Transtasman dogfight

By Lachlan Colquhoun

Friday 19th March 2004

Air New Zealand and Qantas go into a new phase of the decade-long transtasman air war outwardly confident they will soon be united in a new alliance. But behind these positive words the question remains: is Qantas planning, in words attributed to chief executive Geoff Dixon, to 'grind Air NZ into the dust' if the appeals to the regulators fail? Lachlan Colquhoun finds out

With Virgin Blue's new venture, Pacific Blue, now flying from Wellington and Christchurch to Australia, both incumbent airlines are exposed to new low-fare competition for the first time since 1995, when Ewan Wilson's Kiwi International took up the fight.

According to the Australian Competition and Consumer Commission (ACCC), which disallowed the equity deal last year, the two airlines have 91% of the transtasman market between them, and therefore quite a lot to lose. They also have 74% of the cargo.

For Air New Zealand, the stakes are even higher than for Qantas. About a fifth of its total flight revenues come from transtasman flights, and last September chief executive Ralph Norris warned the airline's share of the market was threatening to dip below 30% as a result of the new competition.

Last year, when he disallowed the deal, ACCC chairman Graeme Samuel said Air NZ and its Freedom subsidiary had a combined 52% stake.

Qantas, which the ACCC said had a 39% share, relies on the route for less than 5% of its revenues.

With the arrival of Pacific Blue, 13 carriers are now flying across the Tasman. And with "fifth freedom" operators such as Emirates which flies 14 return flights a week also moving into the market aggressively, capacity is expected to grow 30% this year.

The risk of flying empty planes on the route has never been higher and the result is a predictable fare war.

Both Norris and his Qantas counterpart, Geoff Dixon, are still talking up the chances of the $NZ550 million alliance getting the green light after appeals are heard on both sides of the Tasman this year and say that even if it doesn't get up this time the deal is inevitable.

"It will come to pass over time," Norris said in February, as he unveiled Air NZ's impressive $NZ105 million interim profit.

If it was not approved now, he said it would be within three to five years.

At Qantas, Dixon continues to describe the Air NZ alliance as central to his airline's future.

"I believe that no matter what happens there is a need for scale and we will continue to pursue at this stage the Air NZ relationship," he said.

"I believe at some stage or another the competition authorities will come to realise there is some need for that."

Both airlines will point to the February approval for a merger between Air France and Dutch carrier KLM, to create the world's biggest airline by revenue, as further evidence of consolidation in the global aviation industry.

"As we've said many times, consolidation of the airline industry is inevitable and necessary," Qantas' Dixon said at the time.

"That position will need to be realised at some time in the future in this part of the world."

Air NZ and Qantas will also point to the new competition from Pacific Blue as proof the transtasman competition they need to justify their alliance already exists.

But what if, as many analysts suspect, they don't succeed when the appeals are heard by the NZ High Court and in Australia this year?

Will the would-be partners turn on each other in a renewal of the dogfight they each pursued when Air NZ's lately departed subsidiary Ansett still plied the skies?

After all, it's easy to forget that barely two years ago the scenario was for Singapore Airlines and Air NZ to use Ansett as its main strike force against Qantas in the Australian domestic market while continuing to force the transtasman war with its Freedom Air subsidiary.

Across the Tasman, at least, a common view is that if the alliance doesn't get up, then Qantas has the firepower to blast Air NZ out of the sky, and in the often-quoted phrase "grind Air NZ into the dust."

"In that environment of renewed competition, I think one airline would struggle and I think we all know which airline that would be," said one Qantas insider, on condition of anonymity.

"Qantas is going fairly lightly on Air NZ at the moment for two reasons because it still hopes the alliance can happen and because we are still pre-occupied with the domestic threat from Virgin Blue."

To counter the domestic threat from Virgin Blue, Qantas has rolled out its own no-frills service, JetStar, which begins flying in May, using the same model that Air NZ successfully employed when it used Freedom Air as a spoiler against Ewan Wilson's Kiwi International in the 1990s.

For Qantas, the main game at the moment is defending the line Dixon has "drawn in the sand" the airline's 65% share of the $A10 billion a year Australian domestic market.

Dixon has spoken cryptically of "options" should the Air NZ deal not succeed but reading his thoughts is pure speculation.

Does he mean Qantas will look elsewhere and perhaps buy into an Asian airline such as Thai or Malaysian, which are both screaming for equity partners?

Or does he mean the possibility, first mentioned last year, of a Qantas no-frills carrier across the Tasman in the event that he decides to get tough with Air NZ?

Or, conversely, is he talking about some kind of gentleman's agreement with Air NZ, where they keep out of each other's way in a spirit of peaceful co-existence?

One analyst who firmly believes the Qantas-Air NZ deal won't happen is Sydney-based Peter Harbison, from the Centre for Asia-Pacific Aviation.

Harbison's view is that Pacific Blue's transtasman capacity which equates to 28 return flights between the two countries each week, roughly half of Freedom's 50 flights is too insignificant to be considered the serious competition needed to exist to justify the deal.

"Unless there is a substantial second force in the market which goes way beyond what Virgin is doing, then I think it is extremely unlikely," he says. "There are still only two main players in the transtasman market."

At CommSec, the equities operation of the Commonwealth Bank, aviation analyst Matthew Crowe also sees little hope in the alliance being approved and can't understand the outward optimism.

"I think it's all talk," he says.

"If Qantas had really wanted to get it approved, in Australia at least, there were concessions they could have made on price, for example, which could have got them closer.

"But you have to assume that they didn't want to give those benefits away."

The likely result, then, is a continuation of hostilities, but Harbison says he has changed his view on whether Air NZ can survive full-blown competition with Qantas.

At one point, he says, he would have predicted the airline's demise in any head-to-head but now he's more optimistic about Air NZ's future.

"I think they've built a pretty hard shell for themselves very quickly. They've got low costs, profitable short haul and a strategic selection of long-haul international routes.

"They are clearly going in the right direction, and ownership is not an issue because nobody is about to buy it.

He said these factors, and the way the Star Alliance was configured "on a multi-lateral level," meant there was a "good chance for Air NZ to secure a solid future for itself."

With the changes in the airline industry in recent years, the various alliance groupings have become more important, and Air NZ was getting quite a lot out of its membership, particularly since Star Alliance partner United left the Pacific route.

Harbison says the company also has the option, flagged by Norris in February, of ramping up Freedom Air with more aircraft and using the brand on main city routes.

"And the final point is that even though Qantas is now a public company, it is still very close to the government agencies in Canberra and is still influenced strongly by the politicians and the regulators.

"So I don't think Qantas would ever really go after Air NZ, because I don't think it's in either country's interest for them to be hauled over the coals and I think there would be all kinds of subtle pressures applied to stop them."

CommSec's Matthew Crowe agrees.

"Grinding Air NZ into the dust would cost Qantas dearly. And even if they did that, you would expect that someone else even Pacific Blue would pop up and challenge them.

"They'll compete of course against them, but I doubt either of them will pursue a strategy of trying to eliminate the other, even though the route is nowhere near as profitable for either of them now as it used to be."

Air NZ does appear to have been transformed from the basket-case that, in the aftermath of its disastrous Ansett investment, needed a $NZ885 million capital injection from the New Zealand government.

Post-Ansett, it has moved to a new business model which as Norris said last year "will be underpinned by delivering a service that will enable us to fly more passengers to more places, more often."

The domestic Express Class and its transtasman equivalent, Tasman Express, coupled with the ongoing success at Freedom Air are delivering results, and the company is heading for a $NZ220 million profit this year. Although its transtasman market share has fallen, volumes are up 11% since it launched Tasman Express.

The company has also made a pre-emptive strike in the South Pacific market, where it has slashed fares by an average of 25% on its new Pacific Blue service in anticipation of competition from Virgin Blue later this year.

Harbison sees this as a move to "stamp their ownership" on what has always been a traditional Air NZ market "and with one eye to what might happen if the appeal doesn't get up."

"They are in better shape for competition, and for a head-to-head with Qantas if that happens, than they have ever been," Harbison says.

At Virgin Blue, commercial manager David Huttner says the Qantas-Air NZ deal is of "no consequence" to Pacific Blue's plans.

He wouldn't be drawn on whether Virgin, if the regulators made Air NZ sell Freedom Air as a condition of any deal, would be a buyer.

"As long as we can address our needs, which are adequate terminal access and adequate access to slots at peak times, we don't have a view," Huttner says.

"Virgin is more focused on ensuring it has the right conditions to compete effectively."

In the current market, Huttner's view is that lower fares will stimulate more travel and create a sustainable environment for the airlines.

"There are Australians who would have taken a holiday up the New South Wales coast and who didn't think a trip to New Zealand was within reach but who will now fly there.

"And there are a whole load of New Zealand people who have second homes in southeast Queensland they can afford to make more than one trip a year now.

"This is having a tremendous competitive effect, which is good for both countries."

Harbison agrees the market will grow and estimates that up to half of Pacific Blue's passengers will not be diverted from either Qantas or Air NZ.

"That's a big positive for the majors.

"And even though this is a very mature market, these are affluent countries, both economies are doing well and there is the potential for a growth in traffic.

"Once we start tilting down through the $A400 level for a round trip, there are indications that it really does stimulate extra travel and there's a whole new strata of tourist traffic."

Pacific Blue: a Kiwi clone?

Almost 10 years before the advent of "no frills" carriers such as Virgin's Pacific Blue, there was "nuts and cola" carrier Kiwi International, which shook up the transtasman air market for less than 12 months in 1995 and 1996.

Current Hamilton councillor, Origin Pacific marketing manager and Waikato University aviation lecturer Ewan Wilson's bold but ultimately and unsuccessful venture has telling similarities but crucial differences to Pacific Blue's attempt to take on Air NZ and Qantas.

Like Kiwi International, Pacific Blue is avoiding flights between Auckland and Australia, flying from Wellington and Christchurch where the competition is less intense. And like Kiwi, Pacific Blue is offering "no frills," one-class air travel with the cheapest return fares below $NZ400.

But unlike Kiwi, which started as a travel agency operating once-a-week charter flights, Pacific Blue is a startup venture from a publicly listed company with a current market capitalisation of about $A2 billion.

But like Kiwi, Pacific Blue and its Virgin parent are already planning to take the fight into new markets.

Where Kiwi had ambitious plans for growth in Asia, Pacific Blue is already planning to go up against Air NZ in the South Pacific, flying between Australia and Fiji and Vanuatu.

This time, tackling the transtasman market is still a high risk venture but the risks may be evenly weighted between the new entrant and the incumbents.

Back in 1996, Air NZ's spoiling tactic of using Freedom Air to go up against Kiwi saw Ewan Wilson's dream in the hands of liquidators by the end of the year, only months after he was talking up a $NZ20 million initial public offering.

"We've put in a very limited amount of capacity, and at the same time our competitors are dropping their fares on a very large amount of capacity," says Pacific Blue commercial manager David Huttner, suggesting Qantas and Air NZ have just as much to lose.

No doubt this time the travellers will also be the main beneficiaries and in the short term at least the market is set for considerable growth.

But it is unlikely thousands of travellers will be stranded as they were in 1996 when a Kiwi plane was impounded at Brisbane airport. For that to happen this time, Virgin Blue would have to collapse first and, with a 30% share of Australia's domestic air market, that is unlikely to happen, at least as rapidly as it did for Kiwi.

In comparison, Kiwi always flew close to the wind. It was chronically undercapitalised and was a victim of poor cashflow, going into liquidation in September 1996 after running up debts of $NZ3 million in its last three months.

Another crucial difference in 2004 will be the status of relations between the two incumbents.

Back in 1995 Qantas was busy quitting its 20% stake in Air NZ and turned from partner to competitor.

This time, the Australians are desperate to get back on to the Air NZ share register and reform the alliance they turned their backs on almost 10 years ago, soon after former Australian Prime Minister Paul Keating reneged on plans for a single Australasian air market.

As for Wilson, his attitude to Air NZ and Qantas would seem to have softened considerably. Last year, he wrote to the Commerce Commission supporting the Qantas bid to buy back into Air NZ as long as the barriers to new players in the market were reduced.

Co-incidentally, that also sums up the attitude of Pacific Blue.

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