Losing altitude - the downing of Howard & Costello

Senator Santo Santoro couldn’t do it with his shares; and Kevin Rudd couldn’t do with his smugness and his rat cunning. So it was left to the Prime Minister and his Treasurer to do it with Qantas. Lose this year’s election for the Coalition, that is. Possibly.

When it comes to the sale of Qantas, regrettably most commentary in the media has focused on the questionable nature of private equity, or the potential job genocide that looms large for the Roo’s workforce. Scant attention has been given to real issue: the historic protection of the Monopolistic Marsupial by the government to the direct detriment of the traveling public, as well as the absence of any commitment whatsoever from the government to jimmy open the air lanes to all who wish to fly them.

The promise that VirginBlue will start flying to Los Angeles - given the few Boeing 777s and oily rags Virginblue’s CEO Brett Godfrey’s ordered to serve that route - is inconsequential. And last Wednesday’s quip by Transport Minister Mark Vaile that “the government was not protecting Qantas” is really truly laughable.

If the gnomes at UBS cave in, and the Macquarie Bank-led leveraged buy-out (LBO) goes ahead, the public rage that will follow the likely job losses, route cuts and higher fares, will certainly sweep Team Howard out of power.

And under new management, just how will Qantas change? How many routes will be severed from the mainline operation (the premium priced but low quality Qantas) and be hived off to Jetstar (its low price and low quality subsidiary)?

A good place to start contemplating the privately held Monopolistic Marsupial is with Loizos Heracleous’s account of the success of Singapore Airlines in Flying High in a Competitive Industry.

The book focuses on an airline flying the competitive skies. Where it must eek out a living by minimising cost, maximising yields and delivering stellar customer service. Such is life in the real world.

Qantas of course, sheltered for decades from the harsh winds of competition, has not had to live in such a world, cocooned as it is in the pouch of successive toady transport ministers. For instance, the book reminds us that: “government acquiescence to Qantas’ lobbying against competition on the Sydney-California route has ensured that Qantas maintains 75 per cent of that market, a service that generates 41 per cent of its international profits”.

So once they’ve got their grubby paws on Qantas, just how will the barbarians lining up at the check in counters of Qantas make their money? There are two ways: either squeeze costs and maximise yields before re-listing the monopolist or better yet, squeeze costs and maximise yields before then on-selling the airline to another carrier.

Scenario 1

Airlines make money by maximising prices of seats (this is called yield management) and minimising costs. Minimising costs along every business line.

The main determinants of airline seat prices (yields) are: customer mix; route network; and foreign and domestic government policies. The more business passengers and the less price sensitive leisure travellers Qantas can carry, then the more profitable it shall become. Also the more a government takes notice of Qantas’ lobbying efforts, the better. Better for the airline, that is.

Costs are mainly set by type and age of fleet; government policies as well as home base and route networks. The largest costs are: labour; fuel; aircraft acquisition and maintenance. According to Heracleous, in advanced economies - he cites the United States as an example - labour is by far the biggest cost, which in some cases can amount to 35-40 per cent of the total cost base. Airlines based in undeveloped economies enjoy an advantage in this respect since their wages and social costs are lower.

Other costs such as maintenance are also available at deep discounts in the Third World, and a movement of such functions say from high wage Sydney's MacAirport to Bangkok’s brand new, but troubled Suvarnabhumi Airport could save Qantas not only millions in (the variable) labour costs of aircraft engineers, but will allow hectares of prime Sydney realty to be sold off. A win-win for the airline.

But alas not for those shareholders who left money on the table when they accepted the private equity bid. Or the airline employees, unless of course you’re from rural Thailand and just secured a (relatively high paying) job at Suvarnabhumi. You’d swear all your Buddahs have come at once.

Of course the real bonanza will be when Qantas mainline divests itself of as many low margin routes as possible and allows those services to be provided by third parties, and in so doing, freeing up the Qantas fleet for even higher yielding traffic. And at the same time, pretending to offer low yielding services. It’s a bit like General-Motors Holden selling Belgian made Opel Astras and Vectras and rebadging them as “Holden” and claiming to be selling “Australian” cars.

In order to squeeze costs, conventional wisdom holds that Qantas will hive off many routes to its low cost subsidiary, Jetstar, but that is only part of the picture. Qantas would be actively considering offloading services to its Singaporean subsidiary, JetstarAsia and perhaps some long haul routes (both existing and planned) will be outsourced to other One World Alliance partners.

This could save the airline big money as well as give the public the incorrect impression that Qantas is offering new destinations, when in fact all it’s doing is buying scores of seats on another carrier.

For instance, the latest recruit to One World (the global alliance of which Qantas is a member) is a true beacon of modernity and paragon of technical excellence: Royal Jordanian Airlines (RJ). RJ could fly Australians from say, Jakarta, Indonesia to that bastion of religious tolerance, Riyadh, Saudi Arabia with Jetstar carting Australians from Sydney to Jakarta. While a check of the airline ticket may not reveal the fact that while on such flights you would not set foot on a Qantas jet; you most certainly would have paid a premium for a ticket issued by Qantas.

In fact such outsourcing to dubious carriers (for instance, the flag carriers of Burma, Bangladesh and Pakistan) to service a myriad of destinations looks more and more plausible given the yawning gap in membership by carriers from West Asia and South East Asia in the One World constellation.

Many aviation observers attribute the success of Asian airlines (for example, Singapore Airlines) to their lower wage costs compared to airlines in advanced economies. The argument assumes that as advanced economies strangle airlines with local labour laws and overly indulge in occupational health and safety regulations, Asian carriers operating in societies with far less onerous labour conditions, gives the Asian carriers a distinct advantage.

Singapore Airlines’ top management has always argued that low labour costs are but a part of the advantage enjoyed by the airline. The real story, according to Singapore Airlines is the productivity of the labour force.

Rigas Doganis in The Airline Business in the 21st Century shows that Asian carriers generally had higher output per $1,000 of labour costs, suggesting that low wage rates plays a role but - as other Asian carriers performed poorly compared to Singapore Airlines - it is clear that workers’ productivity plays a bigger role. Thai International for instance offers low wage rates and has low productivity rates among its staff.

Scenario 2

Trimming fat from Qantas and then on-selling it to a mega carrier group.

As the public relations battle continues - in the effort to convince all shareholders just how generous the private equity offer really is - for investors on the other side of the Pacific, the long-awaited consolidation of the airline industry is heating up, with United Airlines holding talks with Continental Airlines about a possible merger. This follows US Airways making a hostile bid for Delta Air Lines last November.

Consolidation (in the US) of the industry follows a severe downturn that began in 2001. Higher fuel costs have taught airlines to quickly pass on such costs to passengers as well as to reduce the volume and quality of meals served on board. As a result, carriers - alas not passengers - are expected to do better financially in 2007. Consolidation will help airlines cut overheads by eliminating overlapping routes and aggregating (perhaps even off-shoring) maintenance facilities.

For consumers, that would likely mean higher fares, smaller seats, smaller (if any) meals and more-crowded aircraft as low yielding flights are rolled back into their hangers. Across the globe, airlines are either keeping a close eye on rivals or are already breaking bread with them. No airline wants to be left without a dancing partner when the square dancing music stops. United Airlines, while talking to Continental Airlines is keeping its options open by reaching out to Delta management saying that it may be a better fit for Delta Airlines than the predatory US Airways.

The options for the Monopolistic Marsupial’s new owners are as beneficial to them as they are detrimental to the interests of the flying public. Not to mention Qantas staff. And the real options - that is, the options that can move Macquarie Bank from being the millionaire’s factory towards becoming the billionaire’s factory - go further than merely the pantomime of possibly re-listing Qantas on the ASX somewhere between 2010 and the coronation of King William V of England.

After Qantas’s balance sheet is recast and as many of the costs as possible (principally what the airline considers as OPWs, over priced workers) are sucked out, then the owners should be able to on-sell the airline to a mega carrier like United Airlines-Continental Airlines (or United Airlines-Delta Airlines) for a price that will make the alleged “generous” $5.45 a share look a lot like Kerry Packer’s (super cheap) buy back of the Nine Network from one Alan Bond. Let’s not forget that TPG, the sharpest participant in the private equity consortium, has a history with Continental Airlines. A very profitable history that is.

A quick look at the route maps of the three airlines (United, Continental and Qantas) suggests they make a good fit. A very good fit in fact. There is little overlap between them.

The Monopolistic Marsupial (when aggregated with its joeys: Jetstar, JetstarAsia and Air Pacific) is strong in Australia, New Zealand, Asia and the Pacific with long paws that reach points in Africa (Johannesburg), Europe (mainly Heathrow and Frankfurt) and North America (LAX, San Francisco and JFK). It also has a well respected management team.

United, from its hub in Chicago, dominates the US Midwest and West, and is strong in Asia.

Continental (like Qantas) is popular with business travellers, able to command higher fares, has strong hubs in Houston and Newark (New Jersey) and extensive routes to Europe and Latin America. It (like Qantas) has a well respected management team.

If United and Continental link up, it will take a few years for the leaner reorganised group to take shape. Probably the same amount of time that it will take for the cashed up ATM (Allco, TPG and Macquarie) consortium to make Thai, Khmer and Vietnamese the low priced linguae francae at Qantas. Soon thereafter, a bid by say United-Continental for Qantas will make eminent sense. And the fat cats at the ATM consortium with infinite patience will await a tsunami of a takeover premium for their shares.

But by then of course it will be too late.

Already by mid 2007, thousands of Australian jobs would have been stripped (or well on the road to be stripped) from Qantas. Unattractive routes would have been hived off to other alliance partners and fares would have risen. Customer service at near monopolist, Qantas, already close to zero, will fall further. And this is just the beginning.

Even if in time the air lanes were opened up to competition, such as Sydney - LAX to Singapore Airlines, Sydney - San Francisco to Virgin Pacific (or similarly named sibling of Virginblue) and Sydney - Johannesburg to Emirates, it would prove to be too little too late.

The reality of looming market dominance by an 800 kilogram gorilla like United Airlines-Continental Airlines-Qantas will scare the bejesus out of Singapore Airlines, Emirates and Virgin's managers. And rightly so.

They don’t know it, but the heat is squarely on the Prime Minister and his Treasurer after not rejecting the takeover. This could be their undoing. If he's lucky, Mr Costello will revert to being no more than the Member for Higgins. Assuming he isn’t thrown out of Parliament altogether. And as for Mr Howard, his “all the way with Geoff Dixon” attitude, could be his undoing as well.

Many Australians thought that Peter Costello was one politician who understood that what’s good for Qantas is by definition, bad for Australian consumers. He has often argued to break Qantas’ monopoly on many routes.

Well Minister, the time for argument is over. The time for action has arrived. It's time to inaugurate open skies between Australia and the rest of the world.

It’s time to wise up to what a buy out of Qantas really means to aviation competition and to the support act (in maintenance) Qantas plays to the Royal Australian Air Force.

And it’s time to count in the thousands, the numbers of jobs that will be decimated by the Monopolistic Marsupial in the quest to asset strip and beautify it prior to a potential trade sale to another airline. Granted Mr Costello, I am not including the low wage jobs the private equity consortium will no doubt create for reservations staff in Chennai, maintenance staff in Bangkok and catering crews in Ho Chi Minh City.

Treasurer, put the interests of the traveling public first and the profits of the billionaire’s factory a distant second. And pray, pray, that UBS rejects the leveraged buy out, and in turn saves your bacon. And that of your government's.