Reference no: EM132229095

Please read the case, then answer the following questions.

Budget airlines find Hong Kong a tough market to crack

Budget airlines are also known as low-cost carriers or no-frill carriers. Budget airlines are generally without most of the traditional services provided resulting in lower fares and less comfort. Most of them provide short-haul or regional routes to places within five-hour flight time.

Budget airlines are thriving in South Asia, but in North Asia – particularly Hong Kong –they are struggling. Hong Kong Express is the city’s sole budget airline so far, launched in October 2013. Jetstar Hong Kong, another budget carrier that has been trying to get off the ground since 2012, is on indefinite hold thanks to delays in its licensing.

Low-cost airlines control about 45 per cent of the South Asian market but just 5 to 6 per cent of the Hong Kong market, estimates Andrew Cowen, deputy chief executive of Hong Kong Express.

Budget airlines cut out all extras such as food or drinks unless you pay for it and charge for check-in luggage. There is no entertainment. They often force passengers to unload on the tarmac using external stairs, to shave off the fractional cost (about HK$1 per passenger) of using a passenger boarding bridge.

The airlines also use a single aircraft type (Jetstar, Hong Kong Express and AirAsia only fly Airbus 320 jets) which not only increases the bargaining power to purchase aircraft in bulk, but cuts maintenance and pilot training costs. Further, to cut the cost, they use the secondary airports or terminals for lower landing fees and airport administration fees.

Budget carriers are also very focused on getting their planes back in the air. Cabin crew clean the plane as soon as it lands, working from the back, which means the plane does not have to wait for a cleaning crew.

AirAsia uses leather seats for the simple reason that they are easy to wipe down (the fact that few people are eating on the plane also cuts down on mess).

These saved minutes add up. AirAsia chief executive Tony Fernandes told the South China Morning Post that his jets take just 25 minutes to get back in the air after hitting the gate, as opposed to the 1-11/2-hour wait seen by a premium carrier. Quicker turnarounds (less time on the ground, more flights per day) mean planes are in the air more, maximising the revenue of each aircraft.

So why is the budget carrier such a difficult business model to pull off in north Asia? Japan only got its first budget carrier in 2012. Taiwan still has none. The mainland is warming to the lowcost model, but its two budget carriers (Spring Airlines and West Air) are on the periphery of that market.

The problem is largely down to North Asia’s high fixed costs. All airlines have to pay the same high wages, fuel bills and airport landing fees. This means that the part of the ticket on which the budget carriers can discount – food and entertainment costs – becomes less significant.

“Hong Kong is a difficult market for the budget carriers. It has high costs and is significantly more constrained,” said Daniel Tsang, founder of Aspire Aviation, an aviation consulting firm.

The problem is partly explained by regulators’ unwillingness in North Asian countries to let budget airlines compete with profitable incumbents with a vast local workforce.

“The Chinese government likes to protect their own interests … and they will block [low-cost carriers] with the airline licensing,” said Daniel Wong, an analyst at Hong Leong Investment Bank.

Cowen said: “I have worked on low-cost carriers where they were not able to come into the market … [because] regulators refused to issue extra licences to protect the incumbent flag carrier.”

Cowen’s comments are slightly ironic in that Hong Kong Express filed an objection – along with Cathay – to Jetstar’s Hong Kong licensing.

Cathay Pacific objected to Jetstar’s application for a Hong Kong licence, in September last year, on the grounds that it violated the Basic Law, Hong Kong’s mini-constitution. In 2005, Cathay also opposed the licence application by the now-defunct Oasis Hong Kong Airlines.

“You have a dominant carrier in Cathay which uses its muscle to slow down airlines that try to come into its market,” said Fernandes. “It becomes a political issue … [Cathay] seem to be dead against any low-cost carrier coming in.”

Cathay Pacific says that granting Jetstar a licence would violate the Basic Law and put important economic assets into the hands of a carrier controlled by a foreign airline.

“This is not a simple matter of a budget airline seeking to establish its operations in Hong Kong. It is much more than that. It is an issue that will have far-reaching impact on Hong Kong’s overall competitiveness and ultimately on Hong Kong’s position as Asia’s aviation hub,” said a Cathay spokesman.

Edward Lau, chief executive of Jetstar Hong Kong, would not be drawn in to comment on the motives of regulators or the companies that oppose Jetstar’s launch, saying simply that it is a process the firm needs to go through.

“It’s the difficulty of launching a low-cost carrier in North Asia. It’s reflected [by the fact that] low-cost carriers hold barely 6 per cent of the Hong Kong market,” he said. “The low-cost model … has not been adopted in Hong Kong.”

Question A

What is value chain analysis? How do specific ways of managing the value chain activities help budget airlines to achieve low cost?

Question B

In general, successful budget airlines focus mainly on short-haul or regional routes. Do you think that the budget airline model is suitable for long-haul flights? Why?

Question C

What kind of uncertainties do budget airlines encounter in the Hong Kong market? How can they resolve these uncertainties?