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    Cathay Pacifik Airways Case

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    € € { LAGER Pw | Centre for Asian Business Cases. | To Move or not to Move: Cathay Pacific Airways In 1991, an explosion and fire caused a shut-down at one of Cathay Pacific's Data Centre offices in Hong Kong. This was an unprecedented incident for Cathay Pacific. Although the Company managed to restore the systems in just thirteen hours after the disaster recovery operation began, and the overall impact on the Company's business was kept (0 a minimum, the Company's senior management realised that the Company should not be exposed to such a risk again, The immediate question raised was: how could the Company ensure the security of its Data Centre operation? The overcrowded situation in the multi-tenanted office buildings in Hong Kong had already placed limitations on the Data Center, as it was operating out of three separate offices. Could Hong Kong provide the solution? Company Background Cathay Pacific is an international airline with a long standing reputation for service and technical quality. Its head office is based in Hong Kong, the heart of Asia. It was founded in 1946 with two DC-3s. In 1960, most of its aircraft had piston engines, and by 1970 it had an all-jet fleet. By 1980 the Company had a full international network. At the end of 1991, Cathay Pacific was operating 45 wide-bodied aircraft [Exhibit 1], with over 12,747 staff [Exhibit 2}, flying from Hong Kong to 39 destinations in 27 countries and territories around the world. In association with Hong Kong Dragon Airlines, it had indirectly extended its regional route network to 24 's in China and eight other Asian countries. ‘The Company provided scheduled passenger services on five continents: Asia, North America, Australia, Europe and Africa. In 1976, one passenger aircraft was converted to a freighter, thus marking the Airline’s entry into the competitive air cargo market. The Airline’s first B747-200 freight aircraft joined the fleet in 1982, and two more were delivered in 1987 and 1990. Pauline Ns prepared this case in conjunction with Lovetta Tsang wnder the supervision of Dr. Ali F. Farhoomand Jor lass discussion. This case isnot intended 10 show effective or ineffective handling of discussion or business processes, This case is part ofa project funded by a teaching development grant from the University Grants Committee (UGC) of Hong Kong. Copyright© 1998 The University of Hong Kong. No part ofthis publication may be reproduced, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise (including the Internet) » without the permission of The University of Hong Kons. Ref. 98002C ————————— ‘This material is only tobe usedin conjunction with MBA lectures Ret: 98/020 ‘To Move or not to Move: Cathay Paci Always In 1987, Cathay Pacific's status as one of the world’s premier airlines was recognised when it received one of the industry’s most coveted accolades, Air Transport World magazine's Airline of the Year Award. Geographic Scope Cathay Pacific's hub was located in Hong Kong where its parent company - Swire Group - possessed a well-developed network and connections. Setting up routes to and from Hong Kong aligned with its emphasis on “The Heart of Asia” and “The Airline of Hong Konj Furthermore, the Swire Group was very conversant with the Asia Pacific region, such that Cathay Pacific could find and acquire the most appropriate place for settling up its routes in Asian cities. However, although the Airline was mainly situated in the Asian region, its customers came from all over the world. Hence, Cathay Pacific developed sales offices all over the globe. The configuration of the primary activities of Cathay Pacific was. geographically dispersed, while the configuration of its support activities was geographically concentrated. However, the corporate office had made efforts to co-ordinate the dispersed activities to ensure quality and consistency. “Totally Customer Driven” To remain competitive, the Company made a commitment to be “totally customer driven” by engaging in initiatives to upgrade its airport lounges, in-flight cuisine and entertainment, and aircraft fleet to meet the needs of its Asian and international customers. US$150 million was committed to a five-year project on Data Warehousing that would transform the use of information technology in the Company. The project was aimed at enabling the Company's information technology to move beyond simply a way to automate tasks, into a tool that would have the ability to improve the decision-making of management and customer services staff. Corporate Mission for the 1990s To meet the challenges of an increasingly competitive business environment, the Company established corporate missions and strategies to sustain a competitive advantage over its competitors. Cathay Pacific made a commitment to being “the airline of the decade”. To achieve this goal, the Company laid down the following aims for the 1990s: + To put safety and security first To be totally customer-driven To produce superior financial returns To provide rewarding and enjoyable careers for its staff To accept responsibility towards the environment ‘To be committed to the communities it serves and to the future of Hong Kong, The Airline Industry The Regulatory Framework Airlines in the Asia-Pacific operated in a tightly regulated environment. Routes and capacity were controlled by bilateral government agreements. Up to the 1990s, Asian carriers were protected from intense competition by regulatory regimes. From the earliest days of aviation, international landing rights were traded by nations, and it was common for a country to nominate its “flag carrier”, Most countries in the region, until recently, designated one or two airlines as ¥ at Lt SS ee, Ff: 98/026 ‘To Move or not to Move: Cathay Pacitic Alnrays ~ their international airline, Flag carriers in today’s context are airlines such as Singapore Airlines, Thai International, Malaysian Airline Systems, and Air New Zealand. Most of these i ‘Were government-owned and they were considered by their governments as an integral part of the national trading infrastructure. However, there was a trend towards privatisation which had intensified competition. Some countries, such as Australia, the U.S. and Canada, had more than & ‘one international scheduled carrier. The Government in Hong Kong had pursued a one-airline- ‘one-route policy and Cathay Pacific had been enjoying the traffic right advantage under the shield of this monopolistic system. An airline required operation licences from both the local and foreign governments. The number of flights and frequency to each country was restricted by these rights. This was an important asset to an airline, thus requiring it to conduct detailed research to determine the profitability of each route. It also had to optimise resources and deploy the appropriate aircraft type to operate © each route. In the late 1980s, a trend towards the substantial deregulation of domestic air transport began in Ww the U.S.A., Canada and parts of Europe. In response to public demand and a perception that customers were paying too much for air travel, this trend also took place in a number of Asia- Pacific countries. Countries such as Taiwan, Japan and the Philippines have deregulated. ev Deregulation was expected to become more universal and new start-up airlines were expected t0 ‘emerge. This would fuel competition and add to the unpredictability of planning within the industry. ~ Industry Growth & From the 1980s to the 1990s, the air industry was one of the fastest-growing sectors in the world, we fuelled by deregulation, open markets, technological advances and a quest for travel. ‘The number of air passengers increased by only one per cent in 1991, having grown by nine per cent - in 1990. Meanwhile, the number of aircraft movements (including passenger and cargo flights) was four per cent higher. The corresponding increase in 1990 was 12 per cent.' The slower increase recorded in 1991 was due mainly to the adverse influence of the Gulf War. & ‘The Far East market for air travel saw phenomenal growth, and many believed that this region ‘would continue to take the lead into the next century. Since 1970, the GDP in the Asia-Pacific = region had continued to outstrip every other region of the world, and this was forecast to e continue into the future [Exhibit 3]. Compared with North America and Europe, the Asian air © transport market was considered to be in its growth stage. For the two major airlines in the region, Singapore Airlines and Cathay Pacific Airways, the Asia Pacific routes contributed significant revenues. we Against this background, and a population level in Asia that represents approximately 55 per cent of the world total, Asian airlines developed into major carriers. Another feature of the Asia- Pacific Region is that it has vast areas of ocean, so air transport provides natural means of both - commerce and social interaction, Vast distances and high population levels are, thus, key features of the region. I is no wonder that many Asian carriers became the top performers 6 worldwide in terms of profitability. & "Source: 1991 Hong Kong Economic Review a Pee Sage Sse eT Tes. os eee uw et: 98/02c To Move or not to Move: Cathay Pacific Aways Labour Resources Cathay Pacific, like any other service company, was labour intensive [Exhibit 2 & 4] In the airline industry, over 70 per cent of staff were rank, and file and most jobs did not require highly- educated personnel. There was an abundant supply of labour, especially in Asia. However, staff retention was also a major issue in the industry. On the other hand, management staff with appropriate experience was difficult to source and retain, and traditionally, these positions were filled by expatriates. Profit Margins and Yields Airlines in the Asia Pacific have also seen profit margins improve. While many airlines in this region have been consistently profitable, increased competition, high levels of capacity growth, and the weakness of the Japanese economy led margins to decline in the early 1990s. Other problems presented themselves. Throughout the industry, airlines were being squeezed because costs were rising faster than yields. In the late 1980s, the top management of Cathay Pacific realised that profitability had been falling due to severe competition in a marketplace where the yield was falling, and where they faced continuous limitations in their attempts to improve productivity and reduce costs. Cathay Pacific had to find other ways to sustain adequate returns on its vast capital investments, by either increasing marginal revenue through revenue ‘management or by reducing its rising costs. This environment was pushing almost all the major players to pare costs and improve efficiency. Furthermore, severe global competition among rivals, encouraged by deregulation, was putting pressure on all players. Despite this, many Asian carriers were among the top performers worldwide in terms of profitability. [Exhibits 5 & 6] Outsourcing Downsizing and outsourcing have become an increasingly popular choice in response to the pressures of cost minimisation within the airline industry. Information technology (IT), catering, cleaning, baggage handling, ticket processing, aircraft maintenance and flight operations have bbeen some of the popular departments for outsourcing. It became easier to find an airline that had already been stripped to its bare bones, with all peripheral activity undertaken by specialist contractors. The new, lean “virtual airline” was more focused on its core competencies. The managing director of Cathay Pacific said, “We need to cut out doing things we do not need to do and to simplify the things we are doing.’ Along with outsourcing feasibility studies in other business areas, Cathay Pacific studied the business opportunity of contracting out parts of its IT functions to outsourcing vendors. Offshore Re-locations In addition to outsourcing, many cost-conscious carriers were moving their back-office jobs offshore. For instance, American Airlines tickets were being processed in Barbados or the Dominican Republic after tickets were taken from travellers by airline check-in clerks. Furthermore, Swissair had announced plans to handle flight coupons from Bombay, starting in 1993. Pinched by rising costs and lower profits, Cathay Pacific and Singapore Airlines were also looking at options to move operations offshore. Cathay Pacific had just finalised plans to move its Revenue Accounting Operations to Guangzhou, and Singapore Airlines was gearing up to * Festa. P. “Wheeling Out the Service” Airline Business, Jauary 1997, 7 ~~ wv Rot: 98/020. ‘To Move or not to Move: Cathay Pace Airways, shift airline computing jobs to Bombay. The Wall Street Journal reported that, “Analysts see such moves as the wave of the future for airlines, in much the same way that New York securities, firms in the 1980s moved their back-office operations out of expensive Manhattan real estate to other U.S. locales”, Bruce Darrington, an analyst with Crosby Securities Pte., Singapore, s “It's cheaper. ‘There are a limited number of things that can be done offshore, and computing is ‘one of them” The Role of the Data Centre ‘The Cathay Pacific Data Centre kept track of critical business functions, such as reservations and ticketing, engineering requests, passenger check-in records, cargo loading, crew rostering, flight scheduling and other supporting processes that make up the Company's business [Exhibit 7] The role of information systems in the airline industry is crucial. As well as CRS (Computerised Reservation System), the PROS (Passenger Revenue Optimisation System), Revenue Management System, CIS (Customer Information System), EIS (Executive Information System), HRMS (Human Resources Management System) and FMIS (Financial Management Information ‘System) are examples of other information systems generally used in airlines to facilitate value chain activities. All these functions were co-ordinated by the Data Centre. ‘The Cathay Pacific Data Centre in Hong Kong was divided into two main sections: production and development. ‘The production section was located in two separate offices on Hong Kong island, and supported the installation and operation of all “production” application systems. The development centre, which provided computer resources for the development and maintenance of application systems, was located in Kowloon. Amongst an array of complex computer systems housed by the Data Centre were multi-million dollar systems that had to be maintained under sensitive temperature control to prevent damage from humidity and condensation. Not only did the Data Centre house some of the most complex and expensive hardware, but it also supported huge and complex application and network systems that provided timely information to the global operations of the Airline on a 24-hour basis. A relocation of the Data Centre would be a major project; one that was unprecedented in the airline industry considering the physical size of the hardware and complexity of the software involved. ‘The Geheral Manager of the Management Information Systems Department was William Boulter. Within the department, there were three sections, namely Telecommunications, Systems Development and MIS Operations. Three managers were employed to head up these sections. ‘The Data Centre operations reported directly to the General Manager. (Exhibit 8] The Fire A major crisis occurred in 1991. fire shut down one of Cathay Pacific's Data Centre offices at Quarry Bay in Hong Kong. Normal business was interrupted for almost 13 hours, After the crisis broke out, the Company's management realised that the necessary repairs would take at least one week. 95 major application systems were shut down and data had to be backed up to tapes in order to obtain a current reading of the Company's business data. These tapes were then physically transferred to the development data centre at Hong Kong’s Kai Tak Airport, where only the 42 most critical systems, including passenger reservations, departure control and crew scheduling systems, resumed operation. Ret 98/020 ‘To Move or not to Move: Cathay Pacific Airways During the recovery period, the Cathay Pacific staff and vendors’ staff had to complete over 500 tasks. After wo very tense weeks, the Quarry Bay office in Hong Kong was finally restored and ready for normal operations again. ‘The disaster demonstrated how vulnerable these offices were, given their location in crowded and multi-tenanted districts. The fire persuaded senior management of a need for a purpose-built building that could ensure the security and reliability required by an organisation as large and as technology-dependent as Cathay Pacific. Furthermore, Cathay Pacific's Data Centre in Hong Kong was located in three separate office buildings and there was no room for expansion in those offices, Finding A Suitable Solution William Boulter said that security, room for expansion, reliability and consolidation of the Data Centre were the four principle objectives that had to be addressed. In addition to this, Ms Esther Hui, Manager of IT operations at Cathay Pacific, had previously raised concerns about the capability of the Data Centre to cope with the rapid business growth of the Company and the airline industry. Furthermore, the frequent power fluctuations, which occurred two to four times per week, were undoubtedly a potential threat to the reliability of data, and this had a knock-on cfffect on the Company's business operations, The immediate decision to be made by the Company was whether it should relocate the Data Centre or outsource the operation. If the Company did decide to relocate to more suitable premises, where should this be? The Re-location Option ‘The Company drew on the experience of other companies that had been involved in data centre moves and offshore relocating: Halifax Insurance’s Data Centre Merge? In August 1993, the Halifax Insurance Company's data centre operations in Toronto and Indianapolis were merged. The two data centre operations were owned by the same parent ‘company, ING Inc. The merger was one example of many that had occurred among Canadian companies’ data centres. Over the past years, Canadian companies’ data centres have been trying to save money by outsourcing, automating, and most commonly, by moving to the U.S. The non-Canadian-owned companies reported that consolidating their operations with data centres in the US helped them to reduce spending dramatically on hardware, software, telecommunications, and personnel. * Monta, K. “Exod tthe Data Center: Effects Felt in Human Terms”. Computing Canada, September 1993, ~ we Ft: 981020. To Move or not to Move: Cathay Pacific Aiwaye Cathay Pacific Guangzhou Data Processing Centre“ ‘The Guangzhou Guo Tai Information Processing Company (GGT), was the data processing centre for Cathay Pacific. It handled the manual data input of the Company's financial data. This re-location represented one of the very first examples of a major Hong Kong company taking office jobs actoss the border in search of comparative advantage - lower labour expenses and land rental costs. The Company estimated that moving the operation to China would save it HKS10 million per annum. However, with the inflation in Chinese cities running at about 20 per cent in 1993, the cost advantage was quickly diminishing. Economists said the escalating prices in China had helped deter other companies from following Cathay Pacific's lead in moving operations over the border. What Hong Kong had to Offer Cathay Pacific operated out of Hong Kong and its head office was based in Hong Kong. Following the Sino-British Memorandum of Understanding on the implementation of the new Chek Lap Kok Airport, and being the flag carrier for Hong Kong, Cathay Pacific made a commitment to establish its new headquarters, called “Cathay Pacific City”, at the new airport. While Cathay Pacific had committed itself to Hong Kong, a decision had to be made as to the location of the Data Centre. Cathay Pacific had always taken pride in the fact that one source of competitive advantage was its geographic location. When a country has a significant advantage in costs or quality used in production, it would be the preferred site. The geographic location of Hong Kong and its close proximity to China attracted business travellers. Hong Kong was a convenient connection point to other parts of Asia-Pacific. Thus, Cathay Pacific’s operation base had a location advantage. In the 1980s, Hong Kong’s economy was booming. Inflation remained high throughout the decade and into the early 1990s, The Consumer Price Index rose by 9.8 per cent in 1990 and 12 per cent in 1991.° Overall unemployment was 1.3 per cent in 1990 and 2.0 per cent in 1992.° With economic activity sustained at a high level, the demand for labour, particularly in the service sectors, remained strong. Both the seasonally adjusted unemployment rate and the underemployment rate remained relatively low, even though they were, on average, higher than in 1990. Following the revival in the latter part of 1990, the Hong Kong economy grew steadily during the course of 1991. Most of the inflationary pressures during 1991 were generated domestically. In the property market, rentals and prices rose sharply during the year. The market for office space remained soft, due to the ample supply already available and in the pipeline. The overall supply of new office space in 1991, at 459,000m2, was 130 per cent up on 1990 levels, and higher compared with the 1981-90 yearly average of 299,000m?.’ Furthermore it was estimated that the total office supply in the three- year period, 1992-94, would represent about 30 per cent of the total stock of office space at the end of 1991. With this rate of increase, and based on the 1991 take- up rates, vacaney levels were predicted to rise. Property prices were the highest in the world, and ‘Bloomberg, “Cathay Blazes Paper Trial in Geangzhou", South China Morning Pos, 2 February 1994, * Source: Hong Kong Economic Review 1991 © Source: Hong King Annual Digest of Statistics 1997 Edition: Census and Statistics Deparment. HKSAR. 7 Source: Proper Review 1992: Rating & Valuation Department, Hong Kong SE 7 Rt: 98/020. To Move or not to Move: Cathay Pacific Airways this was creating a bottleneck for the property industry. Consequently, many companies were seeking cheaper and alternative solutions abroad. Furthermore, in the late 1980s there was growing concern as to the economic and political stability of Hong Kong as 1997 and the handing over of the colony to the Chinese goverment would soon become a reality. The June 4th event at Tienanmen Square in 1989 shocked the world and further added uncertainty as to the future of Hong Kong. Foreign investors were hesitant and some large overseas suppliers placed an embargo on computer supplies to Hong Kong companies that had dealings with China. However, the conclusion of the Sino-British Memorandum of Understanding on the implementation of the new airport and related projects in July 1991 reaffirmed business confidence. Nevertheless, increasing inflation and soaring property and land prices were points for consideration. As an alternative, Cathay Pacific also considered China, Singapore, Thailand, Philippines, Canada and Australia as possible locations for the Data Centre. China and the Open Door Policy In the case of China, the Open Door policy presented an attractive solution to the Company. The Open-Door Policy was the term used to refer to “the set of policies adopted by the reformist leadership since the Third Plenum of the Eleventh Central Committee in December 1978 to Promote the expansion of economic relations with the capitalist world economy”.* The Policy ‘was made up of a set of sub-policies in the areas of foreign trade, foreign direct investment and foreign borrowing. Within the sub-policies the Special Economic Zones (SEZs) were bom. The initial reason for forming SEZs was to contain foreign direct investment within regions and limit their influence on the rest of society. Four SEZs were established in 1979 in Guangdong and Fujian provinces. These offered special incentives to foreign investors in the form of tax concessions, reductions in land use fees and favourable labour policies. Since 1978 the success Of the Open-Door Policy, which Deng Xiaoping publicly acknowledged, had brought into operation further regions designated as SEZs. China had come to realise the significance of participating in the world economy for domestic gain. Hence, Howell documented the fruit of China’s Open-Door Policy as follows: “Since December 1978 the volume of China's external trade has increased five fold, over 41,000 foreign enterprises have agreed to invest in China and foreign debt has risen to the grand sum of US$52.55 billion’ Cathay Pacific and the Chinese government would mutually benefit from the former's decision to invest in and to relocate its Data Centre operation to China. Many companies that traditionally ‘operated out of Hong Kong were relocating to China. However, while moving the operation to China would save the Company an estimated HK$10 million per annum, inflation in Chinese ies was increasing rapidly. Furthermore, although the immense supply of cheap labour and land was undoubtedly attractive, the legal framework was under-developed. Labour management and training were also inadequate in the mainland, and to ensure standards, many companies saw the need to relocate middle management personnel from Hong Kong. But the Cathay Data Processing Centre move demonstrated that the technicians and experts were reluctant to g0 to Guangzhou for on-site support because they thought that the environment was inferior to that of Hong Kong. ' Howell J (1993). China Opens its Doors: The Potties of Transition, Harvester Wheatsheaf Lynne Ricnner Publishers. p.3 “ibid p.10 ~~ € Rt: 8/020 ‘To Move or not to Move: Cathay Pactic Airways Singapore In respect of market potential, business infrastructure, cultural acceptance and personal risk, Singapore was regarded as “excellent” in a survey by Fortune magazine. Singapore's reputation for ‘being one of the best cities for global business was attributed to aggressive government plans and policies. In retrospect, Singapore's government had managed its economic development with a firm hand and had relied on overseas multinationals to build its economy [see Figure 1]. In the 1990s, Singapore aimed to develop itself into a hub for regional services and multinational corporations’ (MNC) regional headquarters, as well as a business, information technology, and financial centre, By nurturing ‘Promising Local Enterprises’, it hoped to develop them into future Asian MNCs. 1990 1991 1992 By Industry (SS bn) Manufacturing 27 29 Commerce 75 96 Transport 19 19 [Financial and business services 248 276 By Source (%) US. 172 177 180 EU, 281 28.0 = UK 120 n2 Netherlands ss 98, 69. © Switzerland 41 40 42 Asia 35.1 341 359 © Japan 195 198 21.1 Hong Kong FOV ING EOF 6S) ™ ASEAN mS:

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