KGB: Virgin's John Borghetti
Virgin Australia's chief executive John Borghetti tells Robert Gottliebsen and Stephen Bartholmeusz:
– Virgin is happy where it is now with capacity growth, having achieved the footprint it wanted.
Stephen Bartholomeusz: John, thanks for joining us.
John Borghetti: Great to speak to you, Steve.
SB: When you decided to attack the core of Qantas' domestic profitability and its high yield passengers by moving Virgin in effect into their space and up-market, did you expect to trigger a capacity war?
JB: Well, I always expected a strong competitive response, so that's not surprising and certainly I wasn't surprised. I think what I was surprised about was the timing of the assault. We started this journey now two years ago and certainly we were in a much weaker position at that point than we are now, so I guess you could say that if this kind of assault that we've had over the last six months, or competition that we've had in the last six months, had happened say 12 or 18 months ago, we would have been in a different position and I'm not sure that we would have come out of it as resiliently as we have. In fact if you look at the key statistics for the last six months, we've outperformed the market on yield, we've carried 10 million passengers, our revenue is up 5.4 per cent and very importantly, and this is a critical point, our cost per available seat kilometre went down 1.5 per cent at a time when we've been investing heavily in product.
And you might recall when we started this journey everybody said: "You're going to spend like a drunken sailor, your costs are going to get out of control". Well, here we are. We've proved that actually the costs have gone backwards, we've improved the product, our revenue has gone up and we've outperformed the market in yield. So I think it proves that it had to happen. But can I make one other point here. Someone said today to me it was a war. Well, let's call it that for the moment. It was a war that had to happen. It had to happen because we have to prove that we have a right to exist and I think we've proved that. And I think the reality of the situation is we do have a right to exist and this is now a duopoly in, and no longer a monopoly in, the premium end.
SB: You are still though, John, a work in progress. And I accept that the metrics of the airline improved and are continuing to improve, but your earnings were almost halved. So, aren't you still vulnerable?
JB: No. Look, it's all comparative, isn't it? I mean we've come out with a stronger balance sheet. You know, we've paid down a debt of $154 million. Yes, of course yield was hit, but we always knew it was going to happen. What element surprised me the most in a sense of the impact on the results, I'd have to say, is probably where the capacity went. We always said when we started the journey – and you can remember this – we said, "look, we're not after market share, what we want is a route network and a frequency that will attract a premium passenger". And in order to have that, we needed three things: we needed a relatively good frequency on Melbourne-Sydney. Well, frankly we had that anyway. We've increased it marginally. We've got 32 flights a day – no big deal there... but the big change was the wide-bodied aircraft across to Perth. And if you look at our capacity growth, 95 per cent of that capacity growth went on Perth across the continent.
The third area was regional Australia with its monopolies. Obviously that's a small amount of capacity and gradually that'll go through. But I think what surprised me was that as we put this capacity on Perth, what we naturally expected was a response that said, well we'll just add capacity on Perth too, so we'll try and hold that position. What I couldn't understand was the capacity going on the Triangle [Melbourne-Sydney-Brisbane]. When it started happening, we said well, we don't know why it's happening, but anyway it's happening, there's nothing we can do about it, let's move on. It gives us an opportunity to march through the schedule changes to Perth. And just on Perth, if I could make the point, we've doubled our capacity there almost in a period of time and our seat factors now on the Perth route, A330, are higher than our national network-wide seat factors. So the market has grown into the Perth capacity. I can't say that about the capacity increase on Melbourne-Sydney-Brisbane.
Robert Gottliebsen: So John, what you're saying is that Alan [Joyce] made two mistakes. Firstly, he didn't attack you early enough when he should have attacked you 18 months ago when you were weaker, and secondly, instead of attacking you where you put your capacity in, he attacked almost at your strength, which has surprised you. So, that's two mistakes he made. And why did he make those mistakes, do you think?
JB: Well, it's not my place to say whether they're mistakes or not – you'd have to ask him. From where we're sitting and what we had planned and what we were expecting to do, that's what we had predicted – that we would have been attacked earlier and that the gate would almost be shut for us on the trans con. We hadn't predicted 50 per cent capacity growth by Jetstar on Melbourne-Sydney to our 3 per cent. So whether it's a mistake or not for him, it's not in my place to say, but it's something we weren't expecting.
SB: It is rational though, isn't it, John, that if he really wants to put pressure on you, the place to do it is where your existing profits are coming from, not where your future profits might – say, the Perth route? So, by putting a lot of capacity in and a lot of Jetstar capacity onto routes where you're already flying and making money, that shakes the tree a bit.
JB: To follow your point just for a moment, on the Melbourne-Sydney sector we're still a small player. We operate narrow-bodied aircraft, we don't have wide-bodied aircraft. We're 30 per cent or something like that of the capacity – actually, a bit less I think it is – so the bulk of the capacity is somebody else's. So if there's any pain on that route, surely logic says the bulk of that pain is disproportionate to the person that's got the most amount of capacity. Now, if we were after – and I should have pointed this out earlier – if our strategy was about market share or capacity share rather than putting our A330s on Perth, for the time it takes an A330 to get to Perth and back, I could have put five or more return services to Melbourne with an A330. That would have got me market share and certainly capacity share.
So it goes back to, what is capacity all about? It doesn't matter what airline you are. In our position, capacity is a consequence of the strategy that we are deploying, it is not the strategy. Our strategy is not capacity, our strategy is penetrating a certain market segment. It just so happens that capacity is a consequence of it.
RG: As I look at your accounts and the effect of the war, or the tussle, with Qantas, whereas the market was expecting you to pay a dividend in say 2014, by the look of it now it'll be about 2015?
JB: I'm not going to talk about dividend because clearly we're in part of a five-year strategy. We're in year two-and-a-half of the strategy, let's call it, and for us at the moment it's prudent to not pay a dividend, but I'm not going to speculate as to when and if we're going to do it. That's entirely a decision for the board at a later point in time.
RG: I do understand that, but you just get the impression that perhaps this encounter with Qantas this time around would delay that dividend force.
JB: I think what it is, Rob, is that there was always going to be a strong competitive response... From the day that I joined this company, I knew there would be a strong competitive response and because I knew that, it made it absolutely imperative that we change the model, and we did so quickly, and I don't think anybody believes us – and frankly I don't know that my executives believed in me when I said it – that if we hadn't moved quickly and the competitive response had come, we would have been in a problem situation.
Now, fortunately for us we did move quickly, and fortunately for us our competitors were tied up fighting other battles and we were able to – call it go under the radar, I don't know what you call it – but we were able to put in place our strategy quickly enough, so that by the time a competition really came back fiercely, we were able to withstand it And I think we've proved it. To come out after these six months with everything we've seen and with some of the stats that I mentioned earlier, I think just shows how resilient the company is.
But even if you don't look at us in isolation and you look at us in a comparative sense to all our competitors – whether it be Tiger, whether it be Qantas, whether it be Jetstar, or anybody – we've outperformed on so many measures. We don't have any one-off payments on our books... Because we outperformed the market on yield and because we added so much capacity knowingly on Perth, therefore the sector length is longer. If anything, on status quo our yield should be dropping because obviously the yield on Melbourne-Sydney is five, and the yield on Sydney-Perth, yet we came out with an outperformance of yield in the market. What that tells you is that our revenue mix, i.e. the amount of business travellers travelling on us, has increased during that period, otherwise we wouldn't have outperformed the market on yield.
RG: I get the impression though from some of your forward-order figures in the balance sheet that a lot of your customers are ordering their fares late as though they're looking for that quick fall in the price that you get when you...book closer to when you're going to travel.
JB: That's a good point. So, can I touch on two areas there? One is our closing cash balance. which you will have seen was down, predominantly due to us bringing down schedules in January to allow a smooth transition of the Sabre system -- and every airline does that -- so obviously we weren't able in December to sell the full extent of our capacity. If I remember correctly, we brought capacity down by about 15 per cent and we capped the flights, so obviously less cash was coming in in December as people were trying to book January. That's an abnormal situation and it's cycled back out now that we're operating at full schedule.
But the second is the booking trend and this is very important. So if you break the customers into two groups, you say there is a business group and a leisure group, there's no question that the business group has been resilient. We haven't seen any drop-off. In fact, we've seen an increase and a gain in share, so that's good...
The leisure market is a totally different situation. I think...there is a need to keep stimulating it and I suspect that the reason that the stimulation effect is needed is because in the last six months or so with this enormous amount of capacity that went on the east coast airlines have come out with sales to try and fill it. So customers see the sale and then they see that there's another sale four or five days later. And they're not silly – they say, "hang on a minute, I'm going to book today, but I know that a sale has just finished yesterday. If I wait till Monday, there'll be another one."
So we're actually educating the consumer to wait for a sale to come out so they can book their ticket. And I think the industry is partly to blame for that more than the economic conditions of the country, and it's going to be interesting now as we go into the second half of the year, and as passenger numbers grow into the capacity, how you take them down the path of, you know, sales aren't going to be as frequent, if that is indeed what happens. But I think...yes, you're right. The booking cycle for leisure has shortened and I suspect that's part of the reason.
SB: John, last question for me on capacity issues. There was almost 11 per cent more capacity in the December half than there had been previously. Both you and Qantas have said you're going to add another 5 per cent to 7 per cent in the second half. How do capacity wars generally end? And how do you think this one could be ended?
JB: I couldn't quite hear the beginning of your question, I think I got the gist of it though. You mentioned statistics on the capacity I think.
SB: That's right – 11 per cent in the December half and another 5 per cent to 7 per cent from both of you in the second half.
JB: Yes, okay. So in terms of the capacity growth in the second half, this current half of the year, there are two things I'd say about our 5-7 per cent.
Firstly, that 5-7 per cent growth is on the corresponding half last year and that was the period where we started bringing in A330s, so that A330 capacity is now washing through. A better comparison would be to say if we look at the Virgin capacity for the second half of the year and compare it to the front half of the year that we've just finished, how does that capacity differ? And if you look at that, it's basically zero. It's not even one per cent growth. And the reason for that is that we've now reached our network footprint, our frequency requirements on Melbourne-Sydney and, importantly, the wide body requirements that we had for Perth. The final step of that is the introduction of an A330 from Brisbane to Perth from April. So half on half, that is, front half versus back half, you'll see our capacity basically flat.
How do these wars end, I think is what you said? One of two ways: either the market catches up with the capacity, or people slow down with their capacity growth. And from our perspective we've reached where we wanted to be. It wasn't about market share. It was about having the footprint. We've done that now and we're quite happy. Now, what other people do is up to them, but as far as we're concerned we're happy where we are and we've said this is where we wanted to be and we'll see where the future goes.
SB: Okay, a different topic: the control of Tiger and that brand. How important to you and your strategy is it to have that other brand to compete with Jetstar and allow you to more fully position Virgin against Qantas?
JB: Well, I have been amused the last couple of days reading the media on what I did say or didn't say on the Australian Competition and Consumer Commission issue with the 35 aeroplanes, so let me tell you what I really said.
First of all, we've always said from day one that if we are going to get a hold of Tiger, then our plan is to grow up to – very important words – up to a fleet of 35 over five years, and we don't see Tiger without our ownership – 60 per cent ownership – being able to do that. So that means it brings competition in.
However, the question I was asked at a press conference was, if the ACCC says that having 35 aircraft is an undertaking, would you still do it? Well, clearly no we wouldn't because no airline chief executive with any sense of intelligence would ever agree to a set capacity growth that triples the fleet within a given period. It's just impossible, because you don't know what's around the corner – bird flu, earthquakes, ash cloud, pestilence, I don't know – so you can't possibly do that. It doesn't change our plan. We still want to get there, but you can't make an ironclad guarantee. So is it important to us? Yes, the Tiger deal is very important to us, otherwise we wouldn't be doing it. But it is not important enough for us to do it at any price.
SB: But is there a plan B if, for instance, the ACCC says no?
JB: Steve, I think you know me. I've got a plan B, C and D.
RG: John, your base Virgin costs, how do they compare with Qantas? Are you lower, or, how much lower?
JB: Well, this is an area of debate. Definitely we're lower, absolutely, and the debate is around the number and by our measurement – as best as we can measure from publically available information and our estimate on what theirs is – it's somewhere around 10 to 15 per cent. Which ironically is probably about the same, except the other way, on where we are versus Jetstar, and probably very similar to where Tiger will be versus Jetstar. So it's actually quite an interesting set of numbers that we've played around with, and within about a five point difference, the gap between the full carriers with Tiger at the bottom, then Jetstar, then us and then Qantas, is about an equal gap in between each player. And it is really important because if we are able to have Tiger, and if we acquire Skywest, we will have the lowest cost provider in all sectors of the market. We'll have the lowest cost provider at the premium end – that is, Virgin versus Qantas; we'll have the lowest cost provider at the budget end – that is, Tiger versus Jetstar; and of course, importantly Skywest, which we'll rebrand Virgin Australia. But that part of the operation, lower cost, is QantasLink. And that's a very, very strong competitive position to be in.
SB: The other dimension to what you've done, John, is the international alliances. They seem to be delivering because of the code share and interline agreements – the revenue from them has been growing very strongly. I take it we wouldn't have seen the impact of Singapore Airlines in those numbers yet, but it could be material?
JB: That's a great question, Steve. We've only just started seeing the impact of Singapore Airlines. But you know what we haven't seen the impact of yet, except for the last three weeks? The influence that our new Sabre reservation system is having on that interline and code share revenue. The amount of bookings that we're seeing come through the system now since we've cut over to Sabre from the likes of Singapore Airlines, Etihad etc., Delta, is really exceeding our expectation.
I'll give you an example. We've had the relationship now with Delta for quite some time, so you could argue it's a mature relationship and in terms of booking trends in the first three weeks of cutover of Sabre – I can't go into numbers, but our revenue people came in and showed me the printout and I said, "look, it's wrong, it can't possibly be right. Please go back and redo it." They came back and said, "John, this is absolutely right."
I was staggered at the growth rate of bookings from America by travel agents in America, because now they can see us. And so I think what we haven't seen there is the full impact of the system change. We disclosed these numbers for the first time, we set ourselves a target this year of $40 million from the code share and interline activity onto our domestic network primarily, and we are absolutely on track for that. Our belief is that next year it'll be somewhere around $100 million and on year three it will be somewhere around, if I remember correctly, a $150 million run rate. That's what this reservation system will do, along with the alliances that we have.
RG: Is this a catch-up with Qantas, or are you ahead of them?
JB: Oh no, definitely a catch-up, absolutely. I mean, we were a low cost carrier. To be frank, the amount of inbound traffic that we were carrying on a domestic network when I started here was in single digits – and by single digits I mean one single digit, closer to the digit one – and clearly that's perfect for a low cost model because that's what it works on, right? No connectivity, etc. That's not unusual. But now we've moved from that and that percentage is growing literally by the day. So, we are playing catch-up, yes, on that.
SB: John, we really appreciate your talking to us and hopefully we can do so again.
RG: Thank you, John.
JB: Thank you very much, gentlemen. Lovely talking to you.
SB: Same here.