Pacific Splash: New entrants make waves in Australia-US market

Brisbane
Source:
This story is sourced from Airline Business
Subscribe today »

A quiet duopoly in the Pacific is turning into a four-way fight as two new entrants dive into the market.

Launching long-haul routes during a recession is something airlines try to avoid. But global strategies factor in the decisions byDelta Air Lines and V Australia to join incumbentsQantas Airways and United Airlines on the nonstop US mainland-Australia route. As a result they are boosting the route's capacity by nearly 30% and raising questions about how any of them will ever see any profit in this suddenly over-heated market.

For the past 15 years Qantas and United have divided the US mainland-Australia nonstop market mostly between themselves. By far, Qantas was the bigger player with about 75% of the capacity. Its only competition most of the time came from the one-stop carriers-Air New Zealand, Hawaiian, and Fiji's Air Pacific, plus the round-about routing offered by several Asian carriers. Of all these, only Air New Zealand provided any serious challenge in terms of seats and schedules.For years this has been a stable market.

dolphins (445) sunset/rex features 
 ©Sunset/Rex Features

The US is one of Australia's top ten markets, with average annual traffic of 1.7 million passengers. The closest Qantas or United has come to revealing the value of this route was when former Qantas chief executive Geoff Dixon disclosed it generated "less than 15%" of total Qantas profit. Dixon had several reasons to downplay this value, and some observers suspect it is higher. Alan Joyce, Dixon's successor, points outtoday the route is unprofitable, albeit cash-positive, but declines to disclose its contribution to total revenue. Whatever its value, Australia's Virgin Blue saw the US market as lucrative enough to justify creating a long-haul unit dubbed V Australia and launchedservice earlier this year. It now operates Boeing 777-300ERs to Los Angeles daily from Sydney, thrice weekly from Brisbane, and, starting in August, thrice weekly from Melbourne. When it set this plan in motion five years ago, Virgin Blue saw the US as a profitable growth opportunity, although it also had another reason for entering this market.

That reason was Sir Richard Branson's dream of creating a round-the-world Virgin network. When Virgin Atlantic launched UK-Australia service late in 2004, that left the Pacific as the only gap. Publicly, Branson threatened to form a separate Australian company and launch US flights on his own if ­Virgin Blue declined to do it. His threat was mostly directed at the reluctant head of Patrick Corp, which was then Virgin Blue's majority owner.

Both Branson and Virgin Blue's senior managers also worried that Singapore Airlines was pressing the Australian government in Canberrafor fifth freedom rights across the Pacific. The upshot was that Virgin Blue told Canberra of its interest in the US route late in 2004, and followed with a formal application the next year. The Open Skies bilateral inked by Australia and the US in 2008 cleared the way for V Australia to operate the number of frequencies it needs to make the route viable.

Delta makes its move

Delta benefitted from the Open Skies dealin the same way. It is launching daily Los Angeles-Sydney nonstops in July, operating 777-200LRs. But it also has other motives for entering this market. Its acquisition of Northwest Airlines last year gave it instant dominance in the Pacific and into southeast Asia via the extensive fifth freedoms Northwest enjoys beyond Japan. The gaping hole in this new Pacific network was Australasia, and that is about to change.

Delta's Sydney route also bolsters its presence at Los Angeles, a point it stressed when it announced this launch, and the Australian route allows it to boast that is the only US ­airline to fly to six continents.

Delta may see Australia now as part of a bigger picture, but this is not the first time it has shown an interest in Down Under. In the early 1990s, when the only way for a US ­carrier to add Australia to its network was to buy route rights from another US carrier, Delta approached Continental about the latter's Australian rights. But Continental entered bankruptcy before any decision, and that was, until this latest move, the end of Delta's flight plan for Australia.

Brett Godfrey, Virgin Blue's chief executive, always expected a fourth carrier on the route, but not so soon.Delta arrived six months earlier than Godfrey predicted, but the irrepressible Branson predicts Delta could make an equally quick exit. He claims: "I would put money on either Delta or United not flying across the Pacific in two to three years."

Whether, when, and which of the four rivals on the market may retreat has already prompted much speculation. None of them are offering predictions. As Alison Espley, United's general manager for Australia and New Zealand, says: "I focus on what I need to do to maintain our position rather than on what the competition is doing."

Worst Time To Launch

Godfrey admits this is the worst time to launch. "When we planned this five years ago, there was no way to predict the current financial crisis. The sweet spot has gone sour, but V Australia is in this for the long haul."

While alsoconceding that times are tough, Richard Branson is more assertive. At the delivery of V Australia's first 777, he stressed: "We love a challenge. If Winston Churchill were alive today, which airline do you ­suppose he would be flying?"

But V Australia is also adjusting to realities. It has deferred delivery of two 777s initially due next year. Capacity on the US-Australia route is still set to rise 30% this year, but V Australia hints that it may tweak its network. One likely casualty is its South African launch. Already delayed once, it could be pushed back further.

Delta's Australian launch also coincides with its own cutbacks elsewhere. It delayed new flights to Sao Paulo, announced as part of the fanfare over its Los Angeles gateway. It plans to cut 10% of its international capacity in September, targeting its Atlantic and Pacific networks. Its use of the 777-200LR on the Sydney route itself represents a cautious start. The 200LR's unit costs are 10% higher than on the 777-300ER V Australia is flying, but its trip costs are 10% lower. Thus, Delta's jets are not the right aircraft for a growing market, but maybe the best aircraft for now.

United cut capacity a year before the current downturn when it dropped nonstops to Melbourne in favor of consolidating all traffic over Sydney. Its only Australian nonstrops now, except for special events like the Australian Open in Melbourne, are to and from Sydney.

And even as Qantas continues to deploy new Airbus A380s on the Pacific market, it is pulling Boeing 747-400s off. At least four are parked at Melbourne airport awaiting sale. By September, Qantas will operate daily A380s on Sydney-Los Angeles. However, for the year Joyce plans "a slight reduction" in capacity.

As carriers adjust capacity the numbers change, but overall it appears by year's end that the nonstop market share will be Qantas 60%, United 17%, V Australia 15%, and Delta 8%. By this measure Qantas has over the past year been the big loser and V Australia the winner, but seats have value only when they are full are that value depends on what passengers will pay to fill them.

V Australia, for instance, is painfully aware that its ability to draw US passengers depends on it becoming a partner in the loyalty ­programmes of US carriers. US passengers who belong to the American or Alaska Airlines plans, for instance, pick Qantas because they earn points on it. But V Australia's options for US partners are limited. Most US carriers are now direct or indirect players in the Australian market, especially as Continental exits SkyTeam and moves toward Star Alliance. Virgin America probably has room on its dance card, but V Australia needs bigger partners to match the draw of Qantas/American, United/Continental, or Delta/Northwest. Few such partners are left.

"We realise the importance of this for outbound US traffic," Godfrey concedes, "but our focus has been on our point-to-point start."

Incumbent Strengths

Incumbents Qantas and United are taking the longer view about the new competition. Neither one seems prepared to defend market share, especially when they see the market flooded with too many seats. But they are both adamant that they will not retreat from the Pacific route. Joyce insists that Qantas will defend its "network", while Espley stresses that United has been in Australia for 24 years and plans to stay.

United claims it is the best prepared of any rival on the route to deal with changing economics and competition. Espley points to the adjustments United madebefore it emerged from Chapter 11 in 2003. "We learned how to manage costs and also make the kind of investment we need. Compared with other airlines, I think we are ahead of the game."

She cites how the Continental alliance will fill holes in United's domestic route map, and thus improve its feed. "Our networks dovetail quite nicely," Espley says."Continental compliments us well on the East Coast, particularly New York."

Delta, with its Northwest acquisition, may now be the world's biggest airline, but Espley concedes nothing about its prowess in the Pacific. "The vast majority of our customers connect beyond the US West Coast, and we offer more connections at Los Angeles than anybody else. We have 165 nonstops to 57 cities," she says. "That's six or seven more than the next largest carrier, American, and twice as many nonstops as other competitors."

The incumbents have been hit hard by a 20% to 30% drop in premium travel over the past year, but both are responding to it. United upgraded the last of its Boeing 747s on the route last November, replacing 73 business class seats with 52 that include lie-flat beds. Cutting premium capacity allowed United to make a corresponding increase of 50 seats in economy. These changes proved clairvoyant in terms of where demand is moving.

Qantas has dropped first class on its San Francisco flights until the end of October and is reviewing other ways to shift more capacity toward the back of the plane. "Premium economy has been the best performing class on our international network," says Joyce. "We configured the aircraft for the best of times. Reconfiguring is costly. The payback period could be long, so part of the decision is over how long this downturn will go on." He predictsno "monumental" changes, saying: "Rather than a major change, it's going to be a tweak."

As the biggest incumbent, Qantas has the most to lose.V Australian has cut into its commanding capacity share at all three Australian gateways; Sydney, Melbourne, and Brisbane. But its lead at all three remains commanding; 69%, 89%, and 72% respectively for US nonstops. It also holds a strong position on one-stop service to the US via Auckland, something its rivals completely lack.

This network strength is first in a long litany of advantages Joyce extols. "Our position is stronger than our competitors," he says, citing the Airbus A380 product, which Qantas alone offers, its strong US partners, its vast distribution network within Australia, a frequent flyer programme with 5 million members, new loyalty links with Australia's largest grocery chain, and so forth. It is indeed an empire any rival would envy.

Both incumbents have also seen other US airlines come and go. American launched Australian flights in 1990 but quit two years later to codeshare instead with Qantas. As American withdrew, Northwest arrived. Northwest seemed more interested in the fifth freedom route between Japan and Australia than US-Australia, and after many arguments with Tokyo and Canberra it withdrew in 1994. In the meantime Continental had also come and gone.

Conversely, V Australia isthe firstlocalrival to Qantas.Ansett was planning a US launch before Air New Zealand bought it in 2000, but it never happened. Quietly, Qantas may even welcome V Australia as a competitor if that helps keep Singapore Airlines off the Pacific.

Each of the four rivals in the US-Australia market would agree that it cannot support the current hugecapacity boost. Joyce speaks for all of them when he says: "Capacity on this route has to rationalise. We've seen this in the past with the arrival of Continental and Northwest. It's always rationalised and it eventually will again because all of these are commercial players."

The issue is how each airline, with its own agenda, will make the cuts needed so that the route becomes sustainable for anyone. As Joyce also says: "It's a vicious circle. Once you start scaling back, you start losing the competitive advantage you have."It becomes a question of who will blink first.

Click here for more on Virgin Blue and V Australia read our recent interview with Brett Godfrey