Qantas and Air new Zealand have failed to convince Australia's competition watchdog over their merger. So what happens next?

Australia's rejection of their proposed equity alliance is forcing Qantas Airways and Air New Zealand (ANZ) to rethink their strategic options. There is still the hope of an appeal, but ANZ for one may soon need to start taking a look at other potential tie-ups.

In its final decision, the Australian Competition and Consumer Com-mission (ACCC) ruled in early September that the anticompetitive effects of such an alliance, which proposed an operational merger in all markets where Qantas and ANZ now compete, outweighed public benefits. It rejected concessions and arguments offered by the airlines since April, when it first concluded on a preliminary basis that the deal should be denied.

The New Zealand Commerce Commission, which reached the same draft conclusion in April, was also expected to render its final verdict late in September. Both competition agencies share information, but make their decisions independently.

Crucial approval

If the ACCC's decision withstands appeal, it does not matter what New Zealand decides. Qantas and ANZ cannot proceed with their deal without approval from both agencies.

But in mid-September the two airlines still hoped New Zealand might be more sympathetic than the ACCC. Not only did New Zealand grant them a full airing of views at a week-long hearing (the airlines waived their right to an ACCC hearing), but New Zealand might be more worried by ANZ's warning that it could die a slow death through attrition if the alliance were not approved.

Thus, to reserve their options, both carriers are appealing the ACCC's final decision to the Australian Competition Tribunal. This tribunal, a quasi-judicial review body, can revoke ACCC rulings and authorise commercial arrangements that would otherwise violate Australia's competition law.

One of the best things the airlines have going for them is that this tribunal is not limited to the evidence put before the ACCC. It can conduct hearings and consider new evidence and arguments. As one law professor explains, it is like starting over. Shortly after the ACCC's draft decision in April the airlines concluded they stood a better chance with this process than in trying to change the ACCC's mind.

It could be March before the Australian Competition Tribunal hears an appeal. Meanwhile New Zealand's decision could moot that process. If New Zealand also rules against the airlines, their chances are effectively zero. Theoretically, appeal is also possible in New Zealand, but only to a court, where judges limit their review to the existing record and give wide deference to commission expertise. Hence, the longer- term strategy could hinge heavily on New Zealand's decision.

Political intervention

The court of last resort, of course, is parliament. Michael Cullen, New Zealand's finance minister, who represents his government's 81% stake in ANZ, has ruled out any political intervention or solution, but John Anderson, Australia's transport minister, has not. Anderson has been a vocal cheerleader for the alliance, urging Qantas to appeal against what he calls "a disappointing" ACCC decision. But whether he would go so far as to offer a legislative fix, and whether others would support him are big unknowns.

Once all the appeals are exhausted, the lawyers will finally need to turn the future of the two carriers back over to the airlines themselves. When that happens, Qantas and ANZ will have to confront the question of where, without their current alliance proposal, to go?

For Qantas, the answer is fairly easy. Despite its wolf-at-the-door complaints, it can continue on its present course as Australia's dominant domestic and international carrier, and a oneworld alliance member with a joint services agreement (subject to ACCC renewal) with British Airways. The present course for Qantas includes restructuring to cut costs, but as Peter Harbison, managing director of the Centre for Asia Pacific Aviation Studies, observes about the proposed Qantas-ANZ alliance: "Qantas wants it and Air New Zealand needs it."

In the absence of this alliance, the airlines' first option could be a scaled-down version of the same thing. The 22.5% stake that Qantas proposed to take in ANZ was not the sticking point with the ACCC; it was the joint operating committee the two airlines proposed to co-ordinate fares, capacity and routes. Remove that, reduce the equity stake to, say 20%, and competition authorities would take a more relaxed view toward an agreement that still might include back-office sharing on such items as engineering and joint purchasing.

If the airlines decided to abandon co-operation in any form - what could be called the "do nothing" option - opinions are divided on the likely result. ANZ stressed in submissions to both competition authorities that in the absence of an alliance with Qantas, it faced a long-term war of attrition with Qantas and Virgin Blue on trans-Tasman and New Zealand domestic routes. It also warned that New Zealand was not big enough to sustain three carriers in the inevitable blood bath, and that ANZ, with fewer resources than Qantas, would eventually follow Ansett into the sunset. In competition terms, ANZ sought a waiver of normal merger rules on the grounds it is a future failing company.

Sceptics dismissed this war-of-attrition scenario as overblown. New Zealand analyst Rob Mercer argues that it would be irrational for Qantas to engage in a prolonged fare war with ANZ. The liberal aviation regime between Australia and New Zealand gives carriers from each country unlimited third and fourth freedoms and cabotage to and within the other country, but that does not ensure their profitability. Qantas admits that its New Zealand domestic operation loses money, but hopes to turn that around with its new JetConnect low-cost unit.

Still, as Mercer says, ramping up capacity and cutting fares on a marginal operation could crush a rival, but then "it is very hard to reset [prices] back to where they need to be. You are never going to get a return on capital through that strategy."

If Virgin Blue (under the name Pacific Blue) starts up in New Zealand, analysts generally agree that it stands no greater chance of dislodging the domestic incumbent than it did when it started up in Australia. Qantas still controls 70% of its domestic market despite Virgin Blue, while ANZ's current share is even higher.

Some analysts claim that ANZ would strengthen its long-term viability by re-entering the Australian domestic market - not with the aim of playing tit-for-tat with Qantas, but because it could pick up behind and beyond gateway feed for its flights from Australia to New Zealand, Asia, and perhaps, the USA. ANZ has been absent from internal Australia since the demise of Ansett.

Ian Thomas, analyst at the Centre for Asia Pacific Aviation Studies, argues that ANZ needs a domestic Australian presence over the long term. In his view, ANZ could easily enter the Australian domestic market. It already flies to all of eastern Australia's gateway cities and is well know among Australian travellers. Until recently, it even flew nonstop from Sydney to Los Angeles.

"Providing domestic links is really an extension, rather than establishment of a new operation," Thomas says. "For all intents and purposes, it can become an Australasian airline in its own right rather than depending on Qantas."

Alternative alliances

Inevitably, this leads to the question of whether ANZ should and will look to some other airline for an alliance and the A$300 million ($200 million) that Thomas estimates it would take to recreate an Australian domestic network.

Ralph Norris, ANZ's chief executive, says the carrier held exploratory talks with Virgin Blue about an alliance, but promptly dropped them. As he told the New Zealand commerce commission, marriage between a full-service and a low-cost airline would have been "quite impossible to consummate".

Singapore Airlines (SIA) is the first, and perhaps only, full-service airline that comes to mind as an alliance candidate. Not only did it own part of ANZ before, but it keeps circling the idea of a domestic Australian presence. That is what it wanted the first time, but ANZ's pre-emptive rights forced it to buy into ANZ rather than Ansett. SIA was burned by that investment, and because of that Norris says it is no longer interested.

But SIA's longer-term interests still converge with those of ANZ in many ways. Both are Star Alliance members, both may be looking at Australia, and if current air service talks between Singapore and Australia produce an open skies accord, both might be flying from Australasia to the USA.

The biggest lesson ANZ can take from the ACCC's rejection of its alliance proposal with Qantas is that competition authorities will not approve any strategic alliance with another airline that directly competes with it in concentrated markets. The current route overlap between ANZ and SIA is minor. Approval would be likely, but what an ANZ-SIA alliance most needs is willing players.

But first ANZ will exhaust its efforts to salvage the current plan. If and when those fail, ANZ will start looking at its other options. n


Source: Airline Business