The truth about Virgin and the dysfunctional airline industry

Photo from AAP

Contributed by Joe Montero

Virgin airlines is in trouble and making big news for it. The usually told story is that Richard Branson’s Australian operation operation has been hit by the Coronavirus, on top of the big debt it had previously accumulated. Both are true. But little is said about how this is related to an industry that has been dysfunctional for decades.

This must come out, if sense is going to be made out of the situation and a proper solution worked out.

Photo from ABS News: Richard Branson

I remember when big brother rival Qantas was owned by the government and achieved an unmatched international reputation for safety and quality of service. Then came a government with an obsession over selling Qantas to private providers.

Not long before this happened, I had been offered a job to join a research project on the subject at Melbourne university. I knocked it back. The outcome had been decided before the research began, and this was to prove that selling Qantas would improve competition and lead to lower prices and better service. The kindest thing you can say about this sort of research is that it’s dodgy.

A report came out and was used by the politicians to sell the privatisation. Qantas was sold to British Airlines. A government monopoly was converted into a private monopoly, given the right to operate domestically as well as in the international market. The private monopoly was made even bigger. Domestic operators Australian National Airlines had gone. Ansett was to follow before too long.

The evidence has always been that privatisation wouldn’t lead to the so-called competitive industry. We ended up with the overwhelming dominance of one airline, a succession of smaller players entering and leaving, and a few even smaller players holding onto niche markets that Qantas has little interest in.

This is the shape of the industry, and Virgin’s fate is a continuation of what has been going on for years. It was never going to stick around for the long haul. The Coronavirus role is that it made the inevitable happen a little more quickly.

Australia’s population is far too small. Most of us are concentrated in a few cities. There are few profitable routes. The most profitable by a long way, is that between Melbourne and Sydney. A long-term survivor must dominate this route and have a big chunk of the international flights market in its hands. Operators like Virgin have no chance of taking over from Qantas here.

Underlying this, is the high cost of keeping the planes flying. Even with the major cost reduction brought about by the introduction of 747’s, it has still not been enough in the Australian context to allow multiple airline to operate.

Realising the limit, even when being the dominant monopoly, British Airways eventually sold sold its controlling stake, and the industry became increasingly dependent on government to prop it up.

Generous dividends to shareholders and fat cat salaries for CEOs, came at the expense of retrenchments, holding down pay rises, reducing working conditions, other cost cutting measures, and government handouts, rather than from operating successful businesses.

Virgin Australia’s CEO Paul Scurrah is pushing a plan to keep on going. He’s been hoping to strike a deal a deal which involves a $200 million government injection to pay off the most critical part of its debt. Then he wants to gather support to convince the bondholders to wait a while longer, or accept payment of only half the $1.6 billion debt. It’s a long shot.

A fundamental weakness of the plan is that it’s no more than a stop gap. Missing is a strategy for longer term success. The airline had come into the coronavirus mess owing $4.8 billion. Unless a lot of money comes in quickly, the debt is going to overwhelm the company. And no-one is going to commit, unless they are convinced there is a workable strategy for future success.

The bonds had themselves been sold to raise the money to pay for the most pressing debts. It didn’t work. Not enough revenue was generated from the operation of the business to cover it. Subsequently, Virgin was unable to pay these bonds and the 8 percent yield on top of this, when they came to maturation. This is what is now pulling it under.

It is hard to see how virgin can survive, and the government is wise to not throw money into this black hole.

The airline industry in a natural monopoly, a limited market and high running costs, with no room for multiple players. Admitting this makes good sense. If there’s a will, something positive can be done about it then.

There are solid reasons for suggesting that when a natural monopoly exists in an industry of strategic importance, the best recourse is for it to be government run. This allows the use of economies of scale to operate more efficiently. In the case of the airline industry, it is easier to cross subsidise unprofitable routes, necessary for the wellbeing of economy and the broader needs of society.

Where the government is nowhere near ready to take over the industry, it could at least consider the opportunity to buy up Virgin at a bargain price. Then it can turn around and use its acquired company to set the pace in price and service. It can challenge the dominance of Qantas.

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