After at least three months of merger talks, British Airways and KLM have finally bowed to the inescapable and called an end to their negotiations. It is surprising perhaps that they lasted quite so long. The obvious question now is where they go from here? For KLM, with a string of failed marriages to its name, that may prove a tough question indeed.
A decade ago when KLM last talked with BA, those negotiations too ended in a stalemate and not for dissimilar reasons. The Dutch carrier had argued then that its excellent prospects at the Amsterdam hub should be recognised by a larger share of the resulting company than a straight valuation might have suggested. BA's shareholders were not so sure. This time too, it was difficult from the outset to see how BA could reasonably have squeezed sufficient value out of what was effectively an acquisition, to justify the apparent asking price. BA's investors were again sceptical and it is far from certain that all of the airline's board were wholly convinced.
The value of any alliance lies in its ability to produce cost savings or to raise revenues - either by increasing dominance in existing markets or opening up access to new ones. KLM was unlikely to deliver any of those benefits to BA.
The Dutch carrier has always lacked the dowry of a major home market; instead building Amsterdam into one of Europe's finest connecting hubs. However, it is not clear what extra scope that would have given BA. Amsterdam could, theoretically, have helped solve BA's need to stem losses from its European network, but that hinged on KLM delivering unit costs significantly lower than BA's own. It did not. As the more prudent analysts warned, the combined company would have faced an alarming round of labour cuts to make the deal work on cost savings alone.
Neither was it clear how KLM would have resolved BA's other pressing problem - the lack of antitrust immunity with a US partner. KLM pioneered such a relationship with Northwest Airlines nearly a decade ago, while BA's more recent attempt with American Airlines was effectively blocked by Brussels. On paper, that might look promising. But in reality BA would have struggled to leverage any more benefit from the Midwest-Amsterdam connection than KLM had already achieved. Northwest's US and transatlantic networks would have been be a poor second best if the price, as seems likely, was for BA to lose American. Continental, in which Northwest holds a significant stake, could have made the equation more interesting, but that too is under doubt, with Washington preparing to renew its legal action to severe the link.
Now that the KLM proposal has been given a fair hearing, BA is free to explore a better merger. With Europe's alliances still in a state of flux there is still plenty of opportunity and time to get it right.
American has already forged a link with Swissair and BA might consider following suit. Although Swissair cannot count on a major home market, there is a cultural and quality fit between the two carriers. And the parent SAirGroup adds a couple more interesting options. First, it has built up host of strategic stakes in carriers around Europe and beyond. Besides the Swissair/Sabena virtual merger and plans to replicate that with holdings in France, it holds international equity positions ranging from Poland's LOT to South African Airways. BA could look to exploit that access.
Second, as it is proud of boasting, SAir is not just an airline, but an aviation group. Half of its revenues, and more of its profits, now come from standalone business in cargo, engineering, IT and services. BA is first and last a passenger airline. Although it has sizeable assets in areas such as cargo or engineering, they are cost rather than profit centres. There lies an opportunity.
Where KLM goes next in search of an alliance partner is less clear. There are few options that have not been tried, with the possible exception of AirFrance and Lufthansa. After the collapse of the first BA talks, it joined the Alcazar project with SAS, Swissair and Austrian. That collapsed when KLM insisted that Northwest be the group's US partner. Then three years ago it won the beauty contest held by Alitalia, beating SAir and Air France with a plan for virtual merger. KLM called that off earlier this year unable to cope with Italy's leisurely pace in resolving key issues of the Milan Malpensa hub plans and Alitalia's privatisation.
Perhaps ironically, Alitalia may still represent KLM's best option. Although the cultural fit never looked entirely plausible, there was a good case for synergy. Alitalia brought access to a sizeable and underexploited home market and KLM brought the network skills to exploit it. More ironic, if KLM were to return to Rome, it would find itself once more in competition with SAir and a revived Air France, which now has a stronger suit than it did three years ago.
In short, there is still plenty to play for in the European alliance game, and probably time to play it. But whatever deals finally get done they need to prove that they are valuable.
Source: Airline Business
