Analysis the external business environment - Essay Example

Introduction Following declining sales and reducing profits, Qantas Airlines, an Australian airline, is probing the possibilities of an Asian hubthat it intends to operate from, to extensively cover the Asian nations. It has hitherto been neglecting the Asian nations and concentrating on the European Nations but to cover the loss from its domestic and international operations, the airline has now been forced to look beyond. One of the bases that the airline is considering in Asia to avoid the high costs and the geographic isolation that Australia faces is China (The China Post, 2011). Before making the move, it would be necessary to evaluate the external environmental factors that could affect the organization’s decision. Markets, competition and airline regulation in China would be equally important to be considered. 2. External factors affecting the organization External factors are those that are external to the organization and over which the organization has no control but still is influenced by it. In this analysis only two such factors would be considered – the macroeconomic environment and the markets, competition, and regulation in the airline industry in China. A country’s institutional environment affects the boundary choice for an organization because this reflects the extent to which a firm can participate in the business environment. According to Brouthers and Hennart (2007) five types of risks influence the decision - product, government policy, macroeconomic, materials, and competition. 2.1 The macroeconomic environment Macroeconomics deals with the economy as a whole and the factors that it encompasses include the economic output, unemployment, inflation, savings and investments (Investopedia, 2011). These are the key indicators of economic performance and are closely monitored by the governments, business and consumers. 2.1.1 Economic output The People’s Republic of China (PRC) is one of the fastest growing economies in the world. According to a government report its annual output should be US$ 3,000 per person by 2010 which is 3 – ? times of the level that it was ten years ago (China Digital Times, 2008). By 2010 China has surpassed Japan on the list of world’s largest economies and stood at the second position behind only the United States (Politics Daily, 2010). The PRC has low vulnerability to external shocks and this has helped it to maintain macroeconomic stability. The PRC has a large internal market, large foreign exchange reserves, low dependence on high technology and has high consumer and investor confidence (ADB, 2005). Macroeconomic stability is essential to attract private investment and create pro-poor markets. Economic growth in China has been consistent under different leaderships. Inflation and unemployment are low when the Communist Party is in power (Feng, 2010). The Party embraces economic performance as its top priority. According to International Monetary Fund (IMF) Beijing will take just five years to become the world’s largest economy (China Economic Net, 2011). The PRC attracts the highest FDI in the region and has been the second largest recipient of the FDI in the world (ADB, 2005). However, there are concerns that the government controlled market system in China prohibits the development of the Chinese economy (Sheng, 2011). Because of its liberalization reforms and investment in infrastructure China has been able to attract considerable FDI. China is now implementing a socialist market economy where the government carries out marketization management of the economy. 2.1.2 Unemployment The International Labor Organization (ILO) defines unemployed workers as those who are currently not working but are willing to work (IndexMundi, 2011). The unemployment rate stands at 4.1 percent in China which is a matter of concern. However, this data is only for the urban areas and if the migrants are included the figure could go up to 9 percent. Besides substantial unemployment and under employment exists in the rural areas as well. Moreover, higher degree of unemployment is associated with lower levels of inflation (Feng, 2010). 2.1.3 Inflation The inflation rate in China has exceeded the government’s target of 3 percent which has led to a policy dilemma in Beijing (BBC, 2010). Alongside the industrial output has slowed which is another matter of concern for the government. There is a jump in cost of production which impacts the consumer prices. However, inflation and unemployment are short-term challenges in the Chinese economy (Feng, 2010). 2.1.4 Savings and Investments Fixed investment has slowed in China – in terms of building of factories and housing which impacts the bank lending rates (BBC, 2010). While inflation is on the rise, deposit rates and lending rates are artificially being held low by the Chinese Authorities. This means that Chinese households feel that the value of their savings is being eroded by inflation. Cheap borrowing can create a bubble economy as the borrowers can make bad investments leading to bad debts. 2.1.5 Political environment For political continuity, leadership initiatives are important in China. Different leaders gave preference to different initiatives but all wanted to leave their personal imprints and legacies behind (Feng, 2010). The government in China forms a pyramid-shaped structure in which the President holds the top position. The President provides the visions, sets the general course for the country. Below this is the State Council comprising of eleven cabinet members and below these are the ministers who are responsible for the day-to-day activities. However economic decision-making in China looks confusing to the outsider. However, the government is withdrawing from direct control of business and providing them freedom from wider policy business (Chinese Marketing & Communications, n.d.). The purpose is to increase the opportunities in the market and lower the bureaucratic burden on foreign business. 2.1.6 Legal environment Overall China’s political situation is fairly stable and the people live and work in peace which serves to attract FDI. The market economy system, the perfected laws and rules create favorable legal environment for attracting foreign investments (SINA, 2004). Foreign investors are further attracted by an abundance of cheap labor. China also boasts of a large number of skilled labor that has been provided adequate training and education so that they are able to meet the high-tech requirements of the foreign investors. Foreign exchange control has also been loosened apart from reducing the customs and abolishing the plan, quota and warrant management. This ensures transparencies of related policies. 2.2 Markets, competition & regulation 2.2.1 Aviation industry in China China’s commercial aviation industry is crucial for sustained continued economic growth and development of the country. According to the World Tourism Organization (WTO) China will be the most sought after destination by 2020 and also the fourth largest source of tourists (Klako Group, 2005). The air traffic is expected to increase by about 7 percent by 2020. The EU has urged the aviation sector to open the aviation industry to foreign airlines and foreign investors to meet the rising demand. As of 2005 only 20 European and Chinese airlines were allowed to fly between China and Europe The demand for air travel in China is surging and the government has plans to invest 1.5 trillion Yuan (US$ 228.2bn) in building 45 new airports and adding 700 commercial planes (Vogelaar, 2011). With the rise in the number of airports the demand for civil aviation is further expected to increase. The regional airports have contributed to the social and economic development and benefits to the local communities. The CAAC (Civil Aviation Administration of China) will also ensure that as the number of airports and the fleets increase, the competitiveness of the domestic airline is strengthened. This is view of the fact that foreign airlines are gaining an upper hand in the lucrative international travel market. The domestic airlines account for only 46% of China’s international passenger market and less than 30% of China’s international cargo market. The administration plans to boost the facilities by developing large-scale aviation hubs and super-network carriers. Two hundred and sixty-seven million air passengers travelled in 2010 and the rapid development has also benefitted the foreign aviation industry. 2.2.2 Markets and Competition The Chinese describe the market place as a battlefield and hence it becomes necessary to check all factors of competition (Wu, Chou & Wu, 2004). An increase in the capacity, routes and flights in the Chinese aviation industry, in addition to the relaxing of regulations by the CAAC, competition has intensified in the sector. Competition has led to price-cutting which is in violation of the rules laid down by the CAAC. The CAAC does have regulations in respect of routes, air fares, jet fuel prices, aircraft maintenance, and air traffic control but the domestic carriers feel that these restrictions pose difficulties in implementing their business strategies (Wikiinvest, 2011). The regulations are not being strongly enforced and discounting in ticket continues. Because of the lax in adhering to regulations and lack in safety norms, the domestic carriers are unable to attract international passengers as much as the international carriers can. Besides, the international airlines have a more comprehensive and convenient reservation system and larger sales network, which allows them access to larger number of destinations. Based on the demand potential, China has a strategic and realistic vision to build a powerful aviation industry with three string pillars – internationalization, mass air travel and safety (Pan, 2011). As the markets have liberalized foreign airlines have been given greater access to the Chinese market. Major European carriers are seeking opportunities in China especially after the 2007 China-US Air Transport Agreement. Foreign low-cost carriers have also entered China thereby enhancing competition. China has also strived to gain a global perspective by becoming involved in international air transport business which led to the signing of ICAO’s Beijing Convention and Beijing Protocol 2010. This helped strengthen the global civil aviation counter-terrorism network. Foreign airlines are entering China through mergers and acquisitions. Cathay Pacific for instance, made a base in China through purchase of one of its domestic carriers – Dragonair (Inman, 2006). In the process Cathay also made an alliance with Air China which includes reciprocal sales representation. This strategic alliance could increase their market share on China-Hong Kong routes although this will exert greater pressure on China Easter and China Southern. Air China stands to gain through this alliance. This deal also suggests that entering China through acquisition of an existing poorly performing airline can be a good strategy. While there is intense competition in the domestic routes, the Chinese airlines cannot compete in international sectors unless they have a strong support of a sophisticated hub-and-spoke network. Spoke airports remain a weak point in China but urbanization and rising income are becoming the driving forces in China’s aviation industry (Pan, 2011). Late hub development in China places it at a disadvantage and the weak international route network of Chinese airlines prevents them from utilizing the network resources of other alliance members. 2.2.3 Regulations The Civil Aviation of China (CAAC) is a ministry-level organ, which is responsible for the national civil aviation affairs. CAAC is responsible for safety regulations, market regulation, air traffic management, drafting laws and regulations on the airline industry, formulating rules and policies for the standards for civil aviation safety and technology (CAAC, n.d.). The schedules to be operated have to be approved in advance and violations you subject to penalties. The two probable hubs in China could be Beijing and Shanghai. Shanghai has been the staging point for Europe in the past while Beijing is further North which increases the distance between Beijing and the Asian nations. Securing approval from the communist Chinese government is a hurdle as the aviation industry is still under central control in China (Heasley, 2011). The expansion plans allow foreign firms combined to invest in and own more than half the shares in the airport as long as the largest single shareholder is Chinese. With decentralization and devolving of power to local authorities, the government has handed down 70 airports to local agencies (Klako Group, 2005). This has resulted in regulatory change which enables the domestic and international airlines to operate more freely. Due to fierce competition between foreign airlines operating in China, the domestic airlines in China have started upgrading their services and facilities. However the private airlines have been facing losses and hence the airlines are reluctant to initiate new routes between China and the United States. Rapid economic growth has resulted in environmental degradation as deforestation has taken place in addition to increase in air and water pollution (Economy, 2003). Reliance on coal for its energy has made the quality of air among the worst in the world. Almost two-thirds cities in China failed to meet the standards set by World Health Organization. Aviation emissions are also high but at present China does not have regulations in place to reduce aviation emission (Shubo, 2011). The EU (European Union) wants to incorporate the aviation industry into the carbon emissions reduced regulations but China and the US are opposing this move. If China participates in reducing energy consumption, increasing efficiency and reducing carbon emissions in the aviation industry, China would not have to pay emission fees (Shubo, 2011). 3. Discussion The different factors of the external environment in the aviation industry in China suggest that the demand potential is very high. The economic output in China has been phenomenal which is perhaps why it is considered one of the fastest growing economies of the world. The economy and the markets are totally controlled by the government and this needs to be loosened to attract new businesses and investors. The PRC is the second largest recipient of the FDI in the world which demonstrates the nation’s potential in every sector. This is the effect of its reform policies. However, the unemployment level in the urban areas continues to be over 4% and overall could be much higher. This suggests that any further investment in China could help in lowering the unemployment levels. Savings and investments have been reducing due to rising inflation but since the disposable income has been rising, the growth in air travel is imminent. The political and legal environment in China is conducive to the aviation sector. However, there is intense competition both from domestic carriers and the international carriers. The domestic carriers have been trying to upgrade their services because of the competition they have received from the international carriers. This is a benefit that developing nations derive when foreign companies enter with FDI. The end beneficiary is the nation due to better use of resources and technology, and the customer who receives value for money. Hence, as far as China is concerned, the entry of Qantas would help the nation to improve its aviation sector. However, despite China having the CAAC to regulate and control the aviation sector, the domestic carriers violate the regulations to their convenience. The international full-service carriers would not do so as it would dampen their image and reputation. This is something that Qantas would have to consider in its decision making process. 4. Conclusion Qantas Airlines, the legacy full-service carrier of Australia is considering starting a full service premium carrier from an Asian hub to cover the Asian nations. This first needs an evaluation of the external factors prevailing in China as these factors influence the decision and the operations of any carrier. The factors that have been researched suggest that the aviation industry in China is growing as the government has invested in infrastructure in terms of airports and aircrafts. It also has a separate unit called the Civil Aviation of China (CAAC) which is a ministry-level organ responsible for the national civil aviation affairs. Entry through acquisition would be the right mode for foreign airlines in China as consolidation is going on in the domestic aviation sector. While the legal and political environment in China is stable and conducive to investment, the aviation industry is still not mature to attract legacy carriers. The domestic carriers do not adhere to the regulations laid down by the CAAC and feel free to violate to suit their business strategies. 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