Hong Kong's protectionist aviation industry is making progress in opening up and embracing change, but it risks being sidelined if it does not move faster in this direction

An old industry joke in Hong Kong had it that the best way to make money was to set up a new airline and wait for it to be bought by Swire Pacific, the parent of Cathay Pacific Airways. Such was the protectionist nature of the Hong Kong market, dominated by a single group and where new players did not stand much chance of success.

But significant changes have - relatively quietly - been taking place in the former UK colony. Hong Kong's aviation environment is now vastly different from that of the early 1990s. Today, Hong Kong's fast-growing second carrier Dragonair is asserting itself as a direct competitor to Cathay on both busy passenger and freighter routes.

A new independent airline, CR Airways, is operating out of Hong Kong with charter services using 50-seat regional jets to secondary destinations. Cathay, meanwhile, is overhauling dedicated cargo subsidiary Air Hong Kong to focus on express freight operations within the Asia-Pacific, rather than on long-haul services. DHL now owns 40% of Air Hong Kong.

At the same time, the Hong Kong government is opening up the market to more foreign airline operations, finally realising there are solid economic benefits to come from allowing additional competition. The government recently signed its first "open-capacity" air services agreements, for example, and more are expected as it pledges to continue with a progressive liberalisation policy.

While the government says that the timing of the new liberal agreements is more coincidence than anything else, such changes would have been almost unthinkable last year, when the territory's airlines were being battered by the effects of the SARS outbreak, which badly affected Hong Kong between March and July.

Liberalisation push

But there has been a clear, steady push toward liberalisation that shows no signs of letting up. In 2000, when Dragonair launched dedicated cargo services, the government relaxed a so-called "one airline, one route" policy, that for years allowed only a single local airline to fly on a given route. In 2002 the policy was effectively scrapped when Dragonair launched passenger services to Taipei in Taiwan in competition with Cathay.

Dragonair, which had traditionally focused on China and secondary destinations in Asia, now competes head-to-head with Cathay on passenger routes to Taipei, Bangkok and Tokyo. It also operates dedicated cargo services to some of the same destinations as Cathay, while the Hong Kong major responded last year by launching competing passenger services to the Chinese capital Beijing.

Dragonair also plans to launch competing passenger services to Sydney next year following the signing of a more liberal Australia-Hong Kong air services accord in April, while Cathay is seeking more access to mainland China.

The new competition has not come without its share of fighting. When Cathay sought approval late in 2002 to return to Beijing after an absence of more than a decade, Dragonair formally objected, forcing Hong Kong's Air Transport Licensing Authority to hold route hearings. Cathay ultimately won the bitter and highly public battle and returned to Beijing late last year, albeit with only a handful of weekly services.

Cathay, in fact, flew to major Chinese destinations until 1990, when it bought into then-struggling Dragonair. It had originally been launched five years earlier as a competitor. As part of the buy-in Cathay gave up its rights to serve mainland China to allow Dragonair to grow.

Perhaps ironically, Cathay still owns nearly 18% of Dragonair, while its parent Swire Pacific holds around another 8%. But since 1996, when China National Aviation Company (CNAC) acquired a 36% stake in Dragonair - later rising to 43% - the smaller carrier has been steadily operating more independently.

Some long-time industry observers in Hong Kong believe Dragonair's objection to Cathay's China route licence application was ordered by Beijing-controlled CNAC. Hong Kong-listed CNAC has made no secret of the fact that it wants to boost its stake in Dragonair and a popular conspiracy theory has it that the intention is to bully Cathay and Swire into selling out. In the run-up to winning effective control of Dragonair back in 1996, CNAC had put heavy pressure on Swire, backed by the threat to launch its own new carrier.

Meanwhile, in the background there is the CITIC Pacific conglomerate - listed in Hong Kong but backed by China. As well as a 28% stake in Dragonair, it holds 25% of Cathay and has been seeking to expand its aviation portfolio by buying into mainland Chinese airlines.

CITIChad been a central player in the 1996 aviation shake-up, as the UK prepared to hand its former colony to China. Early in 1996 CITIC, Cathay and Swire sold the joint 36% holding in Dragonair to CNAC in return for a promise that it would not launch a competitor. CITIC at the same time increased its stake in Cathay from 10% to 25%.

With this complicated ownership regime still in place, Hong Kong is still trying to come to terms in the new environment after all the years of protectionism. It comes as mainland China is itself steadily liberalising and putting pressure on its Hong Kong Special Administrative Region to follow suit.

The players in Hong Kong's airline wars say, however, that increasing competition is a normal part of operational life, and acknowledge that more will come. "It's inevitable, as both airlines want to grow," says Cathay's director of corporate development Tony Tyler. "What both airlines need are networks that cross Hong Kong into each other's patch. Dragonair, if it's going to be a serious airline, needs to have services that are not just Beijing and Shanghai." It is on these routes that Dragonair has traditionally made the bulk of its profits.

"They need to grow and so do we, so inevitably we are going to be treading on each other's toes from time to time. But people can exaggerate the extent to which that matters," says Tyler. "Every airline on earth co-operates and competes with every other airline to a various extent. But we've still got much more in common than we have against each other. We'll have a real go at each other in certain markets and certain areas, and co-operate with each other in other areas. We're still going to feed them on flights that don't connect with our own flights."

Dragonair chief executive Stanley Hui says that despite the new competition with Cathay on passenger routes, that his airline's focus is "still very much mainland China", adding that 90% of passenger revenue comes from services to China and Taiwan. He says the new passenger services to major Asian capital cities are aimed largely at capitalising on the growth in outbound demand from the robust Chinese market.

Hui adds that this sector is growing particularly strongly, as the Chinese government continues to ease restrictions on its nationals travelling abroad. "The lifting of restrictions on individual travel is further stimulating market growth and more people are coming to Hong Kong," he says, adding that the airline plans to expand its fleet further to meet new demand requirements.

The Hong Kong government, meanwhile, says it will continue to open up to foreign airline competition. Principal assistant secretary for economic development and labour Danny Lau says more liberal air service accords are likely after such agreements were reached with Malaysia and Thailand.

Open-capacity agreements

The new agreements allow for unlimited passenger and cargo services between Hong Kong and the two South-East Asian countries, and give airlines more fifth freedom rights to operate beyond the other side.

"We have had a few in the past, but we are now trying to do as much as possible," Lau says of open-capacity agreements covering third and fourth freedom rights. "For example with Spain, we also had negotiations with them and the result was third and fourth freedom open capacity," he says, adding that the timing is "partly coincidence" but that there is also a need to respond to the international trend towards liberalisation. "I think third and fourth freedom rights are something that both partners know there is no point restricting if airlines have plans to operate," he says.

Hong Kong has often been criticised by foreign governments and foreign airlines for maintaining a restrictive policy over air services, and outsiders argue that the territory should be helping the hub against competitors, rather than protecting the airlines. Lau maintains, however, that Hong Kong is indeed acting on its promises to pursue more liberal policies, suggesting that such criticism is no longer warranted.

Hong Kong has, to date, signed around 50 air services agreements, says Lau, which "basically covers all the important markets". One region where it may seek to negotiate new agreements is South America, adds Lau, who also says new talks are likely in the near future with more countries in Europe.

He will not comment on the progress of talks with China. Cathay has licences for more Beijing services, as well as for new services to Shanghai and Xiamen, but it has not been able to take advantage of them because of restrictions in the air services arrangement between Hong Kong and China.

Airport privatisation

Some believe that Hong Kong's government is now focusing more on opening up air services - sometimes to the opposition of locally based airlines - to boost Hong Kong International Airport (HKIA) ahead of its planned partial privatisation next year. Lau says that the opening up will indeed benefit HKIA, but adds that liberalisation is not directly related to the privatisation plan.

"The policy is to facilitate the development of the aviation hub and to maintain our status as an international regional aviation centre. Of course that would include the development of Hong Kong International Airport," says Lau. "We are following our policy of progressive liberalisation. But we would also take notice of what the other aviation partners in the region are doing."

The government announced plans last year to partially privatise the airport authority, which operates HKIA, through an initial public offering in 2005. The government says it expects to introduce a bill for the partial privatisation "around the end of 2004", although many issues still need to be resolved, such as user charges.

Airlines serving HKIA have expressed concerns that the partial privatisation may lead to higher landing and parking charges. The airport's Board of Airline Representatives, for example, claims that HKIA is already around the tenth most expensive airport in the world in terms of aeronautical charges.

The airport authority has countered by pointing to the fact that it ranked 40th among 50 major international airports included in the 2002 charges index compiled by TRL, the UK transport research body. Airlines and their lobby groups, however, dispute the basis for this study which compares a range of different aircraft operations at each hub.

For its part, Cathay supports the privatisation plan, according to Tony Tyler, but it wants some form of economic regulation to prevent abuse of the monopoly position. "As long as it works and we don't have to pay through the nose, we're happy," he adds.

Dragonair's Hui goes further: "It's always a concern of the airlines when you have a privatised entity that is supposed to be doing the best to maximise the profits for a private enterprise. On the other hand you have the wider interest of the community. If the charges become unreasonable to the extent where the airlines find it difficult, then how do they balance that? That is always the problem for governments trying to privatise infrastructure."

He cautions that the Hong Kong aviation community has to be "very careful" however, as potentially competing hubs develop in mainland China. "While we have been very successful in past years - for very good reason because China was not as developed as it is now - today you have a number of airports in China,"he says. "Guangzhou's New Baiyun, when it opens in June, is going to be another major competing airport for international traffic. Obviously it will not have the same international network in the coming years as it takes time to develop, but eventually there will be."

Competitive threat

"If they are more competitive in terms of cost, and since they have a big market around them, where will Hong Kong be?" asks Hui. "In that sense our Airport Authority has got to watch out very carefully if they think they can milk a few more dollars from the operators here."

Hui also warns that Hong Kong needs to become more competitive as a hub given that non-stop flights are likely to be allowed in future between China and Taiwan. China considers Taiwan a renegade province and there are no non-stop services between the two sides, forcing stopovers in other cities, usually Hong Kong or Macau.

In terms of traffic from Taiwan, Hong Kong has been living on borrowed time he argues. "We have been living on the lack of direct flights across the Taiwan Strait for so long, and the fact remains that we are living on this borrowed time,"he says. "As soon as they can go direct, where will we be? What happens when direct flights come? I can see immediately there will be a sudden rapid drop in loads on some of our flights, such as Beijing and Shanghai. I don't think that anyone can deny that would happen. So there are a lot of worrying potential downsides and negatives for Hong Kong as a hub for both passenger and cargo."

At the same time Hong Kong's airlines, as well as its hub, are facing new challenges from low-fare airlines and their destinations of choice. Malaysia's AirAsia recently announced that it and its Thai associate carrier of the same name would start flying in June to another Chinese Special Administrative Region, Macau, just west of Hong Kong. AirAsia decided against serving Hong Kong, saying it was far too expensive and that "Macau was hungry for us".

The HKIA airport authority is promising incentives for new airlines, but in the case of AirAsia it was seen as too little, too late. Hong Kong is indeed making progress in opening up and embracing change, but observers warn that it stands to be sidelined by competing passenger and freight hubs if it does not "find itself" soon.


Source: Airline Business