Virgin sticks to its plan as sky fight gets costly

In the battle for lucrative corporate and government accounts, the struggle between Virgin Australia and Qantas has been likened to David and Goliath.

Virgin's latest results show the fight is bloody - and will remain so - as the two airlines continue to flood the market with excess capacity.

In the past eight months the decision to increase capacity on the domestic airline market has created one of the most dramatic airline price wars since 2004 when Qantas launched Jetstar.

It has cost Qantas more than $100 million in foregone profits and Virgin more than $20 million as both airlines refrained from passing on the carbon tax impost to passengers, increased capacity, chased and protected corporate accounts and offered cut-price airfares.

Qantas's justification for pushing 11 per cent extra capacity into the market was that it was protecting its market share as Virgin went upmarket and tried to take corporate and government clients as well as lift its game on routes including Sydney to Perth.

Qantas boss Alan Joyce said the airline would continue to retaliate to ensure its market share did not fall below its current 65 per cent. He attributed this decision to the so-called "S-Curve" phenomenon, which maintains that in aviation revenue will fall off a cliff if market share falls below a certain level.

But Virgin isn't about to withdraw. It has committed to adding another 5 to 7 per cent capacity in the next six months.

It is part of Virgin's game plan to reposition the airline to become more resilient to market shocks by broadening its revenue base. For Virgin boss John Borghetti it isn't about building market share for market share's sake but adding capacity on routes that had previously been neglected.

"If there is one slide that indicates the airline's resilience it is the capacity slide," Borghetti told investors and the media at the group's half-year profit presentation on Tuesday.

The slide shows that in the past six months Virgin increased capacity by 3 per cent on the Sydney to Melbourne route, compared with 57 per cent for Jetstar and 11 per cent for Qantas.

"When you see this sort of capacity flood, you can see it has had an impact on yield but our yield has performed better than market," he said.

"If this happened 18 months ago, it would have been a different story. We would not be saying we have made a profit, but a loss. The fact is the genie is now out of the bottle and we are a more resilient business and we can cope with the shocks thrown at us," he said.

Virgin reported a net profit of $23 million for the six months to December 31, which was down more than 50 per cent from the previous corresponding period's $51.8 million profit. While some of the fall can be attributed to a higher than expected profit in 2011 due to industrial disputes and the grounding of all planes by Qantas, much of it is due to the competitive reaction of Qantas.

Last week, Qantas reported its domestic Qantas business fell from $328 million to $218 million, wiping more than $100 million in profit, from the excess capacity and the price war with Virgin and Tiger.

The battle is likely to continue, particularly if Virgin gets the green light from the Australian Competition and Consumer Commission to proceed with a 60 per cent stake in Tiger. A decision is expected around March 18.

Airlines have a long history of price wars. The most savage was in 2004 when extra capacity was dumped into the market when Qantas launched Jetstar.

Eventually things settle back down to some kind of equilibrium. But this time the dynamics have changed. This is the first time Qantas is up against a competitor like Virgin, which is positioning itself as a full-service airline. And if it gets Tiger, it will go head to head with Jetstar and QantasLink through its acquisition of Skywest.

The key will be costs and getting efficiencies, and this is Virgin's focus. To this end it has migrated its bookings and reservations to the Sabre reservations system, aiming to grow revenues by giving travel agents ability to book Virgin more easily. It also reported that its business efficiency project generated gains of $25 million in the first half and is on track to extract $60 million in gains by the end of the 2013 financial year.

Virgin is also working on its international business, boosted recently by the emergence of Singapore Airlines on the register with a 10 per cent stake, Etihad, Air New Zealand and Richard Branson.

In the past six months international revenue climbed from $552 million to $595 million and earnings before interest and tax rose slightly from $32 million to $35 million. It is also growing its frequent-flyer business, which now has 3.5 million members.

But the market isn't convinced. Investors pushed Virgin's share price 5.7 per cent lower to 41¢ a share as they questioned where the battle with Qantas might end.

But for Borghetti all is going according to plan. "Two years ago I said we were very focused on making our business more resilient ... many people said we would spend too much money, we would never succeed, the force of the competitor would push us back and we would certainly never be able to break the corporate and government stranglehold. It was a bit of a David and Goliath type position we found ourselves in," he said. Time will tell.