(FORTUNE Magazine) – SOME OF the world's biggest airlines are locked in combat in the skies over Asia -- potentially the richest market on earth. So far, travelers are the big winners. Ticket prices are the lowest in years, down 20% or more on some hotly contested routes. Most carriers are raising service standards to entice passengers. Cocktails and movies are usually free in economy class, and in first and business class the amenities flow like a river of rich plum wine. If you feel like idling away the hours, you can kick back in your sleeper seat and channel-surf on a high-resolution TV screen that pops up from the armrest. If you want to work, you can reach out and touch clients and colleagues with satellite phones and fax machines, even high over the Pacific. Meals tend to be palatable, cabin attendants gracious. Virgin Atlantic Airlines, looking for an edge on the popular London-Hong Kong route, is even offering an onboard masseuse to work out your travel kinks and a tailor to measure you for a new suit. The competition, always fierce, is even more intense now because traffic has slackened, at least by Asian standards. The region is still the fastest- growing market in the world. By some projections, Asia, which now accounts for about 30% of world air travel, could generate half of it within a decade. But annual growth rates, averaging 11% and 12% through the 1970s and 1980s, slipped below 10% in the early Nineties. Though U.S. domestic carriers would kill for that kind of growth, the lower rate was enough to put the squeeze on Asia's lines. The slowdown began in 1991 with the Gulf war. Then the long painful slump in Japan, which accounts for nearly 60% of all international air traffic in Asia, deepened it. But lower growth rates are bound to be temporary (as, no doubt, will today's low fares). GDP growth almost always translates into increased air traffic, and the economies of several Asian nations are among the most expansive on earth. China grew 10.7% last year, and South Korea, Taiwan, and Singapore topped 6%. During the good years, many of Asia's airlines turned into powerhouses. Japan Airlines (JAL), All Nippon Airways (ANA), Cathay Pacific, and Singapore Airlines are all among the world's elite carriers. The region also supports a panoply of national airlines that each have more than $1 billion in annual revenues and extensive international route systems -- among them, Qantas, Korean Air, Thai International, China Air of Taiwan, Malaysia Airlines, Garuda Indonesia, and Air New Zealand. Nearly 40 air carriers, founded by state-owned companies, have sprung up in China alone. THE FALLOFF in traffic, coupled with Japan's recession, has hurt the Japanese carriers most. JAL, which the government privatized in 1987, expects to lose about $234 million for the fiscal year ending in March. Revenues should be $8.7 billion, down $200 million from 1993. At ANA, a predominately domestic carrier that was never government owned, revenues tumbled nearly 5% in the first six months of the fiscal year, to about $3.8 billion, and earnings plunged more than 80%, to a puny $12.7 million. Says Koji Yamashita, ANA's vice president for international marketing: ''We are having a very, very difficult time.'' Even the Asian carriers that have remained highly profitable by global standards, such as Cathay Pacific and Singapore Airlines, have seen their margins tumble from the 20% rate of years past to 12% or so. Most Asian airline chiefs have begun some form of cost cutting, and many are outspoken about what they consider unfair competition from airlines based outside Asia -- particularly U.S. giants United and Northwest. Rod Eddington, managing director of Cathay Pacific, is angry about what he views as disparities in the air agreements between the U.S. and most nations in the region. American carriers can fly into Asia from 21 U.S. cities, while Asian airlines can depart for the U.S. from only nine cities around the region, a pattern that developed partly because American carriers opened the market decades ago. Snaps Eddington: ''This just can't go on -- we must have a level playing field.'' U.S. carriers are not the only outsiders reaping the riches of the Orient. British Airways is the leading carrier in the Europe-Asia market, and Lufthansa is a major competitor as well. But both United and Northwest, having grown leaner and tougher during more than a decade of deregulation battles back home, have had the most success in Asia in recent years. Northwest, a pioneer in the region after Pan Am opened it up, now gets about 30% of its $8 billion in annual revenues from Asian operations, which have been expanding some 7% to 8% a year recently. United has become an Asian powerhouse since taking over Pan Am's Pacific division in 1986. It has added between 15% and 25% more capacity each year, tripling annual revenues from $1 billion to $3 billion. Asia's airlines have hustled to compete by strengthening their computer reservation systems and starting frequent-flier programs. But the U.S. carriers retain one huge advantage: Labor costs, which amount to more than 30% of overall fixed costs, are about half those of their major Asian competitors. That's because the Asian airlines generally have higher wage levels and need more employees to provide the same capacity. To stay alive in the competitive deregulated U.S. market, the American carriers long ago trimmed staffers and negotiated lower pay with their unions. Says Rakesh Gangwal, United's senior vice president for planning: ''Unlike the Asians, we have gone through the hard-knocks school of deregulation.'' JAL and ANA have made some faltering steps toward addressing the imbalance. JAL hopes to cut 5,000 workers out of 22,000 through attrition by 1998 and is hiring more cabin attendants outside Japan. Based in their home countries, these new crew members would not collect costly expatriate housing benefits. ANA has cut back on the number of college graduates it hires each year for its pared-down corporate staff. Japan's Big Two both get some benefit from the recent strengthening of the yen against the dollar. Jet fuel is priced in dollars, so it has become cheaper to buy for the Japanese. And since their cash goes further, Japanese are traveling abroad more. But those advantages are outweighed by the hit Japanese airlines take when they collect fares in cheaper foreign currency. JAL and ANA are also hurting from a structural change in the Asian market. Before the Japanese economic slowdown, the region's carriers made most of their money from full-fare business travelers in first and business class, viewing whatever cash they could gather from the cheap seats as a bonus. Now cost-conscious corporations are trimming travel expenses. Business fliers who used to ride up front have moved back a cabin or two. It all adds up to a major headache for Japan's airline chiefs. Says JAL Chairman Susumu Yamaji, 68: ''This has been a very miserable time for us, there is no doubt.'' An energetic, animated man with a rapid-fire speaking style, Yamaji has become a highly visible champion of Asian airline interests, particularly vis-a-vis what he views as predatory U.S. megacarriers. He argues that aviation agreements between the U.S. and Japan, which date to the early 1950s, must be renegotiated because they no longer reflect market realities.

+ Forty years ago, he points out, two-thirds of the passengers between the U.S. and Japan were Americans. As a result, U.S. airlines got liberal landing rights in Japan. The percentages are now reversed, with Japanese accounting for the larger share, but Northwest and United still enjoy broad access to the Japanese market. Particularly nettlesome to Japan are the Americans' ''beyond'' rights, which allow them more than 150 flights a week that stop in Tokyo or Osaka to drop off and pick up passengers, and then go on to destinations like Hong Kong, Seoul, and Taipei. The U.S. does not allow foreign carriers to pick up and drop off passengers in one American city and then fly on to another. The logic for this disparity has long rested on the notion that there is an intrinsic difference between destinations within one sovereign country and those that transcend national boundaries. Increasingly, however, the big Asian air carriers argue that the U.S. air travel market must be seen as similar to their regional market. In operational terms, they contend, allowing an Asian carrier to fly from New York to Los Angeles and then on to, say, Hong Kong is not unlike letting U.S. carriers use Tokyo as a hub for the rest of the region. The Americans are unrepentant about their success on Yamaji's turf, especially in light of the overall trade picture between the two countries. Said Northwest Co-Chairman Gary Wilson in a recent Washington, D.C., speech: ''Since the airline business is one of the few industries in which American companies compete successfully with Japanese companies, we respectfully would suggest to our Japanese friends that air transportation policy necessarily occurs in a broader trade context.'' Counters Yamaji: ''He is mixing chalk and cheese.'' Yamaji is quick to point out that U.S. carriers hold slots for about 800 takeoffs and landings a week at Narita, Tokyo's extremely overburdened international airport, compared with 830 for Japan's airlines. Yamaji calls this close parity ''abnormal,'' because he thinks Japanese carriers should have more slots than foreigners. Says he, in words American trade negotiators might be happy to echo: ''To exist happily in this world, some stronger people have to restrain themselves at times.'' Japanese airlines presumably could get more slots if Narita were expanded, but militant environmental groups have blocked all efforts so far. A new $14 billion airport on a man-made island near Osaka, scheduled to open next September, will siphon off some traffic. Because U.S. carriers already have such a predominant position, any new airport capacity in the region will help Asia's airlines most. Kai Tak Airport in Hong Kong, Asia's No. 2 aviation center, is as congested as Narita. A $21 billion project that includes a new airport and connecting roads is under way but has been hampered by squabbling over costs between Beijing and Hong Kong's British overseers. Chances are, it will be ready not long after the Chinese take the colony back from Britain in 1997. The new airport can't come soon enough for Cathay Pacific, Hong Kong's leading carrier. Though the airline is still relatively profitable, with operating earnings of $112.6 million in the first half of the fiscal year ending in March, Cathay's managers are bristling over market opportunities lost because of overcrowded airports. Says Nick Rhodes, a Cathay general manager: ''It's like we've been shackled for at least two years, unable to fulfill a lot of pent-up demand.'' Meanwhile, Cathay is reengineering its operations to sweat out some costs. ''It's really just like a good spring cleaning,'' says Rhodes. The airline has moved some office functions to cheaper locations to save money on real estate. For example, the site in Sydney, Australia, where Cathay moved its database center costs about 1% of what a similar plot of land would run in Hong Kong. More crucial to long-term results, Cathay is also trying to bring down sky- high labor costs. Cathay senior pilots, mostly Britons and Australians, can easily earn over $150,000 a year and match their basic salaries in expatriate housing and education benefits. Cabin attendants can bring in $50,000 or more in salary, plus about half that in various allowances. Cathay hopes to cut costs by basing some British pilots in London and Australians in Sydney to save on expatriate payments. Managing director Eddington and his aides must address personnel matters carefully. Last year Cathay flight attendants struck for 12 days over new staffing rules aimed at boosting productivity. Managers must be equally diplomatic about the airline's future status. A subsidiary of the Swire Group, a British real estate conglomerate, Cathay has long been a very visible symbol of Hong Kong's colonial status. As 1997 approaches, the line is responding both cosmetically, by painting over the Union Jacks that have appeared on the tails of all Cathay planes, and substantively, by populating management ranks with more locals and granting state-owned Chinese companies a 22.5% equity stake in the airline. CATHAY'S PLANNERS think such moves are a very small price to pay for continued access to the world's most promising air travel markets. Booming Guangdong province in southern China has become a major manufacturing center and alone will provide a heavy flow of air cargo and passengers. Air travel within China is growing 30% annually, and Cathay will likely be a big beneficiary through a subsidiary, Dragon Air, that flies into China from Hong Kong. Cathay is well placed to score big gains from the rapid economic growth and rising middle-class populations throughout Southeast Asia. The airline's managers point out that Hong Kong is located within a four-hour flight of one- half the world's population. Says Rhodes: ''We really are all set to explode.'' The same geographic case can be made for Singapore, the third important aviation crossroads in Asia. Millions of Indians and Indonesians use the tiny nation on the tip of the Malay Peninsula as a gateway for trips to Japan or on to North America. Japanese and Korean tourists funnel through, heading for holidays in Australia. Australians arrive on their way to Europe and North America. Singapore Airlines is widely considered one of the very best air carriers in the world. It regularly tops the field in profit margins and is weathering the current tough times better than most rivals. The airline, 54% owned by the government, earned an operating profit of nearly $250 million on revenues of about $1.9 billion during the first six months of the fiscal year that ended in March. Singapore's relatively healthy cash flow has allowed it to maintain a fuel-efficient fleet that averages just five years of age without resorting to heavy borrowing or costly leasing deals. The fleets of most other international carriers are twice as old. Conde Nast Traveler magazine has named Singapore the best airline for international travel two years in a row. The trade publication Air Transport World called Singapore ''the world's No. 1 airline over the last two decades.'' At the heart of the airline's service reputation are its smiling, willowy cabin attendants -- outfitted in tight batik sarongs -- unabashedly marketed as the Singapore Girls. There are probably more women professionals per capita in Singapore than anywhere else in Asia, and the politically incorrect nature of the airline's advertising is not lost on them. Even so, thousands of young women apply each month for the airline's rigorous four- month course that emphasizes safety training and encompasses beauty tips, discussions of gourmet food and fine wines, and the art of conversation. Can the airline maintain its lofty service standards in the current slowdown? Top managers insist it will, even though costs are getting a hard look. Some divisions, such as those involving aircraft maintenance, catering, and security, have been spun off on grounds that it's easier to control costs in smaller enterprises. The data-processing division has been moved from high- cost Singapore to Bombay. But the airline's chiefs express a calm optimism. Says managing director Cheong Choong Kong: ''We are doing the things that we always do. We try to avoid knee-jerk reactions -- the good times will return.'' Indeed, a big increase in Asian air travel seems all but inevitable over the longer haul. The big U.S. and European airlines will no doubt continue to make inroads into this lush market, and Asia's carriers are gathering resources to defend their territory. Airlines based in the region have ordered well over $40 billion worth of new aircraft from Boeing and Airbus, to be delivered over the next several years. There have been a few tough skirmishes, but it looks as if the real air war over Asia is just heating up.

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