Qantas spots a silver lining

Virgin has revealed its hand and shown how it will bring the fight to Qantas on the domestic front. But the aggressive strategy offers snippets of relief and opportunity for Alan Joyce and his team.

While it might appear that Qantas is being encircled by an increasingly aggressive and quite creative competitor, the announcements by Virgin Australia aren’t all bad news for Alan Joyce and his team.

In the longer term it probably can’t be good for Qantas for Virgin to be a bigger group with the ability to leverage lower cost bases to attack Qantas at each of its brands’ key price points, which is the potential that lies within yesterday's deals.

Virgin has a lower cost base than Qantas mainline, Skywest has a lower cost base than QantasLink and Tiger has a lower cost base than Jetstar. Their aggregate effect will be to lower Virgin Australia’s overall cost base while also allowing it to target the various Qantas brands with lower cost entities.

Nor, in the longer term, is it likely to be good for Qantas to have its key regional rival, Singapore Airlines, as a strategic shareholder in Virgin and a key partner in the new Tiger joint venture.

Qantas however, has more immediate issues to deal with as it undertakes a massive restructuring of its operations to reduce the losses being generated by an international business not configured for the global aviation landscape that has developed as new airlines operating out of new and strategically located hubs have emerged and the low cost carrier phenomenon has become an established and growing slab of the industry.

It won’t be unhappy that Virgin’s John Borghetti is going to have his hands full bedding down his two acquisitions and trying to stem the losses within Tiger Airways Australia in particular. With three Air Operator’s Certificates to manage and comply with there are going to be some distractions and costs in managing the suddenly more complex group.

Moreover, Qantas knows that Borghetti might be a clever and aggressive competitor but he is also a vastly experienced one.

Borghetti makes a point of never talking about his market share aspirations – indeed he says, repeatedly, that he has none. For him, he says, it is about profit and improving the returns Virgin can generate for its shareholders, which with the addition of Singapore Airlines is starting to resemble a club of Qantas competitors.

If Borghetti remains a rational competitor focused on profit – some of his shareholder/allies might prefer a somewhat broader definition of rational behaviour and their competitive aspirations – he is likely to manage the extra capacity he is acquiring, which he plans to add to, in line with demand and to maximise yields. He’s paying a full price for Skywest and Tiger, which adds to the pressure to improve their performances to generate a return on the investments.

The problem with a Tiger is that, apart from its brand issues, it has been trying to muscle into a market against two strong competitors with only price as a tactic. Despite its modest size, it effectively has set the benchmark prices on the routes it contests – the other carriers have to price by reference to what it is doing. It hasn’t necessarily been a rational competitor.

Given its losses, and his imperatives, Borghetti is likely to introduce greater discipline to Tiger’s pricing, which can’t be bad for either Virgin (which is still over-exposed to leisure routes) or Qantas.

In fact, a key take-away from the deals is that, assuming the Australian Competition and Consumer Commission clears them, the domestic aviation market will be very much a duopoly, which generally leads to rational behaviour.

Virgin’s attack on Qantas’ stranglehold on business travel has seen it add both costs and capacity to its business and the domestic market this year, with the capacity increases matched by Qantas and resulting in lower yields for both carriers, although the capacity wars seems to be abating and were in any event targeted at specific routes.

Until he can end the Tiger losses one would expect Borghetti to be careful not to poke Qantas too sharply and ignite a broader and more destructive price and capacity war.

The other issue that could distract Borghetti is how he manages his unusual share register. He’s adding Singapore Airlines to Richard Branson’s Virgin Group, Etihad and Delta.

Etihad’s James Hogan is unlikely to be pleased that Singapore has been invited in via a placement and will now have a business relationship with Virgin (via Tiger) beyond its alliance and shareholding. That could create some tensions among the Virgin allies, given that Abu Dhabi and Singapore represent rival hubs and gateways into Europe for Australian travellers.

Another aspect of the dealings that would please Qantas is that they could help it get its own vital and deep alliance with Emirates past the ACCC.

To the extent that there were domestic implications flowing from that alliance (a stronger international dimension helps protect Qantas’ domestic dominance) Qantas can now point to a strengthened competitor with a far broader range of alliances that it has, with most of Qantas’ main competitors on its register and with a partnership with the broader region’s strongest carrier.

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