Virgin Blue chief Brett Godfrey believes the carrier can turn high fuel costs to its advantage. Is he being overly optimistic or can the carrier weather the storm?

Trouble creates a capacity to handle it," Oliver Wendell Holmes, a former US Supreme Court justice, once said. He might well have been talking about today's airline industry.

Nowhere is this more true than with the leaders of those airlines who see opportunity in today's high jet fuel costs where others see only crisis. No airline is immune from these costs, but Brett Godfrey, chief executive of Australia's Virgin Blue, thinks the upmarket moves his airline has made position it to ­survive and perhaps even prosper at a time when others foresee potential disaster.

Virgin Blue E-170 
 © Virgin Blue

Godfrey is not alone in this view. Ryanair chief executive Michael O'Leary says he welcomes high fuel prices because he thinks they will kill off some rivals. Others predict failures, but Godfrey does not go so far as to suggest that Qantas, its low-cost subsidiary Jetstar or Tiger Airways - Virgin Blue's three domestic rivals - will take a dive. Rather, he thinks Virgin Blue will benefit because of its strengths.

Opinions differ on how seriously Virgin Blue takes the threat of high fuel costs. UBS analyst Simon Mitchell cautions that Virgin Blue's capital position could be "strained" if fuel prices remain high. JPMorgan Chase ­issued a critical report widely seen as a warning that Virgin Blue might not survive if high fuel costs persist. After Godfrey responded to this with both barrels JPMorgan backed down, claiming its views had been misread. Yet Derek Sadubin, chief operating officer at the Sydney-based Centre for Asia Pacific Aviation, continues to warn that Virgin Blue is stranded in "no man's land" between Qantas and its low-cost rivals, Jetstar and Tiger.

However, uncertainty over Virgin Blue's future was abated, at least for the time being, when majority owner Toll Holdings decided in July to hand over most of its 62.7% stake to shareholders. Sir Richard Branson's Virgin Group is now the biggest shareholder with a 25.5% stake, and says it remains a long-term committed shareholder.

Like airlines worldwide, Virgin Blue has responded to high fuel costs with a series of now-familiar measures - cutting costs, dropping marginal routes, raising fares, adding fees, freezing salaries, deferring aircraft deliveries, and pulling capacity out of the market. Virgin Blue also suspended a major potential aircraft order that Godfrey says the carrier "had been working on for some time" and which would have been "the biggest order we'd ever placed".

Godfrey predicts jet fuel prices will fall back from the peak of $150 a barrel. But "it would be unconscionable if we were to bet on that". The airline's response to such prices is based, he says, on a two-fold analysis of what Virgin Blue needs to do and what its rivals are doing. "We don't operate in a vacuum," he ­explains. "We watch what everyone else is doing and consider the effect of each cutback on market share and the cost of regaining that market share later. We created a matrix what we would do when fuel is at $165, what we would do at $185, and the more severe ­measures we would take if it hits $200."

CAPA called Virgin Blue's initial cutbacks "less than anticipated" and criticised its ­response to the fuel crisis as "defiant". But both Virgin Blue and Qantas announced more capacity cuts in July, and as a result this year's capacity growth is expected to come close to matching historic demand growth of only ­5-7%. Godfrey prefers to call his response to high fuel costs "cautious opportunism".

On the cautious side, he admits that going ahead with a big aircraft order would have been "too great a risk at the moment". But if fuel prices stay high, Godfrey predicts the industry will experience "a massive cleanout".

"We're not going to be one of them," he ­assures. "But there are a lot of weak airline models out there." This is where the "opportunism" part starts. Recalling how Virgin Blue made what he calls "the deal of the century" - the first big Boeing order after 11 September - Godfrey explains: "We're quite happy to run the risk that there'll be some cracks in demand and some hand-backs." Virgin Blue hopes to turn the current crisis into another great ­aircraft deal once the market softens.

This same attitude pervades Godfrey's ­reaction to the claim that Virgin Blue has moved into "no man's land" between network carrier Qantas and low-cost rivals Jetstar and Tiger. "The reality is that if we hadn't moved up, we would be in deep trouble now," he says. "People who have to spend $100 to fill their car at the petrol pump are starting to put money away. The big risk today lies in discretionary travel. I'd much prefer to be in our camp than in the Jetstar/Tiger camp where they are 100% dependent on leisure travel."

Conversely, Godfrey believes Virgin Blue's lower costs also give it an advantage over Qantas in drawing cost-conscious business travel: "When corporate CFOs see a problem, the first thing that's cut is the travel budget. A lot of corporate accounts are coming up for renegotiation." With corporate concerns about an economic slowdown, "I can go to any one of the top one hundred corporations and say, 'you can cut your spend, but you don't have to cut your travel'. With fares 30-40% below the competition, I see it as a great opportunity for the down-trading of corporate travel."

Godfrey remains optimistic over Virgin Blue's prospects in the current environment, and he does not seem overly concerned by the prospect that Virgin Blue's net profit for the 2007/08 financial year could fall 35% from last year to a modest A$140 million ($135 million). He is more relaxed about it now that the latest round of domestic cutbacks has erased most of the capacity overhang.

The other problem, Godfrey claims, is that Australian and international accounting standards require his airline to write off all non-capital expenses in the year incurred. Start-up costs are not capital expenses, yet Virgin Blue will enjoy long-term benefits from its current and costly initiatives in launching domestic New Zealand service with subsidiary Pacific Blue, and preparing to launch a long-haul airline named V Australia that will fly to the USA later this year. "Our costs have spiked, but they are not perpetual," says Godfrey. "Sixty to 70 million in increased costs this year will be stripped away next year."

Brett Godfrey 
"I can't be any clearer in acknowledging that corporates are doing very well for us right now, and we want more of them."
Brett Godfrey
Chief executive, Virgin Blue
Godfrey is losing no sleep over Virgin Blue's graduation from the low-cost sector into a hybrid status that he calls "New World". Indeed, he plans to move Virgin Blue farther up the scale. "I'm only chastising myself that we haven't pushed harder toward the corporate end. If we had, we might have broken the spirit of this company, but in moving in this direction we made the right decision." He ticks off Virgin Blue's upmarket moves over the past three years - a frequent flyer programme, a premium economy class, interlining with foreign airline partners, corporate lounges, Embraer regional jets and, later this year, V Australia's long-haul launch.

"We get a yield premium over Jetstar and Tiger," he says. "Our retail [economy] market is relatively flat, yet our revenue has gone up probably 11%, because our corporates are up 30%. I can't be any clearer in acknowledging that corporates are doing very well for us right now, and we want more of them."

Virgin Blue's evolution fits a pattern recently identified by Sabre Airline Solutions. It says that an emerging breed of "hybrid" carriers, which blend low-cost carrier traits with those of full-service carriers, have cornered nearly two-thirds of the so-called low-cost market. Sabre does not address whether these hybrids are better suited than either conventional low-cost carriers or network airlines to weather the fuel cost storm. But if Godfrey's confidence in Virgin Blue's future yields the results he thinks it will, this hybrid status may actually give the carrier an advantage.

For an analysis of how low-cost carriers are adapting their business models, go to:


Source: Airline Business