An obvious and urgent Qantas response

Despite surprise from the market, confirmation of talks on a Qantas-Emirates alliance has been on the cards for a while. Indeed, a well-balanced alliance has become a commercial imperative.

Given that the market has known for at least six weeks that Qantas has been talking to Emirates about some form of commercial relationship the striking surge in the Qantas share price today was somewhat peculiar.

Emirates’ president Tim Clark was quite open about the discussions last month, disclosing that he had approached Qantas about the concept of a code-sharing arrangement in Oceania, so Qantas’ confirmation that it was in discussions with a number of airlines about potential alliances, including Emirates, should have come as no surprise. The near double-digit percentage spike in Qantas’ share price suggests that it did.

Alliances are an obvious response to the predicament Qantas finds itself, when the massive influx of capacity onto its traditional international routes from the new Middle Eastern hub carriers, among others, with more modern and efficient product has destabilised its own international business.

Last month Qantas shocked the markets by disclosing that it expected its international business to lose $450 million in the year to June. Those sorts of losses, which have been incurred despite a shrinking of the Qantas’ international network, are unsustainable.

With Virgin Australia not only ratcheting up the pressure in the domestic market but striking its own set of alliances with a number of Qantas’ key competitors – Etihad, Air New Zealand, Delta Airlines and Singapore Airlines – to create a virtual international network, Qantas has no choice but to find a creative and capital-light strategy for transforming its international business.

An obvious strategy for Alan Joyce and the new chief executive of the international business, Simon Hickey, is to emulate the Virgin Australia strategy to create a virtual network of their own.

Emirates, one of the world’s largest airlines and which has arguably the biggest international route network of any carrier, operates as a hub carrier out of Dubai. The Middle Eastern ports have emerged as powerful gateways into and out of Europe.

While Emirates’ Clark referred to code-sharing arrangements last month it is uncertain whether a conventional code share deal would satisfy Qantas’ imperatives and it would certainly complicate its existing arrangements with its One World allies and its joint venture arrangements with British Airways on the 'Kangaroo Route', between Australian and the UK, in particular.

To make a new relationship work and to avoid being exploited by the far larger Emirates it needs something akin to the relationship with BA.

In any event, if it could pull off a deal that locked it into a reasonably balanced alliance with Emirates it would instantly have access to a pervasive international network feeding into all the major European ports into which it could channel its Australian-originated passenger volumes, with Emirates able to pour its own volume into Qantas’ dominant domestic network.

If it were able to hand Qantas-carried passengers over to Emirates in Dubai, Qantas would be able to quit its flights to Frankfurt, the only European port other than Heathrow which it now services, and either withdraw some of its older and less efficient capacity from service or redeploy it closer to home.

Joyce has made no secret of his desire to reduce Qantas’ vulnerability as an end-of-the-line carrier competing with hub carriers by evolving into far more of a regional carrier with an extensive Asian network.

A relationship with Emirates beyond code-sharing would, of course, be complicated by the fact that Emirates already carries significant passenger volumes into and out of Australia and has been steadily increasing its capacity on those routes. It would be no easy negotiation to agree something that helps significantly address the structural weaknesses in Qantas’ existing international business.

Whether or not Qantas can agree a value-accretive deal with Emirates, with Virgin Australia’s John Borghetti having surrounded himself – and Qantas – with some of the group’s keenest competitors, Joyce and Hickey have to devise a way to leverage the size and strength of their group’s domestic base and its powerful frequent flyer program into an international presence that makes strategic and economic sense.

Given the magnitude of the losses the business is experiencing, the continual erosion of its share on its remaining routes and the way Borghetti is using his alliances to bolster his domestic business and chip away at Qantas’ stronghold, they can’t afford to dally.

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