Joint vision

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Air France and KLM see their merger as a first step towards creating a truly global European airline grouping capable of holding its own in the world

The merger between Air France and KLM has been a landmark event by any measure: representing the world's first true cross-border merger of two major carriers and along the way creating the world's largest airline group.

It is a deal that has certainly been accompanied by some passionate debate among industry analysts. Depending upon where you stand, it is either a first brave move towards consolidation for an industry that badly needs it, or an unlikely pairing that still has to prove its worth. But for the two central players, Air France's Jean-Cyril Spinetta and KLM's Leo van Wijk, their merger is simply the next logical step in building a truly European carrier for a truly European market. In the background too is the desire to create a counterweight to balance the growing US strength within the SkyTeam alliance.

"Our common target, was and is to build up a real European entity," says Spinetta. "I have always been convinced that there was a contradiction between the European single market and the fragmentation of the European airlines." Today he sees the regulatory model that has kept flag carriers within their national boundaries as "completely obsolete".

Spinetta and van Wijk, now chairman and deputy chairman of the merged group, are clearly comfortable with each other and with the challenge ahead. Talking through the merger against the backdrop of the IATA annual general meeting in Singapore, the two presidents were clear that what matters most is their shared vision. Both point to the success of Airbus and to the creation of a single European currency as an inspiration of how Europe's airlines too must cross their national boundaries to compete on the world stage. "The vision has always been there," says van Wijk.

And if the two men are relaxed in each other's company then perhaps it is because the two carriers have been courting one another, off and on, for the best part of five years. The first time that they sat down together had less to do with air transport than soccer as they watched the French team play in the 1998 World Cup at home in France. At the time both were only a year into their jobs as airline chief executives. Spinetta recalls that van Wijk was most impressed with French defender Lilian Thuram at right-back. "My old position," explains van Wijk, a former amateur footballer.

It was another year before discussions took place that formed the groundwork for the eventual merger. In 1999, Air France was in talks with both Delta and Continental Airlines as it looked to form a transatlantic alliance. Continental in turn was a long-time partner of Northwest Airlines, which had created the first transatlantic open-skies alliance with KLM back in 1992.

Against this background, Air France and KLM held discussions over a possible tie-up themselves as part of a deal between Continental and the French flag carrier. However, by June 1999 the talks had came to nothing, and Air France decided to throw in its lot with Delta, launching what would become the SkyTeam alliance.

 "A lot of people regretted that we did not go with Continental," says Spinetta, adding that this early contact with KLM had left a positive impression on his own management team. Dominique Patry, vice-president international affairs, recalls telling his boss: "We will miss the Dutch." Van Wijk also remembers the phone call that he received from Spinetta. "He told me that they had decided to go with Delta, but he said that they still liked us and who knows what the future will bring?"

Common goals
An important lesson gained from these talks was an early realisation that they they shared a common vision. "Our network manager Bruno Mattheu said that KLM shared the same view on business as us. I never forgot that," says Spinetta, explaining that the two carriers have the same philosophy when it came to network strategy, pricing policy and yield management. At the core was a shared vision of a multiple hub system for Europe, says Spinetta. "We're both convinced that we not only need to operate routes but build up a network and that is not the same thing," says Spinetta. Van Wijk adds that KLM saw the need to go beyond a loose alliance, as it already had through its joint venture with Northwest across the Atlantic. "You can only have combinable fares if you have a common pricing policy," he says.

KLM had, since 1997, been pursuing its own European venture in the form of a virtual merger with Alitalia. In part, the move was designed to provide some added weight in alliance talks then heating up in Europe. "There was a joint understanding between KLM and Alitalia that we were entering the endgame," says van Wijk. "This was a strategic move to provide a joint negotiating position with either Air France or British Airways."

Alitalia was just starting its ill-fated move to the new Milan Malpensa hub in 1999 when van Wijk received the telephone call from Spinetta informing him of the decision to go with Delta. The Malpensa move and Alitalia's promised privatisation became mired in local politics, at which point KLM pulled out of the merger early in 2000 and instead went back into discussions with British Airways, which again failed to result in a deal. Spinetta once more contacted van Wijk, but the Dutch carrier was, by then concentrating on putting its own house in order.

In December 2001, with the aviation industry in crisis following the events of 11 September, informal talks between Spinetta and van Wijk reopened. Again, the choice was between Air France and BA, and their respective US partners, Delta and American Airlines. Then came a twist from the US market. In mid-2002, Delta and Northwest entered talks on a co-operative agreement, and both Air France and KLM took a keen interest in the reaction of the US government, which was positive.

Consolidation acceptance
In Europe, the Competition Commissioner Mario Monti also appeared to be moving in favour of consolidation. "Monti made it clear that he thought that consolidation was inevitable," says van Wijk. "He was looking for balanced competition with a limited number of parties, and wanted a balance to the Star Alliance."

BA and the oneworld alliance came with a major issue attached: the lack of a UK-US open skies agreement and therefore no antitrust immunity. "We knew the complexity involved," says van Wijk. "BA was not prepared to open up, so there was not going to be open skies. There was no US approval."

Against this background, Air France and KLM began informal talks at the end of 2001. "The aim was to try and estimate potential synergies," says Spinetta. "We had to agree a common bottom line." A feature of the more formal discussions that began in August 2002 was how to match together two transatlantic alliances. "We told them that if you have Delta, the deal is done," jokes Spinetta. "And we told them that if you have Northwest, the deal is done," van Wijk ripostes.

Washington cleared the marketing alliance between Delta, Northwest and Continental at the end of March 2003. "Suddenly, we had a key," says Spinetta. The Air France-KLM deal followed soon after in September 2003 and was duly accepted by shareholders in May. That also marked Air France's privatisation, as the government share slipped to 44%.

Concluding the deal has taken long enough, but implementing it is going to be the real challenge. Financial analysts are divided over the true implications of the deal. For some, this is just the first step in a consolidation game that all will have to play, and in which Air France-KLM now holds first mover advantage. "The merger with KLM builds on Air France's core strengths of network and infrastructure. Synergies are modest, but achievable," says Andrew Lobbenberg, analyst at ABN-Amro. Looking in the nearer term, others argue that the deal simply does not deliver enough on the cost savings front. Chris Tarry of CTAIRA argues the target of €500 million ($600 million) after five years lacks ambition. The worry is that while competitors BA and Lufthansa concentrate on cutting costs, the merger process will distract Air France-KLM management.

Perhaps the doubt most often aired has been over whether the French and Dutch business cultures will prove a successful mix. Van Wijk concedes that the example of Royal Dutch Shell, Unilever and others suggest that the pragmatic Dutch work best within the Anglo-Saxon culture. "It's generally appreciated from known examples that the Dutch work more easily with the Brits. That's a given," van Wijk says, noting, however, that KLM has co-operated with the even more culturally distant Alitalia.

Spinetta points out that the cultural challenges are hardly unique, even working within different regions of France, and he argues that it is healthy to retain such diversity. Van Wijk adds: "We will run into some difficulties, but that will happen with any culture." What has mattered more is the shared goal of moving beyond flag carrier status to build a "real European competitor" within the single market. "I think that KLM understood from the beginning what was happening," says Spinetta, pointing to its long search for a cross-border merger.

This pan-European vision includes a multi-hub philosophy based around Paris Charles de Gaulle and Amsterdam Schiphol. The network overlaps are relatively limited. Of 104 long-haul destinations, there are only 34 cities in common, and the two are concentrating resources where routes are too thin to support both hubs. Services to Caracas are being funnelled through Paris, for instance, while Manila passengers will go through Amsterdam. On short-haul, Air France is stronger in southern Europe, while KLM is stronger in northern Europe. Spinetta points out that the multi-hub approach is hardly unique. "The same reality can be seen in the Star Alliance. They have Frankfurt, Munich, Vienna and Copenhagen."

Some of the strongest criticism of the merger has come from the projected cost savings, which amount to €220-260 million after three years and €385-495 million after five years. "They are probably conservative. I hope we will do better than that," Spinetta admits. "We could have said €800-900 million, and we could have justified it, but with €500 million, we are sure that we can implement it." While the initial target may seem small against combined revenues of over €18 billion, he adds that in a low-margin business that could translate into a significant profit gain - more than the record €410 million that Air France made in net profits in 2000.

There is another reason behind the conservative cost-saving estimates. Air France-KLM management is not rushing the implementation process, preferring a cautious approach rather than risk disruption - particularly on the labour relations front.

"We haven't taken the full integration of both organisations into consideration. There is further potential, but we are deliberately not looking at it," says van Wijk. "Many mergers fail because the integration takes place very quickly, and then it turns out that it doesn't work. We will not integrate for the sake of integration. If there is a risk of failure, we will not do it."

Labour relations
The two agree that managing labour relations will be a crucial part of the merger process. "Given the cross-border scope, the sensitivity is high," says Spinetta. However, he is at pains to point out that the merger process does not mean that cost-cutting is on the back burner. "We will focus on our strategic alliance, but also on reducing costs. You have to do both." He emphasises that the synergy benefits will come on top of the cost-cutting plans already in place. Pointing to the programme that is under way at KLM, he says: "This is one of the elements that convinced me that it was possible to team up with KLM." Air France is also cutting costs, and makes it clear that the processes already under way will continue at both carriers. "Air France will have responsibility for costs at Air France and KLM for KLM. We will keep our own houses clean," he says.

Although cost-cutting is clearly an important aspect of the merger, neither Spinetta nor van Wijk see this as the key driving force behind the deal. "I don't believe that you can only solve problems by cutting costs," says van Wijk, arguing that overcapacity is the real cause of low industry margins and that the "long game" is to use consolidation and alliances to bring some more rationality to the market. "The problem is not to reduce capacity," adds Spinetta. "We are not in a normal business. If you give up slots, low-cost carriers will come in and take them." The problem, he argues, is rather to maintain capacity by bringing in traffic from beyond the local market and maintaining a "global reach".

From the outset, alliance strategy has played a central role in bringing the partners together. Spinetta concedes that Europe, and perhaps Asian carriers too, will need to consolidate if they are to maintain an equal voice with US partners within the global alliances. "If you not only want to be around the table, but also have the capacity to direct strategic decisions, you have to have more clout," he says. "We need European combinations, European entities."

If, as Spinetta believes, that other national carriers must face the same need for consolidation, does Air France-KLM hold a first mover advantage? "Yes," says van Wijk. "But we also have first mover disadvantage."

Certainly the merger process has been something of a learning curve. The deal has gained approval from Brussels, despite warnings otherwise from Washington. The tricky bit now is putting KLM, Northwest and Continental alongside Air France and Delta in the SkyTeam alliance. The three new members are scheduled to join in September of this year.

Will this mean that SkyTeam, which will have nine members once the three carriers are added, will move to a separate management structure along the lines of Star and oneworld? This issue is "still on the table", but Air France-KLM seems less than enthusiastic. "Taking decision-making out of airlines creates bureaucracy...It's a question of philosophy. We don't want too many members," says Spinetta, talking about a limit of around 10-12. However, there are still plans to bring in smaller carriers as associate SkyTeam members. Also Spinetta points to the SkyTeam cargo alliance and the new impetus provided by the Air France-KLM merger. The joint cargo business will go to a "common structure" next year with a joint sales force and management, creating the world's largest airline cargo operation.

As the new team grapple with these decisions, others will be watching carefully. There are still hurdles to be overcome, but the two management teams are clearly determined to succeed. "Many people believe this is a daring move," says van Wijk. "We're going to show them. We're going to make it."

 

Different paths

Although Jean-Cyril Spinetta, president of Air France, and KLM chief executive Leo van Wijk, seem to have developed a close working relationship, they do in fact come from quite different backgrounds.

Born in 1943, Jean-Cyril Spinetta has had a French civil service career path, being a graduate of the famous Ecole Nationale d'Administration. He holds university degrees in public law and political science.

Although most of his career has been spent in the French civil service, he did have a stint as president of domestic carrier Air Inter from 1990 to 1993.

After leaving Air Inter, he held advisory posts to the President of France, and also had a short spell in the European Commission, shortly before he took over the reins at Air France in 1997.

In contrast, Leo van Wijk has been with KLM since he graduated from the University of Amsterdam with a degree in econometrics in 1971.

He started his career in automation services, but moved over to cargo in 1977. Two years later, he was appointed manager cargo handling and by early 1983 he had become manager cargo marketing, also becoming deputy to KLM's vice- president marketing.

By 1989, he was senior vice-president corporate development, and he joined the board of directors in 1991.

He became chief executive of KLM in 1997, following the resignation of chairman Pieter Bouw.

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