Across The Border

How low-cost carriers are changing the shape of China’s aviation industry

With their cheap tickets and low operating costs, the mainland’s budget airlines are flying high while their long-haul rivals are struggling

PUBLISHED : Thursday, 08 December, 2016, 6:33pm
UPDATED : Thursday, 08 December, 2016, 10:38pm

China’s low-cost carriers are thriving and poised for further growth as their larger rivals struggle to turn a profit during tough times for the airline industry, according to analysts.

With a business model based on cheap air tickets and reduced operating costs, the budget airlines are maintaining profitability at a time when the mainland’s aviation industry is haunted by a weaker yuan and the prospect of rising fuel costs.

Their success may even force long-haul operators to copy some of their cost-cutting tactics, according to some industry experts.

Offering cheap air tickets has proved a big selling point for China’s growing army of domestic travellers, said Sun Fei, an analyst at Deutsche Bank.

I think it is unnecessary to provide additional services such as food and drinks or entertainment for a journey of less than two hours
Lily Wang, airline passenger

For example, the one-way trip from Shanghai to Chengdu departing on December 19 offered by China’s largest budget carrier, Spring Airlines, offers one of the lowest priced tickets, at just 449 yuan. The flight has a similar departure time to others on the same route but with reduced services such as in-cabin catering, and a fee for checked-in baggage.

“I will choose to buy a cheaper ticket for our family trip if the departure time is suitable,” said Lily Wang, an education consultant from Guangzhou, who flies frequently in China. “I think people have a misunderstanding that low-cost equates to a lack of safety, but that is not the case.

“I think it is unnecessary to provide additional services such as food and drinks or entertainment for a journey of less than two hours. Sometimes I do not eat what the network carriers serve because the food in the planes is always not tasty.”

Many of the mainland’s bigger, long-haul airlines are finding it hard to stay profitable, weighed down by dollar-denominated debt made more expensive by the devalued yuan. On top of this, many industry analysts believe Opec’s recent agreement to cut oil production will drive up fuel costs.

Budget airlines commonly keep their operating costs far lower than long-haul, network airlines by cutting so-called ancillary services to offset the impact of their cheap ticket prices.

Between 2011 and 2015, Shanghai-based Spring Airlines, for example, had unit operating costs that were 35 per cent less than Air China, China Eastern Airlines and China Southern Airlines, the country’s three largest network carriers, according to data from Deutsche Bank.

The lower cost enables the company to deliver better profitability even on much lower passenger yields dragged down by cheaper tickets, said Sun.

Yield is a key gauge of airlines’ profitability, measuring the money earned from carrying a passenger for one kilometre.

Because of its low ticket prices, the passenger yields of Spring Airlines were on average 36 per cent below its network peers during the same period, the data shows.

Low-cost carriers are enjoying such healthy profitability that some industry watchers predict that network airlines will soon adopt certain aspects of the budget airline model, such as cancelling free alcohol and in-flight entertainment.

Mathieu De Marchi, a Bangkok-based aviation consultant at Landrum & Brown, told Bloomberg that

some Asian airlines may be forced to ape low-cost carriers and start charging for extras, from food and alcohol to checked-in baggage - traditionally free services that have been taken for granted on long-haul flights for decades.

However, Victor Au, Delta Asia Securities’ chief operating officer, does not believe this is likely.

He said: “I do not think Hong Kong Cathay Pacific will reduce ancillary services in the short term.”

In fact, Cathay, Asia’s biggest international airline, recently raised the check-in baggage allowance in all classes and cut excess baggage charges despite its net income dropping 82 per cent in the first six months of this year and its forecast that 2017 will be a challenging year.

Ancillary services, which budget airlines normally charge for, carry higher profitability than air transport itself, said Sun, but compared to regional peers Chinese low-cost carriers derived less income from the services.

For example, Spring generated a mere 3.5 to 5.2 per cent of its revenue from the ancillary business in the years from 2011 to 2015, compared to an average 19 per cent for Southeast Asian budget carriers and 23 per cent for Ryanair, the biggest European low-cost airline.

Sun said the market for low-cost carriers is booming in China, with low penetration suggesting room for ample growth. The market share of budget carriers in China’s aviation sector currently stands at 9 per cent, far lower than global penetration.

Low-cost airlines’ market share stands at 56 per cent among Association of Southeast Asian Nation (Asean) countries, 40 per cent in Western Europe and 32 per cent in the US.

“The gap indeed provides growth potential for China’s budget airlines,” echoed Au who concerned the pressure on China’s airlines from weakening yuan.

Budget operators are still at an early stage of their development and have significant room to grow, said Sun.

There are nine major domestic budget airlines in China including Spring Airlines and 9 Air. Most of them operate within a regional network and have fewer than 30 aircrafts in operation, far less than major international airlines have.