SENATE RURAL AND REGIONAL AFFAIRS AND TRANSPORT REFERENCES COMMITTEE

INQUIRY INTO THE OPERATION, REGULATION AND FUNDING OF AIR ROUTE SERVICE DELIVERY TO RURAL, REGIONAL AND REMOTE COMMUNITIES

SUBMISSION BY

FEBRUARY 2018 Introduction

The Virgin Australia Group of (Virgin Australia) welcomes the opportunity to lodge a submission to the Senate Rural and Regional Affairs and Transport References Committee’s Inquiry into the operation, regulation and funding of air route service delivery to rural, regional and remote communities.

As an integrated group, Virgin Australia offers services in all major segments of the Australian aviation market. This includes regular public transport (RPT) flights offered by Virgin Australia Airlines (VAA) as a premium service carrier operating on 71 domestic and 30 international routes, and low-cost carrier Australia’s (Tigerair) services on 23 domestic routes catering to the budget/leisure segment of the market. Virgin Australia Regional Airlines (VARA) principally serves the charter flight requirements of a number of our corporate clients, in addition to operating RPT flights on routes to the Indian Ocean Territories under a contractual arrangement with the Commonwealth Department of Infrastructure and Regional Development. Virgin Australia Cargo offers air freight transport, utilising the cargo hold space on VAA’s RPT flights and through the operation of a network of dedicated freighter aircraft.

In addition to our own operations, Virgin Australia offers travellers access to flights operated by our international partners to over 450 destinations across the world. Our key alliance partners Air New Zealand, Delta Air Lines, Etihad Airways, HNA Aviation Group and also offer code share services on VAA’s domestic flights, including on regional routes. This provides an important additional source of passenger feed on to these routes, enhancing their commercial performance.

Virgin Australia’s contribution to the Australian economy is significant. Our operations as an Australian business with more than 10,000 employees involve the transport of overseas and domestic travellers to tourism destinations across the country, including to regional locations, and also facilitate domestic and international trade through the movement of goods. Deloitte Access Economics estimates that Virgin Australia’s total economic contribution through these activities was $3.4 billion in FY16, which directly and indirectly supports more than 75,000 Australian full-time equivalent jobs, representing 0.75% of total employment in Australia.1

Virgin Australia’s presence in the regional aviation market

Our regional RPT services comprise a large component of our domestic network, with flights operated to 33 regional (non-capital city) ports2 across Australia. Of the 75 domestic RPT routes served by Virgin Australia, 53 include at least one regional (non-capital city) destination.3

In regional markets, VAA’s services are operated with Boeing 737-700/800, Airbus 320, Fokker 70/100 jets and ATR72-600 turboprop aircraft, while Tigerair operates both Airbus 320 and Boeing 737-800 aircraft.

1 Deloitte Access Economics, The economic contribution of the Virgin Australia Group to Australia, January 2017, commissioned by Virgin Australia. 2 Albury, Alice Springs, Ayers Rock, Ballina, Broome, Cairns, Christmas Island, Cloncurry, Cocos (Keeling) Islands, Coffs Harbour, Emerald, Geraldton, Gold Coast, Hamilton Island, Hervey Bay, Mt Isa, Kalgoorlie, Karratha, Kununurra, Launceston, Mackay, Mildura, Newcastle, Onslow, Paraburdoo, Port Hedland, Port Macquarie, Proserpine, Rockhampton, Sunshine Coast, Tamworth, Townsville and Newman. 3 Includes the Onslow-Perth route, which is principally served by VARA for charter operations but also has a limited number of seats available for sale by VAA to the public on a RPT basis.

1

Virgin Australia has made large investments to expand our presence in regional Australia over the past seven years. This includes the deployment of ATR72 aircraft on regional routes, the acquisition of regional operator Skywest Airlines, the commencement of services in a number of regional markets and the establishment of Lounges at four regional airports (Alice Springs, Cairns, Gold Coast and Mackay). Our growth in these markets has boosted competition, supporting regional tourism and economic development, as well as providing increased options for local residents to access air services.

Virgin Australia has been unable to sustain services in some regional markets due to poor commercial performance over an extended period. This includes the withdrawal of services from four intrastate routes in Queensland between August and September 2017. To provide passengers with access to the affected regional destinations, we entered into a commercial arrangement with , which elected to operate these routes in its own right after our withdrawal, with the use of the VA designator code to support the distribution of its airfares. Alliance Airlines bears all the commercial risk associated with these services.

Regional route economics

From an economic perspective, the operation of services on regional routes is more challenging than on routes between capital cities, principally due to difficulties in achieving economies of scale in regional markets. As with all routes we serve, the sustainability of our regional services relies heavily on our ability to match the capacity we deploy with the demand for our flights, as well as the effective management of costs.

In general terms, it is not commercially viable for an airline to indefinitely maintain a service on a route for which revenues earned are insufficient to offset the corresponding costs. While airfares are influenced by a complex range of interrelated factors, airlines operating on a rational commercial basis will price their services in order to cover their costs and, if possible, earn a reasonable return on invested capital.

If costs are outweighed by revenue on a particular route for an extended period, an airline will inevitably look to withdraw its services and redeploy aircraft to higher-yielding routes. For the impacted route, the result will be fewer air services, and depending on the prevailing circumstances, potentially reduced competition, higher airfares and the loss of RPT services altogether. In this regard, we would highlight that many of the regional markets we serve do not deliver acceptable commercial returns to Virgin Australia at current pricing levels. Virgin Australia and all other airlines manage the sale and pricing of their seats in the same manner as perishable inventory sold in other industries, such as hotel rooms, hire cars, seats at special events and advertising space.

Regulatory restrictions which are preventing the expansion of services on regional routes with latent unmet demand, such as those in effect at , also warrant consideration. Additional services on regional routes will increase competition, placing downward pressure on airfares.

For Virgin Australia, the operation of a sustainable network of air services provides us with the greatest opportunity to facilitate the economic development and social cohesion that aviation brings – in metropolitan and regional communities alike – as well as deliver returns to our shareholders as a private commercial enterprise. Government policy and initiatives which have a positive impact on the competitiveness and sustainability of air services will support the long-term viability of the sector and position the industry to play a more effective role as a critical enabler of Australia’s growth, economic transformation and engagement with our geographic region.

2

(a) Social and economic impacts of air route supply and airfare pricing

Virgin Australia appreciates that safe, reliable, regular and affordable air services are vital to regional communities, providing local residents with access to essential medical, financial, educational and other services, while also supporting regional economic development and social connectedness. In many regional centres, the existence of air services plays a key role in reducing isolation from capital cities and metropolitan areas and enhancing the quality of life in such communities. Air services connect regional centres not only to the rest of Australia, but to the rest of the world. This is important for passenger transport and the carriage of freight, whether it be medical supplies or time-sensitive exports.

The supply of air services to regional areas, and the economic and social benefits they deliver, is ultimately dependent on the commercial viability of such flights. In broad terms, the commercial viability of air services on any route will depend on the existence of sufficient demand, an airline’s ability to recoup its costs and competitor dynamics. These are the key factors which underpin airfare pricing. From a cost perspective, one of the most challenging issues we face as an airline is the disproportionately high charges imposed by a number of regional airports, as outlined in further detail under section (d).

Virgin Australia is aware that some regional communities hold a perception that airlines are seeking to earn unreasonable returns in setting airfares on regional routes and/or that airfares on such routes are cross-subsidising pricing on trunk routes. As many of the regional routes we serve do not deliver acceptable commercial returns at current levels of pricing, this perception is inaccurate. If Virgin Australia, as a private commercial enterprise, cannot operate services in such markets on a profitable basis over an extended period of time, this is likely to see the supply of flights reduced, with corresponding implications for the relevant regional communities. This highlights that the continued supply of air services is inextricably linked with airfare pricing, and airfare pricing should not be examined in isolation.

It is important to note that domestic airfares have been trending downwards for more than 20 years, as reflected in the Commonwealth Bureau of Infrastructure, Transport and Regional Economics’ Domestic Air Fare Indexes.4 These indexes are constructed based on the monthly collection of airfares for the top 70 routes in the Australian domestic network, which includes regional markets. They reveal that in real terms, the best discounted fares on these routes in January 2018 are around half the price of those available in January 1998.

Airlines, in common with other businesses selling perishable inventory, will manage the pricing and sale of seats on a flight in accordance with the economic principles of supply and demand. We offer a range of airfares on each of our flights and all regional markets are included in our regular network-wide sale campaigns. We encourage travellers to make bookings at the earliest opportunity, which provides the greatest scope to access the cheaper seats available on a particular flight.

(b) different legal, regulatory, policy and pricing frameworks and practices across the Commonwealth, states and territories

In Virgin Australia’s view, there is a critical role to be played by all levels of government in supporting regional air services.

The Commonwealth’s overarching policy objective for Australian aviation is to assist the industry to grow in an environment that is safe, reliable, efficient and competitive.5 The

4 Available at https://bitre.gov.au/statistics/aviation/air_fares.aspx#anc_table_sum. 5 The Coalition’s Policy for Aviation, August 2013.

3

Commonwealth has policy and regulatory oversight of the 21 leased federal airports and administers the aviation security framework at airports across the country. While the Commonwealth does not have responsibility for economic regulation of any regional air services (this was transferred to the states and territories by the end of 1979), it has established a number of schemes which directly support the commercial viability of some regional RPT air routes and regional airports.

The Commonwealth regulatory framework governing the operation of aircraft movements (slots) at Sydney Airport encompasses special arrangements for RPT services between Sydney Airport and NSW regional communities. While the arrangements were introduced to safeguard the operation of regional services, in reality they are inhibiting the growth of such services in the State.

Under the Sydney Airport Slot Management Scheme 2013, slots assigned to regional services may be converted to slots assigned to non-regional services, but conversions in the reverse direction are not permitted. In 2017, during Sydney Airport’s morning peak period (7.00am-9.00am) and afternoon peak period (5.00pm-7.00pm) there were 42 fewer slot pairs available for regional services compared with 2001 (a decline of 10%). This has created a situation where the availability of slots at Sydney Airport for NSW regional services in the morning and afternoon peak periods is extremely limited. Timings in these periods are necessary for the operation of viable services by airlines, as they enable day trips to be undertaken by travellers originating both in Sydney and regional communities. Accordingly, the current legislative arrangements equate to less competition, fewer choices and potentially higher airfares on routes between Sydney and destinations in regional NSW until Western Sydney Airport becomes operational.

To address this problem and support the expansion of regional services in NSW, the legislative framework should be amended to allow any slot held by an airline to be used to operate a regional or non-regional air service, as is the case in other states and territories, or alternatively, to allow non-regional slots to be converted to regional slots.

A number of state and territory governments have established policy frameworks governing aviation. In some cases, these policies include arrangements for the regulation and/or subsidisation of RPT air services on intrastate routes, which would otherwise not be commercially viable in a competitive market due to low passenger volumes. Virgin Australia considers that regulation of regional RPT services is appropriate and sensible in circumstances where such intervention by government is necessary to ensure the continuity of access to vital services by regional communities. State and territory laws and policies regarding land use are also relevant to the operation of airports and the use of airspace by airlines.

Virgin Australia does not currently operate services on any intrastate regulated routes.

We understand that the Queensland Government is currently in the process of reviewing its regulated RPT intrastate route network and is due to undertake consultation with stakeholders in the first half of 2018. The last review was undertaken in 2013, which resulted in the deregulation of three intrastate routes.

The Western Australian (WA) Government has recently concluded a Parliamentary Inquiry into regional airfares in the State, to which Virgin Australia provided evidence. The Inquiry report made a number of recommendations, including that the State Government undertake a review of its Aviation Strategy, assess whether additional RPT air routes should be subject to regulation and consider whether any current RPT air routes require subsidisation to

4 secure their viability. The Government’s response to the report is due in the first quarter of 2018.

In a 2014 Parliamentary Inquiry into regional aviation services, the NSW Government examined the impact on regional communities, from both a social and economic perspective, of the reduction over the previous decade in the number of regional centres in the State that have an RPT service. In adopting one of the recommendations of the Inquiry, the Government consulted with local councils served through regulated air routes to seek further views on whether deregulation would be preferable to regulation. This has led to the deregulation of a number of intrastate routes since 2015. The Government is currently looking at the potential to deregulate other routes across the State, with this approach driven by a desire to increase competition, reduce costs for passengers and eliminate red tape associated with licensing requirements.

VARA is currently appointed as the exclusive operator of RPT air services between Perth and the external territories of Christmas Island and the Cocos (Keeling) Islands under a contractual arrangement with the Commonwealth Department of Infrastructure and Regional Development. Under this arrangement, we operate one frequency per week on each of the following routes with Airbus 320 aircraft:

 Perth-Cocos Islands-Christmas Island-Perth  Perth-Christmas Island-Cocos Islands-Perth

Under the arrangement, VARA also manages the operation of a fortnightly dedicated freighter service by Toll Aviation.

Many regional airports are owned and operated by local councils. The policies and practices of local governments regarding the management of such airports, including infrastructure investment and maintenance, service delivery and fees charged to airlines, have an impact on the sustainability of regional air services.

(c) how airlines determine fare pricing

As noted above, pricing on any route is driven by a complex range of interrelated factors. Broadly, the key factors comprise:

 supply of, and demand for, air services;  costs of operation of flights; and  competitor pricing.

The amount of capacity Virgin Australia deploys on any particular route is a function of demand. Demand for travel is influenced by the mix of corporate and leisure passengers, the seasonality of the route and prevailing economic circumstances. On most of the regional routes we serve in WA and some routes in Queensland, the corporate segment is the predominant source of demand for our services, driven in large part by the ‘fly-in fly-out’ workforce requirements of the mining and resources sector. It is important to note that the revenue earned on these routes under corporate travel agreements is crucial to the viability of our services. Without the demand from these corporate clients, it is highly probable that capacity and frequency on many regional routes would be lower, and it is also possible that airfares would be higher. In fact, it is likely that RPT services on some regional routes would be unviable if it were not for the demand from the corporate segment.

5

In Virgin Australia’s experience, price discounting offers limited scope to unilaterally boost demand for our flights on routes dominated by corporate passengers, unlike routes with a greater proportion of price-elastic passengers travelling for leisure or non-business purposes. This challenge is exacerbated on routes with low passenger volumes servicing regional destinations with small local populations. Offering deeper discounts is ineffective in increasing our passenger loads and simply reduces the total revenue we would otherwise earn on these services, diminishing our ability to cover our costs of operation and therefore jeopardising the viability of such flights over time.

For any route, airfares and passenger loads will vary depending on the day of the week, time of day and whether the relevant flight is scheduled during a period of peak demand, such as school holidays or a special event. Flights at popular travel times will naturally attract more passengers than those at less popular travel times, and airfares will be priced in accordance with the economic principles of supply and demand, consistent with the revenue management practices employed by all commercial enterprises engaged in the sale of perishable inventory.

In highly seasonal markets, leisure traffic alone is typically incapable of supporting sustainable air services. For airlines to achieve load factors and yields which underpin a commercially viable operation, a combination of leisure and corporate/government traffic is required. Governments can play a role in supporting competition on such routes by ensuring that all travel undertaken by employees adheres to applicable travel procurement policies.

Government strategies which seek to promote regional economic diversification will be essential to ensure sufficient demand for air transport on regional routes continues to exist. For example, implementation of initiatives in the White Paper on Developing Northern Australia will boost overall economic development in the region and provide scope to create the demand conditions necessary to support a sustainable network of air services over the longer term.

Capturing a share of Australia’s current and projected tourism growth presents a significant economic opportunity for regional areas. Developing tourism in the regions, through strategic and focused destination marketing, tailored to consumer preferences and behaviours of domestic and international target markets, will also contribute to the creation of the demand required to support sustainable air services. It is essential that the Commonwealth and each of the states and territories continues to support tourism growth through destination marketing activities, given that most individual tourism businesses do not have sufficient incentive to undertake such promotion, as it would also benefit other commercial enterprises in the same location, ie the ‘free-rider problem’. Governments also have a role to play in supporting the expansion of tourism infrastructure in regional towns, whether through grants or incentive schemes. Growth in tourism will lead to increased demand for air services to regional areas, which will provide opportunities for airlines to realise cost efficiencies that have the potential to deliver lower airfares.

Costs of operation of flights include fuel, airport fees, labour, air navigation charges, aircraft leasing fees, catering costs and general administrative overhead expenditure. Such costs will vary for each route depending on fees charged by the relevant airports, aircraft type used, sector length and frequency of service. The cost of fuel at regional airports is often higher than capital city airports, and while Virgin Australia seeks to minimise the need to uplift fuel at regional airports, there is a need to do so for some flights. The carriage of extra fuel adds weight to an aircraft, increasing fuel burned on such flights.

Due to a lack of scale, costs of operation on a per passenger basis are always higher on regional routes than on trunk routes between capital cities. With fewer passengers and

6 frequencies across which such costs can be allocated, it is more difficult to achieve cost efficiencies on regional routes. As a result, the costs that must be recovered in each airfare on a regional sector are often greater than those applicable to capital city sectors. It is also the case that some regional routes exhibit significant variations in passenger loads depending on the direction of travel. For example, the average load during 2017 on the Perth-Kalgoorlie sector on a Monday was 75%, while the return Kalgoorlie-Perth sector on the same day only recorded an average load of 39%. The overall sustainability of services on these types of routes depends on our ability to maximise revenue generation on flights with high demand during peak periods, in order to offset a likely shortfall in revenue on non-peak services.

While the overall cost of operation for any flight is largely fixed, airfares may change in the lead-up to departure. On any route, Virgin Australia generally seeks to set airfares at levels that allow us, at a minimum, to earn sufficient revenue to cover our costs of operation, and if possible, earn a return on invested capital. On regional routes with marginal levels of profitability, this can be difficult to achieve.

In a competitive market, prices offered by other airlines are also a key influence on the airfares we offer on regional routes. Our competitors will likely face costs of operation similar to Virgin Australia, and will seek to recoup these in setting their own pricing on these sectors.

From a more technical perspective, the airfares available for purchase on any flight are a combination of pricing (individual price points) and inventory management (availability of seats on the aircraft at individual price points). Our airfares are distributed to the public at an all-inclusive level and are based on one-way pricing. This method allows for the greatest transparency and flexibility to build itineraries. The individual components of an airfare comprise a base level, to which airport and security fees are added, with the Goods and Services Tax then applied to the sum of these elements.

VAA markets the ‘Getaway’, ‘Elevate’ and ‘Freedom’ fare families in the economy cabin and the ‘Business Saver’ and ‘Business’ fare families in the business cabin. There are a number of individual fare classes in each fare family. In the economy cabin, our least expensive fares are offered in the ‘Getaway’ family, while the most expensive fares are in our ‘Freedom’ family, providing the greatest flexibility in terms and conditions.

Tigerair offers a single fare type subject to the same terms and conditions, with prices determined in accordance with the inventory available under a range of fare classes. Passengers also have the option of purchasing ancillary items and services (bags, seat selection and meals) throughout the booking process, either separately or bundled with an airfare.

Airfare pricing and inventory management is a dynamic and complex process, which involves strategic, competitive and risk management considerations. The airfare pricing and inventory availability for each route and flight is managed separately. If a flight is building a strong forward load and yield profile in the lead-up to departure, there will be fewer seats available in the lowest-priced fare classes. Conversely, if the forward load and yield on a flight is weak, it is likely that there will be seats available in all booking classes across all families. Accordingly, our pricing and inventory practices will see airfares and their availability typically change during the period leading up to departure. While it is the case that the costs of operation for a flight do not change in the lead-up to departure, the risk of not earning sufficient revenue to cover those costs does. We seek to mitigate this risk through our revenue management strategies.

7

Both VAA and Tigerair encourage passengers seeking the lowest fares on any route to book their travel at an early opportunity. Passengers also have the ability to access discounted fares released as part of regular tactical sale campaigns. The table below provides a snapshot of the sales activity by VAA on a selection of regional routes during 2017.

Total number of days which sale Route campaigns were in market during 2017 Alice Springs-Adelaide 278 Ayers Rock-Sydney 263 Ballina-Sydney 356 Geraldton-Perth 254 Karratha-Perth 263 Mildura- 286 Mt Isa-Brisbane 175 Tamworth-Sydney 226

(d) the determination of airport charges for landing and security fees, aircraft type and customer demand

Airport charges

Airport charges, which broadly consist of terminal, landing and security screening fees, represent a significant proportion of airfares on many regional routes and have an indisputable impact on airfare pricing and the competitiveness of air services. For terminal and security screening fees, charges are typically levied on a per passenger basis, while landing fees are levied on a per passenger basis or per tonne of maximum take-off weight of the aircraft. Some airports offer airlines incentives to grow passenger numbers or increase services, by providing discounts, rebates or caps on fees.

Regional airports are neither regulated nor monitored by the Australian Competition and Consumer Commission (ACCC), which provides scope for these airports to use their market power to unilaterally impose unreasonably high airport charges, which are above efficient levels. As part of this, some airports have demonstrated a lack of transparency regarding operating costs and capital investment. This limits the ability of airlines to assess and determine whether airport charges are commensurate with the level of service provided.

Charges imposed on airlines vary from airport to airport. For an aircraft turnaround at regional airports in WA, such charges are on average around double those levied by the regional ports we serve in NSW and Victoria, on a cost per-passenger basis.6 Charges imposed by some regional airports in Queensland are also significantly higher on average than those in NSW and Victoria (although there is greater variation in charges across regional airports in Queensland compared to WA).

Regional airports should be encouraged to seek funding from the Commonwealth and/or state/territory governments to support investment in infrastructure. This will better enable airports to maintain charges to airlines at sustainable levels, which will ultimately be reflected in airfares and/or the service offering on regional routes.

6 There is some variation in the charging methodologies applied by different regional airports. Turnaround costs have been assessed using average passenger loads during 2017.

8

In Virgin Australia’s experience, in negotiating commercial agreements with airlines the priority of most council-owned airports is generally the provision of services to the community and the broader economic benefits that such airports deliver. There is, however, an emerging trend for local councils to grant the management rights of an airport to a third-party private operator under long-term lease arrangements. The financial benefits derived under such arrangements provide funds which can be used for investment in other community infrastructure, while also relieving councils of the economic burden of investing in airport infrastructure during the relevant term of the lease. For airlines, this results in private operators seeking to earn a commercial return on their investment in the airport lease (rather than the value of the airport’s physical assets), without regard to the broader economic benefits airlines and their passengers deliver to the community. Higher airport charges will either be reflected in higher airfares or absorbed into an airline’s cost base. In either case, this has the potential to threaten the viability of air services to such ports over the longer term. Assertions that small increases in airport fees are not material for airlines are incorrect, as illustrated by the application of the carbon tax to domestic airfares from July 2012 to June 2014, which Virgin Australia and other airlines could not absorb and sought to pass on to passengers.

While it is the prerogative of these local councils to grant airport management rights to private operators and set charges at any level (given there is no regulation governing regional airport pricing), Virgin Australia is of the view that communities may not be aware that this practice is occurring and may therefore simply draw the conclusion that airfares are unreasonably high as a consequence of airline pricing practices alone. Councils should be managing airports in accordance with the expectations of local residents, most of whom are likely to regard safe, affordable and reliable air transport as an essential service in their community, for both social and economic reasons. If residents are voicing concerns regarding airfare pricing, yet continue to regard air transport as an essential service, councils may wish to consider opportunities to reduce airport charges in order to provide scope for airlines to offer lower airfares. While this may entail the need for other council non-airport revenue streams to be used to subsidise the costs of operation of the airport, this is likely to be justified on the basis of the overall benefit to the community that air services provide.

There is also a risk, particularly with private third-party operators, that some airports may seek to invest in infrastructure that does not deliver the operational or service delivery benefits desired by airlines. In some cases, councils may include provisions in the lease agreement that oblige the airport operator to undertake certain levels of investment. This could lead to significantly higher aeronautical charges for airlines, particularly at low-volume regional facilities. To ensure these charges are not higher than necessary, investment in airport infrastructure should be aligned with the operational requirements of airlines, the passenger experience airlines seek to provide their guests and demand for air services, rather than future aspirations of the airport operator. Airlines currently serving a regional airport should not be expected to fund infrastructure upgrades which deliver no commercial or operational benefit. There is a need for regional airport operators to engage in genuine consultation with their airline customers in relation to the delivery of new infrastructure and the consequential implications for pricing.

As a related point, it is also important to highlight that receiving designation as an international airport will not, of itself, result in the introduction of international flights at a regional airport. Airlines will only introduce international services at such airports if they are commercially viable, underpinned by adequate demand. The population size of surrounding communities, and tourism and freight transport potential, are relevant demand-side factors. International designation may, however, see airports move to prematurely undertake costly and long-term investments to upgrade or modify terminals, runways and aprons, with a view to attracting larger aircraft operated by international airlines, motivated by a “build it and they

9 will come” approach. Given the relatively low passenger volumes at regional airports, the costs associated with such investment would significantly increase overall charges levied by the relevant airport operator, which are principally borne by domestic airlines and their passengers. This would directly impact airfares and jeopardise the sustainability of services to these airports operated by domestic carriers, which are vital to the local tourism industry, regardless of whether the airport ultimately secures an international service or not. The costs of such investment should be recovered from international airlines if and when those international services eventuate, and the risk of those services not eventuating should be borne by the airport.

The Commonwealth should carefully assess any application by a regional airport for international designation, in order to properly weigh the balance of benefits to ensure that aviation and tourism will not be adversely affected. Such assessment should also include an evaluation of whether government expenditure to support customs, immigration and quarantine facilities at these airports will deliver value to the taxpayer.

Virgin Australia has settled commercial agreements reflecting a reasonable sharing of risks and returns with a number of regional airports. In this regard we would highlight the pricing practices and service outcomes of Ballina Airport, which is owned and operated by the Ballina Shire Council. Charges levied by Ballina Airport are among the lowest of all the regional airports we serve. Between 2013 and 2017, Ballina Shire Council sought $10.2m from the Commonwealth and NSW Governments to partially fund $15.8m of capital investment necessary to support anticipated growth of 50% in passenger volumes at Ballina Airport between FY12 and FY17. Commenced in FY13 and due for completion FY18, this capital investment included runway strengthening and expansion of the apron, taxiway and terminal. Ballina Shire Council only sought to recover the balance of this capital investment ($5.6m) from airlines. Virgin Australia considers that this approach recognises that the benefits that air services deliver to the regional economy and the community are greater than those which would be delivered through earning a higher return on airport infrastructure. For Ballina Airport, this has resulted in passenger volumes and aircraft movements increasing by around 30% and 20% respectively between FY13 and FY17.

Difficulties experienced by airlines in negotiating with regional airports were noted in the Productivity Commission’s Economic Regulation of Airport Services Inquiry Report in 2011, including inappropriate pricing of services and the use of ‘take-it-or-leave-it’ conditions of use.7 While the Productivity Commission formed the view that it was not necessary to formally extend the Aeronautical Pricing Principles to regional airports, this appeared to be justified on the basis of countervailing power held by an airline in circumstances where it is the sole operator to a regional airport. This view is not valid for regional airports served by multiple airlines, and with Virgin Australia’s expansion in the regional market, is increasingly not the case in practice.

To address the challenges experienced by airlines in negotiating airport charges with some regional airports as monopoly service providers, Virgin Australia would like to see the Government update and re-issue its Aeronautical Pricing Principles in order to confirm their application, at a minimum, to all airports served by more than one airline. In addition, we see merit in the development of a set of guidelines or code of conduct governing regional airport pricing and service delivery, which would cover each of the following:

 defining the rates of return that would be accepted as reasonable for an airport to earn on investment in aeronautical assets;

7 Productivity Commission, Economic Regulation of Airport Services Inquiry Report, No. 57, 14 December 2011, page 329.

10

 establishing parameters concerning the revaluation of aeronautical assets, mitigating the risk of airports revaluing assets as a means of justifying increased charges;

 broadly defining the types of capital investment airports could reasonably seek to recover and earn a return on from airlines, while also specifically excluding speculative investment designed to attract wide-bodied, international or freighter services and the inclusion of the value of assets funded by government grants; and

 establishing principles to ensure pricing equity between airlines receiving the same standard of service in a common-user environment, to preclude airports from charging an airline/s higher fees in order to offset lower fees offered to another carrier/s.

We would also like to see any guidelines or code of conduct specify that regional airports are only entitled to recoup the provision of government-mandated security screening services on a strict pass-through basis. This would ensure that both airlines and airport operators face no financial disadvantage as a result of compliance with mandatory government security regulations and prevent airport operators from seeking to earn a financial return on such services. This view is supported by the ACCC in its 2015-16 Airport Monitoring Report, which provides that revenue earned by airport operators in relation to mandated security screening “is set to recover the costs associated with security services and does not affect the overall profitability of the airports”.8 While this report’s scope is limited to the performance of the major capital city airports, its rationale for the treatment of government-mandated security costs is applicable to all airports across the country and should be adopted in any formal guidelines in relation to pricing.

Commercially-balanced, outcomes-focused negotiations which result in charges which accurately reflect service delivery and demand-driven capital investment incorporating a reasonable return on investment in relevant airport facilities will assist to create the conditions necessary to enable airlines to sustain, as well as increase, services on regional routes. This will allow airlines to realise cost efficiencies and provide scope for lower airfares.

Airport security

As a general comment, rising aviation security costs represent an ongoing challenge to the sustainability of regional air services. On a per passenger basis, security fees are higher at regional airports with lower passenger volumes relative to capital city airports. Virgin Australia will continue to work with the Office of Transport Security (OTS) to ensure regulatory requirements are met while working with each airport to minimise costs.

In Australia, each airport operator is responsible for the provision of its own security screening processes, which in the majority of cases are delivered by security screening service providers. The cost of these services is determined in accordance with the commercial arrangements between the airport operator and the company providing the security screening service. As noted above, airport operators should be recovering these costs from airlines on a strict pass-through basis. The disparate nature of these commercial arrangements represents a practical impediment to the network-wide allocation of security costs. In comparison, delivery of airport security services in countries such as New Zealand and Canada is the responsibility of the central government, which readily enables cost allocation at a network level. Similarly, air navigation and aviation rescue and firefighting

8 Australian Competition and Consumer Commission, Airport Monitoring Report 2015-16, page 174.

11 services in Australia are provided by a single supplier, Airservices Australia, allowing for costs to be allocated on a network-wide basis.

In seeking to find the most economical way to meet the regulations and address the risk of emerging threats, airports and the OTS should be encouraged to adopt a strategic approach to investing in and implementing equipment with advanced technology standards, such as explosive detection systems x-ray with dual or multi-view capability. Adoption of this technology would provide scope to reduce or eliminate other screening processes, such as manual explosive trace detection. At the same time, opportunities to increase the efficiency of security screening processes should be assessed, such as allowing staff at security screening points to perform multiple tasks. These measures have the potential to significantly improve the passenger facilitation process and will assist efforts to minimise costs without increasing security risks. Virgin Australia strongly encourages further investigation of these proposed initiatives while noting that implementation would require regulatory amendments.

(e) pricing determination, subsidisation and equity of airfares

Detailed information as to how Virgin Australia determines its airfare pricing is set out in section (c). While the pricing and inventory management processes we adopt are common across all routes in our network, it should be emphasised that each route has different characteristics which will have a particular influence on airfares, such as level of seasonality, directionality of travel patterns, proportion of corporate/government versus leisure traffic and service and product offerings by competitors. On each route, pricing may also vary from flight to flight, based on demand, the need to cover costs and competitive dynamics. Demand will also be dependent on the population sizes of the destinations at each end of the route.

Characteristics of trunk routes between capital cities, on which multiple return frequencies are operated each day by a number of domestic carriers, are very different to those of regional routes. For example, up to 53 return services are currently operated each day on the Brisbane-Sydney route by four airlines, compared with up to eight return services on the Perth-Port Hedland route, which is served by two airlines. The stronger demand for travel on trunk routes enables airlines to achieve greater aircraft utilisation compared with regional routes, allowing airlines to spread the fixed costs of an operation over a larger base. These cost efficiencies are reflected in airfares.

Virgin Australia manages the profitability of each route separately. As a commercial enterprise accountable to shareholders, we seek to ensure that airfares on each individual route are set at levels which allow us to earn sufficient revenue to offset the associated costs of operation. Accordingly, airfares on regional routes do not cross-subsidise those on trunk routes. In fact, the current returns delivered by a number of individual regional routes are not acceptable, but have strategic value to Virgin Australia from a broader network perspective. These routes are therefore essentially cross-subsidised by our non-regional routes at this time. This cross-subsidisation cannot be continued indefinitely, however, and sustained losses on routes will inevitably result in reductions in services or market withdrawal.

It should also be noted that comparisons of airfares on regional routes with those offered on international routes to/from capital city ports are not valid, as the economic characteristics of such routes are entirely different. A key factor in this regard is the difference in the size of the population and air travel market in regional areas compared to capital cities and major international destinations. Comparisons based solely on airfares and distance are misleading and simplistic, as they fail to take into account the broad range of factors which underpin the pricing and profitability on any route.

12

On international leisure routes, there is significant scope to boost demand and passenger volumes through promotional activities and price discounting. As noted above, such opportunities are limited on certain regional routes where demand is low or more inelastic. It is also misleading to draw comparisons between airfares offered on international routes to/from capital cities by budget carriers based overseas, which operate at lower cost bases than Australian airlines.

On any route, the earlier a reservation is made ahead of departure, the greater the opportunity a passenger will have to access a range of price points on the relevant flight. Accordingly, Virgin Australia encourages passengers seeking the lowest fares on any route to book their travel at an early opportunity. Passengers also have the ability to access discounted fares released as part of regular tactical sale campaigns.

(f) determination of regulated routes and distribution of residents’ fares across regulated routes

It is the role of state and territory governments to determine whether any intrastate routes should be subject to regulation. Virgin Australia provided comments to inform reviews undertaken by the Queensland and WA governments regarding the regulation of air services in those states in 2013 and 2014 respectively.

Virgin Australia does not currently operate services on any intrastate regulated routes, although we previously served four intrastate RPT air routes in WA which were subject to regulation (Perth-Albany, Perth-Derby, Perth-Esperance and Perth-Learmonth (Exmouth)). These routes had been operated by Skywest Airlines prior to Virgin Australia’s acquisition of the WA-based regional carrier in 2013.

Between January 2014 and January 2015, resident fares were offered on routes between Perth and Albany, Esperance and Learmonth (Exmouth), as well as on non-regulated intrastate routes between Perth and Busselton, Geraldton and Ravensthorpe, and the Albany-Busselton and Esperance-Ravensthorpe routes. Under this offer, which was promoted via local chambers of commerce and travel agents, residents were able to access a 30% discount on full economy airfares. This provided the greatest scope for residents to access discounted fares for bookings made close to the date of departure. Local residents were entitled to purchase up to six return or 12 one-way airfares at the discounted price each year. These fares were discontinued due to extremely low levels of bookings.

(g) airline competition within rural and regional communities

As noted above under section (c), competition is one of the key factors influencing airfare pricing. On an unregulated route, competition between airlines will create market forces capable of placing downward pressure on airfares. The majority of regional routes operated by both VAA and Tigerair are served in competition with at least one other airline.9

The ability of a route to sustain competition will largely depend on the level of demand for air travel on that particular route. With high passenger volumes, trunk routes between capital cities are characterised by strong competition from multiple operators. In sharp contrast, some regional routes with low passenger volumes are unsuitable for competition and require regulation in order to ensure communities have access to an RPT air service. The WA Government is of the view that annual passenger demand of at least 100,000 is necessary to

9 VAA is the only operator on the Gold Coast-Canberra, Hervey Bay-Sydney and Kalgoorlie-Melbourne routes, Tigerair is the only operator on the Coffs Harbour-Melbourne and Gold Coast-Hobart routes and VARA is the only operator on routes to Christmas Island and the Cocos (Keeling) Islands from Perth.

13 attract two or more operators on a particular route and that intrastate routes are likely to require regulation below this level.10 In NSW, the threshold for a route being regulated, or allocated to one carrier, is that it operates at or below 50,000 passengers per year (although the NSW Government has been progressively deregulating intrastate routes in recent years, as noted above under section (b)). A passenger number benchmark is not articulated in the context of the current Queensland regulatory framework.

Although a certain level of passenger traffic is a key determinant of whether a route is capable of attracting and sustaining competition, the costs of operation and access to commercially-suitable slots at each end of a route are also highly relevant. Higher costs require larger passenger volumes in order to be offset. In this regard, prohibitively high airport charges at regional airports can significantly reduce the scope for an air route to support competition. Consistent with our statements under section (d), an airport operator should not, however, offer discounts on airport charges to a prospective airline if it seeks to recover such discounts by imposing higher charges on incumbent operators.

In relation to slots, an inability for airlines to operate services at times desired by passengers will inhibit the level of the competition on a route. As outlined under section (b), the Commonwealth legislative framework governing the allocation and use of slots at Sydney Airport is restricting the growth of NSW intrastate regional services, with corresponding implications for airfares available on such routes.

The corporate travel agreements that airlines have in place on a particular route can also affect competition. On low-volume regional routes dominated by passengers travelling for business purposes, if one airline has secured all the traffic under exclusive arrangements with the companies from whom the majority of demand for travel derives, there is unlikely to be sufficient residual demand from those travelling for leisure or non-business purposes to support commercially viable services by another operator. In this situation, airfare price discounting will not be capable of boosting demand in a material way, as the proportion of price-elastic passengers travelling on the route is simply too low. This type of scenario led to our withdrawal from the Perth-Learmonth (Exmouth) route in 2014, after a period of sustained losses following the entry to the market by our competitor after the route was deregulated in 2011. The majority of business traffic that VAA had carried on the route switched to our competitor due to pre-existing exclusive airfares arrangements it had in place with the key corporate entities operating in the region. As a result, VAA was unable to attract sufficient non-business traffic to allow our operations to remain viable.

A number of regional routes are served by low-cost carriers, including 10 served by Tigerair. In broad terms, the business model of low-cost carriers relies on the ability to maximise revenue through high aircraft utilisation and achieving high load factors through offering lower airfares than full-service airlines, while also maintaining a low cost base. The fundamental economic characteristics of some regional routes are incompatible with this business model, which depends on the ability to realise cost efficiencies by operating flights in high-volume and leisure-dominated markets. For example, intrastate routes in WA are unlikely to be commercially attractive to a low-cost operator given their relatively high costs, low passenger loads and the limited scope to boost demand through price discounting.

Initiatives to increase demand and passenger volumes will provide the greatest scope to boost competition on regional routes, in both the low-cost and premium segments of the market. In this regard, government schemes and programs designed to facilitate economic development in the regions, especially in the area of tourism, are critical. Virgin Australia

10 Western Australia Department of Transport, Review of Regulated Regular Public Transport Air Routes in Western Australia Final Public Report 2015.

14 collaborates closely with state and regional tourism agencies, businesses, industry organisations, airports and communities to identify opportunities to stimulate demand for travel in regional markets, and promotes flight and accommodation holiday packages for many regional destinations through our website. With the challenges inherent in the regional aviation operating environment, this approach will ensure that the requirements of all key stakeholders are taken into account as part of developing solutions which will ensure regional communities have access to safe, regular, reliable and affordable air services.

There have been calls by some regional communities for the Commonwealth to consider granting cabotage rights to foreign carriers. While at face value, this may appear to have some short-term benefits, in reality it could be expected to have far-reaching consequences for the long-term sustainability of the Australian aviation and tourism industries. Operating alongside Australian airlines, foreign carriers would earn marginal revenue by offering capacity that could be priced at levels lower than the average cost faced by domestic airlines on these sectors. Over time, this could be expected to lead to network rationalisation by local operators, with aircraft redeployed to higher-yielding routes. This would come at a cost to tourism in regional areas, as domestic airlines play a key role in terms of investment in marketing and promotional activity. It is important to remember that almost 75% of tourism activity in Australia is domestic.11 Cabotage, in contrast, represents an opportunistic play for foreign carriers without a long-term commitment. If a more commercially attractive opportunity presented itself, these carriers would simply redeploy their aircraft.

(h) consistency of aircraft supply and retrieval of passengers by airlines during aircraft maintenance and breakdown

All airlines within the Virgin Australia Group strive to maintain schedule integrity to the greatest extent possible, to meet the expectations of our passengers. It is the case, however, that our services will be unavoidably interrupted from time to time due to unforeseen aircraft maintenance requirements. Service disruptions also arise due to weather conditions and crew resourcing limitations.

The remoteness of a destination and the frequency of operation on a particular route have a bearing on the efficiency of a recovery operation. For example, VAA’s ability to undertake recovery on the 750 kilometre Brisbane-Sydney route, on which we have up to 20 return scheduled frequencies per day operated by multiple aircraft, is much greater than the 1,300 kilometre Perth-Port Hedland route, on which we operate up to two return frequencies per day, or on routes between Perth and Christmas Island and Cocos (Keeling) Islands, where we operate two frequencies a week.

As a service delivery business operating in a highly competitive market, it is in our interests to minimise the inconvenience caused to our passengers as a result of disruptions by operating recovery services as quickly as we can. We are also incentivised to operate to our schedule to the greatest extent possible, given the collection and publication of domestic airline on-time performance data by the Commonwealth Bureau of Infrastructure, Transport and Regional Economics.

(i) all related costs and charges imposed by the Civil Aviation Safety Authority

Virgin Australia does not incur any charges from the Civil Aviation Safety Authority (CASA) which are specific to operations on regional routes. The magnitude of the costs we pay annually to CASA are minor relative to other costs for our business such as labour, fuel and airport charges.

11 Tourism Research Australia, Tourism Satellite Account 2016-17, page 6.

15