Here is the article mentioned:
Australian Financial Review, Page: 48
Monday, 24 September 2012
The grumblings of Virgin Australia’s pilots over pay and conditions are the tip of the iceberg when it comes to concerns over rising costs at the resurgent airline.
With Virgin back in the black, its captains want a better deal to match the pilots cap that chief executive John Borghetti gave them when he took over two years ago. Last week they told Borghetti what they thought of his pay offer, with a solid 62 per cent "no" vote against the deal put on the table. The situation is nowhere close to approaching the industrial relations meltdown at Qantas last year, but the language and demands coming out of one of the two pilots’ unions sound very familiar.
The Australian Federation of Air Pilots, the smaller of the two pilots’ unions involved, has backed the offer from the company. The dominant Virgin International Pilots Associa-. tion says its members are entitled to more, with executive director Simon O’Hara trying to link the domestic dogfight against Qantas to a campaign for similar pay and conditions.
The gap between the two is substantial, with Qantas pilots having built up their conditions over decades of negotiations and Virgin starting with a clean piece of paper 11 years ago. Last week, O’Hara said that if the main competitor is now Qantas, rather than Jetstar, then the company had to pay accordingly.
The trouble for Borghetti is that the union is asking for a lot more at the exact same time as Qantas is dragging down average airfares by adding capacity to protect its market share and destroying Virgin’s recent yield gains in the process. A government index of domestic airfares shows business fares dropped from a reading of 81.4 in August to 64.9 this month.
Being a full-service airline with inflight meals and airport lounges is expensive. And critics and fans alike of Borghetti say the Virgin chief has a flair for the brand and marketing side of the business that is matched with a propensity to spend up in the process.
Qantas’s first class lounge in Sydney is a case in point. The lounge is considered one of the best in the business, but it cost $20 million.
The Virgin chief says he completed most of the past two years’ product enhancements such as new lounges and refurbished aircraft with a business class offering for around the cost of buying a single-aisle 737 aircraft, around $30 million.
But that was only phase one. As Virgin continues to up its game in everything from chauffeur pick-ups for business class transcontinental flights to catering and improved terminal facilities, it is continually adding to its cost base.
At the same time, Qantas is not only bringing down average airfare prices through a capacity counterpunch to Virgin’s own growth but also reducing its cost base through redundancies and efficiency gains to give it more room to fight from a margin perspective.
Virgin’s labour costs rose from $742 million to $841 million last year. A quick glance at the company’s income statement shows every expenditure from aircraft operating costs to fuel and general expenses increased in sync.
Costs per available seat kilometre (CASK), the standard industry gauge for an airline’s outlay, rose 4.5 per cent last year. That paled in comparison to yield growth of 12 per cent, but as Qantas brings down full-service airfares with the mainline brand and attacks the leisure end with Jetstar, the question becomes how much longer the yield gains can outpace the cost increases.
CASK has risen at Virgin every six months for the past two years. Indeed it is at the heart of Borghetti’s strategy to spend more in order to make more, by attracting more business travellers with a premium product.
Comparable costs at Qantas fell 3 per cent last year, with improvements at both the full-service carrier and Jetstar. Its traditional yield premium of between 30 and 40 per cent is slipping at the same time, but CEO Alan Joyce is not likely to pull back from his current domestic strategy soon.
Joyce has made maintaining his line in the sand of a 65 per cent domestic market share something of a corporate mantra, and that goal is one of the key performance indicators towards his annual bonus.
Borghetti must have been hoping that the current round of enterprise bargaining between the airline and its short and medium haul pilots (the vast majority of Virgin’s business) would be conducted behind closed doors and away from media scrutiny.
The company achieved that with its small retinue of long-haul pilots last year, quietly agreeing to a 3 per cent pay annual increase at the same time as industrial relations went nuclear at Qantas.
The Virgin CEO may now settle for not creating a costly precedent.
Aside from the current round of bargaining with the short-haul and medium-haul pilots, Virgin has to negotiate new agreements with its domestic cabin crew, ground crew and engineers over the next year. And just as the formerly no-frills airline benefited through an influx of new passengers during Qantas’s industrial woes last year, it is now on the receiving end of bigger demands from its own staff.
Higher labour costs will also be unavoidable for the company as Borghetti continues to add to his corporate team to better challenge Qantas in the business market. A raft of new senior executive hires are being augmented by new teams working underneath them.
And then there are the added costs of moving to the Sabre global distribution sytem (GDS) from the existing budget distribution model where travel agents effectively link in to Virgin’s website to buy tickets.
Sitting over all of these incremental cost increases is the biggest expense of all, fuel. Just three months ago, Singapore jet fuel looked to fall back below $US 100 per barrel but has since trended steadily upwards to now trade above $US1 30 again.
Additional expenses go hand in hand with Borghetti’s strategy to take the airline upmarket, and it would be tough to describe any as wasteful or extravagant. They are core requirements to being relevant in the corporate game that Virgin is now playing.
Virgin still enjoys a significant cost advantage over its core rival, but the immediate concern is that expenses are being added at the same time as margins are being squeezed in the domestic market. Those concerns were echoed in the raft of 2013 and 2014 earnings downgrades that followed Virgin’s full-year results despite a pledge to deliver $400 million in productivity gains over the next three years.
With unrestricted cash of less than $500 million, compared with more than $3 billion at its rival, Virgin’s ability to withstand a sustained bear hug in the domestic market is not great. If things get ugly, it is the smaller of the two that most say will have to blink first and temper capacity growth Essentially Borghetti and his team could do everything right strategically and still be in for a rough ride this year due to the Qantas response.
Net profit is estimated to rocket to $100 million from $22.8 million last year, but that is still far from what Borghetti wants to achieve.
It is in this context that the pilots’ demands are particularly ill-timed, and why Virgin is keeping a low profile on the industrial relations front.
Borghetti achieved his three-year goal of generating 20 per cent of revenue from the corporate and government market in his first two years in the job. The lightning pace with which he has turned around the airline to date will be harder to sustain in the year ahead.
Andrew Cleary acleary@~afr.co,n.au