The Land of Silk and Money

AN ANALYSIS OF CHINA'S AVIATION MARKET

PART ONE | China's Domestic Airline Industry

Dick Forsberg
March, 2017
Dick Forsberg
Head of Strategy, Avolon

Dick Forsberg has over 45 years' aviation industry experience, working in a

variety of roles with airlines, operating lessors, arrangers and capital providers
in the disciplines of business strategy, industry analysis and forecasting, asset
valuation, portfolio risk management and airline credit assessment. As a
founding executive and Head of Strategy at Avolon, his responsibilities include
defining the trading cycle of the business, primary interface with the aircraft
appraisal and valuation community, industry analysis and forecasting, driving
thought leadership initiatives, setting portfolio risk management criteria and
determining capital allocation targets. Prior to Avolon, Dick was a founding
executive at RBS (now SMBC) Aviation Capital and previously worked with
IAMG, GECAS and GPA following a 20-year career in the UK airline industry.
Dick has a Diploma in Business Studies and in Marketing from the UK Institute
of Marketing is a member of the Royal Aeronautical Society and also a Board
Director of ISTAT (The International Society of Transport Aircraft Trading).

Acknowledgement:
The author would like to acknowledge OAG as the source of the Chinese airline
fleet and traffic data used in this paper, through their Traffic Analyser and
Schedules Analyser products.

Disclaimer
This document and any other materials contained in or accompanying this document
(collectively, the Materials) are provided for general information purposes only.
The Materials are provided without any guarantee, condition, representation or warranty
(express or implied) as to their adequacy, correctness or completeness. Any opinions,
estimates, commentary or conclusions contained in the Materials represent the
judgement of Avolon as at the date of the Materials and are subject to change without
notice. The Materials are not intended to amount to advice on which any reliance should
be placed and Avolon disclaims all liability and responsibility arising from any reliance
placed on the Materials.
The Land of Silk and Money 1
PART ONE | China's Domestic Airline Industry

Contents

1. Introduction 2
2. Key Findings 3
3. Geography and Demographics 4
4. Background To Chinas Economic Development 8
5. The Evolution Of Commercial Aviation In China 15
6. External Influences On Chinas Airline Operations 18
7. Domestic Air Travel Patterns 22
8. Forecasting Chinas Domestic Traffic Flows 28
9. Conclusions 30

Appendix 1
Chinese Airline Fleets At 31st December 2016 31
Appendix 2
Chinas Airlines and Their Principal Bases 32
2 The Land of Silk and Money
PART ONE | China's Domestic Airline Industry

1. Introduction

With 1.375 billion people, China is the most populous country on earth, 5 times larger than
the USA. Its economy, which has been growing at an average of 13% per annum over the past
20 years, now ranks #2 globally, trailing the US by 40% but closing rapidly and expected to
reduce the gap to 20% within 5 years. However, whilst per capita GDP has increased from
$1,000 to $8,000 since 2001, the gulf between the richest millions and the poorest hundreds
of millions of citizens remains wide, resulting in a borderline GINI coefficient of 0.461. Within
the wide-ranging strata of wealth and society, the ranks of the middle classes, a core element
of growth for the air travel market, are increasing at a prodigious rate and now number 109
million, according to Credit Suisse, which is still less than 10% of the total population.

In 2015, over 380 million sectors were flown by
passengers on Chinese domestic routes, filling
most of the 500 million seats offered by 31 airlines.
A further 120 million Chinese travelled overseas,
of whom more than 50 million ventured beyond
Greater China (PRC plus Hong Kong, Macau and
Taiwan), in addition to 26 million inbound visitors
from overseas. The vast majority of international
travel into and out of China was undertaken by air
on over 72 million seats and 350,000 flights, 53%
of which were operated by Chinese airlines, whose
fleets total more than 2,800 aircraft.
The scale and pace of development of Chinas
commercial aviation sector are remarkable, but, on
the face of it, familiar and in line with the myriad
of other remarkable growth statistics emanating
from China over the past 30 years. However, some
of the factors behind the rapid emergence of an
increasingly diversified aviation sector are less well
known and have uniquely Chinese characteristics.
This paper examines the key geographic,
demographic and economic features of China in
the context of the countrys transition from the
immediate post-cultural revolution era to the present
day and into the future. The development of the
countrys passenger airline system and aviation
infrastructure, the evolution of the regulatory
framework governing safety, operations and capacity
and the growth and gradual maturing of domestic
air travel are examined. The key drivers of demand
are also identified, leading to an estimation of the
future growth in domestic air travel over the next
decade.
The burgeoning international air travel market,
equally impressive in its scope and advancement,
will be the subject of a subsequent White Paper,
which will also include an analysis of Chinas future
airline fleet requirements.

1. o
 n a scale where inequality of income distribution increases from a low value of 0 to a maximum of 1 and 0.4 is
regarded as a warning level by the UN
The Land of Silk and Money 3
PART ONE | China's Domestic Airline Industry

2. Key Findings

Chinas economic development is entering Structural problems, including inefficient and

its 3rd phase. The principal central planning
themes are around realignment of the economy,
with emphasis on upscaling industry and
manufacturing and reducing dependence on
foreign demand for manufactured products
through stimulation of domestic consumption.
The unintended consequences of previous
policies and growth plans, including an ageing
population, shrinking labour force, rising labour
costs and extensive damage to the environment,
pose risks to the successful delivery of these
turn-around strategies.
Although GDP growth has been gradually slowing
over the past number of years, absolute increases
in the economy, measured in RMB, remain the
highest in the world, helping to sustain growth in
sectors such as commercial aviation.
limited airspace capacity, congested airports,
a shortage of pilots and bureaucratic approval
procedures will continue to challenge current
operations and potentially hamper future growth.
Nevertheless, domestic traffic growth is forecast
to average 6.8% over the next decade, driven by
economic growth, increasing urbanisation, rising
consumerism and the availability of more, and
more affordable, low cost airline capacity.
LCCs will generate the highest growth rate to
reach 20% market share on domestic routes over
the next decade.

The Chinese airline industry continues to

experience strong demand, with multiple new
entrants and a nascent but fast-growing low
cost carrier segment. In 2015, Chinese airlines
operated over 3 million flights and carried over
380 million passengers on domestic sectors.
Traffic flows continue to diversify away from the
most populous and wealthiest Eastern Region
towards the Centre and West of the country.
4 The Land of Silk and Money
PART ONE | China's Domestic Airline Industry

3. Geography and Demographics

3.1 Regional characteristics
Administratively, China consists of 22 provinces,
5 autonomous regions (such as Tibet and Inner
Mongolia) and 4 central-government-controlled
municipalities (Beijing, Shanghai, Chongqing and
Tianjin). Each of these enjoys a significant level of
fiscal and administrative autonomy but remains
answerable to central government, from which broad
budget funding and targets are allocated.
Geographically, China can be split into four regions
East, Central, Northeast and West (Figure 1).
The Eastern Region includes 11 cities with more
than 5 million inhabitants (2010 census), including
Shanghai, Guangzhou, Tianjin, Shenzhen and Beijing.
It is home to 522 million people, making it the most
populous region of the country with 38% of the total
population. The Eastern Region has the highest level
of urbanisation, with 66% of the population living in
cities. The region also accounts for 51% of total GDP
and 50% of the total urban workforce, achieving all
of these superlatives with the smallest land area, at
924,000 km2 just 10% of the total. Per capita GDP
is consequently the highest of the four regions, at
US$11,000.
The Western Region comprises the largest land
area, more than 70% of Chinas total, but is sparsely
populated, having a total of 368 million inhabitants
and only 3 cities with more than 5 million inhabitants.
The region includes some of the most remote parts
of the country, including Inner Mongolia and Tibet,
less than 45% of the population are urban residents.
Nevertheless, the region now accounts for over 20%
of the countrys urban workforce, many of them
in Chongqing whose greater metropolitan area
accommodates over 30 million people and is one
of the leading beneficiaries of Chinas Go West
policy for redistributing economic activity. The
regions average per capita GDP remains 25% below
the national average, however, at slightly more than
US$6,000.

Figure 1: Regional Populations - 2010 Census

Northeast
West
East
Central
Heilongjiang

Inner Mongolia
110m
Jilin

Beijing
Liaoning
Xinjiang
Ningxia

368m Shanxi
Hebei
Tianjin

Qinghai Shandong
Gansu
Shaanxi Henan
522m
Jiangsu

Tibet
Hubei Anhui

363m
Sichuan Shanghai
Chongqing Zhejiang
Jianxi
Hunan
Guizhou
Fujian
Yunnan
Guangxi Guangdong

Hainan
The Land of Silk and Money 5
PART ONE | China's Domestic Airline Industry

Central China accounts for just 11% of the land The latest data from Chinas National Statistics
area and, with 363 million inhabitants, 27% of the Bureau, for 2015, reveal a new low in the Total
population, making the region second only to the Fertility Rate2, which at 1.05, ranks China in last
East in terms of population density. However, only place globally, behind even developed countries.
one city, Wuhan, has more than 5 million residents It is estimated that China needs a TFR of 2.2 to
and, although there are 55 with 1 million or more maintain the current population and even the recent
inhabitants, the Central Region has the lowest level relaxation of the one-child policy is unlikely to result
of urbanisation, at 38%. Per capita GDP is similar to in more than a short-term spike in the birth rate,
the Western Region, at around US$6,000. since many urban parents find that the rising cost
of living and raising a child has made larger families
The Northeast region is the smallest in terms of unaffordable.
Introduction
population (110to China -urban
million), The Land of Silk(14.5
workforce and Money
million) and land area, each of which accounts The consequences (Figure 2) leave a challenging
for 8% of Chinas total. However, over 60% of the legacy for Chinas 21st century society, with an
population is urban, centred on 14 cities with over
originally to be applied only for a single generation, increasingly
1 million inhabitants, including two with more than
skewed population breakdown by age
its extension over 35 years has created a deep-
and gender, the former steadily ageing and the latter
5rooted
million.problem
This helpsfortoChinas
raise thefuture economic
regional development.
per capita having an abnormally high imbalance of men/boys
GDP figure to $8,500, second to the Eastern region over women/girls.
The latest data from Chinas National Statistics
and 4% above the national average.

Bureau, for 2015, reveal a new low in the Total

3.2 Demographics Figure 2: The Ageing of China
Male 1990 Female
Chinas people2 are
Fertility Rate , which athomogeneous.
highly 1.05, ranks China92%in
oflast
the 100+
population are ethnic Han, sharing strong cultural 90-94
place
ties andglobally, behind
values and even
also a developed
strong patriotic countries.
sense of 80-84
70-74
duty
It is estimated that China needs a TFR of 2.2forto
that fosters a generally compliant regard 60-64
authority and the greater good. This is an important 50-54
maintain thefor
consideration current populationwhen
the government and planning
even the 40-44
30-34
significant structural changes to the economy,
recent relaxation of the one-child policy is 20-24
employment and social services and helps to smooth 10-14

unlikelytransitions.
difficult to result in more than a short-term 80
-80 60
-60 40
-40 20
-20 00
0-4
0 20 40 60 80
spike
A widein the birth
range rate, since
of minorities spansmany urban parents
56 recognised
Millions Millions
Male 2015 Female
find that
ethnic the rising
groups, cost of
the largest living
being and raising
Zhuang, a
Mongols, 100+
Tibetans and Uighurs. Many of these, collectively 90-94
child has made
numbering more larger families
than 100 million,unaffordable.
live in the more
80-84
70-74
remote autonomous regions and, as news coverage 60-64
The consequences
from leave aare
time to time suggests, challenging
not alwayslegacy for
amenable 50-54
40-44
to moves towards
st greater integration.
Chinas 21 century society (Figure 2), with an 30-34
20-24
Aincreasingly
key feature skewed
of centralpopulation breakdowns
planning policy in the by 10-14
0-4
1970s and 80s was the introduction of the one
age and
child gender,
policy, whichthe formerinsteadily
featured ageing and
the 6th five-year
80
-80 60
-60
Millions
40
-40 20
-20 00 0 20 40 60 80
Millions

the latter
Plan having
(1981-1985), butanactually
abnormally high1979
ran from imbalance
until Male 2040 Female
2015, when it was finally phased out. The policy 100+
of men/boys
was intended to over
drivewomen/girls.
Chinas population down 90-94
80-84
to a target level of 700 million, which experts 70-74
Thecalculated
had gender imbalance, which compounds
was the optimum scale to balancethe 60-64
economic and social development with essential 50-54
low fertility
resources suchrate, is a direct
as food result
and water. of the one-
Although the
40-44
30-34
child policy, as Chinese society favours
policy was originally to be applied only for sons over
a single 20-24
10-14
generation, its extension over 35 years has created
adaughters, and the rationing
for Chinasof children has 0-4
deep-rooted problem future economic 80
-80 60
-60 40
-40 20
-20 00 0 20 40 60 80
led to the level of male births exceeding female
development. Millions Millions

births by a margin that is 10% greater than the

global average. Consequently, projections of the future population indicate a peak of around 1.4
billion sometime in the next decade, followed by a gradual decline to stabilise at around 1 billion.
2. Total Fertility Rate is the number of children a woman may expect to have if she lived to the end of her child-bearing
Well before that occurs, Chinas position as the most populous country will have been overtaken
years
by India.
6 The Land of Silk and Money
The gender imbalance, which compounds the low
fertility rate, is a direct result of the one-child policy,
as traditional Chinese society favours sons over
daughters, and the rationing of children has led to
the level of male births exceeding female births by a
margin that is 10% greater than the global average.
Consequently, projections of the future population
indicate a peak of around 1.4 billion sometime in
the next decade, followed by a gradual decline to
stabilise at around 1 billion. Well before that occurs,
Chinas position as the most populous country will
have been overtaken by India.
One manifestation of the ageing population is a
decline in the working age population those in the
15-64 year age bracket. These numbers peaked in
2013 and are forecast to be at least 25 million lower
by 2025. At the same time, the number of senior
citizens is growing more rapidly. In 2015, Chinas
over-65s were more numerous than the entire
population of Japan, at 144 million, with the number
forecast to increase to 225 million in ten years.
The one child policy not only drives a shrinking
workforce and increases the dependency ratio (how
many family members a worker must support), but
also limits the size of the core consumer market of 18
-35 year-olds, which is direct opposition to the need
to increase domestic consumption.
Unfortunately, events have already moved beyond
Chinas control and the consequences for the
development of the economy are significant, both in
terms of the availability and cost of labour and in the
ability to sustain economic growth, both of which
now depend on the economic rebalancing that is
now under way.
3.3 Urbanisation
Since the 1970s, the movement of rural populations
to the cities has been unprecedented, encouraged
at both central and provincial government levels.
Chinas population has been transformed from 85%
rural in the 1960s, and still only 20% urban in 1980,
to 56% urban today. This trend absolutely reflects
the development of the Chinese economy, and in
particular the focus on raising manufacturing and
industrial production that has characterised multiple
five-year development plans, creating the largest
mobilisation of labour ever seen.
PART ONE | China's Domestic Airline Industry
Along the way, existing cities have been massively
expanded and countless new ones have been built,
some of which have yet to see the anticipated
numbers of residents or business enterprises. Across
China, over 200 conurbations now boast populations
of 1 million or more, with 17 of these in excess of 5
million, of which 6 are larger than 10 million and
with substantially larger metropolitan catchment
areas.
Established Chinese cities have tended to grow by
extension of their perimeters, since acquiring land
outside the city limits is considerably cheaper than
developing existing high value urban real estate
upwards. A significant number of city dwellers have
therefore become so by accretion, as boundaries
have been expanded, however the vast majority of
urban dwellers have migrated from their rural origins,
either alone or with families in tow.
Despite the addition of more land around the edges,
city centres are increasingly congested as the
majority of industrial and commercial activity is still
concentrated towards the centre, leaving commuters
to add traffic congestion to the challenges of air
pollution and rising living costs. Although all modern
cities have extensive public transport systems,
increasing numbers are commuting by road, with car
ownership approaching 200 million and increasing
by more than 2 million a month, making China
the largest market in the world, with over 130 car
brands and 950 models on the market. This has
put extraordinary pressure on city infrastructure as
well as contributing to the poor air quality, but with
car ownership growth still at the steepest part of
the economic S-Curve, the situation is expected to
worsen, unless strict curbs are introduced along with
incentives to move to electric or hybrid engines.
Central government plans to raise the urbanization
rate to 60 percent by 2020. That will require
an additional 100 million people to leave the
countryside over the next four years. By 2030
Chinas cities are expected to be home to 1 billion
people, representing a 70% urbanisation rate, a
remarkable level which would nevertheless be
consistent with the per capita income level.
This continued expansion will have direct benefits for
air travel demand, but also have profound effects on
Chinas economic and social landscape.
 Introduction to China - The Land of Silk and Money

The Land of Silk and Money 7

PART ONE | China's Domestic Airline Industry
in the ability to sustain economic growth, both of which now depend on the economic rebalancing
that is now under way.

3.3. Migrant workers

A significant demographic feature arising from the economic and social policies of the past 30 years
has been the rise of the migrant worker population, which has been a product of, but also central to
achieving Chinas economic growth. The number
of floating
3.4 Migrant workers
workers - people who have left their Chart 1: Floating migrant worker population (est.)
A significant demographic feature arising from the
places of origin to work elsewhere - has been
economic and social policies of the past 30 years
300

growing
has been thesincerisethe early
of the 1980s.
migrant Growth
worker was
population, 250

which has been a product of, but also central to

# workers (million)
initially gradual, but accelerated in the 1990s
achieving Chinas economic growth. The number of
200

st
and again
floating in the
workers secondwho
people decade
have of
leftthe 21places
their 150

of origin to work elsewhere - has been growing since

century (Chart 1), to reach a level of 277 million
the early 1980s. Growth was initially gradual, but
100

in 2015, equating
accelerated in the 1990sto 36%
and of the in
again working
the second 50

decade of the 21st century (Chart 1), to reach a

population of 770 million. Although the rate of
level of 277 million in 2015, equating to 36% of the
0

1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
increase
working has beenofslowing
population recently,
770 million. this number
Although the rate
of increase has been slowing recently, this number is
is forecast
forecast to exceed
to exceed 290 million
290 million by 2020.
by 2020. Within the urban migrant group, their sub-division
into employment in industry and manufacturing
Migrant
Migrant workers
workers cancan be classified
be classified as short-
as short- or long-distance
or long- migrants,(21%),
(31%), construction the former relocating
retail sales to work
(12%), hotel
distance migrants, the former relocating to work in and restaurant services (6%), transport and logistics
a in a city
city closeclose to their
to their homehome citythe
city and and the moving
latter latter moving greater distances, over half of them to
(6%), etc. further stratifies their income levels,
another province. Most short-distance workers relocate on
greater distances, over half of them to another which theiratown,
remain a lowwhilst
base a the
greater proportion
average migrant of
province. Most short-distance workers relocate wage is less than US$500 a month. Nevertheless,
onlong-distance
their own, whilstmigrants move
a greater with their
proportion families. Long-distance
of long- migrants numbered 169 million in
from a domestic travel perspective, virtually all
2015, 60% of the total, but are growing at a much slower
distance migrants move with their families. Long- rate (0.4%
long-distance in 2015)
migrants thanpart
will take short-distance
in the mass
distance migrants numbered 169 million in 2015, movement back to their home towns that occurs
migrants
60% of the (2.7%). The
total, but areslowdown
growing atisa driven by two factors,
much slower around i) Lunar
the contraction
New Year and,of Chinas working-age
price notwithstanding,
population as the ageing trend gathers momentumtens
rate (0.4% in 2015) than short-distance migrants andofii)millions
the economic
could be slowdown andfor
in the market particularly
a domestic a
(2.7%). The slowdown is driven by two factors, i) flight at least once a year as disposable incomes rise.
marked
the reduction
contraction in construction
of Chinas working-age activity and the transfer of some manufacturing to lower cost
population
ascountries.
the ageingIttrend
is therefore
gathers likely that the
momentum and migrant
ii) worker population will peak around the end of the

the economic slowdown and particularly a marked
decade, in
reduction with a gradualactivity
construction but steady
and thedecline thereafter,
transfer of but remaining a very substantial element of
the labour
some export force.
manufacturing to lower cost countries. The gender imbalance,
It is likely that the migrant worker population will
peak around the end of the decade, with a gradual which compounds the low
Within the urban migrant group, their
but steady decline thereafter, although remaining a
sub-division into employment
fertility rate, isinaindustry
directand manufacturing
result
(31%),
very construction
substantial element(21%),
of theretail
labour sales (12%), hotel and restaurant services (6%), transport and
force.
of the one-child policy,
logistics (6%), etc. further stratifies their income levels, which remains
as Chinese at a low
society base the average
favours
migrant wage is less than US$500 a month. Nevertheless, from adaughters,
sons over domestic traveland
perspective,
the
virtually all long-distance migrants will take part in rationing
the mass movement back to their
of children hashome towns
that occurs around Lunar New Year and, price notwithstanding,
led to the tens of millions
level of male could be in the
births
market for a domestic flight at least once a year as exceeding
disposable incomes rise.births by
female
a margin that is 10% greater
than the global average.
4. Background to Chinas economic development

4.1. The importance and focus of the five-year plans

Chinas centrally planned economy is now entering its third phase since the first five-year plan was
introduced by Mao Tse Tung in 1953. Many of the policies and goals set out in the plans, or adjunct
to them, have had a lasting impact, not always positive, that will continue to influence Chinas
economy well into the future.

6
 During Phase One, which lasted until 1980, the nascent communist state was focussed on
developing an ideologically-driven economy, built around the Soviet model and featuring the
collectivisation of agriculture and state ownership of heavy industry, with smaller enterprises
8 organised into cooperatives. Policies included the Great Leap forward (SecondThe Land of Silk and Money
Plan: 1958 1962),
PART ONE | China's Domestic Airline Industry
which aimed to turbocharge economic growth by diverting agricultural workers into industry, and
the Cultural Revolution, launched in 1966 to remove the remaining elements of capitalism and
subversive thinking. Although they largely failed in their objectives and caused great hardship, their
mostly unintended consequences imprinted an indelible form on Chinas society and economy.
4.Phase
Background to Chinas economic development
Two of the central planning cycle, which moved the focus away from the class struggle,
commenced under the auspices of Deng Xiaoping, who took forward a series of economic reforms
starting
4.1  in 1978, under
The importance the Four
and focus of theModernisations
five-year plan,
The covering
past 20 yearsagriculture,
have seen industry, science &
the SEZ concept
plans extended to virtually every inland provincial capital
technology and defence. The reforms included an open door policy to encourage foreign trade and
in addition to 15 free trade zones and close to 100
Chinas centrally planned economy is now entering
its inward investment
third phase since thethrough liberalisation.
first five-year plan was They also included setting
development zonesuplaunched
Special Enterprise
and promoted Zones
by
local authorities across the country.
(SEZs) in Southern China, where it was intended that foreign and domestic investors could build
introduced by Mao Tse Tung in 1953. Many of the
policies and goals set out in the plans, or adjunct to
newhave
them, businesses free of
had a lasting manynot
impact, of the bureaucratic
always positive, rules in place elsewhere, with China benefitting
Whilst the initial concept of the SEZs and their
expansion throughout the eastern seaboard has
thatfrom
will knowledge transferred
continue to influence fromeconomy
Chinas foreign JV partners
well andacheap
played pivotallabour
role in providing a competitive
the emergence of China
into the future.
environment for manufactured exports. Shenzhenas and
theXiamen were amongstcapital
global manufacturing the initial SEZs
of just set up
about
During Phase One, which lasted until 1980, everything, the economic benefits for China have
in 1980, along with Zhuhai and the entire Hainan province.
the nascent communist state was focussed on not been Shanghai,
as deep and Tianjin, Guangzhou
meaningful as mightandbe11
other cities
developing followed in 1984, ultimately
an ideologically-driven economy, leading toexpected,
large parts of the
with eastern
issues coastaltoregion
now starting surfacebeing
in the
built around the Soviet model and featuring the form of rising labour costs, pressures on housing and
absorbed in conurbations such as the Pearl River Delta
collectivisation of agriculture and state ownership of
(now with
a maturing a population
migrant of over 50
worker population. million),
In addition,
the industry,
heavy Yangtze withRiversmaller
Delta enterprises
and Shanghais Pudong business
organised city.
not all of the smaller and more recent development
into cooperatives. Policies included the Great Leap zones have generated investment returns and the
policy of build it and they will come has failed to
The past
forward 20 years
(Second Plan:have
1958 seen thewhich
1962), SEZ concept
aimed extended to virtually every inland provincial capital in
materialise in too many second tier cities.
to turbocharge economic growth by diverting
addition workers
agricultural to 15 free trade
into zones
industry, and
and theclose to 100 development zones launched and promoted by
Cultural
The underlying economic theme of Phase Two,
local authorities across the country.
Revolution, launched in 1966 to remove the
which is now drawing to a close, has been explosive
remaining elements of capitalism. Although they
growth in industry and exports. This led to the
largely failed in their objectives and caused great
Whilst the initial concept of the SEZs
hardship, their mostly unintended consequences
and their expansion
build-upthroughout the eastern
of a substantial seaboard
prima facie has
trade surplus,
especially over the past 3-4 years, reaching 35% in
played aanpivotal
imprinted role
indelible in the
form emergence
on Chinas of and
society China as 2015
the global manufacturing capital of just about
(Chart 2).
economy.
everything, the economic benefits for China have not been as deep and meaningful as might be
The 4th plan (19711975) set a 12.5% annual GDP
expected,
Phase Two of with some of the
the centralised unintended
planning consequences
cycle, which
growth now starting
target which to wassurface
carriedin the forminto
through of rising
the
moves the focus away from the class struggle,
labour costs, pressures on housing
commenced under the auspices of Deng Xiaoping, and a maturing migrant
5th plan worker
(1976-1980).population.
The In addition,
establishment of far
the from
SEZs
enabled these growth targets to be achieved, but
whoalltook
of the smaller
forward and more
a series recent development
of economic reforms zones
also ledhave to generated investmentof
a serious over-heating returns and the
the economy,
starting in 1978, under the Four Modernisations
policy
plan, of build
covering it and they
agriculture, will come
industry, sciencehas& failed to materialise in too many second tier cities.
raising inflation close to 20% by the end of the
1980s.
technology and defence. The reforms included an
Thedoor
open underlying
policy toeconomic
encouragetheme foreignoftrade
Phase Two
and
Chart 2: China's Trade Volumes (US$Bn)
inward investment through liberalisation. They
of the central planning model, which
also included setting up Special Economic Zones
is now 2,500 40%
drawing
(SEZs) to a close,China,
in Southern has been
whereexplosive growth
it was intended 2,000
35%
that foreign and domestic investors could build new 30%
in industry and exports. This led to the build-up
businesses free of many of the bureaucratic rules 1,500 25%
of a substantial
in place prima
elsewhere, with faciebenefitting
China trade surplus,
from 20%
1,000
knowledge transferred from foreign JV partners and 15%
especially over the past 3-4 years, reaching 35%
cheap labour providing a competitive environment 10%
th 500
forin 2015 (Chart exports.
manufactured 2). The 4Shenzhen
plan (19711975)
and Xiamenset 5%
were amongst the initial SEZs set up in 1980,
a 12.5% annual GDP growth target which was
along with Zhuhai and the entire Hainan province.
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
0%

th
carried Tianjin,
Shanghai, through into the 5and
Guangzhou plan (1976-1980).
11 other cities Imports Exports % Surplus

followed in 1984, ultimately leading to large parts

The establishment of the SEZs enabled these
of the eastern coastal region being absorbed in
growth targets
conurbations such to
as be
theachieved,
Pearl Riverbut also(now
Delta led to a serious over-heating of the economy, raising
with
a population of over 50 million), the Yangtze River
inflation close to 20% by the end of the 1980s.
Delta and Shanghais Pudong business city.

7
The Land of Silk and Money
PART ONE | China's Domestic Airline Industry
Subsequent five-year plans reinforced the growth
and economic development imperatives, with
a gradual opening of the market to the outside
world starting with the 7th Plan (1986-1990), which
included a 7.5% annual GDP growth target. This was
ramped up to double digits in the 8th plan (1991-
1995), during which time trade volumes grew by
almost 20% per annum and the period ended with
an almost six-fold increase in foreign exchange
reserves.
GDP quadrupled between 1980 and 2000 and the
10th Plan (2001-2005) focussed on rebalancing
regional prosperity and increasing the urban
workforce (the start of the migrant worker surge),
while the GDP growth target was moderated to 7%.
At around the same time, a critical challenge
to future economic growth started to become
apparent. Growing levels of atmospheric pollution
provided tangible evidence of the damage to the
environment caused by the headlong industrial
growth strategies of the previous 30 years,
exacerbated by the indiscriminate zoning of heavy
industries adjacent to residential areas and city
centres and the high dependency on low cost fossil
fuels to power industry and keep the lights on. The
levels of life-threatening pollutants present in the
atmosphere of almost every city in China are now
beyond the red lines set by international agencies for
much of each year and the damage to the health of
the population cannot be ignored.
9
The 11th Plan (2006-2010) introduced the concept of
environmental protection and this was substantially
reinforced in the 12th Plan (2011-2015), which
acknowledged the maturing of the economy
and the need to rebalance from production to
consumption by stimulating domestic demand
and reducing the reliance on exports. Nuclear and
hydro-electric power projects were prioritised to
accelerate a reduction in CO2 emissions whilst other
infrastructure development plans targeted roads,
airports and the high-speed rail network for further
rapid expansion. The Go West policy was renewed
with a call to shift focus from coastal cities to rural
and inland areas.
The 12th (2011-2015) five-year plan identified aviation
as one of seven major strategic industries and
allocated 1.5 trillion RMB (around US$225 billion) for
investment in all areas of the sector, a 50% increase
over the previous plan. However, although such
initiatives result in rapid advances in the hardware
and infrastructure required for a modern an efficient
aviation sector, they do not address softer, but
equally important, factors, such as coordination,
cooperation and harmonisation across regions and
provinces, government offices and regulators, which
affect not only commercial aviation but also many
other sectors.
Introduction to China - The Land of Silk and Money
10 The Land of Silk and Money
PART ONE | China's Domestic Airline Industry
It is clear from the data and the messaging from central government that the economy is now
entering a period of profound change. On the one hand, after more than 35 years of accelerated
growth, the economy is maturing (Chart 3), with double digit compound growth rates no longer
achievable, or reasonably expected. On the other hand, a range of structural issues ageing
demographics, a shrinking migrant worker pool, rising labour costs, extreme levels of environmental
pollution, etc. - are forcing major rethinks on the way forward.

Chart 3: Evolulution of China's Economic Growth

RMB Bn
GDP Growth GDP - constant RMB
16% 70,000
Annual growth in GDP (constant RMB)

14% 60,000
12%
CAGR = 10.4% 50,000
10% CAGR = 10.5%
40,000
CAGR = 9.3% CAGR = 7.7%
8%
30,000
6%
20,000
4%

2% 10,000
Source: IMF
0% 0

Realignment of the economy towards a greener
4.2. Realignment
future and the
is a core element new
of the normal
current 13th Plan
(2016-2020), which has at its heart a comprehensive Target growth rates for
th
The current (13 ) five-year plan is
restructuring of economic objectives that signal the GDP are further moderated,
start of Phase Three of the planning cycle, which will The "Four Comprehensives"
dedicated
take to development
China into indeedgrowth
a period of moderate the to build to at least 6.5%, accompanied
To comprehensively build a moderately prosperous society
a moderately prosperous society.
word appears more than 70 times in the Target growth by the launch of an economic
rates for GDP are further lowered, to at least To comprehensively deepen reform
document
6.5%, and itsbykey
accompanied an theme
economicis the
plan designed realignment plan that will move
to move China
redesign up thedevelopment
of Chinas manufacturingpathvalue chain, To comprehensively
China upgovern the the nation according to law
manufacturing
significantly shrink and restructure the activities ofTo comprehensively strictly govern the Communist party
for the
State coming
Owned decades.(SOEs)
Enterprises The Planand materially value chain.
grow
definesthethe
services
newsector.
normal for the country, anticipating a deep reform that would have profound
impact on the overall development of the nation. In the near term, the Plan calls for a moderately
prosperous society by 2020, one of President Xi Jin Pings four comprehensives. The term was
coined by Deng Xiaoping in 1979 and is now understood to describe Chinas future as a modern
industrialised country offering increased personal wealth, quality of life, environment and culture.

Within the new normal, the economic targets include lowering average GDP growth to 6.5+%
(from 7% in the 12th Plan and closer to 8% achieved), which will result in a doubling of GDP by 2020
compared to 2010, critically linked to reductions in carbon emissions, green lifestyles (renewables,
recycling, hybrid vehicles), improved energy efficiency and reductions in pollution levels. Inter alia,
reforms will focus on expanding the middle-income group and raising incomes for lower earners.

Even at the lower growth rates, however, China continues to generate the highest absolute
economic growth of any country. Measured in RMB, every 1% of GDP growth in 2017 is worth 1.5%
of growth five years ago and 2.5% in 2007.

This is of considerable significance in addressing one of the key challenges for government in the
process of economic realignment namely, how to wean the country and the economy off its
growth dependency. The level of capital formation throughout the 2000s has been significantly
higher than in other major economies, principally driven by nation-wide construction projects on a

9
The Land of Silk and Money
PART ONE | China's Domestic Airline Industry
4.2 Realignment and the new normal
The current (13th) five-year plan is dedicated to
development indeed the word appears more
than 70 times in the text and its key theme is the
redesign of Chinas development path for the coming
decades. The Plan defines the new normal for the
country, anticipating a deep reform that would
have profound impact on the overall development
of the nation. In the near term, the Plan calls for a
moderately prosperous society by 2020, one of
President Xi Jin Pings four comprehensives (see
Box). The term was coined by Deng Xiaoping in 1979
and is now understood to describe Chinas future as
a modern industrialised country offering increased
personal wealth, quality of life, environment and
culture.
The "Four Comprehensives"
1 significantly higher than in other major economies,
To comprehensively build
a moderately prosperous society
2
To comprehensively deepen reform
3 government as a cornerstone of fiscal stimulus and
To comprehensively govern
the nation according to law
4
To comprehensively strictly
govern the Communist party
11
Within the new normal, economic targets include
lowering average GDP growth to 6.5% (from 7% in
the 12th Plan and closer to 8% achieved), which will
result in a doubling of GDP by 2020 compared to
2010, but linked to reductions in carbon emissions,
green lifestyles (renewables, recycling, hybrid
vehicles), improved energy efficiency and reductions
in pollution levels. Inter alia, reforms will focus on
expanding the middle-income group and raising
incomes for lower earners.
Even at the lower growth rates, however, China
continues to generate the highest absolute economic
growth of any country. Measured in RMB, every 1%
of GDP growth in 2017 is worth 1.5% of growth five
years ago and 2.5% in 2007. This is of considerable
significance in addressing one of the key challenges
for government in the process of economic
realignment namely, how to wean the country and
the economy off its growth dependency. The level
of capital formation throughout the 2000s has been
principally driven by nation-wide construction
projects on a massive scale, building new roads,
airports and railway networks, entire new cities with
apartments, factories, schools, hospitals and metro
systems. The fact that much of this development
is not currently required did not slow the pace
of development, which was promoted by central
full employment following the global financial crisis.
Local governments, which were also keen to support
their own local projects to attract greater wealth
and status, took up the challenge enthusiastically
and provided substantial financial and political
support for investment projects, including airports
and airlines.
dependency on foreign consumption and its role in stimulating economic activity cannot be
sustained. The Plan recognises the limitations of the labour force and the unsustainability of fossil
fuel dependency
12 and calls for a major up-scaling of manufacturing production,
The Landsignificantly
of Silk and Money
increasing the value-add component and trading quantity for quality and efficiency.
PART ONE | China's Domestic Airline Industry

This strategy not only recognises the labour shortages that will increasingly limit Chinas ability to
raise production volumes, but also seeks to break the country out of the bottom segment of the
Smiley Curve3 (Figure 3) an economic representation of where profits are generated through the
development of any product.

Figure 3: The Smiley Curve Chinas Dilemma

Customer
High Corporate Support
Brands

Product concept &

industrial design Retailing
Value add

High value Transportation

components

Commodity
components

Low Assembly

This trading up on the value curve will be essential if China is to maintain even the moderate growth
th
rates targeted in the 13
The large absolute Plan,inand
increases will also
the wealth need toThis
being be strategy
underpinned
not onlyby increased
recognises domestic
the labour
generated by the economy may, over time, help to shortages that will increasingly limit Chinas ability to
consumption,
absorb someincreased private
of this excess investment
infrastructure. and design
Today, raise and technology
production volumes,innovation.
but also seeksTo
to date,
break thelevels of
innovation
though,have been islow
this wealth notand have
trickling notfarmaterially
down enough
or fast enough into the pockets of workers or their
flowed through
country out into manufacturing.
of the bottom This is
segment of the Smiley
Curve (Figure 3) an economic representation
3

dependents and the inequalities reflected in the low
GINI coefficient are becoming more widely felt.
3
Named after the eponymous yellow stickers popular in the 1970s
Nevertheless, the rate of manufacturing expansion
has resulted in the rapid escalation of Chinas
position in the global trade rankings, to the point
where exports have generated a trade surplus
equivalent to around 0.5% of global economic
output. However, because the domestic consumer
base is still small, the dependency on foreign
customers to create demand and jobs has been
extremely high, leaving China exposed to the
increasingly real risk that the globalisation trends
may be reversed.
There is now clear recognition, articulated in
the 13th Plan, that the rate of capital formation,
its dependency on foreign consumption and its
role in stimulating economic activity cannot be
sustained. The Plan recognises the limitations of
the labour force and the unsustainability of fossil
fuel dependency and calls for a major up-scaling of
manufacturing production, significantly increasing
the value-add component and trading quantity for
quality and efficiency.
of where profits are generated through the
development of any product.
This trading up on the value curve will be essential
if China is to maintain even the moderate growth
10rates targeted in the 13th Plan, and will also
need to be underpinned by increased domestic
consumption, increased private investment and
design and technology innovation. To date, levels of
innovation have been low and have not materially
flowed through into manufacturing. This is starting
to change, but must be taken to a new level, which
requires a combination of funding, collaboration
and, critically, a level of openness with global
innovators that will challenge traditional conservative
thinking. The drive for technological advancement
and innovation is being boosted by expanding the
number of city clusters along the major development
corridors, which will allow resources to be leveraged
more effectively. The benefits are already starting
to be seen in Shenzhen and the Pearl River Delta,
where high tech companies are incubating with
remarkable speed.

3. Named after the eponymous yellow stickers popular in the 1970s

 1950s to support the management of social welfare, taxation, domestic migration and (political)
surveillance. Every citizen is entitled to a hukou from their city of origin, giving them rights to
housing,
The Land ofa pension and food subsidies, as well as free access to social services such as education and
Silk and Money 13
PART ONE | China's Domestic Airline Industry
health in that city. These benefits are not transferable, however, and the hukou is not reissued if the
holder moves to a new location, leaving migrants severely disadvantaged.

The hukou was originally designed to keep rural families in situ to ensure continued agricultural
production, but was never updated to accommodate changing economic policy. The hukou
permanently defines an individual as urban or rural, depending on the classification of their home
town again, this classification does not change with relocation, resulting in millions of urban
resident
As workerstransition
this economic being classified as rural,
progresses, a furtherwith limited
4.3.2 access to basic
One Belt, One Roadfacilities, services and even
legal rights.
slowing of theChildren are assigned
existing economy shouldthebehukou location
expected Oneof one
Belt, of
Onetheir parents,
Road" even if they
is an ambitious are born
development
whilst the new normal gains traction. The impact can strategy announced by President Xi Jinping in 2013
in eased
be the city
bywhere the parents
the introduction work, resulting
of additional in even
structural greater inconsistencies and inequalities and
and launched in early 2014 to build connectivity
leavingto
reforms migrant worker
the fiscal system,families
marketwith a choice
regulation andbetween having no access
and co-operation among tocountries
subsidised services
lying along or
the business environment to improve market access the original legendary Silk Road trading routes
prolonged
and strengthenseparation oflaw
the rule of parents
not and children. The problems
too challenging are exacerbated as the migrant
between Asia and Europe. One Belt, One Road
to Western cultures,
population ages andbutasstill
andifficult concepts
increasing numberfor of grand-parents move totocities
(OBOR) is intended bothto help with
broaden child-care.
Chinas
some within the Chinese system. trading footprint and increase Chinas presence and
As urbanisation has increased, the pressure on city role infrastructures and services
on the international has alsofour
stage through been
broad
4.3 Two far-reaching and influential policies
increasing, leading to more restrictions on migrant areas; workers, rather than
connectivity, anyeducational
trade, easing of the
and controls.
cultural
4.3.1 The Hukou registration system exchange and government cooperation.
4.4.2.parts
Large One ofBelt,
theOne Road
migrant worker cohort are
marginalised and disadvantaged due to an inflexible Figure 4: Chinas new Silk Road ambitions
and outdated household registration system
One Belt, One Road is an ambitious
the Hukou. This system was introduced in the
development
late strategy
1950s to support the announced
managementby of social
welfare, taxation, domestic migration and (political)
President Xi Jinping in 2013 and launched in
surveillance. Every citizen is entitled to a hukou from
earlycity
their 2014 to build
of origin, connectivity
giving them rightsand
to co-
housing, a
pension and food subsidies, as well as free access
operation
to among
social services countries
such lying and
as education along the
healthcare
original
in legendary
that city. Silk Road
These benefits trading
are not routes
transferable,
however, and the hukou is not reissued if the holder
between
moves to aAsia
new and Europe.
location, Onemigrants
leaving Belt, One Road
severely
(OBOR) is intended to both broaden Chinas
disadvantaged.

The hukou was originally designed to keep rural

families in situ and ensure continued agricultural
production, but was never updated to accommodate
changing economic policy and demographics.
The hukou permanently defines an individual as
urban or rural", depending on the classification
of their home town again, this classification does
not change with relocation, resulting in millions of
urban resident workers being classified as rural,
with limited access to basic facilities, services and
even legal rights. Children are assigned the hukou
location of one of their parents, even if they are born
in the city where the parents work, resulting in even
greater inconsistencies and inequalities and leaving
migrant worker families with a choice between
having no access to subsidised services or prolonged
separation of parents and children. The problems
are exacerbated as the migrant population ages and
as an increasing number of grand-parents move to
cities to help with child-care. As urbanisation has
increased, the pressure on city infrastructures and
services has also been increasing, leading to more
restrictions on migrant workers, rather than any
easing of the controls.
11The terminology refers to two separate zones of
influence identified by President Xi the Silk Road
Economic Belt and the 21st Century Maritime Silk
Road (Figure 4).
In fact, the Belt is a land route connecting China
with countries all the way to Europe and physically
is actually a road (sometimes rail-). The maritime
Road is a set of shipping lanes. The land Silk Belt
will connect with Central Asia, Russia and Europe,
whilst the Maritime Road will largely focus on
Southeast Asia, Oceania and Africa, but also extend
to the Mediterranean.
In total, around 60 countries are included in the
scope of the plan, which envisages a new grouping
of economic interests, built on cooperation, new
infrastructure and broad trade agreements. These
countries account (with China) for around 65% of
the world population, 1/3rd of global GDP and 25%
of total goods and services.
14
At the same time as OBOR initiatives were
launched, a new Chinese development bank, the
Asian Infrastructure Investment Bank (AIIB) was
announced, with a remit to provide capital for
infrastructure projects, particularly those connected
with OBOR. Initially capitalised with 1 trillion RMB,
the AAIB is an integral part of the OBOR initiative
and Chinas rising participation in global commerce.
Clearly the OBOR plans are hugely ambitious and
require substantial levels of engagement, not only
from Chinese companies and financial institutions,
but also from global players. Funding is arguably the
greatest challenge, with the AIIB financing projects
at only modest levels ($27bn in 2015), although other
Chinese funds, including the New Development
Bank and the Silk Road Fund, are also available and
international support is starting to come in, with
countries like Singapore linking with Chinese banks
to fund projects. However the total funding levels
remain well below the US$2-3 trillion annual capital
requirements envisaged by the architects of the plan
and China will need to provide sovereign support for
the bulk of the funding for years to come.
To date, Chinese companies have been mostly
focussing on Central Asia, where they are building
roads, bridges and railways they also plan to
extend the high-speed rail network into large
parts of Southeast Asia. Construction projects
that can absorb some of Chinas domestic excess
capacity are favoured, however China has also been
strategically investing in Central Asia, building oil and
gas pipelines and also acquiring stakes in oil and gas
production.
The Land of Silk and Money
PART ONE | China's Domestic Airline Industry
The near-term benefits are unlikely to outweigh the
massive investments required, but, in the longer
term, the potential to develop new export markets to
support the up-scaled value-added manufacturing
sector is an alluring goal and the potential benefits
suggest that projects will receive substantial long-
term government support and encouragement.
Whilst most of the associated aviation benefits will
be felt in the international markets, OBOR will also
benefit regional development within the country,
since the belt starts in Xian and routes through
Urumqi in the far northwest of the country, whilst the
maritime road utilises coastal ports along the eastern
seaboard.
Funding is probably the
greatest challenge, with the
AIIB financing projects at only
modest levels ($27bn in 2015).
Other Chinese funds, including
the New Development Bank
and the Silk Road Fund, are
also available and international
support is starting to come
in, with countries like Singapore
linking with Chinese banks
to fund projects.
The Land of Silk and Money
PART ONE | China's Domestic Airline Industry
5. The evolution of commercial aviation in China
5.1 Early history
In the immediate post-war years, China gave
commercial air transport a low priority, with most
aviation-related activity and investment dedicated
to military application. However, having identified
the strong relationship between commercial air
services and economic and trade development in
other countries, China introduced the framework
for a nascent airline industry in 1954, under the
auspices of what quickly became the Civil Aviation
Administration of China (CAAC). Initially, and indeed
for much of its existence, CAAC has acted as airline,
airport operator and regulator.
Prior to 1980, CAAC operated as an arm of the
air force, administering control of the Chinese air
transport industry under a four-tier management
system. This comprised the centralised CAAC
functions, plus, as a consequence of the
decentralisation policies of the Great Leap Forward,
six regional Civil Aviation Bureaux, 23 provincial
bureaux and 78 civil aviation stations.
In addition to broad centralised oversight of the
industry (principally financial fitness and safety), the
CAAC ran all of the ancillary services, including flight
operations, airports and the air navigation system.
CAAC also regulated market and route licensing,
service frequency and capacity, ticket prices and
passengers eligibility to travel.
In 1980, control of CAAC moved from the military to
the State Council and, for the first time, it was given
a remit to develop profitable air transport services,
whereby the six regional CAAC bureaux became
operational profit centres, albeit with limited control
over routes, revenues and costs. Almost all of the
route networks at that time remained domestic,
however the country was now seeing more foreign
visitors each year than over the entire previous 25
years, as Chinas new open door policy began to
take effect.
15
5.2 Gradual relinquishing of CAAC control
A major policy change in 1987 saw the separation
of regulation and operations, with CAAC handing
over airline operations to six independent state-
owned carriers, based on regional location China
Eastern, C. Southern, C. Northern, C. Southwest, C.
Northwest and Air China. China Southwest Airlines,
based in Chengdu, was the first to be established,
in December 1987. They were followed in 1988 by
Shanghai-based China Eastern, Air China (Beijing)
and China Northwestern (Xian). China Northern
(Shenyang) came into being in 1989 and China
Southern (Guangzhou) only in 1991.
Also in 1987, the State Council announced the
intention to transfer all civil airports, except for those
in Beijing and Tibet, from CAAC control to local
governments, giving them incentives to invest. As
airport operations began to be separated from the
airlines, the financial and operational burden also
passed to the provincial governments. However,
a rapid increase in traffic volumes in the following
years put pressure on many airport infrastructures,
leading to a spate of costly development and
expansion of facilities, which slowed the transfer
process and full transition of all of the regional
airports was not completed until 2003.
5.3 The accelerating emergence of new airlines
The first non-CAAC airlines were launched in the
mid-1980s. By then, CAACs responsibilities consisted
of airline and route licensing, pricing, securing
bilateral route rights, strategic planning, regulating
safety and maintenance standards and the design
and implementation of competition policy.
Over the next decade, new entrants included joint
ventures between CAAC and local governments
(starting with Xiamen Airlines in 1984), several
airlines that were set up and owned by regional
governments (e.g. Shanghai, Sichuan, Fujian) and
some launched by independent investors and
entrepreneurs, either on a stand-alone basis or in
conjunction with local governments (e.g. Hainan
Airlines).
C. Southern formed through a coalescence of smaller regional carriers into the largest ex-CAAC
operators.

More recent liberalisation has led to the introduction of a small, but growing
16 LCC
The sector,
Land starting
of Silk and Money
PART ONE | China's Domestic Airline Industry
with Spring Airlines in 2004 and now including 9 Air, Lucky Air, Colorful Guizhou, West Air, Urumqi
and others. Whilst some are offshoots of existing legacy carriers, the majority are independent LCCs
and have the support (at least from a policy perspective) of CAAC and the State.

CAAC remains responsible for regulatory oversight and enforcement of flight safety, security and
technical operations, including accident investigation. It also conducts air traffic management and
controls civilian (but not military) airspace and associated services such as meteorology. Oversight of
Itthe
wasconstruction, development
not until the early-2000s and
that thesafe operation of
process airports
The is also
associated GDPa core remit,
multiples along
have alsowith
been
for applying for,and
development andimplementation
being granted, route authoritypricing
of aviation declining
policies(Chart 4), from the
and upholding high
the levels
rights typically
and interests
was simplified and actively promoted to stimulate seen in the early stages of market development to
of air travel However,
competition. consumers. the proliferation of air services a current level of 1.48x which is trending closer to
that followed quickly gave rise to problems as traffic levels seen in more mature markets.
5.4.not
was Leading
stimulated to sustained high
to match the traffic growth
increased capacity
and several of the newer regional operators hit Chart 4: Domestic RPK Growth and GDP Multiples
financial difficulties, racking up substantial losses and
Domestic RPKs increased 67-fold in the 30 years
indebtedness, exacerbated by weak management. 3.0 16% 16% 18%

fromled
This 1985 to 2015, equating
to intervention by CAACtoinaverage
the formgrowth
of price 2.5 15%
regulation (which allowed price competition subject
of 15% per annum. Whilst year-on-year 2.0
11%
12%

GDP Multiple
to a base price floor) and, ultimately, enforced
variations in growth ratesofhave occurred,
eitherthe

CAGR
consolidation. The addition capacity, 1.5
2.75
9%

through direct purchase or by way of operating

long-run
leases, wasaverage
also now maintained
made subject16% to per annum
pre-approval
1.0 1.97
1.48
6%

through 2010. Growth has slowed since were then,

0.5 3%
by CAAC. In October 2002, the Big Three
officially defined for the first time, with Air China, C. 0.0 0%
although
Eastern andstill
C. averaging 11% CAGR
Southern achieving overscale
greater the past
by 1985-2000 2000-2010 2010-2015

five years.
absorbing smaller regional carriers. GDP Multiple CAGR

More recent liberalisation has led to the introduction
of a small, but growing LCC sector, starting with
Spring Airlines in 2004 and now including 9 Air,
Lucky Air, Colorful Guizhou, West Air, Urumqi and
others. Whilst some are offshoots of existing full
service carriers, others are new, independent LCCs
and all have the support (at least from a policy
perspective) of CAAC and the State.
CAAC remains responsible for regulatory oversight
and enforcement of flight safety, security
and technical operations, including accident
investigation. It also conducts air traffic management
and controls civilian (but not military) airspace
and associated services such as meteorology.
Oversight of the construction, development and safe
operation of airports is also a core remit, along with
development and implementation of aviation pricing
policies and upholding the rights and interests of air
travel consumers.
5.4 Leading to sustained high traffic growth
Domestic RPKs increased 67-fold in the 30 years
from 1985 to 2015, equating to average compound
growth of 15% per annum. Whilst year-on-year
variations in growth rates have occurred, the long-
run average maintained 16% per annum through
2010. Growth has slowed since then, although still
averaging 11% CAGR over the past five years.
Business and government travel accounts for an
estimated 80% of domestic air travel, with VFR
(Visiting Friends and Relatives) and leisure trips
14accounting for the balance.
Growth continues to challenge infrastructure and
resources, particularly pilots and en route navigation
capacity, but also a growing number of airports that
are operating at or close to capacity. 20 new airlines
were approved in the five years from 2011 to 2015
and, in 2014 alone, 817 new routes were launched,
including 686 domestic and 131 international services
to 12 new cities. Much of this proliferation has been
driven by the desire of provincial governments to
have their own home-town airlines and constraints
on market access that are driving existing airlines
to open new regional bases, often with financial
support from the regional governments, in order to
deploy their committed capacity.
However, in a recent reversal of its previously liberal
approach to authorisations, CAAC has announced
a moratorium on new airline start-ups, citing safety
concerns, pressure on infrastructure and what it
sees as excessive market fragmentation, with a
heightened risk of financial weakness leading to
airline failures. This freeze may not be rigorously
applied, as was the experience during previous
official pauses, but for a while at least it will be more
difficult for start-ups to secure approval.
omestic and 131 international services to 12 new cities. Much
the desire of provincial governments to have their own
me, constraints
The on market
Land of Silkaccess that are driving existing
and Money 17
PART ONE | China's Domestic Airline Industry
ten with financial support from the regional governments, in
ity.

viously liberal approach to authorisations, CAAC has

ne start-ups, citing safety concerns, pressure on infrastructure
agmentation, with a heightened risk of financial weakness
may not be rigorously applied, as was the experience during a
13, but for a while at least it will be more difficult for start-ups
5.5 Todays airlines and fleets Only 12% of the current passenger fleet, including
Appendix 1 contains details of the Chinese airlines forward orders, are widebodies, compared to 20%
passenger fleets. At 31st December 2016, Ascend of the global fleet. Additionally, less than 20% of all
reported an active passenger fleet of 2,800 aircraft passenger aircraft are future technology variants,
operated by 46 airlines, with a further 1,600 aircraft which compares to a global fleet average of over
st 35%. This is a strong indication that Chinese airlines
nese airlines on
passenger
order or fleets. At 31
under LOI December
(Chart 2016,75%
5). More than Ascend
of
are under-ordered in both categories, however, it
the fleet, including commitments, are mainline
,800 aircraftsingle
operated
aisle by 46 airlines, with a further 1,600
types. does not automatically imply that the corollary (that
single aisle is over-ordered) is true, but rather is a
). More reflection of the historical constraints that have held
Chart 5: Chinese airlines' passenger fleets
tments, back development of long-haul international (i.e.
4,000 widebody) air services.
3,500
3,000 The future fleet requirements of Chinese airlines for
200 2,500 their domestic and international operations will be
2,000 explored in greater detail in a subsequent White
an 200 1,500 Paper.
% of the 1,000
500
Appendix 2 contains details of where the 46
0
passenger airlines currently active or in start-up
Single aisle Twin aisle Regional Future technology mode have their main bases. Unsurprisingly, most of
et, In Service Storage Orders & LOIs
the airline bases are clustered in the eastern region
Source: FG Ascend
of the country, home to half of the airlines and 85%
ies, of the fleet. There are six cities with populations of
Regional aircraft, comprising less than 200
dditionally, less than 20% of all passenger aircraft are future
turboprop aircraft and slightly more than 200
over 5 million that do not currently have a dedicated
airline base, however only three - Wuhan, Shantou
o a global fleet average
regional jets,of over 35%.
account for aThis is a12%
further strong indication
of the fleet, and Shenyang - are located more than 100km from
but only 3% of total seats.
d in both categories, however, it does not automatically imply an existing major hub.

ver-ordered) is true, but rather is a reflection of the historical

pment of long-haul international (i.e. widebody) air services.

he 46 passenger airlines currently active or in start-up mode Only 12% of the current passenger
most of the airline bases are clustered in the eastern region of fleet, including forward orders,
es and 85% of the fleet. are widebodies, compared to 20%
of the global fleet.

15
18
6. External influences on Chinas airline operations
6.1 The NDRC
The National Development and Reform Commission
(NDRC), previously known as the State Planning
Commission, is an agency of the State Council
responsible for a wide range of development-related
activities. These include economic planning policy,
urbanisation and regional development, economic
restructuring, climate change and environmental
issues and the oversight of economic development,
including the approval of all major business
expansion activities, across all sectors of the
economy.
Headquartered in Beijing, the NDRC has regional
representation in many large cities and operates
with a staff of around 1000 civil servants. One of
the roles of NDRC is to issue approvals to airlines
for their capacity growth requirements. They do
this in conjunction with CAAC, who will be normally
contacted by NDRC as part of the review process
prior to approval.
In 2016, the NDRC issued new guidelines for fleet
growth, based on the size of the airline and its
operating performance. The NDRC normally issues
block pre-approvals in March for the following year,
and is now using the following criteria to frame the
annual quotas:
Airlines with <30 aircraft may induct
an additional 3 aircraft plus a maximum
of 3 more if the criteria are met
Airlines with 30-60 aircraft start with
a baseline of 5 aircraft, with up to 4 more
Airlines with 60-100 aircraft get a baseline
of 7 plus up to 5 more
Airlines with >100 aircraft can be allocated
up to 11% of the fleet
The four criteria used to measure performance are:
i) Safety
ii) On time performance
iii) Flight operations performance
iv) Financial fitness
With the exception of the first criterion, where any
incident or accident will result in loss of incremental
allowance, the metrics are relative across the airline
community, rather than absolute, so airlines are not
penalised, for example, by system-wide air traffic
control problems that affect everybody.
The Land of Silk and Money
PART ONE | China's Domestic Airline Industry
Each airline is rated on each criterion, with the top
20% of airlines awarded an A and the next 30% a
B. The additional flex is granted on the basis that
4x As will get the maximum allowance, 3x As plus
1x B get 1 less than the maximum, 2x As and 2x Bs
get 2 less, etc. In addition, before final approval is
given for each delivery, the airline must demonstrate
that they will have sufficient crews to operate their
expanded fleet.
The perception of the approval process differs from
airline to airline, There is agreement on one issue,
however, which is that the lead time for approvals
had significantly increased over the past 12-18
months, and most airlines believe that this, at least in
part, is a response to the crack-down on corruption,
which has resulted in something close to work to
rule by civil servants intent on maintaining strict
adherence to the process.
Where the Government, through the CAAC, imposes
limitations on capacity growth, these are enforced
by the NDRC, which from time to time also operates
its own rulebook. As an example, they stopped
issuing approvals for much of 2015 to try and force
Chinese airlines to follow their guidance that they
should source aircraft from Chinese lessors, not
foreign ones a policy that found no traction and
quietly fell away.
6.2 Air Traffic Control services
One of the most significant infrastructure restrictions
remains the limitations placed on airspace by virtue
of the extent of its military control. With much of
the countrys airspace reserved for military use,
commercial flights have been relegated to a lower
priority despite China having become the second-
largest market for commercial air travel in the world.
Chinas usable airspace is 1/3rd that of the US, with
half the number of air traffic controllers.
A legacy factor arising from the poor historical
safety record of Chinese airlines that extended right
up into the 1990s is that Chinas regulators take
a more risk-averse approach to safety standards
than those in many other parts of the world. For
example, aircraft separation on landing approaches
is up to three times greater than is required in the
USA, thereby further reducing the limited airspace
available. Ad hoc arbitrary closure of airspace
by military controllers adds to the potential for
disruption.
The Land of Silk and Money
PART ONE | China's Domestic Airline Industry
Figure 5: China lags the world for on-time performance The purpose is to improve efficiency in the
2014 airport on-time departure performance
On-time rate
50% 100%
100 10,000 30,000 35,000
The level of flight delays at Chinese airports is
consistently ranked bottom of world rankings
(Figure 5) and even at off-peak times and without
weather or visibility limitations, delays and
cancellations are commonplace. Whilst some of
the problems can be put down to airlines building
insufficient slack into their schedules, the routine
occurrence of delays across the country suggests
that the airlines are not the root cause. However,
whilst there is universal recognition that ATC
provision is inadequate, when the issue is raised with
airlines, most do not expect any near-term resolution
of the problem, but continue to rely on finding
work-arounds to eke more capacity out of existing
airspace.
Nevertheless, recognising the increasing urgency
of the situation, the Chinese authorities tabled a
working paper at ICAOs assembly in August 2016
addressing Chinas Strategy for Modernizing Air
Traffic Management. Within the paper, a section on
civil-military joint operations states that:
19
utilization of airspace resources through flexible
and effective management regimes. Unified
planning, respective implementation and enhanced
coordination are the key for ensuring a scientific
layout of civil and military aviation infrastructure and
seamless mutual communication and exchange of
operational information. Civil and military joint air
traffic control mechanisms will be established at busy
terminal control areas to improve the performance
of civil-military joint traffic control operations.
Coordination on pre-tactical use of airspace will be
strengthened. The civil and military sides will rely
on the airspace management unit to collaboratively
decide how the airspace will be used the next day
Scheduled flights and have their decision published via NOTAM or
Source: FlightStats
the aeronautical information network. The scope of
convergent development between civil and military
air traffic control departments will be expanded to
increase the forms and levels of convergence. On the
basis of information and systems sharing, vigorous
efforts will be made to facilitate coordination in
major activities, emergency response, flexible use
of airspace, joint operations at busy terminal areas
and other joint operational mechanisms in a bid to
improve efficiency in airspace resources utilization
and raise the level of civil and military collaborative
operation in air traffic management.
6.3 Airport capacity
In addition to the ATC issues, Chinas airlines are
facing increasing capacity constraints at many
airports, despite the extensive and continuous
upgrade and expansion programs. This is not only
impacting their on-time performance but also
impeding their expansion plans, as new slots are
increasingly hard to secure at times that passengers
want to fly.
Limitations apply to both runway and terminal
capacity as the number of passengers and the
number of flights have both been increasing faster
than the infrastructure can absorb them. Delays are
now so commonplace that, in 2016, CAAC refused to
allow Beijing, Shanghai and Nanjing airports to add
more flights until on-time performance (excluding
ATC delays) improves.
New airport projects such as Beijings Daxing Airport
will help to alleviate the pressure. Beijing Capital,
the worlds second busiest airport (behind Atlanta)
and Air Chinas primary hub, is full, handling 94
million passengers in 2016. Daxings first terminal
is scheduled to open in 2019, with capacity for 45
million passengers a year. Additional runways and
terminals will follow, ultimately taking capacity to
more than 100 million, which will be addition to
Capital Airport, which will remain open.
20 The Land of Silk and Money
PART ONE | China's Domestic Airline Industry

6.4 High-speed rail - a competitive alternative? Figure 6: Chinas High-Speed Rail Network (2016)
From a standing start in 2007, China now has Grey lines = planned

20,000 km of high speed rail network, the longest

such system in the world and destined to increase
further, to 38,000 km by 2025. Most of the existing
network is concentrated in the Eastern Region of
China, where high population density, relatively short
distances between cities and mostly unchallenging
terrain justify the significant investments. However,
the network is already extended well beyond the
coastal region, serving 28 of the mainlands 31
administrative regions (Figure 6) and carrying over
1 billion passengers annually.

The Land of Silk and Money

Table 1: Comparison of HSR vs Air Journey Times and Fares

7 Days3
Great Additional Rail Avg Rail
2
Advance Advance
2
2nd Cl. 7 Days
3

Circle Air Flight ground Elapsed Fastest Distance Speed 2nd Cl Rail Y Air Fare Rail Fare Y Air Fare
Route Dist. (Km) time time1 flight time Rail Time (Km) (Km/H) Fare (US$) (US$) (US$) (US$)
4
Chongqing - Chengdu 276 03:45 02:20 06:05 01:27 307 212 23 277 23 537
Shanghai - Hefei 423 01:25 03:15 04:40 02:04 467 226 29 128 29 52
Xiamen - Shenzhen 488 01:20 01:55 03:15 03:28 502 145 21 200 22 58
Shanghai - Wuhan 682 02:05 02:00 04:05 04:20 818 189 45 185 63 54
Wuhan - Chongqing 738 01:35 02:20 03:55 06:12 934 151 36 181 36 52
Beijing - Harbin 1000 02:00 02:20 04:20 07:06 1249 176 80 148 80 63
Beijing - Shanghai 1074 02:15 01:50 04:05 04:49 1305 271 81 108 81 80
Shanghai - Guangzhou 1173 02:30 02:15 04:45 06:50 1790 262 117 99 117 86
Beijing - Guangzhou 1875 03:15 02:05 05:20 08:03 2298 285 129 136 129 180
1 3
Travel city centre to/from airport + 60 minutes additional check-in/security 1 week advance booking for travel on 1st March
2 4
6 months advance booking for travel on 31st August No direct flights available - 1 stop selected
Sources: Skyscanner; ChinaTour.net

HSR
Tablefares arecompares
1 above higher than
HSRconventional railover
and air journeys fares, butHSR
lowerfaresthan
are for comparable
higher high-speed
than conventional rail fares,
a range of trip distances, using published standard but lower than for comparable high-speed networks
networks elsewhere in the world. However, there is no price premium for booking rail seats close to
fares for departures 1 week and 6 months in advance. elsewhere in the world. However, there is no price
the
The date
greenof departure
cells show theand thecompetitive
more fastest trains
mode on popular routes
premium forare often rail
booking soldseats
out close
a week or more
to the date of
for time and cost, with amber highlights indicating departure and the fastest trains on popular routes
prior
similartoordeparture. Conversely, many air fares are significantly
identical values. are often sold lower
out acloser
week toor the
more departure date
prior to departure.
and there appears to be little incentive for passengers to plan their
Conversely, manytravel farare
air fares in advance.
significantly lower
closer to the departure date and there appears to
Significantly, no LCC appeared as the cheapest option befor any
little of the for
incentive routes sampled.
passengers to plan their travel
far in advance. Significantly, no LCC appeared as the
Although speeds of 350 km/hr are achievable acrosscheapest option
large parts for any
of the HSRofnetwork,
the routes sampled.
average speeds
are lower, affected by the number of stops, making most journeys above 750 km uncompetitive on
elapsed time, even when flight times are adjusted to take account of the extra ground time required.
On the shorter sectors, some air service attrition has already taken place, including the direct flights
between Chongqing and Chengdu noted in the table above, however no significant additional
schedule cuts resulting from HSR competition are anticipated.
The Land of Silk and Money 21
PART ONE | China's Domestic Airline Industry

Although speeds of 350 km/hr are achievable across
large parts of the HSR network, average speeds are
lower, affected by the number of stops, making most
journeys above 750 km uncompetitive on elapsed
time, even when flight times are adjusted to take
account of the extra ground time required. On the
shorter sectors, some air service attrition has already
taken place, including the direct flights between
Chongqing and Chengdu noted in the table above,
however no significant additional schedule cuts
resulting from HSR competition are anticipated.
6.5 Pilot shortages
Boeing estimates that Chinese airlines will need to
add 100,000 pilots over the next 20 years in order
to meet their growth requirements a recruitment
rate of almost 100 per week. Pilot shortages are a
recurrent issue for Chinas airlines, which in recent
years have been employing foreign nationals
in increasing numbers. However, the regulatory
framework prevents these costly resources being
utilised as efficiently as they might, with a number
of restrictive rules in place. For example, foreign
Any move to open more airspace, especially the
low level airspace necessary for general aviation,
would, in time, facilitate a major expansion in pilot
training capability, not only through the opening of
more training schools, but also by allowing general
aviation pilots access to flying time to build up hours
and qualify as instructors.
Several airlines have set up their own pilot training
schools to ensure they have access to pilots for
future growth. Others make use of costly flight
training facilities in the US or Europe and will
typically indenture their trainee pilots for the
duration of their careers. However, increasing the
numbers of ab initio pilots does not fully address the
pilot shortage issue, since ten years of experience
are required before promotion to captain is possible
under current regulations.

pilots must be rostered with a Chinese speaker in the
second seat, as some regional ATC facilities have no
English speakers. Combined civil/military airports are Foreign pilots must be rostered
often off-limits to foreign crews, whilst experience
earned outside the country is discounted, resulting with a Chinese speaker in the
in unequal seniority between pilots of equivalent second seat, as some regional
capability.
ATC facilities have no English
Until recently, Chinas flight training capabilities did speakers.
not extend much beyond CAACs Flight Training
University, since general aviation as it is understood
in the West does not exist (Table 2), with a
consequent lack of private pilot feedstock to qualify
for flight instructors. There are still less than 3,000
private pilots in China and almost no airspace that
is open to private flying. It is not possible to take to
the skies on a weekend for pleasure - flight plans
typically need to be filed days, rather than hours,
prior to the flight and there are few facilities to fly
out of.

Table 2: General Aviation Comparisons - 2013

# GA Airports # GA aircraft # Private pilots1

USA >24,000 300,000 175,000

China 399 1,654 2,533

Source: China Daily, FAA 1

2014 data
 adjusted
bookingsbymade OAGon to the
reflect
major theGDS actual passenger
systems or with flows
the by sectordirectly,
airlines and route. collected,As such, the latter
collated and is an
estimation
adjusted by ofOAG traffic, rather the
to reflect thanactual
an exact passenger flows by sector Chart 6:and 2010route. As such,
- 2015 Domestic the latter
Passenger Growth is an
record.
22estimation of traffic, rather than an exact 45% Chart 6: 2010 - 2015 Domestic The Land of SilkGrowth
Passenger and Money
PART ONE | China's Domestic Airline Industry
record. 40%
The overall domestic market increased by 76%, 45%
35% 38%
40%
orThe164overall
million passengers
domestic market betweenincreased 2010byand 76%, 30%
35% 38%
25%
2015, equivalent to a 12% average betweengrowth rate

CAGR CAGR
or 164 million passengers 2010 and 30%
20% 23%
25%
(Chart
2015, 6) which followed
equivalent to a 12% a slowing
averagetrajectory
growth rate 15%
20% 23%

7. Domestic air travel 20% patterns

10% 13% 12%
over
(Chart a time
6) whichframefollowed
which opened a slowing with trajectory year 15%
5%
7%
10% 13% 12%
onoveryear growth
a time frame andwhich
endedopened with 9%. with 20% year 0%
5%
7%3
Big HNA Group Others LCCs Total
on year growth and ended with 9%. 0%

There
7.1 Theare significant
current domestic variations in the network
air transport growth rates achievedIn 2015, the by theHNA
Big 3 last full
different
year for
Group
airline groups
which detailed
Others LCCs
and
traffic
Total

The analysis in the section is based in data are available, more than 32 Chinese airlines4
There
market are significant
segments, with variations
the LCCs on thedata
increasing growth ratesvolume
traffic achieved by by 38% theper different
annum,airline followed groups by the andHNA
extracted from OAGs Schedules and Traffic Analyser operated over 3 million domestic flight sectors
market
Group
tools segments,
airlines
covering the withthe
atperiod
23%, theBig
from LCCs 3increasing
January (China
2010 Southern,traffic volume
to June China Eastern
offering by 38% and
almost per
500annum,
Air
millionChina) followed
seats. averaged
Those byflights
the
justHNA 7%
2016. The schedules data reflect commercial airline carried more than 380 million sector passengers,
Group airlines
k and Money annually and allat of23%, the Big
the other full3 (Chinacarriers
service Southern, China
(FSC) Eastern
averaged
representing and
an13%.
averageAir China)load factor averaged of 77% just 7% 7).
(Chart
schedules filed and operated during the relevant
annually
periods andand are allan of the other
accurate full serviceof
representation carriers
the (FSC) averaged 13%.
In 2015,ofthe
number lastand
flights full seats
year for whichondetailed
available each sector. Chart 7: Domestic Airline Supply and Demand
TheIn 2015,
traffic the
data last full
reflect year
passengerfor
traffic data are available, more than 32 Chinese which
bookings detailed
made on 600 Chart 7: Domestic Airline Supply and Demand 79%
the major GDS systems or with the airlines directly,
traffic data
airlines 4
operatedare available,
over more
3 million by than
domestic 32 Chinese
flight 600 78%
79%
network collected, collated and adjusted OAG to reflect 500
4 77%
theairlines
sectors operated
actualoffering
passenger over
flows500
almost 3bymillion
sector
million domestic
and
seats.route. flight
ThoseAs 500
400
78%
76%
such, the latter is an estimation of traffic, rather than Millions
77%

Load factor
data extracted sectors
from
flights offering
OAGs
carried
an exact record. more almost
Schedules than 500
and
380 million
Traffic
million seats.
Analyzer
sector Those 400
300
Millions
75%
76%

Load factor
flights
2010 to Junepassengers,
2016. The carried more than
schedules
representing data380 million
reflect sector
commercial 74%

marketan average byload

76%,factor
300
200 75%
The overall domestic increased or 73%
74%
uring the relevant passengers,
periods
of 77% (Chart 7).
164 million representing
and
passengers are an
between an
accurate average
2010 load
representation
and 2015, factor 200
100
72%
73%
equivalent
of 77% The to
(Chart a 12% average growth
7). data reflect passenger rate (Chart 6)
lable on each sector. traffic 100
0 71%
72%
which followed a slowing trajectory over a time 2011 2012 2013 2014 2015 H1-15 H1-16
ems or with the According
airlines to the OAG data, 97% of theand 0 71%
frame whichdirectly,
opened with collected,
20% year collated
on year growth 2011 2012Passengers
2013 Seats 2015 Load
2014 factor H1-16
H1-15
According
passengers
and ended with to
were the OAG data,
9%.travelling on a purely97% of thedomestic
passenger flows by sector and route. As such, the latter is an Passengers Seats Load factor

passengers
itinerary, with were 3% travelling
(but still 11 onmillion
a purely domestic connecting
passengers)
According to the OAG data, 97% of the passengers
to or from international flights and
act Chart 6: 2010 - 2015 Domestic Passenger Growth were travelling on a purely domestic itinerary, with
itinerary, with 3% (but still 11
96% of the tickets were sold in China, levels that havemillion passengers) connecting
(but stillto
3% remained 11 or frompassengers)
consistent
million international
over theconnecting flights
past severaland to or
96%
45%
years. of the tickets were sold in China, levels that have
from remained
international consistent
flights and over 96% the ofpast
theseveral
tickets were
40% sold in China, levels that have remained consistent
by 76%, years.
35% 38% over the past several years.
10 and Chart
30% 8 sets out the evolving distribution of Chart 8: Top 10 Domestic Passenger Carriers
Chart 8 sets out the evolving
passengers carried by the largest domestic
25% distribution of 400 Chart 8: Top 10 Domestic Passenger Carriers
wth rate
CAGR

passengers
20%
airlines. carried23% by the largest domestic
Chinas Big 3 accounted for 49% of
400
300
ectory 15%
airlines.
the 10%
total Chinas Bigflow
passenger 3 accounted
in
13% 2015, for 49%
carrying 74
12%
of 300
200
20% year
(M) (M)

the5%
million, total65passenger
7%
million and flow
48 in 2015,domestic
million carrying 74 200
Passengers

100
0%
million,Big65 3 million and 48 million domestic
Passengers

HNA Group Others LCCs Total 100

passengers respectively. With 61 million 0

growth rates There passengers

achieved by therespectively. airline With 61 million 2010 2011 2012 2013 2014 2015 H1-15 H1-16
Thedifferent groups and 0
passengers,
are significant HNA Groupsin airlines
variations the growth accounted
rates Top 10 share: 2010
91% 2011
87% 2012
85% 2013
84% 2014
83% 2015
82% H1-15
83% H1-16
81%
passengers,
sing traffic volume
achieved byby38% theThe per HNA
annum,
different Groups
airline airlines
followed
groups byand accounted
the HNA
market Top 10 share: 91%
China Southern
87% 85%
China Eastern
84% 83%
Air China
82% 83% 81%
Hainan Airlines
segments, with the LCCs increasing traffic volume by Shenzhen Airlines Sichuan Airlines Xiamen
ChinaAirlines Shandong Airlines
na Southern,38% China
4
Several Eastern
airlines that
per annum, and Air
followed China)
are subsidiaries
by the HNAaveraged
of larger
Group just
parents7%
airlinesoperate under
China Southern
their
Beijing parents
Capital
Shenzhen Airlines
China Eastern
code
TianJin
Sichuan and are
Airlines
Airlines
Air
notAirlines
Others
Xiamen identified
Hainan Airlines
separately
Shandong Airlines
4
e carriers (FSC)
at Several
in 23%.
the The
data. airlines
averaged Big13%. that are subsidiaries
3 (China Southern, of China
larger parents
Eastern operate under their
Beijing parents
Capital code
TianJin and are
Airlines not identified separately
Others

in the
and Airdata.
China) averaged 7% annually and all of the
ailed
other full service carriers (FSCs) averaged 13%.
Chart 7: Domestic Airline Supply and Demand 20Chart 8 sets out the evolving distribution of
passengers carried by the largest domestic airlines.
20
2 Chinese 600 79% The share of the Top 10 by passenger volume
declined from over 90% in 2010 to 82% in 2015.
stic flight 500
78%
77%
ts. Those 400
76%
Millions

Load factor

ector 300 75%

74%
oad factor 200
73%
100
72%
0 71%
2011 2012 2013 2014 2015 H1-15 H1-16
Passengers Seats Load factor

domestic
assengers) connecting to or from international flights and
4. Several airlines that are subsidiaries of larger parents operatate under their parent's code and
evels that have remained consistent
are not identified separatelyover
in thethe past several
data
 Chart 9: Domestic Operator Segment Market Shares
in 2015, representing 9% of the total market, a
70%
significant ramp up over a short period of time. 60%

TheLand
The other
ofFSCs slightly
Silk and Money increased their 50%
23
PART ONE | China's Domestic Airline Industry
aggregated
Introductionshare of the
to China market,
- The Land toof 29%, with
Silk and Money
40%

30%
112 million passengers carried. 20%

10%
Over
for 16% theofpast thefive totalyears,in 2015, the almost
share ofhalf thebeingBig 3 carried0%by Hainan Airlines.
has been steadily declining from 62% in 2010, 2010 2011 2012 2013 2014 2015 H1-15 H1-16

11 low cost airlines carried 33 million passengers Big 3 HNA Group Others LCCs
when the HNA Group accounted for 10% of the Chart 9: Domestic Operator Segment Market Shares
in 2015, representing 9% of the total market, a
market and LCCs made up just 3% of the total 70%
significant ramp up over a short period of time.
(Chart
In 2015, 9).
Chinas
60%

The other FSCsBig 3 accounted

slightly increased for 49% theirof the total 50% Chart 10: Widebodies on Domestic Routes
passenger flow, carrying 74 million (C. Southern), 12%
However,
aggregated
65 million (C. thesharenew
Eastern) of the entrants
and market,
48 million have to(Airnot
29%, just
with
China)
40%
9.9%
10%
30%
domestic sector passengers.
taken
112 millionaway passengers
market share, but also stimulated
carried. 20%
8%
7.6% 7.4%
7.8%
7.2%
demand
With 61 millionin a similar
passengers, fashion Theto HNA theGroups
marketairlines forces 10%
6.5% 6.4% 6.6% 6.5%

Over the past

accounted for 16% fiveofyears,
the total theinshare 2015, of the Big
almost half3 6% 5.2%

that have
being carried operated
by Hainan in Airlines.
other liberalising
11 low cost markets. airlines
0% 4.1% 4.1% 4.0%
4.4%

has been steadily declining infrom 62% in 2010, 4% 2010 2011 2012 3.3%
3.4% 2013 3.5%2014 3.5% 2015 H1-15 H1-16

Continuing
carried 33 millionthe trend,
passengers a further 2015, fiverepresenting
new entrant Big 3 HNA Group Others LCCs
when
9% of thethetotalHNAmarket, Groupaaccounted significant ramp for 10% up overof the 2%

aairlines
short period opened domestic
of time. The other services FSCs, inincluding
2016.
marketregional
several and LCCs made upofjust
subsidiaries the3% Bigof 3,the total
slightly
0%
2005 2010 2011 2012 2013 2014 2015 2016 2017

Contrary
(Chart 9).their
increased to popular
aggregated perception,
share ofwidebodies
the market, to are WB seat share WB frequency share
29%, with 112 million passengers carried. Chart 10: Widebodies on Domestic Routes
not widely deployed on domestic routes. As far 12%
However,
Over the past thefive new
years, entrants
the share haveof the notBig just3 has
7.2 9.9%
Airline competitiveness
back as 2005, widebodies accounted for only 5% In10%2016, over Chart 11:50% Extent
of all of city
singlepairs
airlinewere
routeoperated
operation
takensteadily
been away market declining share,
from 62% but also in 2010, stimulated
when
of frequencies and 10% of seats (Chart 10). The
7.8%
the HNA Group accounted for 10% of the market by8%a
80%
single carrier,
7.6%
and can be considered 7.4% de facto
7.2%
demand
and LCCs in made a similar
up justfashion to thetotalmarket forces monopoly 6.5% 6.4% 6.6%
routes (Chart 11). The concentration
6.5%

current levels are 4% 3% andof7% the

respectively (Chart 9).
and 6%
70% 5.2%
of monopoly4.1% routes varies from 75% of 4.1% routes
and Money that have operated in other liberalising markets. operating
However, the new entrants have not just taken 4.0%
4.4%

many of these butoperations are extensions

demand in aofsimilar long-
60%
market share, also stimulated 4% within the
3.4% Northern
3.3% 3.5%
Region
3.5%
to 30% of
Continuing
fashion to thethe trend,
market a further
forces that have five operated
new entrant in routes
50% between Central and Northern Regions, while
haul
other
international
liberalising
services.
markets. Continuing the trend, a
2%
almost 50% of routes operating within the most
airlines opened domestic services in 2016.
40%

f being carried by Hainan

further five new Airlines.
entrant airlines opened domestic densely
0%
30% served Eastern Region also had a single
7.2. Airline
services in 2016.competitiveness operator.
2005 2010 2011 2012 2013
In the majority of cases, the monopoly
2014 2015 2016 2017

Contrary to popular perception, widebodies are routes 20%

had more than 3 daily flights, suggesting that
WB seat share WB frequency share
assengers 10%
lack of market size is not the driving factor.
2016,
not over
widely 50%
deployed of all on city pairs
domestic
Chart 9: Domestic Operator Segment Market Shares were routes.operated As far
arket, a 0%

by
70% a single
back as 2005, carrier,
widebodies and canaccounted be considered for only de 5% E-E E-C E-N E-W C-C C-N C-W N-N N-W W-W
Chart 11: Extent of single airline route operation
All

of time. 60%
facto
of monopolyand
frequencies routes10%(Chart of seats 11). The concentration
(Chart 10). The of
80%
50%
Table 3: The 2016 Monopoly League
monopoly
current levelsroutes are varies
4% andfrom 75% of routes
7% respectively and operating 70%
%, with 40%
Total Routes % as only
within
many
30% ofthetheseNorthern operations Region are toextensions
30% of routes of long-between 60%
Airline
Operated operator
50%
Central
haul
20%
and Northern
international services.Regions, while almost 50% of routes 40%
China United 164 79%
10% GX Airlines 94 53%
e Big 3 operating within the most densely served Eastern Region 30%
China Express 319 53%
7.2. Airline
0%
competitiveness
2010, also had 2010
a 2011
single2012 operator. 2013
In
2014
the2015 majority H1-15
ofH1-16
cases, the20%
Loong Air 137 36%
Big 3 HNA Group Others LCCs 10% Tibet Airlines 108 31%
% of the monopoly
2016, overroutes 50% ofhad all more
city pairs thanwere 3 daily flights, suggesting
operated 0% Ruili Airlines 68 29%
e total that
by a lack
Contrary single to ofpopular
marketperception,
carrier, sizecan
and is not the
bewidebodies drivingare
considered factor.
de E-E E-C E-N
TianJin Airlines
E-W C-C C-N C-W N-N N-W W-W
546 29%
All

not widely deployed on domestic routes. As far China Eastern 1174 27%
factoasmonopoly Chartper
routes (Chart
10: Widebodies on
11). for
Domestic
The
Routes
concentration of
Incumbency
back 2005, se is also
widebodies not
accounted a factor, since
only 5%onlyof one of OkayTableAirways 3: The 2016 202
Monopoly League27%
monopoly routes
frequencies
12% and 10%varies of seats from (Chart75%10). of Theroutes currentoperating Colorful Guizhou 38 26%
just the 9.9%
levels Big
are34% airlines
and 7% is amongst
respectively theand topmany ten airlines
of thesemeasured Airline Total Routes % as only
within theare
10% Northern Region to 30% international
of routes between Spring Airlines 266
Operated
26%
operator
ulated operations
by concentration extensions
of of long-haul
monopoly routes (Table 7.8%3). However, Shanghai Airlines 252 24%
Central and Northern Regions, while almost 50% of routes China
7.6%
services.
8% 7.4% 7.2% United 164 79%
ket forces many of the biggest monopolists (which is not intended as GX Airlines
6.5% 6.4% 6.6% 6.5% Air China 660 24%
94 53%
operating within
6% 5.2%
the most densely served Eastern Region China Southern 1186 24%
markets. a4%pejorative) 4.1% are relatively recent market 4.1% entrants
4.0%
4.4%
and/or China Express
Lucky Air
319
212
53%
24%
also had a single operator. In the majority of cases, the
3.4% 3.3% 3.5% 3.5%
Loong Air 137 36%
w entrant Based on 2016 OAG schedule data
monopoly routes had more than 3 daily flights, suggesting Note: Excludes routes with less than 26 annual frequencies 31%
2% Tibet Airlines 108
16. 0% 21 Ruili Airlines 68 29%
that 2005
lack of 2010market2011 size is
2012 not2014
2013 the driving
2015 2016factor.
2017 TianJin Airlines 546 29%
odies are WB seat share WB frequency share China Eastern 1174 27%
Incumbency per se is also not a factor, since only one of Okay Airways 202 27%
s. As far Colorful Guizhou 38 26%
the Big 3 airlines is amongst the top ten airlines measured Spring Airlines
r only 5% Chart 11: Extent of single airline route operation 266 26%
by concentration of monopoly routes (Table 3). However, Shanghai Airlines 252 24%
10). The 80%
Air China 660 24%
many of the biggest monopolists (which is not intended as
ely and 70% China Southern 1186 24%
a60%pejorative) are relatively recent market entrants and/or Lucky Air 212 24%
ns of long-
24 The Land of Silk and Money
PART ONE | China's Domestic Airline Industry

Incumbency per se is also not a factor, since only
one of the Big 3 airlines is amongst the top ten
airlines measured by concentration of monopoly
routes (Table 3). However, many of the biggest
monopolists (which is not intended as a pejorative)
are relatively recent market entrants and/or
operating from second tier airports, which suggests
that the business models of new entrants are more
focussed on avoiding head to head competition
and finding niches where traffic and yields can be
more readily maximised. The legacy carrier model
of blanket service in as many markets as possible
does not appear to have been adopted by the new
generation of domestic carriers.
Table 3: The 2016 Monopoly League
The size of the domestic market, the number of
routes and frequencies and the number of active
airlines all support a view that market concentration
is not a significant concern. The Herfindahl-
Hirschman Index (HHI) is a measure of market
concentration based on the sum of the squares of
each participants market share. In markets where
there is a single supplier, the resulting value would
be 100^2, or 10,000 and, at the other end of the
scale, multiple competitors would take the score
towards zero, signifying perfect competition. Since
2005, the HHI scores for Chinas domestic market
have declined steadily from 0.17 (rated as moderate
concentration) in 2005 to values below 0.1 by 2016,
where 0.15 is the threshold for unconcentrated
(Chart 12).

Airline Unique Sectors % as only Chart 12: Domestic Airline HH Index

Operated operator
0.18
Moderate concentration
China United 164 79% 0.16
0.14
Unconcentrated
GX Airlines 94 53% 0.12
0.10

China Express 319 53% 0.08

0.06
0.04
Loong Air 137 36%
0.02
0.00
Tibet Airlines 108 31%
2005 2010 2011 2012 2013 2014 2015 2016

Ruili Airlines 68 29%

TianJin Airlines 546 29%

China Eastern 1174 27% The size of the domestic

Okay Airways 202 27%
market, the number of routes
and frequencies and the number
Colorful Guizhou 38 26% of active airlines all support
Spring Airlines 266 26% a view that market concentration
is not a significant concern.
Shanghai Airlines 252 24%

Air China 660 24%

China Southern 1186 24%

Lucky Air 212 24%

Based on 2016 OAG schedule data

Note: Excludes routes with less than 26 annual frequencies

The Land of Silk and Money 25
PART ONE | China's Domestic Airline Industry

One measure of competitiveness frequently
used by airlines to compare their effectiveness
in capturing market share is the Competitive
Performance Index, or CPI. This is a simple ratio
of market share : capacity share. On any route or
market, the aggregate CPI will be 1 (100% of the
market divided by 100% of the seats). Each airline
competing in that market will have a CPI at, above
or below 1. A score below 1 indicates a worse
than average competitive performance, since the
market share achieved relative to the seats offered
In aggregate, the other airlines consistently under-
perform, which may reflect a fragmented market
presence or a greater reliance on secondary markets.
Clearly, though, their monopolistic non-compete
route strategies are not delivering discernible
benefits in this regard.
Chart 13: Competitive Performance Index (CPI)
1.10 Better
than
1.05
average

is less than the average. Conversely, a CPI greater 1.00

than 1 indicates better than average competitive 0.95 Worse

than
performance. 0.90 average

In their Chinese domestic airline operations, the Big 3 0.85

have inevitably trended down from their historically 0.80

dominant market position as more carriers entered 2010 2011 2012 2013 2014 2015
the market. They are now consistently achieving CPIs Big 3 HNA Group LCC Others
just above 1, making them the industry benchmark
(Chart 13).
Introduction to China - The Land of Silk and Money7.3 Airport Growth
HNA Group airlines gained competitiveness through In 2015, 380 million passengers were carried on
2012, then declined as capacity was rapidly added, a domestic route network comprising 2,400 city
and7.3.
haveAirport Growth
recently moved slightly ahead again. pairs, which connected 187 airports, with another
4 added to the system during the first half of 2016.
The group of LCCs, from a modest start, put in a
In 2015, those 380 million passengers were carriedThe
strong competitive performance through 2014, but
on a10domestic
largest airports accounted
route network for over 50%
comprising of all
2,400
domestic passenger movements 221 million in total.
fellcity
backpairs, which
in 2015. connected
Given 187
the fluidity ofairports,
route andwith another
The 4 added
five to the
largest, system
in order, during
were theGuangzhou,
Beijing, first half of
capacity development as the LCCs expand, a degree Shenzhen, Chengdu and Shanghai-Hongqiao, with
2016. The 10 largest airports accounted for over 50% of all domestic passenger movements 221
of volatility is to be expected and it is likely that a the combined Shanghai airports of Pudong and
million inadvantage
competitive total. The of
five largest,
3 to in order,
5 points were Beijing,
over the Guangzhou,
Hongqiao Shenzhen,
taking 2nd Chengdu
place (Table anddensest
4). The
average can be sustained into the future. city pairs were also
nd those that connected the same
Shanghai-Hongqiao, with the combined Shanghai airports taking 2 place (Table 4). The densest city
five cities. 25% of all domestic passengers travelled
pairs were also those that connected the same fivethrough cities. 25% of passengers
Beijing, Shanghai ortravel through
Guangzhou andBeijing,
the
top 10 airports accounted
Shanghai or Guangzhou and the top 10 airports accounted for almost 50% of all passenger for almost 50% of all
passenger movements in 2015.
movements in 2015.

Table 4: Top 10 airports ranked by domestic passenger numbers

Rank 2010 2015
(1) Beijing 51,072,678 Beijing 74,824,457
(2) Shanghai 42,818,295 Shanghai 66,237,651
1 PEK 51,006,662 PEK 69,593,519 Beijing - Capital
2 CAN 31,515,109 CAN 43,148,073 Guangzhou
3 SHA 25,409,410 SZX 37,152,154 Shenzhen
4 SZX 23,159,450 CTU 35,860,136 Chengdu
5 CTU 21,410,851 SHA 35,291,041 Shanghai - Hongqiao
6 PVG 17,408,885 KMG 34,063,372 Kunming
7 XIY 15,753,873 PVG 30,946,610 Shanghai - Pudong
8 KMG 15,622,029 XIY 29,441,710 Xian
9 CKG 12,676,658 CKG 25,748,166 Chongqing
10 HGH 12,464,118 HGH 21,837,555 Hangzhou

The top 10 rankings have remained very consistent since at least 2010, however, there has been
more movement in the next 10 rankings, with 3 new entrants (denoted by * in Table 5) rising
through the ranks since 2010.
 (1) Beijing 51,072,678 Beijing 74,824,457
(2) Shanghai 42,818,295 Shanghai 66,237,651
1 PEK 51,006,662 PEK 69,593,519 Beijing - Capital
2 CAN 31,515,109 CAN 43,148,073 Guangzhou
26 3 SHA 25,409,410 SZX
The Land of Silk and Money
37,152,154 Shenzhen
PART ONE | China's Domestic Airline Industry
4 SZX 23,159,450 CTU 35,860,136 Chengdu
5 CTU 21,410,851 SHA 35,291,041 Shanghai - Hongqiao
6 PVG 17,408,885 KMG 34,063,372 Kunming
7 XIY 15,753,873 PVG 30,946,610 Shanghai - Pudong
8 KMG 15,622,029 XIY 29,441,710 Xian
9 CKG 12,676,658 CKG 25,748,166 Chongqing
10 HGH 12,464,118 HGH 21,837,555 Hangzhou

The top 10 rankings have remained very consistent since at least 2010, however, there has been
The top 10 rankings have remained very consistent since at least 2010, however, there has been more
more movement
movement in 10
in the next therankings,
next 10 rankings, with
with 3 new 3 new (denoted
entrants entrants (denoted by *5)inrising
by * in Table Tablethrough
5) risingthe ranks
since 2010.
through the ranks since 2010.

Table 5: Airports ranked 11-20 by domestic passenger numbers

Rank 2010 2015
11 CSX 10,463,967 XMN 18,611,765 Xiamen
12 WUH 9,915,808 URC 17,239,657 Urumqi
13 NKG 9,878,242 NKG 15,089,972 Nanjing
14 XMN 9,558,086 WUH 15,050,500 Wuhan
15 TAO 8,595,708 CSX 14,963,482 Changsha
16 URC 8,040,709 SYX 14,895,471 Sanya*
17 DLC 7,817,036 HAK 14,881,347 Haikou
18 CGO 7,715,051 TAO 14,543,300 Qingdao
19 HAK 7,326,697 CGO 14,301,567 Zhengzhou*
20 SHE 6,464,287 KWE 12,295,558 Guiyang*

th
TheThe12th12five-year
five-year economic
economic plan
plan setset a target
a target toto build 55 airports
7.4  Trafficbetween 2010 and
flows between 2015 cities
Chinas and 90 by
build 55 airports between 2010 and 2015 and 90 by and regions
2020, mostly in Western and Central China, with the objective of having 80% of the population
2020, mostly in Western and Central China, with the In the five years have
from opened
2009 toto2013, the government
locatedofwithin
objective having100km
80% ofof the
an airport. Sincelocated
population 2010, 21 additional airports scheduled
subsidised regional air services to the tune of
passenger
within 100km services, whichSince
of an airport. is below
2010,the
21 reported
additionalrate at which new
US$800 airports
million havethe
and over been
pastbuilt
fiveand
years, traffic
airports have opened to scheduled passenger
opened. Since a number of the new builds have been replacements for existing but outgrown
to, from and between small cities (with populations
services, which is below the reported rate at which of less than 1 million inhabitants) has increased by
new facilities,
airportsahave
shortfall
beenisbuilt
to beand
expected,
opened.but there
Since a are also examples of new airport projects, such as
136%, well ahead of the 75% domestic average.
number of the new builds have been replacements Nevertheless, demand for regional air services
for existing but outgrown facilities, a shortfall is to be remains low, with less than 1.6 million passengers
expected, but there are also examples of new airport (0.4% of the total) travelling on services linking
projects, such as Luliang in Shanxi province, opened
in 2014, and Libo in Guizhou, that have failed to 23 small cities (A-A in Chart 14). A further 63 million
passengers connected between small cities and
generate demand, often hand in hand with the ghost larger ones (A-B through A-D), including 23
cities that they were built to serve. million passengers connecting with the largest cities,
with populations of 10 million upwards.
The Governments 2016 budget for investment in
aviation infrastructure was $11.7bn, with plans for
The largest traffic flows are between the mid-sized
eleven major infrastructure projects and over 50
(1-5 million) and large (>5 million) cities, which
upgrades to existing facilities underway, including
account for almost 60% of the total, or well over 200
new airports in Beijing, Chengdu, Qingdao, Xiamen
million passengers.
and Dalian. This budget also includes improvements
to ATC facilities and airline fleet growth.
Construction of a further 60 new airports Chart 14: Passengers flows by city pair populations
City population key
by 2020 is also well advanced. A = <1M B = 1-5M C = 5-10M D = >10M
400
350
Population - Millions

300
250
200
150
100
50
0
2,010
2010 2,011
2011 2,012
2012 2,013
2013 2,014
2014 2,015
2015

A-A A-B A-C A-D B-B B-C B-D C-C C-D D-D
 2010 2011 2012 2013 2014 2015
e government(A-B subsidised through A-E),
regional airincluding
services 23 million
to the tune of A-A A-B A-C A-D A-E B-B B-C B-D

passengers connecting
ears, traffic to, from and between small cities (with with the largest cities, B-E C-C C-D C-E D-D D-E E-E

bitants) with
The Landpopulations
of Silk andof 10 million upwards.
Money 27
PART ONEChart | China's
14: Domestic
Passengers Airline
flows by Industry
city pair populations
he 75%
The proportions of passengers City population key travelling within and between the regions (East, West, Central &
nd for 400 A = <500K B = 500K-1M C = 1-5M D = 5-10M E = >10M
Northeast)
350
have also been changing over time,
less than Chart 15: Passenger mix by regional flow
Population - Millions

although
300 not as much as might be expected 100%
al) 250 11% 12% 13% 13% 13% 13%
given
200 the economic and demographic drivers 80%
5% 5% 5% 5% 6% 6%
s (A-A
influencing the pace of urbanisation and the
150
60%
26% 27% 27% 28% 29% 29%
ngers 100
9%
mobility
50 of the labour market (Chart 15). 40% 14%
9% 9% 10% 9% 9%
ger ones 0
14% 14% 12% 12% 12%
2010 2011passengers2012 2013 2014 2015 20%
lion Passengers
The proportions
A-A
on of
A-B
routes
A-C
operating
A-D A-E B-B
within
travelling
B-C
the
within
B-D
By 2015, both 32% markets
31% had29% traffic 28%levels27% well in 27%
and between the regions (East, West, Central & excess0% of 100 million passengers (Chart 16), with
cities, Eastern
Northeast)
B-E
Region
C-C
have also have
C-D
beendominated
C-E
changingregional
D-D D-E E-E
over time, flows East-West flows 2011
2010 having more 2012 than
2013 doubled 2014 since 2015

as might be expected given

since the earliest days of domestic air service.the economic and 2010, while intra-Eastern traffic increased by 50%
s. Intra-East East-Central East-Northeast East-West
demographic drivers influencing the pace of (Figure 7). Other traffic flows connecting the Eastern
However, East-West
urbanisation and the mobility trafficof has the been
labour steadily
market
Intra-Central Central-Northeast
Region have also seen strong growth, with East-
Central-West Intra-Northeast

ng within and(Chart
between the regions (East, West, Central & Northeast-West
15). and overtook intra-Eastern passenger Central and East-Northeast flows up by 50% and
Intra-West
increasing
er time, 76% respectively, reflecting the continued economic
numbersChart for15:thePassenger
first time mix byinregional
2013. flow importance of the Eastern region, whose airports are
ected 100% still included in almost 80% of all passenger journeys.
11% 12% 13% 13% 13% 13%
drivers By80%2015, both markets
5% 5% 5%had traffic5% levels
6% well 6% in
Chart 16: Passengers flows between regions
d the excess
60% of 100 million passengers,
26% 27% 27% 28% with
29% East-West 29% 400
9% 350
5). flows
40% having 14%
more
9%
14%
than 9%
14%
doubled 10% since9% 2010, 9%
300
Population - Millions

12% 12% 12%

while
20% intra-Eastern traffic increased by 50%
250
100
112
the 32% 31% 29% 28% 27% 27% 200 77
92
(Chart
0% 16). Other traffic flows connecting the 150 55
69

al flows 2010 2011 2012 2013 2014 2015 100

Eastern Region have also seen strong growth, 50 103
ervice. Intra-East East-Central East-Northeast East-West 69 80 85 91 96

with East-Central and East-Northeast flows up 0

eadily Intra-Central Central-Northeast Central-West Intra-Northeast 2010 2011 2012 2013 2014 2015

by 50% and
Northeast-West 76% respectively,
Intra-West reflecting the
passenger Intra-East East-Central East-Northeast East-West
continued economic importance of the Eastern Intra-Central Central-Northeast Central-West Intra-Northeast
Passengers on routes operating within the Eastern
region,have
Region whose airportsregional
dominated are stillflows included
since in the Northeast-West Intra-West

earliest days of domestic air service. However,

s well in East-West traffic has been steadily increasing The strongest intra-regional growth has been
Chart 16: Passengers flows between regions and
East-West overtook intra-Eastern passenger numbers for the between the Northeast and Western Regions, up by
400
first350time in 2013. 24243% since 2010, albeit off a small base. Intra-Central
2010, 300 traffic volume is small but has remained static, whilst
Population - Millions

50% 250
100
112 intra-Northeast traffic has declined by 22% to around
200 77
92 1 million, primarily due to the replacement of direct
ng the 150 55
69
flights with high speed rail links.
100
rowth, 50 91 96 103
69 80 85
Figure 7: Regional Passenger Flows 2015 vs 2010
Figure 7: Regional Passenger Flows 2015 vs 2010
ows up 0
2010 2011 2012 2013 2014 2015
Northeast
g the West
Intra-East East-Central East-Northeast East-West 1M
Eastern Intra-Central
East
Central-Northeast Central-West Intra-Northeast
7M
-22%
Central
d in Northeast-West Intra-West +243%
Heilongjiang

Inner Mongolia
Jilin

24 Liaoning
Xinjiang
Beijing 4M
Ningxia
+113% 35M
Tianjin
Hebei +76%
Qinghai
112M Shanxi
Shandong
50M Gansu +103%
+105% Shaanxi Henan
Jiangsu

Tibet 2M
22M Sichuan
Hubei 0%Anhui Shanghai

+105% Chongqing
Jianxi
Zhejiang
Hunan 46M 103M
Guizhou
+50% Fujian +49%
Yunnan
381M domestic Guangxi Guangdong

passengers (+76%)

Hainan
 level, it is clear that additional forces are at work 500

and Money in the Chinese market, since the slowing of 400

300

Chinas GDP growth over the past several years 200

28 100 The Land of Silk and Money

has notFigurebeen7: tracked by a corresponding
Regional Passenger Flows 2015 vs 2010 decline 0 PART ONE | China's Domestic Airline Industry

inNortheast
the rate of expansion of domestic air travel
been West
1M
(Chart
East
Central
17). 7M
-22%

egions, up +243%
Heilongjiang

ase. Intra- Looking ahead, demand for domestic air travel will surely be affected by the proposed re-alignment
Inner Mongolia
Jilin

emained 8. Forecasting
and up-scaling of economic activity,
Xinjiang
Chinas 35M domestic traffic flows
4Mpromotion of go West relocation initiatives and urbanisation
+113% Ningxia
Beijing
Liaoning

declined plans which will affect regional 112M

Qinghai
economic +76% activity and migrant worker patterns. Wages and
Shanxi
Hebei
Tianjin

Shandong
50M +103%
ue to the disposable incomes will continue2M to rise, but so too will living costs, especially in the cities, which will
Gansu
+105% Shaanxi Henan
Jiangsu

8.1 Building the model Tibet

Recognising that consumerism is becoming a more
peed rail also affect labour mobility. As disposable incomes rise, availability and affordability of air travel will
22M 0% Hubei Anhui Shanghai
Sichuan

+105%
air travel prominent feature of the air travel demographic in
Chongqing

GDP remains a strongly-correlated driver of103M

Zhejiang
Jianxi
Hunan

be essential
demand to satisfying
at a global demand,
and regional 46M along
level,
+50% however
Yunnan with availability
+49%
Guizhou
China, of core has
Avolon infrastructure,
developed an
Fujian
including
index of pilots,
"consumer
381M domestic
itairports
is passengers
clear that (+76%)additional
Guangxi
satisfaction"
Guangdong
that measures the extent to which
and air traffic forces are Whilst
services. at workbusiness
in the travel has been
Chinese the majority
consumers domestic
are reaching travelof
thresholds
Chinese market, since the slowing of Chinas GDP
segment tothe date, future trends
years will include
beena rising leisure travel component, although thesuch
ownership for high value household items HSR as
Hainan

growth over past several has not

tracked by a corresponding decline in the rate of computers, mobile phones, motor cycles, cars, etc.
raffic flows network and a steady rise in car ownership will absorb
expansion of domestic air travel (Chart 17). that,aonce
growing shareisof
achieved, thattobusiness.
likely lead to increased
expenditure on discretionary leisure items such as
Regression modelling
Chart 17: Chinese GDP has been used
& Domestic to identify significant
RPK Indices air travel.independent
When included variables that can be
in the regression used to
model
as an additional independent variable, accuracy is
represent key historical influencers of demand which
(2000 = 100)
are expected to remain relevant into the
improved and the overall model achieves a statistical
ed driver 800
future.
700 In addition to a GDP variable, the rate of urbanisation
GDP Index Domestic RPK index
is included,
R value of 0.998
2
along with
when applied metricsRPK
to domestic that
ional growth from 1993 to 2015 (Chart 18).
track
600
the market share of the Big 3 and the
e at work 500
penetration
400 of LCCs. Chart 18: Domestic Passengers - Actual vs Modelled
g of 300
500
al years Recognising
200
that consumerism is becoming a 450
Actual Model
100 400
g decline more
0 prominent feature of the air travel 350 R2 = 0.998
Passengers (M)

300
travel demographic in China, an index tracking 250
200
consumer satisfaction has also been 150
Looking
developed ahead, demand for
to measure thedomestic
extent to airwhich
travel will 100
50
be influenced by the proposed re-alignment
r travel will surely be affected by the proposed re-alignment and up-
Chinese
scaling of consumers are reaching
economic activity, promotion thresholds of
of go West
-

motion of go West relocation

relocation initiatives
initiatives and and urbanisation
urbanisation plans which
ownership for high value household items such
ic activity and migrant worker patterns. Wagesand
will affect regional economic activity andmigrant
worker patterns. Wages and disposable incomes
, but so too will living costs,
will continue especially
to rise, but so tooin the cities,costs,
will living which will 25The future projections of domestic RPK growth out
especially in the cities, which will also affect labour to 2026 that have been made using this model are
e incomes rise, availability and affordability of air travel will
mobility. As disposable incomes rise, availability themselves dependent on forecasts for each of the
g with availability of core infrastructure,
and affordability including
of air travel will pilots,
be essential to independent variables. In summary, these are as
satisfying demand, along with availability of core follows:
usiness travel has been the majority domestic travel
infrastructure, including pilots, airports and air traffic
ude a rising leisure
services. travel
Whilst component, although
business travel has beenthetheHSRmajority Independent variable Growth forecast Source
domestic travel segment to date, future trends will
hip will absorb a growing
include a risingshare
leisureoftravel
that component,
business. although Chinese GDP (current RMB) 2017-'21: 6.5% CAGR 13th Plan
the HSR network and a steady rise in car ownership 2022-'26: 6.0% CAGR Avolon
identify significant independent
will absorb a growing variables thatbusiness.
share of that can be used to
emand which are expected
Regression to remain
modelling relevant
has been into
used to the
identify
Urban share of population 65% by 2026 MacKinsey, UN &
others
e rate of urbanisation is included, along with metricsbethat
significant independent variables that can used to
represent key historical influencers of demand which
the are expected to remain relevant into the future. In
Seat share of the Big 3 40% by 2026 Avolon
addition to a GDP
Chart variable,
18: Domestic the rate
Passengers of urbanisation
- Actual vs Modelled
is included, along with metrics that track the market LCC penetration 20% by 2026 Avolon
500
share of the Big 3 andActual
the penetration of LCCs.
ming a 450
Model
Consumer satisfaction index 6% per annum CAGR Avolon
400
l 350 R2 = 0.998
Passengers (M)

300 Applying these inputs, the model predicts an

g 250 average growth rate for Chinese domestic
200
150
passengers of 6.8% per annum over the decade to
2026, comprising an average of 7.7% from 2017-2021
ich 100
50 and 6% from 2022-2026 (Chart 19).
olds of -

ms such

25
 million by 2026.
growth out to 2026 that have been made using this model
8.2. Who will be driving the growth?
s for each of The
the Land
independent variables.
of Silk and Money In summary, these 29
PART ONE | China's Domestic Airline Industry
The recent trend in aviation policy has been to maintain a process of gradual deregulation and be
generally supportive of market liberalisation and the sanctioning of new entrants. However, perhaps
Growth forecast Source
because
2017-'21: 6.5% of the rate
13th at which capacity is being added relative to the availability of infrastructure,
Plan
there are recent
2022-'26: 6.0% signs that this momentum may be paused. The regulatory authorities have yet to
Avolon
demonstrateMacKinsey,
65% by 2025 definitivelyUNthat they support a more liberal regime, but on balance the market forces
& others
already in play
40% by 2025 are likely to make permanent reversals in policy difficult.
Avolon
20% by 2025 Avolon
For this reason, the outlook for future growth
Although the predicted growth rates show a clear Chart 20: Domestic Passenger Growth Forecast
6% per annum
remains of
maturing theAvolon
positive, but over
market morethe
favourable for
next ten years, 2017-2021
these levels still result in domestic passengers 20%
Chinese to
doubling airlines otherby
840 million than the Big 3, which are
2026. 18%
16% 17.6%
cts an expected to maintain a lower growth trajectory 14%
Chart 19: China Domestic Passenger Forecast
stic (Chart
900
20) and will continue to lose market share 12%

CAGR
10%

e decade to the
800 insurgents. The new LCCs in particular, 8%
10.7%

7.7%
will700gain further ground, with close to 15%
Passengers (M)

6%
7.7% from 4% 5.8% 6.2%

hart 19). market

600 share forecast by 2021 and 20% within a 2%
0%
how a Introduction
decade.
500 to China
The HNA Group- The Land
is also of Silk and
expected Money
to out- Total Big 3 HNA Group Others LCCs

next ten 400

Chart 21: Domestic Market Share Forecast
300 26
mestic pace the 2017market
2018 2019(Chart 21) 2022
2020 2021 through a 2025 2026
2023 2024 50%
45%
840 combination of insurgent commercial behaviour 40%
35%
and further airline start-ups. The other domestic
8.2 Who will be driving the growth? 30%

full recent
The servicetrend
operators are policy
in aviation expected to hold
has been to their
25%
20%
maintain
ground in terms of aggregate market share,be
a process of gradual deregulation and but 15%
generally supportive of market liberalisation and 10%
with
been to maintain
the agrowth
processrates
sanctioning ofnew
of in line
gradual with the underlying
deregulation
entrants. However, and be
perhaps 5%
0%
because
market. of the rate at which capacity is being added 2016 2017 2018 2019 2020 2021
ation and the sanctioning of new entrants. However, perhaps
relative to the availability of infrastructure, there are Big 3 HNA Group Others LCCs
s being addedrecent signs
relative tothat
the this momentum
availability may be paused.
of infrastructure,
The regulatory authorities have yet to demonstrate
tum may be definitively
paused. The regulatory
that authorities
they support have regime,
a more liberal yet to Taking the relative segment sizes into account, the
9.
but on Conclusions
balance the market forces already in play are forecast projects that the Big 3 will generate the
port a more liberal regime, but on balance the market forces largest number of additional passengers, up by 65
likely to make permanent reversals in policy difficult.
anent reversals inpolicy difficult.
Chinastheeconomic development
million
is entering LCCs
on 2016 traffic levels. HNA Group and the
its 3rdwill
phase.
For this reason, outlook for future growth eachThe central
increase Planning
traffic themes
by around of the
50 million
growth next 5 to
remains positive, but 10more
years will be around
favourable realignment
for Chinese of the economy,
passengers withcarriers
and the other emphasiswill on the
gain 43 million
Chart 20:
airlines other Domestic
than Passenger
the Big Growth
3, which are Forecast
expected to by 2021 (Chart 22).
for maintain aupscaling of2017-2021
slightly lower industry
growth and manufacturing to deliver greater efficiency, greater innovation and
trajectory
20%
hich are (Chart
18%
20)greater value-add.
and will continue to lose market share to Chart 22: Passenger Growth Forecast
the16%insurgents (Chart 21). The new LCCs in particular,
17.6% 300
rajectory will14% Another
further
gain a keywith
ground, deliverable
15% marketis reduced
share dependence on foreign demand 2016 for manufactured
2021
+65M
250
forecast by 2021.
products through stimulation of domestic consumption
rket share 12%
CAGR

10% 200
icular, Multiple
The8%HNA threats
Group is also arising
10.7%
expected tofrom the above
maintain unintended consequences of previous policies and growth
Millions

average growth
7.7% as recent and future new airline 150 +43M
15% 6%
ventures
4%
plans
(both will
full challenge
service
5.8% and the
LCC)successful
expand
6.2% delivery
their of these turn-around strategies notably the
+48M
% within a market
2% ageing population, shrinking labour force, rising labour and input costs and
presence, with aggregated market share 100
+52M
extensive
increasing
0% from 16% to 20% over the next five
d to out- environmental
years. TheTotal
other domestic
Big 3 damage.
full
HNA service
Group operators
Others LCCs
50

are expected to broadly hold their ground in terms

The very low birth rate will result in China yielding 0
itsBig 3
most populous nation status to India at
HNA Group LCCs Others
of aggregate market share, but with growth rates
26slightly below
somethe point in the future.
underlying However, the population of 1.38 billion is increasingly urban in
market average.
location, with over 200 cities having more than 1 million residents and 17 cities, with more
than 5 million, where industrial growth, rising disposable income and large migrant worker
populations will be central to supporting increased domestic consumption.
Although GDP growth has been gradually slowing over the past number of years, absolute
increases in the economy, measured in RMB, remain the highest in the world, helping to
sustain growth in sectors such as commercial aviation.
New, ambitious and far-reaching policies such as One Belt One Road have the potential to
materially raise Chinas international influence, cooperation and investment activities, but
30
9. Conclusions
Chinas economic development is entering its
3rd phase. The core planning themes of the next
5 to 10 years will be around realignment of the
economy, with emphasis on the upscaling
of industry and manufacturing to deliver greater
efficiency, greater innovation and greater
value-add.
A critical deliverable is to reduce dependence
on foreign demand for manufactured products
through stimulation of domestic consumption.
Success here, as well as in ambitious and far-
reaching policies such as One Belt One Road, will
be pivotal in shaping and securing the next phase
of Chinas economic development.
Multiple threats arising from the unintended
consequences of previous policies and growth
plans will challenge the successful delivery
of these turn-around strategies notably the
ageing population, shrinking labour force,
rising labour and input costs and extensive
environmental damage.
The very low birth rate will result in China yielding
its most populous nation status to India at some
point in the future. However, the population
of 1.38 billion is increasingly urban in location,
with over 200 cities having more than 1 million
residents and 17 cities with more than 5 million,
where industrial growth, rising disposable
income and large migrant worker populations
will be central to supporting increased domestic
consumption.
Although GDP growth has been gradually slowing
over the past number of years, absolute increases
in the economy, measured in RMB, remain the
highest in the world, helping to sustain growth in
sectors such as commercial aviation.
The Land of Silk and Money
PART ONE | China's Domestic Airline Industry
The Chinese airline industry continues to
experience strong demand and growth, with a
gradual relaxation in centralised CAAC regulation
and control providing the framework for
development of a broad-based airline community,
with multiple new entrants, including a growing
number of operators based in secondary cities
and a nascent but fast-growing low cost carrier
segment.
In 2015, Chinese airlines operated over 3 million
flights with 500 million seats on domestic routes.
Over 380 million sector passengers were carried,
producing a system load factor of 77%.
Traffic flows are gradually diversifying away
from the most populous and wealthiest Eastern
Region, mostly towards the Centre and West of
the country.
The top ten airport rankings have remained stable
over the past 5 years and account for almost 50%
of total domestic passenger movements.
Structural problems, including inefficient and
limited airspace capacity, congested airports,
a shortage of pilots and bureaucratic approval
procedures will continue to challenge current
operations and potentially hamper future growth
for the foreseeable future.
Nevertheless, domestic traffic growth is forecast
to average 6.8% over the next decade, driven
not only by GDP growth, but also increasing
urbanisation, rising consumerism and the
availability of more, and more affordable, low cost
airline capacity.
Within the domestic airline community, LCCs will
generate the highest growth rate, whilst the Big 3
will see the largest increase in traffic volume over
the next 5 years.
The Land of Silk and Money 31
PART ONE | China's Domestic Airline Industry

Appendix 1
Chinese Airlines Fleets at 31st December 2016

Total In Service Storage Orders & LOIs Order LOI

A320ceo family 1,345 1,167 12 166 36 130

A320neo family 215 2 0 213 23 190

B737 Classics 10 0 10 0 0 0

B737NGs 1,333 1,149 5 179 126 53

B737 MAX 389 0 0 389 99 290

B757 12 12 0 0 0 0

C919 95 0 0 95 55 40

A330ceo 247 183 0 64 39 25

A350 44 0 0 44 34 10

A380 5 5 0 0 0 0

B747 11 10 1 0 0 0

B767 9 9 0 0 0 0

B777 69 58 4 7 7 0

B787 128 42 0 86 62 24

CRJs 45 28 5 12 12 0

ERJs 22 14 8 0 0 0

C-Series 20 0 0 20 0 20

E-Jets E1 116 90 0 26 16 10

E-Jets E2 20 0 0 20 2 18

ARJ21 121 2 0 119 93 26

MA Turboprops 169 20 1 148 31 117

Total 4,425 2,791 46 1,588 635 953

Single aisle 3,399 2,330 27 1,042 339 703

Twin aisle 513 307 5 201 142 59

Regional 513 154 14 345 154 191

Future technology 816 44 0 772 220 552

Souce: FlightGlobal Ascend

32 The Land of Silk and Money
PART ONE | China's Domestic Airline Industry

Appendix 2 - The Land of Silk and Money

Introduction to China

Chinas airlines and their principal bases

Appendix 2 Chinas airlines and their principal bases

Hohhot .
. Dalian

. Qingdao

Guilin . . Xiamen

. Shenzhen

. Haikou

Airline Base City Province Region Airline Base City Province Region
Fuzhou Airlines Fuzhou Fujian East Henan Airlines Zhengzhou Henan Central
Xiamen Airlines Xiamen Fujian East Jiangxi Airlines Nanchang Jiangxi Central
9 Air Guangzhou Guangdong East Longjiang Airlines Harbin Hailongjiang Northeast
China Southern Guangzhou Guangdong East Dalian Airlines Dalian Liaoning Northeast
Juneyao Airlines Guangzhou Guangdong East Air Guilin Guilin Guangxi West
Donghai Airlines Shenzhen Guangdong East GX Airlines Nanning Wuxu Guangxi West
Shenzhen Airlines Shenzhen Guangdong East Colorful Guizhou Guiyang Guizhou West
Grand China Air Haikou Hainan East Air China Inner Mongolia
Hohot Inner MongoliaWest
Hainan Airlines Haikou Hainan East Air Chang'an Xian Shaanxi West
Hebei Airlines Shijiazhuang Hebei East Joy Air Xian Shaanxi West
China Eastern Jiangsu Nanjing Jiangsu East Chengdu Airlines Chengdu Sichuan West
Shandong Airlines Jinan Shandong East Sichuan Airlines Chengdu Sichuan West
Qingdao Airlines Qingdao Shandong East Tibet Airlines Lhasa Tibet (Xijang) West
Loong Air Hangzhou Zhejiang East Urumqi Airlines Urumqi Xinjiang West
Air China Beijing East China Eastern Yunnan Kunming Yunnan West
Capital Airlines Beijing East Hongtu Airlines Kunming Yunnan West
China Xinhua Beijing East Kunming Airlines Kunming Yunnan West
China United Beijing East Lucky Air Kunming Yunnan West
Okay Airways Beijing East Ruili Airlines Kunming Yunnan West
China Eastern Shanghai East China Express Chongqing West
Shanghai Airlines Shanghai East Chongqing Airlines Chongqing West
Spring Airlines Shanghai East West Air Chongqing West
Yangtze River Express Shanghai East
Tianjin Airlines Tianjin East
More of our insights and thoughts can be found at:
avolon.aero/our-thoughts

Transitioning to Funding the Future

Neo and Max Matching the Demand for Aircraft
with the Supply of Capital
An Investors Guide

Dick Forsberg & Lucas Mollan Dick Forsberg

February, 2013 October, 2013

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Aircraft Retirement Values and Valuers

and Storage Trends An Assessment of the Aircraft Valuation Business

Economic Life Analysis Reprised and Expanded

Dick Forsberg Dick Forsberg

March, 2015 18 February, 2016

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34 The Land of Silk and Money
PART ONE | China's Domestic Airline Industry

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