License article

Virgin throws down challenge

Australia's dominant carrier is under fire on all fronts from John Borghetti's resurgent airline.

IT WAS the elephant in the room at a Qantas cocktail function at the National Gallery on Thursday night, on the eve of the airline's annual meeting in Canberra.

Qantas chief executive Alan Joyce and chairman Leigh Clifford held court at a high-level gathering that included government department heads and ambassadors.

The Qantas bigwigs might not have mentioned it in their speeches but the deals Virgin Australia unveiled three days earlier mean it is game on.

After gaining a boost from what Clifford termed a ''transformational deal'' with Emirates, the focus for Qantas now has to turn to domestic affairs, and quickly.

Virgin's bold but risky move to take control of Tiger Australia and regional airline Skywest will reshape the aviation industry.

''History in Australia suggests that domestic aviation is ultimately a two-horse race,'' says Rod Eddington, a former boss of British Airways and chairman of Ansett.


''What we are seeing today in the context of Virgin looking to take over Tiger is a return to a two-horse race. But the horses are more multifaceted than they were before.''

More than a decade ago, Qantas was battling Ansett. Under the plans on the table now, it will be Qantas, Jetstar and their regional partners slugging it out against Virgin, Tiger and Skywest.

Virgin will pay for the deals by issuing new shares - amounting to a 10 per cent stake - to alliance partner Singapore Airlines. It joins an already crowded share register that includes Richard Branson's Virgin Group, Etihad and Air New Zealand.

While Virgin has cast it as a way to take the competition to the incumbent, Qantas prefers to frame it as the underling reacting to its dominance of the skies - from the lucrative business travel market to regional flying. Having spent the first 36 years of his working life at the Flying Kangaroo, Virgin chief executive John Borghetti was - in the eyes of his rivals - merely creating his own Qantas mini-me.

Whatever way it is spun, Italian-born Borghetti has reclaimed the momentum in his tussle with Joyce. In doing so, he hopes to prevent Virgin from being caught in a pincer movement by Qantas and its budget offshoot, Jetstar.

Less than two months ago, Joyce finally had his day in the sun when he unveiled Qantas' plans for the deep alliance with Emirates.

But Qantas now has everything to lose and Virgin everything to gain. Borghetti is creating his own dual-brand strategy aimed at rivalling Qantas and Jetstar - and operating it at a lower cost.

As much as it is a step up in the battle between Australia's two largest airlines, it is another chapter in a personal contest between two men who squared off against each other in the run for the top job at Qantas more than four years ago.

Since he took the reins at Virgin in 2008, Borghetti has been a man in a hurry. He moved swiftly to ditch unprofitable routes, cemented alliances and reshaped the airline as an upmarket competitor to Qantas. It has involved product improvements such as new airport lounges, including a rival offering to the invitation-only Qantas Chairman's Lounge; bigger domestic planes; an overhaul of its frequent-flyer scheme; and rebranding.

What's more, through some fancy footwork early this year Borghetti rejigged Virgin's ownership structure to enable more foreign investors and airlines to buy in. Virgin retained its rights as an Australian airline even though nearly two-thirds of its ownership will now be in foreign hands.

And this was all before his surprise deals this week.

Now, the fate of this country's airline industry rests in the hands of one man. Both Qantas and Virgin have laid their cards on the table.

Australian Competition and Consumer Commission chairman Rod Sims will decide whether the country returns to an airline duopoly by removing a third player in Tiger, at the same time as he weighs up the Qantas-Emirates deal.

Sims is under no illusions as to the tough choices he will have to make over the next five months.

''It is a quantum shift in the way the aviation industry wants to structure itself. We are acutely conscious that these are big and important decisions, so we are going to look at them closely,'' he says.

''I'm not sure what else can walk through the door now under an 'aviation' heading - we seem to have the lot.''

The regulator has already voiced concerns about the emergence of a duopoly, though some wonder whether it is more chest-beating than a sign of a heavy-handed response looming.

Sims will be conscious that travellers have benefited from the intense competition in the domestic market, at least part of which is the result of Tiger's entrance five years ago.

Latest government statistics show that ''best discount'' fares last month were 9 per cent lower than in October last year.

But it is corporate travellers who have been the biggest beneficiaries. Business fares in October were about 40 per cent cheaper than in the same month last year, just before Virgin began its assault on Qantas' stranglehold on corporate travel.

For travellers, a return to a duopoly - albeit one in which two airline groups have multiple tentacles - threatens to blunt the competitive edge in the market.

Both investors and Qantas and Virgin are already factoring in a return to more ''sustainable'' capacity and pricing.

''[The Tiger deal] should allow the two primary carriers to better manage capacity around demand, in turn allowing for stronger yield management,'' Macquarie Equities analysts noted this week.

In other words, the need for airlines to discount fares heavily to compete will be lessened.

The argument the airlines will mount is that, while the arrival of a third player in Tiger helped lower fares, it is an unsustainable situation in the longer term. Australia can handle only two airline groups.

Eddington says he would be surprised to see the competition regulator knock back Virgin's bids because it understands the ''commercial realities'' of an industry regularly buffeted by shocks.

''The bottom line is that everyone has tried to set up a third carrier but the market has driven it back to two,'' he says.

''It is very difficult for these entities to exist if you don't approve the deal. If you said 'no', it may be that Tiger either folds or remains anything but a significant player.''

Though Virgin's bid for a controlling 60 per cent stake in Tiger was a bolt from the blue for investors this week, it was a possibility Qantas strategists had canvassed in their white-boarding sessions two years ago. In a country of 23 million people, there are only so many ways the market can be cut.

The biggest challenge for Borghetti will be resurrecting Tiger, an airline whose brand has been seriously damaged by safety concerns that led to the Civil Aviation Safety Authority grounding its fleet last year for six weeks.

Large sums of money will need to be invested over the long term to change people's perceptions of the budget airline following the safety and customer-service woes.

Some industry executives believe it will be a tall order to stem Tiger's losses - more than $200 million in Australia over the past five years.

They say a big concern for Tiger will be keeping costs under control, which is especially important for a budget airline.

''It is good that they are slowly getting their house in order but I worry that the people that they are bringing in [at Tiger] won't be cheap,'' one says.

Under the plans, the budget airline will operate under the same brand but as a stand-alone business from Virgin. Borghetti has emphasised the importance of keeping Tiger ''true to the low-cost model''.

Tiger Australia's fleet will be expanded from 11 single-aisle A320 planes to up to 35 over the next five years. Eight of the new additions will arrive within the next two years.

One of the challenges is that Borghetti will not be able to lower the costs of an airline already run on the tightest of budgets. Put simply, he will have do his utmost to boost revenue through expanding Tiger's market size and rejigging its network to optimise returns.

And returning Tiger to break-even relies somewhat on Jetstar limiting growth of its own capacity on domestic routes.

Joyce has made clear that Qantas and Jetstar will mount stiff resistance to Virgin's assault on parts of the market - low-cost leisure and charter flying - that it has not been active in.

''This is a reaction to our success in each of these categories,'' Joyce says of Virgin's attempts to take control of Tiger Australia and Skywest.

''I'd rather be number one. We know that scale and first mover advantage is huge. Tiger has a huge mountain to overcome.''

In the wake of Singapore Airlines taking a slice of Virgin, one of the other questions exercising minds is whether Etihad's chief executive, James Hogan, will act quickly on his plans to lift his airline's stake in Virgin from 10 per cent to as high as 20 per cent.

A share register dominated by Branson and three airlines also rams home the challenge for Borghetti of managing multiple relationships. It will be a labour-intensive job balancing egos and conflicting interests.

Etihad, Singapore Airlines and Air New Zealand will be wanting board seats in the longer term. By giving one a seat at the table, the demands are sure to come from the others. While they can test relationships, the close alliances can also give Borghetti access to strategic advice from some of the best brains in the business.

Importantly, the alliances Virgin has formed with those three airlines and US carrier Delta help to feed passengers into Virgin's domestic network, and vice versa.

Virgin is a natural partner to those airlines because it has a small long-haul fleet, unlike Qantas, which is a rival to them on international routes into and out of Australia.

The consolidation in Australia typifies what is playing out in the global aviation market, albeit that the Asia-Pacific region still has a long way to go before replicating the US or Europe.

John Sharp, former federal transport minister, says the worldwide industry is shifting rapidly to an era where a small number of global airlines such as Emirates will dominate, and the likes of Qantas and Virgin will become feeders to their extensive international networks.

One of Sharp's decisions when he was transport minister in the 1990s was to give Emirates - then an airline unknown to many - landing rights to every capital city in Australia except Sydney.

Sharp, who is now the deputy chairman of Regional Express, recalls the sage advice he received in the late 1990s from British Airways' then chief executive, Bob Ayling, over a beer at London's Canary Wharf.

''He said back then that the way the world is going to work is that global networks will matter and there will be half a dozen global players,'' Sharp recalls.

''And everybody like Qantas will simply be feeder airlines into those global players.

''That was before the Middle Eastern airlines appeared on the scene. Clearly Bob wasn't far from getting it right.''