The gloomy forecast for Germany's economy in January is hardly the kind of New Year's message which will instill confidence in industry or the workforce. On a European level, the prospect of the largest economy sinking further into the mire also casts grave doubts over the viability of achieving monetary union by the 1999 target date. 'I estimate there is a 60 per cent chance against monetary union by 1999 and believe it could be delayed by two to three years,' says Jürgen Pieper, an analyst at Deutsche Bank.
Three economic indicators illustrate just how much the German economy is struggling. Unemployment is already running at 9.9 per cent of the working population and, with the government predicting stagnation in the second half of the current fiscal year followed by an upturn in mid-1996, that number will hit the psychological 10 per cent barrier - or 4 million unemployed - before the month of April.
The rapid decline of the German economy is further underlined by Bonn's draft annual economic report for 1996 which predicts a budget deficit of 3.5 per cent of GDP, down only fractionally from 3.6 per cent in 1995. Both figures are well above the 3 per cent qualifying target required by the Maastricht treaty for monetary union. Pieper estimates that annual GDP growth rates will drop from 2.5 per cent in 1997 to 1 per cent in 1999, which he says will signal the start of a recession. Perhaps more worryingly, other analysts estimate growth for 1996 will not even top 1 per cent!
Even Chancellor Helmut Kohl's revival programme, unveiled in late January and aimed at cutting the jobless total in half by 2000, is being treated with scepticism. Former Chancellor Helmut Schmidt has labelled the German economy a 'shackled Gulliver' in which over-regulation is inhibiting investment.
It is exactly that over-regulation that the third package aims to remove from Europe's air transport industry. More specifically, from April 1997, the barriers to competition that were lifted in the intra-European market in 1993 will also, in theory, disappear in each third package signatory country's domestic market. Germany, with some 16 million domestic passengers in 1995, is Europe's second largest home market after France, but it is more significant than its neighbour for two main reasons. Bonn has allowed a significant competitive dynamic to develop domestically since 1992, while France is only now allowing its domestic players the first experience of open competition. Secondly, Germany leads the European political and economic debate - and politics is having a marked effect in the domestic airline market.
The German domestic market has grown significantly since the mid-1980s, driven by the boom of the late 1980s and the reunification of East and West Germany after the collapse of the Berlin Wall. In 1984, the domestic market totalled 8.8 million passengers. By 1990, the first year of reunification, the market had grown almost 50 per cent to 13 million.
The first stirrings of competition in the market began in 1992, when British Airways took a 49 per cent stake in Delta Air Regionalflug - three German banks hold the other 51 per cent - and renamed the carrier Deutsche BA. Initially, the carrier took over BA's Internal German Service routes from Berlin, but the decision by the UK carrier to retain a presence in the market in the aftermath of the Cold War had started the warning bells ringing at Lufthansa. In the same year, two German regional carriers - RFG and NFD - merged to form Eurowings and, despite, the presence of some 10 smaller operators, like Hamburg Airlines, Eastwest Airlines, SAL Saxonia Airlines and Augsburg Airways, the Dortmund-based regional carrier is the only other German airline, apart from Deutsche BA, considered to represent any kind of competitive threat by Lufthansa.
Nevertheless, Lufthansa dwarfs both its 'competitors' in terms of overall market presence and only competes directly with Eurowings on two domestic routes - Berlin-Nuremberg and Düsseldorf-Dresden. But the proximity of the regional's Dortmund base to Düsseldorf means that Eurowings also competes indirectly on two routes with both Deutsche BA and Lufthansa. The latter two compete head-to-head out of Düsseldorf to Munich and Berlin, while Eurowings operates to the two cities from Dortmund.
Reinhard Santner, Eurowings' chairman and chief executive, confirms that it 'is still our strategy to avoid competition with Lufthansa or any major player' but he admits that due to the airline's size - it operates a fleet of 26 ATR42s/72s and four BAe146s - the Frankfurt-based carrier is 'starting to compete with us', primarily on European routes. Indeed, such is the 'bitter' rivalry between the two that Eurowings operates two domestic routes out of Frankfurt on a wet-lease basis for Lufthansa. Similarly, Santner describes the little competition with Deutsche BA, as 'friendly' and stresses that 'the price war is more between Deutsche BA and Lufthansa.'
Indeed, both Jürgen Büchy, Lufthansa's SVP sales Germany and Richard Heideker, managing director of Deutsche BA, rarely mention Eurowings when discussing competition in the domestic market. Naturally, the focus is on the five main trunk routes where the two have been competing in earnest on price - both mainly operating B737s with Lufthansa also using A320s and Deutsche BA F100s - since September 1994. The advent of this price competition first introduced a dynamic into the market when Eurowings, suffering yield dilution, also introduced a more flexible domestic fare structure, Wings. Yields at Eurowings have fallen 12 per cent over the past 18 months.
As in most price wars, the first battle for domestic business and leisure traffic fought in the German market produced no victor in terms of the bottom line. As Lufthansa does not break out its domestic results, and Deutsche BA refuses to discuss finances, it is hard to quantify the extent of the losses. 'We hope 1996/97 will bring us our first year of profits in the domestic market,' admits Heideker. But he denies that the price war forced a rescheduling of profit forecasts - the original target was 1995/96 - and says the 'shift in our financial expectations was because of our growth in 1994 when we introduced five F100s and a new domestic route, Munich-Düsseldorf.'
There is little doubt that Lufthansa was stung by the financial losses. Only 12 months after trialling its 'reborn' Lufthansa Express product on seven domestic trunk routes with an on-peak, off-peak tariff structure, management withdrew the product at the end of October and re-imposed a common tariff across the market. However, the carrier continues to offer more deeply discounted fares on the five trunk routes on which it is in competition with Deutsche BA.
Express was intended to go systemwide domestically, but proved too cumbersome for the market. The 'Express' branding had been used previously by Lufthansa when it set up a low-cost short-haul operation and some aircraft still carried that branding. 'The use of Express did increase some irritation in the market. We still had Express liveried aircraft from former times, which had nothing to do with the new Express and completely confused some of our potential customers and travel agents in the first few weeks,' admits Büchy. The off-peak concept was also flawed because 'it failed to bring the effect of business people adapting their schedules to take advantage of the lower fares.' A further drawback for Lufthansa was the failure of its much-vaunted 'flexible seat' which was supposed to allow for a quick change in cabin layout. Büchy says Lufthansa has dropped the seat for the time being, while modifications are made, but hopes to re-introduce the seat in future.
Express was undermined by Deutsche BA responding by offering fares up to 10 per cent lower, on the five routes where the two competed. Its simplified tariff did not differentiate between off- and on-peak. And while the drop in prices stimulated both business and leisure traffic it was Deutsche BA that benefitted most. 'They took a greater share of the traffic growth,' says Büchy. Heideker says the price war has depressed yields 20 per cent but says this dilution was countered by a 50 per cent increase in load factors.
Between September 1994 and August 1995, Deutsche BA claimed a 61.1 per cent increase in passengers against total market growth of 18.7 per cent, boosting its market share 2.6 percentage points to 32.2 per cent. More recent figures for the 12 months to December 1995, which includes two months of Lufthansa's revised fare structure, suggest that, while the market on those five routes has grown by 12.9 per cent or some 350,000 passengers, Deutsche BA has captured almost 70 per cent of that growth. The Munich-based carrier claims its average market share has risen accordingly to 33 per cent.
In Frankfurt the abandonment of the Express trial was a timely reminder that market dominance and strong branding are no guarantee of success when faced with a dynamic competitor. But not all trials have ended in disappointment for Lufthansa. The carrier will start introducing ticketless and near-paperless travel into the domestic market from the beginning of March. An eight-month trial of the 'ChipCard' among 600 frequent flyers on the Frankfurt-Berlin route ended in December and 'both the market acceptance and technical aspects went surprisingly well,' says Büchy. The carrier plans to start using the cards on its main domestic trunk routes and will initially issue them to its most-valued frequent flyers.
The ChipCard will allow passengers with hand luggage to check-in at a 'Chip-in' terminal, which issues a print-out containing the same information as a boarding card. A further swipe of the card past a sensor at the gate will confirm boarding. The use of technology is likely to provide Lufthansa with a powerful marketing tool in the future with which to combat any further attempts by Deutsche BA to expand.
And even then Deutsche BA's presence may not worry the carrier too much. One Lufthansa insider suggests that it is better to compete against a carrier with British Airways behind as it makes competition more predictable. The fear is that a US-style, low-cost entrant will come into the market and completely destroy any price stability. And Lufthansa can take comfort from Heideker's attitude: 'The competition people in Brussels say there is no real competition if there are only two carriers on a route. It is our aim to ensure there is no room for a third player.' Santner is not optimistic about the chances of a third player challenging the two incumbents on any of the trunk routes. 'Lufthansa and Deutsche BA both make losses on those routes and any new player will experience how different the German domestic market is with its high external costs.' Santner says charges and taxes accounted for 28.6 per cent of the total ticket price in 1995, before the 15 per cent sales tax was added in.
In an attempt to shore up the balance sheet, Heidecker has put further expansion on hold, although standardisation and renewal of the current fleet will result in two types (most likely B737s and Saab 2000s), as well as the addition of smaller 80-seater jets for the extensive European transborder operations. But he insists that Deutsche BA will challenge Lufthansa's monopoly on the Munich-Hamburg route before April 1997 because 'it is certainly attractive to other carriers.' He is also considering Munich-Cologne and admits that Lufthansa's monopoly on Berlin-Frankfurt, the country's busiest route with 1.4 million passengers annually, is a gap in his Berlin strategy - Tegel is Deutsche BA's primary hub. But capacity restrictions at Frankfurt have so far protected Lufthansa from any serious challenge into its primary hub and Heideker is not convinced even a successful appeal to either the German or European competition authority to free up slots would be worth it, because 'we would end up feeding Lufthansa.'
Indeed, the restrictions at Frankfurt have pushed Lufthansa into re-activating plans to establish Munich as its secondary hub. As Deutsche BA is obviously developing the network out of its Munich base this could leave Heideker facing a similar problem of feeding its rival in south-west Germany.
But infrastructure constraints are not the main drivers behind diminishing opportunities in Germany. Mainstream environmental politics has come down against air travel under 500 kilometres, in favour of high-speed rail. This has led to various local government initiatives which chiefly discriminate against turboprop operations. Heideker says domestically Deutsche BA has four 'substantial turboprop trunk routes remaining.' Furthermore, east-west domestic air traffic has also started to decline for two reasons. The shuttle traffic made up of federal employees and contractors has started to drop as work in the east is completed, improving both road and rail infrastructure.
Büchy admits Lufthansa has lost traffic on those trunk routes where high-speed links are already operating and predicts that the carrier will eventually give up its structurally unprofitable, shorter feeder operations, like Cologne-Frankfurt, in favour of a feeder agreement with the national railway company Deutsche Bahn. 'We don't compete with Deutsche Bahn and we accept the argument that 400 kilometres and less is rail country,' Büchy adds.
Eurowings has also suffered the effects of improving surface infrastructure. It has seen a 60 per cent drop in traffic on the relatively short Hannover-Berlin route in the last three years to just over 50,000 passengers. And with the carrier having pulled off five domestic routes in 1995, this looks certain to become the first casualty of 1996.
Despite the political and economic gloom, Büchy expects to see 3 to 5 per cent growth over the next five years. Heideker also anticipates a similar domestic growth rate into the next millenium, but warns that his projections do not allow for any change in charges, taxes or the introduction of other environmental measures. Heideker predicts passenger numbers will grow from 15.5 million in 1994 to 19.6 million by 2000, rising to 23.9 million in 2005.
Perhaps the strategy of Eurowings is the most telling for any would-be competitor eyeing the German market. Santner insists that the domestic routes, and indeed the whole operation, will show a small profit for 1995, on a total turnover of DM400 million: the first profits since the merger. But the carrier is moving away from its home market into cross-border regional services and pursuing an expansion plan which will allow it to stand on 'three feet.'
Aside from its own operations, Eurowings is developing scheduled services with its partners: Air France, KLM, Lufthansa and, most recently, Northwest Airlines through the first triple codeshare in the German market (the US carrier joins global partner KLM by putting its code onto six Eurowings' routes from Amsterdam). It is also increasing its charter services: the carrier will operate one of its BAe146s on behalf of German tour operator TUI and, after operating a leased A310-300 in a one-off contract for Hapag Lloyd, the carrier plans larger aircraft charters in 1997.
Santner says the change of emphasis away from domestic operations was forced on him. 'This is not a real in-house strategy to move more and more away from the domestic market, but this is a must because the political situation is against flying on short distances.' Should a foreign jet operator decide to target the German market it will find few opportunities that won't involve a good deal of blood-letting.
Source: Airline Business
