After keen investor interest, Australian flag Qantas was all set to become fully traded on the stock exchange from 31 July, and under immediate intense pressure to provide the projected return on investment. Tom Ballantyne reports.As Qantas began its first twelve months as the world's most recently privatised airline in August, the Australian flag carrier turned its focus towards a massive cost reduction campaign it hopes will bring savings of nearly US$1 billion.

While the pruning touches every facet of operations, the biggest gains are expected from a basic triangle of tighter financial controls, negotiated changes in labour contracts, and increasing benefits from the alliance with 25 per cent shareholder British Airways.

As a stock exchange-listed company Qantas now has to make a pretax profit of US$290 million to $365 million every year, says managing director James Strong. In essence, he is betting on these measures creating a stable financial future for Qantas by enabling the carrier to cope better with the inherent volatility of the airline industry.

The strategy is based on a belief that cost reduction, coupled with rational alliances and careful network management, will protect Qantas from fluctuations in market conditions.

Despite this Strong and his executive team are well aware that the airline's ability to deliver on promises to its new shareholders at the end of the current financial year depends on good luck and good management.

Forecast revenue for the latest year to June 30 - audited accounts had not been released at presstime - was US$5.25 billion, up from $4.77 billion in 1994. A further increase to $5.82 billion is predicted in 1995/96, with after tax profits of $173 million compared to an expected $131.4 million in 1994/95.

Investors meanwhile are being led to expect a 6.5 per cent dividend, or 9.5 cents a share, at the end of the first year if market conditions remain unchanged. That's a big 'if'. Despite an impressive turnaround in the airline's fortunes, Qantas' ability to achieve the forecast results depends on nothing untoward happening to upset the applecart.

Analysts, however, agree the airline is in an advantageous position and say the restructuring so far and the resulting profitability have given the airline a solid base from which to work. Qantas has a highly desirable international reputation, with bread and butter markets in the commercially explosive Asia-Pacific region. And two major sectors - the Kangaroo Route and Australia-US - have been turned around, bringing renewed profitability to routes which had been a financial drain. Prospectus forecasts say average annual revenue growth at Qantas from 1993-6 will be 11.6 per cent, against 11.3 per cent for Cathay Pacific, 9.1 per cent for Air New Zealand and 7.3 per cent for Singapore Airlines.

On the downside, debt levels - which stood at US$3.3 billion on December 31 - remain high and a net debt to equity ratio of 70:30 still has to be brought down. Predictions on costs per ASK in 1996 are 7.3 cents for Qantas, 6.9 cents for Air NZ and Cathay and 6.5 cents for SIA.

Meanwhile the horizon is dotted with imponderables. Will Air New Zealand find a way into the Australian market? Can Canberra reach an accommodation with Hong Kong over a new air treaty and avoid reviving a damaging bilateral dispute which, if unresolved, could cost Qantas more than $40 million a year? And will either of two proposed new domestics get off the ground, bringing a potentially costly discounting battle on prime trunk routes? Fluctuations in fares and yields, unstable international travel markets and currency movements all lurk as further barriers to smooth development.

The acquisition of government-owned domestic Australian Airlines in 1992 saw Qantas grow from a medium-sized international operator into one of Asia's largest airlines, with a fleet of 91 jets. Its regional subsidiaries operate another 41 jets and turboprops within Australia. The main fleet consists almost entirely of B747s and B767s for overseas flights and B737s domestically. Four Airbus A300-B4s, a legacy of the Australian merger, are the only exception.

Qantas flies more than 250 services a week to 40 overseas destinations and serves 52 domestic airports with 2,700 weekly flights. When Strong took over the helm the airline was wracked by internal strife, profits had been in significant regression and the debt burden was enormous. 'There was a lot of uncertainty, a lot of negativity around, both on an organisational and a personal level. So it really was a quite critical time for the airline,' he admits. 'I think we are now out there on the track and it's now a question of running it . . . and of course being a publicly listed company is a pretty tough financial discipline,' he adds. As in any public company the overriding issue in Qantas is now the return on shareholders' funds.

Further savings are expected from:

1 Big ticket items. Capital expenditure savings are being pursued through better asset utilisation.

2 New reservation, dispatch and yield management systems are being installed to improve efficiency.

3 The BA alliance. Some $30 million this financial year but most of the benefits are expected to begin flowing through from 1996/97.

4 Waste reduction. Common sense cost cutting has never really been rigorously applied and significant sums can be saved without any impact on product or service levels.

5 Industrial relations. New agreements with unions offering better productivity and a reallocation of staff.

In Australia's often volatile industrial relations system the latter holds obvious perils but Strong is convinced it can be done without disruption. 'We are trying to debunk the myths that suddenly people are going to have their contracts ripped off them . . . we do not see the future to a more efficient and productive company lies in slash and burn - or in asking people to surrender half their pay - because we know that won't work.' A big priority over the next 12 months will be direct discussions with unions to convince them that in pro rata terms the future lies in having fewer people per unit of production, he adds.

Operationally, Strong does not see dramatic route growth for Qantas though he says the carrier is committed to developing its operations into China and places such as Vietnam and will look at other parts of the world, including India and South America. 'But we will be very prudent about whether we want to open up new services and very calculating about the economic outcome. If you go into a new market you have to have a plan to make that a profitable operation within a defined period.'

Qantas is also looking at consolidating routes, adds Strong. 'We are very interested in consolidating our operations. We believe that you should deploy your resources in such a way that in any market in which you are competing you are a substantial player and are getting the efficiency effects [of] the volume of business that you are doing.'

That strategy has paid off in the US market. Qantas swung flights away from marginal routes to increase non-stop, high frequency, business-oriented services to Los Angeles. Strong says renewed profitability on the route was helped by a proper positioning of the product and cannot be attributed solely to the fact that big US carriers such as Northwest, Continental and American pulled out - United is now the only US airline flying trans-Pacific to Australia - or to better economic times.

North America now accounts for 22 per cent of all Qantas capacity, ahead of the UK with 19 per cent and Japan with 16 per cent, although 42 per cent of all capacity is dedicated to Asia as a whole. The airline's market share to the US is a formidable 54 per cent against around 40 per cent for most other markets.

However, the airline's success on the Pacific could tempt other US operators to re-enter the market, a move which would undoubtedly spark another downward spiral of price discounting and overcapacity.

Meanwhile Qantas' new ownership structure oblige, the carrier has no ambitious fleet growth plans. 'Our aircraft strategies are minimum capital expenditure, better utilisation and careful maintenance of the fleet in terms of age - making sure we just keep up with growth without thinking that our future is in sheer size in itself,' Strong explains.

Qantas believes there is a lot more potential in the alliance with BA but stresses that it will continue to cement and seek new linkups with other carriers as well. 'We have no pretensions to be a world airline,' he says. Despite the strong focus on Asia, he dismisses the theory that Qantas will eventually pull out of Europe and link with BA in Singapore or Bangkok, dubbing it 'the Pommy under the bed argument.'

The Kangaroo Route was losing Qantas increasing amounts of money until a 'sweetheart' marketing deal with BA in which they stopped competing with each other turned the tide and enabled the Australian flag carrier to maintain services. 'The irony is that many people who sparred at shadows and thought this agreement was a prelude to our withdrawing totally misread the situation because it's our strategy to stay there in our own right, not in any form of codeshare,' he explains.

That doesn't mean there won't be change. The airline is taking a 'very considered look' at its European strategy and is dropping extension flying such as the Frankfurt-Paris and London-Manchester sectors. There is also a chance it will eliminate Rome and perhaps even Frankfurt, opting instead to fly solely to London and feed passengers on to BA's European services.

Qantas' image is also undergoing a basic transformation following market research showing it was regarded as a leisure and discount carrier. Travellers associated the airline with koala bears, kangaroos and Australia. Executive general manager commercial Geoff Dixon says the emphasis will now switch to advertising the product rather than its country of origin.

'We are going to spend most of our resources overseas on pushing Qantas as a business airline. Most of our advertising will not be about Australia . . . it will now be about Qantas,' he says.

But while it will face intense competition internationally the airline's biggest test may come at home. Last year an ability to throw international widebody capacity onto domestic sectors to meet record demand led to what Strong calls an 'extremely rare trifecta' - a 24 per cent increase in seats with no fall in yield or load factors. That allowed it to overtake rival Ansett and take the lead in the marketplace: the latest Department of Transport figures give Qantas 51.7 per cent of total domestic revenue passenger kilometres.

Air New Zealand has broken off talks about acquiring 50 per cent of Ansett, a move which would have presented a significant threat to Qantas. But the carrier, still 20 per cent owned by Qantas, may yet find another way of entering Australia's domestic market (see feature starting on page 88).

Worse, there are rumblings of two new domestic startups, union-owned ACTU Airlines and Aussie Airlines, another attempt by former Compass chief Bryan Grey to re-enter the fray.

While grave doubts remain over whether either will ever leave the ground, the entry of even a small new trunk route operator would lead to more seats and lower fares and have a serious impact on Qantas' profitability.

Ultimately Strong believes Qantas will benefit from what he sees as a more stable industry climate. He is optimistic a watershed change has occurred as a result of recent bad times, with increasing numbers of privatised airlines being forced into 'more vigorous commercial discipline by the fact that shareholders are lining up for their dividend every year'.

Strong thinks this will 'make people think a lot harder about capacity, capital expenditure, cost control and so on.'

Qantas cannot afford to bank on this too heavily, however. Cost cutting is part and parcel of achievable forward planning and the risk of external influences such as bilateral disagreements, union disruption or unforseen events which cut tourism flows, cannot be discounted.

Source: Airline Business