I know we have heard lots about this recently, but I think this is a well written article (Sydney Morning Herald). There are many sad truths brought up in it.
Personally, as I said in another thread, I think Impulse and Virgin should cooperate and allow each other exclusive access to different parts of the markets. This is the only way I can see them both surviving.
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One will bite the dust as airlines chase a slice of pie in the sky
The recent bleatings from the new players are signs the discount war is starting to hurt, writes Stephen Bartholomeusz.
When start-ups run to the regulator, you just know they are finding the going tougher than they anticipated. With Impulse and Virgin accusing Qantas of capacity dumping and predatory pricing, you just know that the price and capacity war now escalating rapidly in the domestic aviation market is going to result in casualties.
With two new discount-oriented entrants to what had been a two-carrier industry, it was always a long shot that the industry structure would smoothly adjust to allow four airlines to co-exist. It would have required extraordinary discipline, even co-operation, between the new players and a preoccupation with profitability over strategy by the incumbents.
For a while, it looked like Impulse and Virgin might navigate their way through the competitive minefield without blowing themselves up in the process, although Impulse increased their vulnerability to competitive response by establishing unsustainably low precedents for discount levels ahead of Virgin's entry. They were aided by the buoyant domestic economic conditions last year and the financial and operational problems at Ansett, which put a lot of market share up for grabs.
Then they got cocky and started talking about their plans to add lots of capacity to the core east coast routes. Impulse forecast a maiden profit and a public float. Virgin enthused about the degree to which it was surpassing its own original expectations.
Now, weeks after it forecast the profit, Impulse is conceding that it will incur a loss and is trying to raise fresh capital from its investors.
Virgin has started referring to its experience in the UK, where BA tried and failed to drive it out of the market at horrendous cost to both airlines. Both Qantas and Air New Zealand issued profit warnings in the past week.
The abrupt change in the environment follows a significant increase in the intensity and depth of discounting in the market. That is being driven largely by a rapid rise in the amount of capacity being added to the eastern seaboard routes.
Qantas is shifting capacity from recently closed international routes to the domestic market. Impulse and Virgin are both adding planes as part of a planned build-up in their operations. Before the end of this year, there will have been a 30 to 40 per cent increase in capacity in the industry, mostly focused on the Sydney-Melbourne-Brisbane routes. At its peak, Compass probably added only 15 per cent to industry capacity.
The rise in capacity and discounting are having a predictable effect, with passenger traffic soaring, load factors at historically high levels and yields being savaged. As the Compass experience revealed, however, doing increasing amounts of low-yield business ultimately marginalises an airline's revenue structure and accelerates and leverages that into a tide of red ink.
The airlines are, moreover, suffering from more than their own inability to keep the competition civilised. Soaring fuel prices, in Australian dollar terms, have been amplified by the plunging dollar. The lower levels of economic activity are starting to hurt the volume of business travellers, the key to maximising yield.
Impulse and Virgin are relying on their significantly lower cost structures to protect them - Impulse claims a 40 per cent cost advantage over Qantas and Virgin is even more efficient. Compass, of course, had a similar advantage.
The problem for the smaller operators is that once the industry stability has been undermined by deep and broad discounting activity, and the dominant player sees a real risk of its franchise being significantly eroded, the rules change.
Cost advantages are overwhelmed and it becomes a simple matter of whether the players have sufficient capital to survive a fully-fledged price war.
The key message from Qantas's recent redeployment of capacity and its new fare structures is that it is prepared to suffer significant financial pain in the near term, and accept the sharemarket's response, to protect its market share and franchise.
While the likelihood that at least one of the new entrants will be forced from the skies is starting to increase quite rapidly, Ansett is being ravaged by the escalation in hostilities.
Having been starved of capital for a decade by its former shareholders, it now finds itself with an aging and cumbersome fleet, a parent with no balance sheet flexibility and, following a clumsily managed integration with Air New Zealand, poor morale and a dearth of executives with the experience of the two Compass-inspired discount wars.
Air New Zealand's new chief executive, former Qantas CFO Gary Toomey, and its 25 per cent shareholder, Singapore Airlines, are about the only things Ansett has going for it. Before the industry is stabilised, Singapore will either own a lot more of Air NZ or have a direct interest in Ansett. If it doesn't, and soon, Ansett and the long-term health and competitive structure of our domestic aviation market would be at dire risk.
In the meantime, the best hope for Impulse and Virgin, and no doubt the aspiration for Qantas, is that they can strip sufficient market share from a reeling and vulnerable Ansett to improve their own viability, or in Qantas's case, its degree of dominance.
Fasten your seatbelts, there is extreme turbulence ahead.