KGB INTERVIEW: Flight Centre's Graham Turner

Flight Centre founder Graham Turner tells Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:

– The Qantas-Emirates deal and Virgin's potential Tiger takeover should be positive for Flight Centre and its customers.

– The company's online business in Australia is seeing significant growth compared to stores, but it not likely to become more than 10-15 per cent of the business.

– Online-only travel sites like Webjet and Wotif will see reduced growth in the future.

– The Australian market contributes about half of the group's sales, and it sees significant growth opportunity in overseas operations.

– What effect Chinese airline discounting is having on the market.

– Timing was not the only unfortunate aspect of its 2008 Liberty acquisition in the US, but a verdict on the deal won't be possible for another five years.

Alan Kohler: Graham, so welcome to Business Spectator. Thanks for joining us.

Graham Turner: Oh, it’s a pleasure.

AK: Now, the big changes going on in aviation at the moment are the Qantas deal with Emirates and the Virgin proposal to take over Tiger or at least to buy 60 per cent of Tiger. Do you think these things will have much of an impact on the travel market?

GT: I think generally most of it, certainly from our point of view, is pretty positive and I’d like to think from the customers’ point of view it looks pretty good as well. On the Qantas-Emirates deal, I think it’s pretty obvious that Qantas is struggling, particularly in the European market and Emirates is such a big player there now that an alliance like this should help both airlines. But I think the speculation is whether Emirates will start off the dominant tail and will become really dominant or not is one of the questions.

AK: What do you think? Will they become more dominant as a result of this deal?

GT: Look, it depends on quite a few things. Certainly from our point of view there are a few different areas that we need to look at – in other words, what our learning is from it and what our incentives are to push which airline. And my gut feeling is, yes, it’s quite likely that Emirates would become quite dominant over time, but that’s not necessarily a bad thing for Qantas. I think, you know, for that part of the world being in bed with someone like Emirates and having tie-ups with frequent flyers and all the other things is probably positive for Qantas anyway.

AK: Well, what sort of commissions do each of them pay now?

GT: Oh look, believe it or not, that’s a commercial secret.

AK: Come on, Graham.

GT: I can’t get an exact figure, but with most of these international carriers we get around the 10 per cent in margin with some other incentives that rely on volume and volume growth, that sort of thing. So, it does vary but it’s in that vicinity.

Stephen Bartholomeusz: Graham, whether it’s international or domestic, we’re seeing a lot of capacity coming in to the market. I assume that’s good for you.

GT: Yeah. It’s hard to know. Obviously there’s been an element of deflation over the last 20 years and that has its positives and negatives. Obviously the positives are that it’s cheaper for people to travel. The negatives are that growth targets are harder to get for us. But there’s no doubt extra capacity, particularly for big players like Emirates has made the international market, particularly in Europe, very competitive with great deals for customers. And domestically pretty much the same. I think coming back to a virtually two major owners in the domestic retail, probably four or five airlines is probably not a bad thing either. It’s the sort of market with two main costs or two major low costs and two mainstream airlines, so I think it’s generally going to be good for the market. It’s still going to be very competitive, but you know Australia is a pretty big market. I don’t think it’s a small market, but you know four airlines competing in different positioning areas I think is probably pretty good.

SB: Presumably the dollar has also been helpful to you in the last little while.

GT: Yes. The strong Australian dollar certainly for outbound has probably helped us, but we’re quite strong in domestic leisure travel as well, so generally we find if the dollar gets weaker, we pick up the domestic and, you know, domestic travel is not cheap of course or domestic holidays aren’t cheap, so we generally don’t do too badly out of that anyway. So, if we lose the international because the dollar gets weaker, we’re not too worried.

Robert Gottliebsen: Graham, do you think the Webjet model, which duplicates a lot of what you do, but it’s an all-internet model, will eventually replace this very large emphasis you have on physical bricks and mortar branches?

GT: Well obviously this is a question of whether the online players, including our own online players, will become more dominant in bricks and mortar – and it is interesting. If you look at  North America or Australia the large online travel agents seem to be plateauing quite a lot. And our model is what we call a blended travel agency model where we’ll have a seamless interplay between our bricks and mortar and online, which is a typical retail omni-channel type operation.

Now, we’re already two thirds of the way through this. The actual seamlessness part of it is not there yet, so we’ve still got a bit of work to do, but I believe this will be a pretty unique offer in Australia. You know, customers will have a choice. Some customers love online. They’ll only be online. There’ll still be a lot of offline customers, but I think a lot of customers now like to do some of their stuff online and others offline or a combination when they’re doing a trip.

Travel is one thing, particularly leisure travel. There’s a lot of it out there. You just can’t get online and you won’t be able to get them online for years because they’re so complex and that’s one of the advantages we have as well. But I think you are seeing the trends change from online to sort of a plateauing of online. There’s still movement towards suppliers’ websites, but I think the Webjets and Wotifs will reinvent themselves and they’ll continue to grow probably, but they’re certainly not be getting the growth like they have done in the past.

AK: How much of your business is done online now?

GT: This year it will be $350 million in Australia on our Flight Centre site, so probably globally we do $600 million out of about $14 billion, so a relatively small amount, but it’s still significant and it’s not unimportant. And we are doing more and more transactions online. We’ll have more product that will be capably transacted online as time goes on.

AK: But is the online business growing faster than the shops?

GT: It is at the moment in Australia just because in the last year we’ve put a lot more international fares online, so it is growing at sort of 25 per cent, 30 per cent compared to shops about 6 per cent or 7 per cent. So it is at the moment, but that’s mainly because of the product we’ve put on. And we will start promoting it. We haven’t really started promoting it yet, so we do expect more significant growth when we promote our offers, particularly in the Flight Centre brand.

SB: Graham, are you concerned that the growth in the online transaction values might undermine the economics of the physical network?

GT: I don’t think so. As I said before, with the blended model we would like it to be very much online/offline as much as possible, so that our bricks and mortar people, for example, if you do an online booking, you’ll be able to choose a consultant that can help you if there remains a problem such as airline groundings or the more cash sort of stuff.  I’m sure we must be getting ready for another terrorist attack somewhere, so that, you know, they will have a person who is dedicated and allocated to you to help you through your travel arrangements and I think a lot of people like that.

AK: Your income margin has been stable at 13.9 per cent or 14 per cent for some years now. Are you saying that you’re going to be able to keep it at that level as business starts to drift online?

GT: It’s a good point, but there’ve been a whole range of different things that affect our gross margin around that 13 per cent, 14 per cent and it has been pretty stable. I think it’s nearly five or six years ago it went down to maybe 12.9 per cent and the reality is we’ve been growing our corporate travel quite considerably over the last 10 years and it is generally a much lower growth margin.

So, being able to maintain that sort of margin with a lot of corporate in the mix I think means that unless online becomes a really large part of our business, and I can’t see it ever becoming more than 10 or 15 per cent, I don’t think the gross margin is going to change a lot at all.

RG: Graham, what’s your advice to non-food retailers in terms of this online challenge? You seem to be thriving under the system online whereas the retailers are struggling. What’s your advice to them?

GT: I think there are a few interesting things here. I think one of the challenges if you’re a retailer, particularly if you’re in a commodity that can be easily bought online overseas, is that you’re not only paying the GST but in some cases sales tax. This is a major problem. I think the government has realised how many retailers, smaller retailers, are actually going to the wall. So, I think that’s one thing that the government has got to sort out, but I think if you look at the so-called omni channel, there are a few really good examples.

Macy’s I think in the States and John Lewis in the UK, they’ve really made some great inroads and had some great success with combining the online/offline experience. And I think if you look at John Lewis, they find that people who shop online and offline using the omni channel, they spend something like three or four times as much with John Lewis as people who shop only online or only offline. So, there are a lot of opportunities there and you can see most major retailers are trying to catch up with this now. And I think the good ones will get there and the sooner they get there, the more successful they’ll be.

SB: Graham, when you look at your presentations, there’s always a map in it of your global operations. And what’s really noticeable is that you’ve got a lot of points representation in the States, but you lose money in the States. How are you going to fix that?

GT: Well, that’s a good question. We have several major business categories there, mainly corporate, retail and wholesale with our GOGO Vacations operation. And we bought Liberty GOGO in… I think we settled February 2008, which was not good timing and that’s been a business that has been tough. We did make a profit last year out of that business itself and our corporate is going pretty well. I think we’ll make $10 million or $12 million profit in corporate and we’re hoping we’ll still make a small but reasonable profit in the retail Liberty GOGO field.

So now it’s been five years and we’ve still got a long way to go before we’ll be happy with the performance of that and I think the last few times we wrote off some goodwill associated with that purchase. But we’re pretty confident we’ve got a good operation, it’s just the market is pretty flat in leisure and corporate is going very well.

In the States there’s a lot of unmanaged SME corporate business, so it’s not even a matter of having to take market share from someone else, it’s just a matter of showing a lot of these SMEs the advantage of some of your offerings to win the business and we’ve been quite successful at that.

SB: Given that you do have something approaching a global footprint and that Australia represents something like three quarters of your profitability, has that global strategy not been executed as well as you might have liked?

GT: Look, Australia is a significant part of our profitability and about half our total sales, so we obviously want to get our overseas and particularly in the States up to the same sort of level. It’s going to take some time to get to that. But if you look at the UK, it’s going pretty well at the moment.

We’re looking at probably over £20 million profit on about £800 billion sales and we certainly want to get the States to a similar sort of area within the next few years. But the overseas offers us a lot of opportunities for growth and we have such small market share compared to, say, Australia where in leisure we might have 25 per cent or 30 per cent of the travel agency market share and maybe 20 per cent, 25 per cent of the corporate.

We still see a lot of opportunity in Australia and we certainly want to grow the proper way in our overseas operations. Last year they were all profitable in the 10 overseas countries we work out of, but we need a much greater percentage on our tails falling to the bottom line and that’s one of our challenges. But it’s also one of the opportunities. At the same time we’re quite happy for Australia to provide 70 per cent or 80 per cent of our profit.

RG: Is it not surprising that in a place like the States there haven’t been major developed retailers who you take it by the throat and make it quite difficult for you?

GT: Oh look, the States is a big place. One of our main problems in leisure is that the High Street travel agent which, you know, is quite prominent in Australia and the UK and New Zealand and South Africa, has almost ceased to exist and then Liberty Travel, where we have about a 170 shops, is one of the few remaining streetfront retail shops. And so people sort of don’t really know so much that bricks and mortar travel agents still exist except for marketing by people like us.  So, that is one of the challenges. 

And in corporate there are a lot of big players in the States, but the market is so huge.  You know, obviously people at American Express are based there and they’re a big player, but they focus on companies that are often global mandated and, you know, very large sort of companies that weave-on travel. But even if we win some of those accounts, making money out of them, we do prefer there generally, the smaller, you know, $1 million to $10 million accounts and there are plenty of them in the States.  There’s plenty of room for growth even though the States is economically challenging at the moment.

RG: If High Street shops disappeared in the States, why wouldn’t the same thing happen here?

GT: Well, it’s in a different market place and I think one of the reasons they went from 44,000 I think in about in the mid ‘90s to probably about 17,000 today is that the airlines basically cut all commission almost unilaterally in the late ‘90s. And it wasn’t a very smart move by the airlines because it effectively destroyed their distribution channel before they had other distribution channels around and that’s where the airlines in the States since then have been really struggling for profitability.  It means the low cost carriers that distributed through websites certainly got a toehold in there.  So I think if you talk to airlines, you know, they certainly could damage their distribution industry. But generally it’s really not in the interests of people who manufacture airfares to destroy their distribution and I think they would probably say the same thing.  They don’t like necessarily playing margins. But to distribute your own product most of the airlines realise it’s much more expensive to do it using yourself through your marketing and that than have people doing it for you.

RG: But you think what happened in the States is almost an insurance policy that protects your Australian business?

GT: Look, it’s hard to say. It’s early days, but I don’t think Australia will go the same way as the States.  I don’t think the UK will. Thomas Cook is shutting a lot of shops, but that’s the nature of their particular holiday business I think. You know, certainly things are going to go more online. The blended model I think will hold up a lot of the offline opportunities as well and I think there are lessons for most retailers in these omni-channel or blended models in terms of online-offline. And that’s what I see is the way of the future, but you know, I could be proven wrong.

AK: Graham, have Chinese carriers taken over from the Middle Eastern carriers as the most aggressive discounters in the market?

GT: To a certain extent, you know, China Southern particularly has come into this market fairly aggressively.  Their product is still not up to scratch so, you know, they have to be cheaper.  So certainly most of the leader fares you see to Europe, for example, are from the China Airlines or China Southern.  But certainly in terms of value for money, I think the Middle Eastern carriers are, and Emirates in particular. But Etihad and some of the Asian carriers probably still dominate. There’s no doubt the Chinese will get better.

AK: And are they building market share rapidly?

GT: They’re certainly growing. But it is a part of the market that is, if you like, the bottom end of the market generally, so far all inbound from China. So it’s a very competitive market. The Chinese carriers just make a bit more competition at that bottom end.

AK: And just on airfares, I mean as you said before, they haven’t really changed for 30 years and in fact have gone down, so how have you kept growing profits and can you keep doing it?

GT: Yes.  Well, the challenges are when you have such deflation over such a long time because unfortunately our other costs continue to rise, you know, whether it’s wages or rent or even advertising, marketing. And so what’s been one of our biggest challenges over the last probably 10 years is how we cater for increased costs where our income, or our costs of products is basically the same. And the only way you can do it is to grow your productivity and grow your efficiency.  And we’ve done that to a certain extent, but we’ve still got a fair way to go with that, so that’s our big challenge.  We’ve got a lot of projects on the go, effectively growing individual shops and people’s productivity and making sure our systems are more and more efficient. So that’s work in progress, but very important for us.

SB: Graham, you referred to the unfortunate timing of that Liberty acquisition in 2008. Does that make you gun shy on other big acquisitions?

GT: Look, you learn from every acquisition and very few of them go smoothly. With the Liberty one, it wasn’t just the timing. There were probably some other things we could have done, but you know we don’t know whether we’ll regret it yet. We’ll tell you probably in about five years’ time because we need to get a good ROI on that investment. 

But generally we don’t need any major acquisitions in most of the countries we operate in.  In most of our countries now we’ve got a leisure and a corporate offering as well as a wholesale offering and we’ve got a lot of opportunities to grow them organically. Our main aim is I suppose to generally grow vertically and the reason we’ve maintained our profit pretty well over the last 10 years is that we’ve managed to become more vertically integrated.  We negotiate directly with hotels, obviously with most other suppliers and we would run the wholesale business as well as the retail. So between those three areas, you know, you can capture significantly more margin. And we’ve still got a little bit of a way to go with vertical integration.  We’re looking at the possibility of also – in the markets that we have a huge amount of business like Bali and Phuket, Fiji –  the opportunities of perhaps ground handling there. Which obviously is an extra margin that adds onto the rest of our product that we sell.

AK: I think we’ll leave it there, thanks Graham.

SB: Thank you, Graham.

RG: Thank you.

GT: Ok.  Thanks very much.  Thanks, guys. Thanks for the good questions.

AK: No worries.  Thanks for the good answers.