Cathay at risk from challenge by Dragonair

When Cathay Pacific Airways purchased control of Dragonair in 1990 it believed it was securing its place as the dominant Hong Kong carrier.

Yet 10 years on from that deal it is thought that Hong Kong Dragon Airlines, operator of Dragonair, may soon be on the verge of becoming direct competition for Cathay, at least on lucrative routes within the Asia-Pacific region.

This would mean a departure from the unwritten one carrier, one route policy, created in the mid-1980s to protect Cathay when Dragonair was formed.

Steve Miller, a former Dragonair chief executive who helped put the airline together in 1985, said: 'There's no reason why Dragonair and Cathay Pacific can't compete, especially given Cathay's high costs structure.

'I am sure that Cathay and Swire, at the board level, would not like to compete.

'The current situation may be satisfactory for the airlines, carving up the market between Cathay and Dragonair and taking away the need for competition. But if the Government were to want to overturn its policy, I think Dragonair would be interested.' China National Aviation Co (CNAC) has long wanted to start its own Hong Kong-based international carrier. In 1996, to stop it from doing so, Cathay and parent Swire Pacific sold CNAC a 43 per cent Dragonair stake.

Both airlines deny there is any thought of directly competing, at least in the near-term.

Tony Tyler, Cathay's director of corporate development said: 'I'm on the board of Dragonair and I've never heard of them wanting to compete with us. There's a lot of speculation on this topic.

'But if there were changes in policy, Cathay would not be afraid of fair competition.' Dragonair chief executive officer Stanley Hui Hon-chung said: 'We have built up Dragonair on the basis of a very strong presence in mainland China.

'We are now the biggest non-mainland based airline operating in the mainland. That has always been the strength of Dragonair and I don't quite see any major deviations from this focus in the foreseeable future. I can't say how things will be in 10 years, or whatever, but as far as I can see, we will continue to build on this foundation to further develop.' But sources within Dragonair and CNAC say plans to compete with Cathay on certain regional routes have advanced beyond idle speculation.

'The feeling is that if we don't compete with Cathay, someone else will. After all, it was less than five years ago that CNAC nearly set up its own airline in Hong Kong,' a Dragonair executive who declined to be named said.

Dragonair holds many route rights to destinations it does not serve - including routes to Southeast Asia, the Indian sub-continent and within Greater China. It has also held rights to destinations in the US.

While Dragonair refused comment beyond acknowledging it has rights to routes it does not fly, there are some obvious routes which would be in its commercial interest to service.

Air routes are managed by countries on a reciprocal basis, meaning that if two carriers from one country are allowed a certain number of flights on a route, then the second country gets the same.

Hong Kong-Taipei is one of Cathay's most lucrative routes, offering one of the highest yields in the world. Two Taiwanese carriers service the route, while Cathay flies it for Hong Kong.

Another possible route on which Dragonair could compete is Hong Kong-Tokyo, another traditionally high-yield route for Cathay. Two Japanese carriers also work that route.

While Mr Hui refused to comment on specific routes, he acknowledged: 'Of course, we'll continue to look for opportunities in the secondary markets. There are some very interesting secondary destinations in Japan, Korea and Southeast Asia, which we've been exploring and will continue to explore.' Mr Tyler said he believed the no-competition policy had served both Cathay and Dragonair's interests well.

'The structure of no-competition between us has in the past been very successful in building the industry here,' he said.

But the seemingly happy cohabitation between Beijing and Cathay - often perceived by mainland officials as a carry-over from Hong Kong's colonial past - is widely believed to be no more than skin-deep.

'In no country in the world are foreign carriers allowed to fly purely domestic routes within another country. Yet in the Hong Kong Special Administrative Region of the People's Republic of China, the 'flag' carrier is one which is controlled by a British company,' one aviation analyst said.

Nowhere in the world does any airline have to compete as an equal with another airline from the same home base and the economic ramifications for both Hong Kong carriers could be devastating, for example, if a price war were to erupt.

Mr Tyler said: 'Hong Kong is a small place and any other airline setting up in Hong Kong would have to think whether it would be worth it or not.' There is a sense, though, that for political reasons alone, CNAC would be adamant in its desire to compete with Cathay on an equal footing.

Cathay transferred its Beijing and Shanghai routes to Dragonair when it purchased it in 1990. One possibility could involve Cathay asking for its mainland route rights back, in exchange for allowing Dragonair to compete on other regional routes.

Conveniently, a new air services arrangement between the Hong Kong Government and Beijing is now in the process of being hammered out. It is believed that the topic of Dragonair and Cathay splitting Hong Kong's routes is one of the topics being discussed.