One virtual, the other an icon, each in search of a durable international strategy

In the big picture Virgin Australia is arguably strategically better positioned internationally for the long term, relying proportionately much more on its virtual network, a status it intends to maintain. It enjoys solid relationships with Delta (anti-trust immunised partnership on the Pacific and codeshares), Etihad (equity partnership and codeshares), Singapore Airlines (equity partnership and codeshares), Air New Zealand (equity partnership and codeshares), as well as other route specific ones. Its own-metal international services are limited, with few expansion plans.

Qantas is today held back from achieving its preferred international positions by a combination of factors, among them the burden of being a national icon and political toy; a legacy of long-haul operations whose economic fundamentals have been drastically undermined by liberalisation; the Qantas Sale Act; and a high cost base.

Where Virgin Australia has the benefit of international partners, Qantas however has its own advantages in terms of its dual brand policy in its strategically successful low cost subsidiary, Jetstar, with domestic, long-haul and cross border JVs established in several Asian countries – although the strategic leverage is not always matched by short term profitability.

But fundamentally, Qantas has a number of international routes (and aircraft) that it would not plan were it to start from a blank sheet today, whereas Virgin has only a handful of 777s that it would arguably be better off without. In other words, the good news for Qantas is that it has plenty of areas to cut back internationally; the bad news is that it is not easy to do so.

Outside the direct airline operations, Qantas also has probably the world’s most successful Frequent Flyer Programme. Virgin is building up its own programme too, and the airlines share a common need to be able to offer a proliferation of international services in order to maximise the value of their FFPs.

For the final twist in developing a long-term network strategy, each is keenly in need of a suitable means of accessing the burgeoning North Asian market. Virgin Australia has its Singapore Airlines partnership, but serving the big markets to the north via Singapore can only be a temporary solution.

1. The UAE: Onward feed is vital to gaining value from the partnerships

Qantas loads drop almost 15ppts to 61.1% while Virgin picks up to 65.9% – from a very low base of 54.2%

Australia’s airline system has greater reliance on UAE’s aviation resources than does any other.

Both Qantas and Virgin Australia use their respective UAE airline partners aggressively to access European and other markets. They mostly do it “virtually”; that is they rely on codeshares on the metal of their partners, Emirates and Etihad respectively. The UAE airlines fly the routes for the Australian airlines. To that extent, the two Gulf airlines have become an integral - and essential - part of Australian aviation.

Qantas has recently adjusted its network to the UAE and Europe to improve aircraft utilisation, resulting in an additional frame to operate to Dallas/Fort Worth; however there is a significant possibility of overcapacity developing between Sydney and Dubai. Since Sep-2011 weekly seats have increased from a base of 13,321 to 31,248 as Qantas commenced service and Emirates up-gauged to A380 equipment. Qantas is the weaker partner and may need to admit its aircraft would be better positioned elsewhere.

Virgin Australia had previously considered a European tag for its Abu Dhabi service, either to Athens or Rome, but this was suspended due to deteriorating economic conditions in the EU. Virgin’s current schedule leaves the aircraft idle for 36 hours between arrival and departure, excluding a once weekly wet-lease with Etihad Airways to operate an Abu Dhabi-Kuala Lumpur-Abu Dhabi rotation.

UAE-Australia capacity share (% of seats) by carrier: 25-Aug-2014 to 31-Aug-2014

It would be a massive call for Qantas to cease operating to Europe with its own metal. “QF1” operating from Sydney to London speaks for itself, with decades of history.

But Qantas has failed to maintain share even after getting close to Emirates and the service is asset-intensive with significant competition. The airline has halved services since 2012, from four to two daily and operates no services to Dubai from Australian ports other than Sydney and Melbourne.

The absence of any European carrier in Australia, except British Airways, is testament to the demands of operating the route, although Qantas does have the advantage of an Australian network that generates the bulk of travellers.

The removal of one or both Dubai-London frequencies, and even the entire Australia-London service, would free up significant A380 capacity to be used elsewhere in the network where it can arguably be better utilised, such as the US. While unlikely, adjustments to Europe are necessary and Qantas has an enviable partner in Emirates that it can leverage further should it decide to cut.

Virgin Australia’s close partnership to Etihad, and the wet-lease opportunity available in Abu Dhabi likely supports the service to either break-even or profitability, however there is a definite suspicion the service exists as Virgin has nowhere else to send the 777 fleet.

2. US and the Americas: high load factors, strong prospects

Qantas and Virgin have each achieved 80% load factors in a stabilised and growing market

Following a period of rapid expansion in 2009, as both V Australia (now Virgin Australia) and Delta entered almost simultaneously on the back of the Global Financial Crisis, the Australia-US market has reached a point of relative stability – supported by a resurgence in US outbound travel.

Qantas has long held a position of dominance on US routes, holding anywhere between 42% and 50% of the total market. Virgin Australia’s US services are now profitable following a long period of losses, but with five aircraft, a weaker hard product and no dedicated international lounges it lacks the premium proposition that Qantas commands. It has onward Delta and Virgin America connections, but these are not as powerful as Qantas' American links.

Virgin recently announced it would withdraw from Melbourne-Los Angeles in favour of a daily Brisbane-Los Angeles service, consolidating its 777 operations to two ports but increasing Brisbane-Los Angeles capacity by about 28%.

The route most recently recorded load factors of 83.9% and even allowing for improvements in passenger demand with the added timing and connection possibilities, increasing the Brisbane capacity opens the door to at least temorary yield erosion. Virgin would be the likely loser in this scenario, lacking the ability to command a fare premium over Qantas.

Qantas also holds a strong position into Santiago, reporting consistently high load factors and a strong partner in LAN – repeating this strategy into a key Asian port is key.

US-Australia capacity share (% of seats) by carrier: 25-Aug-2014 to 31-Aug-2014

How Qantas’ Los Angeles-New York JFK tag performs is less clear. The service reportedly yields strong premium traffic and Qantas has reportedly toyed with the idea of deploying A380 equipment for it, although its terminal at JFK is not A380-compatible. The service has previously been downgauged to A330-200, so an A380 operation may be too much.

Qantas could leverage its relationship with American Airlines to connect to an A321T ("Transcontinental") product, a significant premium offering as compared to previous products in the US domestic market, although opportunities to redeploy the redundant 747 would be limited.

Sydney-Honolulu is another question mark - recently flagged for a frequency increase to cater for premium demand, it is a highly seasonal market with competition from Jetstar and Hawaiian Airlines. As a leisure market it may be better left to Jetstar (Hawaii being one of Jetstar’s few performing long-haul markets).

When Virgin decided to enter the US market during 2008 the market was a longstanding duopoly featuring Qantas and a tired United. Delta has since become a partner while United has reduced capacity and improved its product, eroding the pot of gold that was so tantalising.

While the US operation has since been improved to the point of profitability, there are two strong US carriers in the market offering significant onward connections in the US. United's upcoming launch of non-stop services on Los Angeles-Melbourne, which is currently served as a tag to Sydney, will add further pressure.

3. The South Pacific: generally low load factors, sometimes with high yields

Qantas load factors on New Caledonia drop to 58% while Virgin manages 68.4% in Vanuatu

Both carriers receive strong yields on services to Papau New Guinea, despite notably low load factors year round. No other service in the region exceeds a 75% load factor. Virgin Australia has clearly reaped the benefits of its trans-Tasman partnership with Air New Zealand while Qantas appears to be struggling – though moving to a more adaptive timetabling model with greater use of Jetstar should yield positive returns.

Qantas earlier this year adopted a proactive stance to its services in New Zealand by pulling back or replacing frequencies with Jetstar in lower demand periods, while ramping up frequency during peaks. Qantas previously failed to manage its trans-Tasman capacity effectively, remaining relatively flat throughout the year.

Jetstar aggressively manages its capacity, as does Air New Zealand, leading to a more efficient matching of supply and demand. Qantas’ operations to PNG and New Caledonia operate under the QantasLink and Qantas Domestic umbrellas while New Zealand operations fall under the JetConnect subsidiary, meaning they are unlikely to be affected by cost-cutting at Qantas International. Nonetheless, Jetstar and Qantas are clearly responding more effectively to the market and there are opportunities for closer integration between the pair.

Virgin Australia has had weak load factors to New Zealand, perhaps suggesting its move to a premium positioning does not match its core trans-Tasman leisure traffic. It too may need to revisit its approach.

Air New Zealand flagged an inconsistent product as a barrier to working closer with Virgin, and this will need to be rectified if Virgin wishes to continue repositioning itself as a premium carrier. Elsewhere, Virgin’s network is a throwback to its LCC roots – highly dominated in leisure markets and overlapping with partner Air New Zealand. Consolidation is to be expected between the pair’s South Pacific operations in the future.

4. Asian markets: Virgin Australia has SIA and Qantas is close to China Eastern, but neither has developed a fully fledged Asian strategy

The Indonesian and Thai markets are highly competitive, with intermediate carriers like AirAsia X also spicing the competition.

Qantas' Thailand load factors have improved year on year to (only) 69.7%, Hong Kong is up to 70.0%, Tokyo to 76.1% and Manila to a quite remarkable 96.1%. But it has watched Jakarta decline to 63.2% as new capacity was added by the competition; Singapore's load factors reduced to a miserly 62.2% - with low yields - as its through traffic was diverted over Dubai (the number of Qantas seats terminating in Singapore increased by 40%); and Shanghai to 69.7%. A drop in Manila is likely from late 2014 as Cebu Pacific enters the Sydney-Manila market and Philippine Airlines increases to daily.

Virgin's load factors have remained relatively steady but fell in Indonesia to 68.1% and posted a slight improvement to the relatively low yielding Thailand at 62.9%

Load factors in Asia-Australia market

The 2013 Emirates partnership was designed to provide Qantas a reprieve from European competition in order to allow greater focus on its Asian strategy, which has mostly consisted of several new codeshare agreements, but not a coherent overall design.

Since Qantas will never serve a large number of destinations to Asia, focusing on simple onward connections through strong partner hubs is going to be key – this is where the challenge lies. Jetstar Asia has been flagged as a saving grace but offers few same-day connections and will not be the premium carrier Qantas needs in the near term.

Virgin Australia’s Asian strategy consists of narrowbody services to Indonesia (Bali) and Thailand (Phuket) with the remaining destinations covered by codeshares on partner Singapore Airlines. The leisure services are highly seasonal, failing to break 65% load factor throughout May-2014 and exceeding this only a small number of times throughout the year despite being some of the longest stage lengths operated by a 737 (some exceed 6 hours).

The airline has a strong customer proposition with Singapore Airlines, a brand well recognised in the Australian market and offering connectivity from almost all major ports, and can funnel European traffic effectively via Singapore and Abu Dhabi with Etihad. For the remainder of Asia, Virgin too has a notable hole in North Asia. Ideal partners would be present in Cathay Pacific or Air China, effectively filling in the gaps for passengers travelling throughout the region, given the diverse nature of markets and heavy competition would make any Asian adventure by Virgin unwise.

Qantas’ operations suffer from the absence of a full-fledged Asian strategy given that strong relationships exist elsewhere. Several existing services would be under the microscope, including Sydney-Shanghai, which could suitably give way to a closer partnership with China Eastern if that were possible.

While the Singapore route has improved substantially since the immediate post-Emirates lows, there is still significant overcapacity into the region and a further reduction in Singapore frequency from Sydney would be an easy fix.

The move to all A330 operations from Oct-2014 will further reduce supply and hopefully command improved yields. Sydney-Manila is an extremely good performer for the group in terms of load, although the entry of Cebu Pacific and added capacity from PAL may place considerable pressure on the low end of the market (although its unlikely Qantas relies too heavily on this at present).

Sydney-Jakarta appears to be another marginal service, operating three times weekly with no regional partners and limited onward connectivity, as is Sydney-Bangkok, although it receives significant partner capacity through Emirates. Hong Kong performs well and is strategically important given the available links to China and North Asia, and an improved in flight product on the A330 fleet should help Qantas remain competitive as the A380 moves to Dallas/Fort Worth.

Virgin Australia’s network to Asia gained greater coherence with its SIA partnership, but the the services it does operate with its own metal must at least break even; they remain a throwback to the Virgin Blue days. An expansion of Tigerair Australia into international markets could eventually work, but not in the short term; the A320 lacks range for the longer legs out of Sydney and Brisbane. Rumours of services to Singapore or Hong Kong have been persistent but are improbable – any potential benefits can currently be leveraged effectively through the existing relationship with Singapore Airlines, and would require either significant fleet investment or a removal of A330s from domestic operations.

5. South Africa: the link is weakened after Qantas and SAA separate

Load factors in the South Africa-Australia market

Qantas is without a strategic partner in South Africa for the first time in 13 years after terminating its codeshare agreement with South African Airways (SAA), citing difficulties in meeting the IASC’s conditions. Nonetheless it retains a healthy market share.

The service may however now be time limited, with load factors rarely exceeding 70.0% and a long stage length requiring two 747s each day to operate the route. Without its SAA partner there would have to be a presumption that yields will fall, even if load factors don't.SAA has recruited Virgin Australia as its new local partner, pressuring Qantas to reduce service.



South Africa-Australia capacity share (% of seats) by carrier: 25-Aug-2014 to 31-Aug-2014

Qantas still has the benefit of a monopoly position into South Africa as the sole operator from Australia’s east coast but this advantage will be eroded with an inability to book passengers to any onward destinations, low load factors and resource-intensive length. Qantas could book customers onward out of Dubai but this would be little consolation to passengers forced to backtrack significantly to reach Southern Africa.

Qantas still needs a strategy for Asia and the US is strong - but elsewhere cuts are more attractive

Qantas' footprint has been too large for what it can sustainably offer and cuts - always unpopular - must be made. Reorientation of the network around strong regional hubs and premium partner airlines would provide Qantas with a firm footing to ensure profitability.

Additional fleet flexibility is required and enacting some large-scale changes would allow the early retirement of more of the 747 fleet and additional utilisation opportunities with the A330s (although likely leaving some surplus to requirements).

The discussion of fleet choices is tired, but a mid-sized aircraft to fill the A380/747 and A330 gap could help in making seasonal adjustments where aircraft can be used best – the 787 or 777 would be an ideal aircraft for this purpose, although the latter is unlikely to be a real option any more. Any changes that are announced are likely to revolve around the accelerated retirement of the 747 fleet and network changes can be expected to assist this progression.

Europe could easily be adjusted for closer ties with Emirates by suspending services to London - but for the time being that would be too close to high treason to contemplate. Qantas is unlikely to reduce services to Dubai, though there is significant capacity and competitive overlap.

Asia remains a problem child and an Asian strategy still seems remote, despite a handful of new codeshare partners. A high-level partnership with an Asian carrier similar to what was established with Emirates is now a pressing priority for Qantas, and non-core destinations such as Jakarta and Bangkok - and even perhaps Shanghai - may be under the axe.

The US is where Qantas remains strongest and recent efforts to fortify its position will serve well – especially on Melbourne-Los Angeles before United enters. The difference between Qantas' position in the US and Asia is glaring, where the airline has an articulated plan and cohesive strategy for connecting traffic to the US, this is absent into Asia. Fortunately for Qantas - and for Virgin Australia - the US market shows signs of revitalisation just as China slows and Japan and Korea lack lustre.

Virgin Australia would ideally become entirely virtual internationally

Virgin Australia deploys 82% of its international capacity into Los Angeles; but its forays to Fiji, Johannesburg and Phuket all failed to pay dividends. The airline’s other 777 operation services the Etihad fortress of Abu Dhabi but loads are weak, frequencies suboptimal and product is not well aligned with its partner.

The airline’s A330s could be deployed into Singapore or Hong Kong but those markets are extremely competitive and Virgin’s resources would be better used elsewhere. CEO John Borghetti hosed down speculation of China and India services, leaving few destinations that are both strategically suitable for the carrier.

With its current fleet of six A330s the airline does not have sufficient equipment to sustain all-widebody services to Perth, meaning any international expansion would come at the expense of its local customer proposition - unlikely as Virgin continues its thrust into the domestic corporate market. The airline had announced a Brisbane-Singapore-Abu Dhabi routing to complement Etihad’s existing service (which will operate nonstop upon delivery of the 787-9), but the plan has been on hold since Aug-2011 and no update has been forthcoming.

Virgin has few cards left in its hand for an international expansion – the airline has no incoming growth in its 777 fleet and has wound back its original plans of seven aircraft to settle for five. It might be happy to settle for none. Previously announced expansion has fizzled out and, barring recent changes to its US network, operations have remained relatively static.

The airline’s propensity to build its virtual network would work in its favour and Mr Borghetti makes no secret of the fact that this is the most viable option for his airline. Virgin has strong partners in Etihad, Singapore Airlines and Air New Zealand and leveraging these effectively can deliver greater benefits than maintaining a boutique long-haul operation.

Qantas and Virgin have little option but to leverage partnership opportunities but Qantas needs to cut aggressively

The emergence of virtual networks for end-of-line carriers is expanding and having relentlessly pursued the trend, Virgin Australia appears willing to adopt virtualism as its long-haul strategy. Its international operation is resource heavy, lacks economies of scale and services a limited number of ports. Taking on Qantas and a sluggish United was an attractive drawcard when planned in the middle of the past decade, but the arrival of Delta eroded available traffic and a more nimble United has since improved its product and reduced its reliance on scraping low-yield economy passengers to fill the 747.

Subject to movement on the Brisbane route, Virgin is likely to hold its existing position on the US and focus on expanding its partner connections while strengthening its domestic position. Other long-haul international routes appear to offer little durability.

Qantas cannot now retain long-haul routes that are anything other than consistently profitable and biting the bullet now rather than later, albeit painful, is undoubtedly the way to go. If it genuinely wishes to cut AUD1 billion from its international costs - and establish long term sustainable routes - any markets other than Dubai, Singapore, Hong Kong, Los Angeles, Dallas/Fort Worth and Santiago should be vulnerable to withdrawal or capacity/frequency reduction; even these may experience some tweaking.

Moving towards an A330/A380 only international fleet is likely, complemented perhaps with 787s and with the younger Boeing 747-400ERs remaining for services to Santiago, Los Angeles and elsewhere as demand dictates. Qantas has strong partners and reliance on them (and possibly others) will only grow in coming months.