A Qantas no-brainer for the ACCC

You've got to wonder why the Australian Competition and Consumer Commission thinks it will take up to six months for it to review the proposed alliance between Qantas and Emirates.

The ACCC has a lot of experience in evaluating proposals for alliances between airlines. Apart from its 17-year history of assessing and endorsing the Qantas/British Airways joint service agreements on the Kangaroo route in the past two years, the commission has reviewed, and approved, alliances between Virgin Australia and Delta, Air New Zealand, Etihad and Singapore Airlines.

It would appear a reasonable understanding that the commission has a solid working knowledge of how the industry operates and what the impacts of alliances are on the Australian market for international travel.

The Qantas/Emirates deal appears a no-brainer. Qantas is going out of the international industry backwards. It lost $450 million in its international business last year after losing the $216 million a year earlier. It has been lopping routes and frequencies in a desperate attempt to reduce the haemorrhaging.

As Qantas said in its submission to the ACCC, its international business is unable to compete or operate profitably in its current configuration and is in terminal decline.

It has cut back its flights to Europe from five a day six months ago to three a day and will withdraw its services to Frankfurt regardless of the ACCC's decision. It has also said it may also withdraw one of its two services to London in the short term.

Absent the deal with Emirates, the losses and the shrinking of its network will inevitably place a question mark over the continued existence of even its truncated international route network. Qantas can't justify investing in new and more efficient and competitive product while it is losing money so the business is in a self-reinforcing and quite destructive spiral.

Virgin Australia has demonstrated one blue-print for a diminished Qantas future by creating a virtual international network. Qantas could do the same.

The reason for Qantas' woes is the structural change that has occurred in the industry in this region, and indeed globally, over the past decade or so as the Middle Eastern carriers like Emirates, Etihad and Qatar have emerged.

Already confronted with competition from hub carriers like Singapore and Cathay, the new hubs in Dubai and Abu Dhabi with their easy reach into a multitude of European ports have steadily stripped market share from Qantas.

Those airlines have a natural advantage from their location, which allows them to feed traffic into their hubs and then aggregate it. As relatively new airlines they have younger and more efficient fleets, they receive some support in the form of favourable tax regimes and government-funded infrastructure and they have significantly lower labour costs.

The Qantas submission said that Emirates' labour costs, for instance were $US47,000 per employee per year in 2009-10. Singapore's were $US45,000. Qantas' were $US92,000.

Looked at from another perspective, Emirates' labour costs represented 13 per cent of total revenue. Qantas' were 25.1 per cent of its revenue.

Thus it isn't surprising that over the past decade Qantas has steadily lost market share. The Qantas brand's market share has almost halved, from 36 per cent to 19 per cent. Even if Jetstar's international services are included it has lost nine percentage points of market share, mainly to the Middle Eastern carriers.

If the Qantas group share were aggregated with Emirates' eight per cent of the market, they would have a combined 35 per cent market share. If this were a conventional merger (which it isn't, given that there are no equity holdings involved) that level of share in a highly-competitive market with a very significant and growing number of competitors wouldn't be an obstacle to a deal.

In fact, the ACCC has signed off on Virgin Australia's four alliances which has created the virtual international network for Qantas' main domestic rival. Between them Virgin and its allies have a combined market share of almost 30 per cent.

Given that the "counterfactual," as competition lawyers would put it, is the continued marginalisation of Qantas as an international airline and potentially its complete withdrawal to its domestic base the status quo isn't likely to maintain current levels of competition.

Australia's "open skies" policy, the entry of not just the Middle Eastern carriers but more recently three big Chinese airlines and regional low-cost carriers to the market means the market will continue to be fiercely contested regardless of whether the ACCC approves the tie-up between Qantas and Emirates.

The Emirates alliance isn't a complete solution to Qantas' challenges but it is an important element of the strategy the group is pursuing to stem the losses and get its international business to the point where it can again invest in it and improve the competitiveness of its product.

For a variety of historical reasons, some of which have to do with nationalism, while the global aviation industry is structurally flawed the normal remedy of consolidation isn't easily pursued conventionally. Alliances and co-operation are the closest substitute.

If Australia is to hope to retain a national flag carrier of any substance Qantas has to be able to complete a deal with Emirates that, while it will improve Qantas' competitiveness and financial position, doesn't appear to have meaningful implications for the overall competitive intensity of the international dimension of the Australian aviation market.