May Report Review

And we don’t say unpopular for nothing. Apart from Ansett, Australian Airlines and their major unions, everybody else from tourist bodies to the smaller airlines were vehemently against the TAP which has ruled Australian domestic aviation since the early fifties. Indeed the Review sums it up thus: “Of those submissions to the Review that offered comments about the TAP as a whole, the overwhelming majority were critical of the present regulatory arrangements. In general, supporting comment was only to be found in the submissions of Ansett Airlines, Australian Airlines and certain unions. Results of the Review’s survey of trunk passengers suggest that there is widespread dissatisfaction with the TAP. In particular, this dissatisfaction involves perceptions of restricted competition, high fare levels, and parallel services. ”

The Report also verified what most aviation mediums had been saying for a long, long time fares were inflexible and often higher than they ought to be, the majors were employing predatory tactics against any newcomer (such as East West), that fleets were under-utilised in capacity terms and that capacity and route entry controls only served to promote the highly unpopular practice of parallel scheduling.

To further quote the Report: “The majority of passengers surveyed expressed dislike of the current nationally consistent, cost-based approach to fare setting. Most respondents indicated a preference for a more flexible fare-setting machinery. ” The Report’s in-depth public survey also found that there was evidence of some degree of brand loyalty in terms of choosing Australian over Ansett, and vice versa (with a marginal preference being shown for Ansett). Many submitters though commented on the trivial nature of the differences between these two airlines. East West Airlines, however, is perceived as offering a significantly different service, and it was rated more highly for its willingness to respond to consumer needs and to provide a greater range of fare types.

The survey also indicated that respondents consider that the present 50:50 market-sharing arrangements that apply on the competitive routes of the two majors discourage these airlines from seeking out new markets and further developing existing markets, since any market gains must ultimately be shared with the competitor. The Review itself found that the present rate-of-return regulation as specified by the Independent Air Fares Committee (IAFC) actually encouraged Australia and Ansett to employ excessive capital assets (notably new aircraft) relative to output levels and this was reflected in low-density seating configurations and relatively low hours of aircraft utilization. On the other hand, load factors are high (on average around 10-15% higher than in the US) and capacity controls have enabled the worst excesses of capacity competition to be avoided. An example of this is the 737-300 which in local service features less passenger capacity than anywhere else in the world (refer p28, Sept 86 M). Ansett in fact introduced their aircraft with only 106 seats whereas most overseas operators are using the aircraft in a 128-149 seat configuration. Ansett also configures their BAe 146s for a mere 75 passengers whereas the overseas equivalent is more like 90 pax. The Report logically states that Australia will never have lower air fares The expensive aircraft assets continue to be deployed with the capability of uplifting a minimum number of passengers.

The Report also found that the present form of regulation serves to restrict the output of Ansett and Australia. This enables and further encourages the two airlines to focus their primary attention on serving the high yield passenger, primarily those travelling on business, at the expense of the discount fare market.

The Report also cited the two majors for predatory actions against East-West Airlines (EWA). To quote: “Since the enactment of the 1981 Airlines Agreement, Ansett and Australian have responded to any EWA initiative that involved actual or potential direct competition with them by either providing similar down market services with comparable fare levels or calling on the first option privileges of the TAP to preclude EWA from starting such operations”. The Report also noted that they had usually initiated legal action in an attempt to block some of East West’s route entry proposals.

The Report also saw a considerable opportunity for smaller niche carriers which is where East-West to some extent wishes to be-providing it is allowed to import the appropriate equipment. “A number of low-density sectors of the present trunk route system offer potential market opportunities for new entrants employing smaller aircraft. At present, there are approximately one hundred routes between trunk centres that are not being served by either Ansett or Australian and a number that are being only lightly served. Canberra, for example, does not have significant direct entry connections with trunk centres other than Sydney and Melbourne. The need to improve service frequency and choice on low-density routes was highlighted in the Review’s own analysis of consumer demand; such improvements would offer opportunities for supplementary airlines”, the Report concluded.

This point also raises another area that is lost to most of the inhabitants of Sydney and Melbourne, and that is that these two cities serve as massive hubs for the majors. Live anywhere beyond these two pivotal ports and you must accept one, two or even three intermediate stops in your journey from A to B. Consider the Canberra resident travelling to any northern Queensland port, or the person in Cairns travelling to Melbourne, or from Hobart to Perth, Perth to Brisbane, Brisbane to Alice, Adelaide to Brisbane-the list is endless and presents an open market for a smaller airline using jet equipment in the F-28, BAe 146 and Fokker 100 class, or, dare we say it – fully depreciated DC-9s that a certain major could viably employ for such services (range permitting) if it were not for the legal constraints of the TAP.

The Report was also critical of some of the actions of the Independent Air Fares Committee. To quote: “Few observers have exhibited a thorough understanding of the operations of the IAFC. The Review also experienced difficulty, arising principally from the lack of clear public documentation of the Committee’s methodology. Additionally, the statement of economic criteria contained in the IAFC Act lacks clarity and explicit content; it also contains conflicting objectives, particularly in relation to the need to take costs and demand factors into account in the setting of fares”.

The Report also concluded that the present discount fares offered by both Ansett and Australian were excessively complicated and overly restrictive, or both. The Report went on to say that EWA had shown greater initiative in offering discount fares that are more acceptable to the public. Generally though, it considered that service levels by both the majors were highly regarded, what was lacking was a true competitive spirit, a greater and less complex range of discount off-peak fares and a reduction in parallel scheduling.

The Report also found that the relatively high cost of air travel and the non-promotion of existing discounts has restricted the widespread use of domestic air travel. The Review’s survey results indicated that the use of air travel in Australia is more restricted than in the US (even allowing for differences between the two countries) and that the gap is widening. Nevertheless, the travel opportunities afforded by the Australian airline system are probably at least as good as those available in Canada. There is evidence, however, that air travel as a proportion of total Australian domestic travel has been decreasing in recent years.

It is interesting to note that since deregulation was introduced in the US in 1978, that coach companies have been losing passengers to the airlines, many of whom actually undercut the coach operators! In Australia, in recent years, the trend has been for the railways to lose passengers to the relatively deregulated Australian long-haul coach operators while the airlines generally look to uplifting a static, or declining, per capita base. The Report went on to say that the percentage of interstate trips taken by air has declined steadily in the past five years and there is reason to believe that market expansion, as measured by the proportion of trunk passengers who are travelling by air for the first time, is below expectations. The Report also found that the Australian majors carried a far greater proportion of business travellers than did their US counterparts; while overall, the major part of travel on Australia’s airline system is for business purposes. The Report also found that the majority of economy class fares were paid on a full fare basis whereas in the US almost all non-premium fares are on some form of deep discount.

On discount fares the Report concluded: “The low incidence of discount fare travel is thought to reflect primarily a lack of awareness of the availability of such fares; the lack of availability of discount fares at periods of peak demand and the unsuitability of fare conditions for some price sensitive travellers were secondary reasons. The best way to encourage more air travel among price-sensitive travellers appears to be through the promotion of discount and off peak fares. Many people who say they avoid air travel because of concern about fare levels are ignorant of the opportunities that do exist. It is likely that many of these people would reassess their opinions about the cost of using air transport if they knew more about discount fares and the associated conditions. ”

On the characteristics of the separate airlines, the Report concludes: The Ansett group of airlines (which includes three of the five regionals) has some 50% of the total trunk and regional passenger market, measured in Revenue Passenger Kilometers (RPK). That the Ansett financial results have been consistently better than those of Australian Airlines and that the trunk network of Ansett Airlines has a competitive advantage over Australian Airlines because of the support it receives from the various Ansett regional airlines and other interests of the ATI group. This would be even more pronounced in comparison with Australian Airlines in years to come if East West were allowed greater trunk route access, thereby diluting further EWA on carriage via Sydney and Perth that presently goes to the Government airline.

Australian Airlines and its subsidiary, Air Queensland on the other hand have some 44% of the market. However, despite recent improvements in its profitability, partly as a result of a substantial capital injection, Australian Airlines is less profitable than Ansett Airlines. The report noted that the financial performance of Australian Airlines is strongly influenced by its Government ownership. The airline is comparatively highly geared with a high debt/equity ratio and as a consequence, a relatively high proportion of its cash flow is devoted to meeting ongoing interest and loan repayments. The Report also generally considered that continued Government ownership of Australian Airlines was detrimental to its overall potential long-term performance due to the large number of constraints that Government ownership placed upon the carrier (refer p75 Nov 86 AA). In fact, if deregulation was to be introduced it would be tantamount to the sale of Australian as it would be inconceivable for a Government owned carrier (which theoretically could make any loss it desired in order to achieve market share in a commercially aggressive environment) to be able to compete head to head with a privately owned airline that must make a profit in order to survive.

East West Airlines meanwhile has some 6-8% market share. Contrary to popular belief, EWA does not have the advantage of a low per seat kilometre cost in comparison with the larger domestics. This appears to be because EWA operates relatively small aircraft over low-density routes under often restrictive conditions. The Report noted that EWA had introduced numerous discount fares since 1981, but the fare-matching provisions of the IAFC have been used to counteract some of these initiatives. Accordingly, the specialised service provisions established in the 1981 Airlines Agreement have proved ineffectual Ansett and Australia have pre-empted EWA’s specialised trunk route service proposals on every occasion.

Regarding Qantas, our international carrier with a certain measure of interest in the outcome of the May Enquiry, the Report concluded that Qantas should have its interlining rights restored. However, this is on the basis that Qantas can prove that it can indeed attract many more visitors to Australia by being able to offer international visitor (regardless of which carrier they fly in or out on) significantly better packages than those presently offered by the two domestics. In this area Ansett and Australian may well further discount their package holidays as coincidentally the Report also found that the overall airfare discount level attributed to these domestic holiday packages was a mere 18% rather than the 33%-45% that is generally considered appropriate. In many ways our largest airline could find itself in the same position as tiny East West in relation to fighting the Big Two.

The Report also discourages Qantas’ aspirations for true domestic services and points out that if this was to be allowed then Qantas and Australian might as well be merged. This is a scenario that this writer would imagine would attract little support from those involved, as evidenced by Qantas’s recent spurning of Australia in favour of a more aggressive Ansett as a partner in the ‘promote Australia’ stakes. A merging of Qantas and Australian would also justify Ansett to quite rightly seek international status, a situation that would gain few real benefits for the players concerned.

So much for how Mr Tom May saw the Australian airline environment, but what of the future?

Essentially the May committee has elected to present five options. These five options run from keeping things as they are to outright deregulation. It is noteworthy that during the Canberra press conference where the Report was released, that both Mr Tom May and Mr Morris thought it unlikely that either of the first or last options would be viable. What happens now is that those concerned (and particularly the four airlines) lobby the Minister for Aviation, Mr Peter Morris to ensure that their vested interests are protected as best as possible. For the two majors this reeks of a suicide mission as the entire Report is a slamming indictment of the perceived unpopularity of the existing Two Airline Policy. Following consultation with industry, the Minister plans to then be able to bring down the preferred option (or mix of options) in Federal Parliament towards the end of the parliamentary session – in other words around late May or early June. The outcome then becomes law and effective from January 27th, 1990 as the airlines have agreed to accept any notice to terminate the TAP retrospectively from January 27th, 1987, the earliest date any notice could have been given.

So much for the coming chain of events but what of the options offered up in this vast 862 page Review? The five range from: (a) maintaining the status quo; (b) a form of revised regulation; (c) a form of modified regulation; (d) partial deregulation; and (e) full deregulation. Let us examine them in more detail.

The first option: The Status Quo

Essentially this option involves leaving things exactly as they are. What the May Report did do was to conclusively prove that the existing TAP is disliked by almost everybody. It is perceived as being anti-competitive in nature, restrictive to new airlines wishing to introduce cheaper and more available discount fares and a major cause of parallel scheduling and inefficiency. Ansett and to a lesser extent, Australian Airlines, would prefer things stayed as they are, while EWA naturally opts for a decrease is regulation though it would not like to see total deregulation as 1t would then have to watch its own six o’clock as the hunted rather than the hunter. It is highly unlikely though that the Government would choose this option, particularly as it is stated Coalition policy to abandon the TAP in favour of ‘liberalization·- East West’s current High Court challenge, to be heard later this year, against the existing TAP, also makes this option a non-runner from the start.

The second option: Revised Regulation

To quote the Report: “The aim of Revised Regulation is to achieve increased economic efficiency, enhanced opportunities for new entrants, and additional consumer benefits through the application of precise and thorough regulatory controls. Such an approach is based on the premise that with continued regulation it would be possible to improve the performance of the industry by making refinements to the existing regulatory framework. It is designed to maintain stability, and to regulate aircraft capacity, route entry and fare setting in such a way· as to increase efficiency in the use of aircraft. Some features involve significant elements of change, especially those that vary the number of airlines on some of the trunk routes. This option may well serve as a first step in a movement towards substantial deregulation. ”

One significant change from the TAP with this option is that aircraft capacity would be on the number of seats available, rather than RPKs, thereby allowing individual airlines to deploy their assets as they wish whereas now, both majors must offer equal capacity over a period to each port served, this is both commercially restrictive, inflexible and discourages meaningful competition throughout the network.

The Revised Regulation option would retain the concept of a trunk route network. While most trunk routes would be reserved for Ansett or Australian there would exist the opportunity for a third operator to fly some of the heavily trafficked routes. Encouragement would also be given for the use of smaller jet aircraft where this equipment served to enhance frequency, etc. Additionally, encouragement would also be given to any operator that wished to serve the great number of non stop city pairs that presently go unserved due to the majors preoccupation with using Sydney and Melbourne as giant hubs. On some dense routes a third operator could be licensed to operate specialised services using jet or turboprop aircraft.

Fare pricing would be designed to give more weight to considerations of economic efficiency than is currently the case. This follows with the abandonment of the IAFC (as we know it) in favour of a streamlined regulatory body (termed the Regulator in the Report) that would approve fares, maintain a watch on predatory behaviour and approve route entries, etc. Much wordage in the lengthy Report is dedicated to the need for the Regulator to be more aware than is presently the case with the IAFC and for the airlines to present a greater array of public information than they currently are required to. To our way of thinking this appears to be a move in the right direction and certainly away from the relative coziness of the present agreement.

The promotion of off peak discount fares would also be encouraged for both economy and premium classes. It is interesting to note that the Report overwhelmingly came down in favour of off peak fares as a means to bolster off peak (nighttime and midday travel) utilization of assets.

In these more commercial options a lot of responsibility falls upon the shoulders of the Regulator. Therefore it is not surprising to find the Report summarising with the following. “This approach relies greatly on the Regulator being well informed, having a thorough understanding of the industry, and diligently pursuing the goals of economic efficiency, even in the face of possible economic difficulties arising from entrenched industry attitudes. _ If the Regulator is unable to achieve this demanding level of performance, the efficiency gains will not be fully realised”. It would be expected, if this option should be chosen, that the suggested dissemination of operating data would be mandatory as a part of the revised Airlines Agreement Act.

The third option is modified Regulation.

Like the second option, Modified Regulation introduces changes but is also developed from the status quo. The changes proposed for this third option are not necessarily more or less extensive than those proposed for Revised Regulation; they are different. As in the case of the second option, an approach of Modified Regulation would enable the airlines to adapt to limited change and allow the government to assess the effects of a relaxation of regulation. This approach could be used as an interim step towards more substantial deregulation at a later date.

The aim of this option is to achieve greater competition while maintaining stability within the industry. Such competition would be achieved by increased but controlled opportunities for entry onto trunk routes by operators other than Ansett and Australian. This would result in a broader range of services and fares. The approach also ensures major continuing roles for both domestics though it is performance-oriented In that it awards to operators capacity in accordance with their success in meeting consumer needs. As such the Report believes that it should enhance the overall efficiency of the industry.

As to capacity, it is envisaged that the present TAP capacity determination system would be retained virtually unchanged. The changes for route entry would allow a third operator onto a route if that operator can prove that it can generate additional or new market traffic that is presently being neglected. The Regulator would also be the decision maker in this case, which operating independently would allow a more flexible arrangement than is presently the case with the confused and restrictive TAP.

The Review’s survey results suggest that there would be some degree of public acceptance of a modified regulation approach because it would result in increased opportunities for new airlines, the elimination of the consultation between the two majors, the recognition of consumer interests, and the introduction of public hearings and greater overall public accountability. In many ways, options two and three represent to some extent a de facto Three Airline Policy!

The Fourth Option: Partial Deregulation

In contrast to the previous two options, Partial Deregulation reduces the extent of detailed regulation and thereby provides greater scope for the play of market forces.

Partial Deregulation goes considerably further than revised or modified regulation in removing Commonwealth controls over route entry, pricing (except in the case of predatory pricing) and much of the capacity determination process. Control of aircraft capacity available to operators would be exercised only at the point of import and it would therefore permit free use of aircraft once they are in the country.

Conceptually, Partial Deregulation differs from outright deregulation only· inasmuch as, in the former situation, the Government retains control over the import of aircraft and therefore over seat capacity. In this way it is anticipated that capacity can be controlled to the point of not allowing excess capacity into the system.

Under Partial Deregulation, there would be no control over route entry, except that Qantas and foreign airlines would not be permitted the carriage of purely domestic passengers. Qantas would, of course have its interline rights restored and would be able to uplift domestic air cargo as available on Australian sectors. There would also be no fare setting mechanism but fares would be monitored and controls established by the

Regulator to prevent predatory pricing. ”This option has the potential to provide a strong impetus to efficiency gains; it would provide a market environment that should motivate all airlines to perform maximally and to seek to expand their market shares in accordance with market demand. On the other hand, there is a risk of predatory behaviour, particularly in the use of capacity. It may quite soon become necessary for the Regulator to use its powers of intervention. Ansett arid Australian would no doubt use their inherited strength to prevent new entrants from gaining a foothold. Competition between the two majors may be lively because they would probably use their new freedom to seek to increase market shares,” stated the Report. In this regard Ansett is best suited for the battle due to its widespread intrastate interests and the availability of leased aircraft from its various international leasing concerns. Australian Airlines would have to be privately owned to even be viable in these conditions and would need a far greater intrastate base than it presently possesses. East West has a fair amount of capital backing from the giant Griffin Group and no doubt would upgrade rapidly to leased jets as required. It is envisaged that East West would begin to operate on the major trunks while also looking to link up some of the city pairs that are now flown via an intermediate port by the majors via their existing hub and spoke networks.

The Fifth Option: Deregulation

As the name implies, Deregulation would result in a virtual lack of control by Government in the day-to-day running of the Australian domestic air transport system. Airlines would be free to import arid operate whichever and how many aircraft they wished. Route access would be free as would be fare fixing. On the surface this sounds like a carte blanche permit for every man and his dog to enter the airline industry. While there is no doubting that some existing transport impresarion such as Mr Bob Ansett, etc may take the plunge, it·could also be said that the overall complexity of running a modern airline would preclude most potential entrants from realistically entering the fray.

Firstly you need modern aircraft, experienced crews, both in the air and on the ground, major engineering facilities; simulators, a massive computer reservation capability, associated resort, accommodation and surface transportation links and last but not least, terminals, Existing Australian airports were all built largely on the premise that there were simply only two major domestic carriers. Thus, there exists little excess space at any of the major Australian airports for additional entrants. Even East West has difficulty gaining accommodation and is forced in many centres to operate shuttle buses to nearby off-line terminals and operate kerbside check-ins, for example at Canberra the airline presently operates from a fleet of vehicles and a four metre square booth!

An entrepreneur dreaming about owning an airline (and aviation, let it be said, makes normally sound businessmen make some very unsound decisions as the ‘romance’ of the industry takes hold – it is often cheaper to perhaps stick with maxi racing yachts and thoroughbred racehorses!) and actually getting it operating, established and making a viable profit are to say the least two different things.

On the other hand, under total Deregulation, you can bet that the Ansett group, with its enormous cash reserves (via TNT and News Ltd) would overwhelm any competitor. It is of course interesting to note that since the issuance of the Report, and the resultant bagging that both majors suffered, Ansett has now completely changed its tack and openly called for either total deregulation or a continuation of the present system. One hates to be cynical but it is also noteworthy that Sir Peter Abeles’s recent calls for total deregulation (which is the exact opposite of what ATI have been preaching these past few years) hinge on Australian Airlines being sold to private ownership. As it is stated ALP policy that Government ownership of Australian is sacrosanct then his change of heart as regards unfettered competition perhaps rings a little hollow! It is also stated Coalition policy to privatize Australia though as the final determination of what will follow the TAP will be law by this winter, and a new Coalition government wouldn’t be in Canberra till early next year at the earliest, then from where we stand Ansett’s new-found enthusiasm for deregulation amounts to more of a PR exercise than a radical change of top level policy.

Meanwhile, Australian Airlines, even under private ownership just doesn’t have the market reach or existing intrastate links to overwhelm a deregulated Ansett.

East West for its part would expand rapidly, basing its operations on discount air travel and non stop services linking the previously mentioned city pairs. The danger for EWA though is that it could easily be gobbled up by one of the majors as could a number of the more viable regional operators. This is exactly what has occurred in the US, New Zealand and Canada, so there is no reason why it won’t happen here also – it is simply an economic fact of life that in a totally deregulated market the big will have to get bigger to ensure that they themselves don’t fall prey of their competitors.

So there you have it. Writing a feature such as this is literally frustrating due to how much we have to omit, for space reasons. Obviously there is a lot that we haven’t covered and to those who would like greater source material I implore you to purchase both volumes of the May Report from any AGPS outlet. For any keen student of the industry, certainly any aspiring airline executive, it is nothing short of essential reading.