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Address To American Chamber Of Com. - Ralph Norris


FRIDAY 6 DECEMBER 2002

Copy of address delivered to the American Chamber of Commerce by Ralph Norris, Managing Director and Chief Executive, Air New Zealand

SECURING A ROBUST FUTURE FOR AIR NEW ZEALAND THROUGH A STRATEGIC ALLIANCE

Good afternoon ladies and gentleman. It is my great pleasure to be here today to have the opportunity to talk to you directly about the recent decision by Air New Zealand to enter into a strategic alliance with Qantas.

Before talking specifically about the proposed alliance let me set the scene by talking about the financial troubles the global airline industry finds itself in.

These troubles have been brewing for quite some time and profits have been in the steady decline since 1997.

It’s pretty clear that well before the shocks of September 11, the airline industry was heading into one of the regular cycles of depression that hits it every decade.

This one promises to be the worst of them, for reasons I’ll cover later.

IATA estimates that airlines racked up a total loss of 12 billion US dollars last year – and are well on their way to a 3 billion US dollar loss this year.

That’s likely to be a conservative estimate given the current state of the US Airline Industry.

In the United States, US Air is sheltering from creditors in Chapter 11.

2 United has warned it’s heading for bankruptcy.

Delta has been tracking badly. It’s accumulated a net loss of more than US$ 900 million in the current year.

American Airlines turned in a modest loss for last year. But it has just declared a mammoth loss for the single quarter ended September of close to US$ 1 billion.

At the other end of the scale, the industry’s top financial performers are the budget carriers – point to point operators such as easyJet, Ryanair, and Southwest.

Despite the talk of a post September 11 recovery in travel demand, latest forecast is that passenger traffic this year will be down on last year.

IATA is forecasting that global passenger traffic this year will be down 3% on 2001.

Now let me come to my main reason for saying the industry’s current downturn is going to be a rough one.

There’s much more surplus capacity in the skies now than there was at the same point in the previous big airline downturns in 1982 and 92.

The industry actually expanded its operating capacity 2.7% in the run-up to September 11 – against a clear pattern of falling demand.

McKinseys produced a forecast for this year that shows capacity is running even further ahead of demand this year.

Sure, major airlines have reduced their orders for new aircraft – but they’re using older planes longer, and have plenty more of them in store.

3 Too many airlines are fighting for the reduced amount of business on offer by offering fares that are artificially low – hoping the downturn doesn’t last longer than their reserves of cash and credit.

It was against that backdrop that Air New Zealand made the decision to enter into a strategic alliance with Qantas. This decision has the unanimous support of both the Board and Management of Air New Zealand, and came after nearly 12 months of negotiations with our new alliance partner. Along the way we also explored alternatives, including staying as a stand alone airline, but as we moved through this process it became clear that the option that by far best met all our criteria to secure a robust future for Air New Zealand was a strategic alliance with Qantas.

It is now a little less than two weeks since we announced this decision, and in that short time we have seen representatives from political, business and the media discuss and debate its merits.

Interestingly, the debate has developed in much the same way we ourselves worked towards reaching an outcome. An outcome we are confident will secure the future of our national airline, and in a form that will ensure protection of those characteristics that we know make Air New Zealand special and unique.

We debated the issues that would cause contention and concern, and in our negotiations we worked to reach an outcome that will ensure these concerns are more than adequately addressed.

We remain confident that as people gain a better understanding of the alliance over the coming months and see for themselves just what it means to Air New Zealand and New Zealand, they will reach the same conclusion as the Board and Management of Air New Zealand.

4 Our application to form the alliance and documentation supporting that application, will be lodged with the regulatory authorities on Monday.

At that time, it is our intention to release to the public the economic report which outlines the one billion dollars in economic benefits that will accrue to New Zealand from this initiative over 5 years.

The regulatory authorities will decide when to release the full application, excluding that information which it has been agreed will be kept confidential for commercial reasons.

Air New Zealand is keen to release all information that is not commercially sensitive as we wish to be transparent in relation to all aspects of the alliance.

We want the public to have as much information as possible.

When reflecting on the comments of those that are not in favour of the alliance, keep in mind that none have yet seen the full details.

So a point I want to put to you is this: how can some parties be so vehemently opposed to the alliance when they do not know the contents of the proposal? This is the response of nationalistic hearts ruling heads.

All I ask is that you give Air New Zealand and Qantas the opportunity to put a case for fair public debate.

Our position is that this alliance is a smart and bold initiative, and is clearly in the best interest of Air New Zealand and New Zealand. No one should be in any doubt that our end objective is for Air New Zealand to be a successful, globally operating airline with a sustainable future and significant growth opportunities.

The business case for Air New Zealand entering into a strategic alliance with Qantas to form a strong, regional airline grouping in this part of the world, is compelling.

5 There are two components to that case. The first is economic. The second, strategic, in that it ensures Air New Zealand remains competitive in the rapidly changing airline industry.

What I would like to do is briefly outline just what it is we are proposing, and what the real outcomes will be from the alliance. Then I would be happy to open the floor to questions.

In considering our strong business case, I want to make it clear that this was not a decision we were forced to accept due to a lack of alternatives. Nor is it an agreement in which we had to give up a lot to achieve a few concessions , or one made from a position of weakness.

In fact, at this moment Air New Zealand is in a relatively stronger position than earlier in the year. And from that position we have negotiated a good deal with Qantas.

You might ask, if Air New Zealand is in a relatively stronger position, why forge an alliance with Qantas? The reason is our time horizon has to be at least three to five years out, and without this alliance there is a high probability that within that timeframe, Air New Zealand could be reduced to a domestic airline.

This is not to say the alliance has been a “take it or leave it” proposal from Qantas. It is a far sighted realisation that the global industry has become massively inefficient in producing any reasonable return on capital. Airlines, governments and capital markets have become more acutely aware of this, especially since “September 11” and the industry is changing dramatically in response. Those which cannot deliver the goods in financial terms are unlikely to survive in the medium or long term. This is a reality recognised by both Air New Zealand and Qantas, and drives our common vision of the imperative of a sound regional base from which to compete effectively in the international markets on which both countries depend.

6 There are some that say that if this alliance is good for Air New Zealand and Qantas, then the public is the one who will suffer. Two key issues over which some have strong reservations are ticket prices and competition.

I want to restate what I have said in other public forums in the past few weeks.

And that is, it is Air New Zealand’s intention to ensure New Zealanders have access to affordable airfares. We have demonstrated our commitment to lower airfares with Express Class, and the results have shown the public recognises the value we offer. Our new fare structure is much more affordable.

Since Express Class was introduced a little over a month ago we have increased patronage when measuring like with like by more than 20%. While it is still early days, the clear message from the public is that it likes what we are offering. To maintain this trend and to build our business to the next level, we know we must hold our fares at affordable prices.

Freedom Air is also offering no frills, cut price fares across the Tasman. Its style of operations commits it to continuing to meet this market sector.

We have also announced our intention to extend Express Class across the Tasman, although it will be adapted to suit longer flights.

There have been calls for Air New Zealand to “guarantee” our current low fares. No business can guarantee current prices. To do so would be commercially naïve. For airlines, which have to manage numerous factors outside their control that might impact on costs, it would be doubly so. Factors airlines have to consider include fluctuations in the price of fuel, a New Zealand exchange rate that is volatile, and those unpredictable events that can have such a severe impact on air travel.

7 In maintaining prices at affordable levels, our aim is to encourage more people to travel more often. We want New Zealanders to adopt overseas trends, and to increasingly use air travel as part of their leisure activity.

Affordability is what will encourage people to use their discretionary leisure dollar on our airline.

The other major concern is that under the alliance, competition will be reduced. The clear and uncontestable fact is that New Zealand is too small to support two full service domestic airlines.

Past years have seen hundreds of millions of dollars lost in fights between Air New Zealand and various competitors in the form of Ansett New Zealand, Qantas New Zealand and most recently, Qantas itself.

Our market is simply too small to enable two airlines to compete head to head nationally and still make adequate returns on the enormous capital investment involved in maintaining a high quality airline.

Sustained competition only comes if the competing parties can all make a profit at the prices offered. If one or both parties lose money, something eventually has to give. Either prices go up or one of the competitors goes away.

The current position is simply not sustainable into the future. There will be changes to the full service, two airline structure with or without the alliance.

The real options for competitors domestically are to “cherry pick” passenger traffic routes while being indifferent to the greater needs of New Zealand.

Alternatively, or perhaps as well as, we expect to see the emergence of a no frills operator.

Air New Zealand believes that a no frills competitor will be competing domestically within three years. This is logically far more likely to occur if the 8 alliance goes ahead than in a market where two competitors are head to head in a value destroying battle.

Let me now move on to what is proposed.

_ All the airline activities of Air New Zealand will combine with those parts of Qantas that operate to, from or within New Zealand.

_ Commercial management of the combined operations will be the responsibility of Air New Zealand.

In effect Air New Zealand will strengthen its position on the trans Tasman routes and in the domestic market. It will give us the ability to live up to our promise of offering New Zealanders affordable air travel while running a profitable business.

While Air New Zealand will be responsible for the commercial management of the two airlines, each will look after their own aircrews, ground staff, air fleet and terminals.

_ New Zealanders will have more options and greater flexibility in that the number of flights available through code sharing with one of the world’s leading airlines will mean an immediate threefold increase in choice.

_ We currently have more than 800,000 Airpoints members world-wide, and the Airpoints Programme is an extremely important part of our customer offering. Under the alliance, Airpoints member benefits will be retained. It is our intention that on implementation of the alliance Airpoints will also apply to Qantas services.

_ As most of you will be aware, Air New Zealand is a member of the Star global alliance and Qantas is a member of the oneworld alliance. In considering this we will work through the best options for the new airline grouping and the commitments each of us has to our current global 9 alliance members. No decision will be made in the near future and it should not be assumed that Air New Zealand will leave the Star Alliance.

_ Qantas will, over time, take up to a 22.5% stake in Air New Zealand while investing some $550 million in Air New Zealand. In stating this I remind you all of the fact that the Kiwi Shareholder agreement ensures that no less than 64% of Air New Zealand can be owned by New Zealanders.

Now, and in the future, New Zealand ownership is secure.

It would be wrong to think this alliance is a clever way of saying Qantas is taking up a controlling shareholding in Air New Zealand. The negotiations recognised that we both face similar problems and constraints, and that together we have a much better chance of meeting our challenges successfully.

Some who are opposed to Qantas have made the comment that they accept an alliance makes sense, they just think we have chosen the wrong partner.

An alliance with Qantas was not the only proposition Air New Zealand investigated. There were other potential alliance partnerships, but none offered the clear benefits that Air New Zealand gains from the Qantas relationship.

The resulting effect is that Air New Zealand will run some 10% of Qantas’ operations while we still retain our independence at Board and Management level. This is not a Qantas take-over. It is a true strategic alliance that sees two companies that share a common understanding of how airlines need to operate in today’s global airline market, showing a sensible level of cooperation.

It is not unreasonable for Qantas to have boardroom representation, and the two directorships they will receive is entirely appropriate to their shareholding.

The claims of control and rights of veto are not borne out by the facts.

10 Suggestions that written resolutions have to be signed by Qantas directors and Qantas directors can prevent board meetings taking place by simply not turning up are smoke screens.

Air New Zealand’s board meetings will be conducted under the normal governance protocol observed by New Zealand public companies.

Nor does Qantas get a 50% say over the commercial operations of the alliance while owning less than a quarter of Air New Zealand. The committee to which this power is being attributed is designed to ensure the alliance works, not to work the alliance. It is called the Strategic Alliance Advisory Group, or SAAG for short.

The committee is advisory only, and has no delegated authority over either airline. Within this forum, each airline will be able to contribute their views on the other.

Let us be realistic. It is not reasonable to presume there will not be disagreements within the alliance. Commercial reality says there will.

This committee will be the first line for resolving issues. If necessary, the chief executives and then the respective chairmen of the two airlines will be the final arbiters.

Air New Zealand will in turn have a seat on the Qantas board. While it is true Qantas will have access to operational information about Air New Zealand – we too will have the same access to similar levels of information about their airline.

Given that we are in a strategic alliance, the sharing of operational information will be routine.

Let me now move on to the outcomes. The clear objective in reaching this agreement was a robust future for Air New Zealand. Hand in hand with that 11 was creating an outcome for Air New Zealand that, as a major company in New Zealand and an integral part of our culture, had benefits for everyone. To determine those benefits and to ensure they were real and measurable, we commissioned NECG to undertake an independent economic analysis of the outcomes from the alliance.

The topline benefit this report identifies arising from this alliance over the next five years is in economic benefit in the order of one billion dollars. Specific benefits will include: _ Up to 50,000 additional tourists arriving in New Zealand each year. Based on Tourism New Zealand figures that accounts for, at a very minimum, an additional 2000 jobs in the tourism sector. So aside from the 50,000 tourists, the flow on effects for employment in tourism are substantial.

_ The strengthening of Air New Zealand and planned expansion of our network will lead to more effective promotion of New Zealand in overseas markets. Consider this, Air New Zealand is the largest private sector contributor in the promotion of New Zealand as a tourism destination.

_ A further benefit, and one that is critical to New Zealand business, is the enhancement of air freight services to and from New Zealand. There has been some concern amongst small to medium size businesses that the alliance will result in increases in prices for air freight through less competition.

Our economic report talks in terms of freight capacity increasing by more than 5% by year three, and improved scheduling providing efficiency benefits, particularly for perishable freight. There are other potential opportunities here in regard to dedicated freighter services which still require to be fleshed out and so have not been included in the economic analysis.

12 _ In addition we estimate that the alliance will lead to the creation of at least 200 additional highly skilled jobs within Air New Zealand. Let me repeat that point. The creation of at least 200 new, highly skilled jobs, the majority of which will be in Christchurch and Auckland.

Let me also remind you just how important Air New Zealand is to New Zealand and how critical it is we protect the future of Air New Zealand.

Air New Zealand employs some 10,000 people, and it is likely that number will increase in coming years as we further develop our domestic, trans-Tasman and international network.

We carry more than 8 million people each year, and can be seen as a critical element in New Zealand’s infrastructure.

And each year we source over $1 billion in products and services from New Zealand suppliers.

One final issue that I want to touch on, and that is why Qantas. I have already talked about the nature of the relationship and that Air New Zealand remains in charge of its own destiny, in spite of the colourful language others might wish to use.

The Board and Management of Air New Zealand saw quite clearly that there were two alternatives. We could form an alliance partnership and remain a global, successful, independent New Zealand airline, or go it alone. Going it alone is a high-risk strategy, which in the Board’s view could over time result in withdrawal from our international routes to become a domestic airline.

The facts tell us that even in an alliance with Qantas, we account for less than 4% of the world’s commercial airline activity. By itself, Air New Zealand is a minnow. Scale isn’t everything, as American experiences tell us. But having financial resilience and flexibility is a prerequisite for being able to capture 13 opportunity in this business and to get to that point, Air New Zealand needs more certainty over its domestic and trans Tasman business.

Obviously, the alliance option is the one we prefer. I want to put on record that if Air New Zealand was offered a sound commercial opportunity to choose any airline in the world with which to form an alliance, then that airline would be Qantas.

So where to from here? It will be some months yet before we can formally establish this alliance, and there are regulatory steps to move through.

The next steps in progressing the alliance from New Zealand’s end are _ First, obtaining consent from the Kiwi Shareholder.

_ Two of the key regulatory bodies that will examine what we propose are New Zealand’s Commerce Commission, and the Australian Competition and Consumer Commission. This will give the public the opportunity to have their say through the submission process.

_ If we successfully cross these hurdles, shareholders will have an opportunity to vote on the transaction.

A reasonable time frame for all of this is _ Kiwi Shareholder conditional approval before Christmas _ Regulatory consent by early to mid 2003; and _ Shareholder consent mid to late 2003.

All in all, we are looking at a six to nine month process.

14 In conclusion I would like to end by restating the words of Air New Zealand’s Chairman, John Palmer, when he announced this decision. And the reason I want to repeat these words is to remind us all just how important this step is in the growth and development of Air New Zealand. John said.

“This decision to form a strategic alliance with Qantas is one that will shape the future of Air New Zealand. It is a decision that will lay a robust foundation for Air New Zealand, our national airline, and ensure it will continue to carry the Koru proudly here and around the world.

It is not too dramatic to say that the alliance is one of the most positive developments in Air New Zealand’s history, an important milestone in aviation’s evolution in this part of the world, and an initiative that will bring tremendous economic gain to New Zealand.

This decision is a key part of the strategic framework that will allow us to continue to grow and develop.

What we are doing is bold and strategically smart.

The decision allows Air New Zealand to retain its autonomy and independence, and to focus on the next stage of the airline’s development as it builds on the considerable resilience, determination and innovation it has shown over the past 12 months.

But most importantly this decision is good news for the travelling public because it ensures a strong Air New Zealand can continue with a domestic and international network that is viable commercially, and affordable for the customer.” Ladies and gentlemen, thank you again for your time. I would be very happy to now take questions from the floor.

ANZCP054


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