What gets bigger must get smaller. An unlikely paradox? Not for the Civil Aviation Administration of China. In its eyes, domestic traffic growth makes only one conclusion possible - the number of airlines must fall.
Most airline CEOs would be positively drooling. A population of 1.224 billion is set to benefit from targeted annual GNP growth of 6 per cent and the increased leisure time of a newly instituted five-day working week will bring more air travel.
As part of its ninth five-year plan, the CAAC expects China's annual commercial airline traffic to grow by some 14 to 15 per cent. This translates into 14 billion revenue tonne km and 100 million passengers a year by the year 2000.
To cope with the traffic boom, the Chinese airline industry is expected to consolidate rapidly during the next few years, arresting the proliferation of new carriers.
In September the grouping of six provincial airlines, led by Hainan Airlines, to form China's first cooperative alliance - named the New Star Air Alliance - marked the beginning of the consolidation trend that is set to dominate Chinese commercial aviation throughout the next decade. 'We're witnessing the tip of the iceberg for structural changes,' says Duan Heming, deputy chief engineer of CAAC's air traffic management bureau.
The CAAC has taken a number of measures to stem years of explosive growth and poor safety performance and to encourage more stable growth. As well as urging China's dominant players to acquire their more feeble counterparts, it has introduced uniform regulations dictating air fares, fuel prices and take-off and landing charges. It is also limiting new aircraft purchases and refusing all new licence applications.
Domestic and foreign fares were merged into one uniform rate as of 1 July, 1997. Previously foreigners travelling on domestic routes were charged 20 per cent more than Chinese nationals. The decision to drop the surcharges for foreign travellers was prompted by Beijing's desire to join the World Trade Organisation and is meant to indicate an open market. While the unified fares may stunt passenger growth, they will also give domestic yields an immediate boost.
Without the ability to lure passengers with fare cuts, the CAAC believes airlines will have to compete on safety and efficiency. Still, one Chinese source sees safety concerns as a convenient excuse for rationalisation, and views the poor financial health of the industry as the real driving force behind the CAAC measures. 'The consolidation is really happening because many airlines are inefficient and cost the CAAC too much money.'
Of China's 27 CAAC-approved airlines, only six are financially viable. The six, namely Air China, China Southern Airlines, China Eastern Airlines, China Northern, China Southwest and China Northwest, collectively accounted for 82 per cent of RTKs in 1996, says Chin Y Lim of investment bank Morgan Stanley in Singapore.
Fostering big conglomerates is essential to China's aviation reforms. As soon as they witness evidence that the New Star Air Alliance is a success, these six dominant players will try and grab the remaining booty, says Chin.
Four potential merger partners with western-type aircraft remain. They are China Xinjiang Airlines, Xinhua Airlines, Air Great Wall and Shanghai Airlines. While China Northern, China Northwest and China Southwest 'may well merge with other groups, the main three airlines - Air China, China Eastern and China Southern - will definitely group with the smaller players. There's no getting around that,' says a Chinese source. Indeed, China Eastern expects to complete the first takeover - of China General Aviation - in 1998.
As the CAAC firms and tones its sagging industry, it's obvious that Chinese carriers need to toughen up to survive. 'Smaller carriers will be more or less forced to join up or get out,' says Helge Stavonhagen, chief representative for Lufthansa in Beijing. 'If a local airline doesn't do well on a certain route, then the CAAC will give that route to another airline,' adds Paul Fisher, British Airways' business development manager in Beijing.
The CAAC hopes the greater size of its top three carriers will raise their stature as international competitors. 'The CAAC wants to push one of its top three carriers into the top 40 airlines in the next two years,' says BA's corporate development executive, Wei Meng.
In this respect the airlines' major downfall is image, or rather the lack of it, due to non-existent marketing prowess. The absence of image is causing them to lose vital international passengers to foreign rivals.
As carriers like Lufthansa, BA, Alitalia and SAS move stealthily into Chinese territory, Chinese carriers are in danger of losing market share to foreign carriers, as a result of the Chinese pervading mentality that foreign equals best. Chinese nationals, as well as foreigners, prefer to fly on foreign airlines.
Lufthansa's Stavonhagen sees Chinese airlines as unreasonably modest about their achievements and encourages them to promote themselves. In contrast to common western perception, he says service and safety standards for major Chinese airlines have improved 'phenomenally' over the past few years. 'Previously passengers were just people stewardesses had to give a meal to; now cabin crew realise that they need to keep the business,' says Stavonhagen.
As part of the drive towards better service, all cabin crew on CAAC airlines will have to be proficient in English by the end of 1998.
Chinese airlines are also turning towards western consultants to update their software and yield management systems and develop infrastructure.
While Chinese airlines may be merrily adopting western techniques, their major challenge may yet be to make the management transition from a state enterprise to a profitable commercial concern.
Chinese airlines are taking to the markets in line with the Chinese government's decision to open up its better performing state-owned enterprises to private investment. China Eastern and China Southern made their debuts on the Hong Kong and New York stock exchanges in February and July respectively, and are now gearing up for domestic offerings.
The listings reduced the CAAC's ownership of China Eastern and China Southern to 65 per cent and 68 per cent respectively, and kept foreign ownership just under the 35 per cent limit allowed under Chinese law.
Now Air China is also preparing to take the initial public offering route. The CAAC's jewel in the crown is restructuring into a joint-stock company with a view to overseas and domestic listings by 1999.
Capitalising on the stock market is undoubtedly a necessary move to fuel the airlines' development and move them further into the tough realms of international competition. The airlines' listings reflect China's 'open door' policy to transform China's central planning economy into a market-oriented one.
While the CAAC is reducing its ownership interest to let capital in and encourage airlines to be self-funding, it is not yet prepared to relinquish control. The authority says it will maintain management control by continuing to elect the directors for Air China, China Eastern and China Southern, and adds that listed airlines will not be treated any differently to unlisted carriers.
The CAAC will have to be careful, however, that its reluctance to cede control does not hinder the airlines' ability to make a full transition from doddering state organisations to profitable, commercial enterprises. For this they will need freedom to make their own decisions without being used as political instruments, manipulated by the government to suit its political goals.
A potential conflict of interest already lies in the CAAC's function of regulatory authority to the airline industry, taken on when the Chinese airline industry decentralised in 1985. As a ministry of the central government, the CAAC is both policymaker and airline owner. The CAAC's commercial arm, CNAC, also owns sizeable stakes in Hong Kong-based Dragonair, and in Air Macau. In late October the crash in regional stock markets forced CNAC to postpone its 30 per cent IPO, which had been due to start trading in Hong Kong in early November.
Lufthansa's Stavonhagen predicts that the CAAC will gradually loosen its grip on the airlines' management, adding up to 'a very soft internal deregulation'. 'The CAAC will distance itself and give more leeway for airlines on major routes,' he says. The industry is not yet strong enough, however, for an external open skies policy, he adds.
While there's no denying the enormous potential of China's domestic growth, the question remains whether China has the necessary infrastructure to support it.
Although China has 129 airports, only 14 can handle widebody aircraft. New airports are under construction at major Chinese gateways, such as Shanghai and Guangzhou, while those in Beijing and Shenzhen are being expanded, but other bottlenecks such as weak transport links to the airports and poor computer reservation systems could hold growth back, says Chin.
While China's airports are being expanded, the airlines are bedecking themselves with western aircraft. The majors' shift from the use of old-fashioned Russian and Chinese aircraft to new international fleets of Boeing and Airbus aircraft, will boost efficiency and lead to lower unit costs.
Chinese airlines are in dire need of marketing knowhow, greater efficiency, freer access to capital, alliances, consolidation and freedom from state interference. Yet the industry is changing rapidly. As rationalisation and privatisation continue, Chinese carriers should benefit from China's developing powerhouse economy, as they move forwards to join the airline industry's most influential players.
Source: Airline Business
