Virgin Australia’s Next Move

The Australian airline industry has become  like a giant game of chess. Virgin Australia 18 months ago, upped the ante with a dramatic series of movies including new planes, refurbished cabins, a business class product and expanded lounges. These changes began in tandem with new partnerships with Delta, Air New Zealand, Singapore and Etihad which plugged the airline into a worldwide network for a much reduced cost. The aim was to poach as many of Qantas customers as possible.

Qantas responded by forming a major alliance with Emirates. This threw the gauntlet down again. I have been very curious as to what Virgin would do next. Now we know. This week Virgin announced not one but two takeovers and a new part owner.

The first take over is 100 per cent of  Skywest,  a regional airline in Western Australia (not to be confused with Skywest in the USA).  They have a huge market with Fly In Fly Out workers travelling to mining sites across the state – and the market is largely a monopoly market. Most of their flights come out of their Perth hub with an international flight up to Bali. The Skywest fleet consists of Fokker 50s and Fokker 100s with a single Airbus A320.

In January 2011, Virgin Australia  began a ten year relationship with Skywest which included linking their frequent flyer program and having some of Skywest’s planes operate under Virgin colours.Virgin then purchased ten percent of Skywest Airlines Ltd on 10 April 2012.

Now Virgin is aiming  to take over Skywest completely in a cash and scrip deal worth $A98.7. The deal has been approved by the Skywest board but is subject to regulatory approvals from the Australian Competition and Consumer Commission, the Australian Foreign Investment Review Board, Singapore’s High Court, and the Securities Industry Council of Singapore.  Skywest will keep its current air operator’s certificate and continue to be Perth based with its own chief executive and management team. The airline will be “Virginised” though, becoming part of the Virgin brand.

It is a smart move:

  • Skywest is profitable
  • Virgin’s operations are dramatically expanded in this key state
  • Virgin has access to the profitable Fly In Fly out market
  • They can feed more of the Skywest flights into Virgin international and domestic services and into code share flights operated by Singapore out of Perth and up to Changi and onto the rest of Asia
  • It eliminates Skywest as a potential competitor
  • It puts Qantas on a back foot in Western Australia

In the same announcement,  Virgin will own 60 per cent of Tiger Airlines Australia. Tiger owned by Singapore Airlines has struggled desperately in Australia.Their product has been inferior to the Qantas owned Jetstar, they have consistently lost money and the airline was grounded last year for breaching safety rules.

The Skywest deal is easy to understand. The Tiger deal is a little less convincing. It gets Tiger off Singapore’s hands and eliminates Virgin’s other Australian competitor. I think repositioning Tiger will take a lot of work, however. Why does Virgin think they can succeed with Tiger where Singapore Airlines failed? In the last quarter, they had an 84.8 per cent load factor but  the carrier still lost money. The involvement of Virgin will undoubtedly add some credibility to the Tiger brand which will help boost passenger loads. Virgin will no doubt want to exploit the Tiger network already in place out of Singapore Changi. Virgin CEO John Borghetti (who is ex Qantas) said in direct reference to Qantas/Virgin “we have learned what not to do in a two-brand strategy”.  Does this mean Virgin Australia (which itself used to be a budget carrier) will take its economy cabins a little more “upmarket”? At the moment, both Virgin and Tiger require passengers to but food while Qantas provides it. Virgin recently began offering meals and drinks to all passengers on its transcontinental routes. Could this service be extended across more services (e.g. Sydney-Melbourne-Brisbane) leading to some fare growth at Virgin ad offloading the purely no frills customers to Tiger?

To fund the deals, Singapore Airlines will buy  ten per cent of Virgin Australia, joining Etihad which currently has ten per cent,  Air New Zealand with 20 per cent and  Virgin Holdings  with 26 per cent. The further tie up with Singapore seems to me to  make it a possibility that Virgin Australia join the Star Alliance. With Qatar going to One World and Emirates tied in with Qantas, could Etihad then move into Star as well?

The result of all of this is that Australia will join South Africa in having a model of two dominant mainline carriers both owning budget subsidiaries.

These moves are another another sign that Qantas needs to do some dramatic re engineering with their domestic operations. A few years ago, Qantas innovated by starting Jetstar and launching Cityflyer between the key capitals. This move challenged the then dominant player Ansett. In the last 18 months, Virgin Australia have been the innovators and Qantas have chugged along with a “business as usual” attitude to their highly profitable domestic services. There seems to be little response to the growing Virgin threat. When flying Virgin, I am finding their lounges full and the business class cabins increasingly being the same. All while they are packed out in Economy. In May, 2012, Qantas split its domestic and international operations. Its time the domestic side did some interesting stuff or they may find the chess game moves to check.

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