ANALYSIS: Lufthansa embraces the low-cost model

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After years of nay-saying and then mild flirtation with the low-cost carrier model, Lufthansa finally decided on 19 September to dip more than its toe in the water and jump straight in to the budget pool.

The German flag carrier's plan is simple; merge its Direct arm - essentially all short-haul non-hub traffic - with Germanwings, the low-cost airline it acquired in 2009. This, it says, is necessary to "make our European operation profitable again".

On the surface, then, an easy solution to a complex problem. But with concern over the strategy already being voiced by its two principle employee unions the situation suddenly seems markedly less certain.

What is clear, however, is what those unions think. Capt Joerg Handwerg, spokesman for the Vereinigung Cockpit pilots association, says it does not understand the rationale behind the move. "Our members are of course curious as to how [Lufthansa] can make more money by dividing a big part of the airline and putting into a new company," he asks, not unreasonably.

His comments are echoed by Alexander Behrens, representing the UFO independent cabin staff association. He adds: "As a carrier, Lufthansa is in good shape. There is no need to do this so the employees do not understand why they need to change the system."

Cabin crew stand to the lose the most if and when they transfer to the new business, says Behrens, noting that Germanwings staff have worse terms and conditions than their counterparts at the mainline carrier. Pay, hours and pensions are all less favourable, he says.

UFO is already at loggerheads with Lufthansa over stalled pay negotiations, hitting it with a series of strikes earlier this month. It is unlikely relations between the two will be improved by the latest move; Behrens indicates that another round of industrial action could begin in late November.

Pilots, meanwhile, will be protected by a pay deal secured in 2010 that saw them accept a 20% cut in wages. Handwerg also points out that any Lufthansa aircraft operated by the new business will effectively be leased in. "If Lufthansa is written on the side then we have Lufthansa contracts not Germanwings contracts," he adds.

"In the long run [Lufthansa] wants to operate with Ryanair conditions but the question is if they can get it. But right now [pilots] will start on their existing contracts."

An agreement with cabin staff, then, is key to unlocking any potential saving from a lower-cost model. But Lufthansa is vague about where any efficiencies will come from and plays down the potential for industrial strife. "We are confident that we will be able to solve the labour issues together with the respective unions," it says.

Many things about the deal are still shrouded in mystery, not least its fleet plans. Lufthansa has stated it will operate about 90 aircraft drawn from Germanwings, Lufthansa and some operated on its behalf by Eurowings, the former Germanwings parent and Lufthansa Regional partner in which mainline carrier holds a 25% stake.

Vereinigung Cockpit's Handwerg suggests that to begin with, the fleet will operate a mixture of Airbus A320-family aircraft from Germanwings and Boeing 737s from Lufthansa. Flightglobal's Ascend Online database lists Germanwings as operating a total of 32 A319s, in a typical low-cost carrier configuration of 144-150 seats. By contrast, Lufthansa's 737 fleet consists of a total of 46 older -300 and -500 models with 127 and 111 seats respectively.

Handwerg suggests the 737s - which have an average age of 21.5 years - will slowly be phased out and the fleet consolidated around A320-family aircraft. Germanwings has four further A319s on order, with six options. Meanwhile, Lufthansa has 25 re-engined A320neos in Airbus's order book.

Lufthansa is not the first legacy carrier to flirt with the low-cost market. Aside from the ill-fated Go Fly and Buzz airlines, launched in the late 1990s by British Airways and KLM respectively, Air France and Iberia have both unveiled budget brands (on in the former's case, growth of its Transavia France operation) as an attempt to cure their short-haul pain.

Size, however, matters, particularly when you are looking to tussle with EasyJet and Ryanair. Analyst Yan Derocles of Oddo Securities, believes Lufthansa is already ahead of its legacy rivals in this respect. "Each story is a bit different, but I think that you have to reach a critical size. This is the case for Lufthansa. Even if you only take Germanwings, on the low-fares side Lufthansa already has critical mass, which is not the case for Air France or for Iberia [Express]."

Peter Morris, chief economist at Flightglobal's Ascend consultancy arm, concurs. "You've got to design something that is an appropriately scaled operation or you'll either lose shed-loads of money or it's not viable to even start it," he says.

So although Lufthansa ticks the "size" box, the second key issue is what you use your low-cost business for. If it's simply to prevent your budget rivals from taking increasingly large bites out of your short-haul market share, says Derocles, then expect to lose money doing so. He says: "The use of the companies only to exclude the low-cost carriers is a nonsense and quite costly.

"In my view this part of the job of [these] new low-cost carriers is painful and they will have significant cash consumption. I think it's impossible for them to compete on every route with the real low-fare airlines."

From Lufthansa's perspective it believes it can offer a genuinely attractive proposition for travellers. "We believe to have a valid concept at hand to respond to the difficult market situation in Europe," it says and stresses its prices are "competitive".

Passengers, of course, are the key. Lufthansa is taking a calculated gamble that it can retain or attract more customers than are put off by travelling on an aircraft with the frills removed. But if they have already been voting with their feet and disappearing in droves to budget rivals, then it looks a risk worth taking.

As Morris notes: "It's far better to have them on one of your planes than none of your planes."