Feature: Empty Skies
The fall in passenger traffic due to SARS is just the latest in a long string of recent problems facing the airlines.
The fall in passenger traffic due to SARS is just the latest in a long string of recent problems facing the airlines.
By Tim Culpan
Just when it seemed like things couldn't get any worse, they did. For the Taiwan airline business, along with its counterparts around the globe, the past twenty months have represented one crisis after another. First the industry watched as its prospects fell along with the Twin Towers, creating fear of flying among passengers worldwide. Closer to home, the loss of China Airlines flight CI611 en route from Taipei to Hong Kong on May 25 last year reminded people why the Taiwan aviation industry has had such a bad reputation, and anxiety about regional terrorism grew after the Bali bombing in October.
Big picture problems, such as the worldwide economic slump and the protracted uncertainty over what would happen in Iraq and when, also took their toll, but in retrospect seem almost insignificant compared to the latest blast -- from SARS -- which has clouded the long-term picture for the Taiwan aviation industry. "With the Iraq war, you have a pattern and you can do some planning," says Andrea Wu, general manager of United Airlines in Taiwan. "This SARS is something nobody has planned for."
The disappearance of CI611 into the Taiwan Strait hit China Airlines hard, and also hurt other players in the Taiwan market. While some passengers opted to fly EVA and other regional competitors, others elected not to fly at all. Even if SARS had not appeared, the industry would still be feeling the effects of that crash.
Cut-Throat Pricing
"China Airlines had to cut costs to get passengers to fly with them again, and that has forced the rest of us to follow and brought prices very low," said one airline executive who asked not to be named. Indeed, Taiwan now has one of the lowest yields in the region even though it sits at one end of one of the world's busiest international air routes -- Taipei-Hong Kong.
United's Wu says that for her company, Hong Kong, Tokyo, Sydney, and even Bangkok rate higher than Taipei for yield, defined as the income (including revenue from cargo) per kilometer flown. While declining to give exact figures, she estimates that United's yield in Taiwan has fallen 10 to 15 percent over the past year, a figure that analysts say is indicative of the industry as a whole.
Ironically, the single biggest competitive edge that China Airlines' local rival EVA and such international players as United might have is one that they can't play up. "No one ever wants to use safety as a sales pitch," says Wu. "It's such a tragedy in itself that I don't think anyone wants to use it against a competitor."
EVA has been the one to benefit most from CAL's poor safety record (five crashes since 1989), since it is the only one to offer similar services and routes, but it too has been muted in its response to CAL's safety problems. EVA officials did not make themselves available to talk for this article, but passengers would be hard-pressed to find mention of safety in EVA advertising or from airline executives.
The combination of China Airlines's safety record and the large number of carriers serving Taiwan has contributed to pushing down prices and cutting the profitability of those who operate here.
"I think all carriers will deny it, but in the Taiwan market the yield is too low. With this price, you can't work up to a reasonable level -- not even saying profitable, just reasonable," says Wu.
Direct Links
A supposed bright light for all carriers serving Taiwan is the prospect of one day being able to fly directly between cities in Taiwan and the China mainland. Both local and foreign businesses have been pushing for such direct flights for years, so as to reduce the time needed for business travel, but progress remains held up by security concerns and political considerations.
Should those obstacles be overcome, the first carriers to gain access to those routes would undoubtedly be Taiwan's EVA and China Airlines, simply because they are based in Taiwan. Foreign carriers such as Northwest and United would need to wait for bilateral deals to be signed by their own governments.
"The potential for China Airlines to make good money is in direct flights," says Christopher Smith, an analyst covering aviation for Primasia Securities. But surprisingly, CAL itself does not necessarily view direct flights as a good thing for its business. "Frankly speaking, we're enjoying our current status," says CAL Chairman Lee Yun-ling. The main route for Taiwan-China indirect flights is that between Hong Kong and Taipei, which is fully served by only four airlines: CAL, EVA, Cathay Pacific, and Dragonair. Other carriers can only participate in that route as part of onward flights to third destinations.
"Right now, the smaller pie is for four operators. If we open up, it'll be a bigger pie but the mainland carriers will also join, so our share could drop," says Lee. In other words, while CAL and EVA enjoy a strong hold on the HKG-TPE route, they are unlikely to enjoy the same dominance of a SHA-TPE route once China's operators join the market. But regardless of the amount of market share it could reap, CAL has completed its preparations in case government policy should change. When could the airline be ready to start flights to China? "Tomorrow morning at eight o'clock" was Lee's reply.
Foreign carriers also make clear their interest in joining the party if invited. "We definitely want to participate if direct links start," says United's Wu.
Strength in Cargo
While the passenger business has suffered from consumer fears over safety and SARS, the cargo business has continued to hold up comparatively well. "Cargo doesn't have the same psychological fears as passengers do -- [packages] don't worry about getting sick," noted an executive from one cargo company. At the height of the hostilities in Iraq, both CAL and EVA managed to raise their cargo rates more than 50 percent with almost no drop in volume. The two companies benefited from a decrease in competition as regional rivals cut back operations and U.S. carriers had to turn over aircraft to the American military to support the war effort.
Now the SARS epidemic has resulted in a reduction in passenger flights, decreasing the amount of space available in the belly of planes for freight. But many customers who are unwilling to travel themselves are making increased use of courier services to take the place of personal visits. "It's too early to make the comment that the express freight business won't suffer," says Jimmy Chen, managing director of Federal Express in Taiwan. "There's a definite decline in airlift capacity. This would probably affect the express business of those that utilize commercial lift." Fedex uses its own aircraft for its express freight operations, while also selling airlift capacity to third parties.
"Taiwan has always been an important market for the express industry, which is why so many express freight companies are active here," says Chen. "It's important because the Taiwan economy is export oriented." In addition, the island's geographical location, right in the middle of routes between North America, North Asia, and Southeast Asia, has made it a busy transshipment hub for cargo operators.
For Taiwan carriers, having a home base in such a geographically convenient location is a definite advantage. Both EVA and CAL have strong cargo businesses that have weathered various macroeconomic storms quite well. The Taiwan carriers are also looking to seize opportunities to expand that business. Cargo accounted for 39 percent of CAL's revenue last year, and the carrier has set a long-term goal of achieving a 50/50 split in revenue between cargo and passenger services. "Our goal is to become a worldwide top-five cargo carrier by 2006," says CAL's Lee.
Being Taiwan-based has many advantages apart from the possibility of cross-Strait flights.
Primasia's Smith notes that CAL has strong prospects in the Greater China cargo business, with its hand strengthened by its investment in China Air Cargo, a joint venture with the mainland's China Eastern Airlines. While CAL may or may not lose its upper hand in the Greater China passenger business as a result of direct cross-Strait flights, there is a strong belief that its cargo business can only get stronger. The same holds true for EVA, which is also very strong in cargo and is looking to build its freight business further.
The wildcard for Taiwan as a base, and for Taiwan cargo carriers, once again remains the if and when of direct links. "Taiwan remains attractive as a transshipment point," says Chen of Fedex.?"However, it needs to improve normalization of cross-Strait trade. Normalization will be good for both sides and for the express freight business."
[Interview] "We Did Find A Lot of Discrepancies."
China Airlines' chairman, Captain Lee Yun-ling, is a 50-year aviation veteran who took up his present post in November 2001 -- in part to help turn around the airline's safety record. Long an active advocate of air safety, Lee was awarded a distinguished service award by the international Flight Safety Foundation in November 2001. He was interviewed for TOPICS by staff writer Tim Culpan. Excerpts follow. ?br>
TOPICS: What was the major thinking behind procurement of the new fleet that China Airlines will be phasing in over the next few years? What are the cost benefits?
Lee: We're trying to reduce the types of aircraft we use to simplify our fleet. Right now we're working with five different types of aircraft. We eventually want to reduce it to three (basic) types by 2006. For each different type, you've got to cover inventory costs, maintenance crews, tooling. And for flight there are simulators, pilot training, type transition, and qualification.
TOPICS: Are there complications from having to buy both Boeing and Airbus equipment?
Lee: In fact, we don't want, as the saying goes, to put all our eggs in one basket -- Airbus or Boeing. For example, when Dragonair's Airbus A330 with the Trent700 engines had a problem, all nine aircraft got grounded. [Editor's note: Dragonair cancelled hundreds of flights and lost more than NT$600 million when engine trouble grounded its A330 fleet in 1997]. That's why we're trying to simplify our fleet, but at the same time we're not counting on [just] one OEM.
TOPICS: China Airlines maintenance has come under the spotlight. How has China Airlines changed its maintenance procedures since the crash of May 25 last year?
Lee: In my last position in China Airlines I was inspector-general to the board, so I happen to know most of the functions. Ever since I came back to the company [July 2000], I found that our maintenance is really a burden for China Airlines. Too many types of aircraft, too heavy an inventory, and a lot of mechanics and engineers who need to be qualified for different types of aircraft. So I asked a few questions. First I said, "did anybody look at the repeated items daily?" Captain A writes some discrepancies, and the ground staff says 'okay, ground check normal.' Then Captain B says the same thing. This is called repeated discrepancies. I said I wanted a daily report.
Then I also asked our maintenance team, did you ever trace our deferred items? And they say "ah, this is being held for next weekend due to shortage of parts." I found one aircraft carried 14 discrepancies, so I said "why? I want to know daily deferred defects."
TOPICS: They weren't even doing daily deferred, daily repeated (maintenance reports)?
Lee: That's right... So, (now) they've got somebody to look over their shoulder.
TOPICS: It's almost three years since you came in, and you're still having to do this. Isn't it a bit strange that the chairman of the company has to take on such tasks?
Lee: I ask our senior VP to do the same thing. But it [gets more] attention when someone in a higher position is watching.
TOPICS: These reports are here, in the chairman's office. Is that the best procedure?
Lee: In the chairman's office, the president's office, the VP's office, the director's office. The same thing is in everybody's office. Then at the end of the month they should do a summary. And I quiz them (to see) if there's any improvement.
TOPICS: Why is it that you, as the chairman, should even be examining daily reports? Should you have to do that?
Lee: Because it's my personal interest. I've been involved in safety management for nearly 50 years. So I ask them to do this [provide the reports].
TOPICS: I've heard stories about maintenance crews saying after the departure of Christine Tsung (CAL's former president) that they were happy they could go back to old way of doing things, which was sloppy.
Lee: She spent a lot of time to motivate people.
TOPICS: It worked, didn't it? Things were going pretty well until May last year.
Lee: I would say the problems that were there only surfaced in May.
TOPICS: So you're saying that the problems existed before May?
Lee: That's right.
TOPICS: Does that then mean that a crash was inevitable?
Lee: So far, we don't know what happened on the flight -- it's still under investigation. However, we did find a lot of discrepancies in our...from my standards [and] I've been behaving like a safety manager all these years.
TOPICS: If they hadn't surfaced in May, some of these maintenance problems wouldn't have been noticed and might have continued.?Does that indicate that some kind of accident was going to happen anyway?
Lee: I don't mean that the May accident was caused by maintenance, because it's still under investigation. But I did notice a lot of discipline problems before that. We disqualified a lot of not-capable mechanics as well. And right now we are working very closely with Singapore Airlines' engineering company to do a three-year program to reshape our maintenance management system. Because most of our maintenance force is technically oriented, not management oriented. We need to adapt some of our management [practices].
TOPICS: How much has the Ministry of Defense asked you to pay for the search and rescue operations after last year's crash?
Lee: That's another issue. I want to ask the defense ministry: "Did we sign a contract? No. So why do you come asking me for money? I didn't ask for your support. The government wanted it." If I need the military to send ships for search and rescue, I will sign an agreement. But there's no agreement. It's part of government responsibility because we are in Taiwan air space. We pay the airspace fee and they have to provide communications, separation, information, and search and rescue service. That's [why] we pay the overflight fee.
TOPICS: Wouldn't it be a good public relations exercise to pay?
Lee: I understand what you mean. But what about my facing the shareholders this coming June? I have to protect all of the shareholders.
TOPICS: What is your feeling about the crash last May?
Lee: I feel sorry about this, but I also concentrate my efforts on fact-finding because we submitted documents to Boeing about this aircraft's structural inspections. All these records went to Boeing and they approved it, so we operated this aircraft.
[Box] Domestic Market Travails
For a market of this size, the number of domestic aviation carriers in Taiwan is bewildering. Four companies -- Far Eastern Air Transport (FAT), Mandarin Airlines, Trans Asia Airways, and Uni Air -- are currently operating on domestic routes, but that situation is not likely to last much longer.
New highways and faster trains have made it easier to get from one part of the island to another on the ground. The domestic airline industry's checkered safety record has also done little to enamour it to the traveling public.
According to Lee Yun-ling, who is chairman of both China Airlines and its domestic subisidary Mandarin Airlines, the only profitable domestic routes are Taipei-Kaohsiung and Taipei-Taichung. Other routes such as Taipei-Taitung, Taipei-Hualien, and even Taipei-Tainan are losing money.
Mandarin Airlines is able to operate only because the parent company provides support by guaranteeing its loans. Mandarin can also cushion domestic loses from its earnings from profitable international flights to such offbeat destinations as Cebu, Yangon, and Chiangmai.
Flights to the outlying islands of Matsu, Penghu, and Kinmen are subsidized by the government. But flights within the main island of Taiwan receive no subsidies despite the government's plea to keep the routes open to boost the tourism industry, an important new policy goal of the Chen Shui-bian administration.
While not asking for subsidies to keep those routes going, Lee wishes the government would scale back the high burden of fees that he says makes the difference between profit and loss. Navigation, noise, and landing taxes account for 15 percent of the cost for any given route, and are levied at the full rate no matter how full the flight is.
As for consolidation, it seems logical that some of the existing carriers will have to combine forces, but politics, stubbornness, and the lack of viable strategies continue to stand in the way.
But if market conditions are bad now, the domestic operators know that worse is yet to come, says Christopher Smith, aviation equities analyst at Primasia Securities. "The high-speed rail [due to start up in October, 2005] will kill the industry," he says flatly.
---Tim Culpan
