Is Qantas Group the most effective airline model in the world?

But Qantas itself is an airline with little future - as an international full service airline at the end of the line in a world where it is helpless to compete with the market and pricing power of efficient Middle East and Asian intermediate airlines able to pick the eyes out of its European and Asian services.

Meanwhile, its only really lucrative international routes, to the US and to South Africa, are being eroded by the entry of a competing and lower cost national airline, V Australia, on both of those routes and additionally by the world's largest airline, Delta, on the US route. And, with 65% domestic share - and only one way to go from there - its largely mature home market offers little for the future.

Thanks to its dual brand however, Qantas Group has a few special features up its sleeve, which other airlines would do well to examine. It combines the features of both sides of the full service/low cost equation and blends them into what is seemingly an impenetrable competitive force.

Fortuitously having avoided privatisation in the debt-fuelled days of 2007 - a private equity bid which would have split up and capitalised on the various segments of the airline as well as loading the Group with debt at probably the worst time in history - it is instead now an integrated, segmented group with enormous internal synergies.

This Case Study: 'Qantas' successful LCC subsidiary: A single-airline group convergence of airline models' is extracted from CAPA's Global LCC Outlook report, available for free download at: https://centreforaviation.com/lcc/report

Domestic domination is a helpful start - but was not a given

It does admittedly have a unique advantage, in jointly owning two thirds of the Australian domestic market. That is, by passenger numbers. Measured in terms of domestic revenue share it is probably closer to 75-80%. Accurate numbers would only be known by management, but Qantas' continuing near stranglehold on corporate and government travel in Australia, as well as its dominance of regional operations, allow it to generate a massive premium over the competition.

This differential derives largely from the Group's operational presence, but also from its inevitable influence in the distribution chain, where its market power can only be guessed at; in a recent attempted class action against the carrier, no travel agent was willing to put its name to an affidavit alleging any improper or other pressure exerted by Qantas in this area. It is an indication of the pain which this downturn is causing (even though Australia is less affected than almost any country) that even with this advantage, the mainline carrier is still unprofitable.

But there is a lot more to Qantas Group's success that is not a product of history, rather of sound strategy - and which is therefore capable of being imitated by others.

Strategic leadership: domestic and international low cost subsidiaries

Just the fact that Qantas was able - against contemporary industry wisdom - to establish a highly successful and complementary low cost subsidiary, Jetstar, has been its prime strategic move in this decade. This enabled it first of all to reverse the threatening inroads being made by low cost domestic competition (notably Virgin Blue) from 2000 onwards, then later to invade Southeast Asia with an international joint venture subsidiary, Jetstar Asia, based in Singapore. A subsequent investment in Vietnam (and a near-miss in Indonesia) further entrenches the Asian future.

The original Jetstar airline was created to head off the threat of domestic competition, the latter to exploit future Asian expansion opportunities not available in its home market.

The Australia-based Jetstar Airways is also progressively taking over Qantas' unprofitable international long haul routes, with a growing fleet of A330s complementing its A320 family aircraft which now operate domestically in New Zealand as well as on medium haul routes in the South Pacific. It operates primarily tourist routes and now occupies Australian flag carrier status in Tokyo for example, after Qantas withdrew.

Jetstar had been scheduled to be the first recipient of the host of B787s ordered by Qantas Group. The delay in delivery of the aircraft has set back expansion plans, perhaps not an unwelcome occurrence as the world economy has slowed, although it has reduced the airline's first mover opportunities, as long haul low cost airlines like AirAsia X intrude into its space.

When the B787-9s eventually appear, Jetstar plans to expand to a range of European, Asian - and perhaps US - routes, complementing and, where necessary, replacing its older brother.

The LCC is a strong contributor to the bottom line; in the financial year to 30-Jun-2009, Jetstar was attributed a profit of AUD137 million in a difficult market, while the full service airline was bleeding heavily.

And synergies are exploited

Although in most ways independent and free to establish its own forward plans, Jetstar is able to benefit for example from the purchasing power of its parent, delivering healthy savings. It also codeshares and interlines with the full service airline and with the Group's Asian subsidiaries, along with participating in the massively powerful Qantas Frequent Flyer Programme.

The third leg: a lifesaving Frequent Flyer Programme to die for

Then there is a third leg to this creature - a frequent flyer programme, modelled on the successful (in one way) Air Canada Aeroplan plan.

In fact, were it not for the Qantas FFP, the mainline carrier would be in dire straits today. Despite aggressive cost cutting over the past few years, it is still an unwieldy, premium traffic-reliant full service airline, currently losing anything between AUD1-2 million a day. But the airline provides a visible branding core for the Programme, now expanding rapidly with various major retail deals.

The FFP reported a profit before tax of AUD384 million in FY2008/09 but the amount it really generates is more a matter for accounting than for determining an independent bottom line. It could easily be three times that amount. That is not to suggest any corporate misbehaviour, but when the Group has complete ability to determine "airline"-FFP pricing arrangements (eg how much the "airline" charges the FFP for any particular seat) and, on top of that to add hefty airline "charges" to any frequent flyer points redemption, the once-loyalty programme is now the Group's golden egg.

It is no secret that redemption seat bookings often earn Qantas considerably more than do online ticket purchases, especially in the premium sector.[1] When accounted as ancillary revenue, this makes Qantas one of the highest generators of non-ticket sales revenue (see the Ancillary Revenue section).

And how well the pieces fit together!

If any illustration of the linked value to Qantas of Jetstar and the FFP is necessary, the contrast between Qantas Group's model and the dying contortions of Air Canada is as close to perfect as possible. Air Canada's disintegration - union opponents called it asset stripping - has spawned a highly profitable loyalty programme, Aeroplan, as well as regional carrier, Jazz and a profitable MRO, Aveos.

Qantas instead remains intact, able for the time being to feed off the wealth of its FFP and to distribute routes appropriately between its different airline models.

Air Canada the airline, is meanwhile only able to survive following a hastily cobbled together bailout this year, having previously emerged from bankruptcy protection only three years earlier.

While the private equity proponents were putting together their bid for Qantas in 2007, there was considerable talk in Qantas of the company's inability to generate investor understanding of the respective values of the Group's assets. The argument went that, with so many streams of business, the "real" value of the Group was hidden, depressing its share price and restricting the airline's ability to raise capital. Following the ACE/Air Canada model was the ideal private equity play. But the shareholders narrowly rejected the bid.

United it stands, divided Qantas doesn't survive

For the time being, the FFP is comfortably supporting Qantas the airline as it goes through its darkest hours. And the Group is able to continue to cover cash outgoings, as Jetstar continues to expand and cover for Qantas. It is able also to respond to aggressive moves by the locally based variant of Singapore's Tiger Airways, as Jetstar contests it in Australia and allocates new capacity at Tiger's home base.

The relevance of Jetstar to Qantas is that, without it (and the FFP), the full service airline would at best be in deep trouble today, and probably seeking a government bailout. The three-pronged vehicle however is able to maintain stability, despite difficult conditions. And, whatever the future outlook, it is sufficiently adjustable to deal as well as any airline with what might come along.

This helps Qantas avoid the reality of whether it has value in a separate investment. The full service arm is still a valuable part of the triumvirate, even if it is losing desperately as an airline in its own right. It provides a focus for the profitable FFP and a foundation for Jetstar.

What that says for the future viability of the full service model in its own right is hardly comforting, but thanks to its dual brand/low cost airline subsidiary strategy, the Qantas Group operation does collectively offer a viable and resilient combination.

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[1] At the time of the proposed private buyout of Qantas, the prospect of selling off the FFP was dismissed by Grant Samuels' Independent Report, filed as part of Qantas' "Target's Statement" required by Australia's Corporations Act: "the program itself would have to be restructured and turned into a "firm seat" program rather than Qantas' current "marginal seat" basis. It is not certain this change is viable and, in any event, it would take a considerable period of time to achieve." (p 62). In Jul-2008, Qantas announced the creation of its "any seat awards" and talk of a hiving off escalated. Then the world changed. The FFP has since been made a fixed "segment" of the Group.