Sunday, March 1, 2009

Leadership Thinking in the Airline Industry

Today's SCMP has an interview with Liu Shaoyong, Chairman of China Eastern Airlines, the weakest among the "Big 3" central state-owned airlines. The 51-year old Liu is a former pilot and former head of China Southern Airlines, another of the "Big 3".

Some readers may remember that, five years ago, China Southern was loaded with debt and in desperate straits. Liu is credited with taking the helm then, and turning things around in two years' time. A similar feat is now expected of him at China Eastern.

Unfortunately for Liu, the bull market that drove demand for air travel as he worked his magic on China Southern has long since ended. He's performing without a net this time.

If I have any regular readers, I'm sure you have recognized by now my particular obsession with business consolidations in China. The China Eastern story presents an interesting case as highlighted in SCMP's interview with Liu Shaoyong:
Q: You have said that a merger between Shanghai Air and China Eastern would be a good thing. Is it on your agenda as one of your aims?

A: It is more complicated than it seems. China Eastern is owned by the central government, while Shanghai Airlines is owned by the Shanghai municipal government. There are no talks between the two companies. However, I do not know whether government officials have entered talks. I am not at liberty to discuss things that involve the government level.
One of the issues with which I have been fascinated is how and why mergers take place in China. Who initiates discussions? Who carries out the negotiations? Who has more influence, firms or governments?

In this instance, assuming that Liu is speaking truthfully, it would appear that Liu expects discussions to be initiated by the relevant levels of government, and that he may or may not be involved once discussions are initiated.

Presumably the companies themselves would eventually become involved so that a proper valuation of the acquiree can be reached, but that may be assuming too much. The story on last summer's consolidation in the telecom industry was that the details were arranged in high level government/Party discussions, and the companies were only notified after the decision had been made.

It is also quite likely that who the respective owners of these airlines are would determine how discussions begin. If both airlines were centrally-owned, then Li Rongrong, chief of Central SASAC, could probably wave his hand and make a merger happen. Since one of the owners is the Shanghai Government (represented by the local SASAC which reports, not to Beijing, but to the local govt), a lengthy negotiation is likely to take place.

Despite its authoritarian reputation, the government in Bejing does not always get its way. And while it may be able to force, say, the government of Sichuan Province to sell its provincial airline to Air China (as it did a few years back), Shanghai's government tends to carry more negotiating heft.

Despite Liu's denial, the SCMP interviewer presses him on the rationale for a potential merger anyway:
Q: State-owned enterprises cannot implement layoffs, but the benefits of mergers and acquisitions are mainly derived from reducing staff. So what would be the real benefit of a consolidation between Shanghai Air and China Eastern, if any?

A: This is "socialism with Chinese characteristics". Chinese enterprises are operating in a tougher environment than other companies in the world. Companies in other parts of the world can either sack people or resort to bankruptcy protection when they are not doing well. Airlines can cancel or delay aircraft where necessary. But this is not applicable in China. We solve problems by growing bigger and lowering unit costs. We aim at making profit by increasing revenue.

Q: Analysts suggest that merging two loss-making companies may not work? Do you agree?

A: Generally speaking, when a company reaches an optimal scale, all the benefits from economies of scale will come along, such as cost-effectiveness.
While profit is a good thing, and keeping people employed is even better, ultimately, the leaders of SOEs gain promotion by expanding their empires. While I have yet to see any empirical evidence that this is true across the board, everyone with whom I have discussed this issue -- and this includes many knowledgeable people both inside and outside of China -- seems certain that organizational size is among the most important factors for a leader's career.

Liu will probably not be successful in turning around China Eastern in the near term. The economic downturn will give him a perfect excuse for not succeeding, and anyway, the government has no problem pumping more money into big SOEs in order to keep them afloat. Hard budget constraints rule in the new China...until they don't.

6 comments:

  1. Hi Micah. Thanks for the tip. I may have to do a whole separate post on that story.

    By the way, you have a very interesting blog. I'm bookmarking it.

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  2. You only mention the "big3" airlines. Do you know how upstart Hainan Airlines (aka Great China Airlines) is doing? They had big plans, but things have become a bit quiet lately. Are they still a serious contender?

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  3. Thanks for your question, Thomas. Though I'm not an airline expert, this is what I know about Hainan.

    The last ranking I saw had Hainan at number four behind Air China, China Southern and China Eastern. Several years ago, they made the news because George Soros took a big ownership stake worth about $25 million.

    Just this past December, the city government of Tianjin provided funding of up to $90 million. (I saw conflicting accounts as to the amount.) Apparently Tianjin wanted to ensure that Hainan continues to use their airport as a major hub. They also wanted to ensure that Hainan continues to buy Airbus A320s which are assembled in Tianjin (whether partial or full assembly, I'm not sure).

    One thing I never figured out about the cash from Tianjin is whether it was in the form of a loan or an equity injection. If it was the latter, I can't imagine Soros was happy to have had his stake diluted. Regardless, the fact that Hainan needed more cash at all is probably just a sign of the times. All airlines are hurting right now.

    An economist I spoke with in Beijing last summer told me that, as successful as Hainan might become, there is no way it would be allowed to eclipse one of the state-owned Big 3.

    Early in January I wrote a post on the difficulties faced by private airlines in China. They are allowed by the Central Government to exist, but their main interest is the Big 3. Knowing that, the help extended to Hainan Airlines by the Tianjin government seems almost like a slap in the face to Beijing. I wonder if that's how it was interpreted...

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  4. I believe their Group structure is rather complicated and intransparent, with lots of regional subsidiaries. The Tianjin-based carrier is probably a subsidiary. Soros is on another level (and I think he already got diluted at some point, but not sure).

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  5. A Chinese SOE with many subsidiaries? Perish the thought. ;-)

    I did a post on SOE structures on my blog some time ago. Check it out.

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