On June 8 Air France/KLM warned about profits and over capacity. Then came Lufthansa on June 11 with its own warning. Such statements from mega-carriers should be taken seriously. Meanwhile, another mega carrier, American Airlines seems quite satisfied with its status quo. Mixed messages for sure. What to make of it?
The big EU carriers are facing disruptive threats. Take a look at this presentation by Lufthansa’s CEO – pay attention to slide five. Two comments jump out here – low cost carriers and consolidation. In the US, we now have the big four airlines; of these the biggest three are network airlines with global footprints and alliances. In the US, consolidation has played out and the financial results speak for themselves. Other than at United, profits are growing rapidly. We expect United to become profitable soon. So in terms of consolidation, the US leads the industry and Lufthansa identifies this issue as probably not yet played out in the EU.
The LCC item bears consideration. The LCC model of avoiding hubs and serving point to point is disturbing for network carriers that are hub oriented. An early example of just how disruptive is to see reaction to the Norwegian 787s flying long hauls to the US. The US carriers see this for what it is – a threat. Ryanair is waiting to pounce, of this one can be sure. Air Asia X is working its own plans in Asia. The long haul low cost airline is a threat to every network airline. Boeing’s Randy Tinseth briefed reporters yesterday and made a great remark – “This is all about demand. It’s no surprise that market has struggled to take hold.” He was talking about VLAs. The only airlines that can afford the 747-8i or A380 are network carriers. A key argument for the VLA is hub dependent. Ergo, if the hub model decays into point to point, the need for a VLA wears thin fast. This is what Boeing sees happening and therefore forecasts only another ~180 VLAs to be ordered.
Lufthansa notes the point to point model is here to stay. The airline is adding a premium economy section to its cabins and reducing its fleet. And on slide 14 of the presentation linked above, you see the very interesting item “wings long haul”. Lufthansa is developing its own response to Norwegian and Air Asia X. We are certain that Air France/KLM and British Airways are watching this very closely. Do not be surprised to see the strategy copied with refinements.
In another presentation by Lufthansa, CEO Carsten Spohr states “We don’t want to be driven by change in the aviation sector: we want to be among the drivers of it”. Therefore we see this strategy emerging – “The new WINGS family, which will build on the success of the Germanwings concept, will be specifically aligned to the high-growth market for private air travel. The Group will use the new WINGS master brand to bundle the various platforms for its point-to-point air travel business; and it is considering extending the concept to intercontinental services, too“. Lufthansa is taking the fight to LCCs on its own terms.
The company has powerful assets it can deploy – not least of which is its MRO. What does this mean? If a Wings family flight experiences a technical hitch – as Norwegian has seen a few times – Lufthansa Group has a fleet which allows a substitute plane right away. None of the Norwegian type responses like chartering an A340 to replace a stranded 787. And with its world leading MRO, it should be rare that Lufthansa has a fleet that is unreliable. Private travelers (as opposed to business travelers) are going to be sent the message that a Wings flight will operate according to schedule – you have the Lufthansa guarantee. It could be a compelling message.
This is a bold move – not driven out of fear, but out of recognition how the market is changing. How long before the other EU mega carriers respond?
But in long haul markets, time and again niche carriers have failed. I mean pure premium-class carriers, but also pure LCC carriers. Having a mix of premium travel, price-sensitive leisure travel and cargo seems to be the most stable and profitable revenue mix. Here the network carriers should have some advantage so long as they can keep their costs in line. Many of Norwegian’s prices for their North America service aren’t much lower than network carrier prices. Of course the MEAs are a big threat with their lower costs, and the LCCs on shorter routes, but for long haul that the MEAs cannot serve, LH and the network carriers should be in a good position to maintain dominance so long as they keep control of their costs such that economy fares are in the same range as what long haul LCCs could offer.
I will posit that these are 2 extremes – Hub vs non-hub. Of course that is a certain degree of BS. Hubs are very necessary for efficiency and after all isn’t that what ALL airlines are really about – operational efficiency rather than all this BS about customers? So VLAs work for large scale hub players. The demand for VLAs which used to be the only way to get from point A to point B ultra long haul pales when you have smaller efficient transports. This is true. But doesnt eliminate the need for VLAs. Especially when the VLA’s load factors were in the 70-80% range and now with a 777-300 can accomodate in the 90% LF range.
Here is the second point that I think you miss. LH and AF suffer from the somewhat arrogant belief that they control their home market. Look at the CASM for AF and LH and their respective subsidiaries. Especially for the short haul flights. Even after the move to 4U and Hop! both airlines still have some of the highest CASM rates for short haul when compared to BA. The reason LH and AF are doing badly is good old economics and failure to reform. Mostly in inefficient business practices and while that can be laid at the door of the Unionized labour force its not entirely justified.
BA and Delta – now joined by American represent a model that proves a mix can work. EK proves that VLAs work. In my view this points to a gaping hole in the Boeing and Airbus product line; a Big Twin VLA. However this unlikely to be embarked on in the near term without a significant investment by both and a joint selection of one single engine provider. Still in 25 years there will be one of these out there. I will bet on that even if I am not around to see it
The US and European markets show two completely different audience characteristics. Comparing the two regions based on one single framework would probably not be ideal. Generally speaking, there is money to be made in a no-frills long-haul carrier, even though most attempts so far failed. Yet, LH faces a serious problem with its newly presented plans: it dilutes the focus on its core business. It is one thing to copy an existing idea successfully, it is quite another to do so based on an internal cost structure coming from a high unit cost organisation. I believe a better strategy would be to focus on its core strengths. If these lie in a no-frills model remains to be seen.