KGB: Virgin's John Borghetti

Virgin Australia chief executive John Borghetti tells Business Spectator's Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:

– The company's capacity growth is prudent, and his interest is not in targeting market share but is focused instead on strategy.

– How the next phase of Virgin Australia's strategy reflects a new paradigm in Australia's aviation landscape.

– Expenses involved in taking Virgin Australia up-market have been prudently managed, and came in below the targeted $35 million in the first year.

– He is not concerned about the possibility of a Qantas alliance with Emirates, which would not affect Virgin's strategy.

– He has no reason to disbelieve Etihad's statements that it is not interested in controlling Virgin Australia.

Alan Kohler: John, you said the other day that 20 per cent of your revenue is now from the business category and that 20 per cent was a tipping point. Can you explain what you mean by that and why it is a tipping point?

John Borghetti: Well, we've actually been running slightly ahead of 20 per cent for the last two or three months, but we've always believed that 20 per cent is really the critical mass that you need – assuming you've got all the product, the network and everything else in place – to actually start making a difference in that sector.

But more importantly than that, our model around our strategy going forward in terms of revenue mix relies on at least 20 per cent of our business coming from that high yielding market, so what that enables us to do of course is to remain more competitive at the lower end of the market. Because we're able to, if you like, average out the fares – and for better than we could have performed, had we been continuing to be reliant purely on the leisure market.

AK: It seems pretty obvious to do that. And it's been in some ways easier than anyone would have expected, to take a discount airline into the business…

JB: I'm not sure if it's beneath me, but…

AK: Well no, but it's certainly been fast. You seem to be way ahead of schedule. I just wonder why Virgin didn't do it before under Brett Godfrey?

JB: Oh look, I can't comment on things before I joined. But what was obvious when I joined was that our cost base had grown to the point that we couldn't keep charging the same fares as the likes of the other low-cost carriers like Tiger and Jetstar – because we simply were uncompetitive in terms of the cost base.

So, we really, you know, saw an opportunity in attracting the higher yield end when we do have a cost advantage and we are able to attract a premium as we are generating now. And we've proven that over the last twelve months certainly, with a yield improvement of 12 per cent given that we only carried 5 per cent more passengers, roughly, at an almost 20 per cent more revenue. You know, I think that proves that it's the right strategy.

Robert Gottliebsen: John, when Brett Godfrey took on Qantas head on he got into desperate trouble and almost sent Virgin broke. Is there a danger that you will also trigger a capacity war?

JB: Well look, to say that is to say he had to believe in the principle that we were always going to be left alone. And I don't believe in that principle. It is all about competition and we have to be competitive. Now, a capacity war, as you put it, what is a real capacity situation in the country? From our perspective, we're certainly not growing at any significant rate.

When you look at our 8 to 9 per cent capacity growth that we planned for the front half of this financial year and you realise that almost 80 per cent of that is purely on the trans-con services, with a substitution on 737s or A330s, you really quickly come to the realisation that on the other routes – particularly, let's say, a Melbourne-Sydney route where capacity is forecast to grow in the front end of this financial year to 24 per cent capacity growth, yet we're only growing at 3 per cent. So our capacity growth is very prudent.

Now, if you were to, you know, quadruple that, it would only be hurting ourselves and we're not going to hurt ourselves. So, you know, what other people are doing is up to them and that's entirely up to them. What I'm interested in is not a market share. I've always said that. We have no line in the sand or any of those descriptive terms that you might want to use. What we have is a strategy that says we want to ensure the best return for the business and the market share will take care of itself. The best market share or your real market share target is the market share that gives you the best profit and so we're very comfortable. And in fact at the end of this half of the year we estimate our capacity share in the country to be somewhere around 28-28.5 per cent, so if anything, we've dropped a point or two.

Stephen Bartholomeusz: John , you've completed a what was supposed to be a three-year program more or less in two years. The next three-year program is called 'Game On'. Can you explain what you mean by game on?

JB: Well, perhaps I'd put it slightly differently. The Game Change program, as we called it when we commenced, it is still the Game Change program. It will be a five-year program, but the second phase of this is really Game On. And what that really means is that we now have the fundamentals, the building block in place now to really play in the game and that is just an illustrative term to say look, you know, we're ready now, we're in good shape; we get there are going to be tough times in the future. Of course there will be, whether it's oil, whether it's the economy, whether it's a competitor – but fundamentally our platform is much more robust than it was two years ago.

SB: But that expression Game On seems to signal increased aggressiveness. Is that what we should take out of it?

JB: No. What it's meant to signal is the fact that we're ready. We're now ready in our new guise. We're no longer the low cost carrier, per se, in terms of model, that we were three years ago or so. We're now a different carrier. We're a different model. So, we're where we are now.

I think that's all it's meant to be. It's not meant to be any form of aggressive tone other than the fact that it is now the new natural look. See, what we have created here is a new paradigm in the competitive landscape of aviation in this country, a competitive landscape that hasn't been here since the day when Ansett stopped flying. And I think Australia deserves that. Certainly the corporate customers deserve that, as well as the leisure customers. And I think we're in a good position in how we go forward.

AK: Are you prepared to tell us how much you've invested in that new paradigm; the new competitive landscape?

JB: Oh, you mean for the product and…

AK: Well, what's the total investment in taking Virgin up-market as you've done?

JB: Well look, it's a really difficult figure to come up with. We said our last financial results and certainly two years ago when we started, that the incremental capital costs of embarking on this program, in the first year, realising we've just finished the second year, was going to be about $35 million. And as it turns out the incremental cost in that first year was actually lower than the $35 million because we rolled some of that in the second year. And so, you know, we've been very prudent with our expenditure.

When you look at our fleet composition, the fact that we've got 50 per cent of our aircraft already painted in the new colours doesn't mean we painted 50 aircraft. What it does mean is that, because we turn over our fleet very frequently, we've got a very fleet age, you know, of just over four years. As new aircraft come in, they come in with the new paint; it doesn't cost you anymore. They come in with the new interiors; it just barely costs you anymore because you're just picking a different coloured seat or a different curtain. So, the reconfiguration program costs were minimal because we're turning the aircraft over so fast.

AK: Is there an operating cost investment as well?

JB: Oh, absolutely there is. Absolutely there is.

AK: And are you getting a return on your investment now?

JB: Oh well, have a look at the yield… have a look at the CASK (cost per available seat kilometres) growth. We've had a yield growth of 12 per cent. We had a CASK growth, cost per ASK (available seat kilometres), of 4.5 per cent. So the margin is there, clearly.

RG: John, when you left Qantas you left on the table for Alan Joyce a joint venture, or an alliance joint venture, with Etihad. Did you have every finger crossed that Alan would be too busy to take it up?

JB: No, not at all. Well first of all, I didn't join Virgin for 12 months, twice my non-compete period, may I add, so there was never any intention to go to another airline. But this opportunity was just so great, how could you knock it back? You know, when we designed that strategy and we knew that we wanted to go into this – it's called a virtual network alliance strategy – clearly we looked around the world for the best carriers and who they would be and how we would, you know, make the arrangements? And it was very clear that the Etihad arrangement had not been taken up, so it was an obvious choice.

RG: You must have been celebrating when you saw this not being taken up.

JB: No, not really. You know, it might surprise you, but I haven't really focused on them very much. I mean I'm very focused on our strategy and on doing what's best for us. You know, what they do is up to them. And I think, by the way, and this is a very important point, that is what has enabled us to achieve what we've achieved in less time than we thought and achieve it.

You know, the fact is that our managing team – and for that matter, our staff and I – have all been focused on the strategy. We're not going forward with our heads looking behind our shoulder. If you do that you'll wind up hitting a tree. We're very focused on our strategy and very focused on going forward.

If we had not done that, we wouldn't have been able to do what we've done. Think of all the distractions that we've had thrown at us over the last couple of years – and in the last 12 months alone – including the floods in Queensland where And I just remind you that Queensland is over, 50 per cent of all our flying is either in and out of Queensland or within Queensland, but half of our business basically was shut down almost because of the floods. Now, these are massive, massive events that had happened, yet we were able to stay focused and stay on delivery times, in fact are ahead of delivery times. And that's a real credit to the staff. I mean frankly I'm honoured to be leading them. I've never seen staff so engaged and so willing to make a difference and look after the customer.

SB: John, those international alliances drove a more than doubling of that interline and code share revenues. What's their potential?

JB: Oh look, poor. You know, well, if you look at the Singapore Airlines one, we've only just started it, so you've only just seen a couple of months' worth of results from that. If you look at the Air New Zealand one and Delta, we started those two about halfway through the financial year – late in the first half if I remember correctly – so the only one that's really matured is the one that we've held the longest which is the Etihad.

But if you look at our next phase of the Game Change program and you see the tight pillars that we've put up, that we do believe in putting out their numbers and being measured against as we did in the last 10 years. You'll see that there's a figure there of around $150 million that we believe we can achieve in revenue in interline and code sharing. So I think the potential is very, very low.

SB: If Qantas strikes its own alliance with Emirates, does that change the game at all?

JB: It doesn't change anything for us. Our strategy is very strong whoever they join, so not at all concerned about that.

RG: Do you think eventually that Etihad will control Virgin?

JB: Look, they've made it very clear that they don't want to and you know as well as I do that there is legal sort of commitment for that and can't say that and do something different. Look, I believe what they say and I have no reason not to believe what they say. Let alone the fact, which goes without saying, that there are regulatory hurdles that they'd need to get through anyway. So no I don't believe that.

RG: Do you think Qantas has lost its way?

JB: Oh, I don't know. I don't even think about it. It's entirely up to them.

AK: John, I'm going to give you an opportunity to do an advertisement. I'm a Qantas Frequent Flyer. I'm in the Qantas Club. Now, I've just joined the Velocity program at Virgin. What will I notice is different when I start flying Virgin and using my card and all that stuff? How will it feel? What will be different?

JB: It depends what you're comparing it to. If you're comparing it to the old Virgin…

AK: No, I'm comparing it to Qantas.

JB: Oh okay. So you're comparing it to the competition. And, by the way, I don't know anything about their club. We don't comment on it. But I think what you will see first and foremost is our staff's attention to you as an individual. I believe our staff treat our customers as individuals more than any other carrier that I know.

You know, your Velocity program is a very important one. For example, with our Velocity card now you can earn points by flying on us, but you can redeem them on either Singapore, Delta, Air New Zealand, you know, or Etihad. Or vice versa: if you're flying one of those four airlines, amongst others, you can use those points and redeem them on us.

You know, from the Velocity point of view, you've got a lot of destinations to choose from and earn Virgin points, over 400 destinations and that's only going to grow, by the way. Our aircraft are obviously more refined, much improved on the previous. And very importantly – very, very importantly – we have a very modern fleet. The average age of our fleet is only just over four years of age, and there are not many airlines in the world that can vouch that. And that of course means passenger comfort.

The ground facilities are being improved on a daily basis. If we did have the club, and I'm not saying that we do, but when you went in there, you would see what I mean by the facilities. They are leading edge. I mean there is nothing, nothing anywhere in the world that comes close to it. So, I think there's a lot of reason for not just leisure travellers but for senior business people such as yourselves flying Virgin, let alone the price difference is very competitive.

AK: We'll leave it there, John. Thanks very much.

JB: Thank you all very much and I appreciate your time.

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