lame
22nd May 2004, 03:34
Jetstar's entry changes Virgin ground rules
By Stephen Bartholomeusz
May 22, 2004
The Age
When Jetstar's planes take to the skies next week for their first commercial flights, nothing much will change for Virgin Blue, or indeed Qantas. However, the ground rules for the longer-term tussle between Qantas and Virgin Blue for market share and profit in the domestic market will be radically different.
Virgin Blue is an industry marvel. From a modest start flying two planes four years ago it has built one of the world's most profitable airlines and grabbed a third of the Australian market.
Virgin Blue had some luck along the way, although it played a significant role in the demise of Ansett, which created the opportunity to become the number two carrier; an opportunity Virgin seized brilliantly without compromising its core competitive advantage, a value-based airline cost structure and positioning. Without the legacy issues that constrain Qantas - 16 unions, national carrier status and the obligation to provide ubiquitous dual-class services that go with that status, and a mixed and ageing fleet - Virgin Blue has been able to steadily strip market share from Qantas while maintaining extraordinary margins.
It has managed that mix of growth and profit with discipline and an unwavering focus on the bottom line.
But from next week it will face a more complex environment because the Jetstar launch is designed to force Virgin to choose between margin or market share. Virgin Blue's Brett Godfrey is ready for Jetstar. When Qantas's Geoff Dixon unveiled his version of a value-based airline this year, he said Jetstar would have a cost advantage over Virgin Blue - its starting point of 8.25¢ per available seat kilometre (ASK) would match Virgin Blue but would fall to 7.8¢ per ASK once the discount carrier shifted to an all-Airbus fleet in mid-2006.
This week Godfrey unveiled his pre-emptive strike within Virgin Blue's results for the 2003-04 year. In the second half, costs per ASK had fallen to 7.73¢. It appears neither of the discount carriers will have a significant or structural cost advantage.
Virgin Blue has at least to match Jetstar's costs because Dixon is targeting the price-sensitive high-volume leisure market - about 65 per cent of the domestic market. If Jetstar could undercut Virgin Blue, it could undermine the volume-sensitive economics of Godfrey's business.
Godfrey would recognise that Dixon does not actually have to operate a lower-cost airline to be able to use Jetstar to slow Virgin Blue's assault on Qantas's market position. Qantas is, compared to Virgin Blue, a low-margin business. Jetstar could operate with margins lower than Virgin Blue and still improve the overall Qantas group metrics.
If Qantas can finesse Jetstar's pricing and capacity and its own, it ought to be able to force Godfrey to choose between profit or share, knowing that he is too disciplined to pursue margin-diluting growth. Dixon's "line in the sand" - retaining 65 per cent market share - was not just bluster.
Jetstar is not designed to destroy Virgin Blue and will not. It was designed to reduce the threat that a value-based airline will always pose for a full-service network carrier in a relatively small market - that Virgin Blue would cherry pick Qantas's customer base to the point where the economics of Qantas's domestic operations unravelled.
It was instructive that Qantas, which has better hedging of its aviation fuel requirements than Virgin Blue, chose to impose a surcharge on Jetstar's fares as well as its own.
Qantas could have imposed short-term pressure on Virgin Blue but chose not to, allowing Virgin Blue to match the surcharge and protect its margins. That signals the civilised and controlled type of contest in which Dixon wants to engage.
Dixon needs time, and the co-operation of his workforce, to change the nature of Qantas's domestic businesses. Jetstar gives him a low-cost platform towards which he can migrate low-margin business - and business that would have been loss-making for Qantas.
The end game for Qantas is probably to have its primary brand flying mainly on international routes and those domestic routes that can sustain twin-class services, Jetstar catering for the leisure and price-sensitive domestic segments and its CityFlyer operations filling the business-traveller/capital city shuttle services gap in the middle.
Controlling the rate and smoothness of the rebalancing of Qantas's business that the launch of Jetstar should enable, will be the biggest challenge of Dixon's career.
If he gets it wrong, his much-derided comments about Qantas's survival will be revisited with less cynicism.
Godfrey is astute. The Virgin Blue team knows that the relationship with Qantas is complicated and is about to become more so. The "game" isn't about supremacy but profitability. It is in both airlines' interest to compete intelligently rather than destructively and create an industry structure that allows both to generate sustainable profitability without creating the kind of duopoly that opens the door to a leaner and hungrier new competitor.
Virgin Blue's interest in trans-Tasman, New Zealand domestic and Asia-Pacific markets is about extending its ability to exert leverage on Qantas outside the domestic market, as well as creating growth outlets that are not reliant on the Australian market. It is looking to a future where its position in the domestic market is mature.
There are plenty of sceptics who do not believe Jetstar can work, mainly because of the unhappy record of full-service carriers launching discount carriers.
The nature of the Australian domestic market - only two carriers, a relatively small population and a plethora of long-haul routes - makes this market quite different.
For those reasons, and the opportunity created by Ansett, Virgin Blue itself is not a conventional value-based airline. It is low-cost but is better described as "low frills" rather than "no frills."
Unlike most of the offshore discount carriers, it is not running point-to-point shuttle services between high-density population centres and from secondary airports but operates a business with increasing network characteristics from the major terminals.
Jetstar, by largely avoiding the major trunk routes (it will operate some services on them to compete for the price-driven flyers) and by operating some of its services from Avalon, will have points of difference with Virgin Blue.
More particularly, because its success will be managed and measured in terms of the overall group's position and profitability, rather than by how many passengers it can attract from Virgin Blue and the core Qantas services, it does not have to be an outstanding commercial success to create or preserve considerable value for the group.
By Stephen Bartholomeusz
May 22, 2004
The Age
When Jetstar's planes take to the skies next week for their first commercial flights, nothing much will change for Virgin Blue, or indeed Qantas. However, the ground rules for the longer-term tussle between Qantas and Virgin Blue for market share and profit in the domestic market will be radically different.
Virgin Blue is an industry marvel. From a modest start flying two planes four years ago it has built one of the world's most profitable airlines and grabbed a third of the Australian market.
Virgin Blue had some luck along the way, although it played a significant role in the demise of Ansett, which created the opportunity to become the number two carrier; an opportunity Virgin seized brilliantly without compromising its core competitive advantage, a value-based airline cost structure and positioning. Without the legacy issues that constrain Qantas - 16 unions, national carrier status and the obligation to provide ubiquitous dual-class services that go with that status, and a mixed and ageing fleet - Virgin Blue has been able to steadily strip market share from Qantas while maintaining extraordinary margins.
It has managed that mix of growth and profit with discipline and an unwavering focus on the bottom line.
But from next week it will face a more complex environment because the Jetstar launch is designed to force Virgin to choose between margin or market share. Virgin Blue's Brett Godfrey is ready for Jetstar. When Qantas's Geoff Dixon unveiled his version of a value-based airline this year, he said Jetstar would have a cost advantage over Virgin Blue - its starting point of 8.25¢ per available seat kilometre (ASK) would match Virgin Blue but would fall to 7.8¢ per ASK once the discount carrier shifted to an all-Airbus fleet in mid-2006.
This week Godfrey unveiled his pre-emptive strike within Virgin Blue's results for the 2003-04 year. In the second half, costs per ASK had fallen to 7.73¢. It appears neither of the discount carriers will have a significant or structural cost advantage.
Virgin Blue has at least to match Jetstar's costs because Dixon is targeting the price-sensitive high-volume leisure market - about 65 per cent of the domestic market. If Jetstar could undercut Virgin Blue, it could undermine the volume-sensitive economics of Godfrey's business.
Godfrey would recognise that Dixon does not actually have to operate a lower-cost airline to be able to use Jetstar to slow Virgin Blue's assault on Qantas's market position. Qantas is, compared to Virgin Blue, a low-margin business. Jetstar could operate with margins lower than Virgin Blue and still improve the overall Qantas group metrics.
If Qantas can finesse Jetstar's pricing and capacity and its own, it ought to be able to force Godfrey to choose between profit or share, knowing that he is too disciplined to pursue margin-diluting growth. Dixon's "line in the sand" - retaining 65 per cent market share - was not just bluster.
Jetstar is not designed to destroy Virgin Blue and will not. It was designed to reduce the threat that a value-based airline will always pose for a full-service network carrier in a relatively small market - that Virgin Blue would cherry pick Qantas's customer base to the point where the economics of Qantas's domestic operations unravelled.
It was instructive that Qantas, which has better hedging of its aviation fuel requirements than Virgin Blue, chose to impose a surcharge on Jetstar's fares as well as its own.
Qantas could have imposed short-term pressure on Virgin Blue but chose not to, allowing Virgin Blue to match the surcharge and protect its margins. That signals the civilised and controlled type of contest in which Dixon wants to engage.
Dixon needs time, and the co-operation of his workforce, to change the nature of Qantas's domestic businesses. Jetstar gives him a low-cost platform towards which he can migrate low-margin business - and business that would have been loss-making for Qantas.
The end game for Qantas is probably to have its primary brand flying mainly on international routes and those domestic routes that can sustain twin-class services, Jetstar catering for the leisure and price-sensitive domestic segments and its CityFlyer operations filling the business-traveller/capital city shuttle services gap in the middle.
Controlling the rate and smoothness of the rebalancing of Qantas's business that the launch of Jetstar should enable, will be the biggest challenge of Dixon's career.
If he gets it wrong, his much-derided comments about Qantas's survival will be revisited with less cynicism.
Godfrey is astute. The Virgin Blue team knows that the relationship with Qantas is complicated and is about to become more so. The "game" isn't about supremacy but profitability. It is in both airlines' interest to compete intelligently rather than destructively and create an industry structure that allows both to generate sustainable profitability without creating the kind of duopoly that opens the door to a leaner and hungrier new competitor.
Virgin Blue's interest in trans-Tasman, New Zealand domestic and Asia-Pacific markets is about extending its ability to exert leverage on Qantas outside the domestic market, as well as creating growth outlets that are not reliant on the Australian market. It is looking to a future where its position in the domestic market is mature.
There are plenty of sceptics who do not believe Jetstar can work, mainly because of the unhappy record of full-service carriers launching discount carriers.
The nature of the Australian domestic market - only two carriers, a relatively small population and a plethora of long-haul routes - makes this market quite different.
For those reasons, and the opportunity created by Ansett, Virgin Blue itself is not a conventional value-based airline. It is low-cost but is better described as "low frills" rather than "no frills."
Unlike most of the offshore discount carriers, it is not running point-to-point shuttle services between high-density population centres and from secondary airports but operates a business with increasing network characteristics from the major terminals.
Jetstar, by largely avoiding the major trunk routes (it will operate some services on them to compete for the price-driven flyers) and by operating some of its services from Avalon, will have points of difference with Virgin Blue.
More particularly, because its success will be managed and measured in terms of the overall group's position and profitability, rather than by how many passengers it can attract from Virgin Blue and the core Qantas services, it does not have to be an outstanding commercial success to create or preserve considerable value for the group.