Qantas takes huge gamble with Jetstar
History shows that cut-price airlines can be disastrous for big airlines, Jamie Freed discovers.
Even Jetstar chief executive Allan Joyce admits it is a risky proposition for a flagship carrier to run a budget division that may compete for the same passengers.
"I think we certainly went into this being very clear that it was something that nobody else had done successfully," he said
at Jetstar's launch party last week.
No major airline has succeeded in the low-cost arena, but that's hardly for lack of trying. There are at least seven high-profile case studies in the last 10 years in North America and Europe.
The hotly competitive US and UK markets may not provide the best comparison to the local duopoly but Canada is close to Australia in terms of population, distances between cities and the number of airlines.
But first, to be clear, the budget label itself is hardly synonymous with failure. Many of the most successful airlines since September 11, 2001, have been budget carriers: Virgin Blue in Australia, WestJet in Canada, Ryanair and easyJet in the UK and Southwest and JetBlue in the US.
There is a key difference between these stand-alone low-cost carriers and Jetstar, however.
Jetstar is run by Qantas, while the others are independent. That makes Jetstar more like Air Canada's ailing Tango operation, Continental Airlines' disastrous Continental Lite and British Airways' sold-off GoFly venture.
Air Canada launched its low-budget arm Tango in November 2001 under market conditions similar to those in Australia. Air Canada bought arch-rival Canadian Airlines in 2000 and took over its business.
Air Canada thought Tango could hold on to domestic market share that new budget airline WestJet was grabbing. Despite these efforts, including Tango perks Jetstar will not duplicate, Air Canada's market share has since dropped from 82 per cent to 59 per cent. For comparison, Qantas has 70 per cent market share in Australia.
Like Qantas, Air Canada relied heavily on lucrative international business traffic for profits. But worries about passengers rushing to buy cheap domestic WestJet tickets that included good in-flight entertainment made Air Canada re-examine the budget market.
"The WestJet invasion was a true disruption," says Canadian aviation consultant Douglas Reid. "The alternative [to launching Tango] was losing customers and revenue."
Tango used its relationship with parent Air Canada to its advantage, enticing travellers with perks such as Air Canada frequent-flyer points for Tango flights. "[Frequent-flyer points] are a very essential decision driver," Reid says.
So far, Qantas is unwilling to give loyalty miles to Jetstar passengers.
Tango passengers can also re-book on to Air Canada flights if Tango flights are cancelled - a bonus Qantas is not offering with the more independent Jetstar.
Still, these perks haven't been able to halt Air Canada's market share and profits from declining. In the past five years Calgary-based WestJet's earnings rose 25 per cent to $C61 million ($63.7 million) and its market share rose to nearly 30 per cent. Since launching Tango, Air Canada's losses increased from $1.3 billion in 2001 to $1.9 billion in 2003, although some of the 2003 losses were due to SARS.
Based on those figures, it is difficult to label Tango a success, even if it has helped to lower Air Canada's domestic costs.
Low-cost ventures by full-service carriers in the US have ended more disastrously than Tango; even so, both Delta and United Airlines have recently tried to re-enter the budget market.
"In the US, an airline within an airline has always been a failure," says US aviation consultant Mike Boyd of Boyd Consulting. "You can't be two products at once."
Part of the problem stems from failure to cut the higher costs associated with a major airline.
In 2001 United closed Shuttle by United, which was meant to be a low-cost venture but actually mirrored the parent company's costs. Continental had the same problem with Continental Lite, closing it in 1995 after it lost $300 million in 15 months and confused full-service customers.
United launched budget arm Ted earlier this year with heavy marketing but Boyd says the start-up is really "a paint job and a press release" with the "same routes, same fares and same hubs" as full-service United flights.
Delta Airlines is on its second attempt with Song, after the failure of Delta Express. But Boyd says Song has the potential to be the one US low-cost venture to break the pattern, even though it is not yet profitable.
Song focuses on direct holiday travel from east coast cities to Florida, something not provided by the full-service carrier.
It's no secret within the airline industry that first class and business seats bring in disproportional profits compared with economy seats. Despite this, low-cost divisions, such as Qantas's international economy arm Australian Airlines, tend to be more successful on holiday routes, where business class seats are removed in favour of higher numbers of economy seats.
To pack in as many passengers as possible, Jetstar's Airbus A320s have "slim-line" seats on a 30-inch (76 cm) pitch, offering less legroom than the 32-inch (81cm) pitch on Qantas and Virgin Blue.
Of course, that could prove uncomfortable for some passengers. "A 30-inch seat pitch is tight for me at 5 feet 4 inches [of height]," Boyd says.
Aside from tighter seating, another step is for Jetstar to avoid cannibalising Qantas's most profitable routes.
The Sydney-Melbourne (Tullamarine) route is one of the most travelled city pairings in the world and has heavy business traffic. Jetstar's Sydney-Melbourne flights will land at Avalon airport, a 65km trip from Melbourne's CBD, compared with Tullamarine's 25km. Some observers said using Avalon might not be the best move for Jetstar when Virgin Blue offers similarly priced flights into Tullamarine.
"I believe [Avalon] is going to be bit of a white elephant," says Hugh Ritchie, managing director of Brisbane's Aviation Consulting International. "If the choice is between Jetstar and Virgin, I'd take Virgin because it's far more convenient."
Analysts speculate that Qantas may be looking to use Jetstar as a vehicle to eventually replace less profitable holiday destination routes such as the Gold Coast and Tasmania, despite company denials at this point. But as a flagship carrier linked closely with Australia's national and international identity, pulling out of Tasmania could be a risky move for Qantas.
"I think there's going to be quite a strong degree of political backlash and a strong degree of public backlash in what they're doing," Ritchie says. "It's not necessarily a good marketing move."
And even if Jetstar turns a profit, it may turn out to be a net loss for Qantas, as in the case of British Airway's GoFly venture. GoFly was too successful for its own good when it was sold to easyJet in 2002.
"On the face of it, Go did achieve a position of a low-cost carrier and did achieve . . . profitability but, for the British Airways group, it did more damage than good to the bottom line" due to cannibalisation, says Irish aviation consultant Conor McCarthy, who advised Jetstar on its initial planning before resigning in January due to AirAsia commitments.
But despite the challenges of lowering costs, avoiding cannibalisation and retaining market share, Qantas is determined to enter the low-fare domestic market routes successfully.