The number of major airlines in Australia is set to double as two low-fare carriers - Virgin Blue and Impulse Airlines - challenge the duopoly of Qantas Airways and Ansett Australia. It is the first serious test in eight years for the incumbents. Not only does it pose questions about how they will respond and the chances that these new entrants will succeed, but, in a broader sense, it is a test of just how committed Australia is to domestic airline deregulation.
It has taken years for this drama to unfold. The cast of characters was set in June when Canberra approved the Air New Zealand (ANZ) takeover of Ansett. That fulfilled the conditions for Singapore Airlines (SIA) to buy into ANZ. In turn, that ended SIA's flirtation with Virgin's proposed start-up, leaving Sir Richard Branson's group to launch its Australian venture alone.
The rules took longer to evolve. They reflect Australia's hesitant transition from a policy that entrenched two domestic airlines, through deregulation that proved to be more form than substance, to a recent decision to remove the cap on foreign ownership, a step seen by some observers as a desperate attempt to attract new blood.
Peter Harbison, managing director for the Centre for Asia Pacific Aviation in Sydney, claims that opening domestic skies to foreigners is a tacit admission that deregulation failed, and a "dramatic and high risk strategy".
Deregulation in 1990 did not bring the promised benefits of competition as major entry barriers were left in place. The Compass I start-up, followed swiftly by Compass II, made valiant but unsuccessful efforts to break through in the early 1990s. Their failures brought criticism of Canberra's role in creating the barriers and then its hands-off approach when Ansett and Qantas, which was still partly government-owned at the time, used their muscle against Compass.
Later, a government review blamed the Compass collapses on under-capitalisation, poor yields and an economic downturn, but many felt the blame could go further.
Long-term leases granted to Ansett and Qantas three years before deregulation effectively locked newcomers out of domestic airport terminals. In Canberra, the nation's capital, the Compass terminal was a tent. Ansett and Qantas either owned, or had commercial control of, every regional carrier in Australia. They either owned or had preferential links with 95% of the travel agents. They controlled listings in the computer reservation systems (CRSs).
As Gerry McGowan, executive chairman of Impulse Airlines, complains: "Where else in the world has deregulation taken place with all the infrastructure and distribution systems left in the hands of the incumbents?"
After the Compass failures, at least five other start-ups tried to break into the A$6 billion ($3.6 billion) domestic market. None made it past the business plan stage. Even airlines already flying, such as Impulse, confronted the spectre of Compass when they tried to expand. "We faced a lot of investor scepticism," recalls McGowan. "All they wanted to talk about in the early days was Compass."
Changes did not start until late 1996 when a new government introduced slot controls at Sydney Airport, because of its key role in the "golden triangle" of Brisbane-Sydney-Melbourne. The triangle accounts for 40% of Australia's 25 million domestic annual passengers, with Sydney as the hub that will make or break most airlines.
Before slot controls, a start-up faced the threat of Ansett and Qantas bracketing its new flights. McGowan says: "If a competitor tried to come in, Ansett and Qantas could just dump capacity. As a result, until the slot system started, Impulse was totally focused on not flying into Sydney."
At the same time as slot controls came to Sydney, Australia began to privatise airports. To loosen the grip caused by its long-term leases, the government required airport bidders to provide other terminal space for new entrants. Brisbane had already met this need with a common user wing in its new domestic terminal. Melbourne and Sydney are now completing modest but adequate new-entrant terminals .
Virgin Blue's green light
The final structural change came last year when Australia's cabinet decided to abolish the foreign ownership cap for domestic airlines. Parliament has since agreed to the proposal.
"That was the green light for Virgin," says Brett Godfrey, chief executive of Virgin Blue. He confirms that Branson had "looked at Australia before" and even considered buying Ansett New Zealand which already had rights to fly in the domestic Australian market. "But Virgin likes to put in its own ideas and start fresh. Branson wouldn't have come in with 49%," he adds.
Thus, Australia's newest airline is a wholly owned subsidiary of the Virgin Group. Its parent's base will be either Switzerland or the UK, depending on final tax advice. Australia held several attractions for Virgin: opportunities for a low-fare carrier; counter-seasonal use for jets during the northern winter, and the challenge for Branson in taking on Ansett and Qantas, an ally of his old sparing partner British Airways.
But without removal of the foreign ownership cap, it could not have happened.
"Foreign ownership caps are basically saying let's keep the competition out," says Godfrey. "If we hadn't come along, there would still be a bunch of sceptics out there who argue that Australia could not support a third carrier. Dropping that ownership cap allows someone to come in and do it a bit differently."
Impulse points to the advent of the Internet as opening the way for its step up from turboprops to jets. Canberra can claim no credit for this change. McGowan says Ansett and Qantas controlled local reservation systems. "Compass couldn't break the distribution system," he claims. "They had to go off-shore for a CRS. That proved to be very expensive for them."
Per capita, Australia is one of the world's heaviest Internet users. "Twenty per cent of our reservations today are taken over the Internet. That, plus our own CRS, has allowed us to get around the distribution systems that previously were a barrier to entry."
Ownership rules
The two airlines have taken different tracks to become Australia's new challengers. The lifting of the foreign ownership cap was particularly significant in the creation of Virgin Blue, but the slow rebuilding of Australia's aviation structure is behind Impulse's growth from a turboprop regional to a jet operator on the golden triangle.
Impulse is likely to be the only home-grown carrier to grow in this way. Unless Canberra orders Ansett or Qantas to divest - which is unlikely - they still own or control all the other local carriers. Hazelton Airlines is the biggest of the independently owned regionals, but it has commercial ties to Ansett that also give the major a pre-emptive right to 20% of its partner's shares in the event of a sale. As McGowan puts it: "Ansett has its foot firmly on their neck."
Sydney slots also favoured Impulse above other regionals. The airport awarded slots in one of four categories: international, trunk, regional and start-up. When Impulse began flying to Sydney as a regional carrier, it was a relative latecomer. Most regional slots had already been assigned to others. Because only trunk slots were left, that is what Impulse got, even though it only flew regional routes at the time. Now it can use those trunk slots in a way that other regionals cannot. Virgin Blue will receive Sydney start-up slots, but it can never match Impulse frequencies at Australia's busiest hub.
It may be significant that neither Impulse nor Virgin is really a start-up. Impulse has evolved into a jet operator from regional roots. It has been flying around south-east Australia for eight years. Virgin Blue is a division of the Virgin Group, which includes Virgin Atlantic and Virgin Express. Five of its senior managers, including chief executive Brett Godfrey, are ex-Virgin.
McGowan is convinced it is easier to grow than start. "Compass commenced operations with A$65 million, which back then was a lot, but when Compass started flying it only had two weeks worth of cash flow. They had spent it all on infrastructure."
Building infrastructure
By contrast, McGowan points out: "For the last seven years Impulse has deliberately built infrastructure - getting our own terminals and check-in staff. We do all of our own maintenance and baggage handling. Our goal was that if we needed to [expand to jets] or if the opportunity arose, we could do it."
Not only that, but Impulse's track record and business plan have allowed it to capitalise at A$100 million, with major institutions, including divisions of AMP, HSBC and Citigroup, as well as GIC Special Investments of Singapore and National Australia Bank. About 60% of privately held Impulse, including the 40% held by McGowan and his family, is in Australian hands.
Some analysts have raised eyebrows at Virgin Blue's capitalisation at $30 million. But Godfrey's response illustrates the close tie between Virgin Blue and the rest of the Virgin family. "We have secured good lines of credit without cash reserves because of our brand. Virgin Blue is not buying or financing any aircraft. We have the credibility to get good operating leases," he says, giving as an example the deal with International Lease Finance (ILFC). "How many start-ups would have been given A$540 million worth of aircraft?" he asks.
Impulse and Virgin Blue are following similar plans. With a modest initial fleet of new jets, both are launching high daily frequency services on parts of the Brisbane- Sydney-Melbourne triangle. At stage lengths of under 2h, both are offering a low-fare, one-class service with limited amenities. Virgin claims its flights will be "a flying bus". By year-end Impulse will be operating five Boeing 717-200s. Virgin is starting with five Boeing 737-400s, but will begin to replace those when the first of ten 737NGs arrive next year.
Both are cautious about how much their low fares will stimulate the market. Even though traffic jumped 22% when Compass launched its low-fare service, neither challenger is banking on such growth to make its plan viable. Both have studied the Compass saga in detail, both claim they will enlarge the pie rather than divert traffic from the incumbents, and both are modest about their market share projections.
Style difference
Despite these similarities, Impulse and Virgin Blue are very different. Impulse is a country airline that grew up. It has prepared its business plan with the deliberation of an outback station in deciding to switch from sheep to cows. Virgin, by contrast, is an international sophisticate with flair and panache. Even though this is the airline's biggest aviation risk so far, Branson talks of "having fun" taking on the incumbents - especially Qantas.
Early on, Impulse and Virgin met to explore co-operating on ground facilities, since they will share terminals in most airports. It did not take long, however, for each to conclude that its culture was so different from the other's that it would be better to go it alone. Each is a bit dismissive of the other. According to Virgin's Godfrey: "Within the next 12 months, I predict we will cross swords with Impulse."
Both recognise that the real test is not between each other but between each of them and the fiefdom that Ansett and Qantas control. Ansett has solid backing from ANZ and SIA; Qantas insists it will play by the rules, but declares itself battle-ready. "Whatever you think of Ansett and Qantas, they are fierce competitors," warns McGowan. "They're going to protect their markets. A wounded elephant is always dangerous."
Godfrey warns that Virgin Blue has set aside a non-capital reserve known as "the fighting fund". The litany of Virgin's litigation against BA shows its willingness to use the courts. By contrast, McGowan is averse to lawsuits. He will take his complaints to the Australian Consumer and Competition Commission (ACCC).
He has already done that three times, with two complaints against Qantas and one against a travel agency aligned with Qantas.
But McGowan also is concerned about the ACCC's powers. "Qantas and Ansett probably have more people looking for ways to screw us over than we have employees. Yet, based on the evidence to date, the ACCC does not have the resources necessary to take with any seriousness or to be of any use to us."
Godfrey has more faith in the system. He points to the assurances that transport minister John Anderson gave to Branson last November. Anderson stressed that Australia has "strong mechanisms for ensuring that anti-competitive behaviour is blocked out".
Godfrey thinks the public protests after the collapse of Compass made a lasting impression on Canberra. "Today the government is about 180í from where it was then in ensuring competition," he claims.
It is too early to tell if these complaints and bravado reflect any real anti-competitive practices. The newcomers may be trying to set a tone. Tough talk and shows of force are standard fare at times like this.
But in a country with such a sketchy competition record with aviation, all the players know this will be a crucial test for Canberra.
Source: Airline Business
