Qantas CEO Delivers Speech

Future Directions for Qantas //
Qantas CEO Geoff Dixon //
Trans-Tasman Business Circle //
Sydney, 25 February 2003
Like many of us over the long hot January, I went to the movies, and on one of those days I took the epic journey through the second instalment of the Lord Of The Rings trilogy, The Two Towers.
No doubt all of us in business can relate to a small band of folk confronting dark and complex forces—and desperately trying to overcome them for our own survival.
But for me, the most exciting part of the film was the sheer majesty of the New Zealand landscape; the awesome technical achievements; and the imagination and audacity of the film`s creators. And there is no doubt that the film`s tremendous success coincides with a boost in New Zealand`s global profile. There is a buzz about New Zealand, whether it is movies, tourism, fashion and music; or nature, safety, security and social tolerance.

Australia and New Zealand are, of course, very different countries. We each have our own distinct national character. And that is never going to change - nor should it.
But one lesson, one theme, one idea has resonated through both our histories. Ever since the feats of our legendary Anzacs, we have shown that we are never more effective as individual nations than when we work together as partners. The existence of bodies such as the trans-Tasman Business Circle attests to this.

Closer Economic Relations (CER)
This is a significant year in the Australia-New Zealand relationship.
It marks the 20th anniversary of the entry into force of the groundbreaking closer economic relations agreement. Through the reduction of tariff and non-tariff barriers - first in goods, and later in services - our economies have been drawn closer together. Trade in goods and services has risen by 400 per cent since 1983. The movement of people has quadrupled. And today we have a total of almost A$50 billion invested in each other`s economies.
As the relationship has matured, efforts have been directed to other areas, including mutual recognition of regulatory standards. In fact, this is set to be extended to aviation this year, with mutual recognition by safety agencies.
The success of CER can be measured in the increased trade in goods and services. But its achievements go way beyond this. CER has helped each of us globalise our economies. By testing our mettle on each other, we have improved our competitiveness in the world. We are more open, resilient and innovative as a result.
Now we are hoping to further strengthen the longstanding partnership between the two countries by forming an alliance between Qantas and Air New Zealand.
The principles and successes of CER clearly underpin the proposed alliance, but the motivation goes much deeper - it is part of both our strategies for survival in a radically changed global aviation market. Before I talk in detail about the alliance, let me turn to the global industry, and our place within it.

Global aviation crisis
Even at its best, aviation is a paradoxical business. It has mining industry lead times and huge investment costs. But it sells a product that goes off faster than fruit. When a plane takes off with one empty seat that seat can never be sold again. Within this high risk operating framework, even short term mismatches between capacity and demand and between revenues and costs spell disaster.
For the best part of the 1990s, the industry was heading for crisis. There were, and still are, too many airlines operating to make sufficient returns. The resulting over-capacity was compounded by threats to revenues from shifting travel patterns and consumer preferences and the proliferation of low cost carriers, and also by rising external costs. Airlines had gone some way down the difficult and lengthy path of adjusting their operating models to meet these challenges when September 11 plunged the industry into its darkest hour, creating an instant gulf between revenues and costs.
In the 2001 calendar year, international air transport association member airlines lost a total of US$18 billion on international and domestic services. That is US$18 billion before interest and tax. Gone. Losses are expected to total at least US$13 billion for the 2002 calendar year.
American Airlines, our oneworld? partner, recently reported that it lost US$3.5 billion for the full year 2002. That was on top of its US$1.4 billion loss in 2001. United Airlines recently followed us airways into chapter 11 bankruptcy protection, with debts of about US$20 billion. It has already shed over 20,000 staff and plans to shed more. The net debt to capital ratio is over 80 per cent for most of the major carriers.
American Airlines CEO Don Carty summed the problem up succinctly: “While there are many factors that impacted our results during 2002 ... , the core issue for our company remains a cost structure that is out of step with the revenue environment facing domestic airlines. As we`ve been discussing with our employees, we believe that a permanent shift has occurred in the airline revenue environment which will require us to reduce our annual costs by at least $4 billion.”

Aviation is in turmoil in North America, but it does not end there. Carriers such as Swissair, Sabena, Canadian Airlines and Ansett - well established with large Frequent Flyer programs, strong brands and substantial corporate accounts - have disappeared, or re-emerged in other forms. Air Canada, despite merging with Canadian to form a carrier with a totally dominant market share, announced a preliminary operating loss of C$218 million for 2002. SAS has just recorded a second consecutive annual loss, and Dutch carrier KLM is expected to do the same. The toll on communities around the world has been huge. British Airways has shed 9,000 staff over the past 18 months and another 4,000 redundancies are planned before March 2004.
Although a few carriers have been allowed to fail, the response of governments to this crisis has generally been to provide financial assistance. This has compounded the industry`s problems. Industry over-capacity worldwide is still estimated at about 20 to 30 per cent. That is 688 million seats.
Roughly two out of three of Qantas` international competitors in the Australian market are majority government-owned. This tilts the playing field dramatically. It means that a high proportion of our competitors do not face the same economic pressures that we do. Taxpayer support means that the pricing policies of most of these airlines, but certainly not all, are not required to reflect their costs of operation or market realities. Ultimately, this damages returns for all players.
The effect on Qantas of the distortions caused by government ownership or various forms of government support - whether it is financial aid, taxation relief, or protection of market access through features of the regulatory environment - can be profound.
While Australia`s approach to aviation liberalisation has been generally beneficial, we should not be so slavish in the pursuit of competition as to disregard the reality that the playing field can be warped by a variety of means. Unless this is taken into account, liberalisation can have unintended consequences that in some cases are quite harmful to the interests of our own industry.
Over the longer term, however, significant industry rationalisation and consolidation is inevitable. For most governments, pouring taxpayers` money into failing airlines is not a sustainable proposition. We have already seen signs of consolidation taking place in various parts of the world. Delta, Northwest and Continental have entered into a wide ranging commercial co-operation agreement, as have united and us airways. Air France and Alitalia have purchased equity stakes in each other. Lufthansa has purchased an additional 10 per cent of BMI British Midland, lifting its stake to 30 per cent. Japan Airlines and Japan Air Systems have merged. And in Brazil, government-owned Varig is considering a merger with the privately-owned TAM after the Brazilian government ruled out further financial aid.
I should point out that not everyone is floundering. Qantas, which I will turn to in greater detail shortly, is growing and investing, and some of our full service competitors in the region - Singapore Airlines and Cathay Pacific for example - are also very successfully negotiating the challenges of the new aviation environment.
There is also another category of airlines that is performing well. Using a strategy of point-to-point flying rather than connecting flights through hubs, low-cost, no-frills carriers like Southwest, Jetblue and Ryanair are both profitable and growing. Texas-based Southwest, with a market capitalisation greater than all other U.S. airlines put together, has just recorded its 30th year of continuous profits and will have its 376th Boeing 737 aircraft delivered next month. Ryanair, which operates out of Ireland to secondary airports in Europe, today has a higher market capitalisation than any other European airline. And closer to home, we have seen the success of Virgin Blue.
This business model generates extremely tough competition by carefully picking off the most lucrative routes and avoiding any which do not meet threshold standards of profitability. What is more, the limited choices offered to customers guarantee extreme business process simplicity and lower costs. And as greenfield operators, they have no legacy costs to contend with, in contrast to established airlines.
Qantas - a fully commercial, privately-owned, full-service airline - confronts both the no-frills players and the government-subsidised airlines. Our success in this difficult environment stems from our protection and nurturing of the Qantas brand, our disciplined approach - particularly where controlling costs is concerned, and our flexibility. Not our size. Let me put to bed the oft-repeated notion that we are somehow a monopoly.
We are not. Although our share of the domestic market overall today stands at around 70%, it is declining, and on key routes it is below 70%. People in this region see Qantas as a giant, but in the global arena, we are only a medium sized player. On international routes, where we have 70% of our assets deployed, we compete against almost 40 airlines.
Our future is certainly not guaranteed. And yet Australia surely needs Qantas, a strong home-based airline with a commitment to this market. The fact is that neither a short haul, no-frills airline nor a foreign airline will ever offer the kind of commitment to the Australian market provided by Qantas.
As a network carrier, Qantas has some scope to offset unprofitable and marginal routes in domestic, regional and international markets against better performing ones. We are one of the main drivers of Australia`s domestic and international tourism industry. It is self-evident that carriers from far away will never make the same investment in “brand Australia” or develop a skilled Australian workforce, or play a defence and crisis management role. Conversely, it must be understood that various measures that impact adversely on Qantas - either directly or indirectly - have the potential to diminish the important role played by Qantas in Australian life.
Air New Zealand similarly makes a significant social, economic and strategic contribution to New Zealand. The value of this important role to our respective countries is heightened in the context of our geographic locations - we are both “end-of-the line” carriers, with none of the natural hub advantages of a Singapore or Hong Kong.
The Qantas-Air New Zealand alliance will provide a platform for a sustainable aviation and tourism industry in both countries, with benefits for consumers, trade, and employment. It will allow us to compete with players that have advantages that neither Qantas or Air New Zealand can match, no matter what changes we make to our business model. And as industry consolidation gains momentum, our region will not be running to catch up, but still squarely in the game.
Let me now talk about the alliance in greater detail.
Qantas-Air New Zealand:
Qantas and Air New Zealand are seeking regulatory approval on both sides of the Tasman for Qantas to take an equity investment in Air New Zealand of up to 22.5 per cent. The proposal will see reciprocal board representation, with Qantas appointing two members to the Air New Zealand Board and Air New Zealand one member to the Qantas Board.
The framework for the alliance is a “joint airline operation” (JAO) arrangement. The JAO covers the entire Air New Zealand international and domestic network, and all Qantas services flying to, from and within New Zealand. Qantas and Air New Zealand will reciprocally codeshare on all JAO flights. Air New Zealand also has the option of codesharing on Qantas domestic services and Qantas international flights that connect with Air New Zealand services.
An independent consultancy`s conservative modelling has found that there will be aggregate net monetary benefits over the first five years of A$665 million for Australia and A$1,105 million for New Zealand.
The benefits will take many forms. There will be improved customer convenience in terms of scheduling and new direct services on several trans-Tasman city pairs. There will be greater freight capacity for exporters and importers.
Staff will benefit through the stronger protection and promotion of skilled employment. And there will be cost efficiencies, which will help us stay competitive.
A huge area of benefit for both countries will be tourism. The tourism industry represents 5.3 per cent of Australian GDP and 6.6 per cent of New Zealand GDP.
That is significant in any terms - and I believe that, carefully managed, tourism`s economic contribution in both our countries could rise still further. By the third year of the alliance it is predicted that there will be a net 53,000 additional tourists to New Zealand each year, and 28,000 more to Australia. And that is a conservative estimate.
I want to stress that this strengthened relationship between Qantas and Air New Zealand will not diminish the character or identity of either partner. These are two fantastic brands. The Koru and the Flying Kangaroo are held in high regard. This relationship is about enhancing, not detracting from these important values. British Airways has been a major investor in Qantas for a decade. But I do not think anyone would suggest that Qantas is less Australian as a result. Of course, a challenge for us this year is going to be achieving regulatory approval for these proposed arrangements. On the face of it, the alliance will reduce competition between Qantas and Air New Zealand. But this will pale into insignificance against the substantial public benefits which will be delivered to consumers and the two economies. And it will be a significant step towards securing a viable future for the aviation and tourism industries of both Australia and New Zealand.

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Half Yearly Results:
Last week I announced the Qantas half-yearly results. As a raw number, the $513 million pre-tax profit sounded, and indeed was, impressive. But it is important to understand the figures in the context of both the instability of the industry and our commitment to growth.
In the domestic market we have grown by 50 per cent since the collapse of Ansett. We had to in order to fill the massive hole in the market. That is equal to seven years normal growth since September 2001. Since the Ansett collapse Qantas has spent A$6 billion - A$2 billion in the past 6 months - on new aircraft, inflight entertainment, product and infrastructure initiatives, and employees - increasing staff by over 2,000.
And we are committed to spending billions more over the coming years, on more aircraft and facilities. We need to make these investments to remain competitive on capacity and service standards. This is a strategy not without its risks. We must meet these ongoing investment requirements despite restrictions on access to foreign equity capital.
This is exacerbated by heightened political and economic uncertainty including the imminent threat of war in Iraq, the downturn in the global economy and anxiety about terrorism.

The Qantas future:
At Qantas we are aiming for sustainable growth to ensure a long term future so that we can continue to make the significant contribution to the region that we make today. The way forward must involve the right strategies, and successful execution of them.
* We need to invest to remain competitive.
* We need to attain consistent profitability levels to justify our high levels of investment, and to continue to provide job security for our people.
* We must develop alliances to give us the scale required to remain competitive in a world of fewer, larger players. Alliances such as that proposed with Air New Zealand.
* And we must contain costs. While we will never operate in the same fashion as the no-frills carriers, they have nonetheless created a paradigm shift in aviation. We need to scrutinise everything we do to reduce process complexity and costs. That is going to mean a higher degree of discipline as well as innovation throughout our company, as we seek out more cost-efficient processes.
AND Conclusion:
Let me conclude. Air services are particularly important for Australia and New Zealand. We are remote, we are export nations, and we are more reliant on tourism than most economies.
The aviation industry is undergoing fundamental change. Qantas and Air New Zealand have to change the way we do things, or risk becoming marginal players in the global market. That is the reality of our industry today.


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