Feature: Waiting In The Wings

Fish need bicycles as much as Air New Zealand would seem to need a “strategic alliance” with its arch rival, Qantas. In fact, the decision to conditionally approve this deal as being in the “national interest” marks a defining moment for the Clark government. Letting Qantas buy a key stake in our national airline was bound to raise concerns about sovereignty. The deal’s creation of a virtual monopoly within New Zealand and trans-Tasman also raises the spectre of reduced service and price fixing on fares and freight, affecting consumers and business people alike. Moreover, the decision has been taken with the odd mixture of timidity (take the conservative business option) and arrogance (but rush the acceptance-in-principle on through) that has become typical of this administration.

One sign of how shaky the government feels about its ability to convince the public is that the deal is rarely being defended from the front foot, on its alleged merits. Instead, Cabinet ministers are readily resorting to what they call the “counter-factual” argument – ie, just imagine what would happen to Air New Zealand if this deal didn’t go through! Despite a public relations blitz unmatched in New Zealand corporate history, the real counter-factual – Air New Zealand remains fully competitive with Qantas until a wary duopoly emerges, outside a formal alliance – is looking rosier by the day, while the rationales for the deal are losing ground. For instance:

Rationale #1.

Airlines are a very, very risky business, so Qantas should be allowed into Air New Zealand, to spread the risk. Yes, the airline industry is notoriously cyclical. It has times when it is highly profitable, and times when it isn’t. Currently, though, Air New Zealand is navigating the recent trough in the global airline industry in better shape than most. As Finance Minister Michael Cullen readily conceded to me, the airline h as now fully recovered from its poor investment in Ansett Australia. Buoyed by its recent low-fare initiatives, the airline is expecting profits of $230 million (before tax) for the year ending June 2003. Even the company ’s international long-haul business – which chief executive Ralph Norris said was losing “a bucketload” last year – is now back at “break even” point overall, according to Air New Zealand’s chief financial officer Shane Warbrick, and in profit on some previously problematic routes. This healthy trend should continue, and would give the airline the time and resources to shop around for better options – which could even include fresh overtures, as the Australian Financial Review suggests (November 27, 2002), to its former suitor, Singapore Airlines.

Rationale #2.

Air New Zealand is too small to go it alone. In fact, Air New Zealand isn’t a small, vulnerable player. It is the local arm of the 14-airline strong Star Alliance, the world’s largest airline grouping. Although United – the major generator of customer traffic within the Star Alliance – has just gone into receivership, most analysts do not expect United to go the way of Pan American and be wound up. Instead, United is expected to use its spell in receivership to slash its labour costs, which are among the highest in the industry. The court rulings on United’s legal moves to scrap its existing labour contracts with the feisty 35,000 strong mechanics’ union were still pending at time of writing – but these rulings will be crucial, and could well see United return to the fray as a leaner, more formidable competitor for global airline business.

Rationale #3.

Air New Zealand needs the infusion of fresh capital from Qantas that the “strategic alliance” provides. In fact, there is no compelling reason why co-operation between the two airlines should be entangled with matters of ownership. Any advantages for Air New Zealand from instigating joint operations with Qantas could be argued on their merits before the regulatory bodies on both sides of the Tasman, without Qantas buying into Air New Zealand. The airline could raise the circa $NZ500 million capital it needs (for new planes, etc) on local capital markets. In fact, if Air New Zealand had taken steps to raise all (or most) of this capital local ly during 2002, it would have been in a far stronger position when it sat down to plan its strategic alliance with Qantas.

Rationale #4.

If we don’t let Qantas buy into Air New Zealand, it will crush our airline. No wonder the Clark government is having trouble selling the public on the wisdom of this deal. It has to portray Qantas as an ogre so big and bad that it cannot be resisted head on – while also claiming that this same ogre will dutifully respect Air New Zealand’s autonomy once its feet are tucked under the boardroom table. The logic that a $500 mill ion stake will induce Qantas – formerly on record as promising “to grind Air New Zealand into the dust” – to respect Air New Zealand’s autonomy doesn’t stack up. Having an equity stake is unlikely to suddenly transform Qantas into a champion of its smaller partner’s interests. The deal may encompass all of Air New Zealand’s operations, but it touches on only 10-15% of Qantas’s network. It seems far more likely that Qantas will use its boardroom access to Air New Zealand’s route and sector profitabilities to nullify our airline as a competitive threat.

Rationale #5.

Air New Zealand cannot compete with Qantas. “If we decide to compete head on with Qantas in full competition,” Cullen says, “why do we assume that Air New Zealand is going to win that competition, and how deep do you think the public pockets should be to keep that competition moving along?” Well, when the low-budget Irish carrier Ryanair took on British Airways, the little guy won on those routes. EasyJet, a start-up airline , has emulated Ryanair’s example in Europe.

In the US, the same story applies. The no-frills, short-haul players – Southwest and JetBlue – are the most successful, most efficient players in the industry. It so happens that Air New Zealand has a similar weapon in it s arsenal called Freedom Air, currently the lowest cost airline in Australasia. Perhaps if Air New Zealand was blessed with adventurous managers able and willing to make full use of this country’s flexible labour laws and our other efficiency advantages, Air New Zealand could expand Freedom Air on the trans-Tasman market – 60% of which is point to point traffic, Freedom Air’s speciality – and win any fight with Qantas. Domestically, Air Ne w Zealand’s raging success with its Express low-cost service would also deter Qantas from assuming it would easily win any campaign of total war that it chanced to launch.

Instead, Air New Zealand and the government have chosen to fold their hand. To me, just before Christmas, Cullen gave a clear signal to the Commerce Commission: “The commission has the power, in the consideration of this proposal, to make some changes which may address some of these concerns [about the loss of competition]. It is not inconceivable that they may order Air New Zealand to divest itself of Freedom Air. Perfectly feasible outcome.”

Freedom Air currently has only four planes flying trans-Tasman. Would divesting it be mere tokenism? Probably. In any case, this solution won’t resolve the deal’s reduction of competition within New Zealand. Tactically, though, divesting Freedom Air would remove one of Air New Zealand’s potential weapons in future – against Qantas, or Virgin Blue. Why, even the beleaguered United is treating as a top priority (see New York Times, January 5, 2003) the creation of a new low-cost, no-frills airline within the United family, to assist its long-haul operation to fly its way out of trouble. Thanks to the Qantas deal, Air New Zealand seems likely to be pushed in the opposite direction. If genuine competition is ever to exist in our skies again, the Clark government seems quite happy that a foreign airline (Virgin Blue), and not a local one, should supply it.

The process of getting the Qantas deal on the rails has been just as fraught as the deal itself. Thanks to Air New Zealand’s calamitous investment in Ansett Australia (for all of the scorn heaped on state involvement in our economy, our private sector has an abysmal track record) and the government’s own subsequent fatal dithering over an attractive offer from Singapore Airlines, we all now own a stake in Air New Zealand. After injecting some $885 million of taxpayer money, the government has ended up owning 82% of the national airline. If it is any consolation, the Bush administration has also pumped about $NZ10 billion of taxpayer money into the US airline industry in loans and grants since the September 11 terrorist attacks.

Thanks to the Qantas deal – which would give Qantas a 22.5% stake – the government’s share in the airline would eventually fall to around 64%. However, an “advisory group” made up equal numbers of executives from both air lines would also be created, to ensure that operational decisions did not upset the smooth running of the alliance. No, says Air New Zealand’s Warbrick, this would not give Qantas veto power over the operations of our national carrier. So, would Air New Zealand need Qantas’s permission, for instance, if it wanted to launch new routes to Japan? Only if these touched on Australia, Warbrick replies. Regardless, critics of the deal – such as National Party leader Bill English – maintain that the advisory group will effectively give Qantas equal control of the operations of our national airline, after buying less than a quarter of it.

Or even less. Can Qantas pull out at 15%, or is it committed to the full 22.5%? “It can pull out short of the 22.5%,” Cullen says. Not so, says Warbrick. In his view, Qantas has to take the full 22.5%, with its only option being how it ultimately gets there. This equity stake will deliver $NZ550-575 million to Air New Zealand over three years, and Cullen is confident that such an investment will induce Qantas to behave itself. “It has real money, over half a billion at stake. Which, even for Qantas, is a significant sum of money.” Couldn’t we have pursued co-operation with Qantas without letting it buy into our airline? “By Qantas coming in with an equity stake,” Cullen replies, “it has literally bought into the partnership. Without it, there’s not the same commitment, and the same joint interest if you like, in the partnership working.”

After two weeks of analysis, the Clark government declared (on December 18) that the deal was in our national interest, while leaving its impact on competition to be analysed and weighed afterwards by the Commerce Commission in New Zealand, and by the Australian Competition and Consumer Commission in Australia. It is expected that this process will take until mid 2003, with opportunities for public submissions.

So far, has New Zealand made any commitments from which we cannot later renege? “We won’t renege,” Cullen says. “It’s an ‘in principle” decision. It’s not a ‘well, maybe, if not whatever’ kind of decision. But it’s obviously subject to the Commerce Commission saying ‘Yes.’ If it says ‘No’, then that’s the finish.” The wiggle room in the documents is that there should be “no material change” to the deal, and that “no significant new information” emerges in the interim. Neither of those terms, says Transport Minister Paul Swain, has been defined. The government has also tried to cover itself politically. Obviously, the deal could cause the operational decisions of the two airlines to become so entwined over time that Air New Zealand would never safely withdraw. Therefore, Cullen has sent a letter (the so-called “Dear John” letter) to Air New Zealand board chairman John Palmer, asking him to (somehow) ensure that this doesn’t happen.

In Swain’s view, the Commerce Commission will not only have to weigh the “national interest” against the already conceded damage that the deal will do to competition, and reach a net outcome, but it will also have to weigh the counter-factual – “What are the benefits of the deal proceeding as opposed to the benefits of the deal not proceeding?” So who will quantify and put the dollar values next to all the factors involved? To date, as Cullen says, the government has relied heavily on advice it has received from Air New Zealand and its own advisers and from contracted private-sector advice – most notably, from the Australian Network Economics Consulting Group (NECG) study headed by Professor Henry Ergas.

No stranger to New Zealand, Ergas was heavily embroiled in the telecommunications disputes of the mid 1990s, where his analytical work for Telecom – in which he argued for a light-handed response to near-monopoly conditions – was hotly attacked by Clear’s consultants, and vice versa. This history highlights the need for contestable advice about Air New Zealand, and for genuine checks and balances in the analysis of the Qantas deal. For it s part, the government has split its responsibilities for the Qantas deal between three ministers – Cullen, Swain and Trevor Mallard – and has sought to fence off the competition issue from its “national interest” decision. So much so, if one can believe Swain, that the relevant ministers deliberately haven’t talked to each other at times: “For example, I haven’t seen all the shareholder papers. Conversely, Michael hasn’t seen all the Kiwi Share papers. We deliberately haven’t met about this, about specific issues.”

All that was foreplay. At crunch, the government is the main shareholder under one hat, but is also the main regulator under its Commerce Commission hat. Given a context of collective Cabinet responsibility that sweeps away any Chinese walls, how on earth can the public have confidence that the process is being credibly managed – given that the government first reaches a decision about national interest, and then delegates the analysis to an entity that it itself controls?

“It doesn’t control it,” Swain says. “The Commerce Act is very, very detailed about how a government can and can’t interfere with it.” Except when, he adds, as in the case of Fonterra, the government chooses to “scoot around” the commission – which, he stresses, it has chosen not to do this time. In his view, the credibility issues are “no different” from the situation where the government effectively owns an airline while also being responsible – via the Civil Aviation Authority – for airline safety. “We have it with Tranz Rail in Auckland. We own $81 million worth of track, but the Land Transport Safety Authority looks after track safety … So what I’m saying is that we try to keep these things separate, but you cannot avoid the ultimate problem.”

No, he insists, the government has not put the cart before the horse by first declaring the national interest, and then doing the relevant analysis afterwards. “The counter-argument was that the airlines would [otherwise] have to run the gauntlet of the Commerce Commission …” As they would have to do, surely, on any similar anti-trust issue in any other country – where this terrible “gauntlet” would be seen as an utterly normal risk of doing business. Why shouldn’t the public conclude – given its experience over the last 15 years – that this is really a collusion for the benefit of the airlines concerned, in which the subsequent process is a charade?

“Well,” Swain replies, “it’s been an ‘on balance’ decision. It’s not, in my view, a collusion for the airlines … The government has had to do two things. It has had to work out what is in the best interests of the New Zealand consumer, and what is in the interest of the New Zealand taxpayer. The New Zealand taxpayer would not like the government to squander taxpayer money on a bad deal, or to look a gift horse in the mouth.” As it did last year, when Singapore Airlines came a-courting? “I’d prefer not to go into that,” Swain replies.

Cullen, for his part, recognises that a case can be made for Air New Zealand being left to continue as before – by leveraging efficiencies from the Star Alliance, bringing its own costs on long-haul services into line wit h its revenues, and using its low-fare, no-frills services to the maximum on its short-haul routes. “I would not say that such arguments are not totally without merit,” he says. “One of the silly things about this debate has been that a lot of people have locked themselves into extreme positions when, as with all judgments of this sort, there are balances. The best judgment we could arrive at in the face of all the advice we had … was that if everything went all right and if all circumstances kept on going all right, then Air New Zealand would be okay. But any number of circumstances were likely to mean that there would be very serious threats of viability. You would always be living in terms of very strong uncertainty in a very uncertain business.”

Welcome to real life in the business world, some would say. The ongoing political management problem, I suggest to Swain, comes back to the government’s claim that it can’t confront Qantas outside the tent, but can preserve Air New Zealand’s autonomy once Qantas is inside the tent. “Fair question,” Swain says. “This is not an easy decision, as you can hear in my voice. All of the things you are raising are the things we have debated. This issue ‘effective control’ – was the most difficult, no question about that. How do we resolve the question of a much bigger airline that has shown animosity to Air New Zealand – how do we try and make a judgment, going forward?”

The advice he got from officials was that – without the deal – Qantas would either withdraw from New Zealand or attack head on. “The advice we got from officials was that the former was not likely, the latter most likely … How do we trust them was basically the question. That’s why, in the end, we spent an enormous amount of time on two issues – governance and operational influence. They got two directors on our board, we got one on theirs.” On operational matters, Swain says, “we have got a 50/50 arrangement”.

Not that the public will necessarily like that outcome. Swain puts much of the public’s unease down to underarm bowling – a basic hostility to Australians – and not to matters of substance. “Its underarm bowling, its last-minute tries in the Bledisloe.” Such sentiments are not, in his view, a proper basis for policy decisions. “Sovereignty is an easy one to run up the pole, it’s a clarion call for a bygone era. It does not recognise, in my view, the modern global imperative which is tougher competition, the freeing up of trade, and countries trying to compete at what they’re good at …” Tourism being, for us, one such thing. “Our producers also have to get their stuff to markets, and we cannot do that without a national airline.” Or without strategic partners, he believes.

Whatever the fate of our national airline, Swain has his own fallback position firmly fixed in his mind. “The line in the sand for me,” he concludes with obvious relief, “is retaining the Black Caps, the All Blacks and the Silver Ferns. That’s the line in the sand for me on sovereignty. It is in making sure that we are still two independent nations still able to compete ferociously on the footy field, you know?”

© New Zealand Listener 2003, republished here with permission.

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