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Cathay explains why it will not follow other Asian carriers in launching an LCC subsidiary or brand

Cathay Pacific Airways remains unconvinced there is value in establishing low-cost carrier subsidiaries or brands even as most of its peers start to follow pioneer Qantas in launching LCCs.

Singapore Airlines’ decision to expand into the long-haul budget sector with Scoot has other full-service carriers throughout Asia and beyond wondering if they should follow the emerging long-haul LCC trend. But while Cathay CEO John Slosar calls Scoot “a very interesting development” he believes SIA may find that it has its hands full as it already owns regional carrier SilkAir and has just increased its stake in short-haul LCC Tiger Airways. “To have that many [brands] will be an issue,” Mr Slosar predicts.

Speaking during the CEO panel discussion at last week’s Association of Asia Pacific Airlines (AAPA) assembly of presidents in Seoul, Mr Slosar pointed out that bringing a new brand to market is a “huge expense”. He expects managing a “huge number of brands” will “turn out to be a challenge” for SIA.

Mr Slosar believes different segments of the market can be more efficiently managed through one main brand. Cathay has a second full-service brand with regional subsidiary Dragonair, which it acquired in 2006, and thinks it can position its product to meet the needs of price-conscious travelers without having to establish a separate brand specifically for the budget sector.

Mr Slosar sees all FSCs catering to both ends of the market regardless if the FSC has an LCC subsidiary or brand. Cathay attracts some passengers by offering a high award-winning level of service while other passengers are attracted to Cathay by low fares. “We think the focus has to be on what’s happening in the market, not establishing a bunch of companies,” Mr Slosar says.

CAPA initially reported in Jun-2011 that Cathay was not interested in following SIA in establishing a long-haul low-cost carrier. Since then the trend of Asian FSCs establishing LCCs has continued with the All Nippon Airways-AirAsia and Japan Airlines-Jetstar tie-ups, which will result in the launch next year of new joint venture LCCs in Japan. Thai Airways also has increased its stake in domestic LCC Nok Air and unveiled plans to launch regional low-cost hybrid carrier Thai Smile as part of a new multi-brand strategy. Malaysia Airlines, meanwhile, forged an alliance with former rival AirAsia.

Asian LCC subsidiary trend could prove to be a passing fad

Mr Slosar says the recent wave of Asian FSCs launching LCCs could prove to be just a passing fad, pointing out how there previously was a wave of LCCs established by FSCs in North America and Europe which all ended up failing. “It could be we go through the same cycle or maybe Asia develops differently,” he says.

The dynamics in Asia are different than North America or Europe given Asia is a growth market and does not have the same union issues that have made establishing LCCs elsewhere a challenge. But even if LCC subsidiaries and brands under FSCs prove to be a lasting characteristic in Asia, Cathay is unlikely to participate.

As CAPA pointed out in June, the long-term strategies of Cathay and SIA have started to diverge because Cathay has been able to continue growing over the last several years while SIA’s traffic has stagnated. Hong Kong has seen continued growth at the top end of the market and has a relatively low LCC penetration rate compared to Singapore and other Asian hubs. This trend is expected to continue as Hong Kong, located at the doorstep of the booming market in mainland China, is well positioned for long-term premium growth. Congestion at Hong Kong International Airport also makes it difficult for LCCs to expand.

The rationale for Cathay not launching an LCC subsidiary, as we wrote in early June, is that:

for Cathay, the need to change is simply not as pressing. While SIA has been struggling to grow its business under its traditional premium-focused model, Cathay has been quickly able to resume growing its premium business after a temporary setback during the global downturn. If SIA wants to again overtake Cathay as a larger airline group (in terms of total passengers, the SIA-SilkAir combination were bigger in the early portions of last decade than the pre-merger combination of Cathay and Dragonair) it has to diversify and take the risk of assuming a new business model.

   Retaining its focus on the premium end of the market allows Cathay to continue spending all of its capital expenditure on its original business model. Cathay is now investing significantly in new business-class cabins and upgrading its lounges at its Hong Kong hub.

See related article: Business models diverge at long-time archrivals Cathay and Singapore Airlines  

Cathay focusing on premium economy rather than separate budget brand

Cathay has since unveiled plans to introduce a premium economy cabin. The investment in premium economy further illustrates Cathay’s focus on the top end of the market and desire to offer different products to different types of customers using the same core brand.

Premium economy also represents a further step in the divergence of models between Cathay and SIA. There is currently no premium economy cabin in any SIA aircraft (SIA briefly experimented with premium economy on its Los Angeles and New York non-stops several years ago before going with an all-business configuration on its A340-500 fleet). Cathay’s decision to go with premium economy was largely a response to repeated requests from its customers and the fact an increasing number of competitors are now offering premium economy including Air New Zealand, All Nippon Airways, British Airways, Japan Airlines, Qantas and Virgin Atlantic.

Cathay’s first aircraft will be re-configured with premium economy in late 1Q2012 although it will not start selling the cabin until 2Q2012. Up to 20 aircraft are expected to be reconfigured by the end of 2012 and the entire long-haul fleet will be retrofitted by 2013.

Premium economy will be offered on flights to Australia, Europe, Middle East and North America. Cathay’s new business class will be offered on the same flights by the end of next year. The new business class product debuted early this year and for much of the long-haul fleet the retrofit for business and premium economy is being completed simultaneously. 

Mr Slosar points out that several times in the past Cathay studied the premium economy market but decided against offering the product. This shows Cathay is willing to adjust its strategy and perhaps could eventually be swayed to launch an LCC.  “Rule number one is don’t fight customers,” he says. “If they do see value you have to see how to deliver that to them. That’s what changed our mind.”

But adding premium economy is a much less riskier proposition than launching an entirely new LCC. Adding premium economy also didn’t require a major strategic shift for Cathay given its traditional focus on the top end of the market.

Premium economy will allow Cathay to split its economy cabin and focus on selling the remaining regular economy seats to budget-conscious passengers. While Cathay will continue to offer a full service in its regular economy cabin, it is not afraid to competitively price the seats at the back. This is necessary not only to compete with long-haul LCCs but even more importantly with Middle Eastern carriers, which offer low ticket prices and a large amount of capacity between Asia and Europe - a core Cathay market. “Competition is competition. We have to be prepared to meet competition in whatever form they might be,” Mr Slosar says.

Cathay doesn't need an LCC to play in budget conscious Asia-Europe market

Competition is expected to be fierce in the Asia-Europe market as carriers of all types pursue budget conscious leisure travelers. Cathay and other carriers expect rapid growth in the Europe-Asia market despite the current weak market conditions in Europe, pointing out that more and more Asians are looking to travel to Europe for holidays as income levels in the region have grown.

Asia's long-haul LCCs aim to carry these types of passengers but Cathay also believes it is well positioned to meet demand from this price-conscious sector without having to establish a long-haul LCC. “It’s an important space for Cathay,” Mr Slosar says. “We will make sure at Cathay that we can compete in that space.”

Cathay has emerged as a bold holdout in Asia, confident it can position its product for all types of passengers without having to use multiple brands. While Asian flag carrier strategies are clearly diverging, there may not be clear winners and losers.

Establishing separate brands for the budget sector may not be needed in all cases to participate in growth in the low end of the market, particularly across long-haul sectors. But having an LCC subsidiary or joint venture can be a tempting proposition for Asian FSCs purely as a marketing gimmick and investor relations strategy because new LCC brands typically generate a huge amount of interest among media, the travelling public and investors. Cathay is holding firm and refuses to be tempted, convinced the benefits of a separate LCC brand are limited and would not outweigh the additional costs and potential cannibalisation effect. At the very least Cathay deserves to be complimented for sticking to its principles.