Using three different formulas, Qantas is aiming to prove that, contrary to prevailing opinion, forming low-cost units within a major airline can work
The allure that low-cost subsidiaries have for major carriers is certainly not due to their success. Continental Lite and Delta Express are history. Air Canada reabsorbed Tango and Zip. And as British Airways chief executive Rod Eddington said when he sold Go, no traditional carrier had ever made a low-cost unit work, arguing that they are just a distraction.
But still the majors try, driven by their legacy cost structures and the need to defend markets against low-cost rivals. Although the road is littered with failures, the network carriers' need compels them to keep tweaking the low-cost subsidiary model in the hopes of eventually getting it right.
Australia's Qantas Airways has done this not once, but in three separate markets with different brands in each, and is now preparing to export what it sees as its successful domestic model to South-East Asia. With all three units functioning, Qantas may be on its way to proving the doubters wrong.
Like majors elsewhere, Qantas was trapped between low-cost entrants and a legacy of high costs left from the days of domestic duopoly with Ansett Airlines. Some 16 unions represented 97% of its Australian staff. Work practices were typically rigid. Service standards won awards, but costs were high. The airline faced a A$6 billion ($4.6 billion) fleet upgrade and, thanks to the arrival of low-cost Virgin Blue, a shrinking market share.
Qantas tried to respond by cutting costs. It dropped business class on domestic Qantas flights, replaced hot meals with a box lunch, and called it OneClass. It was a disaster. Not only did frequent flyers complain, but so too did politicians. Lesson number one emerged quickly: to match customer expectations with a low-cost product offering requires a separate brand.
It was a dilemma typical for a major airline. Qantas needed something separate and with lower costs, but still under its control. As Peter Gregg, head of corporate strategy and chief financial officer at the carrier, recalls: "There was a commitment from here at the top because we had to make it work."
The coincidence of Ansett's collapse and the events of 11 September delayed the launch of a low-cost domestic subsidiary. Qantas was simply too busy with an operation reminiscent of an airlift to fill Ansett's vacuum as quickly as it could.
Offshore experiment
Hence, the first Qantas low-cost experiment was offshore. In October 2002 it launched an international carrier named Australian Airlines. It created Australian to tap Asian leisure markets that Qantas had dropped or planned to drop because the margins were too low for a full-service airline. With a single-class servicefocusing on inbound traffic, Australian worked with group operators in Japan and other Asian cities to bring tourists to Cairns and the Gold Coast, two Australian gateways popular with Asians.
It was a low-risk venture. Much of the infrastructure was already in place. Lease payments on five Boeing 767-300s were the biggest expense. With a knack for turning adversity to advantage, Qantas discovered that the cost of aircraft leases dropped overnight after 11 September. Ansett's collapse also flooded the labour market with unemployed staff.
When Australian advertised for 190 cabin crew, 3,000 applied. Under separate contracts to those at Qantas, Australian paid its staff similar rates, but with different work rules pay was effectively 20% less. In another example of turning adversity around, it was able to exploit Asian fears over travel to the USA in the aftermath of 11 September, promoting Australia as a "safe" alternative.
Qantas launched Australian at the worst possible time in the worst possible place - at the start of the SARS epidemic in Asia. It lost money its first year, but its performance has since improved. "It's doing quite nicely this year," says Gregg. Australian is not a no-frills or a low-fare airline, but it has used its lower costs to supplement its parent's earning at minimal capital outlay.
The second Qantas offshoot is also offshore. It formed JetConnect to operate flights within New Zealand after the collapse of its franchisee - Qantas New Zealand - in April 2001. Qantas held no stake in that airline, but decided after Qantas New Zealand entered receivership to fly in that country in its own right.
Local staff at local rates
This required Qantas to form a New Zealand entity to seek and hold an air operator's certificate. JetConnect recruited local staff and paid them at prevailing local rates in less-expensive New Zealand dollars. By some estimates, that saves Qantas up to 50%.
Qantas transferred five Boeing 737s to JetConnect for domestic New Zealand flights, and has since added two more when JetConnect took over Qantas flights to Australia out of Wellington. All of JetConnect's aircraft and crews are based in New Zealand.
JetConnect operates as Qantas, thus ignoring the rule on separate brands. It offers a two-class service, but is otherwise low-cost, says Gregg. It can do in New Zealand what it could not in Australia because New Zealand passengers do not have Australian expectations about the Qantas brand. It pays to understand your market.
Whether JetConnect actually makes any money is unclear. Qantas does not disclose individual results, but it has often conceded that its small New Zealand operation is not sustained by profit but by its network value. At least JetConnect is saving Qantas whatever it would cost to maintain that New Zealand presence at the parent's higher costs. The only thing that would seem to stop JetConnect from operating more ex-New Zealand flights is that Qantas has agreed with its mainline unions to cap the number of crew based offshore.
The final and most provocative Qantas low-cost unit is JetStar, the domestic airline it launched last May. At JetStar's debut, it was simply a rebranding of the Boeing 717 unit Qantas had bought from Impulse Airlines in May 2001. JetStar continued under its new name to fly the same leisure routes as before with costs, fares, and service levels substantially below those offered by Qantas. Only with its phased refleeting to Airbus A320s, now under way and due for completion by mid-2006, is JetStar developing a network and character of its own. Qantas chief executive Geoff Dixon predicts that JetStar will come to claim a third of the Australian market.
The reasons for JetStar sound familiar. In the first three years after Virgin Blue's launch as a low-cost domestic airline, leisure travel within Australia grew from 35% of the market to 65%, thanks to low-fare stimulation. Despite the potential in that market sector, however, Qantas was handcuffed by costs that Dixon claims were 25-35% higher than Virgin's.
Market share battle
Dixon also worried that Qantas was losing the economies of scale and network benefits of its traditional dominance within Australia. On the eve of JetStar's launch, Virgin Blue's market share was pushing 33% with a declared goal of 50%. Conversely, the Qantas share had slipped to 65%, prompting Dixon to declare: "This is our line in the sand and we will provide the capacity and infrastructure to defend it against Virgin Blue and the other carriers."
JetStar's mission is not to push Virgin Blue into the sea, but to end the erosion of domestic dominance Qantas has long enjoyed and to give the group a profitable piece of the growing low-fare pie. It is also designed to block newcomers. From time to time Singapore Airlines has toyed with the idea of a domestic Australian presence, especially since the demise of Ansett. As Gregg explains: "We thought that the Virgin cost structure wasn't low enough to dissuade anyone silly enough to try to get something below that."
Virgin Blue may be slow to concede JetStar's benefit, but Gregg reckons "they should be thankful that JetStar is there to stop anyone else from coming in".
JetStar and Virgin Blue take turns scoffing at each other's boasts about lower costs, although JetStar's product offering is more basic. Its seat pitch and baggage allowances are tighter and, unlike Virgin, it does not assign seats. At first, passengers criticised JetStar boarding rules, which aim to cut turnaround times and thus squeeze another sector out of every day. Gregg says such complaints have declined.
Until JetStar completes the phase-out of its 717s, it is burdened with two aircraft types. If JetStar's unit costs are not lower than Virgin's already, they will by once that conversion is complete. This is especially likely as Virgin Blue adds inflight services such as Live TV, inan effort to keep pace with Qantas in differentiating its product from the more basic JetStar.
Qantas has tried not to repeat the mistakes of other majors in forming low-cost subsidiaries. After separate branding, its second policy is a strict user-pay system on cost allocations. As chief financial officer, Gregg insists it makes no sense to hide any of a subsidiary's costs within the parent. "The mainline airline can't afford to be picking up these extra costs. That would destroy the biggest part of the business."
Australian, JetConnect and JetStar may benefit from the scale economies, fuel hedging, and superior credit of the Qantas group, but Gregg insists that they pay commercial rates for everything Qantas provides.
Union deals
Qantas has also done a better job than most majors in convincing unions to accept low-cost units. That is largely because it has been clear about their purpose. These units are not designed to shift unionised work from parent to subsidiary, thus threatening current employees. Australian creates new work by flying where Qantas no longer could. JetConnect has taken over New Zealand routes that Qantas never flew. And JetStar gives the Qantas group a chance to compete in the low-fare market where Qantas cannot.
"I want to congratulate the unions," says Gregg. "They worked with us to create more employment." Without that union understanding, Dixon said at the Qantas group's annual general meeting, "other airlines would have filled the void, and the Qantas group wouldhave been smaller and less able to compete as a result."
The most dramatic difference between other majors and Qantas is in the way they govern their subsidiaries. Conventional wisdom holds that a low-cost carrier will not work within a major airline without enough autonomy to create and nurture a separate culture, standards and practices. Even Qantas has paid lip service to this principle. Dixon promised that JetStar would have "a totally independent management team that will be allowed to run it as it should be run, as a genuine low-cost carrier".
To further this appearance of independence, none of the Qantas subsidiaries share their parent's headquarters in Sydney. Australian is based in Cairns, JetConnect in Wellington and JetStar in Melbourne. But they have no real autonomy. Each airline reports on its business each month, and it is monitored "constantly", says Gregg. "The chief executive and I sit down with each airline each month and evaluate its performance," he explains.
The heads of JetStar and Australian also sit on the Qantas executive committee, which meets every second Monday. As Gregg describes it: "There is a fairly constant dialogue."
Qantas keeps especially close tabs on routes and capacity. Representatives from each airline sit with Dixon and Gregg on what they call "the flying committee". "We ensure that what is being flown by each airline is in the best interest of the group, not specifically in the best interest of that airline," Gregg says.
This is in direct response to what Qantas believes was a mistake by BA in giving Go too much autonomy. "Go flew against the mainline quite aggressively. We haven't done that. There's a little bit of competition, but not much," says Gregg. "We avoid most cannibalisation with the flying committee."
Group emphasis
He puts the issue of low-cost autonomy in perspective. "We'd like to see them have a culture that fits the market segments where we want them to operate. But we're not interested in a carrier that can make a lot of money at the expense of one of the other carriers. At the end of the day, what's important here is the Qantas group."
That explains why JetStar is loaning A320s to help launch JetStar Asia, the low-cost venture Qantas is managing in Singapore as a 49% owner. As Gregg explains, JetStar Asia has "substantially better growth opportunity" potentially serving up to 3 billion people, in a market that Qantas cannot access on its own. In this way Qantas closely integrates its low-cost units into the larger group, and that explains its apparent success. Final success, however, turns on a more subtle concern.
It took other major airlines some time to realise that creating a low-cost subsidiary is no silver bullet to avoid more fundamental issues. If exciting new ventures cause an airline to lose focus, that could bring its own risks.
Report by David Knibb in Sydney
Source: Airline Business
