Restructuring the Roo – Where to for Qantas International?

Additionally, Joyce said that the international services would contribute a loss of $200 million for the 2010/11 financial year, making it the first time that the Qantas Group has identified the financial performance of the Qantas international business. Nevertheless, a number of employees have expressed doubts over the figure, particularly with load factors on international services remaining buoyant over the past year.

Finances aside, it has been a challenging few years for Qantas. While the global financial crisis had a major impact on legacy carriers around the world, and once again fuel costs have crept up again, the Flying Kangaroo has been facing more competition than ever before.

Some of that competition has been internal, with Qantas battling for resources within the Qantas Group, as Joyce and his predecessor Geoff Dixon put a large focus on growing Jetstar’s operations in Asia and beyond.

Much more of that competition has been external, with the key European and US routes under attack from a range of new and rapidly growing carriers, such as Etihad Airways and V Australia. In many cases, these competitors have brought in new ideas and superior onboard product, which Qantas has been hard pressed to compete with. Although it still controls nearly 20 per cent of the international market, it has consistently ceded marketshare to fast growing rivals, such as Singapore Airlines and Emirates.

Similarly, Qantas’s brand image has been tarnished in recent years. Although incidents such as the uncontained engine failure on QF32 cannot be blamed on the airline, they stand out against the impeccable safety record that it had for decades prior.

The brand has also been under attack from within, with the pilot and engineers unions locked in an increasingly hostile war with Qantas management, with much resistance to some of the changes that have been brought in by Joyce and Dixon over the past few years.

It was against that background that Joyce announced back in January that executive manager customer and marketing Lesley Grant had been undertaking a review of the Qantas branded international services. Reports were that Grant had been given a wide scope to look at all elements of the airline’s network, product and even the possibility of establishing an Asian based subsidiary to operate some Qantas branded services.

Until Joyce’s June 21 speech, Qantas has kept its plans closely guarded. Indeed, the speech saw Joyce give away few new details, apart from nominating August 24 (also the day the airline will announce its financial results for the 2010-11 financial year) as the date for a big announcement about the future of Qantas International.

Nevertheless, Joyce has already foreshadowed that the airline will increasingly leverage its relationships with other carriers into the future.

“We will be taking these relationships to the next level, including the joint venture level”, he said, and highlighted Qantas’s long standing joint service arrangement with British Airways as the model for such an arrangement.

It is also expected that the August 24 announcement will reaffirm the growth of Jetstar’s international network to complement the Qantas brand, particularly in Asia. That will no doubt see a growth to the operations of Jetstar Asia from Singapore, as well as possibly more joint ventures in markets such as the Philippines and Indonesia.

But the most contentious suggestion so far is that the airline will establish a new operation in Asia to take over some or all of its international services, which some have been quick to label as ‘Qantasia’.

Still Call Australia Home?

The growing speculation that Qantas will establish an offshore subsidiary to take over its international services is a bold one, but carries major risks with it, particularly to the Qantas brand.

Speculation is that the carrier is looking to set up a subsidiary in Malaysia or Singapore, which would operate services to and form Europe and Australia, while it would also give Qantas a foothold in the wider Chinese market which is set to boom over the next decade. As such, such an operation could take over a large part of the Qantas Boeing 747-400 and Airbus A380 fleets, and could also use A330s/787s to feed passengers from Australia and within Asia onto Europe or elsewhere.

Without doubt, a large attraction of the idea of setting up an operation in Asia will be to access lower wage costs and also under local industrial relations laws. The latter point cannot be understated, particularly as Joyce’s comments have come in the context of increasingly hostile negotiations with the airline’s pilots and engineers on new enterprise bargaining agreements. Another substantial benefit, if ownership of its aircraft was transferred to the new entity, would be the lower taxation depreciation rates in Asian jurisdictions.

Qantas has already had experience with setting up and running a wholly-owned offshore subsidiary flying under the mainline brand with its New Zealand based subsidiary Jetconnect. That operation flies Qantas branded, New Zealand registered Boeing 737s with crew employed under local conditions, on the trans Tasman market and. Despite an attempted court challenge from the Australian and International Pilots Association, and some lampooning by TV show Hungry Beast, Jetconnect’s operations have not appeared to do any damage to the Qantas brand, and has allowed it to maintain services in the competitive trans-Tasman market.

Replicating the Jetconnect model in Asia would be ideal for Qantas. Importantly, it would mean that Qantas could have total control over the operating entity, while it would also mean that it could take the full financial benefits of such an operation.

However, that operation would have limited growth opportunities. The carrier would be limited to using Qantas’s Australian designations, and would have to rely on friendly fifth-freedom rights to grow its network. Given the protectionism that some Asian countries are known for and the limited onward opportunities from Australia, the future growth opportunities for the Qantas brand would be stunted.

The other possibility would be to go down the path it has followed with Jetstar Asia, in which it holds a 49 per cent stake while an obliging partner holds the remaining 51 per cent. Commercially, the airline operates under the same Jetstar branding as the Australian carrier, while its status as a Singaporean carrier affords it access to a number of markets around Southeast Asia.

Should Qantas follow that path, there is the possibility that it could give the Qantas brand exposure to a number of new markets within Asia. This could particularly prove interesting once ASEAN moves towards open skies in 2015. That could see Qantas branded aircraft operating flights between cities such as Hong Kong and Ho Chi Minh City.

But managing such partnerships is tricky, and Joyce has had first hand experience with those at Jetstar Asia and Jetstar Pacific. In both cases, there have been issues managing the relationships with other shareholders, while Qantas has also had to dig into its pockets to support their rocky rides.
If it is to go down that route, and assuming it continues to hub through Singapore, it is entirely feasible that Qantas could actually look to leverage the existing Jetstar Asia operations. In particular, the Valuair air operator’s certificate could be a natural launch vehicle for a new Qantas operation.
The other possibility could be a tie up with Malaysia Airlines, which Qantas is sponsoring to join the oneworld alliance. The most likely scenario in that case would be that the two carriers could form a joint venture to operate a joint A380 fleet, which would take advantage of economies of scale, as well as the lower maintenance costs in Malaysia.

However, with the two carriers competing directly for Australian originating traffic, convincing Malaysia Airlines to share the Australia-Europe market could be difficult.

Despite the cost benefits of an Asian operation, any move by Qantas in that direction is no doubt going to raise the ire of the other carriers in the region, such as Singapore Airlines. There are also doubts about how Qantas will be able to compete with carriers who have defined premium travel over the past few decades, particularly when it has a history of under-investing in its product.

But more than the added dimension of competition, the biggest damage that to Qantas would be from the loss of its Australian identity. In an already tough market with many competitors, it is that element which has set Qantas apart for many years. The question will be if it can maintain that identity while operating from an Asian base.

Friends with Hub Benefits

Another part of the Qantas announcement is likely to be a deepening of its relationships alliance partners, which is likely to reshape its network around its partner hubs in the future.

That assertion merely continues a longstanding trend. Qantas has now consolidated most of its European network around London-Heathrow, while it also feeds a large amount of traffic onto American Airlines flights from Los Angeles, and more recently, Dallas-Fort Worth (DFW).

Although DFW has proven to be a challenging route for operational reasons, AA’s extensive hub there means that passengers from Sydney would effectively have one-stop access to most places in North and South America. With the two airlines now seeking approval for a joint venture on the Pacific, expect DFW to play a bigger role in both airlines’ futures.

Driving the move towards consolidating its network around hubs is the fleet. With the A380 and 747-400s forming the backbone of the fleet, Qantas has limited itself to focusing on large volume markets, rather than following the lead of Emirates and other carriers, which have used smaller twinjets to open up a number of routes and grow volumes and yield over time.

From the perspective of Qantas management, the hub strategy poses the least amount of risk, but is also likely to deliver lower returns. It also puts it at a disadvantage against carrier that fly direct services. For time-poor business travellers, transferring between flights is an inconvenience, and they could ultimately choose to fly on more direct carriers.

Then there is the link with soon to be oneworld partner Malaysia Airlines. But with MAS a large player on the Australia-Asia-Europe market with its Kuala Lumpur hub, it will take a great incentive for it to throw its lot in with Qantas, while on Qantas’s side, it would take a lot for it to move its hub from Singapore.

Qantas has also had its difficulties with partner airlines. Within oneworld, it has never sat comfortably with Cathay Pacific, which is a major competitor to it. Similarly, the short lived alliance with Etihad Airways faced challenges due to its commitment to the Kangaroo Route arrangement with BA, as well as its reluctance to fly to Abu Dhabi. That relationship has now been ceded to Virgin Australia which has made it clear that it plans to make it work much better.

With a network focused on hubs, Qantas could become a ripe target for a takeover by a larger airline group, such as BA-Iberia parent company International Airlines Group. However, unlike the aborted merger with BA last year, such a limited network and growth prospect could mean that in any consolidation that it may become the junior partner in such an arrangement.

Star spreads

The upcoming announcement from Qantas is also likely to feature more details about the expansion of Jetstar’s operations through Asia, and possibly into Europe and North America.

Ever since it started operating widebody aircraft, Jetstar has made no secret of the fact that it intends to spread its wings into Europe and possibly even to the continental United States further down the track. Those ambitions have been thwarted by the delays in delivery of its Boeing 787s, but its stated plans to grow the A330-200 fleet (including those with higher gross weights) is likely to see a number of new routes announced soon.
Much of that growth will depend on what the future Qantas network looks like. Should it choose to focus on a few key hubs and markets, Jetstar could naturally take over a number of the Qantas Group’s direct services in Asia and grow a number of new markets. But in doing that, Jetstar could end up stealing traffic away from the hubs, and inevitably there would be a need for the two carriers to compete at some level.

The level of competition in the long haul LCC arena is also set to hot up in the coming years, and will no doubt present a new challenge to Jetstar. While it has been able to grow its operations with competition from AirAsia X, the entry of a new, Singapore Airlines-backed LCC into the market will cause Jetstar some headaches.

Big Expectations

Whatever is announced on August 24, it appears that Qantas is currently at a crossroads and there are some painful decisions ahead, which will have major impacts.

Joyce will be all too aware that any changes to the Qantas branded business will have a major impact on the Group as a whole. While the international services may be underperforming, it is expected that any major pruning of the Qantas network would have a major impact on the current cashcow within the Group – Frequent Flyer.

Although Frequent Flyer makes the majority of its revenue from selling loyalty points to the likes of Woolworths and the major banks, its appeal to the end user is tied in to the opportunity to redeem those points. Thus, if capacity is cut or the redemption opportunities fall, end users could move away from the program and ultimately harm its profitability.

On the other hand, if it can successfully execute the plan, it could be a defining point for the Qantas brand, as it could take it beyond the Australian context, and emerge as a much more global brand. To do that will require perfect execution, and will stretch management in new directions, not all of which will be palatable to Qantas’s existing workforce. And if the brand moves away from being Australian, it could lose its sense of identity altogether.

The timing of the August 24 announcement cannot be understated either, with the carrier about to lock into negotiations with its pilot and engineer groups. In recent months, a number of Qantas employees have been publicly venting their spleens over a range of issues. There is no doubt that they are gearing up for some bad news, and that things will be made very uncomfortable for the airline’s management.

While the changes to be announced will set the direction for Qantas International over the next couple of years, it will not be a silver bullet for the airline. In a market where the barriers have been falling for many years, competition has been increasing and returns have continued to fall, the airline will have to innovate and keep reinventing itself if it is to stay sustainable in such a dynamic market.