Spain's airline market has been forced to consolidate by the country's ailing economic situation and players have been combining, shrinking or, in the case of Spanair, disappearing altogether. All eyes are now on International Airlines Group as it seeks to restructure struggling Spanish flag carrier Iberia, strengthen its budget arm Iberia Express and extract benefits from its latest acquisition, Vueling.
The extent of the task ahead for IAG of attempting to return Iberia to profitability could clearly be seen in the group's first quarter financial results where operating losses deepened to €278 million ($362 million), of which €202 million were associated with Iberia. An exceptional charge of €311 million, primarily related to Iberia's restructuring costs, was included in the results.
The transformation plan will see the loss of 3,141 jobs, a 15% capacity cut and an 11% average salary reduction. An additional 4% salary cut has been applied and will remain in place if productivity talks fail to produce the required results.
The airline was hit earlier this year by 10 days of strike action, which had a net impact of €29 million, and tense negotiations are continuing with Spanish pilots' union SEPLA. "The key is getting meaningful improvements in labour costs and it's not clear they're going to get there with the pilots," says Espirito Santo analyst Gerald Khoo. "It's not clear how much can be imposed on them."
IAG chief executive Willie Walsh points out that "there are other options available to us", noting that the group could potentially restructure under new Spanish labour laws. "We would do this if we had to," he says.
On the capacity front, Iberia is not the only carrier to be making significant reductions in the Spanish market. Capacity at Madrid Barajas Airport fell by 9% in 2012 compared with the previous year and Walsh says that "we were only a part of that".
"The Spanish market is affected by low demand due to the economic crisis and high airport charges, which have increased very much in the last couple of years. This has forced airlines to make very significant capacity cuts," says Iberia director corporate affairs Manuel López Colmenarejo, adding that it is "too early to say if there is still overcapacity or not".
Khoo believes further rationalisation is needed in the Spanish market. "There has been consolidation in the Spanish market with the collapse of Spanair, and Iberia and EasyJet have been cutting capacity, but there is some sense that maybe there needs to be a bit more rationalisation," he says. "We're not in a position where anyone feels comfortable." Khoo adds that existing players are getting smaller and "you could argue that someone else could pass by the wayside".
One of the big questions over the Spanish airline market is how IAG will assimilate Barcelona-based low-cost carrier Vueling into its family. The group earlier this year acquired an additional 44.7% stake in Vueling, bringing its total share of the airline to 90.5%. IAG plans to keep Vueling as a standalone business and Walsh says he will "allow [Vueling] to continue doing what they've done so well". However, he adds that "where we can identify areas to work together we will do".
Vueling chief executive Alex Cruz - who will report directly to Walsh under the post-acquisition structure - is confident that the carrier will be allowed to keep its independence under its new ownership. "[Walsh] says the model we have is the right model and that we do short- and medium-haul in the right way. We do it efficiently and we make money," he says, adding: "If we prove that we can be profitable and continue growing in Barcelona then that's clearly a tremendous contribution that we have."
Cruz likens Vueling to the UK Special Air Service (SAS): "It's a small group, it can travel quickly, inflict pain where necessary, acquire weapons - and we follow orders well. So IAG is convinced it has bought something that works," he says.
Espirito Santo's Khoo does not believe IAG's acquisition of Vueling will have a significant short-term impact because "they already viewed themselves as part of the same family". While he expects that "we'll see a modest degree of migration of Iberia's [point-to-point flying] into Vueling where there's a lower cost base", he stresses that "the key issue is to make sure Vueling remains low-cost and successful".
"The key challenge for IAG is to extract some benefit from owning Vueling over and above just owning it as a standalone entity, without cannibalising the mainline," says Khoo. "It's very likely Vueling will remain a standalone entity with its own air operator's certificate. If not, it becomes Iberia and loses its distinctiveness."
Another option for Iberia to make its short- and medium-haul operation profitable could be to transfer more of these routes to its low-cost arm Iberia Express, which launched operations in March 2012. However, as Khoo points out, "the problem with outsourcing to Iberia Express is there is a limitation under the arbitration agreement on how big Iberia Express can get".
Walsh views this as a "temporary" setback, with restrictions set to end in 2014, and it is clear he intends to play hardball: "Iberia Express has been a fantastic success and in the absence of being able to expand there will be a reduction in the activity of Iberia's short- and medium-haul," he says, adding that IAG is "trying to overturn the restrictions". Madrid-based Iberia Express operates a fleet of 14 Airbus A320s. Its former chief executive Luis Gallego has since been promoted to lead Iberia, following the sudden departure of previous Iberia chief Rafael Sánchez-Lozano.
In terms of long-haul capacity cuts under Iberia's transformation plan, López Colmenarejo says: "The plan includes strengthening the most strategic and profitable routes and dropping loss-makers. This means we are boosting services to some long-haul destinations such as Brazil, Mexico, Central America, Chile and Ecuador, and we have suspended routes dominated by holiday traffic, where Iberia competes on unfavourable terms with other airlines.
"These include Santo Domingo and Havana, while San Juan de Puerto Rico is now offered via Miami and Montevideo via Buenos Aires and Sao Paulo."
Returning to the Spanish domestic market and excluding Iberia, Iberia Express and Vueling, few players remain following the demise of Spanair early last year. Those still standing include Iberia's regional franchise partner Air Nostrum, Air Europa and newcomer Volotea.
Vueling's Cruz does not view any of these carriers as a threat. He believes Air Nostrum "needs to define what its role is in terms of connectivity because there are players with lower costs and bigger aircraft appearing in their markets". And as for Air Europa and Volotea: "There are several airlines we religiously monitor every month and Volotea and Air Europa are not on the radar."
Volotea launched operations out of Venice in Italy, despite being a Spanish airline established by Vueling co-founders Carlos Muñoz and Lázaro Ros. Another telling sign of what Khoo describes as a "lacklustre" domestic demand picture in Spain is the fact that Vueling's future growth plans centre mainly on the international market, with 90% of the carrier's growth this year being outside of Spain.
"This year we will also increase routes that don't touch Spain - this is what we want to do," says Cruz. He adds that the carrier will continue to grow its four international bases in Amsterdam, Paris, Rome and Florence, and will "look for other bases". The "main source markets" for any additional foreign bases will be the Benelux countries, France and Italy.
Vueling will continue to focus on its Barcelona El Prat hub, where Cruz says 18% of its traffic is made up of connecting passengers. As for its regional strategy: "We see ourselves with a role of connecting regional Spain internationally."
Meanwhile, Iberia will keep plugging away at its restructuring plan in the hope that it can one day drag itself back into the black. "The aim [for Iberia] is to again become a profitable airline, as it was from 1996 to 2008, to consolidate its leadership between Europe and Latin America, and to be perceived by customers as a reliable, innovative and competitive airline," says López Colmenarejo.
Whether it can achieve these goals will be the question on everybody's lips. "The first question on everyone's mind is what on Earth will happen with Iberia," says Khoo. "It's going to be interesting to see how things develop over the next 12 to 24 months."