China’s Big Three state-owned incumbent carriers—Air China, China Eastern Airlines, and China Southern Airlines—and their subsidiary airlines have been a bright spot in the airline industry globally, averaging until recently returns of 15 percent. Their success presents a marked contrast to the industry as a whole, which has averaged returns on capital of under 5 percent in recent years. The industry in Europe and the United States was badly shaken when large traditional carriers were caught off-guard by regulatory changes, and low-cost entrants rapidly captured large market shares. While the forecast market evolution in China does not present as stark a picture, returns have been lately falling off and a number of factors are converging that promise to change the industry landscape.

China is moving ahead with reforms in state-owned enterprises, designed to promote efficiency and profitability. Regulations on new entrant airlines and the speed of growth of private airlines are being relaxed. The effect of the reforms will tend to increase market competition. As latent demand for airline travel is building in China, the stage is set for both market expansion and disruption. With the advantage of hindsight on the experience in Europe and America, Chinese carriers are in a good position to develop effective strategies to ensure that the more competitive environment also creates value.