THE CHASE FOR LOWER YIELDS: Why do airlines keep doing this to themselves?
April 8, 2014
Cloudy skies over Europe
October 1, 2015
Learning from the past: Lessons for big airlines
November 28, 2015
Having crossed paths in airport lounge with a senior manager from Lufthansa this week, it was strikingly clear that in this industry we have short memories or we need to be better at learning from the experiences of others.
In this lengthy conversation it seemed clear that this manager credits the success of airlines in the United States purely on the benefit of being able to exploit Chapter 11 and ignores other key strategies and capabilities which the airlines have developed. This manager seemed to suggest that the Lufthansa leadership believes Chapter 11 would solve all their problems (albeit I doubt this manager is truly in a position to represent the views of the leadership). This is an overly simplistic and incredibly unfair representation and is frankly a simple cop out of accepting the real systemic and structural issues facing some of Europe's largest airlines. To simply credit Chapter 11 ignores the hard work and real transformation the current leaders of large US carriers have taken their airlines through. It also ignores the real contribution employees have made to ensuring the future and sustainable success of their airlines.
When pressed, this manager argued Lufthansa faces different challenges. This is an interesting perspective. If Lufthansa faces different challenges to the US carriers, then why should a comparison to Chapter 11 be relevant? It should only be relevant if the challenges are the same. I.e. he claims LH is solely disadvantaged because it doesn't have the remedies available to it that Chapter 11 afforded american carriers.
But let's consider that argument. What is the main benefit of creditor protection and Chapter 11? It primarily allowed the airlines in the US to restructure their balance sheets, to renegotiate debt. Thus providing more financial flexibility. With this they were able to write down undepreciated assets, to reduce leverage and to then reinvest in the product and order more fuel efficient airlines. They addressed labour productivity largely outside of Chapter 11.
Is Lufthansa suffering from not having access to Chapter 11? Not at all. Lufthansa's balance sheet is not in bad shape. It has a reasonably younger fleet than even the US airlines today. It has reinvested in enhancing its product across all classes of service having introduced a new business class and IFE (both albeit somewhat outdated already), an updated economy class and added a new cabin with premium economy. It has also consistently been adding new aircraft with the A380, the 747-8I, Embraer E-Jets, CRJ 900s, and newer Airbus A319, A320 and A321 aircraft with the latest sharklets. It seems Lufthansa wouldn't benefit from Chapter 11 even if it were available to it. It's easy to just credit the US carriers with Chapter 11 and discount the very real pain, suffering and hard work which went into restyructuring these airlines over a 20 year period. The leaders of airlines in both Canada and the United States need to be given due credit for having done the difficult things that needed to be done. But even more importantly, staff, unions and mid-level managers have to be given credit for working together to ensure the success and survival of their airlines. This was not a management success, it was a group effort of all parties, including partners, suppliers, vendors and customers who worked together. Chapter 11 was one small part of this.
Lufthansa's sister company Swiss faced similar challenges to those Lufthansa faces today, and it turned around. Sister company Austrian Airlines has also faced similar challenges and it seems to be on a path to reinvention. So why not Lufthansa? Clearly, the challenges ay Lufthansa are of its own making. They are operational in nature. One hypothesis might be that Lufthansa should look closely at the following
Aircraft size. Although Lufthansa has reduced the number of aircraft in the fleet, it has increased the average number of seats per aircraft and the overall number of seats and available seat kilometeres flown. Thus it has increased capacity and done so in a sticky way. It might argue it has lowered unit costs, but this is only a rational argument if the yields associated with adding capacity on a like for like flight have also held up, which it seems they have not. Adding seats in this way is like reducing the number of retail stores in a chain, but increasing capacity in remaining stores thus having lower like for like sales pr square foot (airline managers like to make their industry sound more complicated, but it is like many others)
Home market. For decades Lufthansa has benefited from the inability for aircraft to efficiently fly long distances. As such, traffic from across the atlantic needed to stop somewhere in Europe before heading to small European cities or further east. As aircraft technologies have improved, airlines began point to point services across the atlantic with the Boeing 767. Airbus introduced competitive unit costs with the larger A330-300 and Boeing responded with the larger 777. As aircraft size at the comparable unit cost grew, airlines consolidated back to feeding hubs. Now a second wave is emerging with the Boeing 787 having lowered units costs again at the 250 seat mark, compared to the 777 at the 330 to 450 seat mark. Airlines can now efficiently bypass large hubs. Fewer takeoffs and landings and countries touching a ticket means fewer taxes and fees and thus lower prices. The reality is that every time this phenomenon emerges, as it did with the innovation of the 767, the 330 and the 777-200, and now the 787, airlines such as Lufthansa are hurt because they don't have a large enough home market demanding services to the main hubs of cities such as Frankfurt, Zurich and Vienna. Airlines such as Air France and British Airways are more resilient due to the strong demand for services to London and Paris. As such, Lufthansa finds itself overcapacity and unable to compete on cost using large aircraft like the A380, B747 and A340. Without a home market, Lufthansa has to fly most of its passengers on at least two sectors where other airlines can carry many passengers on non stop services.
Fuel efficient fleet. Lufthansa operates one of the largest, if not the largest 4 engine aircraft fleet in the world. Enough said.
Unit costs. Lufthansa seems to be under a common illusion that increasing aircraft size results in lower unit costs. This is a myth. In reality there are numerous factors involved and one has to take them all into account. Nevertheless, all being equal, even if bigger means lower costs, it rarely means higher profits because the airline has to discount to fill the extra seats. With the majority of Lufthansa's new aircraft added in recent years being capacity increases, the airline has structurally increased its flying costs per flight and decreased its flexibility. It it is under more pressure to fill seats because the cost of turning on the machine is higher than it was before. Yes, A321 costs more to fly than an A320, even if it costs less per seat per mile, it still is heavier, requires more fuel, carries more water, food, crew, etc. if the airline can't fill it, it actually increases its commercial risk.
Labour costs. Airline managers around the world place far too much attention on labour costs. These are a factor input cost which should be addressed, but unlike a common myth, lowering these costs will rarely make or break an airline. These costs are sticky and even as high as a 20% reduction in base salaries does little to impact the overall flight cost. Lufthansa has far bigger battles to fight than these. Unfortunately, it has been so generous over time, it has created an unrealistic expectation with staff over pay rises.
germanwings and eurowings. Sometimes success goes to ones head. germanwings was built to serve a purpose. It appeared successful albeit it wasn't really since much of its costs were hidden inside Lufthansa. Exploiting it to expand as a platform across Lufthansa short haul was an ill conceived idea. It's been tried by many others which call failed and retreated. Yet Lufthansa thought they could succeed where many an airline went to die. Now that Lufthansa wants to distance itself from this year's crash, it seems to want to rebrand the germanwings fiasco as eurowings, thus continuing down a path which by its own admission is failing to deliver results. Tango, Song, Ted, snowflake, go... how many other examples are needed to illustrate that even some of the best airlines have tried and failed? Lufthansa seems resistant to wanting to learn from others.
If the recent conversation with this Lufthansa manager is representative of what the whole leadership believes, then it seems Lufthansa is going to face a lot of pain and suffering for a long time as it spends its time addressing issues which will not improve its situation.
Lufthansa needs to learn from the past. It needs to look to the successes of airlines such as Air Canada. Look at what they did a decade ago which is now paying dividends. Copying their change of a holding structure or copying their strategies such as establishing Rouge is not the answer (airlines around the world have been copying these without success). ACE Aviation was created to solve specific challenges at Air Canada. Copying this solution at Lufthansa will not help as LH faces different challenges. The Rouge strategy works now a decade after the restructuring. Copying it and forming germanwings and eurowings won't work because it is building those platforms off the wrong base.
Lufthansa has a strong balance sheet. It writes down its aircraft faster than most airlines. Its owns a large proportion of its aircraft. It has tremendous financial flexibility afforded to it by the cash flow from its non core business entities, particularly the maintenance, cargo, and other services businesses. So, it does not follow that Lufthansa is at any disadvantage to lacking the benefit of chapter 11. What Lufthansa is lacking is a home market and it is failing to adjust its business strategy for the core airline. It is overcapacity and adding numerous other airline businesses such as Jump (an internal Lufthansa subfleet flown by Cityline), Swiss, Austrian, Brussels Airlines, germanwings, eurowings, sunexpress, etc simply distracts from the core problems.
It's time for Europe's strongest airline to step back, look at the big picture and get on with fixing its house. This will take a new vision, a new strategy, real engagement with staff from the front line to the executive office, and a fresh approach. Lufthansa needs to remember its heritage and its core values. It needs to shed the recent distractions, and probably with it some of its recently added management (outsiders) who are steering the airline in the wrong direction. It needs to make employees feel valued (which doesn't mean paying them more), and it needs to win back the trust of passenger fed up with constant strikes. Sadly, many passengers have been forced to try other airlines and to learn that there are numerous airlines which are much more reliable, customer-centric and price competitive which are more than happy to serve the German market which is product-sensitive, not price-sensitive.
For what its worth, we keep our fingers crossed that the pilot at the helm of Lufthansa will clear his desk, trim his aircraft and steer it out of the clouds and onto blue skies. He's the right person for the job and he has one of the strongest leadership teams in the industry. So if any team can do it, it is this one. Pressing our thumbs for the yellow crane.