Riding the bumps

In our case, critical to our success and our strategy is our network, and we’ve been very careful not to damage the network. The network has helped us fill planes where other airlines have lost 10 points of load factor, we haven’t. We have almost the same load factor year-to-date as last year – our year-to-date load factor is only one and a half points below last year at 78.9 per cent. That’s 10 points better than some of our competitors. That’s because of our network. We can fill flights, it is not a problem filling planes, the main problem we’ve got is the front end of the plane has thinned out so much. You would have seen the recent IATA figures were they said there has been something like a 23 per cent reduction in traffic in the premium classes – that’s about it, and the yield even more. So the revenue is down even more because the yield is down, and that has had a huge impact on our overall yield.

The other problem we’ve got is cargo. The cargo market has been hit even harder than the passenger market.

But you do what you have to do.

We will be parking some planes. We keep thinking we’re going to sell some but that falls over when the buyer can’t arrange the finance!
We’ve also done unpaid leave. Almost 100 per cent of our staff signed up for some unpaid leave. We’ve staggered so that the lower paid are given a lot less than the higher paid, and that I think was seen by all as being fair, and as a result we’ve been able to get almost all the staff onboard.

So we do what we have to do.

I spend a lot of my time talking to Cathay people, talking to the media who communicate what’s going on. Rod Eddington, an old mate of ours and a former boss, used to say ‘you’ve got to keep saying things until well past the point you are sick of hearing the sound of your own voice, because it doesn’t matter how often you say things you can’t say things too often or to well’.

And you know that you’re getting through when a Marco Polo member told me at lunchtime, ‘you’re crew are fantastic, and you know what, they really get it’. They asked him at the end of the flight ‘how was the flight, how was the service?’, and he said ‘it was great’, and the crewmember said to him, ‘well it is important that you are happy with the service because we know the company is in a difficult position and we want to make sure you come back again’.

When that happens management is getting through to people, they get it. And that’s not the first time I’ve heard that.

Hong Kong, with a population of about seven million people and a tiny little place geographically is never going to generate enough in and out Hong Kong origin and destination traffic to sustain a big business like us. So you have to be in the business of flying Australians to china, flying Japanese to Europe, flying Americans to Vietnam, etc. So you’ve got to be in those markets as well, and to do that you’ve got to have an efficient hub – operating out of a good airport with good schedules in and out with easy and efficient connections, with comfortable lounges where premium passengers are prepared to make the stop, and so on.

Our hub strategy is very important, so when I speak about reducing our schedule I refer to sniping, it’s not cutting, not making wholesale cuts to damage the ability to earn the revenue, getting the frequency and capacity right in different markets.

It’s easy to mess up your business by saying, ‘right, we can’t afford to do that, so we will cut all those flights’ because half the passengers on those flights were connecting with other flights, and when you do that you find a whole lot of other flights become marginal. So we’ve been very careful about how we’ve snipped. As result we’ve probably made less capacity cuts – we’ve reduced our capacity by about eight per cent and other people have cut more, but when we’ve looked at cutting more we’ve said ‘we’re going to cut into flesh and not fat’, we’d do the death of a thousand cuts. So that’s been very important.

On the service side, rather like that cabin attendant, we don’t want to give any other reason for people to stop flying us and start flying someone else. So we haven’t cut the food budget. Yes we’ve economy class Hong Kong-Taipei we’ve started serving sandwiches instead of hot meals as they’re cheaper, but that money is going to get directed to where we need it. So we are not cutting budgets there, we’re not taking cabin crew off flights, we’re still investing in long haul cabin refurbishments, we’re still investing in good inflight entertainment because we want to make sure people keep flying us. And you know it sounds like a sort of council of despair to say it but cutting the peanuts from the service is not going to save me enough money to counter the loss of all my premium traffic, so it is not going to solve the problem, and it just might make it worse.

Operating with our legacy cost structure in an expensive place like Hong Kong we’re never going to match, as an overall airline operation, AirAsia’s costs, however it’s not to say we can’t compete with AirAsia using our backend capacity in targeted markets to make sure they don’t have it all their own way. When you take the average cost of a backend seat of a Cathay Pacific 777-300 operating in the region, when you think that there are premium passengers – although not enough at the moment unfortunately – sitting up the front and you’ve got cargo in the belly, and you’ve got the overall efficiencies of a big network to bring down your overhead costs, we can sell very cheap down the back and still make the whole package economically sensible. So even though on an overall basis our cost per ATK is going to be higher than theirs it doesn’t mean we can’t compete with them in targeted segments, and that’s what we have to do, clearly, because if we don’t, they’ll hollow us out.

That is the big question that is on the minds of all airline managements around the world – what is the new normal. At the moment, we’re in recession, at the moment we’re seeing negative figures. That will not last forever, eventually we start seeing positive traffic and positive revenue growth. So the question is, when the world turns to positive economic growth how strong is premium traffic going to be. On our network the average premium yield ratio is something like five to one in terms of front end-back end – is that going to be achievable (when growth returns)? That is the big question. To be honest nobody knows that. Some airline CEOs are saying the world has changed for ever, it will never be the same, but some of those CEOs have been operating in markets where I suggest that premium iseven higher.

When I look at transatlantic yields in the front end, and we’ve looked at that carefully because we’ve considered operating there, they have been significantly higher. The fares across the Atlantic between London and New York are not that different from what we get Hong Kong-Los Angeles where the distance is 40 or 50 per cent further.

I don’t know. It is certainly going to take time to repair itself, the question is whether it will ever get back to where it was. The banks already have started to change their travel policies again. I believe it will come back, the question is how fast and how high. I don’t believe premium travel has stopped forever. If you’re a businessman in Hong Kong and you’ve got to fly somewhere for 10 hours and start work immediately, you need to go flat and get some sleep. If you don’t you’re not going to trust yourself to do business that day, you’re going to have to spend the day doing nothing, and that is economic nonsense. You’re not going to sit even in a wonderful Cathay Pacific economy seat and expect yourself to be on form when you’ve flown half way around the world. There is going to be a market for flat beds, the question is how much people will people pay for it, and how many are going to do it, and I don’t know that yet.

We’re going to reduce the number of business class seats in our 777-300s in the region, where we’ve had too many for a long time, and we’re going to put more economy class seats in, so that will help the economics of that. But in the long haul, we’ve got no current plans to reduce the numbers. Our long haul 777-300s have 56 business class seats and seven first class, and for the markets we’ve got then them on that’s about right.

The Australian market has been all right. We have had to reduce our frequencies to Sydney. We went to four and we’ve trimmed that back to three, we’ve reduced some of the Brisbane flights through Cairns, with the current conditions those were struggling a bit so we’ve trimmed those down. But generally speaking the Australian market has held up. There was a time when the Aussie dollar was very weak and things didn’t look so great but it has come back a bit and that helps. Australia will always be a critical strategic market for Cathay Pacific, we do see it as part of our backyard, and one that we’ve invested in and been committed to for many years.

We’ve got a lot of Australian pilots, we’ve got a big Australian base here now. The very first Cathay Pacific flight was to Sydney carrying day old chicks, so Australia is very much a part of our heritage, and we feel a very warm feeling towards Australia.

One lesson I learnt, Fridgemobile? had a very sophisticated internal management accounting and profit centre system, and one of the things I learnt when I ran the Adelaide terminal was that I made the biggest profits the Adelaide terminal had ever made within this management accounting system because I found it was much cheaper for me to subcontract someone else to carry my freight to Sydney and Melbourne and Brisbane than it was for to use my own company vans because they had an internal charging system so I made huge profits with my yard filled up with vans and everyone in Sydney and Melbourne and Brisbane screaming ‘where are all the bloody vans?’ and later on when I started studying business properly I realised that the company’s system for internal pricing was wrong, and it gave the wrong signals to management about how to behave. I was only running it for a month or two so it didn’t do too much damage! But it’s one of the reasons while I’m in this seat that we won’t, for example, separate our cargo business like some airlines have done as a (separate) profit centre. It seems to me that the entire profitability of some separate cargo businesses depends on the transfer price of the belly space, and that is a completely arbitrary decision – how do you allocate the cost of the pilots between the passenger and cargo businesses, the cost of the overflight charges? You could do it a number of different ways, there’s no right way or wrong way, it’s arbitrary so I strongly believe that you need to do it differently. The way we run our cargo is the way we’ve always done it – the freighters are easy, the freighters are a cost centre, a profit centre you can see that – the bellys, you’ve got to manage that with the passenger business and you’ve got to motivate your cargo sales people through other ways of revenue targets and efficiency targets and things like. That’s how we do it, and that’s a lesson I learned at Fridgemobile? !

The lesson I learned there was that transfer pricing within a business, unless you get it right, can lead to wrong behaviours which can damage the business. And how you get it right is very difficult. If you don’t have to do it, don’t to do it, keep it simple.

I love to see it, I think it would be great, I just don’t think it’s going to happen. The airline industry is fundamentally dysfunctional because it doesn’t consolidate the way every other industry under the sun doesn’t consolidate, because of the sovereignity of traffic rights. And if you didn’t have that you would get big airlines forming with a whole lot of niche carriers doing their thing. And then there would be some chance that the industry would return its cost of capital. Personally I don’t think it’s going to happen any time, and if the rules of the game are that it’s bilateral traffic rights, it’s haggling between different states, if that’s how the game is played … that’s how it is played. Whether those are the best rules of the game is not for me to say, but those are the rules of the game, and if you go and try to play it some other way you’re going to lose.

We did a big deal three years ago where we bought Dragonair out and we’ve integrated it in quiet a sensible way into the Cathay operation, and at the same time we took a share in Air China, and they in us. But we don’t believe Air China excepted, we don’t believe in taking minority stakes in other companies, and that is all you can do because of the sovereignity issue. If you can’t control the entity we give the money to then we’re not going to do it.

If the world was different, and we could go and buy other airlines and run them and somehow generate synergies out of either the cost or revenue side between the different operations then we would certainly, I’d like to think be in the position that we were the one doing it rather than the one having it done to us. But that is not the way the aviation world works. Europe … but even then they’re have to put structures in place to separate out the traffic rights.

It looked to me fiendishly complicated and difficult to run. And to be honest also I looked at that idea and I couldn’t really see where the synergies were coming from. Cost synergies would be very difficult to get much out of, and then even the revenue synergies, I personally couldn’t see, given the fact they already had this JSA which allows them to pool the big areas of overlap are already pooled, it was hard to see how they were really going to generate huge synergies. And I guess they came to the same conclusion, when they looked at it more closely.

No, we haven’t. Over the years we’ve had some very high level informal discussions about what if, but you pretty quickly come up against some very difficult obstacles. There is the great sovereignity obstacle for a start, if you can overcome that you’ve then got governance issues and you’ve got anti-trust issues, and what would the price be. Let’s face it, if you were putting together Cathay Pacific and Qantas in some way it would dominate the Hong Kong Australia route, and the Australian ACCC, and in the future probably Hong Kong because Hong Kong introducing competition law some time in the next five years, would probably say ‘that’s not right and you’ve got to give something up’ – well you start giving up something that is certain and known and good for the benefit that is uncertain and unknown and maybe not be easily realised, and you start to think is it worth it.

China main game – “Absolutely”

The advantage we’ve got is we serve 17 cities in China at the moment, we’ve had to pull out of one or two due to the crisis but we can always go back pretty easily, and between Hong Kong and most cities in China it is actually ‘open skies’, and between the main cities like Beijing and Shanghai we’ve got as many (frequencies) as we could ever want really. So we’ve got this fantastic network in China and Hong Kong is a great hub, especially for this part of the world, but even to Europe and North America (from China) we still do pretty well. Dragonair is the strongest airline brand name in China and consistently wins best airline in China award. When I get around China and say ‘I’m CEO of Cathay Pacific’ they look a bit blank, but when I say I’m chairman of Dragonair I get (a great response) because it’s known very well.

We’re not going to dominate Chinese aviation, let’s be realistic, but with our partnership with Air China I think we can get ourselves into a position that we’ve got two hubs, Hong Kong and Beijing, they’re more than three hours’ flying apart so they’re not in each others’ backyards and are geographically distinct, and we can in time position Hong Kong and Beijing as the premier hubs for anyone flying into China, out of China, around China. The vision that we share with Air China is that in the years to come anyone who is thinking of flying to China will think of one or the other of us and the Hong Kong or Beijing hubs. So between the two of us we’ll position ourselves very strongly.

Codeshare on all our routes and JV on routes which we both fly

We’re going to do more and more things together. We’ve got codeshares, we’ve got the joint venture flights, we were going to be doing a joint venture cargo business which is taking a long time ot negotiate and get in place, there’s a lot of obstacles to overcome, but we will eventually have a joint venture cargo business with them with a centre of operations in Shanghai covering the Yanghtze Delta, and we’ll own 49 per cent of that.

I think as time goes on we’ll do more and more things together, we intend to be distinct ownership entities

No plans to share greater ownership in each other

Everyone can see that having a strategic friend like that is a good thing

We’re very much now part of the greater China aviation family, and by linking with China we’re very well positioned.

We were hoping to sell five sell five 777s, but we’re looking now at what we want to park, given that we can’t sell them, we’re looking at what makes most sense to park. We’ve parked five freighters already and we’ve leased one freighter out to Air Hong Kong. We will be parking some passenger aircraft but we haven’t announced them. We will be parking five or six aircraft in the near future.

We’ve done a lot of analysis of the A380, and I don’t want to upset anybody, but with our fleet and with our network we see better ways of moving people around than the current version of the A380. I’ve no doubt the A380 is going to be very successful aircraft and a very strong competitor with good economics. We believe there are aircraft at the moment with better economics for our particular network.

The A350 looks a very interesting aircraft indeed, if it does what it says on the box, I think we’d be very interested in that aircraft. The 787 is a very good aircraft, but a bit small for us, and perhaps not quiet the range we want. The 787-10, if it happens, might be a stronger competitor, but then you;re starting to get into A350 territory. It’s the less obvious one for us, although I’m sure eventually it will be a very good aircraft.

I’m very happy with what we’ve got at the moment. Clearly if fuel prices then our 747s are going to look less like a good idea earlier, and we may want to phase them out quicker, meanwhile we continue to develop 777s. We’re telling Boeing and GE we think they’re going to need to ginger that aeroplane up if they want to keep it competitive, and I think they know that. We’ve got 30 on firm order and I can see us eventually probably getting more, especially if the economics are improved of that airframe and engine. And then we’re going to the A350 coming in as real serious candidate, maybe the 787-10, and as I said the A380. I wouldn’t rule out the 747-8 Intercontinental as well, that might do the job for us as well, but at the moment we don’t want a bigger aeroplane, we’re quite happy to go with frequency and not capacity. And the 777, we’ve got three a day to New York – the A380 can’t do New York – our passengers like frequency, and that’s the way to successful airline economics – not having to sell another 100 or so seats at the same time of day. At the moment you’re rejecting those 100 passengers because their yield is lower that the ones you are carrying if you’ve got a sensible revenue management system. So by definition you’re carrying another 100 low yield passengers. If on the other hand you’ve a flight at a different time of the day you’re in a different market , connecting different places, you have people who may want to put a full day’s work in before they fly, or they want to go in the morning and not the evening – it’s a different game, and then you’ve got a change of getting passengers that are high yield. That’s the game we play, the frequency game, and the 777 is a real winner, across the Pacific it’s a real winner.

The A350-1000 could be a 777 killer 45min could be if Boeing/GE don’t develop 777

We’ve got some great 747-8 Freighters coming, with the first deliveries planned for the end of next year. But with six of our own freighters out of operation at the moment it’s something we don’t need at the moment so we’re talking to Boeing about delaying those, and we’re talking to Airbus about delaying some A330s – again a great aircraft, we will need them, but we don’t really need them quiet as early as we’re contracted to take them.

We may have seen it now – freight levelling off, but at a low level

26:44