Air France is moving in the right direction to achieve profitability but some serious contradictions risk undermining its credibility. Jacqueline Gallacher reports from Paris.Air France Group is on the defensive these days, but after receiving a highly controversial FFr20 billion ($4 billion) in state aid, who wouldn't be? With appeals by seven European carriers against its state capital injection still pending at the European Court of Justice, Air France is under pressure for its restructuring plan to produce results quickly.

Already the carrier claims that it has progressed faster than anticipated by the time limits laid down in the plan filed with the European Commission to satisfy the conditions for state aid approval. Both the 5,000 voluntary employee departures and a FFr2 billion cut in investment are expected to be achieved in two years instead of three.

Financially, the losses remain heavy but are moving in the right direction. A change in year-end from December to March blurs comparisons, but in the 15 months to 31 March, 1995 the carrier expects at worst a net loss of FFr3.5 billion ($704 million) on turnover of some FFr40 billion - compared with a loss of FFr8 billion in calendar 1993. But the 1994/5 loss could be closer to FFr3 billion, exceeding the targets filed in Brussels, says Denis Olivennes, Air France's vice president management control. The productivity target for a 30 per cent improvement over three years will also be largely implemented within two years, he adds.

Despite the improvement in Air France's financial fortunes, the future remains far from certain. Several difficult bridges remain to be crossed, including the need to ensure a steady reduction in debt, the transformation of Paris/Charles de Gaulle into a competitive hub, and the successful operation of the airline's 11 'result centres' (CDRs) - employees and critics alike joke that the term 'profit centre' would have been pushing credulity too far.

Meanwhile, some serious underlying doubts and apparent contradictions are sapping management's international credibility and resulting in a sense of malaise at the airline. The strain of keeping up appearances is causing some cracks in the carrier's once smooth outer veneer and is undermining the otherwise positive efforts to resume a profitable and viable existence.

Slot restrictions

Firstly, and perhaps most seriously, there are the slot restrictions at Paris/Orly and Charles de Gaulle. No sooner had Air France agreed to limit its European capacity increases throughout its restructuring in order to convince Brussels it would not use its state aid to buy market share, than the French authorities discovered extremely militant environmental lobbyists around both Parisian airports. So militant in fact that strict, critics say artificial, slot ceilings have now been imposed at both Orly and CDG.

Protectionism? Certainly not, retort Air France Group executives with a shrug of their shoulders. Definitely, say long-suffering independent rivals, who finally won full access to develop scheduled services at Orly after a Commission decision forced the issue last year and the French government lost its appeal. 'France has decided to stop any growth in the airline industry. Admin-istratively both airports are closed to growth,' says Air Liberté president Lofti Belhassine. He adds that, in the minds of the civil servants, the aim is solely to protect Air France: 'You can kill everybody for the sake of Air France and that is a good thing.'

While Air France can distance itself from such issues, there is no doubt that in Brussels and internationally, the carrier's apparent acceptance of this kind of thinly veiled protectionism can only damage its credibility.

The second thorn in the carrier's side lies in the plans to establish a joint European company with Air Inter in 1997. Until then the two companies must remain separate under the state aid ruling, which stipulates that in order for Air Inter to remain outside the state aid conditions there must be no financial transfers between the two airlines. To facilitate controls, both the state's ownership of Air France and Air France's 75.8 per cent holding in Air Inter are now held by a single holding company.

But the proposed merger with Air Inter - which made a net profit of some FFr21 million on revenues of FFr11.75 billion in 1994 - is seen by some critics, including Air Inter employees and their unions, as the enforced marriage of a profitable airline to its inefficient counterpart, Air France's CDR for Europe. Repeated strikes by Air Inter's unions reflect concerns over the lack of an independent future for Air Inter, whose own European development will be limited until the joint company can be established in 1997.

While a few routes, including services from Orly to Madrid and Amsterdam, and from the French provinces to North Africa, are being transferred by Air France to Air Inter, the slot restrictions at Orly rule out any significant growth there for the primarily domestic carrier.

Limited growth

With limited growth prospects, Air Inter is seeking to preserve its financial position until 1997 with a restructuring programme that will include 600 voluntary job losses, productivity increases, and savings on purchases. Christian Boireau, Air Inter's joint director general for strategy and commercial affairs, says the goal is to avoid a deterioration in Air Inter's financial performance in preparation for merger in 1997 with Air France's revamped CDR Europe. 'If both are financially sound, it is unlikely they will not be so when they are merged,' he says. Over the next three years new airline competition at Orly will cost Air Inter an estimated FFr1 billion of total revenues, says Boireau.

But many of the carrier's unions, including those representing its pilots and cabin crew, are rejecting the need to make sacrifices when Air Inter is being denied the right to develop its European operations in the run-up to 1997. At present the only significant possible growth lies in adding a few point-to-point provincial routes or in developing a secondary hub at Lyons. 'We are not against the creation of the new company, we see it as the only possibility to develop the airline, but not at any price . . . In the meantime Air Inter must be allowed to develop,' says Alain Turens, at the cabin crew union SNPNC.

Unwelcome competition

The malaise over Air Inter stems from the fact that historically the carrier has been denied the right to significant expansion in Europe, which would have meant unwelcome competition for Air France. The carrier retained a degree of independence from Air France until early 1990, when the takeover of UTA and its interest in Air Inter gave Air France majority control.

Air Inter long argued that it should be allowed into Europe to compensate for the introduction of the train à grande vitesse (TGV), which has gradually become a stiff competitor for about 80 per cent of its domestic traffic, and because after 1997 its markets would be further invaded by rival European carriers. In fact the opening of Orly, Air Inter's main hub, to French and European rivals came earlier than expected, blasting away the last remnants of protection. Air Inter now faces tough domestic competition on its main routes from Orly to Nice, Marseille and Toulouse, while TAT - in which British Airways has a 49 per cent interest - is moving its limited CDG-based domestic and European services to link up with its much more substantial operations at Orly.

But Air France senior executives gloss over the Air Inter debate. Air Inter's transformation into a separate low cost European airline was ruled out last year due to the difficulty of securing sufficient slots in high density European markets to establish a Southwest-style operation. Its independent development was also ruled out - once again - this time because arguably Air Inter's belated new entry to competitive markets would now be a risky proposition. 'Air Inter must have the possibility to establish itself in the domestic European market. For that it needs Air France's know-how,' says Air France president Christian Blanc.

The scepticism over whether a merger is the best possible use of Air Inter is inevitably casting a shadow over Air France's wider restructuring. So is the airline's defensiveness over the role played by Stephen Wolf, the former chairman of United Airlines who is now acting as advisor to Christian Blanc on behalf of Lazard Freres. Wolf has remained closeted from the media and Blanc dislikes being questioned about the American's role. One rival airline executive claims both Wolf, who was brought in on a six-month contract from August last year, and former United manager Rakesh Gangwal - architect of the new CDG hub - have resigned and that this is being kept quiet until after the French presidential elections.

Despite the shadows, the 15 months ending 31 March were expected to show a significant financial improvement, with a gross operating profit of FFr2.5 billion. However after amortisation and provisions the net operating result will become a loss of FFr2 billion ($402.4 million). The company hopes to achieve operating break even in the year to March 1996 but will have to wait until 1996/7 to break even on a net basis due to the FFr3 billion annual interest payments on debt.

Debt burden

Air France is painfully aware that it can only achieve its financial targets by paying down its heavy debt with the money from the state recapitalisation. It claims that the FFr10 billion received so far has mainly gone as intended to reduce debt from FFr35 billion to FFr27 billion. 'Air France is dragging an atrocious debt burden and it would be suicidal not to try to reduce that,' says Olivennes. But one financial source remains sceptical. 'More money is going into the day to day running of operations than to pay off debt,' he claims.

Air France aims to cut unit costs by 20 to 25 per cent over the three-year restructuring period, and in 1994 achieved a 7 per cent reduction in cost per equivalent available seat km, says Olivennes. This takes into account the company's 4 per cent capacity increase for the period. The target for 1995/6 is a 12 per cent unit cost reduction. Blanc rejects the notion that the 5,000 planned voluntary job cuts are insufficient, pointing out that they come on top of 4,000 departures under the previous management.

Meanwhile, Air France is addressing the fundamental problems of aircraft overcapacity, falling yields and market share. The carrier is selling its older aircraft and has cancelled all 17 Boeing and Airbus orders and options placed since 1990, including seven A340s, three B737-500s, three B767-300s and four B747-400Fs. As part of the move to reduce the aircraft types in its fleet, the carrier plans to seek the best future deal from a single manufacturer, says Blanc.

The fleet reduction is being made possible by a major drive to restructure the carrier's schedules and develop a strong hub at CDG while increasing aircraft utilisation. Amazingly, before the restructuring Air France aircraft were being used on average just eight hours a day, compared to nine or 10 hours for close competitors, says Blanc. Air France had also failed to adopt a hub strategy geared towards sixth freedom traffic, and was flying more routes at lower frequencies than its competitors with far too many aircraft types, says Olivennes. 'The advantage of the schedule restructuring is that it enables us to raise available capacity with fewer aircraft.' Available seats will increase by another 4 per cent this year, he adds. Air France flights typically also made more stops than rivals. 'The schedule changes drop routes that are not productive enough because there are too many stops, to the benefit of productive nonstop routes on which frequencies can be raised to fit hub requirements,' says Olivennes.

Hub strategy

This summer, Air France increased frequencies on 22 routes and withdrew from 10 cities, including Quito, Lima, Bahrain, Khartoum and Glasgow. At the same time, all flights to the key destinations of Sao Paulo, Bangkok, Seoul, Bombay, Beijing and Reunion became nonstop.

An important part of the new hub strategy is to raise yields, in particular through the new medium-haul product launched in March - with two new classes named l'Espace and Tempo - and with the help of a state of the art origin and destination yield management system being purchased from Sabre Decision Technologies. However the new system will not be up and running for another 12 to 18 months. A new long-haul product with identically named brands will be introduced in October.

While passenger yields have been in constant decline, volumes have increased and yields per available seat km are relatively stable, says Olivennes. Air France's revenue seat km increased by 15.1 per cent in 1994 as the average load factor reached an unprecedented 73 per cent. The aim now, says Olivennes, is to raise yields while maintaining traffic volumes. The drive to boost yields is also one way for Air France to compensate for its falling market share. 'We cannot help but lose market share since our capacity is rising more slowly than the rest of the industry. That is a choice we made in the negotiation with Brussels,' says Olivennes.

Olivennes dismisses the idea that a major alliance could be used to help achieve profitability on a particular sector, and says this should be achieved first. After perhaps two dramatic alliance failures - with the sale of the CSA stake and the probable imminent sale of the Sabena investment - Air France will be looking to make a success of any future alliances with its preferred partners American Airlines and Japan Airlines.

Meanwhile a reduction in the number of layers between employees and top management from seven to three, and last September's reorganisation of the company into 11 CDRs have so far produced few tangible results. Still, the heads of the five geographical regions - Europe-medium haul, Africa-Middle East, North and South America, Asia-Pacific and Caribbean-Indian Ocean - are quick to praise their increased responsibility, fast decision-making and greater control over costs and efficiency.

All is not straightforward, however. Fleet and network planning were recently recentralised when it became obvious that the various CDRs were pulling in different directions to the detriment of the CDG hub. 'The aim is to maintain an overall coherence in product, yield management and the development of the network and schedules, but to remove all the inconvenience of a bureaucracy,' says Olivennes. Gangwal is now engaged in a two-year process of teaching the CDRs to work along similar lines, he adds. The CDR bosses appear to have no problems with the centralisation of network planning. 'Half of the Asia-Pacific passengers began their journey somewhere else, so I cannot plan my schedules alone,' says Jean-Michel Masson, Air France's executive vice president and chief operating officer Asia-Pacific.

None of the CDRs are profitable yet but their managers feel that the new organisation gives them far more control than under the previous framework. 'Sixty five per cent of my costs are dedicated so I can see what I can do with my own costs,' says Patrick Alexandre, deputy executive vice president of the CDR for Europe-North Africa.

Alexandre cites flight rotations, ground handling contracts and dedicated sales outlets as example of areas in which he has improved efficiency and made savings. He is also reducing some of the costly privileges enjoyed by overseas company representatives. In calendar 1994 the CDR reduced its losses by half as revenues rose 2 per cent to FFr9.6 billion. It expects to break even in 1995/6.

Human dimension

Alexandre also points out that the CDR's cabin crew and their union representative are now located in the same building as management and are fully consulted about decisions. The Europe-North Africa CDR is unique in that it has kept full control of its fleet.

Masson also sings the praises of the new structure, underlining the fact that he now has the ability to remain competitive by tailoring the union agreement. 'The conditions for pay and employment are fixed at the global company level but the adaptation of these rules is left to the initiative of the different CDRs,' he says.

Each CDR has its own dedicated manager to keep track of financial performance and monitor targets: 'Each person feels more responsible because each one has his problems, his objectives and the results of his actions before him,' adds Masson. Another major advantage is that there is a far greater human dimension involved: 'It is much easier to instill a common approach into 1,350 cabin crew than into 7,500,' he says.

But fine words will do little to convince the outside world that Air France's restructuring is viable, unless the carrier can disassociate itself from its old protectionist ways. Actions and not words are needed, including a disavowal of current slot constraints at the two Parisian airports and the continued profitable development of Air Inter between now and 1997.

But fine words will do little to convince the outside world that Air France's restructuring is viable, unless the carrier can disassociate itself from its old protectionist ways. Actions and not words are needed, including a disavowal of current slot constraints at the two Parisian airports and the continued profitable development of Air Inter between now and 1997.

Source: Airline Business