Too much company in Virgin's three-way alliance

The alliance announced today by Air New Zealand and Singapore Airlines is a rational, albeit limited, response to the larger Qantas and Emirates alliance. It may also have implications for Virgin Australia.

Under the alliance Air NZ will target Asian routes via Singapore and Singapore Airlines’ Asian network. It also gets access to Singapore’s European services on a codeshare basis while Singapore Airlines will begin flying A380s between Singapore and Auckland, with codeshare access to Air NZ’s domestic network. The new allies plan to eventually boost capacity on the NZ/Singapore route by up to 30 per cent.

Given the relatively small size of the NZ market the partnership might appear of only modest consequence. Air NZ and Singapore Airlines are, however, two of the three strategic shareholders in Virgin Australia. The third is Abu Dhabi’s Etihad.

Following Virgin’s recent capital raising Air NZ owns 24.5 per cent of Virgin, while Singapore Airlines and Etihad each hold about 21.2 per cent.

All three of the strategic shareholders have separate alliances with Virgin, which sought them as part of John Borghetti’s strategy of creating a virtual international network.

The foreign carriers, in return, get access via Virgin to the Australian domestic market and in the process have been able to help Virgin attack Qantas – one of their key competitors – to the point where it has been forced into loss and has been destabilised.

Of the three strategic shareholders in Virgin, Air New Zealand and Singapore Airlines were always likely to have the most in common.

Before Air NZ had to be bailed out by New Zealand taxpayers after its disastrous foray into the Australia market with the acquisition of Ansett, Singapore Airlines owned 25 per cent of Air NZ as an indirect way of gaining an exposure to the Australian market via that Air NZ ownership of Ansett. The carriers therefore have some shared history and similar ambitions towards the Australian market.

While it may not be a game-changer for either airline, it is a response to Qantas’ alliance with Emirates, which channels Qantas passengers through Emirates’ Dubai hub and onto Europe. Qantas shifted its regional hub from Singapore to Dubai after cementing the deal with Emirates.

Singapore is quite concerned about the rise and rise of the Middle Eastern airlines and hubs and the shift in passenger flows away from Singapore. The deal with Air NZ is a modest counter to that trend.

Disconcerting for Etihad’s James Hogan is the prospect that the new allies will see Virgin as another element in their particular competitive response to the Qantas/Emirates alliance and its impact on Dubai’s own competitiveness as a hub. Between them they account for about 45 per cent of Virgin’s capital and could, if they acted together, effectively control it.

Etihad, which effectively pioneered the virtual network strategy – a network it cemented with strategic shareholdings and operating agreements – was Virgin’s first international ally. The Etihad strategy, which is being expanded almost on a daily basis, leverages off Etihad’s Abu Dhabi hub.

Hogan appeared initially to be blind-sided by the emergence of Air NZ and Singapore Airlines as Virgin allies and was forced to counter their presence on the Virgin register with share purchases of his own. If they were to act in concert his Virgin shareholding and his alliance with Virgin would be less than strategic and Abu Dhabi could lose Virgin volumes to Singapore.

Qantas, of course, is confronting more direct pressures. It has lost its prized investment grade credit rating, lost money in the first half of this year for the first time since its privatisation after Virgin ignited a capacity war last year and is undertaking an urgent strategic review that could see it selling equity in some of its most valuable businesses, including its frequent flyer program.

It would no doubt be hoping that, just as Borghetti’s encirclement strategy in the domestic market – supported and funded by his allies – appears to be biting, Virgin might be distracted and unsettled by shareholder politics and the potentially competing agendas of its three big allies.