Ansett Australia's collapse created expansion opportunities for Qantas and Virgin Blue. Now they are eyeing the market over the Tasman

Australian flag carrier Qantas and low-cost competitor Virgin Blue have spent the past 18 months filling the void left by the collapse of Ansett Australia and carving up the domestic market windfall bequeathed to them.

Cushioned from the effects of the terrorists attacks on the USA by a relatively strong home market, the two have expanded capacity dramatically, replacing and adding aircraft. Virgin Blue, for example, has trebled the size of its fleet.

But with fierce competition between the two in Australia, both are looking across the Tasman at the New Zealand market. Critical to the future shape of the regional industry is the outcome of Air New Zealand's and Qantas's mutual bid for a new cross-border deal in which Qantas would take 22.5% of Air New Zealand (ANZ) and which has already cleared its first regulatory hurdle (Flight International, 3-9 December 2002).

The sought-after alliance would quash any thought of the flag carrier taking up its rights to operate domestically in Australia, and would cement the competitive duopoly. Similarly, newly created Qantas subsidiary JetConnect (Flight International, 30 July-5 August 2002) is now strategically poised either to take a higher profile if Qantas decides to become a long-term competitor with ANZ domestically, or simply be wound up (or absorbed) if ANZ and Qantas's proposed alliance is approved. This would result in Qantas abandoning New Zealand domestic operations - and would inevitably propel Virgin Blue or another low-cost operator into that market.

Regulators on both sides of the Tasman are seeking public submissions on the deal, with Qantas also talking to most of the interested parties and trying to address their concerns, says chief financial officer and acting chief executive Peter Gregg: "We'd be disappointed if it didn't go through, but we'd just get on with life."

Most observers believe "getting on with life" in this context would mean turning up the competitive heat in the New Zealand domestic market, which ANZ still dominates with far wider destination coverage through its regional networks.

Meanwhile, Virgin Blue commercial director David Huttner says his company will make submissions to both governments in the next few weeks on New Zealand domestic and trans-Tasman operations: "The competitive environment in New Zealand will determine when we enter the market, and how much investment we put into it relative to other opportunities. The question is: do we want to be an opportunistic cherry-picking operation, or do we want to become a viable force for competition? Virgin Blue will enter more aggressively if we can see certain structural changes. One would be to take the low-cost weapon out of the Qantas-ANZ arsenal. That low-cost weapon is Freedom Air."

Tough competition

With Qantas now holding 80% of the Australian market, any start-up carrier there would face even more daunting challenges than those which dispatched Compass Mks I and II - Australian low-fare start-ups of the 1990s, Impulse Airlines, and several Ansett-linked independent regionals. Fierce competition between Qantas and Virgin Blue has led to the latter offering a fare on the prime Sydney-Melbourne route of A$33 ($19), including taxes, which, as Gregg observes, leaves his competitor with A$10 of revenue from the sale. "That tells you how difficult the domestic market is," he says.

When Ansett collapsed, Virgin Blue was flying only eight leased Boeing 737-400s and -800s to nine destinations. It has since expanded its fleet to 29 737s in six different variants, flying to Australia's top 16 cities, and is still growing. With new orders and options announced on 16 January, Virgin Blue has set the stage for an eventual fleet of up to 50 Next Generation 737s, declaring its goal of a 30% domestic market share, and heralding international growth into the Pacific and South-East Asia. Virgin claims it has demonstrated its long-term commitment by deciding to purchase future aircraft rather than lease them.

In the Ansett aftermath, Qantas faced and dealt with more complex challenges. To meet the huge domestic market gap left by Ansett, Qantas had to add the equivalent of about seven years' capacity growth virtually overnight. This was initially achieved by diverting capacity from reduced international operations and by extensive wet-leasing, which it is now replacing with new aircraft. Its domestic operations grew by about 50% in the first six to eight months, says chief executive Geoff Dixon, insisting that its ability to react effectively was the product of strategic thinking and industry awareness.

"There are very few large companies that have had to manage such huge and rapid growth without the benefit of a well- thought-out long-term plan," he says. Ansett had been on track by our estimates to lose close to $400 million annually. Virgin was struggling and, on our modelling, had lost considerable sums in April, May and June [2001], and Qantas, despite good international and subsidiary results, had only broken even on its domestic operations between January and June. In other words, with four airlines being urged on to ever greater price competition by a gaggle of self-interested parties, including some state governments, tourism authorities and hotel and resort operators, the industry in domestic Australia had lost over $500 million in little over nine months.

"The speed and relative efficiency with which Qantas stepped into the fray when Ansett collapsed may have created a false impression in some quarters that the collapse was not as traumatic an event for Australian aviation and the broader economy as it really was. Travellers…have already paid $70 million for the Ansett failure through the Ansett ticket levy [a controversial $10 ticket tax to guarantee outstanding Ansett employee entitlements after distribution of liquidation proceeds]. Australian travellers will continue to pay around $11 million a month for the Ansett collapse. These costs of failure vastly outweigh the short-term benefits of extreme price competition, which despite all the talk of management and other failures at Ansett, ultimately brought the airline down."

In the same period that saw Virgin more than treble its fleet, Qantas increased its core fleet from 108 to 122 (including four Boeing 767-300ERs leased to its new leisure arm Australian Airlines), but this apparently modest growth has translated to a considerably higher capacity increase as smaller aircraft were replaced by those with more seats. Eleven more Airbus A330s, three Boeing 747-400ERs and, later, 12 Airbus A380s will swell capacity, which Qantas will match to demand by controlling the rate at which it retires older aircraft.

Dixon has cautioned the government, the market, industry and the travelling public neither to interpret Qantas's A$631 million profit for 2001-2 as a windfall from Ansett's collapse nor to expect Qantas to sacrifice margins in the longer term.

"The market will expect us to do much better [in the current year] because of the billions of dollars of assets we utilise," he says. "If Qantas had not been relatively strong after years of constant change and hard work; flexible enough to make massive scheduling and people changes almost overnight; and prepared to spend $60 million to lease in capacity quickly, then Ansett's collapse would have had a huge sustained impact across the Australian economy, affecting tourism, business and national life."

Unsustainable grip

Gregg admits Qantas's 80% grip on the Australian market "is not something that we would say is long-term sustainable".

Qantas's fleet situation is now almost stabilised. Firm orders are in place to provide for projected domestic and international growth and to reduce average fleet ages. Leased capacity will soon be reduced to five 737s operating in the domestic New Zealand market with JetConnect; and two aircraft wet-leased to boost capacity on the trans-Tasman routes.

Internationally, much of Qantas's cautious expansion is now expected to be through its low-cost Australian Airlines surrogate, based at Cairns in Queensland. Marketed primarily as an inbound carrier, Australian's outbound potential will also be promoted when its route network grows, placing it head-to-head in its chosen markets with Virgin Blue.

With a start-up fleet of four 767-300ERs leased from Qantas, Australian's role is to revisit Asian ports and win back markets lost to Qantas when it abandoned them in the face of rising costs. In its final form, Australian is expected eventually to fly out of each state capital, reaching a fleet of about 12 aircraft. Gregg says: "We'd like to keep it to a single fleet type - the 767-300ER. In terms of routes, it comes down to whether [Australian's chief executive] Dennis Adams can convince Geoff and myself that he can get a viable operation going. The beauty of the Australian concept is that it's also a single-sector airline, which keeps the costs down."

Source: Flight International