If Cathay Pacific is to participate effectively in the tremendous regional growth this decade has on offer, then it is surely time to launch its own low-cost carrier subsidiary. To delay further merely compounds the risk of being left out of one of the biggest ever growth markets. The competitive landscape will see homegrown LCCs Jetstar Hong Kong and Hong Kong Express, as well as unannounced carriers, either private or affiliates of existing carriers, assuming strong positions. Added threats come from the invasion by carriers from Southeast Asia -- and increasingly North Asia -- that will encircle fortress Hong Kong.

While Asia is still a developing market, the largest growth will come from a handful of carriers positioning themselves now. Cathay is well positioned to stake its claim in one of the region's most blessed hubs: a large financially-oriented catchment area with geography permitting narrowbody flights to much of Asia. Cathay has the experience and clout to capture this low-cost travel growth while it is there for the taking. Better move quickly than eventually be obliged to launch a LCC under duress.

It is understandable that Cathay has not yet launched a LCC and may be hesitant even now ot make the move. Cathay excels in getting its positioning right, but rarely as a first-mover. Its mainland China network, premium products and long-haul workhorse 777-300ER fleet are key assets, but the result of gradual and orderly progression.

Cathay's largest shareholder is the noble Swire Group, a distinguished and longstanding yardstick of quality businesses; employees being groomed for management roles have been referred to as "princes". This is not a group that will be eager to strip away frills as part of establishing a LCC. With time -- the less, the better -- it will see the light.

A Low Cost Short Haul Capability Is Not Part of Cathay's Armoury

Cathay has loosely stated it effectively already has a LCC in the form of discounted economy seats, as well as its Dragonair subsidiary. These are old arguments long discarded by flag carriers to the south. And neither will be able to compete with LCCs. Cathay mainline is focused on long-haul, not short-haul passengers. Dragonair may have a lower cost base than Cathay, but it is far from being an LCC.

Increased competition from Hong Kong Airlines, which sees itself competing more with Dragonair than Cathay, will force Dragonair to move up-market, leaving Cathay exposed on the underside, which is where the growth opportunities are concentrated. Cathay reckons it can respond to lower-end pressure simply by further discounting tickets, but such an approach globally has been shown to be unsustainable.

Cathay Pacific is not blind to the shifting balance towards short haul. In May 2012 it announced it would shrink mainline capacity growth from 7 percent to 2 percent while increasing growth at Dragonair from 7.3 percent to 9.2 percent, reflecting opportunities in Asia.

A similar market outlook was reached from the Singapore Airlines Group, which is accelerating growth at lower cost regional unit SilkAir while mainline capacity remains relatively flat. (And Singapore Airlines owns a long haul low cost subsidiary, Scoot, as well as a substantial share in aggressively low cost Tiger). These growth opportunities are steadily shifting from the medium-cost regional level to the low-cost spectrum. Already eight of the nine countries representing the largest markets from Hong Kong are within narrowbody range from Hong Kong; they represent 72 percent of all seats.

Cathay sees Dragonair as supplementing its growth, but it should be asked how much of a future Cathay Pacific mainline has in regional markets. Cathay will largely be going at growth alone, maintaining (like SIA) a hands-off approach to alliances. Meanwhile, competitors are forming joint-ventures in and outside alliances, such as China Eastern working with Hong Kong Airlines to boost mainland-Hong Kong traffic.

With Cathay's cross-equity stake in Air China, the Chinese region sees itself divided between the Cathay-Air China juggernaut and the rest, who will form pragmatic combinations to combat Cathay and Air China; an early result is the codeshare between China Eastern and Hong Kong Airlines. The result is smarter carriers with more competitive and extensive networks, pressuring Cathay's regional flights, now under greater competition from LCCs.

At the other end of the spectrum, mainland carriers are simultaneously moving up-market and working to develop comprehensive and top-level service, making themselves more competitive with Cathay Pacific in the medium-term and at a fraction of the price. In this evolutionary process Dragonair must then become the primary -- not supplementary -- growth vehicle in regional markets.

U.S. Low Cost Subsidiary Failures Are a False Precedent for Asia's High Growth Markets

Cathay Pacific has deflected questions on a possible LCC subsidiary by questioning the LCC model's longevity, pointing to subsidiary failures in North America. "It could be we go through the same cycle or maybe Asia develops differently," Cathay Pacific CEO John Slosar said as recently as Nov. 2011.

Years ago, seemingly in a different era, but certainly in a very different market, low cost subsidiaries like Song, Tango and Ted were shut down. But their failures offer poor precedents. Those carriers failed, in a slow growth mature market, mainly due to a lack of differentiation.

Cathay will be able to avoid that critical mistake. The North American spin-offs were launched in the mid-2000s amid LCCs -- JetBlue and WestJet in particular -- rapidly gaining market share, offering high quality service with very low costs.

The fate of the Teds and others should not have been a surprise. In the case of JetBlue, the carrier had all new aircraft, offered personal TVs on every seat on every aircraft, had name-brand snacks rather than dreaded meals or sandwiches and worked to create a brand that was enjoyable to experience in an otherwise dreadful aviation period -- post-9/11, Iraq War -- that left a sour experience for those travelling on U.S. legacy carriers. In short, the LCCs created greater value and were cheaper - a nightmare combination for legacy carriers.

Delta responded with Song, which took Boeing 757s from Delta's fleet and, amongst other features, outfitted them with IFE screens at every seat, enhanced the service offering and put staff through re-training. United took a similar but less brand-heavy approach with Ted to compete largely with Denver-based Frontier.

Song and Ted failed for different reasons, both centered on differentiation. Song was clearly different than Delta but in many aspects superior, the inverse of how a LCC-full-service carrier relationship should be. For Ted, the market never understood what it was and how it differed.

A critical fault of Song was that in a move to be a LCC, first class was removed. While a premium cabin can be a point of differentiation between a LCC and legacy carrier, in the Delta-Song relationship there was no alternative: Delta handed many key routes entirely over to Song, eliminating mainline service and perks like first class upgrades, which are typically doled out to U.S. carriers' elite frequent flyers. Flying Delta alongside Song would have jumbled the market: Delta would offer first class but Song in other areas would typically be better with lower fares. The two could not co-exist but were not sufficient alone.

The final decision was to blend: shutdown Song but incorporate its elements into Delta. "Song's ideas and innovations will continue to play a vital role in the refreshment and reinvigoration of the Delta product and experience," a Delta statement read when Song in Oct. 2005 was announced as closing. "Since its launch in 2003, Song has successfully served as a test bed for new ideas and innovations adopted at Delta including zone boarding, faster aircraft turn times, new all-leather seats, designer uniforms, improved snack choices, simplified fare structure and upgraded online presence." Many of those features were carried across to Delta mainline, including an initial 117 aircraft.

In a final testament to Song's achievements, president Joanne Smith was immediately promoted to Delta's vice president of consumer marketing when Song was folded into Delta. A similar fate did not await Ted founder Sean Donohue when United's LCC off-shoot was integrated into United in 2008; Mr Donohue was announced as leaving the company (he is now part of the executive team at highly successful Virgin Australia).

Ted was still upbeat about its position in Oct. 2005, days after Song was called off. "Ted is doing exactly what we wanted it to do. It turned around the financial performance in the leisure markets for us, and we're grabbing market share," Mr Donohue told the Chicago Tribune. Yet there was a premonition of Ted's forthcoming failure, with Mr Donohue acknowledging that: "We're trying to find what I like to call the sweet spot - where people realize Ted has a level of distinction, but it's also part of United."

That distinction was never created or found, likewise with Air Canada's Tango (although Tango benefitted Air Canada with a la carte pricing). The same has not held true in Asia. There is clear differentiation between Qantas and Jetstar, arguably the best and most successful example of a legacy carrier launching a LCC. Jetstar offers no complimentary luggage, seat selection or food and beverage, amongst other parts, whereas Qantas does, even serving hot meals and providing alcohol on one-hour flights. Qantas has upped its premium experience by improving lounges and other perks - all of which were missing on Delta and United, creating little differentiation between their full-service and LCC operation.

The Asian legacy-LCC relationship also includes Singapore Airlines with Scoot and Tiger Airways, All Nippon Airways with Peach, Philippine Airlines with Airphil Express, Thai Airways with Nok and now Thai Smile, amongst the examples.

Critically, the full-service carrier in those relationships is a premium brand, some of which are voted as amongst the best in the world, allowing for differentiation.

And then there is Cathay Pacific. If Cathay is, as it claims, the most premium carrier, then it is best positioned to launch a LCC. With a top premium experience, the differentiation between it and an LCC could be the greatest of any pairing, reducing the prospect of cannibalisation and eliminating the causes of failure in the North American LCC offshoots that Mr Slosar uses as examples to suggest Cathay is right for staying out of the LCC space.

Dragonair Is Not an LCC - But Has a Successful Niche

Few metrics are disclosed about Dragonair's performance. Its passengers carried, load factor, revenue, profit and cost are all grouped into Cathay's top-line performance. But Dragonair does not have the cost base to compete with LCCs, current or future. For example, its utilisation rate is disclosed and in 2011 its Airbus A320s reported a rate of 8.9 hours and A321s 8.4 hours. Dragonair's Airbus A330s - a type which Cathay also operates (33 compared to Dragonair's 15) averaged 12.1 hours, a reflection of congestion in mainland China airspace but also schedules optimised towards convenient times for the business market. In comparison, Jetstar's Australian A320 and A321 types averaged 11.4 hours and its A330s 14.9 hours. AirAsia's A320s approach 13 hours.

Other cost-impacting measures are evident. Its aircraft are not in a high density configuration while meals, drinks and luggage are complimentary. Since Cathay took over Dragonair in 2006, it has maintained a low profile for Dragonair. Not only were Dragonair's long-haul expansion plans cancelled, but marketing has largely been conducted through Cathay, with Dragonair having a subdued brand presence, leading the Hong Kong market to see Dragonair as a so-called "unsophisticated" version of Cathay Pacific.

Yet Dragonair has occupied a successful niche - and is now at an inflection point. Dragonair built up a network in mainland China while Cathay largely ignored the then-nascent market. (Cathay's routes were handed over to Dragonair in the 1990s as part of an equity stake.)

In 2003 Cathay operated to Beijing for the first time in 13 years. Dragonair is currently the largest foreign carrier in mainland China and nearly twice the size of the second largest, South Korea's Asiana. Cathay Pacific is the 15th largest foreign carrier serving the mainland.

Dragonair has had a mainland network for longer than Cathay and tends to focus more on O&D traffic between the mainland and Hong Kong, whereas Cathay's mainland services function as feeder for its profitable long-haul services. Cathay frequently deploys long-haul aircraft -- with high-grade premium products -- to the mainland, ensuring its premium passengers have a seamless product rather than Dragonair's more regional business class offering.

While Dragonair may be seen as a lesser version -- in service and price -- of Cathay, it has excelled in the mainland market, given the historical competition. The mainland carriers are still young despite their prominence; China Eastern and China Southern are in the top 10 globally based on seats. The mainland carriers date back to only 1987, with consolidate in the mid-2000s, and since then have been racing to grow and bring their products to a global standard. In comparison Dragonair's service has been higher.

Changes in North Asia Dictate Dragonair's Move Upmarket

The North Asian market is undergoing tremendous change that will deeply impact Dragonair. First, the mainland market is unergoing a paradigm shift. The old order -- Dragonair and then the mainland carriers -- is being broken. At home in Hong Kong, Hong Kong Airlines is finding success on services to Beijing and Shanghai, also lucrative routes for Cathay and Dragonair.

Hong Kong Airlines is positioning itself as a competitor to Dragonair, with lower prices but newer aircraft, IFE at every seat, developing a brand and other characteristics that Dragonair has intentionally suppressed to secure the differentiation from Cathay.

While Hong Kong Airlines, backed by the mainland's HNA Group (owner of Hainan Airlines), has experienced hiccups and will continue to do so, they will not break the carrier. HNA is in the market for the long-term, and will learn from mistakes - such as the all-premium services to London or accelerated growth without support that led Hong Kong's regulator to curtail its growth. But the latter should be resolved in the short-term.

Lower cost Hong Kong Airlines' presence will most probably force Dragonair upmarket. Indeed there are early signs Dragonair is evaluating a progression upwards, for example by offering wireless IFE that does not take up nearly as much weight as an embedded system (two tonnes). (In this respect, Dragonair will likely also serve as a test bed before Cathay in the medium-term does away with embedded IFE.) Cathay Pacific COO Ivan Chu remarked at the carrier's 1H 2012 results, announced in Aug. 2012, that Dragonair in response to competition will make undisclosed service improvements.

Still in the full-service spectrum, the mainland carriers that have previously set a low bar of competition for Dragonair are now moving upmarket. This achievement is being compressed into years whereas other carriers -- such as Cathay -- took decades to get there. The carriers have the driving conviction they must become more competitive by international standards: Air China says IFE is its third largest investment area while China Eastern and China Southern are also making passenger-facing investments. China Southern is also hiring foreign cabin crew to facilitate a better experience for its passengers. Cathay is familiar with this: as part of its cross-holding with Air China, Air China management and staff go on rotations at Cathay to learn and improve.

The mainland carriers' rubric is the Skytrax rating system, taken extremely seriously, and the so-called Big 3 -- Air China, China Eastern and China Southern -- rate as three-star carriers compared to Hainan's four-stars, a status the Big 3 deeply aspire to. Dragonair's once subdued competition is poised to begin to overtake it - leaving it little option but to raise its own standards or risk losing its customer base.

Low-Cost Encirclement of Hong Kong Leaves Cathay and Dragonair Exposed

The establishment of Hong Kong-based LCCs will quickly force Cathay to acknowledge that Dragonair cannot profitably go up against fully-fledged LCCs. Jetstar Hong Kong is due to launch in mid-2013 on Southeast Asia, North Asia and mainland routes while Hong Kong Airlines' lower-cost off-short Hong Kong Express could be repositioned as a LCC in 2013.

New entrants are likely, in the form of independent carriers, or subsidiaries of established carriers, replicating Jetstar Hong Kong. AirAsia has a dormant Hong Kong branch, Tiger Airways has been looking at how to enter Hong Kong and All Nippon Airways' Peach has casually spoken of a potential subsidiary in Hong Kong (one of its shareholders, First Eastern Investment, is based there).

Jetstar Hong Kong plans to have 18 A320s by 2015, and experience from the group suggests public announcements err on the conservative side. Dragonair at Jun-2012 had 35 aircraft, including 13 A320s, six A321s and 16 A330s. Two additional A320s will be delivered in 2012, one each in Nov-2012 and Dec-2012, and Mr Chu confirmed there will be additional undisclosed aircraft placed into Dragonair.

These carriers promise to deliver considerable pain to Cathay in the form of yield pressure and this at a time of growing price sensitivity. Cathay own's 1H 2012 results noted that "Demand for leisure travel from Hong Kong was relatively healthy, particularly to Asian destinations. But, passengers are becoming more price-sensitive and are booking later." When asked to elaborate, Mr Slosar skirted the matter, saying "passengers have always been price-sensitive".

Jabs from international LCCs will only intensify that damage. In what will prove to be a bellwether for North Asian LCC effects, Cathay in its 2011 annual report remarked that in Korea, "competition for economy class business increased, especially on the Busan route. This adversely affected yields."

The dynamic change referred to is Asiana low-cost subsidiary Air Busan launching services between Busan and Hong Kong in May-2011. The route was, and still is, offered only three times a week and Air Busan is a quasi-LCC that has not made full-scale low cost achievements: it operates A321s and 737-400s, many frills are included, marketing is largely towards Koreans, and fares are lower, but not categorically so, compared to full-service carriers.

Air Busan's service hardly wrought the potential of LCCs: rock-bottom fares, market share erosion and ultimately unprofitability. Those affects will be delivered by new carriers, and in turn the Korean carriers as they inevitably seek to match the new LCC competition. The "adverse" yield competition Cathay experienced to Busan will be tame compared to the pressure that awaits. A LCC can only be combatted effectively with an LCC. If Dragonair not only suffers a higher cost base but is now confronted by the need to move upmarket, Cathay's cost gap in the LCC sector promises to widen further.

The Major Hurdle for Cathay Pacific Is the Ideology Shift Involved in LCC Thinking

Cathay Pacific undoubtedly has the skills and knowhow to establish a subsidiary - and one which carries little threat of cannibalisation. The carrier has exceptional management and the knowledge to put an LCC in place. Even so, the operational work will not come easily.

But much harder on some levels will be the necessary change in ideology to support an LCC subsidiary. This change is needed perhaps not at the management level but at that of its shareholders. Singapore Airlines learned the hard way and is now racing to catch up in the form of Scoot. Well before SIA, Qantas formulated a subsidiary model, subsequently complemented by a growing series of cross-border Jetstar JVs that allow it to establish in foreign markets - including Cathay's own.

Cathay's home market is younger and affords different and even larger opportunities, seldom offered to airlines. Cathay has illustrious achievements under its belt. In a brave new world an LCC would rejuvenate Cathay's market prospects: the opportunity to establish itself as Asia's -- and perhaps the world's -- leading multi-brand airline group.

For Cathay the risk balance has now shifted: where previously it was a measure of the downside in establishing a subsidiary; now the greater threat has become the potential damage if it fails to do so.