BOK MATRIX

CHINA SOUTHERN AIRLINES COMPANY 1

ABSTRACT

This paper focuses on financial control procedures for a system approach to program

management. How cost elements in China Southern airlines, research and development logistic

and support services are explored. The full analysis includes reviewing the competitive strategy,

business models, and fuel impacts, management procedures, current and potential outsourcing,

current financial markets, and macroeconomic. Additionally, an analysis of the strengths,

weaknesses, opportunities and threats (SWOT) of China Southern Airlines, an Asian based

airlines.

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SECTION 1

Introduction

Defined, managerial accounting is the process of identifying, measuring, analyzing,

interpreting, and communicating information in pursuit of an organization’s goals (Hilton,

Ronald W, 2014).Airline travel internationally provides the transportation of passengers and

cargo to destinations throughout the world far and near. International airlines encounter

additional issues dealing with economic impact of foreign currency exchange rates and the rules

and regulations found when operating in global climate. International companies influence the

economies of several countries around the world and can be beneficial and detrimental to the

economic base of individual countries in addition to their country of origin. China Southern

Airlines is based in China representing the Asian Theater.

SECTION II

Competitive Strategies

To understand what it takes for any airline in the market to succeed in this dynamic and ever

changing economy, we must look through the vision and success of our selected airlines

competitive strategies applied in the success of each company. The competitive market dynamics

and improved problem solving skills help managers succeed in decision- making. By using the

latest technology, we will look at the analyze factors related to the market dynamic between

other airliner in China and China Southern Airlines.

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The China Southern Airlines are ranked as the largest number one airliner in China. To

embark in such a successful accomplishment, China Southern Airlines is measured by the terms

of fleet size, number of passengers, number of routes, destinations served, and the number of

flight hours flown. Those five qualities within any airliner is a huge competitive advantage.

These skill sets are also served as competitive strategy within itself. Being the number one airline

in the largest country in the world has an advantage of expansion around the world.

A few other competitive strategies China Southern Airline use was of the “premium

economy class”. Introduced in 2010, this option provides passengers the opportunity to purchase

the maximum value in the new economy class by enlarging the seat by forty percent than the

standard economy class seat. This new option became a huge success because it only raised the

ticket price by ten percent and allowed the enlarged seats to be filled to the planes maximum

seating capacity.

Business Models

Throughout history civilizations have build up their societies near centers of transportation. It

only makes sense that the worlds’ airlines companies would create hubs and market their

businesses to areas that are convenient and popular destinations. China Southern Airlines is more

focused on their international expansion and maintaining their current presence within the

country. This strategy involves creating strategy partners with airlines in other countries. When

choosing airline companies, the hub locations have to be considered before confirming a

business relationship.

China Southern Airline, acknowledge that in order for their brands to succeed their locations

must be where many businesses and people are located. Regardless of the entirety of their

business plan, airlines put forth an immense amount of research into the location of their hubs

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and the location of their partners’ hubs. Airlines must be flexible and have the capability to

change the number and type of aircrafts they send to various locations. China Southern Airline

states in their financial statement, “Our network is supported by a fleet of aircraft that is varied in

terms of size and capabilities, giving us flexibility to adjust aircraft to the network” (Annual

Report, China Southern Airline, 2012, p.30).

This is very wise to plan and expect changes. The airline industry obviously has to prepare

for such things as seemingly minor changes can cost a lot of money. China Southern Airlines

value customer service and brand image. They want repeat customers and to be a preferred

airline offering superior service to their competitors. In reference to the 2013 China Southern

Airline Financial Analysis, they stated that striving for customer satisfaction, a positive brand

image and higher revenue quality are important goals and part of their goals for the future.

All airlines must understand the importance of maintaining the very best impression and

experience for their customers. “In a time of economic uncertainty, airline brands need to

connect with both leisure and business travelers. In difficult economic times, people are looking

hard for value in everything they purchase. Tan Wangeng, CEO, Brand and Advertising, China

Southern Airlines, says that part of China Southern’s objective is to make sure that the travel

experience with China Southern is perceived as an “improving value”. That is a challenging, of

course, because with rising fuel costs, the airline has to cut some of their services and routes,

which puts an extraordinary burden on their people to continue to provide the best possible

service.”(Lee, Yellow Paper Series) China Southern Airlines understand this value and are

creating similar goals toward their success.

As with any business entity, the customer is the most important part of the business plan and

maintaining or improving their business is the end goal. China Southern Airlines has decided to

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invest in developing hubs. They have researched areas of travel that they feel could be very

profitable in the future. Other airline companies have not included this specifically within their

future plans. China Southern Airlines mention the importance of being flexible, adapting to

major markets and mentioned it specifically within their business strategy. Although China

Southern Airlines is seemingly prepping for all aspects of business, they have recently had close

calls when it comes to their financial security.

“In betting the carrier’s future on premium fliers, Etihad Airways PJCS such Qatar

Airways Ltd. and Singapore Airlines Ltd. that upgraded their jets earlier. Asia-based China

Southern Airlines posted five annual losses in six years as labor spending topped fuel, a reversal

of the situation in the newly efficient U.S. industry”(Lee,2014). Additionally, China Southern

Airlines plan to trim the labor force and focus primarily on service, but this will not be the only

aspect of the business he will need to focus on in order to maintain strength within the industry.

To be competitive in the business world, China Southern Airlines must aware of its

competition. Its strategy involves maintaining their current roles as one of the strongest airlines

on its continent. China Southern Airlines is aware that changed in economic conditions, or some

type of incident can dramatically impact their place at the top. The business plan that China

Southern Airlines Company created has been developed in preparation for almost any situation.

Impact of Fuel Expenses

Fuel is the largest single operating expenses to airlines, surpassing even labor costs. Airlines

attribute 27.6 percent of all operating expenses to fuel (A4a quarterly cost, 2014). The reliance

on fossil fuels and the resulting costs incurred by the airlines makes the control of these

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operating costs a top priority for all commercial airlines both foreign and domestic. The price per

barrel of oil can fluctuate wildly for many obvious reasons; geo political crisis, currency

exchange rates, economic sanctions, military conflict, and geographic considerations are just a

few.

Jet fuel is a byproduct of refined crude oil and although the price per barrel of crude does

have an impact on jet fuel prices, refinement adds extra costs to the finished product. One can

draw the conclusion that many facets are involved in the final price of the delivered product that

airlines use to fuel their aircraft. The difference in cost incurred to produce jet fuel from crude oil

is referred to as the crack spread. The crack spread differential is determined by converting the

product (jet fuel, gasoline, diesel, kerosene etc.) prices in dollars per barrel cost and then

subtracting the dollar cost per barrel of crude (“China Southern Airline’s unconventional

fuel,”2012). This differential factor is influenced by many factors including refinery capacity,

supply and demand, transportation costs, government environmental standards, and crude supply

costs.

China Southern Airlines is subject to wild swings in price of both raw crude and refined

fuel with having its own myriad of influences affecting bottom line cost to the airlines. It

employed several different tactics to minimize the cost of these fuel price swings. China

Southern Airlines employed various major strategies to combat this pricing structure. Fuel

hedging is a strategy that employs buying contracts in advance for fuel based on the airlines

inclination whether the prices will increase or decrease in the future. These contracts purchased

and sold through commodities brokers amount to gambling on fuel futures based on a best guess

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analysis. For example, you buy a contract for a range of $110-$130 a barrel and oil prices go to

$160 a barrel, in this instance your hedge pays off and you save $30 a barrel.

In contrast, if this same contract is in force and crude drops to $70 a barrel, you have a lost

on your hedge and you are paying $110 a barrel for $70 per barrel oil. Hedges are very expensive

because the cost for the contracted oil is up front and is very capital consumptive. China

Southern Airlines is more apt to employ hedges due to access to capital for upfront cost. It makes

large capital expenditures to update its fleet equipment to newer more fuel-efficient aircraft that

utilize lighter materials and efficient engines hoping that fuel savings will help offset the

enormous cost of this strategy. This strategy is effective in the short range, but as costs of the

new aircraft increases and the price of fuel inflates over time, the calculations used to make this

decision changes.

This model would not be feasible as a standalone solution but when incorporated into a

broader fuel strategy could achieve the desired cost saving results. Fuel surcharges added to

ticket prices as a tool to offset the increased cost of fuel to the airlines bottom line is a strategy

not accepted well by the flying public and alienates many travelers from an airlines revenue base.

Airlines have not enjoyed the luxury of passing increasing costs onto customers as most business

model does. The overcapacity in the industry in recent years has eroded pricing power and tilted

the advantage to the demand side of the equation. Pricing power has improved due to

consolidation of the industry of late, especially in the domestic markets, but lags in the foreign

carrier markets.

China Southern Airlines has implemented a unique plan to combat rising fuel expenses and

met its share of criticism for the strategy it has chosen to employ. China Southern Airlines

realized that crude oil prices were out of its control in large but identified a plan it could institute

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to control the crack spread of refining the crude. In September 2012, China Southern Airlines set

up wholly owned subsidiary Monroe Energy and purchased the idled Trainer oil refinery in

Pennsylvania (“China Southern’s unconventional fuel,”2012). China Southern Airlines acquired

the refinery for $150 Million and invested another $100 Million to maximize the production of

jet fuel from the plant. The Yuan has fallen against the dollar by 0.95 percent. The weakened

currency has affected the prices China Southern has to pay for fuel and services purchased at

airports outside of China (Wang, 2012). With the weakened exchange rate, China Southern pays

increased amounts of Yuan compared to previous years resulting in a substantial loss in profit

due to no other factor than the rate of exchange. The advantage of the strong Yuan against the

dollar is not expected to return in the near future (Wang, 2012). Fuel surcharges are not accepted

well and are extremely unpopular in China due to the intense competition and over capacity.

Additionally, China Southern has employed a strategy to use capital expenditures to purchase

newer, efficient aircraft. The corporation currently operates five Airbus A380’s and is

anticipating the arrival of the nation’s first 787 later this year (Wang, 2014). China Southern

utilizes a million dollar System Operation Control (SOC) system to fill its planes with fuel. The

SOC determines the precise amount of fuel needed for a flight with minimal surplus fuel. This

practice optimizes fuel burn and ensures fuel is not utilized to haul the extra weight of unneeded

fuel load (“New step to”2006).

Managing in Trouble Times

To maintain the success of the Asia’s airliner China Southern Airlines, trust test of success is

how they manage to stay ahead in trouble times. China Southern Airlines has had troubled times

in the past but recent news headlines of China Southern Airlines reported that they sold two

tickets to holders of stolen Austrian and Italian passports. These stolen passport passengers were

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on board the Malaysia Airlines flight MH370 that went missing. Of the recent turn of events with

this missing aircraft, investigators are still wondering how this was not caught earlier. Troubled

times will soon again loom from this devastating possible crash (“Disappearance of Plane

Remains,”2014).

To manage in these troubled times China Southern Airlines is looking through these ticket

sales and the process of how they scan passports. “With a fleet of 512 modern aircraft and

serving 193 cities in 35 countries and regions worldwide, China Southern Airlines has

manifested its leadership in aviation” (CS-Air,2014). In order to keep the company’s reputation

positive they work hard to ensure aviation safety is a priority. In 2013, they have recorded the

top safety record of flying over 11.4 million flying hours in only 230 months with zero defects.

The record in itself honored them with the Diamond Flight Safety Award received by the Civil

Aviation Administration of China (CS-Air, 2014).

Outsourcing Trends

Outsourcing is a term used to describe a practice used by businesses to export a function

to an outside company for hire when it has been determined that cost savings can be obtained.

This strategy is utilized by businesses all across the spectrum to include airlines. The first step

taken by a business is to analyze their products and establish a core value or competency to the

company. In other words what does my business do well and where do we profit? After the core

competency is established, the second step is the identification of areas that were not as efficient

or profitable. Areas of weakness are examined and a determination is made if it makes good

business sense to contract with an outside firm. One decision factor includes labor intensity; can

labor be utilized more efficiently elsewhere? The second decision factor is the availability of

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resources. Is it cost effective to have resources shipped to our business or is it more effective to

perform the work at an offsite location? These questions are addressed by all businesses as an

ongoing process due to the business maturity cycle. Business is fluid and ever changing and if

steps are not taken to stay in front of the business cycle curve your competition may overtake

you. Outsourcing can be a valuable tool or a complete disaster but business evolves to maximize

the opportunities.

China Southern Airlines already has the benefit of labor cost advantage over some Asian

airlines. In light of the labor cost advantage China Southern Airlines would be more driven to

analyze geographic advantages and contract to have servicing performed on location. It would be

more cost effective to have a service performed by a company or airline based in Narita as

opposed to locating your own people in foreign locations. It would be difficult to determine

which carrier has the upper hand on outsourcing because each has different factors that go into

determining core competency. Each outsourcing decision is a unique and complicated as this

airline. The edge would go to the most financially stable airline because execution of core

competency is directly reflected on the individual corporation’s financial bottom line.

Financial Markets

To be successful in the global economic environment, corporations must engage in

strategic and financial planning for growing revenues, controlling expenses and increasing

market share. This section reviews the financial information extracted from the Annual Reports

Fiscal Year ending December 31, 2012 of China Southern Airline’s current review and proposed

future financial information. China Southern Airlines is an international corporation who has

posted financial success in its operations. China Southern Airlines posted operating revenues that

are equivalent to $2.57 million USD (Annual Report, China Southern, 2012, p.17). Overall

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operating expenses totaled an equivalent of $2.48 Million USD resulting in a net operating profit

of $131.9 Thousand USD in fiscal year 2012. This is a small profit but this airline is moving in

the wrong direction compared to a net operating profit of $707.8 Thousand USD in fiscal year

2011 (Annual Report, China Southern, 2012, p.17). Operating expenses continued to represent

96 percent of the total operating revenue earned by corporation. Fuel expense, landing, and

navigation fee increases were responsible for eroding the operating revenue of the corporation

(Annual Report, China Southern, 2012, pp.19-20). Recognizing that the fuel expense was beyond

the control of the corporation top decision makers concluded to move the company in a new

direction and increase their footprint internationally.

Taking a customer service approach to increase revenues the company-launched activities

designed to build their international footprint rather than reduce costs. New routes launched

brought China Southern to London and created new hubs of operations in Guangzhou effectively

connecting Europe and Southeast Asia. The campaign titled “Year of International Brand

Service” designed to increase awareness of the company to passengers (Annual Report, China

Southern, 2012, p.14). This plan, incorporated in 2012 is primarily responsible for the additional

outlays in expenses directly related to the reduced profits posted in 2012. The plan is initially

successful as passenger traffic increased and customers reported highly satisfying experiences

received from flying (Annual Report, China Southern, 2012, p.14). Banking on good experiences

combined with competitive pricing is a formula that China Southern Airlines hopes will increase

their global footprint and earmark them as a company of the future. (Annual Report, China

Southern, 2012, p.14).

Macroeconomics

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Macroeconomics is the global effect a corporation inflicts on the economy of other

nations. China Southern Airlines is severely impacted by the price of oil but still managed to

outgrow other airlines and return China air traffic to double digit percentages (Seeking Alpha,

2012). Economic projections indicate that one of China’s most important travel centers will have

sustained growth-benefiting China Southern as the major carrier at the hub center (Seeking

Alpha, 2012).The primary area that affects all airlines in the international arena is the stability of

the financial markets. The changing financial markets cause currency fluctuations that effects

corporation costs when operating in foreign lands. This can cause revenues and expenses to rise

and fall increasing the difficulty a corporation faces when compensating for foreign currency.

SECTION III

Strenghts, Weaknesses, Opportunities, and Threats Analysis (SWOT)

SWOT is a tool used by business and financial analysis to identify the strengths,

weaknesses, opportunities, and threats that may encounter any business. The analysis, when

completed, assists the corporation in determining what avenues the business should follow to

achieve their desired accomplishments. The threats portion of the analysis provides valuable

information to the corporation on the potential obstacles looming on the horizon. When properly

completed the SWOT analysis provides the basis for a comprehensive strategy plan that the

company can implement in their business model and utilized as a future strategy for success.

(SWOT Analysis, n.d.).

Strengths

China Southern Airlines is the largest air transport network in China with access to cover 150

cities and over 600 domestic routes. China Southern Airlines is located in Guangdong for easy

access to rapid industrial growth of Pearl River Delta. China Southern Airlines is culturally,

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politically, linguistically, and historically synchronized with Chinese Airport system enabling

them to merge into the system and experience tremendous growth (Shaw, S., pp. 18- 24). China

Southern Airlines has a global network through recent alliance with SKY Team (Shaw, S., pp.

18-24). China Southern Airlines has a history of State Owned Entity and residual access and

political access with the Civil Aviation Administration of China.

Weaknesses

China Southern Airlines financial position is weak due to low market capitalization, low

liquidity, and high debt/equity ratio. Additionally, China Southern Airlines experienced several

safety problems, including fatal crashes in 1992 and 1997 that reduced consumer confidence in

the company. China Southern Airlines incorporated a small cargo business segment with limited

operating experience. The lack of operating experience resulted in this business segment posting

lower than expected revenues. “China Southern Airline is a new and relatively un-integrated

member of the SKY Team Alliance” (Wells, A.T., Wensveen, J.G., 2004, pp. 375-387). China

Southern Airlines has incorporated strategic plans to undergo a continuous business

reorganization to manage and operate more efficiently and deal with the cultural changes

resulting from Chinese air transportation deregulation, recent acquisitions, and alliances.

Opportunities

China Southern Airlines created opportunity when it utilized the first-to-market advantage

designed to build customer loyalty and “lock-in” air cargo customers via contract and real-time

technology before competitors commence expanded services in Chinese domestic market.

Similar language based enabled China Southern Airlines to utilize their cultural and linguistically

background to implement Chinese information technology processes for air cargo transportation

that reduces cost for independent shippers/forwarders in China through real time shipment

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communication and a unique opportunity for China Southern Airlines. “China Southern Airlines

established communication centers accurately predicting package/cargo volume reducing wasted

cargo space on domestic routes”(Taipe,2004,pp. 1-12). Opportunities exists for China Southern

Airlines to improve China/Europe routes through enhancement of SKY Team code sharing and

linear programmed routes through Europe designed to reduce emptiness on westbound flights

resulting in optimal connections through European hubs.

Threats

The worldwide economic crises severely affected the airline industry. The credit crunch and

the volatility in the oil price, then the financial crisis, all had direct consequences for the airline

industry. The airline industry is highly cyclical, and the level of demand for air travel is

correlated to the strength of the global economies. China Southern Airlines inadequate grants for

hub slot space and access to international hubs reduces their ability to compete internationally

especially when combined with the absence of further follow-through alliances. China Southern

Airlines threat increased as competition from substitutes increased and Chinese surface transport

infrastructure developed (Hart, J., 2004, pp. 42-63).

Conclusion

This paper is based on business models, petroleum industry impact, management practices

during troubled times, outsourcing trends, financial markets, macroeconomics, and SWOT

analysis. China Southern Airlines realized that there are some give and take with the partnerships

as some business will overlap, but as of yet the alliances have been more beneficially. This

airline company plans to continue the established relationships and grow in the international

markets. China Southern Airlines is a member of the SKY Team anti-trust alliance. Research by

the airlines involved in these alliances have proven that it cuts costs and enables them to lower

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ticket prices by at least 25 percent than airlines working outside international partnerships

(Brueckner,2000). China Southern Airlines must constantly research and implement new plans

of action to maintain their strength as leaders in the industry domestically and internationally. As

mentioned in the “managing in troubled times section,” airlines must be prepared for any future

difficulty. So much of the industry is beyond their control. Focusing on operations and continued

development will be what allows China Southern Airlines to move forward in the future.

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References

Annual report. (2012, December). Guangzhou, China: China Southern Airlines.

China Southern Airlines Maintains Altitude. (2012, June 4). Retrieved from Seeking Alpha

website: http://seekingalpha.com/article/636781-china-southern-airlines-maintains-

altitude

http://gulfnews.com/news/world/usa/china-southern-airlines-sold-7-tickets-to-flight-1.1301453

Neelam, H., Dawn of discounters, Aviation Week & Space Technology, p.p. 17-24.

New steps to save fuel for china southern. (2006, April 07).

Quick facts. (n.d.). Retrieved from China Southern Airlines website: Retrieved

from:http://www.chinahighlights.com/china-airline/southern-airline.htm

SWOT analysis. (n.d.) Retrieved from Investopedia website:

http://www.investopedia.com/terms/s/swot.asp

Shaw, S. (2004), Airline marketing and management, 5th edition, Ashgate Publishing Limited,

pp. 18-24

Taipei, (2004), Southern airlines soars on debut, pp. 1-12

Wang, J. (2012, August 27). China southern air tumbles after profit: Hong Kong mover.

Retrieved from http://www.bloomberg.new/news/2012-08-27/china-southern-profit-slumps-84-

on-slower-travel-fuel-prices-html

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