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Transportation: China Eastern bets on lower fares to fly high

By Wang Ying (China Daily)

February 27, 2009

Ailing Chinese carrier, China Eastern Airlines, is betting on low fares on rationalized routes to attract new

customers.

The company, which has suffered huge losses (on paper) due to hedging on crude oil prices and dwindling

demand, said it was adding 900 transit flights through traffic hubs in major cities. This includes its home

base of Shanghai, and Wuhan, Kunming and Xi'an.

The planned revamp of its flight network means the fares of transit flights would be significantly lower than

direct flights of its chief competitors, Air China and Southern Airlines. The airline would be able to do this

without having to make big investments in new aircraft, it said.

The company said the hub approach would give its customers more options on their flight plans.

China Eastern carried out extensive market research that showed there was a growing demand for flights

between many second- and third-tier cities. The cost of launching new routes to cater to such demand

would have been prohibitive, a company official, who declined to be named, said.

This is the reason why the inter city air travel market has largely been ignored by other carriers, the source

said.

For instance, a passenger flying from Shanghai to Tengchong in Yunnan province would have to fly first to

Kunming and then take another flight (operated by a different airline) to Tengchong.

The total airfare would come up to 3,000 yuan. But if the same person flies China Eastern through its transit

hub in Kunming, he would be able to save a few hundred yuan, the source said.

"Customers can choose the intermediate stop at any of our hub cities," the source said. This arrangement

would not be limited to domestic flights alone. "We will try to ensure a smooth transfer for passengers of our 

international flights to their domestic destinations at our hubs," the source said.

China Eastern operates a fleet of nearly 250 aircraft on 293 domestic routes and more than 80 internationalflights.

"The hub concept has the potential to become a win-win situation for passengers and the airline," said Li

Lei, an analyst with CITIC China Securities.

"There is nothing new in the idea of transit flights. It helps lower the airline's operating costs. That can

translate into reduced fares," said Michael Peng, sales manager, Shanghai Business International Travel

Service Co. But "we are not sure if it holds any appeal to business travelers who put a premium on their 

time," he said.

Peng and other travel agents said they remain skeptical about the appeal of transit flights to business

travelers, even in an economic downturn when cost matters much more. "I have to say that the business

travelers I know won't choose to fly on transit routes just for the lower fares," Peng said.

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"Just imagine, you have to stay in the transit lounge for two or three hours waiting for the onward flight,

always worrying that you may miss the appointment," he said. "You would wish you were flying direct."

According to Yao Jun, an analyst at China Merchants Securities, flight punctuality is the key to making such

flights popular among passengers. "Such transit flights are more time-consuming, and it is vital for the

carrier to guarantee the shortest time at the transit," Yao noted. "The delay of one flight will affect many

following flights," she said.

China Eastern reported a net loss of 2.34 billion yuan in the first nine months of 2008. It posted a loss (on

paper) of 6.2 billion yuan on fuel hedging contracts throughout last year.

Trading of China Eastern shares has been suspended on the Shanghai bourse as the carrier is scheduled

to hold its second board meeting to vote on a decision that will see it getting 7 billion yuan in cash through

the sale of shares to its State-owned parent company.

China Eastern shares edged up by 0.19 percent to close at 5.29 yuan a share in Shanghai on Wednesday.

Assignment:

1. Read the article.

2. Look at the description “Airline Hub and Spoke”

3. What does “hedging” mean? Why do you think China Eastern and other airlines hedged on crude oil

prices?

4. Assume you are a member of the Board of Directors of China Eastern Airlines. The CEO has made a

proposal to the Board to implement the hub and spoke system. Write 4 questions that you would ask him

in your role as a Board member to help you make a decision on his proposal.

• What background information would you want to know?

• What facts and figures would you want to know?

• What else would you want to know?