What do you get if you cross an English mother company with French and German subsidiaries? The airline industry is still waiting for the punchline as British Airways pursues its so far unprofitable attempts to move into the French and German domestic markets via subsidiaries TAT/Air Liberté and Deutsche BA.

One certitude emerging from British Airways' endeavours is that expansion into non-native domestic markets is far from easy. BA may be the world's most profitable airline, but its French and German subsidiaries lost US$111 million between them in the year to March 1996, on top of $270 million in the previous two years.

The losses may relate to a case of wanting too much, too soon. 'The mistake in part was to assume that BA would immediately work in Germany and to start too many routes when we didn't have the capacity or the brand recognition,' declares DBA chief executive Carl Michel.

Both DBA and the newly merged TAT/Air Liberté, however, are endeavouring to rectify their over-ambitious expansion, drastically cutting back their networks and the number of different aircraft types in a bid to gain profitability within the next few years.

The restructuring efforts will be led by capable new chief executives installed at the subsidiaries' helms. DBA can rely on 33-year old Carl Michel's vigour while TAT/Air Liberté has former AOM president Marc Rochet's expertise to fall back on through the difficult few years ahead.

The CEOs' task is certainly daunting. They need to lower the subsidiaries' costs in high cost-base countries while grappling with the dominance of flag carriers Air France and Lufthansa.

Rochet must also curb union resistance - a ticking time-bomb as staff protest against TAT and Air Liberté's merger and the imposition of Air Liberté's lower working conditions on traditionally high-cost TAT. At presstime the strikes had been running for 17 days.

The commercial tribunal in Créteil approved BA's recovery plan to take over insolvent Air Liberté on 9 January 1997. BA started merging Air Liberté with its subsidiary TAT on 1 April.

Despite the inherent difficulties, BA is determined to abide by its strategic decision to be present in France and Germany. BA director Europe George Cooper views market presence as a prerequisite to being a successful pan-European airline. 'Clearly the UK, France and Germany are the three largest European markets. To be big in Europe, then you must have a presence in those markets.' Cooper says BA simply made the move 'ahead of the rest' at a very early stage of the deregulation process.

Developments over the next few years will in many respects determine how BA's long-term European strategy will pan out. 'The next few years in Europe are going to be quite critical - the next ten years will be decided by the next three years,' pronounces Cooper.

The subsidiaries are therefore directing all their immediate energies into achieving profitability.

DBA expects profitability by 1998/99 - 'this year I'm allowed to make some losses!' exclaims Michel. The airline has been in the red since its launch in 1992.

Only after improving Air Liberté/TAT's performance will BA start concocting 'solid' long-term plans for the French company, says Cooper.

Longer term objectives include creating operations that efficiently feed BA's intercontinental network, says Matthew Stainer, analyst at Morgan Stanley.

Future BA plans may include converting the French and German subsidiaries into franchisees to add to BA's flourishing franchise family. 'If you were Coca-Cola but had to call yourself something different at first in a new market, you'd probably have a long-term aim of calling yourself Coca-Cola there,' hints Cooper.

The subsidiaries' ownership structures may also change - 'these are not cast in stone', says Cooper, although BA is keen to maintain financial institutions as shareholders. TAT is 100 per cent BA-owned, while French banking group Rivaud holds 28 per cent of Air Liberté with BA holding 67 per cent (the remaining 5 per cent is held by various shareholders). 'BA welcomes a powerful French investor,' declares Rochet.

Michel states that links with German financial institutions 'can help pull the right strings and make the right contacts'. Bayerische Vereinsbank plans to sell its 16 per cent shareholding in DBA but Commerzbank holds a 19 per cent stake and Berliner Bank 16 per cent, with BA owning the remaining 49 per cent.

The equity involvement of native French/German investors also helps BA achieve its aim of creating two companies which are as 'French' or 'German' as possible, says Cooper.

Rochet states that 'what BA wants from him' as joint CEO of TAT/Air Liberté is 'being a French guy, with French experience, who knows about French culture and day to day management'.

The French identity extends to the airline's name. The merged TAT/Air Liberté airline will 'definitely' be rechristened Air Liberté, reveals Rochet, as the name is seen as a 'good, strong French name', respected in France. 'Our first target is to come back to break even which we can do with the brand recognition of the Air Liberté name,' says Rochet.

But to do the Air Liberté name justice the company desperately needs to boost its equity value. Breakeven is targeted in two years' time yet Air Liberté was estimating a loss of some FFr1 billion (US$173 million) in 1996, while TAT lost some FFr200 million last year and was expecting a small operating loss in the year to March 1997. Air Liberté aims to divide total losses by nearly four to FFr300 million (US$52 million) in 1997 and cut costs radically by 1999.

The major hurdle which Rochet will have to cross is to lower TAT's 'too high cost structure' which is 'totally incompatible with market conditions', he says. The airline is determined to reduce labour costs by 20 per cent to Air Liberté's level, despite vehement opposition by both Air Liberté and TAT cabin and cockpit crews. Air Liberté's lower working conditions are being gradually imposed from the start of the preliminary takeover phase, which started on 1 April, until the merger is complete. Unless the unions agree to bring the expiry date forward, this will not be before the final TAT contract for cabin crew expires on 28 March 1998.

Rochet's problems do not end there. While TAT employees are unwilling to accept Air Liberté's lower working conditions, Air Liberté's are no longer prepared to continue under existing conditions which were tolerated 'only as a temporary measure in order to save the airline', states a representative from Air Liberté union Intersyndicale. 'We have our limits,' he says.

Air Liberté pilots agreed to a 25 per cent productivity increase and five rest days per month, as opposed to their desired 10, before the BA purchase, he points out.

Despite losing some 80,000 passengers per day through the strikes, Rochet is standing firm on his targets. These include reducing TAT's pilot personnel costs by at least 15 per cent. Job reductions will only arise if unions do not agree to the new conditions.

The CEO is adamant that the targets cannot be moved. 'We need the targets, otherwise there will be no business.' Rochet declares, however, that 'the way to go to our targets can be moved'. Rochet is prepared to accept a gradual imposition of new working conditions before contracts expire and is ready to think about a profit-sharing scheme when 'we're back on target'. But he adds that 'we want to be very prudent'.

In late April, Rochet persuaded the pilots to return to work in exchange for a deal under which some TAT benefits, such as 10 rest days a month and an annual bonus, would be retained by TAT pilots and extended to Air Liberté ones. However Jean Immediato, president of TAT's section of pilots' union SNPL, said other forms of action would continue. The flight attendants remained on strike at presstime.

Unfortunately Rochet does not have time for lengthy negotiations. 'We would prefer that union agreement is achieved via discussion, the usual BA way, but we don't have a lot of time here in which to do it,' says Cooper.

Even if the union dispute is settled soon, Rochet's problems will be far from over. The next priority will be to sort out 'the dog's dinner of a fleet', declares Cooper.

The airline has already withdrawn five Airbus A310-300s and intends to sell its Fokker 28s and return its leased B737-200s to Euralair by the end of the year.

TAT/Air Liberté will focus on a fleet of three McDonnell Douglas DC-10s for long-haul flights; eight MD-83s and 11 Fokker 100s for short-haul services; and eight ATR42s and two ATR72s for regional operations. The airline will not expand its fleet within the next two years as part of its bid to attain profitability.

After streamlining its fleet types, Air Liberté will concentrate on reducing its network. The new airline's core network will be composed of 57 routes to 27 French towns. Air Liberté/TAT has around 20 per cent of the French domestic market and some 22 per cent of the coveted slots at Paris/Orly. The airline aims to carry 4 million passengers this year.

The restructuring will involve dropping longer-haul services to Tunisia, Senegal and Cote d'Ivoire, but operations to the French overseas territories and Morocco will be retained. The French West Indies account for more than 2 million passengers per year and Morocco is the airline's only existing profitable overseas destination.

Charter routes to Turkey, Greece and Majorca will be maintained as these account for some 15 per cent of Air Liberté turnover and provide good use of aircraft at the weekend, says Cooper.

The trimmed network contrasts sharply with Air Liberté's previous rapid expansion, attributed as the major reason for its bankruptcy by one French consultant. Former president Lotfi Belhassine endeavoured to increase the airline's market share as fast as possible in order to sell the airline to a foreign company, the source claims.

TAT/Air Liberté's plan to install a good yield management structure, using BA technology, will help to rectify the other major factor behind Air Liberté's bankruptcy - 'its suicidal price-dumping policy', the source says.

Both Air Liberté and Air France Europe were seriously wounded by the vicious price war which they fought out on domestic routes. Air France will be far more able to cope with TAT/Air Liberté's future 'sane development', in contrast to its former 'suicidal prices', the source says.

By implementing 'a powerful yield management structure' the newly merged TAT/Air Liberté will be able to offer a low price structure, Rochet insists. He sees it as 'impossible', however, to be a low-cost airline in France at the moment, due to the high costs brought about by the country's heavy social charges and airport fees. He adds that 'we clearly want good costs that are compatible with the market'.

Air Liberté will not attempt to offer a 'no frills' service but will offer meals and a two class system, targeting a 50:50 ratio of business to economy passengers.

Providing Rochet gets union backing for lower prices, simplifies the airline's fleet, trims back its network and offers low prices, the new Air Liberté will offer a competitive product which has 'every good chance of success', the French consultant states.

In Rochet's mind, the future for BA's French subsidiary seems clearly mapped out. 'We will become the number two airline in France after Air France, offering easy access to the BA network and its frequent flyer programme. We want to be a French company with a very good service, linked to BA'.

BA's German subsidiary, DBA, is following a similar strategy to its French counterpart - reducing its network and aircraft types in a bid to become profitable by 1998/99.

However, DBA is further ahead than TAT/Air Liberté. DBA relaunched on 1 January 1997, focusing its operations on the German domestic market.

Restructuring has included dropping unprofitable international routes, from Munich to Paris and Madrid, and from Berlin to Oslo, Moscow and St Petersburg. The only remaining international services are from Hamburg, Munich and Berlin to London/Gatwick, operated in BA's livery.

The slimline network aims to reverse the airline's 'too rapid expansion to too many foreign destinations,' states Andreas Diederich, who represents foreign airlines in Germany.

The airline is now directing its efforts towards operations on seven out of Germany's 11 domestic routes - Munich to Cologne, Hamburg, Berlin and Düsseldorf and Berlin to Düsseldorf, Cologne and Stuttgart. The seven routes give DBA a market share of just over 40 per cent. Average load factors are some 51 per cent, with breakeven at 59 per cent.

The four high yield German routes which are not in DBA's network are from Frankfurt. The airline has been deterred from starting Frankfurt services by its lack of slots. 'I can't even start services that would bring sensible yields. Lufthansa really has a grip on Frankfurt,' says Michel. Routes into Frankfurt would also feed Lufthansa's long-haul services.

Michel states that he would contemplate launching Frankfurt services provided that 'it was worth it' and DBA could obtain sufficient slots to start at least three services a day.

DBA would also consider reintroducing international services but 'not as a poor third airline on the route, only as an equal second,' exclaims Michel.

Route expansion in Germany, such as Munich-Hannover or Stuttgart-Düsseldorf, is also 'quite appealing,' says Michel. Other expansion possibilities include services to UK regional destinations - Munich-Glasgow for example, possibly in cooperation with BA Regional. A Munich-Paris/Orly link, connecting TAT/Air Liberté's hub to DBA's, is a further possibility, says Michel.

DBA will concentrate all its efforts in 1997, however, on restructuring its fleet. Like BA's French subsidiary, DBA's fleet is composed of too many different aircraft types, namely nine Boeing 737s, five Fokker 100s and five Saab 2000s.

The airline's new domestic strategy, however, is based around high-frequency jet-only services using 18 B737-300s - 'a well-trusted workhorse in the short-haul market', explains Michel.

The airline plans to have withdrawn all its F100s by the end of the year and is in the process of finalising the sale of its turboprop operations to Nantes-based Régional Airlines, which Michel views as a 'possible good future partner'.

While the airline's rationalised fleet structure makes economical sense, Jürgen Pieper of Deutsche Bank queries DBA's logic in ordering seven more B737-300s, with deliveries starting in August, in a deal worth US$287 million.

In Pieper's opinion, the fleet expansion renders unrealistic DBA'starget of turnaround within two years . 'The only chance for a quality airline in Germany is to keep capacity as low as possible and be careful about expansion - DBA's capacity is growing faster than demand,' Pieper says.

Pieper states that DBA's high cost-base, which stems from its German location, also makes its two-year profitability target unrealistic. The airline's airport costs are inherently high as are its personnel costs.

However, Michel stipulates that there is 'always scope' to reduce personnel costs and plans to cut costs further by optimal aircraft utilisation; fast turnaround times; outsourcing ground handling and telesales services; and using just three cabin crew on board aircraft or a younger crew.

The introduction of a single class on board all DBA services except Gatwick aims to reduce costs further and appeal to the 'egalitarian German psyche', says Michel.

Michel insists that DBA 'is operating very much as a low-cost airline in the BA group'. Indeed, he sees DBA's main aim as 'not to contain Lufthansa on the continent but to establish a low-cost operation on the European mainland'.

Michel claims to have adopted a 'Southwest style, low-cost attitude for Germany,' though he has no plans to extend this to introducing 'no frills' services.

The airline's 'quality emphasis' targets the large number of 'Mittelstand' or small German businessmen who are attracted by the airline's 'good value fare with no ifs, buts or special surprises', Michel declares.

The airline's new simple price structure on all routes, bar Hamburg, has just three price levels set at DM190, DM290 and DM520, variable according to how far in advance the booking is made.

The fares represent a saving of 40 per cent on DBA's previous prices and have stimulated the market by some 15-20 per cent on Munich to Hamburg and Cologne, though not markedly on other routes, says Michel.

Lufthansa fares remain some 15-20 per cent higher than DBA's new prices, despite the flag carrier's moves to reduce its fares solely on the routes where it competes with DBA. The route specific fare reductions have precipitated a 5-10 per cent drop in DBA's yields.

Michel sees the reductions as a 'blatant case of predatory pricing' though he predicts that 'it would not be possible to get the case through the German courts as they would say that we're subsidised by BA. By the time we prove it, it would be in two years' time'.

Lufthansa claims that it does not feel threatened by the emergence of a stronger competitive threat on the German domestic market. 'We offer different competitive advantages, including the largest route network, fast check-in times, frequent flyer programmes and electronic ticketing,' states Lufthansa's board member for sales, Stefan Pichler. But Lufthansa must be watching carefully as DBA restructures with a simplified fleet and network and lower costs.

BA means to take full advantage of full European airline deregulation by creating subsidiaries that appear quintessentially French and German but maintain the BA touch. However amid the losses and cutbacks at both carriers and the continued labour strife at TAT/Air Liberté, BA has yet to prove that it can succeed in the two largest domestic markets on the European continent.

Source: Airline Business