What Is The Outlook For LCCs In China?

Transcript

Steve Saxon:Okay, in, in the last session before lunch, we're going to look at low-cost carriers in China, what's holding them back, and the potential for their growth. I'd be delighted to introduce my panel. Please all come up and join me on the stage. So we have Mr. Jianming Qiu, who is from 9AIR. based in Guangzhou. Kathleen Tan, who is President of China and North Asia for AirAsia. Mr. Jiawen Fu, who is Chief Financial Officer for Lucky Air. Dr. Shaoxuan Liu, who is from MIT SCALE NSCIIC in Ningbo. And Jonathan Hutt, Vice President from Spring Airlines. Over the next 40 minutes or so, we will discuss as a panel what's holding Chinese LCCs back. First, allow me to just sort of set the scene and give you a little of the fact base, building what I think you heard from Will earlier on today. So first of all, LCC growth in China is clearly very highly dependent on the CAAC and its regulation. So LCCs have long existed in China, ever since Spring entered back in 2004, but the pace really picked up after 2013. CAAC did the review very positively, looking at the economics of the low-cost carriers and saying, okay, this is a model which we need to grow and to prosper in China. Since that deregulation, they opened up for many, many new entrants. And as you'll see from the huge number of logos across the bottom, there were 20 or so new entrants over the next few years. So a huge flurry. CAAC then was like, ooh, what happened? Are we comfortable with this big explosion? In particular around, are we comfortable that All the regulations are in place, and the growth is well moderated. And they've closed down again. It's now very hard to get new licenses, and it's hard to convert cargo licenses into passenger. And so kind of the growth of new carriers has slowed down substantially, and there's just one or maybe two in 2017. However, even with the challenges, With this huge proliferation of new entrants, the absolute share of LCCs in domestic China market is relatively low. However, LCCs in China is not only a domestic phenomenon. It's also an international phenomenon. This chart here looks at all the foreign-based LCCs who are flying into China. China's largest LCC, if you actually look at it, is the AirAsia Group, In terms of the number of seats flying into China. And there are carriers we've heard earlier from Korea, Japan, Southeast Asia, all serving multiple points into China. The share, though, of LCC as classically defined is very low, like less than 5% or less of these of the seats from China-based carriers are LCCs. Significantly lower than we see in the United States and significantly lower than Southeast Asia, where, at least in some of the countries, that's now touching up to 50%. Part of this, though, is a definitional question. What really is an LCC, and what differentiates an LCC from other airlines? And we do see business models highly converging from both sides. I flew here on Spring yesterday in Spring Plus with a business class. Jetstar has got multiple different fleet types, has a business class, connects passengers to itself and to Qantas. AirAsia has made, especially with X, is doing a big push on the connecting product. China Airlines has a hand baggage only fare where they charge you for the first bag and they charge you for meals. So I think there is a big debate around kind of where— what really is a low-cost carrier. I was seeing earlier that Lucky Air now has A330s with business class flying long-haul to Moscow. The pure dividing lines between the LCC and the full-service carrier clearly are blurring. I think in our view, It's good for everybody to be low cost. It's not like the full-service carriers don't also want to keep their cost base down. And the key question is, what is your passenger segmentation and what are those customers willing to pay for? Our view is everybody is converging somewhere in the middle. And frankly, if I was, I would much rather be converging in the middle by starting from a low-cost point of view and selectively adding things on, then I would be starting from a high-cost point of view and needing to figure out, okay, well, what do I take away? I think that's the challenge which a number of the full-service carriers are currently feeling, both in China and also more broadly in Asia. We're going to move now into the panel discussion. And I'd like to start by asking the panel— and I think this is such an important question, I think all the panelists should answer this. What's holding China back? What would it take to get Chinese LCC penetration to the sorts of levels which we have seen in other markets?

Jianming Qiu:So, at present in China, there are no dedicated LCC terminals. The government of China towards all airline carriers. The fare is determined, landing fees and the same charges are regulated by the government of China. So in LCC, we couldn't really get that discount from the government. Another point in LCC cost, I would say compared to other airlines, LCC beverages you have to pay for. In our case, Spring Airlines, we introduced our own system, but those costs we are talking about, we can actually take them as costs, but there is no really price gap with LCC and other FSC or other carriers. When it comes to the consumers, well, consumers are interested in LCC, but they still actually feel resistance, like extra charges for the additional check-in luggage and have to— and also payment for the beverages and foods. A lot of consumers, the Chinese, are not familiar with them because they're— in the past, they always flew in FSC. So they question, why do we have to pay for this, for LCC? So they make a lot of complaints. There are increasing number of complaints, then the government of China will send us written questions. So how to reduce the number of complaints is another challenge. Yes, there are many hurdles.

Steve Saxon:Thank you. Kathleen, obviously the penetration in China is significantly below where it is in your core— AirAsia's core home markets. of Southeast Asia. What do you see as the differences with China?

Kathleen Tan:I think for a start, the regulatory— CAC has a very big role to play influencing the development and growth of low-cost in China. The need to understand the awareness and slot constraints, I think airport As what the exchange was discussed earlier between Japan, I feel that it will take time because there's a lot of regulations. And now with the new leadership in CAAC, where they focus on 3 pillars that all airlines, full service and low cost, has to play by the new rules, which will be 3 pillars: on-time performance, Customer service and safety. I mean, safety ranks really high. So, if you look at China, there are a lot of airports. We fly majority to second-tier airports. It requires a lot of education, winning, influencing the local government. I think we in AirAsia, we have been very lucky because I started China journey in 2004. So, I spend a lot of time winning and influencing government from a lot of stakeholders. It's not just talking to one. We spend a lot of time engaging CAAC, but you cannot change the mindset. It takes time. But China is very big. One of the things is slot constraints. On-time performance is very challenging. There is no way we can operate 25 minutes in China now because the China airspace is really congested. Full-service carriers in China are also operating, adding a lot of capacity, long-haul everywhere. So foreign carriers are also flying to China. So the space in China is tight and airport has no control over CIQ. So slots, they can give you a slot at 3 AM But a lot of airports with CIQ will say, sorry, we don't operate at this hour. So those are also challenges. And because the air traffic is so congested, ATC, you are really at the mercy of ATC as well. So OTP is also a challenge. So for LCC, when you operate on high aircraft utilization, when you have a flight that's delayed, that will cause chaos. Delays. So I think this is also one of the challenges. We have been operating in China for more than 10 years, so we evolve, we learn, we have locals there. We spend a lot of time engaging local stakeholders as well with ATC because, to be fair to these guys, there is not a lot of understanding on LCC as well. But I believe the last few years— They're learning. There is this need to want to know more by the regulators, but I don't think it's going to scale like Southeast Asia. It will take time, but it all depends on the government. If China government says yes, let's do it, they can make it really fast. Just look at the high-speed rail.

Jonathan Hutt:Yeah.

Shaoxuan Liu:Thank you, Mr. Fu.

Jianming Qiu:Yes, exactly as they said. CAAC in China has a big influence. So in terms of market in China, I would say the following. Since 2014, the dollar gets higher and we had different exchange rate and there's a declining of demand to China. And the CAAC published document with respect to the charges for services and also the landing fees was raised by 15% or so by that document. In the past several years, the— in the oil price declining, airline company increased the freight size. Well, last year, In our case, the fleet size increased to 15 aircraft. With the increase of the crude oil, our operation cost also goes up. So for the future growth and development, this will be certainly a constraint. Since 2014, inside China, the growth of overseas The number of trips has been increasing. It made sure a whole trip to Southeast Asia has been affected. When it comes to the opportunities, there is a One Road One Band system initiative by the central government of Japan. On the west side of China, and there will be an aviation agreement to be open to the cities of the Western world. So liberalization in aviation agreement is something the central government is advocating for recently.

Shaoxuan Liu:So I first I'd like to like to say that a great. I would like to answer the question from an LCC's perspective. Actually, there are, from LCC's perspective, there are external factors that are holding LCC back, and there are also internal factors. For the external factors, I would say there are 3 main factors. One is the government's regulation. We all know that in order to do business, successfully in China, you really have to understand the government's attitude about this particular industry or sector. So the government's regulation is playing a critical role in LCC. We have seen that China is gradually deregulating the aviation industry, but there's still a long way to go. We will see that there's more market-oriented aviation market in China. So my observation is that the government now is more encouraged LCC for the international routes instead of the domestic routes. So for the domestic routes, we will see that CAAC is more conservative. So for LCCs to operate within China, they face more challenges. That's one factor. The second factor, I would say, is the infrastructure. We are seeing most of the airports, for example, in China, when they design the airport, is designed for the full-service carrier. There are very few airports in China has dedicated terminals for LCCs. Okay, and also the LCCs are treated differently with, I mean, the airport treat LCC and the full-service carrier differently. So that's the second factor. And the third factor I would say is the competition, is the competition from, in particular, from the high-speed Railways. So we've seen, we have witnessed that since the year 2013, the high-speed railways has really increased dramatically, and the Chinese government is spending trillions of RMB investment in this area. So that's for the external factor. Internal factor, I would say from LCC's own perspective, I think there are many Many rooms for improvement for the LCCs. I think we have heard this mentioned that the service reliability is critical. We have seen that actually the punctuality flight rate is quite low in China, and it hit the LCCs hardly, and that's one thing. The second thing we know for the LCCs, we all know that the value proposition for LCC is low cost and convenience, but the cost actually, I would say, is not attractive enough. One of the reasons I think is that because the main revenue generated for LCCs are coming from ticket selling. The ancillary revenue, I read a report last year, for the LCCs in China, it's less than 10% of their revenues is coming from ancillary revenues. So, I think the LCCs really have to diversify their source of revenue in order to pass on some of this, benefit to the passengers, to really lower the ticket fare rates in order to stimulate the demand in this area. And the second thing is the convenience. We don't see, if we look at the development, the successful story of Southwest Airlines in the United States, they really have this high—

Kathleen Tan:Frequency.

Shaoxuan Liu:Density in terms of the number of flights between the origin and destination, but that's not the case in China now. My personal experience is that the flight between the 2 different cities for the low-cost carriers is not frequent enough. I think this area can also be improved. And so there are external reasons, And internal reasons. If we can, we can do this, overcome these factors, I think there's a huge potential for LCCs in China.

Steve Saxon:Jonathan, we saw Spring's growth rate significantly lower than, for example, what JetBlue managed to do in a similar-sized market. What's holding you back?

Jonathan Hutt:Well, you know, think about next month we actually celebrate our 12th birthday, and a huge amount has happened in that. As you mentioned, We originally had a much higher fleet plan, but that's not realistic. Some of the things that held us back were things common to all airlines, full service and LCC. Pilot shortage was very important. Aircraft acquisition, also difficult. But, you know, we have to be flexible. As an LCC, you have to look at the market and what it allows you to do. And I think we've done fairly well in that regard. Looking at the new priorities, it's really about what we need to do to stay relevant in that market. And that means some of the things we're doing are not really LCC-centered. We really do focus— I know that you flew over on Spring, and you did have a delay, and I publicly apologize for that delay. But, you know, Spring is actually the most punctual airline amongst all major airlines in China now. That is very critical for an airline which is flying very core routes, which are out of primary airports, serving not just price-conscious leisure travelers, but also business traffic as well. The other thing about internals is you look at that— Cask that we have in a very LCC unfriendly market. We have a good cask, but the competition is getting better. Yeah, we see the full-service carriers doing very, very well. So we have to be on our game. An LCC has to be adaptive to the market, look at the growth potential, see where that is. Clearly density would be a great thing. Is it reasonable to expect? Not right now, but slowly if the slots. Thank you.

Steve Saxon:I think we've heard from many of the panelists that airports is a big constraint. I think we have a panel question on this, so if we could just call up the question while I— yeah. So we've heard, I think Dr. Liu talked about airports are designed for full-service carriers, not low-cost carriers. Slots are hard to come by in the leading airports. So I wonder if you could talk about the challenges of getting into the airports.

Kathleen Tan:Yeah.

Steve Saxon:On-time performance is caused by some of the congestion issues. I'd like to ask the panelists, where do they see most of their growth coming from in the future in China? Is it going to be coming from all the airports, or are low-cost carriers going to be forced into secondary airports? Mr. Qiu from 9AIR, you're obviously in a major airport as your hub. What's What's your view about the ability to continue to grow in a primary airport?

Jiawen Fu:In building a new airport, especially with regard to local airports, it's not just building an airport. It has to be a— we have to consider it's going to be an airport for FSC or LCC, but this is not decided from the beginning. We focus on the access. With regard to large airports, The national government has designated 8 major airports, and with regard to these airports, in order to increase the flight number, there are some airports who are considering LCC-designated or dedicated terminal. In case of Beijing, a new terminal is being built. However, in terms of construction, in the process of construction— This airport is for LCC. Xinchao is for FSC, sorry. And another airport is for LCC, is for cargo only. So that kind of allocation is being made. And also, the LCC in the primary airport is to be separated in the future, and there may be some impact because of this movement.

Steve Saxon:Thank you. Mr. Fu, from the Lucky Air point of view, you're mostly focused on airports outside the primary airports today. Do you see that changing? And does some of the new airports being constructed, including Beijing Daxing, does that change how you view the opportunity?

Jiawen Fu:Yes, Kunming is our major hub. Kunming is our major hub, and also in the 4th and the 5th largest hub airport is also located in Chengdu. So, Their focus is on the international market. And with regard to tourists heading towards overseas, we need better hub airports. So the hub airports will become the key to support these overseas tourists, or tourists heading towards overseas.

Kathleen Tan:Thank you.

Jiawen Fu:And, uh, Peking— Beijing and Guangzhou and other— and Shanghai, these large cities have many international flights. And on the other hand, the other cities are focusing on the LCCs for short-hauls and mid-hauls. So as Professor Qiu said, With regard to Junzhou in China, they are— this is for— this is a good location for LCC. And also in the future development, the market is looking for LCC, that's for sure.

Steve Saxon:Jonathan, are you going to open a new base at Beijing Daxing?

Jonathan Hutt:Well, you know, we're very blessed to have our major base in Shanghai, but it's also a curse. So the same would be true of Beijing. You're competing against some very, very strong carriers with huge fleets and a very strong market. We're very keen to, to place our aircraft in cities which we see are very strategically important to our long-term future growth. And last year and this year you've seen a lot of focus on cities like Yangzhou and Ningbo, which give us connectivity in the Yangtze River region, but also help us connect North China to East China and also into Southeast Asia. Our bases will expand domestically and internationally. We hope to grow our international presence at Kansai and also Nagoya. That's very, very important for us. We feel that that market is very critical to our long-term growth. We feel that it will make us a very strong player in the region. Domestically, as these new airports and these new markets mature, there are so many openings which are best served by an LCC, and we feel that we can identify New networks which will help us get better utilisation of our aircraft, will allow us to have much more synergy in our network and to provide connectivity as we get to a stage where we have a scale which is— really gives a little added complexity to what we're doing. And that added complexity will mean we'll need to focus more on our unit cost. to make sure that we stay very true to that LCC DNA that we have. So growth is many, many places in China, whether that's Daxing, or whether that's Yangzhou, or whether that's Kunshan. We're ready for it.

Steve Saxon:Okay, thank you. LCCs, the model is typically mostly short-haul, and within China it's been heavily focused on domestic and regional. However, if we look globally, there's a clear trend of more and more long-haul LCCs. Being launched. And I want to start first with sort of the long-haul opportunity into China. AirAsia X is amongst the first and has a substantial presence already. Kathleen, how do you view the opportunity for long-haul LCC growth into China?

Kathleen Tan:I think there's a lot of potential because LCC in Southeast Asia started with— we started with 320, there's a limitation of we can only fly within the radius of 4 hours. And the people who fly AirAsia, they love the low fare. I mean, what LCC has done is open up new markets. So these are the customers that, you know, in the past keep writing to us to say, we want to fly, please don't discriminate us. And that's how LCC AirAsia X was formed for that purpose, to serve the same market who wants low fare. And China is so huge, I mean, it's got like 30 over provinces. So we started flying, our first route was to Hangzhou, so that was about 5 hours. I just feel like in China, well, it's predicted that there's another 200 million who wants to still travel outbound. Many want to travel. You're talking about the internet generation, Those born in the '80s, '90s, 2000s. A lot of our core customers are young, right?

Shaoxuan Liu:Mm-hmm.

Kathleen Tan:They are the internet generation. So there's a huge appetite who wants to travel. So I believe long-haul, well, AirAsia X, we've flown to 6 cities. Hopefully we will fly to one more city coming up soon. And that's the key where we can feed traffic off each other. So China is so huge, 1.4 million, and is already a global economic power. So I just think that long haul has a market, but you still need to be very disciplined. The capacity is a volume game.

Steve Saxon:Thank you. Mr. Fu, you've just acquired A330s and are going long haul with a business class. Is that part of a new strategy for you, and is that still LCC?

Jiawen Fu:Yes, the local government's impact does exist. And from Kunming to Moscow, it's 9 hours. There was a great demand from the local government for Kunming to Moscow flight. And with regard to— We started off with the primary airport. With regard to this route, and we were able to do the majority of the handling. And in 2016, we started off with LCC business, but prior to that, when we look at the aviation industry in China, the scale is expanding, and also with regard to the private sector, If it's a national company, there's support from the central government to buy aircraft. But in our case, the aircraft that we can introduce is limited— A139 or a Boeing 700 or 800 series or a 330. These are the major aircraft that we use, and it is limited compared to the national Airlines. And in the aviation industry, there are various aircraft that are being used in a mixed manner. But in our case, we are concentrated— concentrating on certain kinds of aircraft in order to make it more efficient. And also, we are expanding for international airlines starting from last year using various transits, and unit cost is something that we want to focus in the future.

Steve Saxon:Thank you. Mr. Qiu and also Jonathan, do you see an opportunity in long-haul? Is 9AIR or Spring going to place a 787 order?

Jianming Qiu:Yes, in our case, next year, it will be next year that 737 MAX will be introduced compared to the existing 800 that could fly longer. In Japan, there are some routes beyond 5 hours from Guangzhou to Urumqi. There is a flight over 5 hours, but the key question is, what do you target? Depending upon that target setting, you have to— you have to divide. Should it be a long haul or mid-haul? Who would be the target customers or target layers? So depending upon which customer group you want, then we would like to consider the routes.

Jonathan Hutt:Anything that hints that we're going to go long haul, I'll have Boeing on the phone, I'll have Airbus on the phone, And I have every aviation leasing company on the planet calling our CFO saying, when are we going to make the order?

Steve Saxon:So is that a no?

Jonathan Hutt:We've always had our focus to become the stronger and largest and most efficient LCC in the North Asia region. We believe that's core to our long-term sustainability, but also it is a feeder network which we can provide to airlines that would fly long-haul, whether that's for the full service or a low-cost product. When we get that right, then we would think about it. But right now, we're in a stage of acquiring the scale we need.

Steve Saxon:Thank you. Dr. Liu, on both the long-haul and also the convergence of the models and the ancillary revenue, what's your perspective?

Shaoxuan Liu:Actually, I have a quick comment on this. I think for LCCs, It's tempting to get into the long-haul business, but it has to be very careful because if we look at the history, look at the LCC's development history in the US, we have People Express and American West, right? They were started as a low-cost carrier and soon after their development, Yeah. They entered into the long-haul business, but it turned out it's not very successful. So I think it's tempting to get into the long-haul business because we know when the airline company's making money is when the aircraft is on the air, right? The long-haul usually will lower your cost, but I think the LCC differentiated from the full-service carrier in the low cost, fast turnaround, and convenience. If they are getting into the long-haul business and to compete directly with the full-service carrier, it will be challenging and it will be difficult. So I agree with Jonathan that it has to be a very careful decision to make whether the LCCs want to compete in this area with the full-service carrier.

Steve Saxon:Thank you. Our time is up, so please join me in thanking the panelists for a great discussion.

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