Air France's effective acquisition of KLM has been headlined as an opening salvo in the long-awaited consolidation of Europe's flag carriers, but the deal starts off with surprisingly modest ambitions in the near term and a long-term strategy that has still to emerge.

When Air France unveiled its plan to take control of KLM, it did so amid talk of taking an important first step towards consolidation in Europe. That may yet be true and few doubt that it is a step that Europe badly needs to take. However, now that the initial excitement has subsided, it may be time to ask just how much, in fact, the deal actually changes.

On the surface, at least, the merger indeed creates a giant. On present standings it would have the largest revenues of any airline group and with a clear lead in the European market whichever way the figures are cut.

But recent air transport history is littered with cautionary tales about the pitfalls of building scale for its own sake. Swissair's acquisition spree started with Sabena amid very similar language about industry consolidation. Swissair shot up the rankings but it did not live long enough to see any strategic benefits from that scale. Air New Zealand may have had good strategic reasons to buy into Ansett Australia but the deal all but killed it. American Airlines too has since all but dismantled the TWA business that it fought to acquire.

Those strategies largely failed because the airlines being acquired brought with them weak market positions and huge structural problems which ultimately sank the acquirer. In short, they were fire sale items, but with no-one else on the market, they were the only goods on the shelf. The Air France-KLM deal is different. While not exactly a merger of equals, KLM is a major in its own right and with a highly respectable track record.

However, the same tests apply. KLM has, on and off, been on the market for most of the last decade. The reason is clear enough. The Dutch home market was too small to secure it a place on the top tier, but its hub traffic too large to be a niche player. As a former KLM president was wont to ask: is KLM too big for the country, or the country too small for KLM? A decade ago KLM was in merger talks with British Airways, which foundered over the valuation. KLM was understood to be wanting equal standing and some 40% of the merged group. Since then there have been a string of deals, including the ill-fated merger with Alitalia and renewed talks with BA. Today the Air France deal will leave KLM shareholders with 19% of the combined group. KLM will also retain its own brand, hub and management team, for five years at least.

While KLM may be thankful to have found a safe haven, there are still questions to answer about the benefits that the deal will yield to Air France.

In the short term, the answer is not much. For all the long-term strategic possibilities, the guarantees to leave the KLM operation untouched for the time being limits any major. Air France has promised some highly unambitious benefits which effectively include as little as €250 million ($295 million) in direct annual cost savings after five years. Once the guarantees end the potential should be become much more interesting (unions allowing), but the end of the decade is well over the distant horizon for an industry changing almost daily.

KLM does bring with it some other interesting assets. The combined group would beat even the mighty Lufthansa Cargo in the freight market and join the top table in maintenance. More importantly, KLM potentially brings some strengths in northern Europe where Air France is at its weakest. But to realise the potential of this largely connecting traffic means taking on Lufthansa, BA, SAS and others in their home markets, not to mention aggressive low-cost competition. Unless its cost base changes, that is not going to be any easier for a merged KLM than it is today.

The gamble that Air France may hope to win is the longer-term ambition to build an imposing power bloc in Europe, balanced within the Sky Team alliance with an equally impressive grouping of Delta, Northwest and Continental on the other side of the Atlantic. Together they would command some 30% of seat capacity on the North Atlantic .

But that is a long-term game and it is not clear that the Air France-KLM merger on its own will give a decisive first-move advantage once the game gets into gear. If the merger begins to look less like an amicable alliance and more like an aggressive acquisition then the advantage might be telling. In the meantime, regulators and competitors seem strangely content to let the deal go through. Perhaps after all this is not the beginning of the end, but only the start of the beginning.

Source: Airline Business