A clock in the reception of British Airways’ Waterside headquarters counts down the days to the London 2012 Olympics, in recognition of the UK carrier’s role as official airline of the London games. But for chief executive Keith Williams and his management team, a more crucial countdown began on 19 April. For that was when parent International Airlines Group concluded the acquisition of British Midland International, firing the starting pistol for what is probably BA’s biggest integration challenge ever.
Williams is excited by the prospect of the London Olympics and is confident that BA will benefit from having renewed its association with the global sports event on its return to the UK. “British Airways [through its predecessors] had an involvement with the Olympics back in 1948 when it was in London, and roll on 64 years and its back here. It’s a big event for the UK, and BA is part of the country’s heritage so we’re an ideal fit.”
While the games are likely to put a “slight damper on business traffic” to the UK as corporates will advise staff to avoid London or work from home, Williams sees long-term benefits from the association: “You get the halo effect of the Olympics for Britain and for British Airways of the business going forward.”
But there is no disguising that Williams feels like he’s already landed a gold medal with the acquisition of BMI. For Williams, who was promoted from CFO in January last year when Willie Walsh moved up to head the newly created IAG umbrella company as part of the merger with Iberia, BMI has been a long-awaited prize.
The acquisition by the Oneworld alliance founder member of BMI from Star Alliance rival Lufthansa magnifies BA’s already dominant position at its London Heathrow base. It provides BA with an immediate 8% capacity boost at what is one of the world’s most growth-limited airports after a decade of decline. But even without the BMI deal, BA was gearing up for expansion, as it looks to leverage the significant cost reductions it has been progressively implementing.
“Between 2001 and 2010 we reduced the amount of flying by about 20% in ASK terms. That capacity reduction came from a mix of disposing of non-profitable subsidiaries like Air Liberte and Deutsche BA, and ceasing unprofitable flying. And some of that flying was unprofitable due to our cost structures,” says Williams.
“Over that period the number of employees fell from 60,000 to 35,000 and the productivity improvement was about 50%. Unfortunately a lot of that cost improvement was eaten up by fuel price increases.
“But if you look at the business, last year we achieved a 5.5% operating margin in a pretty sluggish economy, and that’s as a result of the restructuring we’d done over the last decade. We’ve also set in place future cost structures – the ‘Mixed Fleet’ cabin crew agreement being a good example – which will allow us to fly to places that we’d previously been uncompetitive.”
Mixed Fleet crewing was introduced in 2010, combining long- and short-haul operations, meaning that it offers crew a broader mix of routes but on lower salaries and benefits.
“So for the first time in a decade you’re seeing BA grow, and this is being accelerated by the acquisition of BMI,” Williams adds.
He says that some of the big improvements over the last decade have been around labour and distribution costs – for example, the BA.com website made a big difference to selling capability and now accounts for 30% of business.
“Labour costs have remained relatively flat over the last 10 years, distribution costs have more than halved, but fuel costs have gone up,” he adds.
The chief executive’s immediate priority is to integrate BMI – and it is no secret that he and his colleagues have had their eyes on their Heathrow neighbour for some time.
“BMI has always been a positive opportunity for British Airways, and the combination [of the two] is a positive for UK aviation. But against that, the fact is that [BMI owner] Sir Michael Bishop had the put option on Lufthansa, so because of that relationship over the last seven, eight or nine years Lufthansa had always been in pole position,” Williams says.
So Lufthansa became owners of BMI when Bishop sold up, but was unable to take advantage of the UK airline’s prized position as number two at the world’s biggest international hub.
“Lufthansa came to the sensible conclusion – for me – in terms of setting up a secondary hub at Heathrow [that this] was not the right place to be, and made a sensible decision to dispose of it.”
Williams says he never thought that Lufthansa could make a success of its BMI acquisition, but concedes that four or five years ago, when Lufthansa did the BMI deal, the industry was operating in a different environment. “Back then growth was expected, and this was an opportunity to grow. If you look at where the industry is today, it’s clear in Europe that growth isn’t going to be as fast as it was, so Lufthansa made the sensible decision to offload it.”
But having seen its parent IAG grabbing BMI with both hands, BA now has the job of turning the loss-making business into a success through the speedy integration into its Heathrow operations. “It’s a good opportunity but at the same time you’ve got to recognise that this is a business that lost more than £150 million ($232 million) last year – it’s losing £3 million a week and that’s before you take account of the full oil price increase, so in reality its probably losing £200 million a year. And turning that around needs quite a lot of change - and that [change] needs to happen relatively quickly.”
IAG expects BMI will start contributing positively by 2014, and to add €100 million at an operating level in 2015.
Although it has its roots firmly in BA’s foundations, the BMI acquisition was in fact the first concluded under the new structure whereby parent IAG pulls the strings.
IAG agreed to pay £172.5 million for BMI – a figure that is still subject to a discount for having to take the unwanted BMIbaby and Regional. Lufthansa acknowledges that the final price will be “clearly negative”.
“It was very much a decision by IAG to acquire BMI. The strategy is performed by IAG. IAG saw great sense in acquiring BMI provided it was on the right terms,” says Williams. “For BA it meant that I needed to convince IAG that the best way of structuring that business going forward was within British Airways. Given the scale of the losses at BMI, part of the BMI acquisition is about changing structures within British Airways as well as at British Midland.”
MAN WITH A PLAN
Williams says that as part of his bid to IAG, BA entered into agreements with its pilots regarding seniority lists, to enable the BMI merger to work. “So there were a lot of discussions within BA to ensure that we could get a bid to buy the business from IAG to make it work for BA.”
Following the initial agreement between IAG and Lufthansa in December last year, Williams says that BA effectively “put together a plan to buy BMI” from IAG once the deal was completed.
Since the deal was consummated on 19 April, Williams and his management team have been working hard to address the losses at BMI and formulate an integration plan.
“There are three ways to improve the business: looking at the costs, the network opportunities and the strength of BA’s selling,” says Williams.
The golden prize is BMI’s batch of 42 daily slots, and over time “a quarter to a third” of these will be moved to long-haul routes. The first phase of this transition was unveiled in May, with the announcement of a new route to Seoul which begins in December.
“We were always pot-bound at Heathrow because of the lack of slots. What BMI does is give us the slots to grow the long-haul destinations as well as giving us more of an opportunity for feed from the BMI short-haul aircraft. So overall we’ve got cost savings along with network and revenue benefit.
“O&D [origin and destination] traffic tends to attract a price premium, and BA has got more than most other carriers – London is a rich catchment area. We have about 35–40% transfer traffic and we can turn that tap on, depending on how the O&D is going, to top up with the transfer. One of the benefits that BA has with its existing presence at Heathrow is that we can use the BMI slots to maximise transfer opportunities. We have the capability to move the flying around to time the slots into the best feed for long-haul.”
Beyond the integration, BA faces the challenge of finding the metal to operate the additional long-haul routes it plans, as well as the headache of parking all this additional equipment at its Heathrow hub. The airline is about to begin a major re-equipment exercise, with the first of 12 Airbus A380s and 24 Boeing 787s it has on order due to start arriving in the first half of next year. This renewal has been delayed primarily due to the slippage in 787 deliveries – they were originally due to be delivered from 2010 – which means that it had to retain older widebodies that were earmarked for replacement.
“We’d ordered the A380s and 787s and we had some 777-300ERs coming in, and those aircraft would either have been replacement for our 52 747s or, if the market was there, for growth. The upside is flexibility, the downside is the 747’s poor fuel efficiency,” Williams says.
The airline’s 21-strong 767-300ER fleet is divided between its short - and long-haul network (14 aircraft and seven, respectively), and the twinjet’s ability to serve both markets provides additional flexibility in light of the BMI deal, says Williams.
“BMI’s Airbus A320 family fleet complements BA’s fleet, and we can use some of the BMI A320 fleet to fly to destinations currently served by the 767s, and move the 767s into flying more long-haul. That’s something we’re looking at.”
While it is the intention to redeploy BMI’s 25-strong A320 family fleet within the BA business, the future of the airline’s two A330 widebodies is less clear. They will be retained in the short-term, but these “aren’t a fit” in the BA fleet structure so will be earmarked for disposal. “They might be used elsewhere – Iberia for example,” Williams says.
A solution for the Heathrow parking problem is still in development. BMI currently operates from the Star Alliance-dominated Terminal 1 (T1) and was due to move with the Star airlines into the new T2 when this development is completed next year. Meanwhile, BA is spread across two Heathrow terminals, with the bulk operating from its exclusive T5 and some flights going into T3.
“BMI is due to go into T2 and we don’t know yet if that’s going to be the case,” Williams says. “Unfortunately T5 isn’t big enough to take the BMI operation so in the short term were going to be in the three terminals – T1, T3 and T5 – and we’re now planning out what we would do in the longer term.”
He adds that the BA/BMI decision is bound up in the next quinquennial review that decides which part of Heathrow is earmarked next for development. This review decides the funding regime for the airport’s development over next five years. “BAA needs to decide which end of Heathrow gets developed next – west or east – and as part of that we need to plan out where we put the BMI operation. One of the plans being considered is whether to expand the main terminal building of T5 [with side extensions]. There are a lot of possibilities and these will need to be decided as part of the quinquennial, which is currently under discussion and needs to be completed in the next 12 months.”
Williams says that most of the 1,500 BMI mainline staff who will come across through the acquisition are subject to TUPE employment regulations – meaning they retain their existing terms and conditions.
There are 1,200 redundancies proposed as part of the acquisition, mainly located at the airline’s East Midlands base. BMI flight attendants can join one of two BA cabin crew groups – Euro Fleet or Mixed Fleet. “We’re consulting with the trade unions on the staff transfer at the moment,” says Williams.
The BMI air operator’s certificate is being gradually transitioned to BA as aircraft are moved across and repainted over the next six-to-nine months. This transition will also involve re-working BMI joint service agreements with national authorities.
The transfer of BMI booking inventory to BA began in May, and Williams expects its name and brand to have disappeared by year-end. “It’s a fairly quick transition,” he says.
BA is now a year into a merger with Iberia and has extended its ties with, for example, the latter’s Madrid flights moving into T5.
Central to the merger and creation of IAG was the target of achieving €500 million in annual synergies by 2015, split between cost and revenue.
“The revenue opportunities are built around connectivity – hence the Iberia T5 move – and we can offer customers a broader base through Madrid,” says Williams. “We’ve aligned the frequent flyer programmes and there are joint-service initiatives, and there are the obvious back-office synergies combining functions such as treasury. There are also the procurement benefits.”
Williams does not see the two airlines abandoning their individual identities.
“The BA brand is very strong in the UK – and on the other side of the Atlantic – and Iberia’s is in Spain. I don’t see the two coming together.” But he adds that a long-term question surrounds the differential between the respective cabin product offerings of the sister airlines: “In certain areas there will never be alignment, in other areas there will be,” he adds.
Despite all the changes and improvements BA has implemented over the last 10 years to remain competitive, Williams is acutely aware that this evolution must continue: “The playing field is changing all the time – there is still a need for constant change within BA.”
And BA’s London Gatwick hub is where the evolution spotlight is shining brightly, he says. “We’re discussing changes in Gatwick, which faces the threat of low-cost competition – EasyJet – more fiercely than at Heathrow.
“Short-haul needs to be profitable enough to allow us to keep re-investing in it. I’ve put a team down at Gatwick because we’ve got an old 737 fleet which needs to be replaced, and I need to justify that to IAG with a plan that is built around the ability to make a return.” But despite the competition and fleet issues, Williams remains committed to offering short-haul services from its second London hub: “Even with BMI, there still isn’t enough London [short-haul] capacity out of Heathrow [and London City] without Gatwick.
“We need the re-fleeting decision within two or three years, but it has to be built around profitability.”
BA’s joint business agreement with embattled Oneworld partner American Airlines is “working well” for both airlines, and Williams views its partner’s bankruptcy filing as “a huge positive” as the restructuring plan will allow flexibility and re-investment.
“The JBA is a revenue sharing agreement, so the more they get out of it the more benefit I get out of it,” he says.
But like most airline chief executives, Williams’ major headache is the price of oil. While acknowledging that the airline’s projections five years ago about what strategy to adopt if oil reached $120 drew a blank, he points out that it has now been at that level and BA is still making money.
“As part of this year’s plan, we’ll look at what would happen at $140.” Williams also sees benefits for industry consolidation with the high oil price. “Chief executives are looking over their shoulders saying this industry wasn’t built for the oil price at $120 and we need to do something about it.
“That business model encompasses mergers and acquisitions and where do you want to be positioned in the industry’s future framework.”
And he believes this plays to the strengths of the BA/Iberia/IAG structure: “In a world that has become much more about consolidation, while BA spends a lot of time dealing with the tyranny of the urgent – the day-to-day operations – having IAG with an eye to what is happening in the broader world is the right thing to be doing.”
Williams joined BA as group treasurer in 1998 from the computing world and remarks that the pressure-cooker atmosphere has been a constant of the global airline industry since 9/11. “I used to work for Apple. I say to people that I swapped a company that had $10 billion of cash for one that had $10 billion of debt,” he jokes. “And I’m an accountant!”