China’s Bullet Trains

China is already home tbullet traino the world’s longest high-speed rail line and some of its fastest bullet trains, and the government is pouring billions of yuan into building new capacity. In fact, China plans to add more than 3,100 miles of high-speed rail track by 2015, bringing the total length of the system to about 9,000 miles. Meanwhile, China’s airlines are also growing rapidly, with nearly 100 new airports planned by 2020.

The turbocharged expansion of ultra-fast train networks has led some investors to question whether bullet trains could poach passengers and profits from airlines, Credit Suisse transportation analysts Davin Wu and Timothy Ross explained in a report called “Can Airlines Beat High-Speed Rail?” “The major concern of the market is that the airlines will cut airfare to protect their market shares, and that load factors (a measure of how full flights are) could be substantially lower than the levels before the launch of high-speed rail,” they wrote.

But the analysts go on to say that such fears are probably unfounded. China’s fast-growing middle class is more mobile than ever, and should do enough traveling in the future to keep both sectors healthy. In addition, the competition will be most heated on short routes, a realm in which airlines have already shown a willingness to cut their losses early and avoid costly price wars.

Current data suggest the possibility that the growth of the middle class doesn’t have to result in a zero-sum fight-to-the-death between the two forms of transport. According to the International Air Transport Association, China’s domestic passenger travel rose by 13.4 percent in May, the healthiest growth rate of any country despite a continuing slowdown in the Chinese economy. Meanwhile, more than 1.7 billion passengers rode the train last year, up nearly 5 percent from the year before, according to Bloomberg. “There is enough room in that internal market for everybody to have a piece of the pie,” said Amir Sharif, an operations management professor at Brunel Business School in London, calling the threat of airlines losing out to rail “a red herring.”

That’s not to say that high-speed rail won’t have a marked effect on certain parts of domestic airline’s business. The Credit Suisse analysts concluded that airlines stand to lose about 6 percent of their passenger traffic on 25 key domestic travel routes between 2013 and 2015 due to competition with the railroads. The highest attrition rates will occur on routes of less than 310 miles, where train travel tends to be faster, more convenient and cheaper.

But Chinese airlines have already showed a canny knack for maintaining profit margins by quickly responding to increased competition. Last December, when China’s newest high-speed rail line opened – a 572-mile high-speed line connecting the northeastern cities of Harbin and Dalian – most airlines simply left the market, cutting routes that overlapped with the rail corridor and shifting planes to other, less competitive routes. “We see this swift capacity adjustment, instead of cutting their airfares and profit, as a good sign that airlines can be nimble in competing [with bullet trains],” the Credit Suisse analysts wrote. “While rail will remain a major competitor in the domestic market, its impact has largely been reflected in airline fleet planning strategies.”

Air China, which does most of its business on international and long-haul domestic routes, is likely to be the airline least affected by high-speed rail competition, Credit Suisse analysts said. China Southern Airlines, the country’s largest carrier, will suffer a greater loss of passengers, particularly along the new Beijing-Guangzhou train line, but should be able to adapt quickly. The airline’s high-growth western hubs of Urumqi and Chongqing, along with an expansion of service to the United States, Europe and Australia, will help boost capacity by about 9 percent annually over the next three years, Credit Suisse said, offsetting losses in domestic routes competing with high-speed rail. Assuming that western China and international travel continue to grow quickly enough to fill the new seats, profit growth should rise steadily, too, Credit Suisse analysts said.

The caveat: Chinese consumers have shown themselves to be very price-sensitive, and a high-speed rail fare cut could pose a serious risk to airlines, Credit Suisse warned. Taipei offers an interesting precedent. In 2007, the year high-speed rail lines opened for business in Taiwan, air carriers pared back capacity on the critical route from Taiwan city to Kaohsiung, the territory’s second-largest city, by nearly 44 percent. In an effort to undercut train prices that were 15 to 32 percent lower than airplane tickets, airlines cut fares by an average of 36 percent. Not to be outdone, high-speed train operators responded by slashing their prices an additional 20 percent. At that point, the airlines cried mercy: By the end of 2008, every airline with the exception of Mandarin Airlines had stopped flying the route. And Mandarin eventually conceded defeat in 2012.

For now, a major move to cut rail ticket prices doesn’t seem likely, the analysts said. For one thing, though bullet trains are significantly more expensive than China’s highly subsidized “slow trains,” the rates are still relatively affordable – an average worker’s monthly income buys 24 tickets on a fast train in China, higher than the 23-ticket global average. In fact, Chinese high-speed rail fares are the lowest in the world, with an average price that is 36 percent lower than the cost of an airline ticket. What’s more, the Chinese government has no interest in allowing a hard-fought price war, Credit Suisse said, and officials will be able to keep a closer eye on price competition now that officials have dissolved the Ministry of Railways and merged railway regulation into the Ministry of Transportation, which also regulates airlines, shipping and road travel.

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