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Nov 26

China’s Big Three Airlines on a Fast Track to Overtake U.S Big Three

By Dan Reed, Forbes

The Big Three U.S. airlines – American, Delta and United – might as well start planning their complete withdrawal from the Chinese air market in the 2020s if – and it’s decent-sized “if” – Chinese airlines continue expanding their fleets at the breakneck pace they’ve been on over the last decade.

Earlier this week China Southern Airlines president Tan Wangeng, speaking at an industry conference in Guangzhou, said his carrier, Asia’s largest and the world’s sixth-largest, plans to have 1,000 jetliners – real ones, big ones, not small regional jets, turboprops or ancient aircraft built in the old Soviet Union or more recently in the third world – in its fleet in less than two years. Given that China Southern currently has more than 750 such planes, growth to the 1,000-plane mark would equal a 33.3% increase in its fleet in less than 30 months.

Tan Wangeng

And by 2035 Tan said China Southern will have a fleet of at least 2,000 planes. That would be a fleet growth rate of 287% over 16 years.

Oh, and its two closest rivals – also dominated by holding companies owned by China’s government – pretty much are on the same growth trajectory.

China Eastern Airlines currently is only fractionally smaller, in terms of fleet numbers, than China Southern, with around 750 planes. Air China is only slightly further back with around 720 aircraft in its fleet. And all three have orders in for hundreds of additional planes built by the two big western manufacturers, Boeing and Airbus. Plus they’ve all three publicly declared their intentions to keep on placing big aircraft orders over the next 15 years.

That’s a far cry from just 20 years ago, when China’s pathetic little airline industry was figuring out how to operate with far less government direction and control than had been the case historically. Back then two U.S. airlines -United and Northwest utterly controlled the U.S.-China air travel market. Both benefitted from trans-Pacific service rights granted in the years immediately after World War II. In United’s case it has bought those rights in the 1980s from Pan Am, which then was in the process of slowly selling itself into oblivion one chunk at a time. Delta acquired Northwest and its well-established Asian route network in 2008.

Other big U.S. carriers, American, Continental and, to a smaller degree, Hawaiian, fought ferociously back in those days for what were, in effect, table scraps – limited numbers of new route authorities made available now and then by the Chinese after intense negotiations that often looked more like U.S. begging sessions. But in the mid-’90s the Chinese government backed away from dominating its many airlines and encouraged them all to begin competing (though the government still owned controlling interests in all of them then, as it still does today). That resulted in a decade-long round of consolidation and period of learning how to operate in a competitive market. And that, beginning roughly a decade ago, led to the rapid growth of the Chinese airline market led by China Southern, China Eastern and Air China plus their respective subsidiary airlines.

All three now rank in the world’s top 10 carriers ranked by fleet size, revenue and capacity measured in seat miles. And it won’t be long until they begin overtaking the U.S. Big Three carriers who sit at the top of those world rankings.

The Chinese carriers’ growth already has been making life tough for the U.S. Big Three, each of which has been forced to scale back China service. Earlier this year American stopped flying Chicago-Beijing. Then last month it said it would cease serving Chicago-Shanghai in October. Vasu Raja, American’s vice president of network and schedule planning, candidly admitted that his airline had never made a dime serving those two routes because of heavy competition from the fast-growing competition in the U.S.-China market. And ever-rising capacity will make it even harder to make money on those routes going forward. Lots of capacity always results in lower average fare prices, and U.S. airlines, with their higher operating costs, can’t stay in the game with Chinese carriers operating with much lower labor and other costs.

United, too, has pulled back, cutting service between San Francisco and Hangzhou in 2017. It has reduced service to other second-tier Chinese cities, and even a bit on routes to China’s mega-cities, though company President Scott Kirby recently said he believes their China market position has stabilized.

Hawaiian also will suspend Honolulu-Beijing service next month. Executives there and at United, like those American, say that while there are particular issues with each individual route, the overarching problem is the rapid growth of capacity – and the low fares that come with that – on U.S.-China air routes being driven by the Big Three Chinese airlines.

Since the loosening of Chinese government control over China’s domestic marketplace and financial sectors in the 1990s, demand for travel among China’s fast-growing middle class has exploded. But instead of getting on just any ol’ airplane to see the world – particularly America and Europe – Chinese citizens are choosing to get on the flights of their own Big Three. Their inherent language and cultural advantages, and their deep reach into China’s domestic air travel market make the Chinese carriers the natural preference for China-originating travelers the same way that Americans opt to fly on U.S. carriers, Germans opt to fly on Lufthansa, and so on, even when they have a choice of traveling on a carrier based in another nation.

And that points to the one unassailable advantage that China’s Big Three have over their U.S. – and other foreign – carriers: population.  At something over 1.4 billion, China’s population is more than four times that of the U.S.’s population of around 325 million. And the rapid growth of the Chinese economy over the last 20 years means that around 70 percent of all Chinese citizens now statistically qualify as middle class. Thus, about 1 billion of them can afford every now and then to fly out of the country on vacation or to visit friends and relatives. And that’s on top of China’s burgeoning business travel market.

As a result, The Boyd Group, an aviation consulting firm based in Evergreen, CO, predicts that 12.8 million Chinese will fly to the U.S. in 2024. That would be nearly triple the 4.3 million Chinese who’ll fly here this year. And at least two-thirds, if not more of them will arrive on Chinese carriers’ planes.

Boeing now predicts that Chinese carriers combined will buy 7,690 new planes worth US$1.2 trillion over the next two decades. Many will be deployed on domestic routes to fill in the gaping holes in China’s current aviation infrastructure. But expect at least a third of those new planes – and most of the really big ones, at that – to be deployed on international routes.

U.S. carriers have plans to buy lots and lots of planes, too, over the next decade. But because the U.S. is a well-established, mature and slower-growing market air travel market, most of those new planes will be used to replace the many older planes now flying for U.S. airlines. China’s carriers have much younger fleets that won’t require much in the way of replacement aircraft for another 15 years. As a result 80% or more of the planes the Chinese carriers have order or will be ordering over the next 20 years will be used to grow their market reach and penetration. Indeed it won’t take them long to move ahead of the U.S. carriers in fleet size. American, the largest of the bunch, currently has 948 full size jets in its fleet, plus 575 or so regional jets flying for its American Eagle partners. So China Southern is on schedule to become the world’s largest operator of full-size jets, supplanting American, by 2022, if not sooner.

Is it possible that the Chinese carriers will slow their roll in the next few years? Sure.

China Southern’s Tan surely knew when he spoke at the conference on Monday, that his growth projection would cause the CEOs at American, Delta and United to look down at their cards once again and begin recalculating just how strong or weak their poker hands are. So, is Wan bluffing? Maybe. Bluffing is something of a Chinese business art form. But China’s population numbers and economic growth rate would appear to make Wan’s fleet growth boast a realistic prediction. The same would be true of China Eastern’s and Air China’s growth projections.

So betting that the Chinese Big Three will ease off the growth throttle would be, in effect, placing a big bet against the continued growth of China’s economy and industrial base. Were China a normal, western nation with a long history of free or mostly free markets with little or no government direction, that might be a sagacious bet to place right about now. But China is not a free economy. The Chinese government still has massive influence and even ultimate control over it – especially that very high-profile end of the market where international airlines still are perceived to be far-roaming exemplars of a nation’s economic might.

Thus, it might be that U.S. carriers mostly or completely will exit the China air market, by 2030 and perhaps sooner. Their Chinese rivals are positioning themselves to dominate that market with huge amounts of capacity and their inherent advantage in a market catering increasingly to Chinese, not western travellers.

Indeed, that’s in part why both American and Delta have taken baby steps toward buying their way into the Chinese industry. American last year invested US$200 million for a small stake in China Southern. Delta three years ago plunked down US$450 million for 3.5% of China Eastern’s public shares (the Chinese government has a special class of shares that give it final say on what its airlines say and do). Those small stakes, which could grow a bit over time, may wind up being the only way that U.S. carriers will ever make money in the Chinese market of the future.

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