Air New Zealand sees its future in a global alliance but has yet to gain access to the Star Alliance. Meanwhile the carrier still needs to overcome major challenges close to home. David Knibb reports from Auckland. Air New ZealandThey say events often happen in threes - all the more reason to hope that the three key decisions on which Air New Zealand's future depends turn out to be good ones. But even if those all play out as Air New Zealand hopes, it still must confront the regional challenges that have led to two consecutive years of falling profits.

As Air New Zealand awaited the outcome of Australia's review of its joint request with Ansett and Singapore Airlines to coordinate operations and codeshare beyond Australia, Lufthansa's willingness to sign a codesharing agreement and the Star Alliance's acceptance of Air New Zealand into the fold both remained under question.

The application to Australia's Competition and Consumer Commission seeks to match similar approvals recently gained by Qantas and British Airways. Air New Zealand, Ansett, and SIA want permission to coordinate their operations and codeshare between Australia and Europe. With Canberra having granted Qantas/BA similar rights, Air New Zealand's application might have seemed straightforward had it not been before a different agency than the one which approved Qantas/BA and were it not for the Australian authorities' track record of scepticism towards alliances.

New Zealand's antitrust agency has already approved Air New Zealand's alliance with SIA for direct New Zealand-Singapore services. But Air New Zealand needs an answer to the strength of Qantas/BA out of Australia and a better hedge against differences in Australian and New Zealand travel patterns. An ACCC decision could still take months, however.

The second pending proposal is the codeshare with Lufthansa. Air New Zealand has been talking for six months about its 'agreement in principle' with Lufthansa and the latter's recent pact with SIA makes an Air New Zealand alliance even more compelling. Both carriers see Singapore as a southeast Asian hub able to link Australasian and European routes. Lufthansa could also help Air New Zealand break free from the constraints of the German bilateral and boost flagging South Pacific traffic from Germany.

Jim McCrea, Air New Zealand's managing director and chief executive, is not worried about the delay with Lufthansa. 'It all has to do with priorities. Lufthansa has been busy with Star and SIA. With Lufthansa and Singapore you're talking about two heavy hitters. We only have three flights a week.' McCrea expects to wrap things up with Lufthansa 'in the next few months.'

Effective partner

A codeshare deal with Lufthansa, coupled with Air New Zealand's current United alliance, would appear to give Air New Zealand the practical benefits of Star Alliance membership without the actual need to join. But McCrea doesn't favour that approach. 'You can gain certain benefits by being engaged but never married, but to be an effective partner, you have to be a member of the alliance.' Air New Zealand is actively seeking entry into Star, but McCrea is cautious about predictions. He notes that current Star members are still working out protocols between themselves to cover common standards, handling transfers, and one-stop check-in. 'I'd like to think [Air New Zealand's entry] is more a question of 'when' than 'whether,' but with respect to all the parties and all the protocols, it would be presumptuous for me to say that.'

An entry into Star by both Air New Zealand and Ansett would not be without its complications. Star does not require exclusivity, but each Star member must have an alliance relationship with each other member. That means Air New Zealand and Ansett would need an alliance with Thai Airways, in addition to their existing relationship with SIA. At the moment, neither of them even flies to Bangkok. Inevitably the question arises of the implications of SIA joining Star for Thai's continued presence in the group and Lufthansa's recent SIA alliance only heightens this issue. McCrea denies any knowledge of Singapore's intentions, but does say: 'We talk to our alliance partners (Singapore and United) and they both see our strategy as quite compatible with both of theirs.'

The global mating dance makes a fascinating spectacle, but only partly addresses Air New Zealand's needs. One of its biggest challenges is to match the growing regional presence of Qantas/BA, especially in the integrated Australia-New Zealand market. Such concerns drove Air New Zealand to acquire half of Ansett Australia, but the challenge now is to make that pay off. 'Ansett is our bedrock alliance,' McCrea stresses. 'It is the one that ultimately builds an Australasian airline.'

Building that airline has become a major project. 'It's a question of lining up a big Australian domestic with a medium-sized international airline,' McCrea explains. Teams are reviewing 12 areas of operation, ranging from engineering to schedule integration and in-flight standards. Both airlines have delayed aircraft orders while a procurement board reviews fleet commonality. The toughest area to integrate may be labour, due to differences in New Zealand and Australian culture. Traditionally, Australian unions are more adversarial and assertive. With a bottom-line oriented New Zealand company now calling the shots at Ansett, relations with Ansett's unions could grow stormy. McCrea stresses that 'this is an equity alliance, not a commercial alliance' but refuses to elaborate, except to warn: 'You're only seeing the tip of the iceberg.'

Air New Zealand is not delaying Ansett's realignment to await the outcome of its ACCC application or entry into Star. 'We're working at the pace we effectively can,' says McCrea. 'These things are complicated.' The Ansett alliance is the foundation that ultimately supports others, he adds. 'If we didn't have a strong regional core, quite frankly the international alliances would not be as effective.'

One area of integration that has already gone as far as it can on its own is the restructuring of Air New Zealand's Australia-Asia network. Several factors have fuelled this, including the desire to exploit Ansett's Australian domestic feed, identity, and routes to Asia; and Air New Zealand's desire to show sceptical Australians that this alliance is actually good for Ansett. Hence, Air New Zealand seeks or has secured approval to codeshare on Ansett's routes to South Korea and Taiwan. A three way codeshare to Taipei between Ansett, Air New Zealand, and EVA Airways was due to start on 1 April. Codeshares to Hong Kong, Osaka, and China have been temporarily shelved because the bilaterals do not allow third country codeshares.

Air New Zealand noticed traffic slowing out of several cities even before Asia's currency crisis. In response it pulled out of Bangkok, Indonesia, and Kuala Lumpur even before the foreign currency traders. Air New Zealand now only codeshares with SIA to Bangkok and Kuala Lumpur. Canberra allows Air New Zealand 12 weekly 747 equivalents beyond Australia and Qantas has equal rights beyond New Zealand. But codeshares with Ansett count against this. 'Under current market conditions we have to use our limited rights in the most effective and efficient way,' says McCrea.

Inbound tourist destination

Air New Zealand would like more rights beyond Australia, but not necessarily to Asia. Falling traffic from Asia was one of the main reasons why Air New Zealand's profit fell by a third last year. New Zealand has always been an inbound tourist market and Air New Zealand has built its strength around that; 92 per cent of its RPKs and 60 per cent of its revenue come from international flights. In recent years, it has placed more emphasis on Asia. Despite last year's storm warnings, Asians still accounted for almost a third of New Zealand's short-term visitors and 22 per cent of Air New Zealand's revenue.

The growing problem is that New Zealand's dollar, while falling to a four-year low against the US dollar, keeps rising against most Asian currencies. If ignored, this combination could be devastating.

Other sectors of New Zealand's economy are already shifting away from Asia. New Zealand's Export Institute recently launched a trade mission to California, advising exporters to look to North America to counter 'the current financial turmoil in some of New Zealand's important markets.' Noting a drop in Asian enrollment, New Zealand's English language schools are seeking students from South America.

Air New Zealand is also shifting. After the plunge in Korean traffic, both it and Ansett suspended all flights to Seoul. Air New Zealand replaced another Asian route with its sixth weekly Sydney-Los Angeles nonstop. 'With the Asia currency crisis, we clearly have to re-prioritise,' says McCrea.

That means confronting the strength of Qantas/BA on long haul routes. In the US Air New Zealand is bolstering its alliance with United. This year Air New Zealand and United will add codeshares to six more US cities. Air New Zealand will 'put shoe leather on the streets of America' to boost its presence, McCrea promises.

Qantas has already moved to daily Auckland-Los Angeles nonstops, lifting its share of New Zealand-US capacity to 30 per cent. Paul Donovan, Qantas regional manager for New Zealand, says: 'I've spent the last 12 months proving to people that Qantas is not just an Australian carrier. It's a world carrier operating out of New Zealand, offering a choice to the former national carrier.' McCrea replies that Air New Zealand and United combined have the greatest market share to the US from New Zealand and are 'about even' with Qantas on combined Australia/New Zealand-US routes.

Air New Zealand's efforts to boost its European presence await codesharing talks with Lufthansa and Australia's decision on its joint application. Currently, the German-New Zealand bilateral does not allow codeshares, but McCrea thinks that could change once Lufthansa and Air New Zealand sign an alliance. The UK bilateral already allows codeshares, but again McCrea is awaiting Australia's approval before launching joint services with SIA. Flying east, Air New Zealand recently added its sixth weekly Los Angeles-London flight.

McCrea also foresees Latin American opportunities. Once Asia recovers, which he thinks could take five years, he expects more traffic between South America and Asia. His job will be to convince everyone that a South Pacific route via New Zealand is shorter and better than North Pacific routes over the US. But this is long term, McCrea emphasises. 'With the crisis in Asia just now, most of us are looking at how we maintain our earnings without trying new destinations.'

Low yields

Air New Zealand's final problem is closer to home. New Zealand-Australia competition has always been robust, but last year low yields across the Tasman Sea were the second biggest cause for Air New Zealand's falling profit. That was partly due to low-cost upstart, Kiwi Airlines. After its collapse in September 1996, Kiwi complained about predation but New Zealand's Commerce Commission cleared Air New Zealand, noting that its response to Kiwi was lawful.

That response was mostly embodied in Air New Zealand's launch of its own low-cost subsidiary, Freedom Air. To the surprise of many, 18 months after Kiwi's collapse Freedom Air is still flying, operating a leased Boeing 737 from secondary gateways in Hamilton, Palmerston North, and Dunedin. In the meantime another New Zealand would-be upstart quit before it started, protesting that its investors were spooked at the spectre of predatory pricing.

Does Air New Zealand keep Freedom Air flying as a deterrent to more upstarts? McCrea replies: 'We had planned a low-cost operation for the last five years. We wanted to test the depth of the secondary markets. They're not extremely deep. Freedom's washing it's face [breaking even] so it's useful. It created some new traffic, but it's very price sensitive. Right now fares on the Tasman are still pretty competitive.'

Bigger pictures

Air New Zealand now faces a new Tasman challenge: Qantas is introducing 737s. 'My vision of Qantas here is to have a frequency story, not capacity,' says Donovan. 'So we offer four to five services a day with smaller aircraft to give people choice. We plan to add more 737s to keep our frequency advantage over Air New Zealand.' McCrea concedes that 'we allowed our position on the Tasman to deteriorate,' and predicts that the Ansett alliance will help boost that.

Both he and Donovan are coy about divulging specific plans. McCrea prefers to focus on bigger pictures. 'The challenge for chief executives today is to convince their shareholders that airlines are good investments and will give good returns,' he says. 'Airlines with a long term view can be very successful over the next five years as this deregulation process works itself out and regional airlines build the critical mass they need within their regions to answer to their partnerships.'

Thus Air New Zealand pursues its twin goals of building regional mass and using it to support global partnerships. McCrea would be the first to admit that such things are easier said than done. Recalling the problems he has faced over the past two years, he winces and adds: 'This business doesn't get any easier.'

Wellington's scorecard'Our aim has been to get government out of airline decisions because the market should determine air services,' says John Bradbury, international relations manager for New Zealand's Ministry of Transport. In his 25 years at the ministry, Bradbury has seen New Zealand retreat completely from a policy of reciprocity. In his role as chief air services negotiator, he finally feels he is making some progress in pushing for liberalisation.

In the past 10 months New Zealand has negotiated its first three 'open skies' bilaterals - with the US itself, Singapore, and Malaysia. The term 'open skies' is reserved for agreements that follow Washington's model, even though Bradbury claims Wellington's is more liberal. He points to New Zealand's recent pact with the United Arab Emirates, which is as permissive as any US pact but even more relaxed on fare filing and foreign investment in airlines.

New Zealand had less success last year in Europe. Bradbury believes airlines linking Auckland and London need more fifth freedoms but the UKwas only willing to increase such frequencies from five to seven. Germany was another disappointment. The Germans raised New Zealand's fifth freedom quota from 20,000 to 30,000 passengers, but further liberalisation seems to hinge on a deal between Lufthansa and Air New Zealand.

Jim McCrea, Air New Zealand's CEO, likens the German bilateral to 'a chicken-and-egg' situation. 'Most negotiators are trying to protect their country's airlines,' Bradbury complains. 'Our aim is to protect New Zealand's economy.'

However, Wellington also recognises its flag carrier's needs. Talks became necessary, for instance, when Air New Zealand switched partners from Canadian to Air Canada. Air Canada cannot codeshare across the Pacific because Canadian policy only allows Canadian to be designated to serve New Zealand. 'We'd be quite happy to see both Canadian airlines here, but Canada precludes that,' says Bradbury. 'The way the world is going with alliances, I can't see how we're going to maintain a decent level of service with Canada if its designation policy can't take account of new alliances.'

Increasingly, Bradbury sees his job as fostering competition. 'We're trying to get out of tariff supervision and leave it to competition authorities to adjudicate,' he says. 'Globalisation makes us more aware and alert for anticompetitive conditions and a need to balance them.' He cites Brunei as an example, where he hopes to encourage Royal Brunei to operate New Zealand-Singapore sixth freedoms. 'We need that to counter the Singapore-Air New Zealand alliance in that market.'

Alliances are not inherently anticompetitive, Bradbury insists. 'We see codesharing between alliance partners as good if there is competition between sets of alliances. Having Qantas-BA and Air New Zealand-United both flying the Pacific offers vigorous competition between big alliances that each offer a good spread of services.'

Most Australia-New Zealand issues are now settled. Cross-border traffic still must clear customs and immigration, but in terms of first, second, third, and fourth freedoms, New Zealand and Australia are now one country. Fifth freedoms remain the area of dispute. Airlines are frozen at 12 weekly 747 equivalents. Qantas does not use all its allotment; Air New Zealand would like more rights beyond Australia.

'There's a jaundiced view in Australia that Air New Zealand is a parasite because it takes passengers out of Australia,' says Bradbury. That, he argues, ignores Air New Zealand's marketing of Australia and New Zealand as a dual destination. The next move is Australia's, but it seems in no hurry to act. Still, Bradbury predicts that Canberra may be 'more relaxed' about fifth freedoms once it is certain of Ansett's future.

Source: Airline Business