Where next for Qantas?

In 2008, at an interview with the writer upon his retirement Dixon repeated the warning; “Certainly there is absolutely no guarantee.” But he added that he thought Qantas would continue to be a “successful, growing and profitable airline.”

As the 10th anniversary of Ansett’s demise approaches there are some who fear that Qantas in its present structure is not equipped to face further global liberalization just as Ansett, burden with baggage from the Sir Peter Abeles era, was not positioned to withstand the ill winds of domestic de-regulation.

Like Ansett, Qantas has a host of strengths, such as the world’s best domestic airline but it also has weaknesses with fleet and union problems and it faces not only the onslaught of low cost carriers both domestically and internationally but also greater market access from premium airlines such as Emirates.

That problem was put into perspective in January when government figures for October showed that low cost carriers accounted for about a fifth of the Australian international market and for the first time equalled Qantas’s market share.

Qantas’s share slumped to 19.5 per cent but Jetstar’s share of 8.1 per cent lifted the group’s market share to 27.7 per cent down from 28 per cent.

By December the numbers had sank further with Qantas down to 17.7 per cent and Jetstar at 8.1 per cent. Singapore Airlines had 9.2 per cent, Air New Zealand 8.5 per cent and Emirates with 7.9 per cent.

Compared to December 2009, Qantas Airways’ share decreased by 0.9 percentage points and Jetstar’s share remained the same.

And LCCs AirAsia X, Indonesia AirAsia, Jetstar, Jetstar Asia, Pacific Blue, Polynesian Blue and Tiger Airways accounted for 18.4 per cent of total international passenger traffic to/from Australia in December 2010 compared to 17.4 per cent in
December 2009 – an increase of 1.0 percentage point.

Over the past two years Qantas has lost five percentage points of market share, although some of that has been given to Jetstar as the legacy carrier took itself out of various markets. But the group’s share in 2008 was 30.7 per cent with Qantas at 24.7% and Jetstar with 6 per cent.

However what is of even greater concern is the Sydney centric weighting of the international numbers. Qantas’s Sydney share in 2009 was 26.7 per cent down from 32.2 per cent in 2006 but in markets like Perth Qantas has only 14.1 per cent in 2009 down from 24.7 per cent in 2006.

In 2009 Qantas had just 16.8 per cent of the Melbourne market, 12.2 per cent of Adelaide market and 14.7 per cent of the Brisbane market. The figures are of course somewhat distorted as many passengers from other capital cities – particularly to the US – go through Sydney.

To address the threat from full-service carriers, a special team headed by QF Group Executive-Customer and Marketing Lesley Grant will investigate ways of improving the performance of the international business in areas such as lounges, menus and check-ins although the changes are thought to be evolutionary rather than revolutionary.

Exposed

The GFC and liberalisation have wrought havoc on Qantas with CAPA’s Peter Harbison saying at the height of the downturn that Qantas would be “dead in six months” and faced restructuring on the Jetstar model with more job cuts if the market did not pick up within six months. Fortunately it did.

“If we continue on our current path, there will be a real question mark over the viability of Qantas International. And I have no intention of letting our flagship business decay through lack of action.”

Over the past two years as premium traffic –particularly international – plummeted Qantas Group’s Jetstar and FF program have been the stellar performers that have kept the airline out of the red.

For the year ended June 30, 2010 Qantas reported a $116 million net profit down 5.7 per cent on the prior year but the underlying profit before tax leapt 277 per cent to $377 million.

The frequent flyer program delivered EBIT $328 million, while Jetstar contributed $131 million, Qantas mainline $67 million, Qantas Freight $42 million and Jetset Travelworld $14 million.

Yields were down 7 per cent at 10.61 cents but were improving.

Jetstar’s capacity was up 28 per cent and passenger numbers grew by 36 per cent with the airline serving 52 destinations in 18 countries with more than 350 flights a day.

Qantas International suffered an 18.5 per cent decline in passengers, although that figure in part reflects the transfer of routes to Jetstar International.

In the prior year to June 2009 the result was a disaster with Qantas reporting a $123 million net profit down 87.3% from $970 million earned in the 2008 year, prompting a three-year, $1.5 billion cost-cutting program called “Q Future.”

One-time events also weighed down the bottom line included industrial action by the
ALAEA which cost Qantas an estimated $130 million, the impact of the swine flu scare estimated at $45 million and costs associated with introduction of the A380 $37 million.

Highly volatile oil prices and a 31 per cent fall in the Australian dollar relative to its US counterpart were factors as well, particularly in the first half ended December 31, 2008.

Biggest performer was the FF program with EBIT $310 million, while Jetstar contributed $126 million while Qantas EBIT was a loss of $77 million.

In the six months to December 31, 2010 Qantas’s profit has certainly picked up with a
reported a statutory net profit of $239 million with Qantas contributing EBIT $165 million, Jetstar $143 million and the FF program $189 million.

While the mainline airline is now bouncing back its underbelly has been exposed as vulnerable and one of the major fundamentals that have caused that – greater liberalization- will only get worse.

And the competition from overseas carriers is just one problem with Virgin Blue set to re-launch itself as a premium airline on domestic routes where Qantas has enjoyed a virtual monopoly.

Qantas’s unions need to understand that some of their angst with the state of Qantas ought be directed at government which has set in train the market dynamics that see the airline under siege.

In fact Qantas’s issues are the same that have devastated many listed airlines around the world; largely regulated workforce; competition from government subsidized airlines or airlines with lower labour costs; monopoly service providers such as airports and a fully or partially de-regulated marketplace.

The most sobering number is the manpower costs per ASK at Qantas which has remained static at around 2.62 cents over the past five years despite a host of cost cutting exercises.

Change

At the press conference in July 2008 to announce Alan Joyce’s appointment as the airline’s new CEO, he joked to the media that “hopefully the only difference you [the staff] will notice between me and Geoff [Dixon] is an Irish accent.”

The reality has been that many aspects of the airline’s operations have changed and while that was accelerated by the GFC, Joyce’s appointment over previously anointed successors, such as John Borghetti, was a clear sign that change was needed to meet the gathering storm clouds.

However, Joyce was quick to dismiss concerns that his brief from the board was to gut Qantas and rebuild it in the mould of Jetstar. At the time Joyce said: “First class in not dead. You know 12 months ago with soaring fuel prices everyone said that the low cost model was dead! The great thing about the Qantas group is the portfolio of businesses. They all go through cycles and one will outperform the other in cycles,” Joyce insisted.

Joyce’s mission was to get the group’s businesses better matched to the market. “There are three major stakeholders – customers, employees and shareholders. We want to offer the best customer proposition, engage the staff and produce shareholder returns that enable further investment,” Joyce said at the time.

Joyce in an interview with Australian Aviation at the time freely acknowledged the very real challenges in all areas, particularly with the staff. Qantas’ industrial relations over the past few years have been more confrontational with devastating effects on its image where the airline has become the butt of jokes around the BBQ.

Contract negotiations with the Australian Licensed Engineers went sour in 2007 and they waged a very effective campaign alerting the media to every daily maintenance problem that affected Qantas. A short strike and work to rule campaign resulted in Qantas’ on-time record slumping to a paltry 54 per cent. Joyce laments: “The engineering dispute did cause us the worst on-time performance in our history.”

Dixon blames “a few” trouble makers. “They have every right to be aggressive but they have overstepped the mark. Most Qantas unions accepted the annual 3 per cent EBAs.”

Relationship with the unions has not been a strong point for Qantas and that went south during the Airline Partners Australia proposed $11 billion buyout announced in late 2006 to take out existing shareholders and the airline off the Australian Stock Exchange.

That bid was met by a chorus of criticism from the market–despite the fact the bid price was nearly double the then-share price–from staff and the public, many of whom at the time thought Qantas was still government-owned.

Dixon in 2008 conceded he was “very surprised on one hand” by the backlash. “But perhaps I shouldn’t have been. I naively thought the market would greet the deal as a great thing. The price was 35 per cent ahead of the market price at the time. I was also surprised at the depth of the feeling in the wider community. Qantas is an iconic name and the public reacted accordingly. The involvement of management [in the buyout] had a negative aspect.”

Surveys at the time indicated that 70 per cent of Australia’s were against the deal.

And there is still mistrust in management particularly after the deal ended up as a fiasco and one of the main players went into liquidation.

Joyce has mergers and buyouts off the agenda preferring where possible to pursue organic growth or small acquisitions such as the Network Aviation deal to secure a foothold in the FIFO market or JVs to extend Jetstar’s reach or leverage on its model such as the recently mooted deal in Japan.

One of the major criticisms of Qantas has been its top heavy management which significantly hampered flexibility and innovation. Joyce took an axe to the problem eliminating 90 key positions and laying off another 500 managers in 2009 but Joyce promised that the blood-letting of management “has finished – absolutely.”

Joyce added perspective at the time saying that Qantas was an 88-year-old company and it is critical to “regularly revisit management structures. The years add layers!” He also conceded to Australian Aviation that “some departments had become too bureaucratic.”

Missed opportunities

Many say that the bureaucracy that Joyce alluded to has hindered Qantas with previous CEOs telling Australian Aviation at varying times over the past 13 years that the airline’s middle management could not make the business case for the 777-200ER, seatback videos for economy passengers in 1995, premium economy in 1996 or the 777-300ER/200LR in 2005. In fact Qantas has knocked back the 777 on many occasions.

Dixon conceded to the writer in 2008 that the airline had “missed opportunities”, such as premium economy, and said “the 777-300ER would be handy right now.”

Joyce also conceded that the airline has been too focused on premium classes and quickly moved to change the configurations the Boeing 747-400 with one layout having only 307 seats – 14 first, 66 business, 40 premium economy and 187 economy. “That is just not enough seats,” said Joyce at the time. And perhaps not surprisingly the airline’s A380s have the lowest seat count – 450 – of any airline up till the introduction of Korean Air’s first A380 which will have just 405.

The question many in the industry, particularly the tourist industry, ask is should the Australian public support Qantas when it makes these sorts of errors of judgment or is one of the last to market with customer innovations such as IFE.

The role of lobbyist for foreign airlines for greater access to the Australian market is made easier in Canberra when these missteps are highlighted by consumers and unions and when the politicians themselves chose to travel on the foreign airlines because of better in-flight product.

Certainly the airline has been let down badly by Boeing and Airbus on deliveries with the 787 and A380 that would have enabled the retirement of many older 767 and 747s.
Dixon said in 2008 that “nothing can really compensate” for the delays. “Our business would be totally different if they had been on time. People just don’t realize the great disruptions to our business and fleet planning of aircraft delays,” Dixon told Australian Aviation.

And those delays, particularly the 787, have been rolling delays typically of six months which have prevented any decisions on upgrades or a replacement order.

However this writer and this magazine have lobbied Qantas constantly since 1995 about IFE, the virtues and market opportunity of premium economy, and the 777, which are the most successful products or innovations over the past 20 years which dominate the long-haul sector of the industry.

Yet incredibly Qantas has been laggards on all three with Dixon admitting that the airline should have done premium economy a lot earlier. “But there are just so many things you can do. Sometimes we are a leader, sometimes we are not.”

Problem is too often the airline has not with the last major game changing innovation being business class in 1979.

Qantas finally took the plunge into premium economy in 2008 –nearly 20 years after it was first introduced – adding the product to its 747-400s and then A380s to respond to Air New Zealand and V Australia offerings in regional markets. Not surprisingly the airline’s 32 premium economy seats on its A380s are extremely popular.

Interestingly the world’s three most profitable premium airlines and Qantas’s major competitors Emirates, Singapore Airlines and Cathay Pacific have two things in common – pioneers or leaders in IFE and huge 777 fleets.

One former Qantas senior executive told Australian Aviation late last year that had Qantas gone down the 777-300ER route it would saving tens of millions over the 747-400. Cathay Pacific Airways CEO is lyrical about the performance of the 777-300ER. “I rang Willie Walsh the other day just after he took delivery of the first -300ER and said you are not going to believe the fuel you will save over the 747-400,” he told Australian Aviation late last year.
The problem for Joyce is that as with Ansett, equipment and innovation decisions or lack thereof made in the prior two decades are baggage weighing down the airline and not easy to change with lead times sometimes up to three years.
In February however Joyce told Australian Aviation that the airline was “looking at what Boeing is doing with the 777-300ER” as an option for replacing some 747-400s. QF will eventually have a fleet of 20 A380s and nine 747-400s, which will need replacing from 2017.
Those nine 747s will be made up of six GE powered – 400ERs and three Rolls Royce RB211 powered aircraft. Qantas is installing an upgrade package on the RB211s which should address reliability issues according to Joyce.
“We are also looking at the 787-9 to replace some 747-400s and also examining what improvements Boeing will offer on the 777 with 787 technologies. If there are considerable 787 technologies in the [improved] 777 it could be outstanding.”
One opportunity that hasn’t been missed is the LCC and Dixon and Joyce deserve rich praise for being able to build up Jetstar when countless legacy airlines around the world have failed to build a discount airline under the umbrella of a legacy operation.

Joyce maintains that Jetstar will “grow aggressively but in harmony” with Qantas and denies that the takeover by Jetstar of the NZ domestic routes was a portent of things to come, although he concedes there will be “more tweaks.”

One of those tweaks that’s causing grief with pilot unions is the hiring of Singapore based and paid pilots to operate the airline’s Singapore based A330s. While this is all part of the “new norm” in airlines it is sacrilege to the heavily unionized pilots.

Back to the wall

As 2011 opened Qantas had its back to the wall facing problems on virtually every front. Ageing fleet, A380 issues, ongoing late aircraft deliveries, greater premium domestic competition to start in May and more potent international alliances and union unrest.

But working for the airline is a deep rooted love and pride in the name Qantas with most surveys showing that despite all the media attention over seemingly countless incidents Australians by and large trust the airline. And overseas those safety concerns haven’t registered at all.

In a poll taken just before the A380 incident last November pollster UMR found that 80 per cent believed that the airline was safe to fly on up from a low of 66 per cent at the height of the engineer’s strike.
However, about half of those surveyed believe Qantas safety standards have deteriorated over the past few years, although that was down from a 2008 high of 63 per cent.
By February all the airline’s A380s, with the exception of the crippled VH-EBA, were back in service and new deliveries on track with passengers filling seats.
And also working for the airline is its stranglehold on domestic business class, not to mention economy for those who have had enough of LCCs, it world leading lounges and its frequent flyer program which now has nearly 8 million members an extraordinary number for a country with the population size of Australia.
CBA Equities Matt Crowe, one of the industry’s leading analysts agrees. “It’s [domestic business class] one of Qantas’s greatest strengths. Its position with the corporate Australia is extremely strong – a near monopoly,” Crowe told Australian Aviation.
And Crowe is bullish on the Qantas FF program. “I don’t think there is another carrier in the world that dominates its market like Qantas does with the frequent flyer program. Virtually every adult who flies is a Qantas frequent flyer member. They are profitably selling sell seats that would have been very hard to sell.”

To head off the looming competition from Virgin Blue’s makeover into a born again premium carrier Qantas has marshaled heavy metal for the premium transcontinental routes to Perth.
In February Qantas announced it will deploy internationally configured 747s and A330s with lie-flat beds on the transcontinental routes from Sydney and Melbourne, to match Virgin’s two new A330s to be launched in May.
Joyce told Australian Aviation that the changes were a direct response to the growing demand for travel to Perth, particularly from business passengers. “Increasing the premium service we provide business customers flying from east to west will help further cement our position as the ‘Best for Business’ airline,” said Joyce.
Joyce added that on long haul routes, where possible, the airline would deploy aircraft -747s, A330s and 737s – with seat back videos throughout rather than 767s which would be used mainly on east coast short haul routes.
At the same time Joyce added that Qantas will from May add more services to Perth, lifting capacity by 15 per cent and 90 per cent of services will be with wide-body equipment.
Domestically there is no doubt that Qantas offers the world’s best airline service with its lowest fares often cheaper than LCCS once the seemingly endless and irritating add-ons are factored.
And it is hard to see Virgin Blue, even with everything going its way, putting a dent into Qantas’s share of the premium market in the short to medium term. However it may well dent Qantas’s premium yield as it discounts to both garner market share and to lure passengers to “try as now, we’re different.”

Virgin has a number of delivery issues with its premium product related to the A330 and 737 with seats, galleys and IFE some of which are legacy decisions that will mean the roll out of the new business class will be fragmented in many markets. Thus it may be well into 2012 before Virgin can really gain traction on Qantas with a uniform product.
And in Perth Virgin will not have access to its new terminal till early 2013

However on the international front the forces arrayed against Qantas keep gaining momentum. Whereas once it enjoyed a virtual monopoly on the Pacific with up to 30 per cent of its profit coming from that route according to some analysts that has well and truly changed.

According Crowe “in a normal year” Qantas earnings are slit 50/50 between domestic and international.

Challenges come from “born again” Air New Zealand, V Australia and Delta Airlines, with the latter two likely to have their alliance approved by US regulators. While Air NZ doesn’t serve Sydney-US any longer it is taking some market share from Melbourne and Adelaide with straight through connections to Los Angeles and San Francisco via Auckland.

And while business has started travelling again with air fares rising by up to 6 per cent in last year they are expected to level out this year.
According to an American Express Business Travel report first class fares rose by between 5 and 6 per cent last year, while full and discount business class rose 4 per cent.
However in a telling development competition from new airlines such as V Australia and Delta on flights to the US limited the fare increases to just 1 per cent.
And soon Qantas will face another market distortion with the European ETS due to start in 2012 with airlines hubbing closer to Europe at an advantage says Crowe, although that advantage pales when put alongside the likelihood of further rising fuel prices warns Crowe. “No cost cutting program will dent the impact of soaring fuel prices.”

Conundrum

Both the pilots and engineers have lobbied strongly for job security and no-one denies the desirability of the goal but as Sir Rod Eddington said in 1997 when asked about job security at Ansett, “there is no such thing in this industry anymore.”

In fact there is virtually no job security any industry and hasn’t been for many decades and the airline industry is the most volatile and the one most exposed to global labour markets and wage levels and the tide of liberalization, which is more like a Tsunami.

The airline’s relationship with staff, at least at a union level, seems no better than under Dixon.

The conundrum for engineers, who are increasingly unsettled by their union’s strong stance, is that the more they undermine the public’s perception of Qantas’s safety and maintenance standards, the more market share it loses and thus their job security becomes more and more tenuous.

For the pilots, some of whom earn close to $500,000 a different equation applies and that is they are in serious danger of pricing themselves out of a job. The airline industry as it is today simple cannot sustain those salary levels.
Overwhelming the engineers and pilots know which way the wind is blowing and understand the dynamics of the industry but they are in danger of losing out because of the agendas of a handful of antagonists, whose agendas are not those of the greater good of Qantas.

Long gone are the days when Qantas could charge a premium for its safety record and passengers constantly change airlines for $10 or less.

During a flight attendant dispute early last decade the union posted on its website a comparison which claimed proudly that the Qantas staff were more efficient than its main competitors on European routes – Alitalia, Air France, Lufthansa and Swissair. It omitted the real competitors at the time Singapore Airlines, Cathay Pacific, Thai International.

Over the past 40 years, Qantas and Air New Zealand’s competitors have changed dramatically. In the 1970s it was Pan Am with its fleet of 747s, Alitalia, UTA, BOAC, Air India and the new kid on the block Singapore Airlines which snubbed its nose at IATA and gave away free drinks and plastic headsets.

Through the 80s and 90s Pan Am waned and collapsed replaced with United which went the same way in 2001, while Cathay Pacific, Thai International and Malaysia Airlines secured footholds in Australia and the first of the Middle East giants, Emiartes started services to Melbourne.

In the past ten years even more changes as AirAsia, Tiger Airways at the bottom end ravage yields and distort passenger perceptions on fares, while Emirates, Etihad and Qatar lure passengers with innovation and sporty fares.

While some extreme elements in the unions need to smell the coffee and understand the rapidly changing market dynamics and distortions, Qantas management’s focus ought be about getting on the front foot with innovation, something Joyce has been striving to achieve, once the internal structures are right.

Following is no longer an option and Qantas must lead as it does operationally and build on what is the best reputation for safety in the world which according to Crowe is still intact. “There is no doubt the brand is in good shape. Very much so.”

To paraphrase “Build it and he will come”, Qantas management ought to “Lead and the staff will follow as will the passengers and then the shareholders!