The chief executive of KLM is about to bring to an end more than 10 years of alliance manoeuvring when he links his airline to either the oneworld or SkyTeam alliance
KLM chief executive Leo van Wijk seems remarkably relaxed for a man preparing to decide the fate of Europe's fourth largest carrier. At some point over the next few months, he will, barring a major change of plan, tie the Dutch flag carrier to either the oneworld or SkyTeam alliance. The carrier's future shape and even its very survival are at stake. Either way, one thing is clear: there is no going back. "This choice will determine the future of our company," he admits. "This is a once in a lifetime decision."
Van Wijk says he expects to take the plunge this autumn, and while he readily admits that these timetables have a habit of slipping, he is confident that the waiting will soon be over. "We have done the right thing by taking our time, but if we wait another six months we won't know any more than we do today," he says. "We are now assessing our final options, and we know exactly what those options are."
The decision will be the culmination of nearly 15 years of alliance manoeuvring by KLM. The carrier's partnership with Northwest Airlines was forged back in 1989 and has operated under antitrust immunity since 1993, after the Dutch Government pioneered the first "open skies" agreement with the USA. It has operated as a joint-venture since 1997. Despite a boardroom bust-up in the mid-1990s as KLM raised its ownership of Northwest shares (which eventually ended with KLM selling its 19% stake) the partnership is considered the most integrated of the transatlantic alliances.
The depth of this partnership makes KLM's decision all the more tricky, however, as the costs of uncoupling the two airlines would be proportionately higher than it would be for, say, oneworld partners British Airways and American Airlines, or even United and Lufthansa.
Because of this, it has been presumed by most observers that the two carriers would decide to stick together, placing the Air France/Delta Air Lines-led SkyTeam alliance as firm favourite to land the Dutch carrier following the tie up between Northwest, Continental Airlines and Delta in the US domestic market. Van Wijk is obviously playing his cards close to his chest, but gives strong hints that the decision is more open than some people think.
What is clear, however, is that the attempt to forge a fourth force in world aviation is over. The KLM/Northwest partnership has failed to develop beyond the two carriers to achieve the global presence of oneworld, SkyTeam or Star. KLM and Alitalia formed a strong partnership in 1996, which was moving towards a "virtual" merger. But this fell apart acrimoniously in 2000 after KLM walked away as Alitalia's plans for a hub at Milan Malpensa foundered and doubts remained over the privatisation of the Italian carrier. KLM then went back into merger talks with BA, with whom it had talked before in the early 1990s. Those talks again fell apart for a host of reasons, including differences over valuation and complications over traffic rights.
Once the BA talks ended in September 2000, van Wijk decided to take a year to regroup away from all these distractions. "We had to go back to managing our operations as efficiently as possible." Then, of course, came 11 September. "The focus was then on survival."
This process was well under way when, in the middle of last year, the crisis in the US airline industry suddenly looked as if it would result in previously elusive consolidation. Approval for a wide-ranging partnership between United Airlines and US Airways was swiftly followed by a similar deal covering Delta, Northwest and Continental. "Developments in the USA showed us that regrouping was possible. There could be a change of thinking within the US government," says van Wijk.
Global thinking
This created new opportunities for KLM to implement its long-term alliance strategy on a global scale, preferably with its partner, Northwest. "The final shaping of the alliances is taking place," says van Wijk. "The question had been, will there be three or four global alliances? Although the Delta/Northwest/Continental deal was predominantly domestic, it showed us that there are likely to be three alliances." As he puts it: "The alliance between Northwest and KLM was not going to be successful over time. There were not enough partners around the world." By the end of the year, KLM was deep in talks with both oneworld and SkyTeam.
Van Wijk is busy weighing up the attractions of the two offerings. "In the USA you have American versus Delta, Continental and Northwest. In Asia, oneworld has Cathay Pacific and Qantas and Skyteam just has Korean, but what will they have in five years time? What are the Chinese going to do? What is Japan Airlines going to do?"
He is at pains to point out the importance of the relationship with Northwest in the airline's thinking. "We are still very much focused on improving our own alliance. We see this as the main plank for making our decision. We review the relationship annually, and, at the last review, we agreed there is still a lot of upside for both carriers." On the other hand, he makes it clear that a parting of the ways is definitely an option. "It could end up that the longer term interests of Northwest no longer line up with those of KLM."
The relationship between KLM and Northwest is governed by a 10-year agreement signed in 1997. If the two carriers go their separate ways, there are two options, says van Wijk. Either the agreement runs out in 2007 or the two sides will negotiate an early end to the contract. He says that both carriers have agreed that they do not want to break up, but if it is necessary for their long-term interests, it will be an amicable divorce.
If van Wijk is keen to dispel the view that SkyTeam is practically a racing certainty, the same can be said of the belief that Amsterdam and London go together better than Amsterdam and Paris. "The overlap in terms of route networks between KLM and BA is actually bigger than that between KLM and Air France," he says. He admits that London Heathrow has constraints that prevent it operating as an effective hub, but adds: "Heathrow still has sizeable transfer flow."
As he readily points out, however, Paris and Amsterdam both have room for significant growth - a rare luxury nowadays at a European gateway but also a potential source of future conflict.
Van Wijk insists that the dual hub concept can work, and picks out alliance partner Northwest's Detroit and Minneapolis bases as an example. "There is some overlap in the US mid-west, but the two airports exist quite efficiently together," he says. "The key is to arrange natural flows over natural hubs." He points to the northern part of the UK, Scandinavia, the North Atlantic and Asia as KLM's natural market.
While there would seem to be room for conflict, van Wijk has been over this ground before. "We had the same discussions with Alitalia. Over time, the market will decide. Once aeropolitical barriers disappear, carriers will be driven back to their natural positions anyway."
Van Wijk is alluding to the expected consolidation in the airline industry on the back of last year's decision by the European Court of Justice (ECJ) to outlaw nationality restrictions in bilaterals. This led to the European Commission gaining a mandate to negotiate an open skies agreement with the USA in early June.
"The ECJ decision has given a very strong impetus to consolidation - it is just a matter of time. With the ECJ ruling, it will become virtually impossible for any state to deny mergers taking place," he says.
"Step-wise" approach
He warns, however, that an open skies deal with the USA is not just round the corner. "It may take time to negotiate. It is hard to make an estimate of how long it will take. It depends on the ambition level, and the EC's [European Commission's] are relatively high. They may not find enough joint areas of interest with the USA." Van Wijk would prefer to see what he describes as a "step-wise" approach, taking one step at a time and avoiding for the time being some of the more contentious issues that are high up on the EC's agenda, such as ownership restrictions. "We have to let the market do its work," he says. "This means a more relaxed attitude to mergers." This, he believes, should be the aim of the talks. Airlines cannot afford to be choosy where investors are coming from given their dismal record on the stock exchange, he points out with a rueful smile.
Van Wijk attended the IATA annual general meeting in Washington in June, and seems to have come away in optimistic mood. He was encouraged by the Department of Transportation's public support for raising ownership limits to 49%. "Some people in the administration take a more liberal view on these negotiations," he says, but notes that the Pentagon and labour unions remain major obstacles to progress.
In the long run, however, van Wijk sees consolidation as inevitable. Pointing to the pressure on costs in today's environment, he says, "you need scale - you can't afford duplication of all types of systems." Even so, he recognises that there is a further hurdle beyond a more relaxed aeropolitical environment, at least for flag carriers. "There will be much emotion attached to these decisions," he warns.
KLM will most likely be the junior partner in any merger, but Van Wijk is adamant that the airline will not simply be gobbled up. "KLM will not simply disappear. There is too much invested in the brand," he says. "There are two approaches to mergers. The big-bang approach, a straight takeover. This is a high-risk scenario. The second is a step-by-step approach."
Van Wijk envisages a holding company structure with two separate subsidiaries - something that has a number of precedents as far as the Netherlands and the UK are concerned. Airline Business publisher Reed Elsevier is one notable example, as are Royal Dutch Shell and Unilever.
Van Wijk describes these types of merger, which he sees being phased in over a period of, perhaps, five years, as "a far more intelligent way of doing business." He sees joint sales and marketing, engineering, handling and IT as prime benefits, with a particular stress on the latter. He adds, however, "that to integrate the operations in Amsterdam into either London or Paris doesn't make too much sense. Buying aircraft together makes sense."
The alliance issue is far from van Wijk's only problem. The carrier reported a $133 million operating loss last year, and is busy slashing the cost base of the KLM group by 10%, including a cut in the workforce of up to 4,500 out of a total of around 34,700. Van Wijk is an admirer of the Future Shape and Size cost-cutting programme at BA, but says that BA has an advantage that is not available to KLM. "It was relatively easy for BA to say goodbye to Gatwick," he says.
Financial analysts say that KLM is in a difficult position when it comes to network cuts due to its reliance on transfer passengers - around 60% of its traffic. "We have come more or less to the limits there. Originating traffic has not grown as rapidly as transfer traffic." Van Wijk warns: "We can't presume the same growth rates as we saw in the 1990s." He points out that KLM has had a conservative approach to capacity over the last few years and has reduced its network in certain areas - it no longer flies to Australia for example. However, he says the lack of profitability is "across the board", with no parts of the network performing markedly worse than the average. He adds that reducing the network will drive up unit costs. "The network is not really a significant part of our cost-cutting efforts."
Van Wijk states that around 50% of KLM's cost cuts are "internal", with labour accounting for two-thirds of this. The rest is mainly accounted for by offices and operations. "Over the last six months we have also been taking a new approach to costs of external suppliers," he adds. "We have been much more aggressive."
Van Wijk strongly feels that airlines need more support from outside the industry. "We can't take more costs," he says. "Some people think we are a pot of gold." Looking at the $950 million operating profit at UK airport operator BAA, he says that "something is wrong here." When he was chairman of the Association of European Airlines last year, van Wijk carried out a study to pinpoint areas in the value chain where there were "structural problems" and he says private airport monopolies featured high on this list.
Much of the pressures on yields have come from within the industry, however, with the low-cost sector an obvious example. KLM has been one of the European flag carriers (others include BA, SAS and Lufthansa) to try and take on the low-cost carriers at their own game with the launch of UK-based Buzz in 1999 and the introduction through leisure-oriented subsidiary Transavia of the Basiq Air brand in 2000. Buzz was sold to Ryanair earlier this year, leading to some smug smiles among analysts who had doubted the wisdom of mainline carriers trying to enter this market. For his part, Van Wijk remains adamant that it is possible, pointing to the long-time existence of leisure-orientated Transavia within the KLM group, "but only as long as you keep the cost structures separate".
Low-cost pressure
He says Buzz was an "opportunistic play" at a time when the pressure on KLM uk from the low-cost sector was making the latter's London Stansted mini-hub "untenable". Buzz was well on the way to achieving profitability, he says, until late 2002 when easyJet bought Go and Ryanair expanded aggressively. It became clear Buzz would have to grow rapidly or face being a number three carrier in the low-cost sector. The latter option "was not sustainable in the long run," says van Wijk. The risk and money involved led KLM to seek a partner to take Buzz forward. And then came a spate of low-cost start-ups. "It became clear that easyJet and Ryanair were going to defend their markets," Van Wijk says. "We thought this is going to be a crazy game to be in." He admits that the decision to sell to Ryanair was "a quick departure from our strategy" but seems relieved to have done the deal. "This is not a business area that is going to be healthy. There will be a lot of casualties."
The suddenness of the decision to sell Buzz to Ryanair shows nothing in this industry is set in stone, but even so, the impending alliance decision will set the tone for KLM's future, and, whatever future shape consolidation takes, van Wijk is clearly determined that KLM will have its voice heard, and will not simply be swallowed in any future merger mania.
KLM career
Leo van Wijk, born in 1946, has spent his entire career with KLM, first joining the carrier after leaving Amsterdam University in 1971 with a masters degree in Econometrics.
He started work in automation services, but moved over to KLM's important cargo division in 1977. Two years later he was appointed manager cargo handling and by early 1983 he had become manager cargo marketing. At the same time, van Wijk also took on responsibility as deputy to KLM's vice-president marketing. A year later in May 1984 he took on the marketing position himself.
In May 1987, he moved to a new position as deputy to the senior vice- president commercial services. Two years later, van Wijk became senior vice-president corporate development. He joined the board of managing directors at the start of 1991.
In 1997 the carrier's senior management was reorganised in the wake of the sudden resignation of KLM's chairman Pieter Bouw. At that time the group was still reeling from a sharp fall in net profits reported for the 1996/7 financial year.
Van Wijk became chief operating officer in January 1997 and by August had been named as president and chief executive.
He is married with two children and two grandchildren.
REPORT BY COLIN BAKER IN AMSTERDAM PHOTOGRAPHY BY ETIENNE DE MALGLAIVE
Source: Airline Business
