BUSINESS 478-Section D400 CASE SYNOPSIS:

BUSINESS 478-Section D400 CASE SYNOPSIS: CATHAY PACIFIC Group C: Clarence Yip Loveleen Sangha Wing Chun Tang Kristy Hoi Ching Luk Jia Wen Zhu Date: October 14, 2015

INTRODUCTION Background Cathay Pacific Airways is an international airline registered and based in Hong Kong. The airline was founded by American Roy C Farrell and Australian Sydney H de Kantzow on 24 September 1946, is an international airline registered and based in Hong Kong. The airline expanded fast, and in 1948 Butterfield & Swire, one of the Hong Kong s leading trading companies, took a 45% share in the company. In 1964, the airline celebrated carrying their one-millionth passenger and during the worldwide economic boom in the 1980 s, the airline industry was doing magnificent. Business travelers, tourists and cargo flights were at an all-time high, which led to the expansion of Cathay s international network to include London, Frankfurt, Vancouver, Rome, San Francisco and other major cities in the world (Cathay Pacific, 2015). The Organization Today In 2002, Cathay became joint venture partners in Air Hong Kong, along with DHL. Air Hong Kong today has a fleet of eight Airbus, 300 freighter aircraft and also a network for express overnight cargo deliveries. They signed an agreement in 2006, which brought Dragonair into the Cathay Pacific Group as a wholly owned subsidiary, and also around the same time they established a close relationship with Air China. Today, the Cathay Pacific Group s fleet includes more than 150 wide-body aircraft with an average age of 8.5 years. The aircraft travel to about 130 destinations across the globe and they are committed to operating a modern, fuel-efficient fleet (Cathay Pacific, 2015). Cathay Pacific and its subsidiaries and associates employ over 20,000 staff in Hong Kong (Cathay Pacific, 2015). Mission Cathay s vision is to be the world s best airline. Being the best means that Cathay always strives to excel in everything they do. Their dynamic team provides the highest quality service so that their customers because of choosing Cathay Pacific (Cathay Pacific, 2015). General environment EXTERNAL ANALYSIS Economic, demographic, sociocultural, political, technological and global segments are discussed below. 1

(a) Economic Gross Domestic Product (GDP) of Hong Kong has been growing gradually from 2011 to 2015 at a pace of around 2.9% per year (Forbes, 2015). The inflation rate in Hong Kong in 2015 is expected to be around 4%. The GDP per capita is $54,700 USD (Forbes, 2015). According to The World Bank, Hong Kong is listed in the high income level category. These positive numbers show that Hong Kong has strong economic performance and high purchasing power to remain a strong market for Cathay. (b) Demographic The following table shows the targeted population and the median monthly income measured in USD. TABLE 1: Demographics of Hong Kong: Demographics 2014 Population between 15-54 4,165,000 Median Age 43.2 Median Monthly Domestic Household Income $3,300 Source: http://www.gov.hk/en/about/abouthk/factsheets/docs/population.pdf The majority of population in HK is between 15 and 54 (around 60%), with a median age of 43.2. They have a high median of monthly domestic household income of $3,300 USD per month (Gov HK, 2015). (iii) Sociocultural Segment There is an increasing environmental concern towards the aviation industry in recent years. As airplanes emit large amount of greenhouse gases while operating, this will greatly affect the air quality and accelerate the process of global warming. Approximately 60% of total aviation emissions stem come from international flights (David Suzuki, 2015). This results in more and more concerns from the public, government, NGOs and the airline companies themselves regarding the air pollution.. (iv) Political/Legal Segment There are taxes charged on the fuel used by flights in Hong Kong. That tax is called Passenger & Cargo Fuel Surcharges. Another tax is called Air Passenger Departure Tax, the HK$120 ($15 USD) is 2

normally levied on each passenger aged 12 years or above who departs from Hong Kong by air. These taxes are usually collected from the airlines when the passengers purchase their air tickets. (v) Technological Segment In 2011, Hong Kong Productivity Council (HKPC) successfully developed Hong Kong s first passenger aircraft cabin seat in full compliance with international aviation safety standards. These cabin seats are made of carbon composite seatbacks, which are 30% to 40% lighter than traditional aluminum alloy products, which can help to save fuel cost. Also, as the production line will be set up in the Pearl River Delta region, the production cost is expected to be 30% lower than the overseas competitors. (vi) Global Segment There is also a growing middle-class in emerging countries, especially in Asia such as China and India. These countries increase the demand for travelling and this makes them critical global markets for the aviation industry. Moreover, the Air Bus aviation global market forecast of 2013-2032 shows that there is an increasing propensity to travel in China and India (Air Bus, 2015). This also shows that China and India are important global markets for the aviation industry. INDUSTRY ENVIRONMENT Threat of New Entrants: Low The large start-up capital creates a huge entry barrier to enter the aviation industry. The expectation of providing high-quality and reliable services heightens the entry barrier. Also, customers tend to select reputable airlines to ensure a safe and comfortable flight. The market is so saturated that it will be hard for the new entrants to differentiate themselves. If they offer air tickets at a low price, entrants will suffer operating losses. The airline industry is also well-known for its long and strict safety requirements and regulations. The number of years of experience required, regulations, and capital requirements are difficult enough to prevent new competitors entering the market. Bargaining Power of Suppliers: High All airplanes need fuel, this makes Cathay being highly dependent on fuel suppliers. Cathay needs to purchase fuel to run its business and leaves no room for bargaining. The next important suppliers are 3

airplane manufacturers such as Boeing and Airbus. They are the sole suppliers of airplanes and it is almost impossible for Cathay to switch to other smaller manufacturers. The long-term contract with manufacturers further increases the switching cost. Cathay must also obey the rules set by different countries air control authorities to grant permissions using the runways in their airports. Bargaining Power of Buyers: High For individual buyers, they can compare airfares via various channels such as online agencies, official websites of airlines and so forth. They can pick the lowest airfare by just one click. It is so easy for Cathay s competitors to attract customers with a low airfare. There are low switching costs because many people can easily choose the flight based on locations and prices. For group buyers, they tend to work with multiple airlines to provide tickets to customers. If Cathay cannot provide desirable prices for the agencies, they can easily switch to other companies without significant losses. Threat of Substitutes: Moderate There are many substitutes for flying because people do not need to take planes to travel. People can choose car, cruise ship, train and other form of transportation to reach their destinations. People are able to travel around at a lower cost and this makes these options good substitutes for planes. However, as planes are much faster than other forms of transportation, some customers are willing to pay more to save time. Different options capture different niches. The total impact of all these factors poses a moderate treat of substitutes to the industry. Intensity of Rivalry: High As mentioned before, the industry is very saturated and it is in the mature stage of the business cycle. The significant fixed cost and set up requirements make airlines reluctant to leave the industry and stay in business. The huge number of staff employed and complexity of long term agreements with other businesses further heightens competition. Airlines often need to promote special offers to maximize their own productive capacities. This is done by cutting ticket prices. In recent years, there are more Hong- Kong based budget airlines appearing in the market. The rivalry of existing players is high and airlines that do not have enough competing power will be forced to exit the market. 4

Competitor environment Competitors of Cathy Pacific can be classified into two main types. The first type of competitor is the traditional airline which provides full and quality service to the customers. Examples include Singapore Airlines and Emirates. The second type of competitors are budget airlines which provide limited service to the customers and low ticket prices. These airlines will offer flights to the destinations that Cathy Pacific offers. Examples include Hong Kong Express, Vanilla Air and Peach Aviation. CURRENT SITUATION Financial The following table shows the encouraging financial performance of Cathay Pacific from 2012 to 2014. Cathay is performing better each year, with an increasing revenue of $1,000 USD million and $300 million USD increase in profit before tax. Cash flow has also increased over 30% and profit margin has increased over 50% in three years. TABLE 2: Three Years Financial Performance of Cathay Pacific, 2012-2014 Financial Indicator 2012 2013 2014 Operating revenue (Millions US $) 12,829 12,960 13,667 P/L before tax (Millions US $) 191 462 552 Cash flow (Millions US $) 987 1,313 1,559 Profit margin (Percent of Sales) 1.49 3.56 3.82 Source: https://mintglobal.bvdinfo.com/version-2015107/report.onepage.serv?_cid=103&context=2os5br39zygk22e&format=default&fromid=list&seqnr=1 Expansion Cathay is trying to expand the number of routes it flies to increase its market share. In September 2015, Cathay announced that they will be adding service to Madrid in 2016. By then, Cathay will become the only carrier that provides direct flight from Hong Kong to Madrid. Cathay is differentiating itself with new products and launching various campaigns to increase its attractiveness. Cathay started Fanfares, a program that promotes limited number of special offers to designated places. It aims to attract more customers to enjoy Cathay s service by buying these special tickets at cheaper prices (Cathay Pacific, 2015). 5

STRATEGY Business Level Strategy: Increase Passenger Capacity/Differentiation Cathay s increase in passenger capacity is reflected by the introduction of new routes and more flights on some existing routes. In May 2015, Cathay Pacific introduced passenger services to Zurich in March and to Boston in May (Cathay Pacific, 2015). Cathay also differentiates itself by investing in new aircrafts and cabin technology such as cloud-based inflight catering system and distributing mobile tablet devices to cabin crew to provide top-class services to customers (Cathay Pacific, 2015). Corporate Level Strategy: Related-Constrained Diversification Cathay diversifies its business by having different separate business units: Cathay Pacific Freighter, Cathay Pacific Catering Services, Air Hong Kong and Dragonair (Cathay Pacific, 2015). The multi brand strategy helps to diversify the business risk and capture customers from different sectors. International Strategy: Global Operation Cathay Pacific operates globally, its flight network covers more than 1,000 locations worldwide and covers almost all major cities (Cathay Pacific, 2015). Cathay s global network is shown below: FIGURE 1: Cathay Pacific s Global Route Network Source: http://www.cathaypacific.com/content/dam/cx/about-us/investor-relations/interim-annual-reports/en/2015_cx_interim_report_en.pdf 6

Cooperative Strategies: Horizontal Alliance Cathay continues to strengthen its global network by extending their codeshare agreement with airline companies around the world. These companies include: American Airlines, Bangkok Airways and Qatar Airways (Cathay Pacific, 2015). By forming a global horizontal alliance with other giant airlines, Cathay is able to expand and consolidate its positions in foreign markets. MAIN STRATEGIC CHALLENGES Cathay Pacific s main challenges are: declining customers satisfaction, poor hedging performance, an intense labour dispute and strong competitors in Asia. Declining Customers Satisfaction Cathay Pacific s world ranking in The World's Top 100 Airlines in 2015 dropped to 3rd place in 2015 (SkyTrax, 2015). Cathay is also becoming notorious for delaying flights schedules, declining service quality (e.g. flight attendants inappropriate manner, poor plane maintenance and other issues). These negative factors lead to a loss in passengers confidence and satisfaction in Cathay. Customers are less happy and less willing to choose Cathay because of its declining service quality. Cathay needs to address the declining customers satisfaction to stop the slide in ranking. Poor Fuel Hedging Performance As is the case with all other airline companies, Cathay Pacific hedges against changes in oil prices to lower its fuel cost. However, due to the significant decreases in oil prices, Cathay recorded poor fuel hedging performance. The hedging performance plummeted from a gain of $130M USD in 2014 to a loss of $470M USD in 2015 (Cathay Pacific, 2015). Considering the uncertain outlook for oil prices in the coming years, the company needs to review its hedging strategy to stop incurring potential hedging losses. Intense Labour Dispute In May 2015, Cathay Pacific faced the threat of its Cabin crew s striking. Employee s dissatisfaction negatively influenced their motivation and the quality of service provided to customers. The strike also paralyzed the airline s operation and brought a negative image to Cathay. Based on SkyTrax, Cathay Pacific is ranked in fifth place in the list of the World Best Airline Staff in Asia. However, Singapore 7

Airline, one of Cathay Pacific main competitors, ranks the third. The slide in ranking is primarily due to unsatisfied staff. In order to increase employee loyalty and service quality (SkyTrax, 2015), Cathay Pacific needs to effectively manage the relationship between employees and company. Strong Competition of Air Freight in Asia Although Cathay Pacific is one of the leading companies for airfreight in Asia, the company is still facing challenges from its rivals. The following figure shows the aspects and degree of rivalry: FIGURE 2: Drivers of Degree of Rivalry in the Asia-Pacific Airfreight Sector 2014 Source:http://documentslibrary.bvdep.com.proxy.lib.sfu.ca/mapperMarketResearchPDF/fapeedgdlkhgpgaainkejdkedglfhnmbdgoejfjgnilpjgfahjdfaeeb.pdf While European and North American markets are facing many economic uncertainties, the strong Asian aviation market s high level of competition make it just as uncertain. As shown in Figure 2 above. there are a large number of players with similar size and fixed costs competition in a zero sum game. A zero sum game means each participant s gain or loss of utility is exactly balanced by the losses or gains of the utility of the other participants (Investopedia, 2015). Given the fierce competition for a small profit margin in the Asian market, Cathay would need to have a well-formulated strategy to enhance its competitiveness and consolidate its leading position in Asia. 8

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