Applying the New Trade Theory in Qantas - Case Study Example

Multinational Enterprise (Qantas) – Assignment 2 Name Course Tutor’s Name Date Executive Summary This paper is an analysis of Qantas Airway’s international business based on the new trade theory. The paper commences with a background check that reveals that like organisations, Qantas has strengths it capitalise on, weaknesses it can improve on, opportunities it has not fully utilised, and threats that it needs to manage effectively in order to avoid resultant risks. The paper then identifies issues that Qantas faces as the Qantas Sales Act, which has so far limited the airline’s foreign ownership; the nature of the aviation industry; fuel hedging by the airline; a loyal workforce; debt; competitive pressure; and the contribution the airline has to the Australian economy. Applying the new trade theory in Qantas reveals that the company cannot possibly attract the passenger volumes needed to remain competitive in the international market without a change of strategy. The options available for the airline include changing its pricing strategy, or adopting a differentiation strategy. Whichever option the airline opts to work with, the paper notes that a critical evaluation of the strategy will be important in order to save its declining fortunes. The paper specifically notes a need for Qantas to pursue efficiency, flexibility and/or learning in its international business. Efficiency in its operations would reduce associated costs, while flexibility would make the airline less risk averse and more willing to try out new routes or strategies. Learning from its exposure in the new markets means that the airline can make use of lessons learnt to enhance its competitive position. The conclusion notes that analysts and critics have sufficient reason to believe that Qantas may not survive in the competitive international markets if it does not rethink and change its current strategies. The paper however recommends that whatever strategy Qantas adopts needs to be well thought out especially considering that its relevance and profitability will depend on it. Table of Contents International business at Qantas 4 Main issues facing Qantas in a competitive environment 9 Theory application: New trade theory 14 Analysis 15 Conclusion 19 Introduction Qantas Airways has recently been suffering on its international routes (The Economist 2014). The reasons for Qantas ill fortunes on the international front have been cited as the stiff competition from the more financially powerful, state-owned airlines from the Middle-East and Asia, which Qantas has to compete with. Such airlines are able to provide travellers with diverse destination choices, and cheaper airfare. Reportedly, the international competitors have not spared Qantas in its home market either; according to The Economist (2014), the competitors presence in Australia has increased by 46% in four years only. Yet, competition is not the only thing that Qantas has to withstand. Rising jet fuel prices, coupled with a high value Australian dollar are some of the other challenges that Qantas has to deal with. The latter is significant in that the high exchange rate occasioned by a high value Australian dollar discouraged oversees travellers/visitors from coming to Australia. The foregoing corresponds with the argument that when the exchange rates of a specific currency appreciates, exports (and foreign travel into the affected country is one such export) is discouraged (Cavusgil, Rammal & Freeman 2011). Notably, Qantas has tried to battle the challenges as evident from the alliance it formed with Emirates Airlines in an effort to cut costs on some of its international routes. This paper analyses Qantas international business based on new trade theory and argues attaining passenger volumes by the airlines amid stiff competition is a milestone whose attainment or lack thereof will depend on pricing or differentiation strategies that it adopts going forward. International business at Qantas Qantas has operated as an Australian government-owned enterprise since 1947 (Qantas 2008). The airline is the country’s national carrier and only become a publicly listed company in 1995 (Ibid.). Before the year 2000 when the Australian government enacted an open-skies policy that allowed international competitors into the Australian market, Qantas was one of the two airlines offering flights in Australia. With the new policy however, Qantas has faced competition (especially from Virgin Blue airline), and as a result, has divided its attention between the home market (by establishing Jetstar airlines as a low-carrier subsidiary) and the international market. Performance of Qantas international business’s loss making in years 2012 and 2013 is shown in figure 1 below. Figure 1: Qantas Earning for years 2012 and 2013 Source: Matt (2013) Since Qantas’ operation in the international market is the focus of this paper, it is important to indicate that Qantas has approximately 850 flights weekly to 38 countries (Qantas 2008). Like Tribe (2011) notes, the general motive for most companies which establish multinational operations is to maximise their profit-making potential. Profit maximisation is however dependent on a firm’s ability to derive more revenues from the international operations so as to cover and exceeds the costs of operations (Tribe 2011). Notably, Qantas decision to fly to the 38 countries is not only based on commercial interests alone, but is also based on prevailing industry and regulatory frameworks. It is worth noting that by 2008, Australia had 65 bilateral air service agreements with other countries, and that such agreements: prescribe routes that Qantas (and other Australian airlines) can operate in; attach air traffic rights to specific routes; indicate the capacity of airlines (i.e. frequency and types of aircrafts); code sharing rights; and designation (i.e. usually a nationality criteria which relates to ownership and control of airlines (Qantas 2008). The foregoing notwithstanding, Qantas , just like other leisure producing and marketing firms does not have strong ties with any of the national economies or regions it operates in (Tribe 2011). Effectively, the foregoing means that Qantas would be willing to stop, re-launch or shift its operation to different destinations based on the favourability of the locations, and of course if the regulatory framework allows. A background check of Qantas airline reveals that the airline has strong backing from the Australian government, especially since it is the flag carrier. Additionally, the airline has a string route network which consists of 38 countries (Stanley 2014). As part of the oneworld Alliance, the airline is part of a global network that enables travellers to try to an estimated 1,000 destinations in more than 150 countries (Qantas 2014). By being part of the oneworld alliance, Qantas encourages its customers to travel with its oneworld partners to destinations that it does not fly to. The oneworld alliance consists of American airlines, Aer Lingus, Cathay Pacific, LanChile, Iberia, Finnair, and British Airways (Bartsch 2013). Among other of Qantas strong areas include its brand name and logo, which are globally recognisable, its excellent safety record, and its operational excellence especially having won commendations for its engineering excellence (Bartsch 2013). Like other firms however, a background check on Qantas reveal some weaknesses, which include: High operating and labour costs especially because of a high unionised workforce; the airline concentrates too much around Australasia; and the airline’s inability to change with the times and adopt an effective international strategy (Stanley 2014). The foregoing notwithstanding, there are opportunities that Qantas can utilise to advance its competitive position in the global airline industry. Such opportunities include: international destinations that Qantas has not fully utilised especially in Asia; the airline can enter into strategic alliances in order to enhance service offers to customers; the airline can enter into code-sharing deals, which would enable it to fly to destinations it has not yet fully exploited, increase its brand reach, and increase its passenger volumes; and Qantas can form alliances with other major airlines (Crisp 2012). The foregoing would be good especially for purposes of countering the Virgin-Etihad alliance that has eaten into Qantas market share (Crisp 2012). A background check into Qantas international business would be incomplete without identifying the threats that the firm needs to manage. Competitive pressures especially from airlines that have more money resources to invest in new aircrafts, better airfare deals, and cheaper but quality workforce are one such threat (Crisp 2012). In the international routes, Qantas main competitors include tiger airlines on the Singapore-Melbourne route (Murphy 2008), Virgin Blue (under the V-Australia brand) on different trans-pacific routes (Carswell 2008), and Air Asia X on several Asian routes (Rochfort 2008). It has also been noted that since Japan is Australia’s third largest source for inbound travellers, the route is likely to attract competitors (e.g. emirates Airlines). To remain competitive on such routes, Rochfort (2008) argues that Qantas needs to develop business strategies that would enhance the airline’s capacity to attract and retain customers who would regard it as the preferred airline of choice. Additionally, Qantas inability to keep pace with changing times (e.g. by forging partnerships that can enhance its competitive position) may work against it in the long-term (Harcourt 2014). The airlines’ volatile industrial relations with its unionised workforce may work to its disadvantage especially since disagreements lead to a lack of motivation in the workforce and at times, the airline can even ground its operations. Finally, it is worth noting that demand for airline travel is very much aligned to economic factors such as states of the world economy, where bad economic times would lead to less demand and hence lower profits for the airline. The volatile jet fuel prices also make operational costs for Qantas (and other airlines) unpredictable. To operate in the international markets (and in foreign markets), Qantas has adopted a two-prong approach. It operates alone (from its basis in Australia) in international markets, and it has also gotten into international collaborative venture with Emirates airlines. The former is in line with exporting as a foreign market entry strategy where a firm offers its products or services in markets abroad, but still has its basis in a home country (Cavusgil et al. 2011). Qantas alliance with Emirates on the other hand fits into the international collaborative venture, which is a foreign market entry strategy where different partners share the costs and risks involved in an operation by pooling their resources together. Main issues facing Qantas in a competitive environment Like other multinational enterprises, Qantas airlines play a significant role in globalisation since it operations (just like other airlines operating in the international market) involve transporting people across international borders, and by so doing spreading and enhancing the adaptation of cultures. By the very nature of its operations, Qantas airlines is influenced by the international environment (e.g. by competitive forces in the international market), but it also influences the international market through its business approaches. It has been observed numerously that Qantas advent into the international markets started out strongly (Airliners 2013; Philips 2014). Over the years however, its performance in the same markets have dwindled culminating (but could worsen) in losses in the 2012-2013 financial year (Greenwood 2014). But what exactly are the key issues facing Qantas? 1. The Qantas act Qantas Sales Act was enacted in 1992 when government gave up ownership of the airline giving was to privatisation (Flynn 2014). The Act however put limits of ownership at 25% for single foreign investors, 35% for foreign airlines, and 49% for total foreign ownership. In other words, the shares owned by single foreign investors and foreign airlines should not exceed 49%. The Act has been criticised for handing Qantas the worst of both worlds, in that it limits the financial opportunities (in terms of investors) for the airline, and adds costs to the airline business since although a private listed company, Harcourt (2014) observes that the government still expects the airline to run like a private company. 2. Global aviation industry The structure of the global aviation industry is also another issue that Qantas has to contend with (Harcourt 2014). It is indicated that while (most of) Qantas’ global competitors have government ownership ties thus providing them access to capital; Qantas does not have the same privileges. Even in the domestic front, Virgin through its foreign ownership can access capital at cheaper rates compared to Qantas, which essentially means that the playing field is not levelled for all players. 3. Loyalty in the workforce Another issue that Qantas has to grapple with is an exceedingly loyal workforce (Harcourt 2014). Ideally, loyal workers should not be an issue for an airline; nevertheless such loyalty becomes an issue when a firm has to downsize its workforce for purposes of trying to work within its profit targets. In December 2013 for example, the airline announced plans to cut 1,000 jobs following half-year losses of $300 million (The Australian 2013). Whenever it has to downsize it workforce like it has had to do for reasons indicated in figure 2 below, the airline has to find a strategy that does not demoralise the remaining workforce and one that will not be contested by the labour union, in which most of Qantas’ workers are members in. Figure 2: job cuts and the most affected regions Source: News Limited (2014) 4. Debt The debt issue cited by Harcourt (2014) is yet another milestone that Qantas needs to overcome. With a huge debt on its balance sheets, it is hard for Qantas (especially as a national carrier) to fly to routes its Australian loyal customers would love for it to go to by operating an extensive domestic and international network. It is even harder for it to compete with other players on low priced airfares since after all, it has a debt to service, and that matters if the airline will be sustainable in the long-run. 5. Qantas contribution to the Australian economy Another issue of relevance to Qantas is related to its contribution to the Australian economy. As Harcourt (2014) notes, the airlines has about 30,000 workers, spends approximately $6 billion purchasing Australian products and services for in-flight and office administrative purposes, and pays an approximate $1.4 billion both in direct and indirect taxes to the Australian government. In economic lingo therefore, Qantas provide positive externalities to the Australian economy by making travel, connections, and travel easier both out of and into Australia. 6. Competitive pressure Perhaps the most significant issue for Qantas is competition. According to Dennis (2012, too many carriers in the international market have resulted in an oversupply of seats in airlines, consequently driving airfare down. Since Qantas is a full-service, high cost airline, the low airfares makes it hard to earn sufficient revenues to pay its bills and remain profitable (Dennis 2012). Its economic fortunes are further complicated by the high taxes that the company has to pay to the government. 7. Fuel hedging Qantas has also been faulted in how it hedges its fuel funds, which according to Harcourt (2014), has led to a lot of losses. But why would Qantas (or any other airline), hedge fuel funds. According to Cobbs and Wolf (2004), hedging generally locks the cost of fuels purchases in future. Such locking is desirable to airlines since it protects them against losses should fuel prices rise suddenly. However, locking also ensures airlines do not gain from any decline in fuel prices. In other words, hedging is a risky undertaking by airlines since no airline can determine with certainty whether oil prices will rise or fall going into the future. In most airlines, fuel costs represent 15% of the operating costs (Jones & Kaul 1996; Morrell &Swan 2006). However, oil prices are the most volatile of all costs that airlines have to contend with. The truth about hedging is perhaps best captured by British Airways’ CEO Rod Eddington (cited by Cobbs & Wolf 2004) who said that any sensible airline knows that hedging does not save on fuel bills; rather hedging is only a way of reducing the uncertainties in fuel prices. From the figure 3 below, years 2006, 2012, 2010, 2011, and 2013 appear to have been hedging years for Qantas since the airline ended up losing millions of Australian dollars from the practice. Figure 3: Qantas’ fuel hedge history. Source: Matt (2013) Eddington (cited by Cobbs & Wolf 2004) further said that when airlines hedge, all they do is bet against oil market experts, and pay middle men. In the long-term therefore, airlines cannot save money by hedging because the odds that oil market experts would win are high, and this means that airlines who hedge can run from high jet fuel prices briefly, but cannot sustain their efforts to evade the high prices for long. If anything they end up losing even more because they pay the brokers as well. Theory application: New trade theory The new trade theory proposes that economies of scale are critical if some industries are to perform well internationally. The theory further contends that even where superior comparative advantages are absent, producing and selling volumes enables some companies to remain profitable and succeed in their performance (Button & Vega 2006; Button & Vega 2008). Further propositions of the theory indicate that competitive markets facilitate the movement or goods and/or services by overcoming distortions that may arise when countries protect their home industries (Button 2010). While the arguments in trade theory may not always be sound, its application in Qantas (or any other airline) would mean that the airline needs to attract and retain large numbers of customers on its international routes. The theory argues that as firms specialise in the production or provision of specific services, the economies of scale are realised and the unit costs for the production and/or provision of goods and services decrease. The realisation of economies of scale means that demand of specific product/services offered can only support a few firms in each industry. Additionally, firms that had established their presence in the market have first-mover advantages, and do not have to experience barriers to entry, which late market entrants would be exposed to. Yet, and as indicated by Greenwood (2014), Qantas is not successful in attracting and retaining consumers in its international routes mainly because its airfare prices are not as competitive as those of its competitors and it does not service as many routes as some of its competitors. An example of reduced flight routes is offered by eGlobal (2014), who indicates that Qantas no longer flies to Singapore or Hong Kong from Perth. The only way to fly to Hong Kong by Qantas is through Sydney. The alliance with Emirates airlines has also been cited as working in favour of the latter while disadvantaging Qantas (eGlobal 2014). The foregoing means that gaining volumes is still a milestone that Qantas need to achieve. True to the new trade theory, firms which succeed in attaining economies of scales and minimising their costs of production are more likely to exhibit global strategic rivalry through the same economies of scale, experience and scope (Fujimoto & Shiowaza 2011). In the airline industry, the foregoing is evident because some airlines are more dominant in specific routes, and as a result, their competitors cannot operate profitably on such routes. When such a thing happens, declining profits are evident, and sometimes, an airline may be forced to abandon some routes and concentrate more on others or form an alliance with the dominant airline on that route as evident in the Qantas-Emirates alliance. Analysis The arguments in trade theory assume that efficient markets are a consequence of competition and optimal provision of goods and services (Button 2010). Market instabilities especially those that arise because of the presence of fixed costs (e.g. fuel costs, human resource-related costs, and airport-related costs) and unguaranteed supply of passengers, are bound to occur. Arguably, Qantas is suffering from such market instabilities because its cost entails sunk costs which include the cost of maintaining and fuelling planes, the costs of landing slots, and the cost of the handling staff and crew members. When Qantas’ competitors price down their airfare in order to recover their short-run marginal costs, Qantas arguably cannot do the same because of its status as a full-onboard carrier, its debt, and other financial obligations, which prevent it from competing on low airfares. Simply put, Qantas is unable to recover its full costs of operations on international routes, hence explaining recent losses on the same routes. As seen in the figure 4 below, Qantas’ international business has strategic priorities that seek to improve its fleet economic, strengthen alliances, optimise networks and offer world-class services. Arguably, the content of the airlines strategic priorities does not offer much differentiation from what its competitors are offering, and it is possible that they (priorities) would succeed in generating volume travellers for Qantas. Figure 4: Qantas strategic priorities Source: Qantas (2013, p. 6). Button (2010) contends that airlines that are risk averse, and those that act rationally are more likely to be unstable financial mainly because they are more likely to have sub-optimally low passenger numbers. The foregoing is true in Qantas because, the airline not only pulled out of some routes when competition increased, but also entered into an alliance with Emirates on specific routes. In both instances, Qantas was risk averse, and was acting rationally. The consequences of both actions however show that the airline has lower passenger numbers, and that its brand recognition is suffering due to its alliance with Emirate airways. Porter (1985) offers solutions to the problems similar to what Qantas is experiencing by stating that cost reductions can work, in which case Qantas would need to become a low cost airline. Alternatively, Qantas would need to engage in product differentiation (e.g. through network differentiation, loyalty programs, complementary airport facilities, and on-plane facilities. The problem with product differentiation is that it is not enduring (Button 2010). Sooner or later, competitors will catch up with whatever differentiation strategies an airline adopts. The relevance of the new trade theory in Qantas context aside, there are also other concepts worth analysis in this paper. For example, Cavusgil et al. (2011) indicate that the foreign entry strategy that a firm chooses ought to be based on several factors which include the goals and objectives of the organisations (e.g. in Qantas case, the firm seeks a competitive positioning based on market share and profitability (Greenwood 2014)); degree of control (e.g. would Qantas still be able to make decisions in relation to its alliance with Emirates?); the firm’s technological, organisational, and financial resources and capabilities (e.g. does Qantas have the financial, technological and organisational capabilities needed to operate independently and profitably in specific routes); and the inherent risks posed in each market and the ability of a firm to manage such risks effectively (e.g. does Qantas have the risk management capacity to handle the political, financial and operation risks present in a specific airline route?). Additionally, and as indicated by Cavusgil et al. (2011), a firm considering forming an alliance needs to consider prevailing social, cultural, legal, economic and cultural factors i the target market; the extent and nature of existing competition; and the presence and capacities of partners who would be willing to form an alliance with them. Strategically however, a firm needs to consider the long-term importance that a specific market has. For example, if Qantas did not consider the specific Asian routes as being of any strategic relevance to the firm in the long-term, it would be willing to enter into an alliance with Emirates on the same route. The contrary would most likely be true if the route(s) were considered to be of strategic importance to the firm in the long-run. Cavusgil et al. (2011) also indicate that a firm that aspire to gain competitiveness globally need to strive for three strategic objectives namely: efficiency, flexibility and learning. From the Qantas narrative above, it would appear that the company has efficiency as an objective, but has not quite achieved the same. For example, hedging fuel prices seems like an activity meant to attain efficiency in a manner that would lower the fuel costs of the airline. However, and as indicated by Thomas & Trotman (2012), Qantas CEO Alan Joyce blamed the hedge funds for the firm’s share collapse, meaning that the hedge funds did not have the results they were expected to have. The foregoing is tantamount to strategy failure. Flexibility on the other hand demands that a global firm manages country specific opportunities and risks by utilising resources that are available in the diverse country where the firm operates in. Moffett, Stonehill and Eiteman (2005) indicate that risk and opportunity management requires firms to first identify all the existing risks and opportunities. Risks for Qantas for example include: the political risks (i.e. firm-specific risks e.g. governance risks, foreign exchange risks, and business risks); global specific risks (i.e. risks emanating from the global level but which affect an international firm at the corporate or project level (e.g. global recession and terrorism ); and country-specific risks e.g. transfer risks that block funds from being transferred and cultural and institutional risks which sprout from the ownership structure of the firm). Qantas was prone to the cultural and institutional risks specifically because foreign ownership was limited to 49% while its competitors’ ownership was liberal meaning they could easily access cheap funds more easily compared to Qantas. Learning as indicated by Cavusgil et al. (2011) on the other hand require the firm to develop products, skills, capabilities and technologies by internalising knowledge that is acquired during international ventures. Not much learning is evident in Qantas from the reviewed sources; however, and as indicated by Cavusgil et al. (2011), successful firms do not have to excel in all three areas (i.e. in learning, flexibility and efficiency). Rather, excelling in one or even two of the objectives can make a firm competitive in the global environment. Conclusion Analysts and critics alike have reasons to believe that Qantas will not survive in the international business environment if changes to its current strategy are not executed soon. The competitive pressure from well-funded and more strategic airlines seems to be forcing Qantas out of the market and its strategies as seen in fuel hedging and forming an alliance with Emirates airlines, do not seem to be working to advantage either. The new trade theory applied above contends that in the absence of competitive advantages, Qantas need to increase its passenger volumes in order to remain competitive. Yet, volumes in passengers is something that Qantas cannot quite achieve considered its reduced routes of travel, and its high air fare prices, which drives away the price-sensitive consumers. Horizontal integration in Qantas has led to forming an alliance with Emirates, but this too has been faulted because it ostensibly prevents Qantas from building on its brand image. From the analysis section however, it has emerged that Qantas can only succeed in building its competitiveness by pursuing efficiency, flexibility and/or learning. Efficiency in fuel usage would for example prevent the airline from procuring losses, while flexibility would require it to take advantage of opportunities while effectively managing its risks. Learning on the other hand would require the organisation to internalise knowledge gathered during its international exposure and use the same to create products, skills, capabilities and technologies that will enhance it performance hence improving its competitiveness. Whichever strategy Qantas adopts needs to be well thought out especially considering that its relevance and profitability will depend on it. References Airliners 2013, ‘Print from airliners.net discussion forum’, viewed 14 May 2014, . Bachman, J 2014, ‘After 94 years as Australia’s airline, will Qantas get a foreign owner?’ Blommberg Business Week, viewed 14 May 2013, . Bartsch, R.I 2013, International aviation law: a practical guide, Ashgate Publishing, Farnham, Surrey, UK. Button, K & Vega, H 2006, ‘Airline competing with themselves: a note on the temporal pattern of fare setting prior to departure’, International Journal of Transport Economics, vol. 31, pp. 341-350. 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