Silicon Hutong

Re-Post: The Brazilian Job (with update)

In the Hutong

Digging deeper into aerospace in China

0038 hrs.

I get asked now and then what I would consider a case of foreign companies learning to play by Chinese rules in China. There are plenty of good cases, but one I particularly like - because it is a quick one to tell - is something that happened to Brazil's EMBRAER about two years ago.

Kung fu, meet Capoeira 

The Civil Aviation Administration of China, (CAAC, through whom all orders by Chinese airlines for airliners must go) had apparently been sitting on an order for some EMBRAER regional jets. The Brazilians, who had built a factory in Harbin with the expectation that China would be a gigantic market for regional jets, was apparently finding things a bit rough going for its China operations, as the Harbin plant was apparently all but idle. 

So the guys at EMBRAER made it known that they’re going to shut the doors in Harbin due to a lack of orders.

This clearly struck someone in the civil aviation bureaucracy as a bad idea. It would have been a step backwards in China’s efforts to attract foreign airframe manufacturers (and build its own airframe manufacturing industry), and it would have ruined the rationale for local player AVIC to develop its own regional jet, the recently-unveiled ARJ-21. 

So, next thing you know, EMBRAER  scores an order for 100 of its puddle-jumpers from HNA Group, the parent company of Hainan Airlines, Xinhua Airlines, Chang An Airlines, Shanxi Airlines, Yangtze River Express, and bizjet operator Deer Jet.

Without arguing the merits of the deal for HNA (frankly, I think they’d be better off putting their money into larger planes), you have to give EMBRAER credit for playing the game by Chinese rules in China - and winning. 

They're Cute, but do they pay?

I am not a fan of regional jets in China I had planned to write a long piece here excoriating the EMBRAER deal even as I applaud the Brazilians for their innovative tactics. 

My thinking is simple, and perhaps simplistic, but I think it is commons sense. With growing passenger loads, airspace that is limited by both nature and by outdated procedures, and one airport for every 11 million people, China needs bigger aircraft.  

And that's without even broaching the matter of air cargo, which these little planes are completely incapable of carrying in any reasonable quantity (i.e., no pallets or containers.)

It's the juice, stupid.

But I have to confess concern when I see oil prices shooting beyond any presumed cieling. At some point, the oil companies in China are going to get their way, and airlines in the PRC will have to pay global prices for their Jet A. The airlines will have to raise fares in response, stymying growth and keeping volumes down for a while. 

A longer term dislocation in oil prices will hit Chinese airlines even harder, and will either keep people at home or will send them scurrying back to surface transportation. 

For a long time, observers of China's aviation industry have believed that the PRC would follow the US in making air travel the primary means of travel between cities. Now, I'm not sure. I see greater things ahead for rail transportation in China.

And I see Chinese airlines facing a future that, for similar but different reasons, is as uncertain as the horizons that confront U.S. carriers. 

Stick with the little jets for now, guys. In the end, if nothing else, you may be able to lease them to United for their Los Angeles - San Francisco service when oil hits $200 a barrel. 

Boeing, helicopters, corporate conduct, and China

Starbucks Pacific Place

People are to caffeine like dolphins are to anchovies

1355 hrs.

Longtime readers of this blog know that I am a longstanding Boeing partisan. Apart from having flown on just about every model of Boeing jet ever made (save the military ones), they were an important customer for my dad when he was an aerospace subcontractor in the 1960s and 1970s, and I've always admired them for their endurance and the core role they have played in the creation and growth of the aviation and space industries. 

Things Are Getting Better

The last few years have been hard on us BA fanboys, watching Airbus emerge from a niche player to a real competitor to a contestant with Boeing for the leadership of the business, and standing by as Boeing proposed then withdrew a sequence of interesting commercial aircraft that didn't make it beyond the drawing boards. 

On the upside, Boeing has significantly improved its internal processes, created the economical 787 and an updated 747 just in time to catch $150/barrel oil, and has slowed (if not ceased) developing a 737 successor because it still has a huge backlog in 737 orders, all as China and the rest of Asia discover the wonders of air travel and start expanding their fleets.  

Or Are They?

But recent news implies that the internal problems that brought about Boeing's eventual loss of a critical USAF tanker project have not yet been exorcised. Military.com is running the first in a series of articles from Aviation Week's Defense Technology International that suggest that in the selection of Boeing to supply a new combat search-and-rescue helicopter (the the kind of helos that yank soldiers, sailors, airmen, and Marines out of dangerous situations) the interests of contractors have been placed ahead of the needs of the people in the field:

The story that emerges from this study reveals how the acquisition was skewed in favor of certain helicopters from the very beginning by lawmakers and Pentagon officials, regardless of the requirements set forth by the Air Force’s own CSAR experts.

If true, Boeing is going to take some heat, and rightfully so. Nothing comes before passenger safety in commercial aviation, and nothing should come before the needs of the people in uniform in defense procurement. 

But if these charges have some value, I would hope that the "lawmakers and Pentagon officials" involved in the process get skewered at the same time. 

We will learn more about the veracity of these allegations soon, but it does not take someone imaginative to think that at the very least hearings are in the offing. Congressional and Defense Department Inspector General reviews are apparently already under way. 

China and the Corporate Social Contract

This lends some perspective to the challenges businesses face in China. Collusion between the regulators and the regulated to distort what should otherwise be clear commercial and technological choices is by no means unique to the PRC. It also underscores that simply pointing to the competition and saying "but everybody does it" is morally bankrupt. 

There are foreign-invested companies in China who seek to do good via acts of philanthropy or corporate social responsibility. The reaction from multinational enterprises in the wake of the Sichuan earthquakes has been huge, rapid, heartfelt, and highly commendable.

But one has to question the value of corporate community largesse when it is but a fig-leaf on a company's failure to operate by its implied social contract, which begins with its responsibility to "first, do no harm." 

A number of government officials in China have publicly reacted to the queries of enterprises and CSR consultants about what civic acts of kindness are most appropriate in China by noting that CSR misses the point. The first and most important obligation of companies in China is to hire lots of people, pay them well, and pay their taxes, all while behaving in a way that benefits society rather than damages it. 

Simply put, if we seek a more open, more transparent China, our obligation as foreign enterprises is to lead the way. Don't come to Rome and do as the Romans. It may demand some sacrifices. It may mean you lose some big contracts. But in the end, it is better both for your company and for China. 

What Happens in Seattle Doesn't Stay in Seattle

Boeing may be completely innocent of the allegations covered in the story in DTI. As a Boeing fan, I hope so. (It is worth pointing out, in the spirit of fairness, that Airbus parent EADS has come under scrutiny in Europe for a series of alleged offenses, most recently for alleged stock trading improprieties on the part of senior executives.)

But if it is not, company executives must recognize that its modus operandi in its home country will affect the way it is perceived overseas. Eventually its conduct in China would come under scrutiny, by authorities either in China or elsewhere: surely, the thinking will go, a company that engages in improper collusion with government officials in its own country would feel free to do so elsewhere, right? 

Perceptions matter. In a country that will need over 2,000 commercial aircraft in the next two decades, Boeing cannot afford such headaches. The company needs to do everything possible to clear up the matter of CSAR helicopters as soon as possible, lest it damage its prospects at home and abroad. 

Been watching the PLA on TV?

In the Hutong 

Wondering where Silverman is 

1721 hrs.

I consider myself something of an amateur military historian, so it is particularly vexing to see a chunk of the PLA in action in Sichuan and have absolutely no idea what I'm looking at. That is even more embarrassing when you consider that my wife is a PLA brat and both of my in-laws are retired senior officers. 

The web has some superb cheat sheets, though. If you're inside the GFW you may occasionally have to do without the superb Military Analysis Network at the Federation of American Scientists' website. If so, SinoDefence.com is also excellent - longer on the photos and much deeper on the PLA than the FAS. 

Black Hawks over China

Jingshun Road

Another Manic Wednesday

1605 hrs.

Those of you who have been watching the coverage of the rescue and recovery operations in Sichuan may have caught a glimpse of a familiar aircraft bearing unfamiliar colors: Sikorsky Black Hawk helicopters sporting People’s Liberation Army markings. 

One person I mentioned this to remarked that they had not realized that U.S. assistance to China after the earthquake included helicopters. In truth, it didn’t. The planeloads of supplies and equipment delivered by the C-17s of the US Air Force included a lot of gear, even a fully-equipped urban search and rescue vehicle courtesy of FEMA and the Los Angeles County Fire Department. But no helicopters. 

The Black Hawks - identical in many respects to those flown by the US military around the world - are a relic the 1980s, a time when it was politically correct to see the PLA and the US armed forces as potential allies. Despite consistent efforts on the part of Sikorsky, its parent United Technologies, and others, further sales have been politically impossible since 1989. 

I am among those who believe that the calculus of global security changed significantly on September 11, 2001, and that in the kinds of non-traditional conflicts that look set to define military operations in the 21st century, the U.S. (as traditionally strong maritime power) and China (as a traditionally land power) are natural allies. It simply requires both sides to move beyond their doctrinal beliefs that the most likely next enemy is the big kid on the other side of the pond. 

But I am in the minority, and so the Chinese Black Hawks will be departing the skies soon as their airframes reach the end of their effective lives and they are replaced by comparable (albeit larger) Russian-designed Mil Mi-17s produced in China under license. 

In the meantime, it is somehow gratifying to watch them at work, saving lives on hillsides, valleys, and floodplains across the earthquake zone.

America's Airline Mashup and China's Future

In the Hutong
Dreaming of Islands
1902 hrs.

The normally astute (and often erudite) BusinessWeek falters a tad in analyzing the value of the coming wave of airline mergers in the United States.

The question BW asks is almost the right one - it wonders if the creation of a small number of American Megacarriers - Northwest/Delta, United/Continental, and American/player-to-be-named-later - will be enough to fend of European competition. The large U.S. carriers - with the sole exception of Southwest, a huge, well-run discount domestic-only airline - lose money on domestic service, making it up only on international passengers and freight. European carriers are, naturally stronger than US carriers in this space.

Asian Airlines are not Chopped Liver

Not a bad question. I suggest there are two others:

1. Given that there are only two airline models that seem to make money (low-frills and high-efficiency discount, or full-service, long-haul international), how is creating larger airlines that do neither of those very well going to make the U.S. industry any stronger? Nobody seems to have picked up the ugly reality that combining two mediocre airlines does not make the resulting company better - just bigger. Opportunities for economies of scale aside, this will still not solve the long-term problem: with the sole exceptions of Southwest and possibly JetBlue, U.S. airlines are operating on an obsolete business model.

and

2. If you think the British Airways, Lufthansa, and Air France/KLM are such a threat, have you ever paused to consider that Singapore Airlines, Cathay Pacific, and ANA would tear even bigger holes into what have become U.S. carriers' most profitable markets - the trans-Pacific trade? It it particularly surprising that BW seems to dismiss the Asian carriers completely out of hand. With the sole exception of Virgin Atlantic, I cannot think of a single European carrier that approaches the quality of service, youth of fleet, and profitability of Asia's leading airlines.

Don't Follow The Americans - At Least Not THOSE Americans

All of this is instructive for China's airline industry. As Air China pursues ownership of China Eastern, it heeds my second question while ignoring my first. Yes, it would probably be bad for Air China to stand by and let Singapore Airlines get its nose under the proverbial tent. Apart from that, however, it will simply create a larger, less nimble, less efficient carrier right at the time when the Chinese airline industry needs to rethink its structure.

China would do itself an injustice by learning the wrong lessons from all of the noise around M&A activity in America, and would do better by looking around the world for airlines that work brilliantly.

Making Old Jets Green Again

Lobby of the China World Hotel, Beijing
Surrounded by the Chindians
1439 hrs.

It's getting to the point where you can't go a day without hearing another recycling story. This pictorial essay on CNET today walks us through the recycling of airliners that have exceeded their economical service life.

(The whole concept of "economical service life" is, of course, highly relative. I think Aloha Airlines is flying 737-200s that are nearly 40 years old, while much younger aircraft have already gone through the shredder.)

The U.S. leads in this field because a) there are lots of large surplus airports in relatively remote areas, and b) the country has a highly developed recycling industry, and c) the costs of getting chunks of old planes to said recycling facilities - and getting recycled material to customers - is still low.

Let's see: South Asia recycles ships. America recycles planes. What about China going into the business of recycling railroad rolling stock?

Anyway, what is interesting is that products made from recycled materials are now no longer just paper and beer cans. There are companies coming up with ways to use recycled wood, rubber, and even carbon fiber composites. The green/sustainability direction the world economy is taking has created new incentives for the recycling business to invest in new technologies.

If recycling is a growing business, one that is ready to pay for innovations, it is clearly another direction in which China could consider investing its "independent innovation" efforts.

China Leading the World in e-Tickets. M-Tickets anyone?

In the Hutong
Back from the Hutong Summer Holidays
1950 hrs.

After a month's physical holiday and a month's writing holiday - in succession, not in parallel - the issues surrounding air travel remain fresh in the mind. So it was with great interest that I read cNet's report noting that the International Air Transport Association (IATA) was confirming that it would meet its June 1, 2008 deadline to eliminate paper tickets everywhere in the world, completing a switch to e-tickets.

Here's the kicker: China will be the first country to completely switch over.

This makes a lot of sense. Chinese airlines need all of the help they can get: constant price wars have driven profits in Chinese air travel into the sewer. $9 per ticket may not sound like much, but I'm sure the airlines of the PRC will take it. China Eastern Airlines, for example, lost US$365 million last year on 35.04 million passenger journeys. In other words, it could eliminate $315 million of that loss. It would have nearly doubled Air China's profit for the year.

Needless to say, that's significant. The question is, how else can this technology be applied in the industry to either improve efficiency or make flying more convenient?

Today, E. Tomorrow M

The systems that were the toughest to put into place for e-ticketing in China were reimbursement policies and ways of handling travel agents and ticketing offices that were, er, technology-deficient. Stunning as it is to believe, there is actually still an embarrassingly large number of places to buy air tickets in China that don't have computers or printers. No single solution appears ready to bridge this technology gap.

What would go a long way, however, would be a system that would send the e-ticket information directly to a mobile handset from a central office. I have no hard data, but apocrypha and experience suggests that the vast number of airline passengers in China are shlepping cell phones. All that would need to happen to make this system work right now would be to whittle down the information so it would fit into 1 or 2 SMS messages.

This way, a travel agent without a computer could call a central office with the necessary information, and that office could generate the m-ticket and send it to the customer's mobile. There would be all kinds of other benefits as well, including the ability to buy a ticket without having to set foot in a ticket agency (or, indeed, buy it as you drove up to the airport.) In other words, it would go a long way toward making air travel more convenient.

eBoardingPass

The mobile handset is going to be the key to the airlines' next step as well: the eBoardingPass. IATA is helping to work out the kinks in a uniform system to allow passengers to print their boarding passes at home, using a unique barcode, with which some airlines are experimenting already. At the same time, IATA is pushing self check-in systems that have been installed in some two dozen airports around the world.

Combine the two, and self check-in with the mobile handset, with the airline sending an MMS with the bar code and some basic information would be a logical next development step for China's busy airlines and overcrowded airports.

At least it would eliminate the problem of a dozen people cutting into the check-in queue at the airport.

Paulson's Airline Deal Kills Open Skies

In the Hutong
Listening to the sound of mosquitos
2131 hrs.

About six weeks ago the U.S. Secretary of Transportation showed up in China suggesting that an open skies agreement between the U.S. and China would happen by year end.

We said then - and say now - that hoping for open skies with China in the foreseeable future is at best an existential exercise, and at worst it is self-delusion.

Wu Yi's trip to the US to talk to her old pal Hank Paulson, while producing precious little, did manage to land an agreement to significantly increase the number of flights between the U.S. and China over the next year or so.

What nobody has caught yet is that this basically ends the whole open skies idea. It's dead, folks.

Before you don the sackcloth, though, recognize that what Paulson and Wu agreed upon is actually all we can get rightnow. If we had started on SecTrans Mary Peters' path, we would have been talking our faces blue trying for a home run when all we needed was a single.

Delta Airlines Should Fire Their PR People. Now.

In the Hutong
Watching the Markets
2139 hours.

In an absolutely unforgivable PR gaffe, Delta Airlines PR department or agency decided to have the airline's CFO do an remote interview about the company's emergence from bankruptcy in a loud, echoing hall filled with screaming Delta people. In the end, it was impossible for the CNBC anchors to conduct the interview because it was impossible for the Delta executive to hear anything. Holding both hands to his ears and smiling gamely, the executive hardly presented the image of confidence, competence, and cheer that would make me want to fly with them anytime soon.

Whoever in the Delta organization or agency suggested that setting for an interview deserves to be put on permanent waivers. The whole thing did hideous damage to Delta's image at a point where image is critical. Completely uninspiring, unnecessary, and unprofessional.

The Pipe Dream of Open Skies

In the Hutong
Welcome to the suck
2210 hrs.

Secretary of Transportation Mary Peters was in town last week talking to Chinese officials about the possibility of setting up an open skies agreement between the U.S. and China. I think it's a great idea, and I'm personally looking forward to direct flights between Beijing and Honolulu. Nonetheless, for several reasons I don't hold out much hope for an agreement in the near term, despite the SecTrans' optimistic tone.

The good news is that cabotage - or the ability of a U.S. airline to carry passengers between points within China, or of a Chinese airline to carry passengers between U.S. cities - appears to be off the table. Cabotage creates serious domestic political opposition, and would do so on both sides of the Pacific. Leaving cabotage out of the discussions apparently helped US conclude their open skies agreement with Europe last month. Secretary Peters, apparently flush from that success, is now tackling a much tougher nut in China.

The SecTrans is Smart, but...

From what I hear from some of the reporters who had contact with Secretary Peters during her jaunt through China last week, she is one very bright lady. Indeed, in the words of one journalist, she stands out among the Bush appointees as a singularly intelligent, well informed, down-to-earth, competent administrator.

The one challenge she faces, however, is that she is, by both training and disposition, a highway engineer. This means that not only is she an outsider to the politics and peculiarities of the aviation industry, she is also more accustomed to dealing with government issues in a domestic (rather than international) context. Her experience dealing with the Chinese is, therefore, also somewhat limited.

So when she predicts that the US will see an open skies agreement with China within the year, and a framework for discussion within a month, she can, therefore, be forgiven for her optimistic assessment.

Because anyone with experience negotiating international agreements with the Chinese government knows that reaching any bilateral accord, much less something with significant potential impact on China's economy, is not a quick process. Things just don't move that quickly here, and they are less likely to in this case.

Anyone familiar with the grunt work involved in reaching a bilateral open-skies agreement also understands that this will be a very long process. One friend of mine, working for a major wire service, noted that when he spoke to a senior U.S. airline executive recently about the possibility of open skies with China, he noted that he did not expect significant progress for at least a decade.

There are lots of reasons why this is the case. Two of them immediately come to mind.

What is Hong Kong?

One of the biggest questions in the discussions is the status of Hong Kong and Macao in the agreements. If you exclude Cathay Pacific and Dragonair from the discussions, open skies looks like a great deal for U.S. carriers, but not necessarily such a hot deal for domestic Chinese airlines. Short of a significant upgrade of the reputation and service offered by Chinese airlines on their North American routes, chances are the U.S. carriers would dominate the routes, at least taking the more profitable business and leaving the Chinese airlines to scoop up the leftovers.

On the other hand, if China managed to convince the U.S. to include Hong Kong and Macao, the tables would turn. All of a sudden, you could fly Beijing to Los Angeles, San Francisco, New York, Chicago, and DC on Cathay Pacific. That would allow CX to take the cream, with the American carriers fighting the mainland Chinese carriers for everything else.

While the Chinese may not want it (ownership structures notwithstanding, there's no love lost twixt the mainland carrier and it's Hong Kong cousins), would be a great tool to use to slow down negotiations and exact concessions from the US. Regardless of how the Chinese feel about it, the U.S. airlines certainly don't want to face CX on what are rapidly becoming the most profitable routes in the business.

Are the Chinese ready for open skies?

Here is the real kicker. You have to assume that at some point there will be an open skies agreement between the US and China. You also have to assume that the US wants this, because they are driving the process at the moment. This means that the Chinese control the timing of the process.

So the real question is "when will it make sense for the Chinese to go for open skies?"

The short answer to that is "not right now."

Apart from the obvious question of service quality, China's airlines aren't ready. Marketing is weak, the brands need pumping - even the liveries on the sides of the aircraft look like throwbacks to the 1970s. Domestic demand is rising quickly, and the companies are having to deploy most of the aircraft, pilots, and financial resources they can muster simply to handle local growth.

Keeping up with a sudden inrush of airlines who are much larger and more experienced airlines would swamp the locals, who would be unable even to match the growth in routes. If it happened today, would Air China, China Eastern, and China Southern be able to start direct service to another half-dozen US cities without stripping their networks of assets? Already China needs to find 11,000 new pilots and 2,500 new aircraft in the next 20 years just to keep up with organic growth. Competing under open skies would only add to this burden.

Give them an inch...

There are other reasons for the Chinese to want to go slow on open skies with the US.

For one, the Europeans would show up the next day demanding open skies for their airlines, too. They'd be followed by the Japanese, the Singaporeans, and nearly every country in the world. In other words, even if you don't think United, American, Delta, Continental, Northwest, USAir, and Hawaiian could collectively deliver a mortal wound to the international services of China's airlines, you have to assume that adding the rest of the world to that burden isn't going to help. At the very least, international growth opportunities for China's airlines would be stunted, and this at a time when those services are desperately needed to help make ends meet.

Bottom line, as hopeful as Secretary Peters might be, if I were her I wouldn't count on making open skies happen with China before her boss leaves office in January 2009.