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ESMT–315–0165–1 ES1651 This case study was prepared .docx
- 1. ESMT–315–0165–1 ES1651 This case study was prepared by Urs Müller and Francis Bidault of ESMT European School of Management and Technology. Sole responsibility for the content rests with the author(s). It is intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. Copyright 2015 by ESMT European School of Management and Technology, Berlin, Germany, www.esmt.org. ESMT cases are distributed through Harvard Business Publishing, http://hbsp.harvard.edu, and The Case Centre, http://www.thecasecentre.org.Please contact them to request permission to reproduce materials. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise - without the permission of ESMT. November 19, 2015 ESMT Case Study Dealing with low-cost competition in the airline industry (A):
- 2. The case of Lufthansa Urs Müller Francis Bidault Introduction Early 2002 Germany’s Deutsche Lufthansa (DLH) was Europe’s most successful airline and a fully privatized group with about 380,000 shareholders. In IATA rankings, Lufthansa achieved top spots in both scheduled passenger and freight traffic. Lufthansa carried some 46 million passengers in 2001. The summer 2002 route network covered 327 destinations in 89 countries. The Lufthansa fleet totaled more than 300 jet aircrafts. With an average age of 7.8 years, it was one of the youngest and most environmentally friendly airlines in the industry. The aircraft were kept in pristine condition by Lufthansa Technik. With hubs in Frankfurt and Munich, the carrier was part of the Star Alliance global airline network that included United Airlines, Air Canada, and All Nippon Airways. Lufthansa also had interests in travel-related businesses, including ground services, IT services, catering, and leisure travel services. Distributed by The Case Centre North America Rest of the
- 3. world www.thecasecentre.org t +1 781 239 5884 t +44 (0)1234 750903 All rights reserved f +1 781 239 5885 f +44 (0)1234 751125 e [email protected] e [email protected] case centre U sa ge p er m itt ed o nl y w ith in th es e pa ra m
- 9. ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa 2 Despite the successful turnaround in the 1990s Lufthansa was facing new threats: the burst of the “New Economy” bubble, the 9/11 attacks, and as a consequence the rapid decline of business and leisure travel. In addition to that the entry of low-fare airlines like Ryanair, easyJet, HLX, and Air Berlin significantly increased the competition in a market that was currently shrinking. The new competitors had embraced a radical new business model, the “no-frills” approach that cut costs drastically. As 2002 got underway without any sign of a fast economic recovery, DLH’s top management wondered how to respond to these new competitors. The beginning The Weimar government created Deutsche Lufthansa (DLH) in 1926 and managed to build Europe’s most comprehensive air route network by 1931 – with operations that included services to the Soviet
- 10. Union and China on the basis of joint ventures. After World War II, the Allies allowed the recapitalization of DLH in 1954. The airline started with domestic routes, returned to London and Paris in 1955, and then re-entered South America (1956). In 1958 DLH made its first nonstop flight between Germany and New York and initiated service to Tokyo and Cairo. The stable West German economy helped Lufthansa maintain profitability through most of the 1970s. Having been a nearly 100 percent state-owned company, the German government started to reduce its ownership in 1962. In 1966 DLH stocks were traded publicly for the first time. However, the German government still owned more than 50 percent of DLH at that time. The crisis and the turnaround In 1991 when Jürgen Weber was appointed CEO, Lufthansa was well known for its high reliability, order, and technical excellence. But the sharp decline in air traffic during the first Gulf War (1990/91) and the recession thereafter led to serious overcapacity in the airline industry worldwide.
- 11. In 1991 the seat load factor (SLF - proportion of available seats filled) sank to about 57 percent in Europe. Lufthansa noticed the crisis later than most other airlines. In 1992 Lufthansa suddenly realized it was left with only 14 days of operating cash in hand. Weber approached all the major German banks and asked them for money to pay employee salaries. No private bank believed in Lufthansa’s survival. Only a state-owned institution, the Kreditanstalt für Wiederaufbau, agreed to fund the company. Realizing the need for a major change initiative, Weber invited about 20 senior managers to the training center at Seeheim for a “mental change” meeting – later called the “crisis management U sa ge p er m itt ed o
- 17. M -J U J9 K -P JM N 9I Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1 3 meeting” – to create an understanding of the urgency of the situation. The Seeheim workshop was repeated three times with different groups, each consisting of 50 managers, to let them feel the threat and urgency. The Seeheim experience persuaded most senior managers to commit to extremely ambitious goals. There were 131 initiatives identified
- 18. for reducing payroll and non- personnel costs – including downsizing the fleet – and increasing revenues. These initiatives were listed in the so-called “Programm 93.” By and large, a high level of consensus between management and other stakeholders was achieved and there were no strikes. In November 1993, 18 months after the initial crisis management meeting, the first results became visible. However, Lufthansa realized that much more had to be done to sustain long-term success. Even though the net result improved significantly it was still negative: -€46.8 million in 1993 (up from -€200 million in 1992; see Exhibit 6). Lufthansa began negotiating with the German government regarding its privatization—which was achieved in 1997, after having come to an agreement with the German government on pension funds. During the early 1990s Lufthansa had six departments (finance, personnel, maintenance, sales, marketing, and flight operations) each led by a member of the executive board. Top management was actively involved in operational matters leading to slow decision processes, low levels of
- 19. transparency, and a lack of accountability. Restructuring became necessary to reduce costs, respond quickly to market needs, and speed up decision making. Lufthansa concluded that it would be more successful as a federative group of small, independent units than as a functional, monolithic block. Ultimately, six businesses were spun off as legally autonomous, strategically independent subsidiaries (see Exhibit 1): Passenger business, LH Cargo AG (logistics), LH Technik AG (maintenance, repair and overhaul service), LH Systems GmbH (IT services), Thomas Cook (leisure travel), and LSG Sky Chefs (catering). Passenger business remained under the everyday influence of the top management, with more than 30,000 employees in the cockpit and cabin, at ground stations, and worldwide sales. In the mid 1990s after many of the “Programm 93” projects had been implemented, Weber decided to take the transformation process further. “Programm 15” was designed to make Lufthansa more competitive through cost management and cultural change, generating a cost-consciousness across all levels. The number “15” stood for 15 German pfennigs per SKO (“seat kilometers offered,” the
- 20. cost target for transporting one aircraft seat one kilometer). Lufthansa indicated it would reduce costs from 17.7 pfennigs in 1996 to 15 pfennigs in 2001, amounting to an overall cost reduction of 20 percent within five years. Line managers were made responsible for the cost reduction. As Lufthansa restructured itself, a pilots’ strike in 2001 came as a major setback. During the negotiations in the spring of 2001 the pilots’ labor union, Vereinigung Cockpit (VC), demanded an increase in salary of 30 percent and underscored its demands during a warning strike by threatening to take confrontational measures. Lufthansa’s management refused to make any voluntary U sa ge p er m itt ed o nl
- 26. -J U J9 K -P JM N 9I ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa 4 concessions whatsoever. A new wage agreement was finally concluded on June 8, 2001. However, the pilots’ strike had far-reaching effects on Lufthansa. The two- and-a-half-day strike cost Lufthansa €75 million and the additional permanent annual staff cost totaled about €125 million. Aside from this, the company’s culture, especially its community spirit, suffered great damage. The gap that had
- 27. already existed between the pilots and the ground crew widened. The discord came to a head on May 17, 2001, in the form of a counterdemonstration by the ground crew, who wanted to publicly demonstrate that the pilots’ strike was causing unrest within Lufthansa. D-Check In April 2001 Lufthansa’s management decided to introduce “D- Check,” a sequel initiative to “Programm 15” and the third major cost-oriented program in a decade. In an analogy to the regular D-Check of airplanes, the DLH D-Check called for a systematic “organizational check-up” to ensure the company’s competitiveness. The basic idea of the program was to take apart, test, and – wherever they proved risky or defective – exchange every “part” in the company. D-Check was designed to have a long-term impact and to focus on cash flows. The business units were asked to identify various risks (i.e., price fluctuations, sudden drops in load capacity, or infrastructural bottlenecks) to their business units in the next three years. By considering all these potential risks in sum, they then determined a worst-case scenario in which Lufthansa would have to generate €1
- 28. billion over the long term in order to prepare the Group for future risks. So D-Check’s purpose became to raise €1 billion over the medium term from June 2001 to May 2004. Though the program did not initially elicit high commitment, the outlook changed radically with the events of September 11. The consequences of 9/11 far exceeded the risks calculated. Lufthansa cancelled 233 flights during the four-day national airspace shutdown over the US. As a result, 56,000 passengers were unable to travel as scheduled. The number of passengers who did not show up also rose, sometimes even 50 percent more than on a normal business day. Additional costs were incurred for security measures at airports and in the planes themselves. The insurance companies cancelled the airlines’ coverage for war and war-like events within a few days after 9/11. The insurance companies hiked the rates for full war coverage by more than 10 times. For Lufthansa, basic coverage for the fleet alone was another financial burden of about €50 million. In the first few months after the attacks Lufthansa transported about 30,000 passengers per day,
- 29. about 25 percent less than usual. Demand fell particularly for first and business class, resulting in losses of €50 million per week. Other Lufthansa Group companies were hit hard, too. In particular, Lufthansa Cargo suffered dramatic losses. To manage the crisis, Lufthansa once again deployed several of the measures used during the turnaround in the early 1990s. Routes were reviewed for profitability and the route network reduced. Even before 9/11, Lufthansa had decided to downsize U sa ge p er m itt ed o nl y w ith in
- 35. -P JM N 9I Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1 5 its original flight offering and to withdraw 12 short-range aircraft from its fleet. However, Lufthansa chose to ground another four. The new policy put 20 of Lufthansa’s 236 aircrafts out of commission and people expected more to follow. As a reaction to the terrorist attacks and their economic consequences, DLH focused especially on rapid results and immediate cost cuts with an additional project D-Check acute, primarily focusing on systematic cost and multi-project management. In a short span of 17 days an action plan was
- 36. developed, presented to the labor unions, and approved by the executive board. Apart from capacity reduction, the action plan included other drastic measures, such as a freeze on capital investment and hiring. The greatest challenge was to cut down human resources costs in line with the law while remaining flexible and being able to quickly return the crew to full capacity once the crisis started wearing off. Unpaid vacation time and offering more part-time work were some of the measures introduced. The labor unions agreed to an extension of the wage agreement for ground and cabin crew and the postponement of the wage increase for cockpit personnel. The executive board waived off 10 percent of its salary. Other members and the non-tariff employees were asked to contribute 5 to 10 percent of their salaries to the crisis management efforts. Three-fourths of them did so. They were even encouraged to give up their Christmas bonuses temporarily and lend the same to the company at zero interest until August of the following year. Lufthansa was the only airline other than Air France not to dismiss some of its employees after September 11. This was possible only because of the D-Check
- 37. acute action plan. The security surcharges on tickets and cargo goods generated a cash flow of €530 million within three-and-a-half months. Despite the considerable efforts made to manage the crisis, Lufthansa reported a loss of €633 million for 2001. The European airline industry in 2001 The four largest airlines within Europe were Air France, British Airways, Lufthansa, and Royal Dutch Airlines (KLM), all of which had been set up in the 1930s or earlier. They had all joined airline alliances. Lufthansa was the founding member of Star Alliance, Air France had joined SkyTeam in September 1999, British Airways had joined OneWorld in September 1998, and KLM was partnering with Northwest Airline. All these airlines flew in the national, European, and global markets. Till the late 1970s almost all governments pursued policies to control strategic sectors of the economy. Airlines topped the list. However, during the late 1970s and early 1980s government thinking changed. Market-oriented ideas such as deregulation, privatization and competition became the flavor of the day. The US deregulated the airline industry in
- 38. 1978. Slowly but surely, the European airline industry evolved from being public utilities companies, run by government agencies, to market-driven companies. Fares went down drastically as competition intensified. Low-cost U sa ge p er m itt ed o nl y w ith in th es e pa ra
- 44. ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa 6 carriers (LCCs) introduced innovative business models. Yet deregulation in Europe, in terms of increasing competition and privatization, did not go as far or as fast as in the US: government influence on the operations of the airline industry remained strong. Landing rights, related time slots, and other privileges were still awarded by government institutions. So established players like British Airways or Lufthansa controlled 38 percent and 60 percent respectively of the total slots at their hubs at London Heathrow and Frankfurt am Main. Airports in Europe were mostly state owned, though privatized state and local governments played a major role in expanding capacity by building new runways and providing the related infrastructure. Governments were also responsible for negotiating “open sky agreements” which regulated air traffic between countries.
- 45. After September 11 the European airline industry faced a serious crisis. Sabena, the Belgian flag- carrier had to close down its operations. Sabena’s main shareholder, Swissair, went through restructuring and survived only with massive support from the Swiss government under the umbrella of Crossair as a new, much smaller national airline. Most European Airlines laid off thousands of people during 2002. British Airways (BA) cut 7,000 jobs, which represented approximately 12.5 percent of its total workforce. United Kingdom Alongside the 9/11 effect, the growth of low-cost carriers presented a major threat to the European incumbents: in terms of penetration, the UK was the most affected. Although Ryanair was Irish, London Stansted was its most important base. easyJet, established in 1996 out of London Luton, became the leader in the LCC segment. In January 2002 the LCC share of international routes involving a British airport was 25 percent, and only three percent on routes that did not involve a British airport. As a result, BA was the company most immediately affected by the growth of the
- 46. LCCs. Domestic and European international operations accounted for 10.3 percent and 28.1 percent of BA’s 2001 turnover respectively. Damage was most noticeable on the secondary routes (e.g., London to Genoa), where BA permanently lost 12 to 55 percent of its passengers. The LCCs threatened incumbents in terms of both market share and yield. One example was the London-Glasgow route. Before easyJet and Ryanair’s entry in 1995 and 1997, respectively, BA had enjoyed a duopoly on the route with British Midland, garnering the vast majority of the market share. By 2000 BA’s market share had fallen to 50 percent. In May 2001 BA’s share dropped to 39 percent with Ryanair grabbing 20 percent, easyJet 15 percent, and Go six percent. Faced with intense price pressure, in April 2002 it announced a significant price reduction, offering tickets up to 70 percent cheaper – although Ryanair was still 50 percent cheaper than that (tax excluded). The entry of LCCs substantially expanded the market. Route profitability usually recovered three years after the low- cost entry, although average yield was permanently 20 percent lower than the original level.
- 52. ig ht e nc od ed A 76 H M -J U J9 K -P JM N 9I Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1
- 53. 7 In Europe, BA became the first incumbent to adopt the low-fare business model in May 1998. It invested £25 million to set up its own low-fare subsidiary, Go, based in London Stansted. BA gave the subsidiary full autonomy. Go sought to differentiate itself from its rivals with better customer service. For example, passengers could buy better food and beverages on board. It was the first LCC to launch full-scale television advertising in the UK. easyJet reacted aggressively to the news, claiming that the move was anti-competitive and aimed at eliminating LCCs. It filed a series of court cases against Go, alleging that BA was subsidizing its insurance, advertising, aircraft leasing, and other services. easyJet even started a promotion campaign that offered free flights to customers who correctly guessed Go’s first year losses. After Go’s entry, Ryanair immediately lowered its fares from London Stansted. In September 1999 nine of the 17 (53%) routes operated by Go were in head-on competition with either Ryanair (one route),
- 54. easyJet (four routes) or Debonair (five routes). In contrast, easyJet had only five of its 23 routes (22%) in head-on competition with other LCCs and Ryanair only two of its 34 routes (6%). Go sustained pre-tax losses of £20 million and £21.8 million in the financial years ending March 31, 1999, and March 31, 2000. But the situation improved rather swiftly and the company recorded its first profitable quarter in September 1999, moving into profit in 2001. However, just as there were indications of a turnaround, BA decided to sell it off. In 2002 easyJet acquired Go for a net price (discounting cash within Go) of £257.6 million. In January 2000 KLM converted its British regional subsidiary, KLM-UK, into Buzz, a low-cost airline based at London Stansted. Despite strong growth in traffic, it never recorded a profit. Its fleet of BAe 146s put the airline at a cost disadvantage relative to those LCCs operating more efficient jets. In January 2003 Buzz was sold to Ryanair for just €5 million net. France LCCs first arrived in France in 1996, when easyJet and Virgin Express launched new routes to Nice from London Luton and Brussels respectively. Ryanair was the
- 55. first to fly into Paris in 1997 from Dublin using the Beauvais airport located 70km north of the city center. In subsequent years, new routes to France steadily emerged. In March 2003 Ryanair operated 10 routes connecting London Stansted mainly with small towns served by no other airlines, like Pau, Carcassonne, and Perpignan. easyJet, on the other hand, was more focused on high-density routes, flying five routes into Paris. Its applications to start a base at Paris’ Orly airport were regularly turned down by the French government due to lack of slots. In February 2002 Air Lib, a loss-making French regional airline, established a low-fare subsidiary, AirLib Express. Based in Orly, it focused on domestic routes. Despite some promising early results, Air U sa ge p er m itt ed
- 61. H M -J U J9 K -P JM N 9I ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa 8 Lib failed to overcome a financial crisis and filed for bankruptcy in February 2003. In April 2003 the French government allocated the freed slots at Orly to several airlines including Virgin Express and, finally, easyJet. Air France’s reaction to low-cost entry seemed relatively
- 62. moderate. Aggressive responses and cut- throat price wars were not on its agenda. In September 2002 it launched several promotions and rebate programs for frequent travelers on peak-hour flights and one-month advance bookings. Since 2000 Air France had consistently outperformed its European counterparts financially, particularly in the international arena. The Paris airport overtook London Heathrow to become the busiest hub in Europe. Air France attributed its strong performance to a combination of factors including the superior results and financial strength of Delta Air (its partner in SkyTeam) over United Airlines and American Airlines. Air France had its eye on expansion, with plans to grow SkyTeam by absorbing the KLM/Northwest/Continental group. In February 2002 the French and Italian governments agreed on a two percent equity swap of their flag- carriers, prompting rumors of a merger between Air France and Alitalia. Business models Low-cost carriers (LCCs) LCCs emerged in the US after deregulation. The profitable growth of Southwest in the US led to
- 63. imitation in Europe. After visiting Southwest in 1991 Michael O’Leary, the CEO of Ryanair, adopted Southwest’s business model. O’Leary turned around Ryanair from the brink of bankruptcy to profitability by 1992 and within 10 years multiplied the revenues by 12. Ryanair’s success quickly lured other LCCs, including easyJet (1995), Debonair (1995), Virgin Express (1996), Go (1997), Buzz (2000), and others. The penetration of LCCs on all intra-EU capacity grew from 3.7 percent in July 1998 to six percent in July 2000 and 12 percent by the end of 2002. LCCs were different from full-service airlines in various ways. The most significant cost saving related to the higher seating density, achieved through the use of all- coach seats and less space between rows. Faster aircraft turns, through simplified boarding, disembarking, and servicing processes represented a major process innovation. Online sales also led to major cost savings. Catering costs were reduced, as there were no in-flight meals. Snacks were offered in-flight, but the passengers had to pay for them. Check-in was manual, there was no business lounge, and metal stairs were used for
- 64. boarding instead of air bridges. They generally did not provide refunds for delays or cancellations. U sa ge p er m itt ed o nl y w ith in th es e pa ra m et er
- 69. op yr ig ht e nc od ed A 76 H M -J U J9 K -P JM N 9I Dealing with low-cost competition in the airline industry (A):
- 70. The case of Lufthansa ESMT–315–0165–1 9 LCCs like easyJet often started as “virtual airlines” in terms of operations. Ground operations and maintenance were outsourced, which increased flexibility and reduced the number of direct employees to save costs. LCCs usually used only one aircraft type, typically the Boeing 737 or the Airbus A320. With fleet standardization, LCCs could cut flight crew, maintenance, and training costs. LCCs avoided the complexity of creating connections and hence saved on baggage handling costs. It was not necessary for LCCs to cover against delays on incoming flights or to build time slack between flights to allow for connections. With point-to-point operations, LCCs did not have to reposition flights. They could operate on a tighter schedule and also experiment with new markets because of the short flight lengths. LCCs typically managed with only one maintenance base and did not leave aircraft outside their operation bases overnight. This further avoided costly duplication of facilities
- 71. and housing the crew when abroad. LCCs generally flew from secondary airports close to large cities. These airports, despite being remote and offering few interconnections, were acceptable to many price-sensitive passengers. LCCs could obtain slots easily. Since these airports usually welcomed new business, LCCs were in a stronger position to negotiate favorable deals. Most LCCs were start-ups and unburdened by legacy costs and Labor costs were lower as crew wages were linked to productivity. FSCs had high base-salary levels, generous pensions, and inflexible labor conditions. LCCs were also not forced to fly on loss-making routes for political or prestige reasons. LCCs enjoyed relative protection from business cycles, since in hard times demand for premium service tended to decline as more passengers sought less expensive travel alternatives. However, the low-cost business model faced various concerns like low passenger comfort and uncertain consequences of future expansion. The service provided by LCCs was too basic for many travelers. Business travelers in particular were often ready to pay a higher
- 72. price for a better quality as these were often company-paid trips. Also, they did not tend to accept the cancellation of flights due to low load factors. The exclusive use of secondary airports was not always in the travelers’ best interest. There was also suspicion about the safety of LCCs. The media had accused pilots of ignoring instructions from the tower. Pilots also seemed prepared to do almost anything to save time. But supporters of the LCCs dismissed these arguments, pointing out that the world’s biggest and oldest LCC Southwest Airlines had not caused one death through accidents in its 32-year history. Meanwhile, the way LCCs were aggressively adding new destinations might also lead to problems in the long run. Both Ryanair and easyJet announced massive orders of planes in 2002. Ryanair intended to increase the number of passengers from more than 10 to 40 million and ordered up to 150 new Boeing 737-800 planes to be delivered by 2010. LCCs also pursued acquisitions to establish dominant leadership positions in the European market. However, as LCCs became larger, there was a possibility that airports might no longer grant them low landing fees.
- 78. ig ht e nc od ed A 76 H M -J U J9 K -P JM N 9I ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa
- 79. 10 Full-service carriers Full-service carriers (FSC) offered a broad range of destinations including all distances, from short haul to long haul, and usually followed a premium pricing policy based on high quality and service standards. Examples were United Airlines, British Airways, Lufthansa or Japan Airlines. Such FSC airlines typically used a hub-and-spoke system. Hub-and-spoke meant flying passengers from feeder cities on the spokes of the system into a larger central hub, from where they were redirected onto a flight to their final destination. Thus, multiplier effects in terms of the number of connected cities and load factors on the long-haul routes were gained. In addition to that they created linkages to other airlines through alliances. Typical features of such alliances included code sharing, that is, sharing routes and slots among member airlines, the mutual acceptance of frequent flyer programs, and common quality and service standards. The major challenge for these airlines was to maintain high load factors. To improve the economics
- 80. of their flight operations, all major airlines were working with yield management systems, which helped them to sell spare capacity at discounted fares. Hence, airlines created a large number of booking categories, each with a specific price and conditions. Profitability depended to a large extent on the load factor and the share of business class travelers. Thus, American Airlines, BA or Lufthansa, for whom high-yield business travel historically constituted a major portion of business, were particularly suffering from a weak rebound in business travel after 9/11. Apart from less business people traveling, Lufthansa also observed that business travelers were increasingly switching to LCCs. FSCs were fighting to restore profitability and pondered over how to react to low-cost competition. Almost all carriers had initiated substantial cost- rationalization programs mainly in terms of capacity and schedule reductions, however, it was not only Lufthansa that had already picked the low-hanging fruit in the past by conducting three consequential cost-cutting programs. The response of the full-service carriers to LCCs was rather mixed. BA and KLM entered this business
- 81. aggressively with their own low-cost subsidiaries GO and Buzz. But synergies were obviously difficult to reach. Consequently, both airlines divested their low-cost operations. The major players raised capacity on low-cost routes and offered deep discounts for unsold seats in off-peak times. BA and Lufthansa radically simplified their fare structures to keep business travelers from defecting to low- cost competitors and to steal market shares from alternative transportation solutions. In August 2002 BA offered tickets, priced almost 80 percent below comparable fares offered in June. The German airline market German domestic flights were 20 percent more expensive than the European average. But after December 1992 any airline with a majority European shareholding was eligible to run an airline and was free to fly on any route between two EU countries. By 1997 EU airlines were allowed to operate U sa ge p er m
- 87. A 76 H M -J U J9 K -P JM N 9I Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1 11 domestic flights in any EU country. Both new start-ups and incumbent airlines geared up to compete after deregulation. Eurowings charged $250 for its Nuremberg- Cologne route, compared to
- 88. Lufthansa’s $414 in 1997. In 2001 Eurowings recorded an annual passenger volume of 3.5 million. In January 2001 Lufthansa acquired 24.9 percent of Eurowings and converted it into an operating partner with an option to increase its stake further to 49 percent. BA launched its German subsidiary Deutsche BA (DBA) in 1992 to counter Lufthansa on the main domestic routes. This led to a fierce price war. For example, DBA offered the Hamburg-Munich service at DM 650, over 30 percent lower than Lufthansa’s price of DM 950 (which was later reduced to DM 840). By 1997 DBA had become Lufthansa’s biggest domestic competitor. DBA captured 15 percent of the market, while Lufthansa still held 80 percent market share. In reply, Lufthansa teamed up with franchises like Augsburg Airway to lower its operating costs. Germany’s specific circumstances also provided additional protection. In 2003 Germany had only 30 civil airports, France had 69, and the UK had 55. Most German cities had only one airport, which was also usually congested. Entrants often found it difficult to obtain landing slots, which reduced
- 89. competition on certain routes. For instance, on the Frankfurt- Berlin route, which had no competition, Lufthansa priced its tickets at about DM 900 per round trip. But on the competitive Cologne-Berlin route, which was a little longer, the ticket was priced at about DM 700 in 1997. The LCC challenge in Germany remained insignificant during the 1990s. Debonair was the first entrant in 1996, a short-lived start-up airline based in London Luton. In 1999 Ryanair entered Germany by flying to Hahn, 120km east of Frankfurt. easyJet flew to Germany once it inherited Go’s only German route, Stansted-Munich, in the merger in 2002. In 2001 Ryanair announced that it would upgrade its operation in Frankfurt Hahn into an operation base in February 2002. Ryanair undercut competitors’ fares by more than 50 percent. Throughout 2002 Ryanair expanded its routes to and from Frankfurt to 14 and carried about 2 million passengers on those routes during its very first year of operations. On August 29, 2002, TUI launched Hapag-Lloyd Express (HLX) with the slogan “Flying for a price of a taxi.” HLX started its operations in December 2002 with eight Boeing 737-700 aircraft chartered from
- 90. Germania (also a TUI subsidiary). Initially based in Cologne- Bonn, HLX quickly added a second base in Hanover. By March 2003 HLX was operating 14 routes connecting to Cologne and 11 to Hanover. Even other existing players were attracted by low-fare air travel in Germany. In October 2002 Air Berlin launched a scheduled travel product: the “City Shuttle.” It connected 11 major European cities and seven German airports using Boeing 737s. This airline did not follow a typical “no-frills” operation model. It offered in-flight catering, seat reservations, distribution through travel agencies, U sa ge p er m itt ed o nl y w
- 96. J9 K -P JM N 9I ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa 12 and a loyalty plan. But the airline was able to compete with other LCCs and maintain a competitive ticket price because of lower labor costs. Future outlook In May 2002 Lufthansa started another experiment by offering 6-times-per-week dedicated business flight services between Dusseldorf and Newark. The flights were operated by a charter company, PrivatAir, which used Boeing 737 aircraft with only 48 seats. Lufthansa announced satisfying results
- 97. and planned to offer similar services on the Chicago-Dusseldorf and Newark-Munich routes. And for the winter season 2002-03, Lufthansa announced cheap flights within Germany as low as €98 compared to the previous €143 (including airport taxes). But despite these individual initiatives, Lufthansa realized that it had to make a decision to respond to the emerging low-cost challenge. U sa ge p er m itt ed o nl y w ith in th
- 103. JM N 9I Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1 13 Exhibits Exhibit 1: Deutsche Lufthansa: Business segments Lufthansa was comprised of several business segments that covered its various markets and value chain activities. Passenger transportation Passenger services constituted Lufthansa’s core business, generating more than 60 percent of revenues. Lufthansa’s aim was to expand into Europe and become a leading network carrier. Lufthansa hoped
- 104. its multi-hub strategy, centering on Frankfurt and Munich, would fuel growth through increased frequencies. Logistics Lufthansa Cargo, in charge of airfreight and the marketing of air cargo capacities, was a leading provider of logistics services in the airport-to-airport segment and was fueling its growth with profitable premium and general cargo services. In the face of increasing competitive pressures, the company had launched an “Excellence + Growth” program aimed at ensuring lasting and profitable expansion. The program was designed to transform the company into a process-oriented organization with leaner internal structures, including the shedding of 10 percent of existing jobs. Processes were integrated and tightened in a bid to improve the procurement of services, network optimization, sales, yield management, and pay settlements. Maintenance, repair, and overhaul (MRO) business Integral to the MRO group’s strategy was business expansion with airlines outside the Lufthansa Group. A key element in that policy was the internationalization
- 105. of production activities. By broadening the geographic reach of its production facilities, Lufthansa Technik was getting closer to customers, harnessing lower local cost structures to reduce unit costs, and lessening the effect of currency movements on its results. The group was not only committed to the MRO business, it also developed new products. Catering By 2001 DLH had fully integrated the former partner “Sky Chefs” into the “LSG” resulting in “LSG Sky Chefs” as part of the Lufthansa Group. LSG Sky Chefs was the world’s biggest in-flight caterer. Since 9/11 the market had contracted by 30 percent and most of all in the Americas, where the business volume had slumped by more than 40 percent. Whereas American carriers were offering in-flight food on 7,700 intra-American flights in the year 2000, that number had dipped to just 900 flights, daily, in U sa ge p
- 111. ed A 76 H M -J U J9 K -P JM N 9I ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa 14 2004. The LSG Sky Chefs group was consequently in the process of restructuring in the changed industry environment.
- 112. Leisure travel The Thomas Cook leisure travel group’s (owned half-and-half by Lufthansa and Karstadt Quelle) major sales markets were Germany, the United Kingdom, France, and the Benelux countries. It was active in new markets in Eastern Europe, Egypt, India, and Canada. The crisis in the leisure travel business impacted the group in a difficult phase – immediately after its takeover of Havas Voyages in France (2000) and Thomas Cook in the UK (2001). Fierce price pressures and weakening demand for holiday travel since 2001/02 plunged the group into heavy losses. IT services Lufthansa Systems, together with its network of affiliates, managed to reinforce its global presence in 2000. By the end of 2001, besides Germany, Lufthansa Systems was represented at 17 locations in 13 countries. Lufthansa Systems was focused on the airline and aviation market. In this field, the company possessed proven process know-how and would further expand its position as a full-service IT provider on an international scale. The systematic extension
- 113. of its market orientation by strengthening its service portfolio along the business segments and its internationalization through a concept of distribution based on geographical areas would help to move this process forward. Service and financial companies The activities of the Lufthansa Group were supported by service and financial companies. These included Lufthansa Commercial Holding GmbH (in Cologne), Lufthansa AirPlus Servicekarten GmbH (in Neu-Isenburg), Lufthansa Flight Training GmbH (in Frankfurt), and diverse financial companies. U sa ge p er m itt ed o nl y
- 119. U J9 K -P JM N 9I Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1 15 Exhibit 2: D-Check result up to December 2001 Notes: Figures in million euros. In the year 2001 D-Check supported by D-Check acute has achieved an extra cash flow of €127.2 million. Source: Lufthansa Group (2002). Annual report 2001. http://investor-relations.lufthansagroup.com/ fileadmin/downloads/en/financial-reports/annual-reports/LH- AR-2001-e.pdf (accessed June 26, 2015).
- 125. yr ig ht e nc od ed A 76 H M -J U J9 K -P JM N 9I ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa
- 126. 16 Exhibit 3: Lufthansa key data 2001 2000 Change in percent Revenue €m 16,690 15,200 9.8 of which traffic revenue €m 12,253 12,549 –2.4 EBITDA €m 1,448 2,598 –44.3 EBIT €m –292 1,547 –118.9 Loss/profit from operating activities €m –316 1,482 –121.3 Net loss/profit for the period €m – 633 689 –191.9 Operating result €m 28 1,042 –97.3 Capital expenditure1) €m 2,979 2,447 21.7 Operating cash flow €m 1,736 2,140 –18.9 Total assets €m 18,206 14,810 22.9
- 127. Shareholders’ equity €m 3,498 4,114 –15.0 Average number of employees 87,975 69,523 26.5 Staff costs €m 4,481 3,625 23.6 Losses/earnings per share € –1.6 1.81 –191.7 Dividend per share € 0.60 100.0 Creditable corporation tax € 0.26 100.0 1) Capital expenditure without results of joint ventures and associated companies accounted for under the equity method. Previous year’s figures not comparable due to changes in the group of consolidated companies. Source: Lufthansa Group (2002). Annual report 2001. http://investor-relations.lufthansagroup.com/ fileadmin/downloads/en/financial-reports/annual-reports/LH- AR-2001-e.pdf (accessed June 26, 2015). U
- 133. ht e nc od ed A 76 H M -J U J9 K -P JM N 9I Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1
- 162. 9I ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa 18 E x h ib it 4 : G e o gr a p h ic i n
- 195. M -J U J9 K -P JM N 9I Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1 19 E x h ib it 5
- 230. ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa 20 – o f w h ic h f ro m in ve st m e n ts a cc o
- 273. Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1 21 E x h ib it 6 : T e n -y e a r st a
- 308. ESMT–315–0165–1 Dealing with low-cost competition in the airline industry (A): The case of Lufthansa 22 N e t w o rk in g ca p it al (c u rr e n t a ss
- 354. Dealing with low-cost competition in the airline industry (A): The case of Lufthansa ESMT–315–0165–1 23 E x h ib it 6 : T e n -y e a r st a ti st ic
- 427. JM N 9I ASSIGNMENT, N1588, CASE STUDY MODULE ASSESSMENT GRID FOR SECOND ASSESSMENT CRITERION A Excellent . >70% B+ Good 65- 68% B Good 60-64% C Satisfactory 50-58% REFER/FAIL <48% Presentation & style 10% 1 5% Presentation Polished and imaginative approach. Clarity of message and information. Excellent formatting, use of white space, numbering & bullets. Excellent use of graphs and diagrams to support argument. Carefully and logically organised with clear message and visual effect. Good use of white space, numbering & bullets. Good use of graphs and diagrams to support argument. Shows organisation and coherence. Visual aspect of presentation is good with adequate use of white space, numbering & bullets. Good use of graphs and diagrams to support argument.
- 428. Shows some attempt to organise in a logical manner but lacks structure or visual impact. Patchy, inappropriate or absent use of graphs and diagrams to support argument. Disorganised/ Incoherent. Not all material is relevant. Presence of irrelevant material. Poor or absent use of graphs and diagrams to support argument. 2 5% Clarity of expression (incl. accuracy, spelling, grammar, punctuation) Fluent writing style appropriate to a Business Report. Language fluent Language fluent Meaning apparent, but language not always fluent Meaning unclear and/or grammar and/or spelling contain frequent errors Content and knowledge 70% 3 Structure of the market: sector, competitors, consumers, company. Analysis of global/regional competitive forces, based on strategic and financial analysis of firms. Good understanding of the effect of historical and cultural issues on a company’s ability to compete. Comprehensive/detailed knowledge of how market power is shared. What the drivers are of this structure.
- 429. Excellent grasp of the implications of the issues of scale. Excellent understanding of the issues of how historical and current culture and structure affect a company’s ability to complete. Excellent use of financial and strategic analysis to support this discussion. Excellent reading and citations. Good knowledge of how market power is shared. What the drivers are of this structure. Good grasp of the implications of the issues of scale. Good understanding of the issues of how historical and current culture and structure affect a company’s ability to complete. Good use of financial and strategic analysis to support this discussion. Good reading and citations. Mostly good knowledge of how market power is shared. What the drivers are of this structure. Mostly good grasp of the implications of the issues of scale. Good understanding of the issues of how historical and current culture and structure affect a company’s ability to complete. Mostly good use of financial and strategic analysis to support this discussion. Good reading and citations. Patchy knowledge and discussion of how market power is shared. What the drivers are of this structure. Mediocre discussion of the implications of the issues of scale. Mediocre discussion of the issues of how historical and current culture and structure affect a company’s ability to complete. Patchy use of financial and strategic analysis to support this discussion. Patchy/ limited reading and citations. Poor or absent knowledge and discussion of how market power is shared and what the drivers are of this structure. Poor or absent discussion of the implications of the issues of scale. Poor or absent discussion of the issues of how historical and current culture and structure affect a company’s ability to complete.
- 430. Poor or absent use of financial and strategic analysis to support this discussion. Poor or very limited reading and citations. Overall thinking & analysis 20% 6 20% Intelligent and informed commentary on industry analysis. Good information drawn from financial, strategic, and cultural sources, with an understanding of how these affect the ability to compete. Excellent commentary on the questions, drawing meaning from financial, strategic and cultural sources. Good commentary on the questions, drawing meaning from financial, strategic and cultural sources. Reasonable commentary on the questions, with reasonable intelligence extracted from financial, strategic and cultural sources. Limited and mediocre commentary on the questions, with limited intelligence extracted from financial, strategic and cultural sources. Very little, poor quality commentary on the questions, with very little intelligence extracted from financial, strategic and cultural sources. Presentation of data in place of intelligent discussion. 3000 words QUESTIONS FOR LUFTHANSA CASE ANSWERS TO QUESTIONS ARE TO BE BASED ON DATA
- 431. UP TO AND INCLUDING 2002 ONLY ANY DATA THAT IS USED AFTER 2002 WILL LOSE MARKS · WHAT WERE THE REASONS FOR THE FAILURE OF BA’S AND KLM’S LOW COST STARTUPS GO AND BUZZ? You might like to think about the areas of culture, financial structure, and operations in answering this question. 20% · IN 2002, WHO WERE THE DOMINANT LOW COST CARRIERS IN EUROPE? WHAT MARKET SHARE DID THEY HAVE? (please be sure to distinguish market share by passengers from market share by turnover in your answer) WHAT WAS THE SIZE OF THE LOW COST CARRIER MARKET? HOW HAVE THESE MARKET SHARES DEVELOPED OVER TIME TO 2002? 20% · PLEASE COMPARE AND CONTRAST THESE DOMINANT LOW COST CARRIERS AGAINST EACH OTHER (you might like to think about issues like culture, management, finances, profitability, operations, experience). BASED ON THIS COMPARATIVE ANALYSIS, PLEASE IDENTIFY THE COMPETITOR THAT IS THE BEST PREPARED FOR FUTURE COMPETITIVE SUCCESS : please make sure you provide solid evidence for your forecast 20% · BASED ON THE ABOVE ANALYSIS, WHAT WOULD YOU ADVISE LUFTHANSA TO DO, TO 40% ADDRESS THE THREAT OF LOW COST CARRIERS? Please make sure that you give your proposed actions a full discussion, bringing in as evidence to justify your recommendations data from the case and your above analysis, plus other data you have obtained from your research. Please rank suggestions, and provide a full discussion for each one’s place in the ranking. Please provide
- 432. your assessment of how successful you expect this recommendation to be (or not), and why. Please also provide a time frame for your recommendations, and the major steps in achieving them, preferably in a GANTT chart) SOME GENERAL NOTES ON REPORT WRITING (much of this does not apply to your Case Study report) 1.0 EXECUTIVE SUMMARY 1.1 Introduction (no executive summary required for Case Study 2018) Generally, when writing reports, I suggest you use an Executive Summary. In business life you will find that people do not have the time to read extensive reports. They will read a short summary and then scan the main report & any appendices for points of interest. This means you have to ‘sell’ your report on the Executive Summary. 1.2 Content The Executive Summary should include a summary of the ‘brief’, that is the objective(s) of the report and any special issues that you have been asked to investigate. If the Report involves research, you should identify your methodology briefly. Don’t discuss it, just state it. If it involved telephone interviews or on-line research, say so. Give it an appropriate heading such as Research Methods. Identify your main research findings. List them using numbering or bullet points. Keep your findings brief and totally
- 433. relevant to the brief. Again, give this section a heading. Do not use jargon. It is better to say Key Performance Indicators rather than KPI’s, as long as you do not have to use the phrase intensively. If you do, then introduce it in its long form, and after this (KPI). 2.0 STRUCTURE 2.1 Style Your report should be: · Easy to read · Lucid, well written, with no typographical errors · Visibly appealing · Crisply worded · Well structured with numbered sections Use white space and avoid visually intense & long paragraphs. Separate paragraphs with a space. Use bullet points as above to identify a number of issues or topics and then address them one at a time. This enables the reader to see your structure at a glance. Keep your paragraphs short and crisp. Don’t drift away from your key argument. Don’t use ten words where five will do. 2.2 Numbering You can use mathematical numbers in your text as this is a Business Report. It is not an essay. Structure your report sensibly. For example, 1.2 is acceptable but 1.2.1 is unnecessary. Make sure your numbering is consistent throughout the Report.
- 434. 2.3 Excessive detail Give numbers in the main body of the report if they are necessary to follow the argument you are making. If they are merely supporting data, put them in the appendices. Don’t give more detailed information than is necessary. In giving numerical data you may be advised to round large numbers to make them easier to absorb. For example: 2006 Sales £3,768,789.45 is too complex. 2006 Sales £3,769k. or £3.8m. may be much clearer, where: · £k. K means thousand · £m. M means million Make sure that you report the sector, market or demand statistics appropriately. For instance, if you are discussing the mobile phone market, if you report it in financial terms, that will not represent realistically the split by usage between smartphones and dumbphones. It would be better to report this market, for instance, in terms of units, and also in terms of revenue. 2.4 Using tables It may be better to use tables or charts to give summary information. Don’t add more information (numerical data) than is necessary to illustrate your point. You can provide the full
- 435. table as an Appendix. 3.0 COMMENTS RELATING TO THE BUSINESS STRATEGY REPORT 3.1 General points Don’t lose sight of the purpose of this coursework. It is to show your understanding and real life application of competitive and strategic analysis. Introduce the frameworks, tools, concepts etc as you use them. We need to see that you understand them but we don’t need to see a description of, for example, the meaning of Porter’s 5 forces or Ansoff’s matrix. We do need to see you apply them (if you feel they are appropriate). There is nothing to be gained by including analysis tools just for the sake of including them. You should not need to describe any strategy jargon or methodologies. 3.2 The Word Count Tables, charts, contents page & appendices are not part of the 500 or 3000 word count. Markers have been asked by the university to take off marks if the word count is exceeded. This is also useful discipline for your business /professional life. 3.3 Relevance Be ruthless in looking at your work to see if every paragraph is
- 436. relevant. Does it add value or is it irrelevant ‘padding’. Are you using strategy theories, concepts, methods etc that do not have much to add to your analysis? If so, cut them out. Lisa Blatch N1588 Case Study module University of Sussex