In for the Long Haul

Developing a Sustainable Operating Environment for Airlines in China

In early June, the European Chamber published a report outlining the structural challenges facing European airlines operating in China, In for the Long Haul: Developing a Sustainable Operating Environment for Airlines in China. Tom Groot Haar, Policy and Communications Coordinator with the European Chamber, outlines some key findings of the report.

Over the last several decades, the European Union (EU) and its member states have taken a significantly different approach to China with regard to developing the respective environments in which their airlines operate. 

Before the EU liberalised the bloc’s aviation sector, there was limited competition between different European airlines and prices were high. The introduction of the EU internal air transport market in 1993 brought European air carriers under the supervision of the European Commission, and EU competition rules were applied, slashing the then widespread use of state aid. Frequencies and destinations also increased drastically, and the entrance of low-cost carriers into the EU market increased competition and drove down prices. 

The increased air traffic in Europe pushed member states to optimise the operating environment for airlines by adhering to international standards regarding slot allocation procedures and air traffic management. Additionally, European airlines were incentivised through EU competition law and fiduciary responsibility to focus on profitability and sustainability of operations, transforming them from bloated drains on public resources into sustainable, thriving businesses in an industry that boosts European connectivity, growth and employment.

China’s aviation industry has developed quickly, but its airlines lack competitiveness due to an operating environment that is strikingly similar to that found in Europe prior to the 1993 reforms. While aviation cooperation between the EU and its member states and China has borne fruit by increasing connectivity and trade, in order to ensure global sustainability of the airline industry, their two respective models need to become more aligned.

Although China’s state-owned airlines were consolidated in 2002, making the country’s airline industry slightly less dependent on state-owned enterprises, it is still markedly different to the EU and United States’ industries. China’s model remains primarily orientated towards building scale and driving connectivity, rather than sustainable profitability.

In recent years, China has made progress in aligning its slot allocation and air traffic management practices with international standards. However, these standards are still not fully adhered to, and China’s airspace is mostly closed, as it remains under military control. In order to create a sustainable, open and competitive operating environment for both domestic and international airlines, more reforms are needed, especially in the areas of government financial support and competition.

In China, only international long-haul routes to and from either Beijing or Shanghai are profitable. Therefore, in order to attract investment and increase connectivity with other destinations in China, many local governments of smaller cities offer airlines financial support to open international routes. However, this subsidisation is failing to make these long-haul routes sufficiently profitable. More often than not, either because the subsidies are eventually withdrawn or because European airlines do not project a sustainable flow of income in subsequent years, flights to second- and third-tier Chinese cities end up being cancelled.

While Chinese airlines face the same issues as European airlines with respect to profitability, many can absorb losses on routes to and from these smaller cities. First, Chinese airlines can offset a loss-making, long-haul flight by connecting it to a profitable domestic flight, sourcing passengers from other cities that would have otherwise travelled through Beijing or Shanghai. Second, they can afford to operate the routes at a limited loss by leveraging subsidies. Third, they have extensive lines of credit through state-owned banks in China that can offset losses indefinitely.

This has resulted in many of China’s smaller airlines establishing long-haul flights from second- and third-tier cities. Even if the international leg of the itinerary makes a loss, or has to run on a very narrow margin, local subsidies help cover the loss, and more profitable connections to medium-sized Chinese cities can help squeeze a small positive margin out of the whole setup. However, the sustainability of this approach is highly questionable. These practices drive up the number of seats available to Chinese passengers wanting to travel to Europe. The imbalance between demand for seats and their supply then drives down prices, and reduces the sustainability of the already-functioning flights based out of Beijing or Shanghai.

In the short-term, the Chinese system gives its airlines an unfair advantage to quickly gain global market share. However, in the long-term, this is neither sustainable nor beneficial for airlines. When faced with the same problem nearly three decades ago, Europe took action to reform the sector. With its aviation market expected to become the world’s largest in 2022, China will have to move swiftly to similarly develop a sustainable airline industry.

Until the two respective models can be better aligned, Europe needs to be fully aware of the complexities of China’s market, particularly when renegotiating air traffic rights. The EU must weigh such considerations against the remaining untapped potential in China, while avoiding being sucked into a ‘race to the bottom’ on profitability on long-haul flights between the two destinations. The fact that European airlines have a fiduciary responsibility to shareholders and have to comply with EU competition law means that Chinese airlines will be able to last longer in such a race.

To download In for the Long Haul: Developing a Sustainable Operating Environment for Airlines in China, click here.