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The Big Story

Asia's airline wars: The great profit squeeze in the sky

Competition from budget upstarts and Chinese carriers is hitting flag carriers

MAYUKO TANI, CK TAN and NIKKI SUN, Nikkei staff writers | China

SINGAPORE/HONG KONG -- On Jan. 3, Singapore Airlines shocked its customers with a plan to charge up to 50 Singapore dollars ($37) just to use a credit card to book its cheapest seats. The reaction was swift and furious. "Disgraceful money grab," wrote one of the many angry customers who took to the internet to vent.

Singapore Airlines retreated the next day. "Following a further review, Singapore Airlines will not be proceeding with the implementation" of the credit card service fee, it said in a three-line statement.

The unhappy New Year episode was a rare embarrassment for Singapore Airlines, known around the world for its best-in-class customer service and luxury image. But it also reflected the tough reality that national flag carriers all across Asia are facing.

Even as rising prosperity across Asia has led to a huge increase in air travel, its most renowned airlines -- including Singapore Airlines and Cathay Pacific Airways -- have faced turbulence.

They have been hammered by budget carriers such as AirAsia at the low end of the market, while Persian Gulf airlines like Emirates Airline and Qatar Airways have eaten into their business for premium long-haul flights. At the same time, Chinese airlines are becoming more competitive on both ends of the spectrum. And while this intense competition is great for Asia's air travelers, it is leading to lower ticket prices and massive over-investment that signals more pain in the future.

"Competition has become more and more intense and you have a lot of aggressive competitors these days," said Brendan Sobie, chief analyst at Sydney-based aviation think tank CAPA.

To fight back, the airlines are in the midst of serious restructuring efforts, searching for new ways to make money and frantically cutting costs.

Singapore Airlines's botched credit card fee was just one idea it has pulled from the well-worn playbooks of the budget carriers. After posting its first quarterly net loss in five years in March 2017, Singapore Airlines and its chief executive, Goh Choon Phong, embarked on a three-year "transformation program." The ideas range from cutting out bureaucracy and introducing a new revenue management system to charging some customers $5 to select a seat in advance, a policy it introduced in December.

Sixteen years after AirAsia brought the budget airline model to the region, flag carriers like Singapore Airlines are finally beginning to adopt some of its practices, as their European and American counterparts have already done. "What Singapore Airlines is starting to do is not new to the industry," Sobie said. "They are following the trend."

Travelers pass through Hong Kong International Airport. Competition to tap surging demand is prompting Asian flag carriers to take cues from budget airlines. (Photo by Shinya Sawai)

Cathay Pacific, which embarked on a restructuring after an annual loss in 2016, is also planning to squeeze its economy class customers. Its new Boeing 777-300 cabin will jam 10 smaller seats into a row from the current nine. More vulnerable is Malaysia Airlines, which for a decade has been fighting a price war with pioneering budget airline AirAsia. The national flag carrier was taken private by the government after two devastating plane accidents in 2014, and it has embarked on a five-year restructuring. But the plan appears troubled after its CEO abruptly announced his resignation in October just a year after taking the job. He was the second CEO hired to implement the reform effort.

The common thread for these Asian flag carriers is declining ticket prices. Passenger yield -- the revenue an airline receives for flying one passenger a kilometer -- fell for airlines in the Asia-Pacific region for three years in a row from 2014 to 2016, according to the International Air Transport Association, or IATA.

Remarkably, this has been happening in the region where passenger demand growth is the fastest in the world. Fueled by rising tourism and business travel, passenger traffic growth for Asia-Pacific airlines is estimated to have increased 10% in 2017, the third straight year of double-digit growth, IATA says.

And while the pace of decline has slowed in recent months, the yield remains low. Singapore Airlines managed to swing back from its first-quarter loss, helped by rising passenger carriage at its low-cost player Scoot, but ticket prices remained a major headache. "Going forward, we are still seeing the demand [increase], but we are also seeing more capacity being added," Goh said in November.

Sensing years of rising passenger growth ahead, Asia's airlines are investing heavily in new airplanes. Boeing estimates that the Asia-Pacific region will see delivery of 16,050 new airplanes in the next 20 years, close to 40% of its total. Carriers in Southeast Asia have 1,600 aircraft on order to add to an active fleet of close to 2,000 in the region, according to CAPA. Low-cost airlines account for about 70% of the orders, the think tank said.

The airlines' expectations for growth are not unfounded, however. Over half of the new air passengers in the next 20 years will live in Asia, the IATA forecast last autumn. And it said China will displace the U.S. as the world's largest aviation market by 2022. Still, some worry the heavy fleet investment is not sustainable. 

An Emirates jet in Hong Kong: Persian Gulf airlines are clouding the prospects of Asia's premium long-haul players. (Photo by Shinya Sawai)

"There may be too much capacity in Asia ... [to] keep ticket prices steady," said Mark Webb, an analyst at Hong Kong-based research company GMT Research.

Some governments are trying to curb this overcapacity. South Korea rejected applications by Aero K and Fly YangYang on the grounds that the market is saturated with low-cost airlines. 

As difficult as this highly competitive environment has been for some of the airlines, they have at least enjoyed low fuel prices in recent years. But even this had limited benefits. "What has happened in Asia is that most of the savings airlines gained from lower fuel prices have been passed through to consumers in lower ticket prices," Webb said.

But the pressure on their bottom lines could intensify if fuel prices begin to rise. IATA has forecast that airlines' fuel spending will increase 19.6% in 2018. "Lower fuel prices have aided airlines ability to reduce prices and be very aggressive," Sobie said. "It will be interesting to see if fuel prices increase."

Uber of the skies?

The disruption is not limited to Asia's traditional flag carriers, however. Even AirAsia, which pioneered no-frills service in Asia when it launched in 2002, is feeling pressure from rising competition.

On a recent AirAsia X flight from Kuala Lumpur to Wuhan, China, Fabian Kong decided to pay extra for a premium flatbed. That premium gave the businessman business class perks at nearly half the price he would have paid on a full-service carrier. "It was very comfortable. I could rest well during the return flight at midnight," said Kong.

Kong's pleasant journey was thanks in part to pressure on AirAsia, which operates the AirAsia X long-haul flight, to bring in more revenue as a way to offset lower passenger yields. But Tony Fernandes, AirAsia Group CEO, is looking beyond bringing in extra money from add-on fees.

He is planning a wider shake-up of the company that would push it further into digital payments, e-commerce and retail. He is beefing up AirAsia's digital infrastructure with an eye to pushing offerings to customers through technologies like artificial intelligence and the internet of things. "With customer data, we can sell more to our customers like what Alibaba and Amazon have done," he said in December.

AirAsia Group CEO Tony Fernandes says he wants the Malaysian airline to be seen as a "digital company that moves people around like Uber."   © Reuters

Fernandes created a new deputy CEO position to oversee nonairline units such as online payment BigPay, duty-free shopping and parcel courier Red Box. The plan is to eventually spin off these units through listings.

"I hope people will not see us as an airline but as a digital company that moves people around like Uber," Fernandes said.

The digitization initiative is also part of a groupwide reorganization to create a leaner corporate structure. The Malaysia-listed AirAsia, which owns affiliates in India, Indonesia, Japan, the Philippines and Thailand through joint ventures, has proposed swapping its partners' stakes into shares in a holding company. This is to streamline its group structure, with a long-term goal of achieving full ownership of each unit.

The moves come as AirAsia, which controls nearly 50% of the market in Malaysia, faces rising competition from Malindo Air, a Malaysian airline launched in 2013. Malindo is a premium carrier backed by Indonesia's Lion Air, which decided to push into Malaysia after AirAsia entered its home market. Now Malindo is focusing on regional destinations, escalating its competition with AirAsia. CIMB said in a July report that Malindo's seats were expected to grow by 18% in 2017, higher than AirAsia's 6%.

Malindo has been adding capacity to Indonesia, South and North Asia, too, competing head-to-head in certain AirAsia routes. With a fleet size one-third that of AirAsia, Malindo competes on 71% of the former's short-haul routes and 20% of its long-haul routes, according CIMB. The airline may move further into AirAsia's mid- to long-haul territory based on a target of adding 10 aircraft yearly.

For passengers in AirAsia's home market, the fierce price war between the two airlines has had an upside: Malaysia is one of the cheapest countries in the region for flights.

Focus on ultralong haul

Yumiko Tanaka traveled between Hong Kong and Toronto every year between 1995 and 2005 on Cathay Pacific, but lately she has been shopping around for cheaper fares. The emergence of China's low-cost airlines has given her plenty of choices.

On her most recent trip home for the holidays, she chose Hong Kong Airlines, a unit of China's HNA Group, which was almost 600 Canadian dollars ($483) cheaper than Cathay. And while she thought the food wasn't quite as good as Cathay's, she said it was as "satisfactory experience as anyone flying coach would have."

The shift of travelers like Tanaka highlights the mounting challenges facing what has long been routinely voted the world's best airline. Cathay Pacific had a turbulent 2017, reporting a disastrous loss of 8.46 billion Hong Kong dollars ($1.08 billion) due to a bad bet on the future price of fuel. It removed its longtime chief executive Ivan Chu Kwok-leung, and in August the airline posted its worst first-half loss in 20 years. In November, Qatar Airways bought a 9.6% stake in Cathay for $662 million. Its restructuring plan, which includes the loss of 600 jobs, has led to nasty labor disputes. On top of all that, Hong Kong's flagship airline continues to lose customers to low-cost players -- both at home and abroad.  

Better days: A Cathay Pacific jet lands at Hong Kong's now-closed Kai Tak Airport in July 1998.   © Reuters

Chinese airlines have been pushing hard into long-haul flights, with Air China and Hainan Airlines adding new U.S. routes. In particular, Cathay is losing ground to Hong Kong Airlines. Last year, it launched flights from Hong Kong to Auckland, Vancouver and Los Angeles at much cheaper prices than Cathay's. It is also planning new routes to San Francisco, London and New York this year.

The mainland-backed airline is able to operate the same routes at much lower costs thanks to its Airbus A330 and A350 carriers, which are smaller and more fuel efficient than Cathay's superwide Boeing 777 models. A single Cathay ticket from Hong Kong to Vancouver usually costs 50% more than what Hong Kong Airlines offers. Cathay's plan to add an extra seat to each row of its Boeing 777 models this year could help ease that cost gap, but it also risks alienating some of its frequent customers, many of whom are business travelers looking for more room and a more luxurious experience.

In response, Cathay is expanding its global network by adding more ultralong-haul flights. Last year the airline announced a new nonstop flight to Washington from Hong Kong. The 17-hour flight will shave two hours off the trip and become the longest commercial route running in Hong Kong.

Analysts say it makes better sense for Cathay to enhance its advantages on long-haul markets and business travel, rather than compete with budget carriers on short-haul routes. "Many travelers complain about Cathay, but they continue to consume Cathay," said Geoffrey Cheng, head of transportation and industrial research at BOCOM International Holdings.

Singapore Airlines CEO Goh Choon Phong, right, inspects the carrier's revamped business-class cabin in December. Many wealthier travelers are still willing to pay a premium for better services.   © Reuters

Despite losing some market share to rivals, Cheng said Cathay still had supremacy among business and affluent travelers willing to pay extra for punctuality and better services. He said Cathay should try to develop direct flights to more exotic destinations where the competition was smaller.

Another worry for Cathay, Cheng says, is the internationalization of nearby Shenzhen airport. While Hong Kong has long served as a transfer hub for mainland Chinese flying overseas, mainland carriers are increasingly able to bypass the city on their international journeys. Shenzhen last year served about 3 million passengers on international flights, and its operator hopes to increase its traffic to 15 million passengers by 2025.

The  proximity of the two airports not only forces Cathay to compete more fiercely with other domestic airlines, but also with one of its own shareholders. State-owned Air China, who has a 30% stake in Cathay, last month launched a direct flight from Shenzhen to Los Angeles. Cathay operates four direct flights to Los Angeles per day.

To make things more complicated, Air China is also a majority shareholder in Shenzhen Airlines, which operates 17 international flights from the southern Chinese city. While analysts had expected the competition between Cathay and Air China to lead to deeper integration between the two companies, Qatar's investment altered the dynamics. Cathay's shares fell as much as 5% after the news was announced, as investors saw the deal as a way to block Air China's takeover of the Hong Kong-based airline. The two carriers' love-hate relationship is likely to continue.

In the meantime, Cathay must contend with the loss of longtime customers like Tanaka, who now has plenty of different airlines competing for her business. For her, low prices trump other considerations. "I have no allegiance to Cathay per se," she said.

Researcher Ying Xian Wong contributed to this report.

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