CEO Asia Update Luncheon

Introduction

Asia is the big Twenty-First Century growth story for Australia. Our current prosperity is very much a result of the economic growth across the region, particularly in China and India and our future depends upon how well we manage the opportunities and challenges that lie ahead.

Qantas, of course, is no newcomer to Asian markets. We have been providing services to link Australia and our near neighbours for more than seventy years. In many ways we have been an important standard bearer and facilitator of Australia’s trade, economic and cultural engagement with the region.

But the current dynamic growth of Asian markets presents a new set of challenges – and, like all Australian companies, Qantas is going to have to be smart, patient and flexible if we are to succeed, for ourselves, our shareholders and all the Australians who rely upon us to fly the flag.

Our strategic goal remains the same as always – to be the leading provider of air services linking Australia and Asia. So today I would like to set out a bit of the history of our role in Asia, the magnitude of the changes we now confront, and how we see the future.

Where we have come from?

Let me start with where we have come from. Right from the early days of international air travel Qantas took the lead in connecting Australia with Asia. We ran passenger services to Singapore in 1935, and today that city/state is our most important hub. In the years immediately after World War II we established services to India, Hong Kong, Japan, Indonesia, the Philippines and Thailand.

Over the second half of the Twentieth Century the returns from the many different Asian markets varied enormously. Japan grew strongly to become one of our most important routes. But other routes were more problematic.

That said, we were always prepared to risk some poor returns in order to fulfil our role as Australia’s leading air carrier, bringing in tourists, providing direct business links, and supporting political and cultural ties.

Take China for example. We had operated a service from 1984 through to 1987. We came back again in 1995 – initially to Beijing and later to Shanghai – but by 2000 we had accumulated losses of more than $30 million. China’s vast population and strong economic growth had pointed to significant demand. However, this was difficult to tap and restrictions on Chinese outbound travel were being lifted more slowly than we – and indeed many other airlines – had anticipated. We were again forced to withdraw in favour of a code share arrangement.

But throughout the past 60 years, Qantas has remained a positive force in Asian aviation. We were involved in the establishment and development of airlines such as MSA, from which Malaysia Airlines and Singapore Airlines emerged. We played a leading role in the growth of Changi and Bangkok as regional hubs. We trained aircraft engineering apprentices for Bangladesh and civil aviation pilots for China. And more recently we worked closely with the Chinese authorities during the development of a new routing through Chinese airspace for services from Singapore and Bangkok to Europe, saving 53 precious minutes of flying time.

As the Twentieth Century drew to a close, China and other Asian nations were moving into high growth and the aviation markets were looking very promising. From the Qantas perspective it looked like our commitment to Asia was going to produce, at last, some big returns. Then the region, and the world, were rocked by the Asian financial crisis in 1997, followed by the SARS health scare, terrorist bomb attacks and most recently the tsunami. Each crisis caused its own form of human misery, and Qantas provided immediate and longer-term assistance, as we always do. But there were also widespread impacts on markets. The SARS crisis alone caused us to reduce the number of international flights by 20 percent.

In each case we had to make rapid adjustments when the expected returns on long-term investment failed to eventuate. Aviation is never an easy business but that period was extremely difficult.

Present Situation

Which brings us to today. We find ourselves in a period of Asian growth that is unprecedented in its scope and, we hope, duration. And our aim is to take full advantage of the opportunities.

Passenger traffic in the region is growing at about eight percent per year, compared to global growth of about five percent. Meanwhile China’s travel market is simply taking off – it is forecast to grow at 14% a year for the next four years, and the Olympic Games will add a further boost in 2008. By 2014, China should be the biggest aviation market in the world outside the United States, an incredible growth made possible, as we all know, by the combination of an extremely large population, rapid GDP growth and a liberalising economy.

We are very confident about the Australia-China air passenger market. We have been back in China since 2004 and are now serving Shanghai four times weekly and Beijing three times weekly. We expect to have daily services to both cities by 2008 and services to other cities through Jetstar.

The most recent estimates by the Tourism Forecasting Council suggest that we can expect to receive 1.2 million Chinese visitors in Australia by 2014. Putting that into perspective, by that time: 100 million Chinese are expected to be travelling abroad every year.

While India is also very important – we recommenced three services per week to Mumbai in 2004 – it continues to prove a difficult market in which to sustain operations. We face strong competition from carriers operating from mid-point hubs that can serve multiple gateways in India and are able to offer connections with their Australian services. Our performance has been improving in recent months and we are working to combat the network reach of hub carriers by working closely with our domestic airline partners in India to carry traffic from points other than Mumbai.

Qantas currently flies to 12 cities in eight Asian countries and roughly half our international services have Asian destinations or stop at Asian hubs.

We strongly believe that as Asian societies become more and more prosperous, there is going to be greater demand for value tourist trips and more traffic coming out of smaller cities. On some routes there has already been a switch from having a majority of Australians going out and coming back to having most seats filled with visitors to Australia.

It is important for inbound tourism, and for the Qantas Group, that Australia has a good spread of source markets and remains competitive as a friendly, exciting and interesting country to visit. Worldwide competition for the tourist dollar is aggressive and becoming more so, and nothing can be taken for granted as country after country increases its marketing spend.

Our experience in the Japan market is a case in point. It may surprise many of you to learn that commercial returns on the Japan route are poor, and Qantas is now sustaining significant losses. The inbound visitor market, which currently accounts for approximately 88 per cent of traffic, has been stagnant for the past five years in overall terms – albeit with significant fluctuations in between. In 2005, the number of visitor arrivals was four per cent below that for 2004.

These trends reflect the maturity of the market, destinational competition for Japanese tourists and, most significantly, a 45 per cent appreciation in the Australian dollar against the Japanese yen since 2001.

This is a national issue and requires a national response. We are working closely with government and industry as part of Australian tourism minister Fran Bailey’s action plan for Japanese tourism. However, Australia’s decline as a preferred destination for the Japanese highlights how fierce the competition has become.

Strategic Challenges

So growth opportunities in Asia require more than simply an expansion in destinations and frequencies. They offer strategic challenges and opportunities as well, partly because of their own internal dynamic and partly because they are reflecting broader changes in the global aviation market and consumer behaviours.

As you may well know, Qantas has segmented its business to provide a number of differentiated product and service offerings. As well as enabling us to meet different customer needs, this approach provides us with greater flexibility, transparency and opportunity for strategic growth.

Going forward, we will be moving to a two-brand structure for our flying operations, with Qantas focusing primarily on routes with premium demand, and Jetstar targeting leisure-based markets, in both the domestic and international arenas.

Jetstar is very exciting. The value tourist market is a huge opportunity, not just for the Qantas Group, but for the Australian tourism industry. An Australian who wants to fly Jetstar from Melbourne to Brisbane may well be interested in flying Jetstar to go on to an Asian holiday. Equally, Asian tourists visiting Australia on Jetstar may well explore more of our big country on domestic Jetstar flights or Qantas flights, on which Jetstar code shares.

There are well over 200 cities in Asia that have more than half a million people, and 130 of them exceed a million. China alone has 43 cities with more than a million people and India has 37. The only solution to servicing such dispersed demand is more point-to-point flying – which is our goal with our new super efficient Boeing 787 aircraft, the first 12 of which will go to Jetstar. The economics of Jetstar also allow us to fly to cities that have proved difficult in the past for Qantas. Jetstar is poised to expand internationally from late this year and its initial Asian destinations will include Bangkok, Phuket, Ho Chi Minh City, Bali and Osaka.

Of course, the future in Asia is not only about Australia-Asia links: great opportunities are emerging in intra-Asian travel. So Qantas has also invested in Jetstar Asia, based in Singapore, as a way of servicing demand between cities within Asia. This is a very tough market, but co-operation with Jetstar flights out of Australia should help in achieving the necessary scale. Other options, including joint ventures, are also being considered as we look to expand our position across the spectrum of Asian demand.

In addition to passenger markets, the freight market is also expanding. We have been growing the transport of time-critical freight – particularly primary products such as food and flowers – from Australia to various Asian ports. And now we are exploring new opportunities on Asia-US and Asia-Europe routes with eight dedicated freighter flights per week from Australia to the US and Europe via China.

Of course, central to all the growth forecasts for aviation in Asia is china. The figures are simply mind-boggling. The Chinese aircraft fleet will grow from less than 900 today to nearly 1,600 in 2010, and 4000 by 2025. That means in less than 20 years China will have more than four times the current number of aircraft. Obviously this means a huge requirement for pilots, aircraft engineers, and other staff, with one estimate that China will need more than 35,000 new pilots over the next 20 years.

Infrastructure development is going to be enormous. Over the next five years, the Chinese government will invest US$17.5 billion in expanding 55 existing airports and building 42 new ones. Comparison is difficult, but think about reproducing the entire Australian aviation infrastructure every four years within the next two decades and you are getting close.

India and other Asian nations are also expanding their aviation fleets and infrastructure, making the growth potential of the entire region quite incredible. And there is a great rush by old and new players to get a share of the action.

While some of the region’s carriers are struggling, others are growing fast and doing well and include some of the best performers in the global market. The US$1.5 billion profit by the Asian region’s carriers in 2005 compared with US$1.3 billion in Europe and losses of US$10 billion in the US.

Competition is, and will continue to be, very fierce. While Asia is filled with opportunities, and Qantas will continue to engage with the region, we approach it from an end-of-line location. In addition to being advantaged by generally lower labour costs, our key competitors are based at major hubs within the region’s high-growth markets.

Hubs such as Singapore, Hong Kong and Bangkok are engaged in their own competitive struggle. Hong Kong’s position stands to be enhanced following Cathay Pacific’s recent announcement that it will take over Hong Kong based dragon air and double its stake in Air China from 10 to 20 per cent, boosting Cathay’s access to mainland China.

Hub advantages are relevant not only in terms of competing within Asia but also in competing with Asian carriers in key markets that lie beyond, such as the UK and Europe. Unless approached carefully, they can lead to unbalanced outcomes for an end-of-line player like Qantas when market access arrangements are being liberalised under the bilateral system. No doubt this was an important factor weighed in the Australian government’s highly publicised decision to deny Singapore Airlines access to the Pacific route earlier this year. A sensitive decision, to be sure, but not as simple as it seems.

Significantly, the playing field is tilted in other ways. Many full service airlines in the region are government owned or supported and enjoy advantages over privately run airlines like Qantas. In some cases, aggressive “national agenda” growth ambitions, or the lack of a genuine bottom line focus by government-backed carriers, have contributed to over-capacity problems within the region.

And all too rarely do we find within the region anything resembling the ACCC, or the competition policy that we know in Australia. As a result, Qantas is sometimes confronted with a variety of competitive practices and market arrangements that would simply not past muster at home, or in other jurisdictions, such as Europe and North America.

So to plot a strategic path through this complex field of high growth, great opportunity and extreme competition is no easy matter.

With our two-brand strategy, our engagement with intra-Asian travel and our commitment to the freight market, we are confident of success. But the ultimate key to our success lies in the maintenance of a strong base in Australia. We must remain profitable in our established markets or we will lack the financial strength to survive the ups and downs that come with the rapid growth and new challenges in Asia. Australia must remain an attractive destination for travellers in a variety of categories.

We cannot succeed in Asia unless we succeed in Australia; it is as simple as that.