The world's top cargo players are rushing to cement joint ventures in China. But is the market big enough for all their ambitions?
The Chinese government has a history of making quiet shifts in policy that have dramatic effects. One came in mid-2003 when it loosened the restriction on joint ventures between Chinese carriers and foreign investors.
Slowly at first, but now gathering pace, this has led to a gold rush of foreign cargo carriers seeking joint venture partners, often with newer independent Chinese airlines. Meanwhile, the big three carriers in China seem to be finally realising they need foreign help to win their share of the country's booming cargo market, and are seeking joint venture partners of their own.
China is the engine of cargo growth for many of the world airlines, and most expect it to continue to be. Looking at the top 50 cargo airports in 2005, nearly all of those with double-digit rises in volumes were Chinese hubs - or, like South Korean capital Seoul, airports which draw lots of traffic from China. Official figures say cargo throughput at China's airports grew 13.8% in 2005, and some reports say international cargo is growing even faster, at over 20%.
That makes it a market none of the world's major cargo carriers can ignore, and it is revealing that the top seven non-express cargo carriers in the world - Air France-KLM, Cathay Pacific, China Airlines, EVA Air, Korean Air, Lufthansa and Singapore Airlines - now either have joint venture cargo airlines in China or are having talks about them. The two express operators in the top 10 - FedEx and UPS - are also setting up hubs there.
Meanwhile, Chinese carriers are keen to redress the balance that has seen much of the country's cargo growth go to foreign players. Liu Xiaoxiao, vice-president cargo at China Southern, in a recent presentation, claimed that foreign carriers account for 76.2% of China's international air cargo market, and that as much as two-thirds of cargo from China flies via Hong Kong, Seoul or Tokyo.
Why the big three Chinese carriers have not taken more advantage of growth there is a mystery. China Southern made an impressive start at the turn of the millennium when it bought two Boeing 747-400 freighters, while China Eastern operates a fleet of six MD-11Fs, and has two 747-400ERFs (extended range freighters) on order. Air China has slowly built up its fleet to four -200Fs and four -400Fs.
But compare that with China Airlines of Taiwan, which now has 18 747-400Fs or Korean Air which has 17 -400s and -400ERFs along with two -200Fs. Or compare it with Jade Cargo International, newly launched cargo joint venture between Shenzhen Airlines (51%) and Lufthansa (25%), which got its first -400ERF in August and will take delivery of a further five over the next 18 months.
Some say the failure of the big three to grow their cargo fleets is due to a focus on passenger growth. Certainly, as China Southern says, it is in the middle of a rapid expansion of its passenger fleet.
But another concern has undoubtedly been how to generate return cargo, given the notorious imbalance of China's cargo market towards exports. Outbound, rates can be as much as $3.50 a kilo, and - until very recently at least - there has been no trouble filling freighters. On return legs from the US and Europe, rates are as low as 50¢ a kilo and carriers are happy to get load factors of 30-40%.
Sales networks
In this return market, it is foreign carriers who have the advantage, with their embedded sales networks. Joint ventures can provide some answer, offering Chinese carriers access to a partner's sales networks and market experience. "It would be hard for a Chinese airline to find someone, for example, who spoke Portuguese to open an office in Portugal," China Southern points out. "So China Southern is definitely looking at what resources a partner can offer."
China Southern is in fact considering setting up a joint venture cargo airline with Air France-KLM, having earlier made some overtures to Korean Air. Both carriers are natural partners for it: Korean being a fellow SkyTeam member and having failed in July after a year's talks to set up a joint venture partnership with Okay Airlines and KLM already being a partner on freighter flights between Amsterdam, Shanghai and Shenzhen.
The rumours of talks between Air France-KLM and China Southern about a cargo joint venture were finally confirmed in mid-September by Air France-KLM chairman Jean-Cyril Spinetta. The carrier says this could be based in Shanghai, and include the injection of capital and management expertise.
Around the same time, Korean Air announced it had picked former Chinese state forwarder Sinotrans as its partner in a joint venture airline to be set up in Tianjin in mid-2007. The carrier will initially operate with one 747-400 freighter leased from Korean, and two Airbus A300-600s for regional feeds. Eventually, says Korean Air Cargo president Ken Choi, it will have five to six 747-400Fs and fly to both Europe and the USA.
Jade Cargo, which launched in August with flights to Amsterdam and Seoul, also plans to fly to North America, but has been unable to get traffic rights as yet - something that will be a problem for other would-be start ups. But Yangtze River Express, a domestic Boeing 737 freighter operator established in 2002 as a subsidiary of Hainan Airlines, has had no such problems.
It started 747F freighter services to Los Angeles in June, using a leased aircraft, and has applied for rights to New York and Boston. Since January, it has been 25% owned by China Airlines, and 24% by other Taiwanese investors. Previously China Airlines had tried to buy a stake in China Cargo Airlines.
Shanghai Airlines, already a regional freighter operator with two 757s, also launched services to Los Angeles in early July with a wet-leased 747-200F, and has plans to operate 10 747Fs by 2010. Its joint venture partner is EVA Air, which in July gained approval from the Taiwanese authorities to buy a 25% stake in a new joint venture airline, Shanghai Airlines Cargo International, 55% of which is owned by Shanghai Airlines, and the rest by Taiwanese shipping corporation Evergreen.
Fleet expansion
There is also Cathay Pacific, which is merging with Dragonair (itself a not insignificant 747 freighter operator out of Hong Kong) and expanding its own fleet with six 747-400ERFs. Its director and general manager cargo, Ron Mathison, admits the carrier is in discussions with Air China about a joint venture airline to be based in Shanghai, but will give no further details.
This would only leave China Eastern, and its China Cargo subsidiary, unattached, and there are rumours that it is planning to join the Cathay/Air China joint venture. But an intriguing alternative is that it might tie up with Singapore Airlines.
The latter suffered a heavy blow in August when Great Wall Airlines, its joint venture cargo airline with Chinese aerospace company Great Wall Industry Corporation, was grounded after just a few weeks of operation when the Great Wall parent company was embargoed by the US authorities for allegedly supplying missile components to Iran.
Although during its brief weeks of operation, Great Wall stressed its independence, its joint venture parent Singapore Airlines was closely involved in the carrier. Two of Singapore's 747-400Fs were on lease to the venture and the carrier had provided the heads of each of Great Wall's departments. Officially, Great Wall is confident of restarting flights, but analysts are not so confident. The carrier has, at the very least, failed to restart in time for the 2006 peak season, and will have trouble getting further aircraft in what is a very competitive leasing market.
Although none says so openly, other players in the market must be feeling a certain amount of relief at Great Wall's grounding, as it removes six freighter flights a week from Shanghai, which despite its explosive growth (13.7% at Pudong last year, 56% since 2002) has been showing signs of overcapacity.
China Eastern, which is based at the airport, saw cargo yields fall 6.3% in the first half of 2006, for example, while Air Canada recently became one of the few carriers to scale back its freighter operations from Shanghai, citing falling rates. "Shanghai was a goldmine three or four years ago, but today it is very competitive," says vice-president cargo Claude Morin. "I think its golden days are over."
Stan Wraight, vice-president scheduled operations for Russian carrier Volga-Dnepr, and in overall charge of its AirBridge Cargo 747F operation, sees worse to come: "It is the same as happened in the Japanese market when Osaka's Kansai airport opened and there was a rush of new capacity," he says. "Rates went down the tubes, and with all the additional capacity coming into Shanghai later this year, I think the same will happen."
Joint venture bloodbath
That raises the question of whether now is the right time for so many new cargo joint ventures to be launching themselves on to the Chinese market. David Hoppin, principal of Washington-based consultants MergeGlobal, thinks not. "I think there will be a bloodbath. There is too much capacity, especially on the transpacific," he says. "The herd has decided they all need to go to China and quite a few of them are going to be trampled."
There is a whole host of other wannabe start-ups including Donghai Airline and Uni-Top in Shenzhen Datang Qili Airlines in Tianjin Pan Asia Airways in Ningbo Rainbow Cargo Airlines in Guangzhou and Shaanxi Delong United Airlines in Xian. The latter actually did do one DC-10 freighter flight to Nuremberg in Germany early in 2005, before sinking into obscurity again, but is now apparently hoping to relaunch.
At Korean, Choi is more optimistic about the market potential, however. He dismisses official predictions of 10-15% growth as too cautious, and says Korean's own studies suggest 20-30% growth in the next few years.
The as yet unnamed Korean-Sinotrans joint venture will at least have two factors in its favour. It will be based in Tianjin in the north, and thus will not be competing directly with the other joint ventures in Shanghai. And Korean has also chosen a partner with a strong ground network throughout China.
The venture will also be focusing on regional as well as long-haul routes, using its A300-600s to feed cargo into Tianjin from other parts of China and South-East Asia, before flying it on to Europe or North America. That will give it more versatility than some others.
Another of the new joint ventures taking a hubbing approach is Jade Cargo. Its choice of 747 ERFs may be aimed at efficient operation on long-haul routes to Europe and China, but its vice-president commercial and corporate affairs Tobias Lubecki says transiting on to regional routes are also key.
"This is the new concept we are bringing to the market - hubbing in China. At the moment this is done in Hong Kong, but not in China," he says. "It will help us fill the flights on the way back to China and thus make them more profitable."
As an example, when Jade's second 747 ERF comes in November, it will add Brescia in Italy, Barcelona in Spain and Osaka in Japan to its route network. The hope is not just that by providing direct service to two unusual European stops the carrier will be able to win cargo from other European operators providing indirect service, but that the intra-Asian connections will help it win return cargo.
In this, Jade has the advantage that its handler in Shenzhen is a 50/50 joint venture between the airport and Lufthansa Cargo, guaranteeing it the highly efficient cargo ground processing needed for a successful hub operation.
That said, the 747-400ERF is a rather curious aircraft to use on intra-Asian routes. Lubecki insists it can be viable, but admits the airline originally planned to use A300-600s for regional routes, but was banned from wet-leasing them by the Chinese authorities. "It was always our intention to operate intercontinentally, but it would have been nice to have the intra-Asian network in place first," he says.
Shanghai Airlines and Yangtze River Express, meanwhile, will be looking to their joint venture partners to help them with return cargo to China. Mark Lin, general manager cargo planning for China Airlines says it already acts as a general sales agent for the return leg of the Chinese carrier's flights to the USA, and expects to do the same for any flights Yangtze launches to Europe.
EVA Air also recently started selling space on Shanghai Airlines flights to the USA, and while EVA executive vice-president KW Nieh stresses the joint venture will have its own sales force, he says EVA will provide assistance such as acting as a sales agent, or space sharing on its freighters.
Such arrangements might bring up conflicts of interest, however, as the case of Jade illustrates. It opted to appoint not Lufthansa, but the cargo arm of Swiss as its sales agent to represent it in most of Europe. Given Swiss's focus on premium belly cargo, this was a curious choice. "We chose Swiss because we believed they were the right partner for us in this market," Lubecki says. "We do also co-operate with Lufthansa on some things, but there is no rule we should do that."
The example of Jade also raises the question of whether joint ventures will be good for the foreign airlines that back them. Lufthansa sees Jade as a way to share in Chinese cargo growth, but it is also a way for Shenzhen to learn from an experienced partner with which it might strongly compete in the future.
It has already been pointed out that indirect cargo from Italy or Spain to China, Korea and Japan is one target for Jade, and Lubecki also sees another in cargo currently trucked to Hong Kong. In both cases, Jade is to some extent directly competing with Lufthansa. Before its grounding, Great Wall also said a major opportunity was competing with all the indirect carriers to China - that is, Asian freighter operators like China Airlines, EVA Air, Korean or even Singapore Airlines who transit cargo to China via their main hubs.
Korean's Choi concedes the new Tianjin-based joint venture with Sinotrans could attract some traffic that currently flies from China to the rest of the world via Seoul. "Sure the customer will like direct service better than indirect, and this will compete with Korean Air's own strategy," he says. "But we have to do this to ensure that we get our share of the direct market."
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Source: Airline Business
