Domestic dogfight

Currently losing in excess of $60 million annually and having chalked up red ink to the tune of $216 million in the past six years, clawing its way back along the path towards profitability will be pitted with obstacles. And while Sharp and Virgin chief John Borghetti think it can be done within two years, achieving that target may depend as much on how Qantas and Jetstar react in the marketplace as it does on the Virgin group’s own strategies.

As for reputation, while Tiger’s operational performance has improved out of sight in recent times, there remain lingering doubts among the flying public, a hangover from its poor service standards in its early days and the grounding of its fleet for safety reasons way back in July 2011. Marketing will have to be a major element in the recovery plan.

Whatever happens, there is going to be a firefight in Australia’s skies. Talk of a return to the duopoly days of privately-owned Ansett versus state-owned Australian Airlines misses the point. The public is actually going to witness a battle between six airlines on several fronts with Qantas, Jetstar and QantasLink on the one side and Virgin Australia, Tiger and Virgin Australia Regional (formerly Skywest) on the other.

The stakes are high and this domestic confrontation cannot be seen in isolation. It is part of a far wider scenario that stretches well beyond Australia’s shores, presenting the first, really genuine challenge to Qantas’s market dominance. Put simply, until now Virgin, as it transformed itself from a low-cost carrier into a full-service operator, has been competing as a single entity at home and abroad on multiple fronts against Qantas mainline, Jetstar and others. Now, for the first time, it can face its enemy head-to-head in every sector, on trunk routes with Virgin, in the budget market with Tiger and on domestic regional routes with Virgin Regional.

Coupled with this, its strong alliances, most of them involving equity stakes, offshore – with Etihad Airways, Singapore Airlines, Air New Zealand and Delta Air Lines – give it impressive international reach. This web of connections delivers what it has never had before: a virtual domestic and international network comparable to Qantas and an ability to strike deep into both corporate and leisure markets.
The trick for Borghetti will be to turn this potential into reality.

For him, though, it isn’t about getting one up on the former employer which chose Alan Joyce to lead Qantas instead of him. Indeed, in interviews it is extremely difficult to get Borghetti to say anything nasty about Qantas. He is all about business and building the Virgin group into a solid, sustainable operation.

“The trick for Borghetti will be to turn this potential into reality.”

Tiger is a critical element in that, but it has a mountain to climb. Borghetti is consistently adamant competition with Qantas is not about market share. It’s not the share you get, he says, it is how profitable you can make the share you have. The fact is, however, that whatever his view, the ability of Tiger to eat into Jetstar’s slice of the domestic pie will, to a great extent, influence its success or failure in reaching for that elusive component, profitability.

The domestic market share statistics for April show that Qantas currently controls 42.2 percent and Jetstar 18.1 per cent of the domestic market, giving them a joint 60.3 per cent. Virgin has 30.3 per cent and Tiger a paltry 3.3 per cent. Some 6.1 per cent is held by Regional Express and others. Joyce has made no secret of the fact that Qantas intends to do everything necessary to defend that “line in the sand” – the 60 per cent or more control it has.

And there lies the rub for Tiger. To survive it will have to increase its share, at the very least to 10 per cent or more. Currently operating a small fleet of 11 aircraft (Jetstar has more than 50) it simply has to lift its network reach and frequencies in order to satisfy a demanding market and make its operations viable.

Currently, the minimum plan is to increase the fleet to 23 and the maximum to 35 by 2018. That means thousands more seats entering the budget sector. If Jetstar wants to defend its patch it will have to react meaningfully in an arena where capacity is already an issue and pricing is crucial. That in turn raises the possibility of fare wars, squeezed yields and profit reduction.

Domestic operators have grown use to capacity issues in recent times. Both sides have been feeling pain over the last 12 months in a continuing ticket price and capacity tussle between the major combatants. Transport statistics show that in the 12 months to the end of February the number of domestic passengers rose four per cent, from 54.57 million to 56.73 million. While revenue passenger kilometres outstripped that, lifting 4.7 per cent from 63.65 billion to 66.63 billion, the available seats in the market rose a whopping 7.1 per cent from 70.28 million to 75.29 million. Overall, during the 12 months, airline load factors dipped 1.6 percentage points to 77.4 per cent.

The danger to yields is real and analysts are already raising red flags.

Qantas’s Joyce recently disclosed the airline was doing it tough in the current fiscal year, saying that although the domestic Qantas business remained strong it faced a tough environment with a high degree of capacity growth on the market, which was pushing down yields and profitability.

That prompted Deutsche Bank’s analysts Cameron McDonald and Entcho Raykovski to revise their prediction the carrier would scrape home with an underlying second-half pre-tax profit of $8.8 million to a loss of $135.8m, slashing full-year earnings forecasts for Qantas by 60 per cent. Their comments reflect a wider market view: aggressive competition from “rival carriers” is eroding yields in both domestic and international markets.

The emergence of a reinvigorated Tiger on the scene will put immense pressure on the Qantas Group at a time it is clearly battling to restore financial health to its operations, particularly the struggling international arm. Continuing to lose big money offshore, the profitability of Qantas Domestic and Jetstar (as well as its Frequent Flyer scheme) have been the assets enabling the Flying Kangaroo to keep its head above water. Having said that, Virgin faces precisely the same issues in striving to bring sustainable profitability to its operations in a domestic industry caught in the traditional grip of repetitive price wars and fierce competition.

While Borghetti has been extremely successful in the transformation of Virgin Blue into a significant and extremely high quality full-service airline, bringing the different strands of his new empire into alignment to present an ongoing cohesive force will be no simple task.
Taming the Tiger will be Rob Sharp’s job, though Borghetti himself will chair the carriers’ board. They both worked at Qantas through the years it launched Jetstar and embarked on its ‘two-brand’ strategy, a tactic many detractors forecast at the time would simply not work.

It did – spectacularly – and both Sharp and Borghetti are well aware of the methods then Qantas chief Geoff Dixon used to make it work. One key component was the weekly meeting of the heads of the different group brands and key management officials to ensure there was no cannibalisation and that no single entity did anything that might harm another.

Already, it has become clear Virgin is well aware of that danger. Tiger will not codeshare with Virgin to avoid “brand contamination”. The key to it is “managing your multi-brand portfolio and getting that balance right in terms of timing so you’re not actually tripping up,” Sharp has said.

And he is in a fighting mood, saying he is keen to cement Tiger’s position in the Australian market and is prepared to fight to achieve that. Importantly, Sharp, who quite rightly doesn’t see any “magical silver bullet”, believes a key to survival is achieving critical mass that generates efficiencies, although growth will have to be driven by market dynamics.

One area that will be closely watched by observers is whether Virgin shows any signs of doing what Qantas did: replacing the mainline airline on poorer performing routes with Jetstar because of its ability to turn them into profitable services through a far lower cost base.

So far, indications point to this not being entirely replicated at Virgin. Sharp has already said Tiger will be looking to expand its network to areas where it can challenge Jetstar’s monopoly and bring more competition rather than pulling off existing routes. Borghetti has underscored that thought, telling investors at a Macquarie conference in Sydney they will not see it pull out of routes and service them with the budget carrier.

“We won’t do wholesale substitution. We won’t pull Virgin out of any port and impose a product type on the customer base, irrespective of what they want,” he declared. “What you might see is on particular destinations you will tweak it, so if there are five flights a day to a particular destination on Virgin and Tiger operates one a day, we might drop to four and say, ‘you increase yours to two because the market is out of balance now’, but you are not going to see wholesale withdrawal”.

In parallel with fleet and network expansion there will have to be some serious spending on the marketing front, not only in terms of fares that will attract customers but on image promotion that will convince potential customers they will get the service and safety they expect, even though there is little doubt the days of Tigers safety woes are well and truly over. Airlines that get a bad reputation for delays and cancellations can suffer for years because of the deep-rooted perceptions created amongst the travelling public.

“We won’t pull Virgin out of any port and impose a product type on the customer irrespective of that they want.”
Borghetti

In Tiger’s case the facts today actually disprove the myth. In March this year, the latest figures available, it had the second-best on time departure rate of 81.1 per cent, just a shade behind Qantas at 82.1 percent, ahead of Virgin at 77 per cent and Jetstar at 74.6 per cent. In terms of on-time arrivals it was also second at 79.1 per cent after Qantas with 81.5 per cent, with Jetstar at 76.9 per cent and Virgin at 74.8 per cent. It has been achieving such result for more than a year and clearly Tiger is doing well in terms of operational efficiency.

Translating that into public confidence will be an important contributor to success.

So far, Borghetti has displayed a huge amount of street smarts and business acumen in steering Virgin to where it is now, from the hybrid offering it represented when he took over in 2010. The string of deals – attracting equity investment from the likes of Etihad, Singapore Airlines and Air New Zealand, taking over Skywest, grabbing control of Tiger – have not only taken Virgin Australia to a new level, but have altered the Australian airline landscape. He has also exhibited a keen sense of the moment and an ability to deal with developments that might have threatened his plans.

When Australian Competition and Consumer Commission (ACCC) chairman Rod Sims hinted at the possibility he might want guarantees from Virgin regarding fleet growth before giving the Tiger bid a green light, Borghetti took a not so subtle approach, retorting if that was the case he might abandon the deal altogether, making the point fleet expansion really depends on market conditions and no airline chief could give such a guarantee.

It wasn’t exactly blackmail but it made clear to the ACCC that a “no go” decision would certainly lead to the collapse of Tiger, the loss of a lot of jobs and a weaker competitive landscape.

In the end there is no doubt the emergence of a strong Virgin group will be good for consumers because it will bring heightened competition and a continuation of affordable and at times even cheaper air fares. The bad news is that it will also likely bring more pain to the airlines themselves, at least until the dust settles.

“There is no doubt the emergence of a strong Virgin group will be good for consumers.”

Given what Virgin and its new no-frills arm aim to achieve that could take at least two years. Realistically, if Tiger succeeds, Qantas’s 60 per cent line in the sand will certainly be broken. But in the process the struggle will drive all carriers towards further efficiencies in their operations to offset the debilitating impact of yield shrinkage. That can only be good for the airlines. But then these sorts of pressures are no strangers to Borghetti, Joyce or the rest of the airline industry.