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Qantas and Virgin Australia seek to establish international strategies

Airline Leader

In comparison to improving domestic performance, Virgin Australia's 1H2015 losses increased by 54.8% to AUD49.5 million (USD38.7 million) from a AUD31.9 million (USD24.9 million) loss in 1HFY2014. Meanwhile in 1H2015, Qantas International returned to profit for the first time since the global financial crisis. Although domestic flying remains their core business, outbound tourism has overtaken inbound visitors. What are Qantas and Virgin's long-haul strategies?

Summary
  • Virgin Australia's losses increased by 54.8% in 1H2015, while Qantas International returned to profit for the first time since the global financial crisis.
  • The geographical challenges faced by Australian airlines due to the country's remote location and lack of major intermediary hubs in Asia and the Gulf.
  • Qantas and Virgin Australia's focus on deep partnerships and joint ventures, particularly in North America, to expand their presence in their largest market.
  • Virgin Australia's long-haul strategy is heavily reliant on partnerships with American airlines, while Qantas is exploring partnerships with Chinese carriers.
  • The challenges and opportunities in the Southeast Asian market for both Qantas and Virgin Australia, with Jetstar accounting for a significant portion of the group's capacity in the region.
  • The importance of partnerships and joint ventures in shaping the international strategies of Qantas and Air New Zealand, as they move towards leveraging modern technology to stay ahead in the industry.

In aviation, geography gives and geography takes. This is especially the case in Australia, an island continent dependent on not just air service but relatively long flights. The closest major international city, Auckland, is over three hours away.Singapore is about seven hours from Australia's east coast and Western Australia's Perth, the most remote capital city in the world, is about five hours from Singapore, for as it is from Sydney.

For these and similar reasons, "the tyranny of distance" has become a common phrase, making aviation more than merely a luxury. Further supporting aviation's interest is the market's penchant for outbound travel and a local tourism industry supporting inbound growth.

But the geographical pendulum swings the other way. End-of-line positioning exposes Australia to intermediary hubs in Asia and more recently the Gulf. This is further hurt by Australia's high cost base. Australian carriers in 2014 had only a 32.1% share of the international market, down from 37.2% in 2000. In absolute numbers, the market share decline is not so bad: Australian carriers flew 6.1mil international passengers in 2000 and 10.6mil in 2014.

There are exceptions to rules and what geography should dictate. Australia's international anomaly is critical: despite Australia and North America being 14 hours apart, there are no major intermediary hubs. That leaves traffic to airlines on either end, and here the US carriers have a theoretical advantage. They have the larger population, corporate and loyalty power as well as a domestic network providing beyond traffic. And yet the US airlines' interest in Australia/New Zealand is cursory - stronger than serving Gulf hubs - but not overwhelming.

The result for the Qantas and Virgin Australia groups is a focus on deep partnerships, including joint ventures, and concentrating their presence in North America, their largest market. This was illustrated with the Jun-2015 announcement that American Airlines would re-enter Australia with its own metal and form a joint venture with Qantas (it was already codesharing on the route).

Much of the plan was due to Qantas wanting to grow but lacking aircraft. American will pick up some of Qantas' Sydney-Los Angeles frequencies while other shuffling will allow Qantas to re-launch Sydney-San Francisco, with its North American network growing by one additional weekly frequency. San Francisco joins Dallas (the hub of AA), Los Angeles with tag service to New York, and seasonal service to Vancouver.

Virgin and Delta (with an immunised JV) remain only in Los Angeles (United also serves San Francisco, but does not codeshare with Air New Zealand, its only Star partner in Australasia) while Air New Zealand is growing beyond Los Angeles, San Francisco and Vancouver with service to Houston.

North America will account for 38% of Qantas' ASKs in 2015, up from 28% in 2005. This is not just the result of cuts elsewhere; Qantas in North America will be 7% larger in 2015 than its previous peak in 2008. Virgin Australia will have about 37% of its ASKs allocated in North America while Air New Zealand is about 35%, including Los Angeles-London flights.

For better or worse, Virgin Australia owes its long-haul existence to American airline reticence. American Airlines withdrew from Australia in 1992 while Continental and Northwest did so in 1993. That left only United, which achieved lower market reception from perceived inferior service, and the difficulty of aggregating Australian traffic behind its main gateways. The American airlines were interested primarily in the North American market and then Europe. In Australia and elsewhere, they left traffic on the table, and it was Qantas that benefitted for many years.

Although the market was referred to as the Great Duopoly, one between Qantas and United, really it was a Qantas show. That gave Virgin the impetus to go long-haul, as it moved from being a simple low-cost airline to one that now sought out corporate travellers. If US airlines had been more active and the North American market competitive, Virgin would not have been so keen to enter and acquire widebody aircraft. In 2007 then-Virgin Blue ordered six Boeing 777s with an option for six more and intent to lease one.

The gods were not kind: after delays in delivery of the 777, Virgin entered the market in early 2009, as the worst of the global financial crisis hit the US, and Delta - coincidentally - also decided to enter with a daily service. The 777 fleet for some years has stood flat at five, serving Los Angeles double daily and Abu Dhabi only three times weekly.

North America was Virgin's reason to go long-haul but was not intended to be the sole focus. V Australia (as the long-haul operation was called before it exercised the expensive option of franchising the Virgin brand internationally) flew to Johannesburg as well as more questionable routes to Nadi and Phuket - leisure markets not suitable for a premium-heavy aircraft, although Nadi allowed for aircraft utilisation. International bled, and incoming CEO John Borghetti cut the three non-Los Angeles markets and prospects for 777 growth.

North America has now stabilised for Virgin. It had quickly achieved a joint venture with Delta; initial anti-trust approval was dragged out and renewed in 2015. But the parties now must play their hand, with American Airlines re-entering in Dec-2015 as part of the agreement with Qantas to expand their partnership to a JV. Delta has remained in the region with one daily 777 flight despite Virgin wishing to grow the competition. Virgin is timid about long-haul growth, which carries a disproportionately larger risk than at the massive Delta. But for Delta, Australia remains a blip.

Virgin's Abu Dhabi service was launched as its contribution to a JV with Etihad, announced in 2010. Virgin flirted with flying beyond Abu Dhabi to Europe, but nothing materialised. Virgin was due to fly from Brisbane to Abu Dhabi as well, but lost interest: Abu Dhabi was not a strong performer, Virgin's core domestic network needed urgent addressing and the Virgin-Singapore Airlines partnership in 2011 started to make Etihad strategically irrelevant, although the carrier has built up its equity stake in Virgin to nearly 25%.

Mr Borghetti inherited the long-haul division; he certainly did not create it. He would almost certainly have liked his US partner to adopt a more expansive stance, instead of leaving Virgin with a sub-scale 777 network while retaining a commitment to flying long-haul. Mr Borghetti has however made the long-haul division work. While physically small, it did at one point financially endanger the entire airline. The question now is where to, but once again there are more pressing matters: the core domestic business, under pressure from Qantas' successful restructuring, as well as Virgin's short-haul international operation.

It was the Etihad-Virgin deal that helped provoke the Qantas-Emirates JV - and an ocean of change. The historical friendship between Mr Borghetti and Etihad's James Hogan (and Qantas' decision not to partner with Etihad) made possible a deal in which Etihad acquired equity in Virgin. Although the strategic rationale may have since subsided a little, the implications continue to reverberate. Qantas and Emirates partnered, which saw Qantas drop its longstanding deal with British Airways and shift its Asian stopover hubs - mostly Singapore - to Dubai.

Qantas and British Airways jointly served two European destinations - London and Frankfurt - while separate Qantas codeshares with Air France and Cathay gave access to Paris and Rome. Those partnerships were also unwound in favour of one-stop service from five Australian cities to Emirates' European network of nearly three dozen points, although there were initial shortcomings on Dubai connections. Qantas retained two daily London Heathrow services, although one was re-scheduled in 2014. Although seemingly minor, this required breaking legacy mindset of having early morning Heathrow arrivals. A later arrival time allowed increased fleet utilisation, but the network is still less than ideal. If Qantas were truly free of political influence - or the need to, the second London service would probably be gone.

Europe and the Middle East comprise 16% of Qantas Group's ASKs - the same as Northeast Asia. Europe is an old world market with uncertain financial prospects. Emirates and Qantas are both warm to extending the partnership beyond the initial 2018 expiry, and Qantas' expected 787-9s could come into play in the partnership in a few years. It is Asia that is more dynamic for both Qantas and Virgin and which promises growth if they can navigate headwinds.

Southeast Asia is the second largest market for Australia. For Qantas, it currently comprises 21% of ASKs, less than North America's 32% and more than Northeast Asia and Europe/Middle East at 16% each. For Virgin, Southeast Asia is actually third largest on size (20% with New Zealand and Pacific Islands second largest at 35%) but arguably second largest in terms of needing attention.

Southeast Asia for Qantas Group is different than for Virgin. Jetstar accounts for 48% of the group's Southeast Asian capacity and is mostly flying to leisure points like Bali and Phuket. Qantas is focused on corporate destinations, although the two overlap, such as in Bangkok and Singapore. Virgin however is serving only leisure points, with the bulk of its capacity directed at Bali. The growth of Garuda, as well as Asian LCCs, has hurt Virgin, which is further disadvantaged by having a full service narrowbody cost base; Jetstar is low-cost and often uses efficient widebodies.

Virgin's international ASKs account for over a third of the group's capacity, but in 1H2015 Virgin's international network posted an AUD49.5 million (USD38.7 million) loss compared to domestic's AUD103.8 million (USD92.3 million) loss.

Virgin has said its LCC, Tigerair Australia, will fly internationally, but has not provided a timeframe or specific destinations. Moving from a domestic-only business to international will come at a cost to Tigerair. Alternatively Virgin could look to re-deploy its A330s out of the domestic network; there is an initial effort with them serving Fiji. However, this has worrying echoes of V Australia's 777 days. Southeast Asia is not core for Virgin, but Virgin does not want to give it up.

Less good news is that Southeast Asia soured for Virgin before the launch of Indonesia AirAsia X, which wants to link Bali with multiple Australian points. Further growth will aggravate not only Virgin, but Jetstar too.

Virgin has mooted changing from only serving Asian leisure points to serving business cities also. It has repeatedly ruled out points in China and India, pointing to those markets being fragmented and better served over Singapore with partner Singapore Airlines (SIA); this important relationship gives Virgin access around Asia and to Europe, a far wider reach than Etihad. SIA in 2014 accounted for 8.7% of the international Australian market compared to 2.3% for Etihad.

It would be logical for Virgin to serve Singapore to complement its partner, but SIA has typically resisted having its partners serve in parallel and wants to keep Australia-Singapore trunk routes for itself. Virgin has been uninterested in thinner markets like Darwin and Cairns to Singapore, so SIA regional unit SilkAir has opened those markets instead.

Despite a restructuring, Southeast Asia still remains a challenge for Qantas. This may be the case for some time. Qantas flights to key Asian cities had been scheduled to connect with onward European services, rather then being tailored to the needs of the local Asia-Australia market. Moving the European hub to Dubai therefore prompted changes to Qantas' Asian network. While overall seat capacity decreased, this was due to removing seats that were sold for onward service to Europe. Qantas calculated that after its Asian restructuring, capacity sold for the local Asia-Australia market increased by 40% in Singapore and 10% in Hong Kong.

Qantas has some major advantages: the Australian corporate market and its potent frequent flyer programme, although members can usually just as easily earn points with Cathay, a major competitor. Qantas also pushed flying into one Asian city and out of another non-stop on both legs, although this was relevant on only limited combinations.

The Asian carriers carry considerable weight: multiple services a day to each city, numerous Australian destinations, and networks beyond Asia to help fill flights. Emirates' few Asia-Australia flights, operated with local traffic rights, help provide some frequency scale and transfer passengers. Beyond access is helped by Singapore-based Jetstar Asia as well as some other partnerships, but this is relatively small.

The Melbourne-Singapore market is expected to become much more competitive with the entry of SIA's low-cost long-haul subsidiary Scoot. Scoot will complement and compete with SIA as well as Qantas, its LCC Jetstar and strategic partner Emirates all operating between Melbourne and Singapore. In comparison, the larger Sydney-Singapore market has only four operators - and even this may still be one too many. Jetstar is probably the weak link, with Emirates' pricing often similar to the LCC. But Melbourne-Singapore is an important route for Jetstar, connecting the group's two major hubs to allow a pan-Asian strategy. Tigerair linked its Australia operation with Singapore as part of pursuing that same pan-Asian dream, but found the reality lacked profitability.

Besides Singapore and Bangkok, Qantas' quieter markets of Jakarta and Manila are under pressure with more growth from Garuda as well as PAL and Cebu Pacific. A once-proposed partnership with Malaysia Airlines fizzled, and a solution to improve its Southeast Asia presence is not immediately apparent. Probably with some reluctance Qantas is re-entering Perth-Singapore, but a five times weekly 737 flight is far from the double daily widebodies of past years. Parts of its Asian network may be condemned to being "strategic" rather than meeting cost of capital. A withdrawal, however, is largely unthinkable, and profits elsewhere can prop up Southeast Asia.

Northeast Asia offers better prospects for Qantas. After Singapore, Hong Kong is Qantas' largest Asian point based on seats and ASKs. It faces similar challenges to Singapore, with the added complication of local competition Cathay offering perks to Qantas loyalists through the oneworld network. Hong Kong is tighter on beyond codeshares and there is no local Jetstar operation - and should Jetstar Hong Kong launch, Qantas' flight timings means there are limited connecting opportunities.

China is the tourism story for Australia, but Qantas maintains only a single daily flight from Sydney to Shanghai. Both Qantas and Air New Zealand pulled out of Beijing, too far north and without a willing partner. In Shanghai Qantas has China Eastern, with whom it has a proposed joint venture, now going through the regulatory process. China Southern's growth in Australia had intimidated China Eastern, but it sees benefits from a partnership. Perhaps greater than the opportunity for coordination is learning from Qantas, which generates much higher yields.

Qantas also has a codeshare with China Southern, effectively stitching up the available partnership market and preventing Virgin from making a move. Virgin has spoken about adding Asian partners but so far only has SIA - a valuable partner, but it cannot deliver non-stop access to China. Despite longer routings of stopping over in Southeast Asia en route to North Asia from Australia, SIA carries not insignificant Australia-North Asia volumes.

During Australia's last big tourism influx, with Japan, Qantas supplied half or more of the non-stop capacity despite that market largely being outbound Japanese. There Qantas had a lower cost base but between China and Australia, Qantas is disadvantaged in terms of cost. Its future expansion in China will be muted, although perhaps see some acceleration from the China Eastern deal. Chinese carriers will inevitably outpace Qantas over time. Meanwhile, Jetstar's new Gold Coast-Wuhan route is effectively a charter.

While JAL has shrunk in the Australia-Japan market, Qantas' dual brand strategy with Jetstar has allowed it to preserve much of its size by shifting flights from Qantas to Jetstar. As the yen depreciates, making inbound travel to Japan more accessible, Qantas is mounting a new Brisbane-Tokyo service. This will help claw back some sixth freedom traffic flows from SIA and Cathay. Despite JAL offering only a single daily Australia flight, it appears uninterested in a JV with Qantas. Discussions to have All Nippon Airways re-enter the Australia market seem unlikely to materialise.

Elsewhere, Qantas' long-haul operation is a tidy affair. Johannesburg and Santiago are quiet but good achievers. For these routes, in the southern hemisphere along with Australia, transiting via a northern hemisphere hub is very circuitous. Qantas' partnership with South African Airways was however not renewed by Australian regulators on anti-competitive grounds; SAA now partners with Virgin.

To South America, Aerolineas Argentinas has exited but Air New Zealand will launch a new service to Buenos Aires. Prior to establishing Santiago where its one world partner LAN is based, Qantas served Buenos Aires but was unable to make it work partially as regulators blocked cooperation with LAN Argentina. Air New Zealand will partner with national airline and Star member Aerolineas, so no regulatory problems are expected. Australian traffic has been a good filler for Air New Zealand's North American network, but the airline will be relying on Australia far more for the Buenos Aires service. An expanded Australia-Chile air service agreement should allow Qantas and LAN to increase their flights, covered under a partnership.

There is still much to mourn from the glory days of Qantas International - but it is at least growing again. San Francisco and Perth-Singapore are being restored and a trans-Pacific route to Auckland may be picked up by American Airlines. But Perth-Tokyo, Sydney-Beijing and Melbourne-Shanghai are gone, along with other vestiges from the early 2000s, such as to Kuala Lumpur and Seoul.

The glory days of Qantas International were also often the loss-making days, but a near domestic monopoly offset the costs. There was also no thinking back then of having a virtual network; it was assumed Qantas metal had to fly overseas in order to attract passengers in the profitable domestic market.

Partnerships now shape Qantas International, and most markets operate under a strategic partnership. Virgin has more of a virtual network, and planting the Virgin tail elsewhere in the world is not a priority. Qantas meanwhile is on the mend with growth after years of contraction. It was often asked when the international cuts would end. With Brisbane-Tokyo and re-entering San Francisco, Qantas International shows it has bottomed out - but Southeast Asia and Europe may still need help. An expected exercise of 787-9 slots may help Qantas, but others are re-fleeting, too.

In recent years Qantas and Air New Zealand have been contrasted, as Air New Zealand reported improving conditions and record profits while, thanks to the media, the sky seemed to be falling for Qantas. Geography allowed Air New Zealand an easier time than Qantas, with light domestic competition and some insulation from foreign carriers.

Jetstar's entry into regional New Zealand later in 2015 and a prospective new trans-Pacific competitor may not be welcome news for Air New Zealand, which currently dominates those routes - but nor are the moves lethal, at least in the short term.

Geography cannot be beaten, so Air New Zealand and increasingly Qantas are moving from beyond using replicable physical assets - aircraft - to less replicable behind the scenes strategies.

The existing wave of partnerships and joint ventures, while seemingly advanced, may be only one evolutionary step as airlines look finally to harness modern technology to set themselves apart. Intruding airlines may be bigger, but not necessarily smarter. Air New Zealand and Qantas need to stay ahead, and for that willingness to change is critical. Air New Zealand has long demonstrated that, and now Qantas is too.