virgin blue's pacific solution

1:42 PM, 11 Dec 2009 Stephen Bartholomeusz
Bartholomeusz: Virgin Blue's Pacific solution

The Australian Competition and Consumer Commission’s decision to authorise the planned joint venture between Virgin Blue’s V Australia and Delta Airlines on the trans-Pacific route is, at face value, curious. It isn’t apparent where the public benefit lies in effectively reducing the number of competitors, on that now intensely competitive route, from four to three.

The nub of the ACCC’s thinking, however, may have been encapsulated in a comment from its chairman, Graeme Samuel, who said the joint venture would be likely to assist Virgin Blue and Delta to compete more effectively against the incumbents, Qantas and United Airlines, and create more sustainable competition on the route. It may not have escaped the Commission that reducing the threat V Australia poses to Virgin Blue’s financial stability also shores up its ability to compete in the domestic market.

Virgin Blue has conceded that the launch of V Australia was ill-timed. It was too far down the track with the launch to abandon it when the global financial crisis overwhelmed the aviation industry and, as a consequence, having spent $60 to $65 million on start-up costs, lost $30 to $35 million on the route last year.

Delta’s launch in July this year was very oddly-timed and the four-cornered contest has helped push fares to levels that Qantas’ Alan Joyce has made it clear his group believes are unsustainable.

Virgin Blue launched V Australia because the trans-Pacific was probably Qantas’ most profitable route and therefore not only was there a prospective profitable growth opportunity but it fitted with the broader Virgin Blue strategy of shadowing Qantas’ core routes to reduce Qantas' ability to impose pressure on Virgin Blue's own business.

Delta came onto the route, it appears, as part of a long-running strategy of putting pressure on United. Qantas may have dominated the trans-Pacific route but United shared in a profitable duopoly.

Delta has been launching new services out of Los Angeles Airport in an effort, it appears, to push United out of LAX, which is a key element of its domestic network. Delta, the world’s largest carrier, has a relatively modest presence at LAX, but may sense United’s vulnerability. United has lost nearly $US1 billion in the first nine months of this year, although the rate of loss has been substantially reduced in recent quarters.

The joint venture will give both Virgin Blue and Delta access to each other’s domestic networks, allow them to reduce costs and coordinate schedules and capacity. Virgin Blue has said it would enable V Australia to be operating at break-even by the end of this financial year. The deal should remove V Australia as a threat to the financial stability of the wider group.

Qantas has a code-sharing deal with American Airlines, which means that United will be the player on the route without a tie-up with an Australian domestic carrier. It will also lose its status as the number two carrier on the route, with its market share of about 21 per cent trailing the combined 29 per cent share of the joint venture and Qantas’ 50 per cent.

Qantas didn’t object too fiercely to the joint venture, perhaps mindful that it will have to gain re-authorisation for its similar joint venture with British Airways on the Kangaroo route, but also perhaps because more rational competition on the trans-Pacific is good for its business.

While V Australia and Delta have said capacity won’t necessarily be reduced, it would make sense for them to manage their combined capacity in a way that supports better yields and generates profitability on the route. That’s in Qantas’ interests too.

If United were driven off the route by an extension of the current unsustainable fare structures, that might be regarded as a bonus, returning the route to a comfortable duopoly, although that isn’t necessarily how Qantas would see it.

It would be far more concerned about Singapore Airlines’ hitherto unsuccessful lobbying for beyond rights so that it can service the trans-Pacific, than the continued presence of two competitors. While there is obvious competition on the route, and the other Australian domestic carrier, Virgin Blue, is flying the route, it is less likely the Federal Government will accede to Singapore’s requests.

The big winner from the decision is Virgin Blue, because of the shadow V Australia had cast over the solid profitability of its domestic franchise. The joint venture will make it less exposed to the continuing attack by Tiger Airways on Qantas and Virgin Blue’s domestic businesses.

There was an excellent analysis in Crikey yesterday, of Tiger’s belated disclosure that it lost $50 million in the year to March, by veteran aviation writer Ben Sandilands, who concluded that it was funding the losses and its continuing and expanding capacity from its receipts for forward bookings.

Tiger can remain unprofitable but keep cash flow positive provided it keeps growing those forward bookings strongly, which might explain why it has grown its fleet from four to seven aircraft and entered the Sydney-Melbourne route.

It is vulnerable, however, to increased losses, or anything that reduces or threatens the flow of cash from advance sales, until it can improve the actual profitability of its operations.

Qantas, having had a lot of experience with attempted start-ups in the domestic market, this week announced it would add 700,000 new seats to its domestic Jetstar route network. If it were to use Jetstar to mount a full-scale assault on Tiger it could cause the airline, and its major backer, Singapore Airlines, some discomfort.

Tiger has been talking about an initial public offering, although that would be difficult unless it were able to create a more sustainable operating performance. Under pressure, Singapore and the other shareholders – which include Singapore’s Temasek, the Ryan family (the founders of Ryanair) and US private equity interests – might have to provide the capital themselves.

The joint venture with Delta makes Virgin Blue’s domestic business less vulnerable and will make it easier for it to contemplate joining any Qantas assault on Tiger.

Thus, while the joint venture with Delta is ostensibly and, indeed, primarily about the trans-Pacific route, it could have broader implications for the Australasian aviation market, including the domestic competitive settings.

courtesy Business Spectator