loss-making airports have a net benefit to the economy of the region they serve.
Sydney was never an ideal destination for the A380 in the short- or medium-term (one day, yes) and despite financial challenges to China Southern that will arise out of that, there are upsides. These are confined largely to the public and tourism bodies, reinforcing the epithet that everyone can make a profit from airlines – except the airlines themselves.