---

Hickey's role the toughest in Qantas split

I started at Qantas alongside Simon Hickey back in September 2004 in the strategy area.

Simon's a really smart, take-no-prisoners, hard-working guy. He has done a terrific job with Qantas Frequent Flyers but he has his work cut out for him in his new position as the CEO of Qantas International.

I say this because Qantas international hasn't consistently made money for 15 years. And this time interval is restricted to the past 15 years because I can't remember seeing any data on international profitability beyond this period.

What does Simon Hickey need to do to turn the international business around, and will the change in airline management structure enable him to do it?

The biggest problem Qantas faces in the international business is that the market is saturated with seats. While Qantas international has control over its own seats it has no direct control over those of its rivals.

If its rivals decide to expand capacity at four or five times the average growth rate, which is true of its Middle East rivals Emirates and Etihad, this action deeply and adversely affects Qantas international yields.

About the only thing Qantas can do in response is to lobby the government to reduce the rate at which it is granting new capacity rights to overseas carriers which are attempting to grow too quickly.

And the lobby message must be that extra seats may be good for international airfares, but it is terrible for Australian tourism at current exchange rates.

The tourism story would be quite different, however, at an exchange rate of 70 US cents, so Qantas would need to get into see the government at current exchange rates because its arguments would be more convincing than if or when the dollar dives.

Oil prices

The international business is more heavily impacted by the price of oil than the domestic business because international flights are over longer distances, and fuel burn is a direct function of distance.

The rapid increase in the price of oil since early 2000 has meant that international airlines should no longer think of growing at 5% per annum as the norm but more like 2% to 3%.

They should lose their preoccupation with market share, and their fear that they may lose market share if they grow at 2% to 3%, because market share doesn't equate to profitability.

And they should forget about fuel surcharges because they just don't work in isolation from lower capacity growth.

Simon Hickey should work more closely with the fuel hedging team in the Treasury Risk Management department, putting into place a framework that better meshes operational means for reducing the impact of higher oil prices with the use of financial instruments to reduce the exposure.

They should contemplate fuel and exchange rate hedging policies that are unique to the international business because the residual exposure of the international business to the price of oil differs from that of domestic operations.

Premium mix

The premium mix is the percentage of seats on the plane that are in first, business and premium economy classes. The higher the premium mix the more exposed an airline's earnings stream is to downturns in the economy.

Relative to other airlines, Qantas international has a high premium mix, which means its exposure to downturns is high.

Given that Qantas international is highly exposed to countries that are likely to experience slow and volatile growth over a long period of time, most notably Europe, the USA and Japan, then it should consider reducing its premium mix. Such a move, though, is likely to be too late for the current batch of aircraft that are due for arrival at Mascot.

Management

I can't help but think that the new CEO of Qantas international will struggle to implement the changes indicated above, even if he does agree with them.

The Group has had the opportunity in the past to implement these strategies and they have chosen not to. Their senior executive group and the board is essentially the same – they are just two fewer.

The one part of the Qantas announcement that is a concern is that they will manage Qantas domestic and international as “two distinct businesses”.

The domestic and international flying segments can't be managed as two distinct businesses. There is enormous overlap between the two.

Around 10% of domestic air travel involves international connecting travel or foreign visitors who fly into a major port and want a domestic side-trip. Successful airline businesses are able to link their international services with these types of domestic connecting and side trip customers.

There is also a large subset of the international market that competes with travel in the domestic market.

Australian resident travel to international leisure destinations such as New Zealand, Fiji, Phuket, Bali, Vanuatu, Tahiti, Honolulu and New Caledonia competes with domestic travel to Coolangatta, Maroochydore, Cairns, Ballina and Margaret River.

The domestic and international CEOs can't make capacity decisions independently in markets such as those just mentioned – but I'd imagine that the Flying Committee at Qantas will have the final say anyway.

Let's hope for the sake of Qantas shareholders that it's the correct say.

Tony Webber was Qantas Group chief economist between 2004 and 2011. He is now managing director of Webber Quantitative Consulting and Associate Professor at the University of Sydney Business School, and contributed this article to BusinessDay.

---