KEY POINTS:
As Air New Zealand planes took off above them, Pacific Blue strategists enjoying a meal near Christchurch Airport launched Project Salmon - an operation to bushwhack existing airlines and give domestic travel the biggest shakeup in six years.
Their secret plan got its name partly in reference to
the fish that looks something like a big red herring, but mainly in honour of the long, wine-aided lunch at a salmon fishing lodge in early May.
It was then that after three years of hovering around our domestic market and the odd PR swoop, Pacific Blue executives got serious about starting up the budget domestic service.
Pacific Blue's general manager of operations Adrian Hamilton-Manns said he and fellow executives realised at the May 9 lunch at Sharvin Lodge that the cards had fallen into place.
New planes became available in March and the airline had a foothold here through its short-haul international transtasman and Pacific services.
"We asked ourselves did we think we could do it, can we hit the load factors and revenue that we need to achieve? And we thought, yes we can."
The strategy was approved by parent company Virgin Blue's board in August. The announcement of its entry to take on Air New Zealand and Qantas - and to cut off the Aussie airline's budget carrier Jetstar at the pass - came on August 23.
The ambush still gives Hamilton-Manns some satisfaction.
"No one expected it - they expected us here next year. When we turned up this year with 737-800s people said 'oh dear, didn't see that one coming'. We were very happy about that."
Secrecy was critical among a 15-strong team in the airline's Christchurch base and Brisbane head office.
"There was a lot of subterfuge and concealment of our true intentions and it worked very well, as evidenced by the fact that it caught everyone flat-footed. We didn't quite lock everybody in the room but we came close to it."
The airline grew quickly and now has around 550 staff based in New Zealand.
Air New Zealand - which has a stranglehold of around 80 per cent of the domestic market - became aware Pacific Blue was adding more planes and hiring more cabin crew and pilots.
"We argued that we were losing everyone to move across to Australia to work for Virgin - we just had extreme attrition," Hamilton-Manns says.
Despite its limited number of main trunk services, Pacific Blue could still take tens of millions of dollars off Air New Zealand, according to one analyst. Another says the price of fuel is a bigger concern for the national airline whose range of services ensures it won't be adversely affected by the newcomer's modest ambitions.
Air New Zealand, which has seen its domestic passenger numbers nearly double to 7.2 million in the past decade, says it always knew Pacific Blue would enter the market but admits the timing came "out of the blue".
Virgin Blue's co-founder and chief executive Brett Godfrey says New Zealand was a "battlefront" that had to be taken on at some point. He fires a shot at Air New Zealand over the lack of discounting before Pacific Blue, which claims passengers saved more than $4 million in the days after it hit the market with the first batch of $39 specials.
"They [Air New Zealand] certainly have a colourful history on how they have dealt with competition. I have little doubt they will price-match and use there significant local scale to endeavour to stymie our development or even our survival.
"We have our own race to run and won't waste too much time or energy constantly looking over our shoulder to see what the other guy is doing."
It's a sentiment shared by the "other guy".
Air New Zealand's deputy chief executive Norm Thompson is a veteran of managing the airline's domestic operation. He's seen a long list of airlines come and go but Qantas, which was the last big player to enter the market six years ago, and now Pacific Blue, were different propositions.
"If you have a look at the competitors we've had in the past they've been highly geared and haven't had strong capital backing. We're dealing with two very strong companies here but that doesn't make us afraid. We don't want to lose customers ... and we'll do everything we possibly can to hold on to them."
In a strategy welcomed by financial and aviation analysts, Air New Zealand has resisted any temptation it to get drawn into a full-blown price war.
Apart from renewed promotion of its Grab A Seat deals, with fares as low as $1, it has emphasised its frequency - it flies much more often than Pacific Blue on the main trunk - and most significantly has decided to fortify its position at the upper end of the market.
Air New Zealand is adding two Boeing 737s to its 14-strong fleet, giving passengers paying top dollar a more comfortable ride in bigger seats, complimentary snacks and drinks on some flights and better in-flight entertainment systems.
On the ground there will be smoother check-ins, improved frequent flyer benefits, free parking and Koru Lounge for those paying higher fares.
It's an approach supported by analyst Peter Harbison, executive chairman of the Centre of Asia Pacific Aviation in Sydney.
"It's the kind of response you'd have to make as the incumbent carrier - you don't want to be discounting everything."
Goldman Sachs JBWere has calculated Pacific Blue could wipe $31 million off Air New Zealand's operating profit over the 2008/09 financial year.
Head of research Marcus Curley said the loss was calculated as high as $50 million, but this was revised down after Air New Zealand's response.
"If they're losing share across the board they may look to review that strategy but at the moment they don't look as if they're going to go hammer and tongs at each other to the same extent that we initially thought."
Air New Zealand appeared to be putting a $20 premium on its seats.
"It looks as if its giving up the real low end of the market in terms of that price point and hence you're conceding market share at the end, which I think is the right approach," Curley says.
Rob Mercer, head of research at Forsyth Barr, says Air New Zealand's entrenched position, with its much greater frequency, should minimise the impact of Pacific Blue. He says fuel costs are a bigger problem.
Aggressive discounting on 10 per cent of seats for Air New Zealand could lower the impact while the newcomer could initially be forced to discount up to 50 per cent of seats, he says.
Pacific Blue's parent is, for the time being, owned by transport and logistics giant Toll Holdings and the UK-based Virgin Group. It is hardly the underdog.
Given its unambiguous local ownership, Air New Zealand can play the Kiwi Made card.
Air New Zealand spokesman Mike Tod says: "In essence Air New Zealand faces potentially strong competition from two Australian-based companies, whose sole interest is to return significant profits back across the Tasman, just as other Australian companies have done here in sectors like banking and retail."
Pacific Blue counters points out it is not an Australian division but a New Zealand-established company with headquarters in Christchurch "paying GST and corporate tax on any profits, just like Air NZ".
Tod also says that when Virgin Blue entered Australia in 2000 it effectively bought a slice of the domestic market by making an abundance of low airfares available.
"Once it had cemented its position, fares started to edge up and it also sought to extract money from customers for add-ons to the point where it is now one of the most profitable airlines in the world."
Virgin's migration up the service and fare scale came almost by default as it filled the vacuum left by the 2001 collapse of Ansett - it was dragged into the high-yielding business market which it is now enthusiastically serving across the Tasman. Harbison says this could be a pointer to the future here, while others say this is not likely. Pacific Blue says discount fares will appeal to some businesses.
And what about Qantas?
Its immediate response was to reinstate its Wellington to Christchurch service and like Air New Zealand has targeted the business market with a $13 million spend-up.
Lounges are being upgraded, there's more food on flights, better check-in systems are being installed, and its Boeing 737 fleet is being expanded to five in an effort to improve punctuality.
Equities analyst Mercer says Qantas has always had trouble cracking the market here.
"It's a difficult balance between offering a minimal service where you've got a brand and presence and deciding to get to a service level that gives you load factors and overall yield and make a profit. That's the problem Qantas has got."
Qantas, in announcing its revamp said it was committed to New Zealand. But Air New Zealand has another view.
"We would not be surprised if Qantas pulled out in the medium-term and replaced the brand with Jetstar, which would give it a lower operating cost base and a better ability to compete in a market that has proven in the past that it is capable of sustaining only two airlines profitably on the main trunk," Tod says.
Jetstar has been flying across the Tasman out of Christchurch for two years now and said last month it was still eyeing a domestic service, but is short of planes.
So how is Pacific Blue going to survive in a market where, on the main trunk, three is already a crowd?
Aviation analyst Harbison says that even though Pacific Blues's entry is relatively modest it does have a disproportionate impact on its competitors. It also has the potential for further growth, eventually.
"I don't think they're going to make a quick entry and then run if things don't work out. I think this a strategy which will even allow them to absorb some losses for a long time if necessary."
And although Air New Zealand has gone through a "remarkable transformation" it is a small carrier in a small country and vulnerable, he says.
Pacific Blue's Hamilton-Manns says the planes are close to full in the short term but is expecting this to fall to around 80 per cent, on a par with Air New Zealand's domestic flights, which were 76 per cent full last month.
It then comes down to yield - revenue per passenger-kilometres. Hamilton-Manns stresses the advantage his airline has on the cost side given its greater capacity to outsource ground handling, engineering, crew support and infrastructure such as hangars.
"You can't engineer a company down to the same cost level if you engineer it up from the base and that's what we've done. No matter what Air NZ do, they're never going to have our cost base."
That may be the case, but Air New Zealand's Thompson is keen on cost-cutting in the wake of 200 head office jobs going about 18 months ago and the outsourcing of some engineering work.
Thompson joined Air New Zealand in 1968 and while he has doubts there's enough room for three players he's positive low fares are here to stay.
