INTERVIEW: Lufthansa chief executive Christoph Franz

Frankfurt
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Cover interview from August 2013 edition of Airline Business

Transparency and globalism are the hallmarks in the design of Lufthansa's de facto headquarters at Frankfurt airport. Exterior and interior walls of the building, which has a largely transparent, paraglider-inspired roof, are glass. The complex is divided by nine atriums, with internal gardens that reflect the natural habitats of different continents. Glass lifts move silently up and down the six-storey courtyards, which not only separate the office areas into blocks, but also provide natural light to the lower floors and regulate the internal climate of the Lufthansa Aviation Centre (LAC).

It should be noted that the airline, which is officially seated in Cologne since its post-war resurrection in 1955, is not calling the building its headquarters, yet.

However, the top-floor office of Christoph Franz, chief executive of Lufthansa Group, stands apart from the rest of the building's emphasis on airiness and transparency. The glass walls have been made opaque with coloured foils. This simple, yet effective, way to provide privacy seems to reflect Franz's attitude towards the LAC's idealistic design, which was commissioned during Jürgen Weber's reign as chief executive in 1999 and completed under Franz's predecessor, Wolfgang Mayrhuber, in 2006. "Let's not talk about its [LAC's] costs and practicability," says Franz. "But the architecture is attractive."

This throwaway comment perhaps shows more than simple scepticism over expensive vanity projects. It may indicate a deeper, critical stance towards a sense of entitlement among the generally proud Lufthansa staff, which might be at the heart of building swank offices while other airlines are lowering costs.

Franz wants to deeply reform Lufthansa for greater efficiency and profitability, even though the airline group generated a €524 million ($672 million) operational profit on revenues of about €30 billion in 2012, with a €990 million net profit.

The objective of the three-year "Score" cost-cutting and revenue improvement programme is to raise the operational profit to at least €2.3 billion in 2015. Franz's argument is that the group is in a stronger position today to lead such change than in future, when it could be forced to adapt to survive.

The biggest step in the streamlining process so far was the transfer of Lufthansa's European network outside the main Frankfurt and Munich hubs to its low-cost subsidiary Germanwings on 1 July. The point-to-point traffic created three-digit million euros losses a year, says Lufthansa, as competition from thoroughbred budget carriers such as EasyJet and Ryanair increased on the continent.

When the group launched the Germanwings brand and product revamp in December 2012, Franz said Lufthansa had two choices: either follow British Airways' strategy of withdrawing its direct European services from secondary UK airports - making it, as Franz puts it, a mere "Heathrow Airways" - or develop a new model with lower costs to stand a better chance against the budget carriers. "Of course there were concerns from customers in the run-up [to the Germanwings transfer], but also, more intensely, from the press," says Franz. "We looked at that in detail and used some of the feedback to fine-tune the product." This comprises a three-tier ticket price system to offer a quasi-business class with all-inclusive service, conventional economy class, and no-frills tariff.

The Germanwings transfer decision came in steps however. In 2011, Lufthansa planned to hand over its routes to the low-cost subsidiary in Stuttgart and Hanover only. But the airline was cautious to force its "business-affine" clientele in the "focus cities" Dusseldorf and Hamburg onto the budget fleet too.

For Berlin, Lufthansa had yet another idea as the local airline market is dominated by low-cost carriers. Lufthansa intended to base a dedicated, mainline-branded fleet in Berlin with local pilots and temporary staff as flight attendants. But the plans ended in the cabin crew strikes in August/September 2012, as the employment of external staff on Lufthansa aircraft was a central issue in the confrontation with flight attendants.

The goal of the Berlin model was to "exploit all degrees of freedom of the Lufthansa brand to test whether we could compete with the low-cost carriers under our own name in Germany", says Franz. "But then we became relatively quickly convinced that with the way the market was developing, we needed more freedom."

Lowering the expense of flying staff was a central objective. With the transfer to Germanwings, Lufthansa expects cabin crew costs to be 30% below the mainline carrier's level, while pilots should come at a 15% lower price - making the two together the single largest contributor to the $200 million savings goal for the operational move by 2016. However Lufthansa had to improve salaries for Germanwings cabin crews in July, as the flight attendants at the budget branch threatened to take industrial action.

The separate brands will also create significant savings on the ground, says Franz. "If I operate [non-hub traffic] under the Lufthansa brand, there will automatically be cost consequences because I need to maintain certain product features that might not be relevant for point-to-point services. We also realised that customers have expectations, which force us to offer the same [services] on a point-to-point product like on a network work product in the hub." Lufthansa also expects Germanwings' airport costs to be at least 30% below the mainline carrier's level because of less complex ground operations and the greater employment of external passenger handling agents. "The brand separation of both business models was thus a very important step forward to help us find a future-proof set-up for the point-to-point traffic outside the hubs," says Franz.

In the long-haul arena, the focus will lie on striking a balance between cutting costs and maintaining the traditional quality values of a network carrier. Competition is particularly tough against the Gulf carriers which, Franz says, are not only in the market with large capacities - and thus greater economies of scale - but operate within a different business framework, with lower cost structures.

"We have to be able to compete [with the Gulf carriers] on the cost side. We will probably not get to the same level. I don't believe that either, but then we need to achieve the differentiation through quality," says Franz. "Given the costs associated with our location, we have to position ourselves as a top quality carrier across our entire network. [We need to] make respective investments in our products, not just on board but also on the ground. And make the necessary efforts to maintain our customer base which has shown above-average loyalty - and which Lufthansa always benefited from - in future so that they are willing to pay more than average prices for our products. This will be crucial, and only be possible on basis of quality."

The carrier's efficiency programme dubbed Score appears to be a diet prompted by heart problems - after Lufthansa gorged on airline acquisitions between 2007 and 2009, most notably the takeovers of Swiss International Air Lines, former UK carrier BMI, Austrian Airlines, and a 45% holding in Brussels Airlines.

Franz rejects the idea Lufthansa bit off more than it could chew. Unlike goods that can be purchased at any time, he says airline takeovers do not only happen when it is convenient. "It requires willingness from both sides. The partners also need to fit to each other. So if there are any attractive opportunities, they need to be taken when they arise. This [timing] can just not be controlled."

However, he admits Lufthansa had to restrain itself so the acquisition of loss-making airlines did not become too heavy a burden with the parallel unfolding of the financial crisis from 2007. "Business plans and developments - which we had banked on for the investments in our airline group - did not turn out as planned, because the environment changed," says Franz.

Lufthansa realised it needed to focus on turning around loss-making subsidiaries and creating savings within the group before making further acquisitions. Networks and schedules of the group's carriers had not been co-ordinated so they were competing against each other with significant cannibalisation on certain routes. In future, ticket prices should also be better co-ordinated within the group, as far as possible under anti-trust regulations.

Turning around loss-making subsidiary Austrian was more difficult than expected, says Franz. Air Berlin's takeover of Austrian low-cost carrier Niki was, he says, a substantial change in the alpine country's market. But Europe's sovereign debt crisis created much larger, unexpected problems. "We had not been prepared for the economic downturn due to the euro crisis. This made the challenge more severe." Franz says. "Strategically we are still convinced that Austrian fits very well in our airline group and that we have a strong supplementary hub [in Vienna] which we can use with its focus on Eastern Europe," he adds.

Despite its airline acquisition woes, Franz says the expansion strategy has not changed and the group wants to build its shareholdings in additional carriers. The current consolidation phase is a matter of "wise restraint to concentrate on the important things", he says. "But this does not mean that in future, when the degree of freedom increases again and our shareholdings become again more successful on the market, we will not look at new opportunities." He adds that after being a "pioneer" in Europe's airline consolidation, Lufthansa wants to continue as a driver of further industry rationalisation among a few large groups. Such investments, he says, could either be in the European or intercontinental arena.

No such tangible projects are on the horizon, he says. "But it is important that we develop again the ability [to make such deals]. And for some time, we were not in that position due to our own internal challenges. Even if there had been an opportunity that was attractive for us, we would not have been able to respond to it." Lufthansa says the "Score" programme is necessary to make large investments possible. At €618 million, "Score" delivered twice as much in operational savings in 2012 than planned, partly due to legacy effects from previous cost-cutting scheme "Climb 2011", which had also exceeded its savings target. As early as December 2012, Lufthansa was confident enough to order 100 Airbus A320s. Yet Franz's team appears to insist on restructuring without compromise. About 3,500 administrative jobs will be slashed across the group.

Lufthansa pilots have accused management of deliberately cultivating an atmosphere of fear to make employees more co-operative. The pilots are negotiating a new labour agreement with the airline. Franz warned flightcrews in November 2011 that their careers would be compromised at other airlines, because pilots typically start at the bottom of a carrier's seniority list. "It is not my job - I find a job elsewhere - it is all of your jobs which are at stake here," he said.

"Fear is an extremely strong motivator," says Franz, but he insists that it is not an "instrument" used by the company. Given the size of Lufthansa's workforce - the group had about 117,000 staff at the end of 2012 - he down plays the 3,500 administrative job cuts, which have so far been revealed as "not a dramatic restructuring" measure to improve the company's financial performance.

"The objective of this whole Score programme is to secure the vast majority of jobs in our group for the future and also create new jobs again. This is why we need to be willing to position ourselves differently than in the past," he says. "[But] if the competition forces us into a situation where we not just stop growing for some time but actually shrink, then jobs will get lost."

Franz's argument sounds reasonable given that Lufthansa's strongest competitors are airlines which the nearly 90-year-old legacy carrier did not have to face in the past. A central challenge for the chief executive seems to be, however, explaining to his employees to what extent Lufthansa's problems are a result of the changing marketplace or have been caused in-house.