Having pulled together the constituent parts of the group under the newly christened Virgin Australia banner, former Qantas executive John Borghetti is on a mission to complete the maturing carrier's journey from low-cost entrant to a business player
Legacy carriers are blurring the lines between themselves and their low-cost rivals by adding ancillary charges for what used to be an array of services included in the fare. This is a deliberate down-market move.
Simultaneously, low-cost carriers have been adding complexity by interlining, selling through GDS channels, and adding other services to the point where their unit costs and revenue, especially in mature markets, are nearing those of legacy rivals. This has been a result more of natural evolution than any strategy to become legacy lookalikes.
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This trend is about to change. Legacies may be moving down, while low-cost carriers are evolving up, but Virgin Australia, along with Air Berlin, is among the first in the low-cost genre to take deliberate steps to change its model. Virgin Australia intends to become what John Borghetti, chief executive of the Australian Virgin Group, calls "an airline relevant to all sectors of the market".
Launched in 2000 as Virgin Blue, it grew quickly as Australia's only low-cost carrier. Qantas, Australia's dominant airline, formed Jetstar four years later as a low-cost response. Jetstar successfully blocked Virgin Blue from moving past 35% of the local market. Each boasted that its costs were lower than the other's. Then Singapore-owned Tiger Australia arrived in 2007. With undeniably lower costs, it assumed the role of spoiler. As Jetstar and Tiger flailed away at each other with discounted fares, it became clear to Brett Godfrey, founder and chief executive of Virgin Blue, that this was a fight without a future.
Virgin Blue's upmarket move had already started with small steps, but Tiger added impetus to its transition from traditional low-cost carrier to a hybrid that Godfrey referred to as a "new world carrier". Virgin Blue still held this status when Borghetti took over in May 2010 and began to rethink the airline's strategic direction.
The product of that rethink, a decision to seek more high-yield traffic, has been born of one part opportunity and about three parts necessity. Paradoxically, the opportunity comes from the near-monopoly that Qantas enjoys on business travel, which itself creates an opening for anyone who can offer travellers a choice.
The necessity stems from what some observers call Virgin's predicament - squeezed into a "no man's land" between full-service Qantas and the low-cost combination of Jetstar/Tiger.
"If you believe that the low-cost model has to be fed by growth," says Borghetti, "you reach a point in Australia with only 23 million people where you can't grow anymore. You have to start morphing into a different type of airline."
This brings higher costs, which put more pressure on Virgin Blue to distance itself from the Jetstar/Tiger model, where capacity growth kept pushing yields down.
The global financial crisis underscored the other part of Virgin's dilemma. To compensate for the plunge in discretionary travel, airlines everywhere were seeking higher-yield traffic. The need for Virgin Blue to move upmarket became obvious.
"The biggest problem", Borghetti says, "was that our heavy reliance on leisure travel made us more susceptible to the regular shocks that affect this industry - interest rate rises or disasters like Queensland's floods and cyclone. By contrast, Qantas was more resilient because it had a larger portion of the business market."
It was certainly easier for Borghetti, who had worked as a senior Qantas executive for years, than for Godfrey, who boasted that his "feet were firmly planted in the low-cost sector", to make the model change that Virgin Blue needed.
"We only had two choices," Borghetti recalls. "One was to go back and unwind what we'd already started, try to take costs out. The other was to go forward."
Going back "would have been an impossibility", he predicts. "How do you take costs out - your labour rates, your infrastructure? Look at so-called legacy airlines around the world who are trying to take costs out, and look at how difficult that is. So you go the other direction. You've already taken your first step, so now you better be going in boots and all."
The "boots and all" plan that Borghetti developed is more dramatic than it sounds. It only targets raising Virgin's share of domestic business traffic from its current 10% to 20%. But the dramatic part is in what it takes for a hybrid low-cost carrier to remake itself enough to attract that second 10% of Australia's business travellers.
How Borghetti picked this 10% target is instructive. Virgin flies 30% of Australia's capacity, leading some to wonder why it would not accordingly aim for 30% of the business market.
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"It's a question of investment for return," he explains. "Aiming higher means you have to invest considerably more to collect an extra one or two points of market share.
"Where those lines cross for us is around the 20% mark. Based on the level of investment we were willing to make, we can offer a product that equals and in some instances is even better than our competitor's and it should attract a certain percentage of the market. The sweet spot for us is around 20%."
This target would differ for another airline and depends on how much capital it is willing to spend. "It could also be different for us," Borghetti adds. "At this stage, this level of investment is all we want to do."
Borghetti puts the price tag at A$30-35 million ($32-37 million) - remarkably low for what Virgin is trying to do. But as he points out, this is the "incremental spend" - how much more Virgin will spend to upgrade its product.
"Over the coming year, we have about a dozen aircraft coming in, mostly to replace existing ones," he explains. "So with the new aircraft you order them with the black leather instead of red leather. The incremental cost of that is very small. You have to pay for the seats anyway," he says.
"Same thing with lounges. Our Brisbane and Melbourne lounges were due for a refurbish. The only incremental cost is in refurbishing to a better standard. So we're getting a big bang for a relatively few bucks."
Rebranding is one cost higher for Virgin than it might be for other airlines trying to achieve the same thing, but it is essential to Borghetti's strategy. When he arrived, the Virgin Blue Group consisted of Virgin Blue, the domestic carrier, Pacific Blue, its short-haul international arm, V Australia, the long-haul international arm, and Polynesian Blue, a joint venture with the island nation of Samoa.
This brand proliferation was the product of a 1999 deal between the UK's Virgin Group, owned by Sir Richard Branson, and Singapore Airlines. When Singapore Air bought 49% of Virgin Atlantic, it also bought the right to veto use of the Virgin brand on any other international airline. This effectively confined Virgin Blue to Australia.
Borghetti took the lead in negotiating a change in this, and he succeeded. His terms remain secret, but Virgin Blue gained consent from Singapore Airlines (and Virgin Group) to use the Virgin name overseas. Four days before Borghetti's first anniversary as chief executive, he was able to announce on 4 May that Virgin Blue was changing its name to Virgin Australia, and that Pacific Blue and V Australia would also become Virgin Australia before the end of the year.
Besides brand integration, the other big change has been Virgin Australia's creation of a globe-spanning virtual network. Three of its strategic alliances already enjoy antitrust immunity - those with Air New Zealand into the key New Zealand market, with Etihad to the Middle East, Africa and Europe, and with Delta Air Lines to North America. A fourth into Asia has just been unveiled with Singapore Airlines and awaits approval from competition authorities, which could rule by year-end. With these alliances, the Centre for Asia Pacific Aviation calls Virgin Australia "the largest virtual airline in the world".
Domestically, Virgin Australia has introduced widebody transcontinental flights with its first business class, upgraded lounges at Australia's main airports and changed uniforms and livery. It has also added in-flight business class meals, revised its fare structure, and brought in a host of other enhancements for business travellers.
By year's end, the airline plans to have all 63 of its Boeing 737s reconfigured with new interiors and business class, an overhauled frequent flyer plan that favours business travellers, better computer reservation access for travel agents, and a domestic regional partnership with Skywest Airlines that will bring outback and mining towns into the network.
Each of these is a major project in itself; collectively they represent a sea change. Some were also on the to-do list of predecessor Brett Godfrey, but Borghetti has managed to motivate the airline's staff to move forward simultaneously on all these fronts.
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"Yes, we've had to deal with cultural change," Borghetti admits, "but not to the degree that I expected. I feel very positive about the competence and enthusiasm of the staff." As with any chief executive change, he has seen some turnover at the middle and senior levels, and he has induced a number of former colleagues from Qantas to join him at Virgin Australia. Whether holdovers or new, however, Borghetti boasts: "We now have a management group that will stack up against any airline."
The team has had a baptism of wind and water. Earlier this year, while trying to implement all these changes, it also faced a devastating cyclone and floods. Over half of Virgin Australia's flights are in, out, or within Queensland, the hardest-hit state. Even the basement of its headquarters in Brisbane was under water. "Trying to manage an airline in the midst of Queensland's crises was a big enough issue," Borghetti recalls. "Plus trying to make a transition here on top was almost impossible."
Natural disasters aside, the longer-range challenge for Virgin Australia is still over how much business travel it can woo away from Qantas. Virgin has the advantage of a younger fleet (4.7 years on average) and a cost base at least 20% below that of Qantas, but no-one can be sure what it will take to convince business travellers to switch.
The airline's Asian strategy could be problematic. Singapore Airlines can provide good feed to India and parts of Southeast Asia. Both are growing business markets for Australia. But Singapore is not on the way from most of Australia to destinations such as China, Japan, Taiwan, or South Korea.
Convincing business travellers to connect through Singapore when rivals offer non-stop flights to these destinations will be daunting. The alternative is for Virgin to build a fleet of widebodies and serve these markets itself. So far, Borghetti has shunned this approach in favour of alliances.
Virgin Australia does not expect to start seeing results from any upmarket moves until the first half of next year, but the early signs are encouraging. When the airline unveiled its new Sydney airport lounge and business class on its Airbus A330 flights to Perth, corporate procurement people took notice.
Several days after the unveiling, Borghetti recalls "the head of sales came to me and said, 'John, we have had almost 40 corporates ring us and say we saw what you're doing. Could you please come and talk to us. '."
Borghetti adds: "In my 38 years I've never heard of corporates ringing the airline asking 'please come and talk to us about what you've got'. Normally you have to break the door down, and plead please can I show you, can I show you?"
Government statistics help explain the cause for this apparent interest. According to the bureau that analyses transport economics, leisure class airfares within Australia have declined over the past decade from an indexed 100 to around 70 today. With the arrival of Jetstar and Tiger in that period, it is no small wonder.
By contrast, business class fares are still indexed at 100, where they were in March 2002. They have not declined. This, Borghetti claims, "is an important illustration of the lack of competition in business travel that's occurred in this country in the past 10 years".
When a newcomer enters a monopoly market, he says, consumers appreciate finally having an option. "The incumbent will lose something and the entrant will win something. The only question is how much."
Regardless of how much business traffic Virgin is able to attract, Borghetti is starting to look farther ahead. "By the end of this year Virgin Australia will be a completely integrated airline," he says. "I'm spending more of my time now thinking about three to four years from now."
Looking ahead he says: "Our biggest challenge going forward is with ourselves. We have so much momentum, so much hunger, so much of all the good things, that I never want to see that diminish. As we accomplish all that we have in the past 12 months, I remind my staff: 'This is not the end. It's actually day one of the beginning'."
Our heavy reliance on leisure travel made us more susceptible to the regular shocks that affect this industry"
- Check out our cover interview from 2009 with the then respective heads of the various Virgin branded carriers
Source: Airline Business
