Interview – John Menadue

JM: In the past we have observed that profitable airlines have not experienced difficulties in arranging finance for aircraft, whereas weaker airlines have either gone out of business or been taken over by others which are more successful at managing profits and liquidity.

Qantas is regarded as an extremely good credit risk with strong cash flows but we need to lift our profit performance.

JT: Over the past three years the Australian dollar has fallen to the point where Australian carriers are effectively paying a 50% plus surcharge on new aircraft. At the same time many of your prime competitors have actually seen their currencies appreciate against the greenback, thereby allowing them the opportunity to actually buy cheaper aircraft. How will this affect your ability to compete operationally with them and their new 747-400 aircraft in the future?

JM: There are swings and roundabouts in the currency issue. While it is true that the Australian dollar cost of Qantas aircraft has risen drastically in recent years, the fact is that virtually all of the costs of our purchases during the 1980s are covered by foreign earnings surpluses. This includes currencies such as the Japanese Yen which has little direct involvement in our capital equipment but has risen dramatically in value and in its share of our total revenue. I think you’d be aware that the balance of earnings in Qantas has swung sharply around in favour of overseas currencies in the last two or three years, and the airline is now nearing a 70% earnings base in foreign currencies. This trend will continue.

As an Australian exporter, Qantas has some advantage in a devalued Australian dollar in that it improves our competitive position, and at the same time encourages tourism to Australia, which benefits us because that’s where our operations are concentrated. Our traffic sold in foreign countries last financial year increased by around 23%, which has the advantage of being an increase of outward travel by Australians, but this hurts our competitors more because the majority of their traffic is Australian.

Qantas has had to face up to the cost advantages of other competitors before. The labour cost advantage of the ASEAN carriers is a good example; the labour-busting tactics of the US carriers in more recent times is another. Our response then and now is the same: to give the market the best price-service option available. We must also lift our productivity to overcome our labour cost disadvantages.

That includes operating state-of-the-art technology, including the 747-400s which we also will be operating from 1989.

Unfortunately the 400s don’t offer the same technology breakthroughs and productivity gains that the first wide bodied aircraft provided.

JT: On the subject of new aircraft, a 747- 400 presently costs around $A200m. With Qantas passenger growth tipped at around 10% per annum over the next decade and a large number of 747-200s soon reaching retirement age, it is no secret that Qantas could require upwards of two dozen such aircraft before the end of this century. How will you go about financing this massive capital investment?

JM: Our projections suggest that this capital investment can be accommodated by a combination of overseas borrowings and our own cash resources accumulated from profits. Borrowings would be serviced from our extensive offshore earnings. Airlines will also need to cooperate further to minimise new equipment purchases.

On the other hand, it would be reasonable – as it is customary in business – to expect the shareholder to cover some of this very large expenditure through subscription of additional capital, bearing in mind the greater earnings potential of an improved fleet and the cyclical nature of the international airline business.

JT: With Qantas in effect earning over $4 billion each year for Australia in invisible export earnings – fares paid in overseas currencies, travel and accommodation here paid for by overseas tourists brought here by Qantas plus overseas currencies earned through freight operations, use of maintenance facilities, etc. – do you feel that you are making the average Australian sufficiently aware of the massive contribution Qantas is making to the health of the nation’s current balance of payments problem.

JM: We’re trying hard to make them aware, but of course we could always do more, so I’m glad you raised the matter.

I believe it is very important for all Australians to be aware of the enormous economic value of having competitive and efficient Australian airline capacity operating in the world markets. Tourism is now generally accepted to be the biggest single industry in the world, generating thousands of millions of dollars in expenditure on airline tickets as well as ground services. We can’t expect to earn a share of that air travel revenue, and bring it back to Australia unless we invest in the best equipment, operate it efficiently and profitably and develop policies at the national and state levels, in terms of tourism and aviation, that safeguard Australia’s interests.

Qantas is both a way to tap the air travel wealth and an essential infrastructure for entrepreneurs to invest confidently in our hotels, resorts and other ground services infrastructure for visitors to Australia. Expenditure on these services by all our overseas visitors last year was more than $1. 5 billion, which sustained something like 50,000 jobs. We expect to earn $1. 8 billion this year.

I think people are becoming more aware of these inputs and this is probably evidenced by the way our Governments are paying more attention to tourism than ever before and by the willingness of private enterprises to invest billions of dollars in tourist services.

We need to be careful however of thinking that tourism is the answer to all our prayers.

I think there is a cargo cult mentality about tourism in some parts of Australia.

JT: The present forty one year old bilateral agreement with the US is now of course a contentious issue, with Qantas and other regional carriers calling foul as the agreement now greatly favours the ultra-large US carriers. What changes would you realistically like to see embodied in a new bilateral?

JM: Simply – and realistically – the bilateral should contain market-driven mechanisms to relate capacity to demand and prevent dumping.

This sort of provision is fundamental in air services agreements all over the world, as is the principle of fair and equal opportunity. The United States cannot have it both ways; it cannot on the one hand conduct its aviation relationship with Australia on the basis of a bilateral agreement and, on the other, ignore fundamental bilateral principles.

We cannot and will not live with a situation which imposes on Qantas restrictions which are not reciprocal on the US airlines between and beyond the two countries and which enables US carriers to dump product in our markets over the legitimate objections of Australia.

At present there are 6,700 seats per week each way on the US-Australia route which are not being used to carry passengers between our two countries. The US carriers propose to increase this to 8,000. In 15 years the US Government has dismissed every objection raised by the Australian Government.

The Australian side wants a fair go, for both sides. It has proposed a simple formula, based on genuine market performance, which would achieve that while at the same time stimulating the market and promote competition.

The US side has not entered into any meaningful negotiations to date.

JT: Your Deputy Chief Executive, John Ward, recently stated that Qantas had lost more than $1oom on the Pacific routes since 1980. Considering that Qantas is beating its US competitors on these routes in the high yield first and business class markets and also generally runs higher load factors overall, isn’t this indicative that United and Continental would be losing even more?

JM: On the face of it, highly likely. But the way the US carriers are misusing their capacity to Australia introduces several points to consider. For example, Chapter 11 wage cuts would have had some effect as would between international and domestic operations. US domestic routes extend of course as far as Hawaii.

US airline revenues between Australia and the Government has dismissed every objection raised by the Australian Government.

The Australian side wants a fair go, for both sides. It has proposed a simple formula, based on genuine market performance, which would achieve that while at the same time stimulate the market and promote competition.

The US side has not entered into any meaningful negotiations to date.

JT: Your Deputy Chief Executive, John Ward, recently stated that Qantas had lost more than $1oom on the Pacific routes since 1980. Considering that Qantas is beating its US competitors on these routes in the high yield first and business class markets and also generally runs higher load factors overall, isn’t this indicative that United and Continental would be losing even more?

JM: On the face of it, highly likely. But the way the US carriers are misusing their capacity to Australia introduces several points to consider. For example, Chapter 11 wage cuts would have had some effect as would crosssubsidisation between international and domestic operations. US domestic routes extend of course as far as Hawaii.

US airline revenues between Australia and is and indeed has the very same attitude as Australia when the boot is on the other foot.

The USA is a party to treaties all over the world in which the principle is applied that 3rd/ 4th freedom capacity shall be used primarily for the purpose for which it is intended. Fifth freedom operations are universally accepted only as ‘fill-up’ operations, ancillary to 3rd/4th freedom operations.

If the USA wants to re-write international aviation principles to suit its argument with Australia then it ought to practice universally that which it preaches in this country. I’m sure a lot of airlines with similar bilateral disputes with the USA would be happy to trade fifth freedom rights for US cartage rights.

JT: Qantas presently derives a third of its total uplift from its Pacific routes whereas for United and Continental combined, this region constitutes barely 3% of their total passenger uplift. Obviously, either or both carriers could really squeeze Qantas hard in this important area if they wanted to – does Qantas actively fear this prospect and do you perceive a means of defending your market share against such predatory tactics?

JM: The ‘squeeze’ – to use your word – is not a prospect; it’s already a reality and Qantas is certainly concerned.

Ever since Continental’s obviously predatory ‘Koala’ fare set the scene several years ago we have been assailed by a number of pricing actions which have clearly been more concerned with establishing a market presence or taking market share than with legitimate stimulation.

It stands to reason that if a fares war to you means cutting a finger, but to your competitor, it means cutting a throat, then you will be tempted to start the war faster and stay in it longer. The Pacific is vital to the Australian industry, accounting for some 30% of our operations, but I suggest marginal to the US industry, accounting for only around 3% of its operations. The US carriers are obviously well aware of the pricing advantage which this gives them.

In this environment, Qantas is not so much concerned about the market share as about survival and that is why we have expressed so much opposition to a bilateral agreement which allows the situation to be perpetuated. The defence against predatory behaviour is an acceptable set of rules of market behaviour – in this case a renegotiated bilateral.

JT: Many overseas carriers are trying to get access to Australia so that they may siphon off traffic, not to and from their homeland, but merely as intermediate stops on the Australia/ Europe route. Air Lanka, Korean Air and Air Mauritius all come to mind as recent examples of this. Does Qantas feel confident that, all things being considered, you will win the day in Canberra in your efforts to protect your own interests in this vital market?

JM: We have no objection to increased traffic rights for foreign airlines, provided there is a fair and equal opportunity for Australia.

Australia provides an aviation subsidy to Asean countries of over $300m per annum because under the bilaterals, Asean countries have not provided the same aviation opportunities to Australia that we provide to them. As we are now a poorer country there is an increasing appreciation in Canberra that we can no longer afford these sorts of subsidies.

We have pointed out that, in each of the examples you mentioned in your question, there was no such reciprocity and that, to give airlines access without this, is to deny our own airline a truly fair chance to compete, and ultimately burden the Australian economy with lost exports, tourism and jobs.

The interests we are trying to ‘protect’, as you put it, are the national interests of Australia. Our country has a very large investment in the Qantas transport infrastructure; you have already acknowledged the contribution which that investment returns to the economy, now running at more than $4 billion a year.

In the present economic climate we have to do all we can to increase exports and reduce imports, including international airline capacity.

JT: Do you feel that privatisation of some of your primary competitors – BA, JAL, That, MAS and Cathay Pacific – will be of long-term benefit to them?

JM: Privatisation in those countries is a matter for those governments and those airlines.

I’m sure the circumstances are quite different in each case, but I am not sufficiently familiar with them to comment.

JT: In 1979, the then Coalition government recalled your important interline rights without comment as to why this had been done. The recent May Report suggests that these rights should be speedily returned so that you can offer better holiday packages to the international aviation community than is presently the case. Do you feel that Qantas will in fact have these rights restored prior to 1990?

JM: On a number of occasions prior to the May Inquiry, Qantas formally requested from the Government the restoration of its international interline rights. The Government’s most recent response was to the effect that the interline issue would continue to lie at rest until the Government had an opportunity to consider the findings of the Inquiry.

The Inquiry, as you say, has come down firmly in favour of the arguments put forward by Qantas and many organisations and Government departments that interlining rights for the Company would have benefits that significantly outweigh any ‘losses’ to the domestic airlines. It also supports the rather obvious point that the domestics could reduce their interline revenue losses by making some competitive responses of their own.

We have always taken the view that interline rights lay outside the central issue of domestic policy because Qantas’ rights to carry this traffic were already provided in the existing legislation. No special legislation is necessary to have them restored.

With the findings of the May Inquiry going public, we have again formally requested the restoration of our legitimate rights, making the point that any remaining ‘impediment’, if there was one, would have now been removed by the findings of the May Committee.

JT: Obviously, reinstatement of your interline rights would enable Qantas to gain a far better return on investment on its domestic staging routes. However, when you lost these in 1979 your all 747 fleet flew these connecting routes continually with very low load factors whereas nowadays most of these ports are served as direct services via the 767 twinjet. Would not this tend to nullify much of the gain you would nowadays achieve by reinstatement of these routes?

JM: Not at all. Our domestic sector network is larger today than it was in 1979 because additional developing gateways have been added to the traditionally combined ports We fly nine domestic sector legs today. All of these legs are relevant to tourism development. All with the exception of three are served by Boeing 747 aircraft and all flights, regardless of the equipment used, are potentially able to carry very large numbers of interline passengers year round. Some seats will always be unused on staging flights, so there will always be spare capacity.

Typical interline routings available would include: Cairns/Brisbane/Sydney/Melbourne/ Hobart; Cairns/Brisbane/Sydney/Adelaide/ Perth; Darwin/Cairns/Brisbane/Sydney and then southward or westward across Australia; Darwin/Townsville, with an alternate to Cairns or Brisbane and thence southward to Hobart or westward to Perth.

We have always seen the gain to be made from restored interlining as more in terms of tourism promotion and development for the whole of Australia, based on lower fares, rather than revenue gains for Qantas and conversely revenue losses for the domestic airlines. A second issue was always that, with interlining rights, Qantas would have a better chance to match some of the marketing practices of competitors which have in their own countries not only interline rights, but full domestic rights

JT: Qantas’ performance in air cargo in recent years has certainly been stunning. Your annual report shows record growth of more than 10% for the last financial year alone. How important is cargo to your overall financial target and what do you see as the long-term future for Qantas air freight?

JM: We are proud of our cargo performance and take heart that in 1986, Qantas was the 9th largest scheduled international freight carrier in the world. Cargo produces 18% of our total airline revenue and should continue to do so for the next 5 to 7 years. In kilo terms we enjoyed a growth in 1986/87 of 37% over the previous financial year.

The thrust of our cargo policy in Australia is to offer low rates in order to give a break to Australian exporters, particularly farmers, but the irony is that existing rates are restricting exports as well as our own growth because they are too low. Rates have to go up.

A consequence of this is that Flying Tigers usually repositions empty to Asia twice a week with a capacity of 100 tons per flight rather than incur fuel and handling costs which cannot be recovered from the low freight rates. This absurdity is hard to equal. On the Singapore route, cargo flying into Australia returns an average rate of $5. 23 per kilo whereas the outbound rate is just $1. 05. At these prices airline companies cannot afford to offer dedicated freighter aircraft on a scheduled basis which, with their high volume capacity, are what exporters will need in order to develop food exports into Asia on a really large scale in the future. In order to mount operations by a Boeing 747 freighter, assuming a load factor of 70% and a small profit, the market would have to support an export rate of $2. 30.

In return, the 747F would have the capability to provide volumes of 100 tonnes on a scheduled, planable basis which would offset the cost of the higher rate through an increased turnover in a bigger market.

JT: Last year you had to set aside a very large sum, more than $16m, for Fringe Benefits Tax. Additionally, new taxes such as a 3% increase in company tax, newly introduced charges for government loan guarantees, the cost of OF now having to collect its own departure tax on behalf of the government, all cost Qantas more than an additional $13m last year. As this comes straight off the bottom line, do you feel that the government is becoming too greedy in its ever-growing range and rate of taxes on aviation?

JM: The taxes you mentioned will all impact on the Company’s future profitability and its ability to compete in an extremely aggressive marketplace.

We have not borrowed funds since the Government applied its charge for guaranteeing our loans, but as the charge is higher than the difference between the costs of guaranteed and unguaranteed loan arrangements, it’s highly likely that our future borrowings will not be guaranteed by the Australian Government.

JT: Qantas is interested in both the MD-11 trijet and the new Airbus A340 ultra-long-range medium sized transports. Can you give us more background on this specific requirement and will these aircraft ultimately replace the twin-engined Boeing 767?

JM: Qantas closely evaluates every aircraft type that is potentially suitable. In any case it is far too early to talk about the types you mentioned because at this stage we do not have firm plans about the routes,services and frequencies we will be operating after 1992.

JT: The Boeing 767 twinjets have now been in service for more than eighteen months. How are they performing in a marketing sense? For instance, has enhanced regional frequency stimulated traffic growth and is the absence of a dedicated first class capability considered a drawback to your 767 operations?

JM: The 767s are performing very well in a marketing sense in that they provide greater frequency of city pairs previously operated by 747s, and are opening up new markets.

For example, Brisbane/Singapore now has four flights a week instead of two and we have accordingly improved market share. Growth on the route during 1986/87 was a very good 40%.

Tokyo/Cairns and Tokyo/Perth are new markets opened by the 767s; Cairns in particular has done very well and is probably ready for a second service in the near future. Tokyo/Perth is doing less well, but this is probably being constrained by a lack of opportunities for Japan Air Lines to interline its passengers to Qantas for cheaper flights to the east cost, which would stimulate growth.

JT: Regarding the special joint marketing agreement between Qantas and Ansell, how is this working and what do you foresee as the future benefit to both carriers of this agreement?

JM: The arrangement between the two airlines succeeds because it provides more benefits than the alternatives and because their respective passengers agree that it does.

Each carrier in its own particular field is widely perceived in the marketplace as the industry leader. This creates in the mind of the passenger a perception of product quality and delivery that has a price as well as a benefit. For example, it imposes a strict marketing discipline in maintaining standards that must not only satisfy the partner’s needs but stay consistently ahead of the competition.

All the indications are that there will be some liberalisation of domestic aviation in the near future. This would enable domestic carriers to be more innovative and progressive, thereby stimulating growth that will have benefits directly for both Qantas and Ansell.

JT: Something that will assist Qantas this financial year, at least outside Australia, is a lower oil cost. How much do you envisage this saving Qantas in 1986/87 and do you feel that after prices will remain stable in the years to come?

JM: The expectation is a reduction of about 30% on our total budgeted fuel bill during 1986/87, due to lower prices overseas and their subsequent effect on the Australian crude price.

Jet fuel prices will probably rise by about 10% per year on average over the next five years based not only on crude oil prices but a possible demand imbalance with other petroleum products. While jet fuel demand is expected to rise, there will be slower rates of demand for other products and in some cases declines. This may persuade the refineries to reduce their crude runs to satisfy jet fuel in order to avoid surpluses in other products, thereby restraining the supply of jet fuel and consequently forcing up its price.

JT: Qantas has one of the world’s most respected in-house engineering facilities. Additionally, in recent times you have won several important support and maintenance contracts from overseas airlines. How important to the overall revenue plan is the engineering capability at the Mascot Jet Base and what are your plans for this endeavour in the future?

JM: Revenue from engineering customer work should exceed $40 million in 1986/87. Airline customers included Malaysian, Saudia, Cathay Pacific, Air New Zealand and Varig of Brazil, as well as the Royal Australian and Indonesian Air Forces.

Engineering contract work not only increases Qantas revenues but, as an exported Australian service, helps the national balance of payments. The volume of customer work at Mascot equates to 700 jobs. It also broadens the base of Australian skills in advanced technology areas.

Future plans include consolidating the important contract won last year with CAAC, the Chinese airline. Now that we have done heavy modifications of the 747 aircraft to the extent normally done only by the manufacturer, we plan to continue this line of work and have organised to do the mandatory forward fuselage structural inspections and modifications to the 747 required recently by the FAA. The devalued Australian dollar will make us more competitive in winning this sort of work. We may also undertake conversion of passenger aircraft to freighters.

We are also talking with Royal Brunei Airlines on engineering support for the Boeing 767 they plan to buy, and we are trying very hard to break into the US defence forces market.

JT: Finally, what do you foresee as the greatest challenges for Qantas in the coming decade?

JM: A decade is a long time in the airline industry, so I really can’t expect to be too specific at this point about issues in the late 1990s. There are, however, some critical problems we can talk about. Qantas already has a great product – amongst the best in the world. Our airmanship, technical standards, reliability and service are our strengths but we need to improve further as we grow. Our aim is to be clearly the best long haul carrier in the world – providing the best service at a competitive price.

We aim to improve our product as we grow into a substantially larger airline on a sound, profitable basis. International airlines cannot simply stand still while the world grows around them. Qantas’ obligations and responsibilities will increase as Australia’s role in world aviation and tourism grows. We must be sure that the national carrier is properly equipped and managed to handle the task. New equipment is very expensive and we thus need to lift our profit to purchase it.

We must also be more productive just as the Australian economy must be more productive. We face excellent Asian carriers with lower labor costs than ours.

On the Pacific we face a carrier that is not only highly productive but is non-unionised with labour costs 30% below the US average.

In the short term we can be smarter and better in the market, but in the end we cannot survive unless we have higher productivity to match our higher labour costs. That challenge has to be addressed by the whole company.

The development of the Asia-Pacific region is critical and will change the face of Qantas. I’ve seen predictions that this region will become the world’s biggest air traffic region in 4 or 5 years from now. Qantas has to be equipped and set up in such a way as to enable Australia to earn the biggest possible share of that growth and prosperity.

Another challenge is to encourage our governments and entrepreneurs to develop the right policies for our tourism industry so that Australia will continue to be an attractive and competitive destination for the world market. I think we all see the potential of tourism; it’s where the future of Qantas is. But we must not forget that it is particularly sensitive to trends and unexpected setbacks. Our tourism product must be broad, deep and flexible enough to handle any sudden surges or reductions of demand which must inevitably occur from time to time as we join the big league. Keep in mind that the North Atlantic market reportedly declined by 6% last year due to a weakness of the dollar and fear of terrorism.

In the final analysis the survival of Qantas rests with the consumer and whether we can provide the consumer with the best service at the right price.

Freedoms of the Air – What Are They and How Do They Work?

Throughout any article on civil international air transport, there will emerge from time to time a reference to the various Freedoms of the Air. These Freedoms were established as law via the International Air Services Transit Agreement of 1944 and have since served as the basis of bilateral air agreement negotiation between sovereign states. In essence, they are:

The First Freedom – The privilege to fly across another country without landing.

The Second Freedom – The privilege to make a technical (refuelling) stop in another country but with no commercial rights to uplift or set down passengers in that country.

The Third Freedom – The privilege of carrying traffic (pax, freight & mail) from the state of aircraft registry to another country. The Fourth Freedom – The right to pick up traffic from another country and fly it to the state of registry.

The Fifth Freedom – The privilege for an aircraft registered in one state and en route to or from that state, to pick up traffic in a second country and put it down in a third and vice versa.

The Sixth Freedom – The right to take on traffic in a second state, transport it via the country of registration and put it down in a third. Cabotage – The right or freedom of an air transport operator to pick up or set down traffic in another country for hire or reward.

It is the matter of Cabotage and 5th and 6th Freedom Rights that nowadays creates the most problems during international bilateral negotiations.