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Economics & Finance

Consolidation in turbulent times

Grace Segran |

Lufthansa carried a total of 70.5 million passengers last year and was ranked number one by IATA (International Air Transport Association) for having carried the most number of passengers on international scheduled routes, leaving number two Air France lagging some 20 per cent behind.

The airline also made headlines when it made a number of strategic moves last year, such as establishing Lufthansa Italia, a market-specific network in Italy; buying a stake in American carrier JetBlue Airways; and exercising an option on bmi, giving it the second most number of slots after British Airways at London Heathrow, Europe’s busiest airport.

It also took a leading role in consolidating in Europe by taking over Swiss International Air Lines and Austrian Airlines (subject to regulatory approval by the European Commission), and acquiring a 45 per cent stake in Brussels Airlines with an option to acquire the remaining 55 per cent of the company in 2011 (again, subject to regulatory approval by the European Commission).

Wolfgang Mayrhuber, executive board chairman and CEO of Lufthansa spoke to INSEAD Knowledge on the sidelines of the 65th IATA Annual General Meeting on how the airline competes in the market and why consolidation is necessary during these turbulent times.

Knowledge: How does Lufthansa compete with other airlines in this harsh market environment?

Mayrhuber: First of all, it’s our people. I am proud of the team’s achievement ‘on the playing field' and I’m confident they will rise to the challenge when the chips are down.

In addition to our people are our robust financial base and our expertise and experience in dealing with difficult situations.

A major contribution to the stabilisation of the group’s profitability as a whole in this environment is made by our portfolio of business segments. Thanks to the different cycles in the individual segments, they decisively support the sustainable development of the group. Equally decisive, however, is the fact that all business segments in themselves have a significantly lower volatility today than they had a few years ago. Through the combination of these two factors – which is a direct result of our strategic orientation and our profitability claim in all parts of the company – even in stormy times, Lufthansa can keep on track better than the competition.

What are the main aviation trends currently?

Even in the current downturn, air transport is a growth industry. While aircraft size has doubled, fuel efficiency has improved by 70 per cent over the past four decades. One main trend that’s clear in the aerospace industry is to find new answers for environmental challenges, as demand for mobility rises and resources are limited.

Consequently, improvements on the ecological side will positively influence the economic figures. The aim is to continuously improve operating costs and increase productivity, while simultaneously reducing environmental impact.

According to IATA, airlines worldwide will record losses amounting to $9 billion this year. Lufthansa appears to be leading consolidation in Europe with its recent partnerships and acquisitions. Is consolidation one of the ways to combat these losses?

In the long term, we believe that consolidation offers the best opportunities for remaining competitive in the world market. It ensures that hubs are retained and it provides better connections and better fares, and it also helps to secure jobs in the downturn.

Besides making the future of our group more secure through meaningful acquisitions, new partnerships and tie-ups, we have also shown with (the acquisition of) Swiss (International Air Lines) that this approach works: once Lufthansa stepped in, Swiss was able to invest over one billion euros in new aircraft and expand its selection of long-haul flights. Not only did Switzerland profit as a travel hub but the economy in Baden-Württemberg also benefitted a great deal.

It is true that the underlying conditions at the time of our decision to integrate Swiss were conducive and it was followed by boom years, and that is not the case at present. The economy is in crisis but it will not last forever.

With Brussels Airlines, Austrian Airlines and bmi we will be able to link several hubs and create added value for our customers and ourselves.

You mentioned that Lufthansa has a robust financial base. What is it like?

Our liquidity adds up to a current figure of 4.8 billion euros. In addition, Lufthansa holds 366 million euros in long-term securities which, however, could be made liquid at any time and is part of the strategic minimum liquidity reserve. The total liquidity base of the group, therefore, currently amounts to about 5.2 billion euros.

Our declared objective of being able to call upon a strategic minimum liquidity of two billion euros at any time, continues to be pursued even in these times. We also continue to have bilateral credit lines totalling approximately 1.7 billion Euros at our disposal.

In addition to liquidity, our group fleet is valued at nine billion euros. Our short depreciation period of 12 years and our strategy of relying mainly on ownership rather than leasing particularly pays out in the current situation. Some 70 per cent of our fleet is financially unencumbered – that means that these aircraft do not serve as securities for financial loans or are encumbered with other access rights of third parties.

What is the near-term outlook for the industry and for Lufthansa?

We expect that weak demand will persist this year. It is not yet certain if it has reached rock bottom. The priority, therefore, is to safeguard our profitability. We are relying on strict capacity and cost management in all our business segments. We are well equipped and can decide independently to boost capacity as needs dictate.