For insight into the competitiveness of China's main airlines, overlook their domestic operations, which are generally profitable—though not lately. Domestically, the carriers compete mainly against each other. Their true strengths and weaknesses are evident in international operations, where the big Chinese carriers shy away from fully competing with experienced foreign airlines.

“They are not as strong as they look,” says analyst K. Ajith of Singapore brokerage UOB Kay Hian, dismissing their domestic performance as an indicator of management efficiency. Yes, China Southern Airlines is now Asia's largest carrier, with compatriots Air China and China Eastern Airlines not far behind, and all three are growing powerfully year after year. But their reluctance to put much resources into the international market is proof that, a quarter of a century after they or their predecessor companies were formed, the giant industry is still not up to world standards.

Gradual improvement is likely, say analysts and industry officials, whereas a radical attempt by Beijing to force rapid change on its airlines is quite unlikely. There is no sense of crisis, and China can get along with imperfect airlines, just as it copes with other industries that are much further behind international standards than its commercial aviation sector. Indeed, commercial aviation is quite open by the standards of other industries.

But it could be more open still. For example, China has just one well-developed budget carrier, Spring Airlines, whose growth has been constrained. How fast the Big Three improve in the coming 10 years or so “depends domestically on whether Spring and others are allowed more access,” says Guo Yufeng, director of the Chinese aviation service for consultants ICF SH&E. In fact, the government does seem to be looking more favorably on low-cost carriers, and the extent to which they are allowed to develop may soon be the biggest question in Chinese commercial aviation (see page 52).

That does not mean unbridled competition from budget airlines is imminent. Even if the government thinks a dose of low-cost competition is just what the Big Three need, it will be careful not to prescribe too much, because the cure could be worse than their disease.

China Southern, Air China and China Eastern each have just 25-30% of the international traffic at their home bases—Guangzhou, Beijing and Shanghai, respectively. This low level seems all the more remarkable considering the traffic feed from their enormous internal networks and those of their substantial affiliated domestic carriers. Instead, alliance partners seem to benefit from all that connectivity.

Moreover, Chinese airlines should have the great advantage of low costs in competing with foreign carriers based mainly in fully developed economies. The Big Three are cheaply capitalized (and sometimes recapitalized) by the Chinese state and its banks, the government orders aircraft for them in bulk to obtain keen prices, and, above all, they have the advantage of an inexpensive labor market.

And they are no longer new to the game. The Civil Aviation Administration of China (CAAC), now the regulator, was the airline until 1988, when its regional divisions became airlines that were progressively exposed to competition. But they still seem to have so much to learn.

“The weakness of Chinese airlines in the international market is mainly due to a lack of experience,” says a senior CAAC researcher. “They feel they are not fully prepared for international competition. And there is another factor: The supply of aviation resources in China, such as skilled staff, is still inadequate, so the airlines lack a motivation to pursue the international market.” In other words, they are busy enough domestically.

Why do they still feel they can deploy those resources more profitably at home than internationally? It is partly, as the CAAC researcher says, because they are more experienced in their home market, and partly because competition in China is restricted.

Limited competition is hardly apparent from a glance at timetables. Only 8% of Chinese trips are on routes without competition, and for 32%, passengers can choose among at least five airlines, according to Amadeus (see chart). But the local market is more comfortable than it seems for Chinese carriers because it is controlled in two important ways.

First, national capacity is carefully limited by the CAAC and the National Development and Reform Commission, which was the central planning committee in China's truly socialist era and still at the center of attempts to orchestrate much of the economy. Those two bodies approve aircraft imports with an eye on demand for travel and the availability of technicians and pilots. Whether they are directly concerned with airline pricing or mainly about keeping the skies safe amid a skills shortage, restricting capacity restricts competition.

Second, there is limited access to that managed market. The fourth-largest carrier, Hainan Airlines, is now basically a private business, despite its earlier links with the provincial government of Hainan, but it carried only 3% of the Chinese industry's passengers last year. Almost all of the rest of the market is in the hands of the Big Three and their affiliates, such Shenzhen Airlines, partly owned by Air China, and Xiamen Airlines, partly owned by China Southern. The state carriers have advantages in attracting personnel as well as acquiring aircraft, runway slots and traffic rights, which limit the opportunities for private carriers to open or expand, say industry officials.

For six years until this May, a new private carrier could not even begin operations. During that period, the CAAC had a policy of not accepting applications for air operator certificates. In fact, it continued to approve airlines with at least partial government ownership, so the policy was in effect a ban on new private airlines. The stated reason, which is not in doubt, was safety. In 2007, the CAAC was concerned about a surge in new airlines with limited management experience amid the already serious shortage of technicians and pilots. Again, the lack of resources benefited the incumbents.

The result of this structure is that the Chinese domestic market is one in which state airlines compete mainly against state airlines. According to Ajith, that hides their inefficiencies. One measure is the productivity of their workforces.

China Southern, Air China and China Eastern collected revenue of $210,000, $270,000 and $200,000 per employee in 2012, respectively. Such figures must be handled with caution, since some carriers contract out more than others, but it is still notable that the Chinese values are around half the levels of United Continental and Qantas ($420,000 and $440,000, respectively). Asian competitors Cathay Pacific Airways and Singapore Airlines show even higher labor productivity on that measure, with revenue per employee above $500,000, but neither has narrowbody operations, which are relatively labor-intensive.

It may be argued that China is a developing country, so labor efficiency is only naturally lower here. But the major Chinese airlines have largely failed to fully exploit the related, powerful factor of their country's cheap labor market. Any Chinese person outside the industry would be startled—indeed, intrigued—to learn that Air China's staff costs worked out at $39,000 per employee last year, four times the average wage of even Beijing, where labor costs the most. For United Continental, the figure was $90,000, in a country where GDP per capita is eight times as high. Even allowing for the bargaining power of Chinese pilots, it is hard to see why Air China is spending so much.

China Southern's staff costs are a good deal lower, at $29,000 per employee, but still remarkable by the standards of Chinese workers. Figures for China Eastern are unavailable.

To some extent, the inefficiencies of Chinese state enterprises are the familiar ones of large government businesses anywhere. The big Chinese state airlines have private shareholders, but there is not the slightest doubt that their managers pay overwhelming attention to their ministerial masters. Indeed, in one respect the airlines have an even deeper state character than, say, British Airways had before privatization. The top managers are Communist nomenklatura, moved into and out of managing airlines as they ascend in their careers. The former chairman of Air China, Li Jiaxiang, is now head of the CAAC.

They are classic examples of the economic system described as “Socialism with Chinese characteristics.” More than anything, the often-heard but little-understood phrase means the Chinese state continues to own large slabs of the economy but its enterprises must accept market prices for their products. At least in theory.

In practice, the state fiddles with the market, as when the authorities determine air capacity. The very geographical arrangement of the Big Three shows this mentality of planning competition. Each is based in one of China's three traditionally leading cities, spaced well apart and with approved route networks. They cannot set up a new base wherever they wish; they must ask the CAAC, which will consider the health of the market before deciding. As government operations, airlines can easily object to each other's plans that present unwelcome competition.

A striking current example of this is China Southern's struggle to utilize the five Airbus A380s it ordered for the sake of national prestige in 2005. Ideally, they would fly intercontinental services from Beijing, but Air China has successfully resisted that, forcing China Southern to try the best route it could find from Guangzhou—to Los Angeles. That transpacific service used up only part of the A380's capacity, however, and so by this July, China Southern was reduced to announcing that the aircraft, with a range of 15,400 km (9,600 mi.), would also fly 3.5-hr. services between Kunming and Beijing, probably the longest domestic route on which it could imagine using them. Lobbying from China Eastern, which has a base in Kunming, put a stop to that.

It is not quite a bed of roses for the Big Three, however. For a start, the government, through the state-owned Assets Supervision and Administration Commission, wants profits from airlines, as it does from most of its enterprises. The airlines must be at least competent enough to exploit the managed market to generate a return on their equity—although when they fail, the state has been repeatedly ready to recapitalize them.

Further, the Chinese state is not monolithic. Different groups have different interests, and so not everything is nicely coordinated. The air force refuses to give airlines enough airspace for the traffic they handle. The CAAC and Air Traffic Management Bureau, evidently fearful of the political consequences of crashes, further limit airspace capacity by being far more conservative about aircraft separation than authorities are elsewhere. The state railways, independent of the transport ministry, have built a colossal high-speed network in direct competition with the airlines. And, every so often, the central planners miscalculate the amount of capacity that is needed. When the economy turns out not to demand the air traffic that the airlines can generate, profits sink.

The carriers are in exactly that situation just now. Amid capacity growth of 7.5-11.9%, the Big Three made little or no operating profit in the first half of this year.

Still, the domestic operating environment for Chinese airlines is probably one that most foreign carriers would be pleased to enjoy, even without the attractions of strong traffic growth. And it is hard to imagine airlines coping in highly competitive markets with the Chinese service standards.

“Our airlines are a long way behind on service, and not just in the air,” says a senior marketing officer of a state carrier. “We have problems from end to end in the task of providing a travel service, getting important details right and setting up systematic processes. Staff quality is not good enough. They need to develop experience.”

Their service shortcomings are particularly noticeable in Asia, where standards of non-Chinese major airlines tend to be high. Foreign passengers in particular are reluctant to accept such common Chinese airline characteristics as late departures, barely acceptable meals, occasionally loose cabin lining, and dirty nooks and crannies. On Asian regional services, Air China appears to stock Boeing 737 and Airbus A320 flights with only two bottles of mediocre wine—one red and one unchilled white—for about 150 passengers. The carriers seem unable to master such details as always having a stock of landing cards on board; even cards for China are only sometimes available. And they are further burdened by often unruly passengers and lax cabin discipline, which are not problematic domestically but do not please foreigners.

Another factor in Chinese state airline management is that, to a some unquantifiable extent, the Chinese government is weighed down by the national game of building relationships to gain favors—guanxi (pronounced GWAHN-shee). The problem is so obviously pervasive that comment on it outside of China seems surprisingly rare.

In the guanxi culture, a person will almost instinctively look for a chance to build a good relationship with someone with power, typically buying the connection with meals, gifts and, in the end, maybe cash and other monetary kickbacks. As the two parties see it, they are helping each other. This extends to getting promotions.

Guanxi does not just raise questions about staff quality. In most Western countries, the line defining corrupt behavior is now pretty sharp. In China, because of guanxi, it is a perfect blur. The favors of a relationship may progress from being allowed early departure on Fridays to costly perquisites and eventually management of a contract that the subordinate knows should go to a friend of the boss.

This certainly does not mean that Chinese managers have all bought their way up, nor that competence is absent even from those who have. In the case of state airlines, analysts say the guanxi culture is much less severe than in other parts of the government. Maintaining safety must hold it in check. But Chinese state enterprises will probably always suffer from the culture more than do private enterprises, where bosses maintain firmer control.

Tap the icon in the digital edition of AW&ST for a closer look at China's major domestic air routes and data on the top 10 airlines, or go to AviationWeek.com/chinamajors