Share tactics in a fight for flight

Rob Fyfe hopes the codeshare deal will make the airline some money. Picture / Brett Phibbs

Rob Fyfe sees himself and Air New Zealand caught between a rock and a hard place in the vital transtasman market.

On one side, the Tasman Express strategy - to boost revenue on transtasman routes by cutting fares and providing more seats - didn't attract enough extra passengers.

On the other side, competition on the Tasman route has heated up, with 10 airlines now fighting over a limited market, so there's no chance to put up fares.

That squeeze, says Fyfe, means "we're burning shareholders' funds there at the moment ... and that can't continue".

The airline's solution is the codeshare deal with Qantas which would allow it to rationalise services, reduce capacity, cut costs and, hopefully, make some money.

The trouble is that might see travellers taking that nasty spot between the rock and the hard place instead.

More than half the journeys New Zealanders make overseas are to Australia, and Air New Zealand and Qantas between them control 76 per cent of that market.

When the Commerce Commission turned down a more comprehensive proposal for the two airlines to get together in 2003 it concluded that if the deal went ahead then in its first three years the lack of competition would see transtasman fares rise 16 per cent faster than would otherwise be the case.

Should we be equally nervous about this latest plan?

Fyfe says there's much more reason to be nervous if it doesn't get approval, because at that point the airline's only option will be to start cutting services.

"One way or another, we have to at least get this market back to break even and we've tried everything else."

The big thing Air New Zealand tried was, of course, the lower cost Express service. The first stage, in the domestic market, worked well.

The airline dropped fares, increased capacity by around 25 per cent and Kiwis flocked to take advantage, says Fyfe.

"We got a 35 to 36 per cent increase in travellers so that was a winner for everyone."

But when Air New Zealand took the strategy into the transtasman market things weren't so good.

"On the Tasman we reduced price and increased capacity over three years by about 45 per cent ... but we only got about 36 per cent increase in demand so unfortunately we're worse off as a consequence."

Fyfe believes there were two reasons. First, the lower fares had little effect on the business market, and in any case, with more New Zealand businesses being owned on the other side of the Tasman, more corporate travel policies are requiring executives to fly Qantas.

Secondly, although more Kiwis were encouraged to visit Australia, Aussies did not repay the compliment. Even though Australia has five times the population, "if you look at traffic across the Tasman in terms of points of origin it's basically the same from either side and that defies logic", says Fyfe.

The failure of that strategy means the Tasman is now losing even more money. How much?

"We've never put a specific figure out in the market. About 12 months ago we indicated we were losing around $1 million a week. This year is not looking quite as bad but it's still tens of million of dollars annually."

This is an area he has to be cautious about, because the airline is a listed company and there are rules about the release of sensitive information, but he adds, "Given that I've said tens, plural, that kind of says it's more than 20, and you don't have to extrapolate much to work out that more than $70 million has been lost on the Tasman in recent times."

What about Qantas? "I suspect", says Fyfe, "that Qantas is in a similar position to us."

The Australian flag carrier has certainly moved to curb its losses by reducing transtasman services and getting its low-cost carrier, Jetstar, to take over the Christchurch routes.

Air New Zealand, too, has taken drastic steps to cut costs. Now, says Fyfe, the point has been reached where there is little more to cut. "We can only go further by reducing our capacity, whether we do it by this [codeshare] mechanism, or another."

So how will the codeshare achieve that? Basically, by putting all the services operated by the two airlines into a pool and reorganising them to achieve maximum efficiency, while still hoovering up as many customers as possible.

Flights will be spread more evenly through the day, in contrast to the present situation where Qantas and Air New Zealand flights often take off at the same time.

Services will be provided by whichever airline can do them the most efficiently. So, for example, the Wellington-Melbourne service will be done by Qantas, while Auckland-Adelaide will be Air New Zealand territory, because "that will most effectively utilise our fleets".

Overall there will be 7 per cent fewer flights and 5 per cent fewer seats across the Tasman but still, Fyfe says, more than enough capacity to meet the present demand.

"All we're doing is reducing the number of empty seats - at present our flights are, on average, only 72 per cent full - while still leaving plenty of seats for anyone who wants to fly."

That process will allow Air New Zealand to take two aircraft off the Tasman, producing savings of more than $40 million a year, probably enough for it to break even in that market.

The revenue from the joint service will be shared between the two airlines according to a formula based primarily on their present market share (53 per cent Air New Zealand, 47 per cent Qantas) but with a bit extra for Qantas because it gets a higher average price from its passengers.

For customers it should be largely business as usual. They'll go into the Air New Zealand website, ring up or visit a travel agent, see the full range of flights listed as operated by Air New Zealand and select the one that best suits. Then they'll be advised which airline is actually operating the flight and, if it's Qantas and the customer objects, an alternative will be offered, if possible.

Regardless of which airline customers fly with, if they've booked through Air New Zealand they'll get Air NZ airpoints, be able to use Air NZ lounges and check in at Air NZ counters. And the same will apply in reverse if they book through Qantas.

So far, so customer-friendly, but what about the Commerce Commission fear that if the two airlines were allowed to get together the lack of competition would see fares soaring? After all, competition authorities generally reckon it is unhealthy for one operator to get more than 40 per cent of a market, let alone 76 per cent.

This view, says Fyfe, is based on two misconceptions. First, "what constitutes market dominance varies from industry to industry, and what impacts prices in the aviation industry is not market share but the competition for the marginal seat".

For example, on an Air New Zealand Airbus 320, which typically would have 100 passengers in its 140 seats, "the difference between profit and loss is about five passengers. So an airline with only 5 per cent of the market can still take away enough of those marginal passengers to force you from being profitable to break-even or even loss-making.

"What airlines have to do in that situation is to say, 'Oops, I'm losing passengers, I need to drop my prices in order to increase my load factor. In other words, in the airline industry it isn't market share which keeps the lid on prices, it's all about these marginal customers who make the difference between profit and loss."

And you don't have to take his word for it. During the debate about the previous merger plan "the competition authorities on both sides of the Tasman accepted our argument on this".

Okay, but that begs the question, if the competition authorities bought the argument, why was the proposal turned down?

This brings us to the second of the two misconceptions which bedevil the alliance proposal: the extent of competition on the Tasman.

"Last time," says Fyfe, "we weren't able to convince the competition authorities there would be sufficient competition to prevent us from putting prices up. Neither Pacific Blue/Virgin Blue nor Emirates had entered the market at that stage so it was all, as the commission saw it, hypothetical".

Now not only have those two airlines arrived, but Emirates have already carved out nearly 12 per cent of the Tasman market, and Pacific Blue has 6 per cent. The combined market share of Air New Zealand and Qantas has dropped from 93 per cent in 2000 to 76 per cent today. That, says Fyfe, "suggests competition is alive and well ... and from all the signals given by Emirates and Pacific Blue/Virgin Blue they're here to stay".

This time, of course, the proposal isn't a merger but a codeshare arrangement which means it requires approval not from the commission but the Ministry of Transport.

That means it will be looked at less in terms of competition issues, which are the commission's concern, and more in respect of the structure of the aviation industry which will best serve the country, which is the ministry's main focus. And that, it is generally thought, means there's a very good chance it will get approval.

But, just in case it doesn't, what would Air New Zealand do?

Because of his belief that there is little room for further cost-cutting and no scope for raising prices, Fyfe warns there will be no alternative but to reduce capacity more brutally. "We'll have to have a review of specific routes and markets and see if we should drop them from our network."

Airlines do tend to make such threats when they're trying to make a point but there are signs that this time the airline is serious. Although it is trying to expand its long-haul service - principally by offering an extra service to London and a new direct route to Shanghai - it has also started to cut loss-making routes.

The Christchurch-Los Angeles service stopped over winter. The airline no longer flies to Nagoya in Japan or Taipei. And, Fyfe adds, "with the fuel price where it's at we have other long-haul routes under review.

"Traditionally the airline would have persevered. But I'm driving a much more pragmatic view that we just can't afford to cross-subsidise routes to any degree. Otherwise the profitable routes have to make more money than would otherwise be necessary ... and being highly profitable they'll tend to attract new competitors.

"Frankly, if fuel prices stay at present levels and we can't improve the underlying economics of the business we may be forced to park some aircraft on the ground.

"That would be a disappointment because everything we're doing is about trying to grow this airline, to get more travellers into the country and create more options for people going overseas. But we can't continue to burn money."

It's hard to quibble with Fyfe's passionately held view that if Air New Zealand is forced to retrench it would be a retrograde step. But it would be equally retrograde if the hook-up between the two dominant airlines on the Tasman saw fares soaring.

Fyfe also presents a convincing case for there being enough competition at the margins right now to keep things honest. But the industry is changing so fast that it is impossible to predict what might happen.

After all, in February, Fyfe was justifying support for our national carrier by warning that foreign carriers such as Emirates might - like the American airlines which used to fly here - not be in it for the long haul.

And just three weeks ago he was underlining Air New Zealand's importance to the economy by pointing out that Cathay Pacific has cut capacity here by 42 per cent, Singapore Airlines by 21 per cent and Malaysian Airlines by 15 per cent for winter.

Chances are Qantas and Air New Zealand will get the go-ahead for their codeshare. Chances are, too, that even by the time it comes into force the transtasman market will have changed from the way it looks today.