Air China chairman Kong Dong is aiming to tap China's vast potential, heading an ambitious drive to position his carrier among the top 10 airlines worldwide within the next six years
If China's population, economic strength and growing international prominence are any gauge, in a few years it will have one of the world's most lucrative airline markets. The country's carriers certainly seemed on track earlier this decade, with several years of breakneck growth resulting in back-to-back record profits. But that ideal world came tumbling down in 2008 as the economic crisis and fears over the H1N1 virus affected demand, and high fuel prices drove up costs.
Air China, China Eastern Airlines and China Southern Airlines - the big three - posted a collective loss of $4 billion in 2008. Some factors were beyond their control, but they were also guilty of failing to rein in costs and aggressively trying to grow market share at the expense of yields. Unsurprisingly, all three once again turned to the Chinese government, their main shareholder, for a bail out. It was a surprise when China Eastern and China Southern got the cash, while a request from flag carrier Air China for 3 billion yuan ($439 million) was turned down.
© Law Kian Yan
Kong Dong, Air China's politically connected chairman, remains coy about the reasons. Speaking at his office on the 28th floor of the Air China building in Beijing
's fashionable Chaoyang district, he draws an analogy to US car manufacturer Ford, where his "friend" and former Boeing
head Alan Mulally is chief executive.
"General Motors and Chrysler got state aid, and Ford did not because it was better run. So maybe, we are like Ford," he says through a translator. "Last year, we suffered a big blow from the financial crisis and fuel prices. However, we can depend on ourselves to overcome the hard times and to solve the problems. We have a healthy debt ratio of 77%. If we run our operations prudently, we won't have big problems with cash flow."
Then, with a smile, perhaps unable to resist taking a dig at his domestic rivals, he suggests that, just like GM and Chrysler, the government aid went to those who really were on the brink of collapse. "We fully understand the government's support to China Eastern. They truly needed the help and the largest amount of aid. And China Southern, they are also in financial difficulties and their debt ratio is not reasonable. So we understand that as well."
He may not say it aloud, but the reality is that there is little love lost between the three carriers. Brewing inside China, beneath the polite nods, gentle applause and friendly smiles, is a fierce battle to become the country's pre-eminent carrier. The state even appears to be stepping back as the heavyweights take their gloves off in what could become a battle for survival.
Privately, Air China's officials resent suggestions that the three are equal. Symbols matter in China and very few things are more important than having the flag on your tail. Being based in the Chinese capital of Beijing helps the carrier's profile, especially since the country's political elite are now mostly from the city. Chinese leaders also only fly on Air China when they travel overseas. And the carrier is the grooming house for aviation industry leaders - Kong's predecessor is China's civil aviation minister.
"Air China is the leading carrier in China," insists the 60-year-old. He took on this job in January 2008, after various other roles in aviation, and is helped on a day-to-day basis by high-flying 45-year-old chief executive Cai Jiaxiang. Together, they are plotting Air China's plan to carry more passengers, transport more cargo and make more revenue and profit than any other airline in China.
But last year, that plan suffered a setback. After the crisis broke, the state encouraged Air China to bid for Shanghai-based China Eastern. It was partly political, tying in with the government's aim of consolidating the airline sector, and partly to prevent the entry of Singapore Airlines - which was bidding for part of China Eastern - into the Chinese market. It also made business sense for Air China to diversify its revenue streams to include China's economic growth engines in the south.
China Eastern's shareholders turned down SIA's offer for being too low, but the carrier itself rejected Air China's bid, claiming it was "insincere". Its senior officials felt China Eastern would be better off alone and began exploring the purchase of city-rival Shanghai Airlines later in 2008. It made a formal offer in July and should complete the deal in 2010.
How the Chinese domestic market is recovering click here
Kong admits that Air China was disappointed, but he adds that they faced this with a "positive attitude". Shanghai had been pinpointed as the engine for the next phase of the carrier's growth. And, in keeping with this plan, earlier this year Air China announced plans to set up a subsidiary in the city, with several aircraft based there, developing Pudong airport as a second base after Beijing.
"With our own subsidiary in Shanghai, we can use the city as another home base and devote more attention towards the development of the Pudong hub for our growth," says Kong. "During this crisis, we realised that the domestic market has been much more lucrative than the international market." Five of every six Air China passengers fly on its domestic network, making it a key segment.
It builds on Air China's strengths:a Beijing hub that Kong calls "one of the best airports in the world", strong domestic brand recognition, and its Phoenix Miles frequent flyer programme which is the most popular in China with 10 million members. A base in Shanghai will target the large number of passengers who fly into China's financial capital, and then on to other parts of the country, he adds.
Shanghai will also help expand Air China's footprint in the international market, especially since many of its Star Alliance partners have extensive services into the city. The carrier has begun to restore some of the international services which it terminated in the wake of the financial crisis, and will increase frequencies and start new flights out of both Beijing and Shanghai in the near term. "Our planned growth will be in line with market recovery," says Kong. "However, Air China and its Star Alliance partners will have a significant market share in Shanghai after this happens. We will have significant advantages and attach as much importance to Shanghai as we have to Beijing."
In the cargo market, Air China is forming a Shanghai-based joint venture with Cathay Pacific Airways. It will likely own 51% of the venture and base several freighters in Shanghai, which overtook Hong Kong as the largest cargo market in the region in 2008. Apart from turning the screws on China Eastern, it will also target China Southern, which isbased in China's industrial capital, Guangzhou.
"I am confident about the future of the cargo market, especially in Shanghai. If there is any recovery from the American and European market, then the Shanghai market will definitely have a good performance," says Kong. "Air China will put its cargo business into the joint venture to carry cargo through Shanghai, while we see that Cathay has established very good international networks. By combining our advantages, it will be a very good opportunity for both companies."
This relationship with Cathay is part of Air China's plan to extend its reach. In 2006, Cathay bought an 18.09% stake in Air China and the Chinese carrier picked up 17.49% of the Hong Kong airline. In August, Air China bought another 12.5% of Cathay from Citic Pacific, increasing its holding to 29.9% - just shy of the 30% mark which would have triggered a mandatory takeover offer. This latest move allowed Air China to add two more directors to the Cathay board and Kong became the vice-chairman.
In many ways, the two are strange bedfellows. Insiders say directors took time to get used to the different working styles, but things are now much better. "The Hong Kong and Chinese corporate cultures are very different, but there's a realisation that this is a mutually beneficial relationship," says one observer.
Cathay gains access to the economically and politically important Chinese market, while Air China uses the Hong Kong carrier to build up its expertise in management, airline operations and service standards. Several Air China staff are being trained by Cathay, and a long-term secondment programme for its top management is being studied. Cathay also appears to be Air China's proxy in southern China, a second defence against competition from China Southern and China Eastern.
"I have been in aviation for many years and my view is that Cathay is an advanced airline with precious values. Therefore, after overcoming the current difficulties, it will be a very good airline with high value and strategic importance for us," says Kong.
He adds that Air China is happy with its existing stake in Cathay. Any ambitions it may have to own the carrier outright may anyway be thwarted by the Swire Group, which owns just under 42% of Cathay and remains committed to it. Kong says that for as long as that continues, Air China will not be able to do anything. However, he admits that if the situation changes, it could make a move. That can "only be answered by time", he adds.
As it has with Cathay, Air China uses its Star Alliance membership to learn from other airlines and improve its operational levels and product standards. Since it joined the alliance in December 2007, it has had a bigger voice in the international aviation community. On a more practical level, the Star Alliance carriers are co-operating more closely in China - such as moving to Beijing's Terminal 3 and offering standardised products and service. This has led to tangible gains.
"After joining Star Alliance, we enjoyed an additional 1 billion yuan [$145 million] revenue in 2008. We seat many passengers from Star Alliance member airlines and we believe that it is truly important to the Chinese market that we are part of this," says Kong.
The economic crisis has also shown the value of groupings like Star Alliance, he adds. "After joining the alliance, we saw during the crisis that our members appreciated our domestic market. When our Chinese travellers go abroad - and they still travel despite the financial crisis - our Star Alliance members benefit a lot from this. American and European travellers have reduced a lot in this financial crisis, but for Air China, we maintain a very balanced passenger structure through support from Star Alliance," he says.
Good airports in Beijing and Shanghai help this, but the reality is that much of China's infrastructure remains undeveloped. With 129 aircraft on order, including Boeing 737-800, 777-300ERs and 787-8s and Airbus A320s and A330s, Air China needs the infrastructure to improve to grow.
"Airports construction still cannot meet the needs of our national economic development. In the 12th [government] five-year plan, we have plans to build airports at the secondary and smaller cities. But we have a lot of room to improve on airport construction. For Chinese aviation, we still cannot meet the needs of our Chinese general public," says Kong.
If that improves, it will help Air China increase its profits from operations. In the third quarter of 2009, it made an operational profit of 1.3 billion yuan, up from a loss of 2.4 billion a year before. That included a gain of 553.6 million yuan from changes in the fair value of assets, mostly fuel hedging gains.
"The reduction in fuel pricing brings benefits to all airlines worldwide. For Air China, fuel hedging accounts for only half of our profits. The other half is from performance and we aim to continue with that," says Kong. "We also always keep good control over costs. Although revenue is decreasing in all airlines, our cost reduction is more than the reduction in revenue." The financial crisis and high fuel prices of 2008 were a major setback for Air China's plans, and Kong is acutely aware that another major downturn or a virulent variant of the H1N1 virus would be a big blow. Yet, he remains optimistic and ambitious.
Service levels are also high on his list of priorities, and observers say the carrier actually began answering letters of complaint after he took over. "Air China must improve its service quality if it is to differentiate itself from other airlines," say Kong. The aim, he says, is for Air China to become one of the top 10 airlines in the world by 2015. He disagrees with the measurements used by rankings like the Fortune 500, which he says are "overly dependent on revenues and turnover" and ignore other important factors such as profitability, brand recognition and service levels.
"Our timeline is six years. We must become one of the top 10 airlines by then. Although the dream is truly challenging, my team and I, and all of Air China's employees view this seriously and want to work on it," says Kong. "The top airlines are Lufthansa, Air France-KLM, SIA, Cathay, British Airways and Emirates, and, in the USA, United and Continental. We want to be one of them, to be mentioned in the same breath as them in all ways."
Air China may not have received state financial aid, but Kong says that the government has done a lot to help airlines overcome the economic crisis over the last 18 months.
IATA is forecasting industry-wide losses of $11 billion this year and Kong describes this as "a severe challenge".But China has been spurred to a quick recovery by stimulus measures which have boosted domestic consumption and helped local companies.
"For the Chinese aviation market, this has been a positive influence," says Kong, referring to the dramatic growth in domestic passenger figures this year after last year's slump.The Chinese CAA, he adds, has helped by returning fuel surcharges and construction funds to airlines. "There are various methods being employed and rules are being relaxed to stimulate the aviation industry. That is beneficial for us," says Kong.
But one of the government's aims encouraging the few privately-owned carriers, which have been badly hit by the crisis, to merge with government-owned airlines has not gone to plan. Air China's plan to buy Wuhan-based East Star Airlines, for example, fell through after the carrier's owners appeared to prefer bankruptcy to state control. Some critics say the government should not interfere to such an extent, but Kong prefers to focus on the fact that this will set carriers like Air China up to grow once the crisis blows over.
"We truly appreciate all of the valuable support from the government," he says. "After the financial crisis, there will come more challenges and also opportunities. Air China will not give up any opportunities, and this is a good chance to meet the challenges and come out even better."
If you like Wei Qi, the Chinese board game more commonly known as Go, and have played it online, you may have pitted your wits against Kong Dong.The 60-year-old has longbeen a fan of the game, which is sometimes referred to as the Chinese version of chess. "When I am home after work, all I want to do is relax," says Kong. "So I just log on to the internet and play Wei Qi with people who want to play. It is partly exercise for the mind, but mainly just for fun."
Kong Dong has helmed China National Aviation Corp, China Ocean Helicopter Company and Shenzhen Airport Group. And, in 2002 after China's state-owned carriers were consolidated into three, he became deputy general manager of Air China's parent firm, China National Aviation Holding Company, becoming chairman in 2008.
Little is known about his personal life, but one newspaper described him as "the son of a legendary revolutionary couple who were in the thick of the action when New China was founded 60 years ago". CITIC Group chairman Kong Dan is reportedly his older brother.
For more on the resilience of the Chinese domestic market in 2009, see: