THE Qantas alliance with Emirates will unambiguously improve its bottom line compared with a world without it, as is reflected in the 13 per cent lift in the share price over the past 24 hours or so.
Nanjing Night Net

The ”if you can’t beat ’em, join ’em” strategy is an admission that the airline can’t compete with Emirates on price (or costs), product and network footprint in Europe. It’s also a realisation that Qantas had to do something radical to stop the bleeding of its international business.

The other seemingly forgotten benefit of the Emirates alliance – and it is material – is that Qantas and its passengers will pay lower departure taxes to British and German government authorities.

The UK departure tax, called the air passenger duty (APD), is higher for UK flights departing for Australia that hub through Singapore, Hong Kong and Bangkok than for flights that hub through Dubai when passengers stay at the hub point for 24 hours or more, which is the case for a high percentage of passengers.

This difference is because the APD rate, quite unfairly for Qantas, is based on the distance travelled between Britain and the port where the aircraft lands. The longer the distance, the higher the rate that is paid.

Qantas was paying an APD of £92 ($A142) for economy class passengers and £184 for premium economy, business and first-class passengers using the Singapore hub. By hubbing through Dubai, the rate paid by Qantas passengers falls to £65 and £130 respectively.

The variance between these rates of tax can be the difference between a profit and a loss on some international routes.

The German authorities impose an air travel tax of €45 ($A55) for travel to Australia via Singapore and €25 for travel to Australia via the Middle East. Qantas will save €20 per passenger for a large percentage of passengers immediately by hubbing through Dubai rather than Singapore.

While the alliance with Emirates will no doubt provide a profit boost for Qantas, the most pressing question is whether it will lead to the airline more consistently achieving its return on invested aircraft capital.

Time will tell, but it is doubtful. It will certainly contribute to solving the primary underlying problem with the international business. The carrier is dogged by persistent excess supply or capacity, resulting in yield and margin compression in an environment of growing unit costs.

While the pact will contribute to solving the problem, it won’t eliminate it because the mentality of expanding supply too quickly is ingrained in the aviation system.

The supply of seats on international routes should be growing at a long-run average of 2 to 3 per cent rather than its present 5 per cent rate. The latter is suitable for a $US20 a barrel oil price, not a $US110 one. Emirates is growing at a long-run average rate of more than 20 per cent.

International airlines are preoccupied with market share. They err on the side of expanding capacity too quickly rather than too slowly, despite the fact that the incremental costs of doing so these days are considerably higher.

Aviation competes in a way that is similar to what economists call a prisoner’s dilemma – in short, two prisoners are better off if they both plead innocent than if they both plead guilty.

In aviation, pleading guilty is analogous to raising capacity too quickly (above about 5 per cent, especially in a weak demand environment) and pleading innocent is analogous to growing capacity more slowly. Airlines are generally guilty as sin.

The Emirates pact with Qantas will do nothing to counteract the effect on the international flying business of an elevated fuel price.

As seen when Qantas announced its annual results recently, higher fuel prices can devastate an airline business – and it doesn’t discriminate between carriers.

While the Emirates alliance will help with competition on the European route, it will have no effect on the Pacific (US) route, and will have little impact on competition intensity and the supply of seats on most of Qantas’ Asian routes, its South African route and smaller routes in the neighbourhood of Australia, such as Port Moresby and the Pacific islands.

The US and Asian routes are likely to represent a big chunk (in excess of 50 per cent) of Qantas’ available seat kilometres or seat supply. These routes are still likely to experience considerable yield and competitive pressure, exerted by growing Chinese carriers, and the likes of excellent carriers such as Singapore Airlines and Cathay Pacific.

While Qantas will put a bandage on its international wound, the blood is still likely to seep through. But at least it has made a start in the right direction.

Tony Webber was Qantas Group chief economist between 2004 and 2011. He is now managing director of Webber Quantitative Consulting and associate professor at the University of Sydney Business School.

This story Administrator ready to work first appeared on Nanjing Night Net.

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