With the collapse of negotiations to buy a stake in Ansett Australia and the future of the single Australasian marlket still hanging in the balance, Air New Zealand must continue to focus on cost control and selective expansion. Report by Tom Ballantyne.Air New Zealand managers like to say the carrier is an airline second and a business first. For one day every month the company's most senior executives disappear behind closed doors with their taciturn managing director Jim McCrea to rake through the carrier's latest operational and financial statistics, analysing the results in microscopic detail.

McCrea pummels everyone with his favourite phrases: 'You have to be able to compete' and 'you have to create a margin'. If the market can't give the airline a yield increase, he says, they have to turn back to costs and eke out more gains there.

Insiders say the carrier has never before spent so much time on the dynamics of the business, nor put so much cash into marketing and financial systems. 'One of the biggest changes is the ability to measure performance pretty exactly and not have any amorphous pockets interfering disproportionately with revenue or cost,' says Tony Marks, general manager sales and marketing international.

This approach appears to be working. McCrea reminded delegates at a recent conference that since Air NZ was privatised in 1989 the international aviation industry has lost the equivalent of all the profits it ever made. In those five years Air NZ has achieved significant increases in operating profit and ASKs, while reducing staff numbers. The company's business unit structure has been reshaped to help identify cost and operating efficiencies and a joint agreement with combined unions offered staff a share in benefits in return for increased productivity, bringing an across the board wage increase of 5 per cent last year. Gains have come from foreign exchange - the NZ Dollar has been appreciating against some of the world's currencies - but Air NZ's diligence over cost reduction has paid handsome dividends. 'We endeavour to declare every cost variable and treat every cost as high,' says Marks.

'We have learned to work harder and smarter. Progress has been achieved in a marketplace where pressures on pricing and margins have all been downward. We have been relentless in increasing our competitiveness, and unswerving in our commitment to meeting the requirements of shareholders who have put their capital at risk,' says McCrea. Between 1991 and 1994 earnings per share increased 230 per cent to 43.3 NZ cents while the ratio of net debt to capital funds declined from 136 per cent to 47 per cent.

The proof is certainly in the pudding. Latest annual results, for the year to June 30, are expected to show a net profit of around US$170 million, up from US$107.4 million in 1994. With revenue approaching $2 billion, Air NZ is the country's fifth largest public company and brings in more than $1 billion in foreign exchange a year, a third of the nation's total earnings from tourism.

McCrea's emphasis on solid business disciplines, strong international growth and a dynamic New Zealand economy have brought a sustained rise in profitability. Yet the future is far from gilt-edged as Air NZ continuously strives to sidestep serious barriers to long-term development.

In July the abandonment of long-term negotiations with Rupert Murdoch's News Ltd to buy its 50 per cent stake in Australian domestic Ansett shattered the carrier's plans to break into its trans-Tasman neighbour's market. Without unfettered access to Australia's skies - a development which would immediately lift its home market passenger base from 3 million to 20 million - Air NZ will continue to be hobbled by the disadvantage of being based in a small antipodean country.

Selective route development brought impressive growth in offshore business last year: Asian traffic increased by 18.6 per cent, North American by 13.8 per cent and Australian by 14.8 per cent. But the increases are likely to flatten out if Air NZ fails to take the next step in its growth strategy and get full access to Australia's skies.

Despite earlier signs that Canberra was more than happy to wing its way towards a single trans-Tasman aviation market, its establishment has proven to be far from easy. Air NZ already has excellent fifth freedom rights through Australia to Asia and the US but Canberra has placed a freeze on any increase in the current allowance.

Australia reneged on a single market deal last year - apparently due to concerns over the impact on the Qantas flotation - just days before Air NZ was due to be granted full rights to its neighbour's far wider domestic skies.

A huge question mark hangs over whether moves towards a single market will be put back on track now that the Australian flag's privatisation is complete. Many cynical New Zealanders are reluctant to place their trust in Canberra's promises.

One way or another, Air NZ is determined to break through and until recently the carrier had pinned its hopes on a back door entry through half ownership of Ansett. The deal collapsed at the end of July however, apparently because the US$360 million being demanded by News Corp for its 50 per cent share of the airline - which hasn't been performing too well in recent times - was considered far too high by Air NZ.

Air NZ may return to the negotiating table with Ansett in an attempt to hammer out some sort of major non-equity commercial alliance with the potential to give it many of the benefits of partnership without the heartache of part ownership.

Another attempt by Air NZ to buy into Ansett can't be ruled out - it first tried to negotiate a deal in 1993 - and a merger still makes sense. It would see the formation of a strong new Australasian airline group more suited to meeting Qantas on equal terms by raising the Auckland carrier's size and status. Air NZ/Ansett's integrated network of domestic and trans-Tasman flights would feed the Asian, North American and European flights operated by Air NZ and the Asian services flown by Ansett International.

Another possibility being considered by Air NZ is involvement in the setting up of a third Australian domestic which, though managed from Auckland, would be majority owned by Australians. This option would scarcely be more costly than the Ansett investment but would raise fears of overcapacity and fares discounting in the Australian market, threatening both Ansett and Qantas. Failing that, Air NZ must pin its hopes on a single Australasian market eventually becoming reality.

The inevitable transformation of Australasia's aeropolitical climate raises some complex bilateral questions, however. If Air NZ eventually operates or owns part of an Australian airline and a single market comes into existence, will air service agreements have to be renegotiated for example?

McCrea is mindful of the shadow boxing that is needed to clarify these issues. He makes the point that some airline behaviour challenges the basis on which governments have endeavoured to provide for a fair and orderly exchange of operating rights. Alliances such as those between BA, Qantas and USAir; KLM and Northwest; and Lufthansa and United are a 'natural and necessary evolution of the airline industry', he says. But they do not fit 'the traditional patterns of individual national identity in airline ownership and control that have been the foundation of the bilateral processes between governments for managing the exchange of market access rights . . .', McCrea adds.

The consequences of failure to win Australian access has been a subject of constant and very serious debate at Air NZ because it would stifle the carrier's future growth. 'We have specific goals of being a major inbound carrier in the Australia and NZ markets and between the two,' says Marks. 'A significant number of tourists who come to the South Pacific wish to go to Australia as part of their itinerary and obviously if we don't have a reasonable level of access to enable them to stay on line with us to achieve that, then over time it would be deleterious to our performance.'

Granting unfettered access to and through Australia can only help bring more visitors to both countries, says Marks. He draws an analogy with Japan's car makers, which 'compete very significantly against each other but their collective ambition has enabled them to become very effective as car manufacturers overseas'. Qantas and Air NZ should be blood brothers, he adds.

Qantas has dabbled in such cooperation but the rivalry is bitter and runs deep, even though Qantas holds a 20 per cent stake in Air NZ. The Australian flag's chairman Gary Pemberton and managing director James Strong had to step down from Air NZ's board earlier this year because of the ongoing Ansett negotiations.

The extent of Air NZ's fifth freedom rights still rankles with Qantas because they allow Air NZ to fly through its Brisbane hub to highly lucrative destinations in Japan, Korea, Taiwan and Thailand, and from Sydney to the US - all critical routes for Qantas. Qantas has similar rights through New Zealand but bemoans the fact that apart from flying on to the US through Auckland, about the only other place it could go is Antarctica.

As both carriers chase costs, every percentage point of market share becomes increasingly important and the philosophical difference over how they should attack world markets is likely to be a continuing battleground.

Given Qantas' relationship with BA, a second plank in Air NZ's development will certainly have to be a major alliance. Existing arrangements with other carriers are of the codeshare-frequent flyer kind. Partners include Taiwan's EVA Air and Mandarin, Delta and Northwest in the US, and Canadian International, SAS and Virgin, with an Asian operator expected to be added next year.

Some sources suggest a obvious option would be a link with the KLM-Northwest alliance which would give Air NZ excellent US coverage. Air NZ does not fly to Europe on the Kangaroo route but its wide-ranging services to Asia would connect quite naturally with the Dutch flag throughout the region and in Australia.

Officially Marks will only say that Air NZ 'would be very happy to join a bigger family if we establish that was ultimately to our and their benefit,' says Marks. Interestingly, he adds: 'I rather suspect there will be opportunity in the fullness of time. We are quite aggressive in investigating every opportunity that comes up. There are always irons in the fire.'

Meanwhile, Air NZ intends to pursue its philosophy of selective expansion, concentrating on routes which provide good profitability and shying away from fares discounting to win passengers.

Recent development has largely involved raising capacity to Korea and Taiwan, two of its fastest growing markets, and to the US. Six flights a week were added to Osaka, including three through Brisbane. Air NZ also hopes to add Fukuoka to its current Japanese destinations of Tokyo, Osaka and Nagoya and has rights to China, with services likely to be launched next year.

The overall aim is double digit revenue growth in the range of 10 to 12 per cent, although the carrier will readjust capacity to match demand. One reason it did well during the recession is that it moved quickly to lease out unwanted capacity and Marks says that will be done again if the need arises. Air NZ's fleet of 21 aircraft, including five B747-400s and six B767-300s for international services, remains small by world standards. No new aircraft are due this year but orders have been placed for a B767-300 for delivery in 1997 and a B747-400 in 1998. McCrea knows there will be more skirmishes. 'We cannot assume that as demand for travel grows, supply of airline capacity will unwittingly follow,' he warns.

As it contemplates the future Air NZ's decisions about where and how to operate will be made as investment decisions, not just operating or tactical marketing moves. But the carrier will be hard pressed to achieve lasting prosperity if events with its larger Australian neighbour continue to go the wrong way.

As it contemplates the future Air NZ's decisions about where and how to operate will be made as investment decisions, not just operating or tactical marketing moves. But the carrier will be hard pressed to achieve lasting prosperity if events with its larger Australian neighbour continue to go the wrong way.

Source: Airline Business