When in the autumn of 1997 former Air Inter boss, Jean-Cyril Spinetta, was air dropped into the chief executive's seat of Air France, prospective investors were anxious. Competitors rubbed their hands. Christian Blanc, the man assigned to turn the carrier's fortunes around, had resigned over the incoming left-wing government's refusal to sanction full privatisation. But Spinetta has been no soft touch.
In many ways, he appears to be picking up where Blanc left off, pushing ahead with restructuring and the dilution of the state's shareholding - albeit at a slower pace than had been originally hoped.
So far Spinetta and his new management team appear to be producing the goods. The numbers look good. Air France is finally profitable, posting a Fr1.3 billion ($230 million) profit for the half year, representing a respectable enough margin of around 6%. Unit costs were down by 3.4%, helping break-even load factors edge down. Debt continues to move downwards, passenger numbers are growing strongly and the carrier remains dominant at home, controlling three-quarters of the domestic market, which with 24 million passengers is Europe's largest. It also sits on arguably the most promising hub in the continent.
But there are many challenges ahead. While the principal European competitors are moving ahead with their global alliances, Air France does not yet know with whom it will make its bed. It is expanding rapidly when everybody else is gearing down for recession. The management is still only at the start of work on the recurring issues of state ownership and high labour costs.
Flotation planThe first issue could be resolved soon. Following last year's delays, the government now aims to sell 20% of the carrier's shares, which could be floated as early as February in an initial public offering (IPO)on the Paris stock exchange. Around 3% of this stake is earmarked for general employees, who already hold some 5% of shares, while up to another 12% - valued at some Fr1.3 billion - is being offered to pilots as part of their contract settlement. The government, which currently owns a 97% stake, aims to reduce its share to 51-53% by the end of the year through the issuing of a further 5% of shares owing to staff, and 5% to French creditor bank, BNP.
Because of years of government dithering on privatisation, the investor community is understandably sceptical about this latest attempt. But some now believe the government is keen enough to demonstrate to the European Commission and the markets that it is committed to the commercialisation of Air France that it will push ahead with the sale regardless of a weak price. The carrier estimates that the 20%stake will generate Fr4 billion, which suggests that the deal is being priced for a quick sale.
Spinetta's right-hand man, Air France's executive general director, Pierre Henri Gourgeon, gives few clues. "An IPOis technically feasible in the first quarter," he says. Having been forced to postpone a flotation scheduled for last September, the former boss of subsidiary Servair has good reason for choosing his words carefully.
"One of the main challenges in the process of preparing for an IPO was whether of not we could reach an agreement with pilots on a salary cuts for shares exchange," says Gourgeon. "Month after month we understood that we were going to have quite a conflict with pilots because they could not accept straight away our idea about the control of their salaries."
Pilots' strikeIn the end, the one-month pilots' strike last June has cost the airline around some Fr1.5 billion. But the real issue is whether Air France has indeed emerged with the long-term savings that it wanted. The cause of the strike was a demand to shave Fr500 million a year from a pilot wage bill running atFr4 billion annually, as part of a three year plan designed to bring Air France into line with wage levels at British Airways or Lufthansa. It remains unclear whether the final deal, hammered out in October with the SNPL pilots' union and ratified in December, will achieve this lasting competition edge or is ultimately only a quick fix.
Although the government backed the management in its showdown with the pilots, the central demand for a compulsory wage cut in return for shares has been abandoned. Fortunately some 80% of pilots have now opted for shares, providing for an annual reduction of Fr240 million in pilot costs. But, while the carrier has convinced the pilots to accept a wage freeze, the original management demand for savings by 2001 will now have to be met four years later in 2005. "Seven years is a hell of a long time in the airline industry," comments one London-based analyst.
Nevertheless, cautiously confident that the pilots are now on board, the carrier is turning it attentions to other cost problems. It wants to lop off an additional Fr2.5 billion from its annual expenses, and produce a 5% net unit cost reduction by April 2001.
Gourgeon says savings can be made from improvements in "internal processes" and efficiency, as well as optimising the network and improving fleet utilisation. That should be helped by the replacement of ageing Boeing 747-200s and -300s with a new fleet, and cramming more seats into aircraft.
The carrier also wants to tighten up other areas. "Direct distribution is a key issue," says Gourgeon. "We must convince travel agents to charge reasonable commissions. The era of fixed commission is behind us. We have been reducing the guarantee minimum and replaced it with incentives for market share growth. This will help us reduce distribution costs." Gourgeon says the company is currently testing electronic ticketing, but referring to a series of false starts in the past, admits that Air France has "not been as quick as others" in this field.
So far so good, but Air France's ambitions still look modest compared with its principal competitors. BA and Lufthansa, starting from more competitive positions, plan to cut costs much further and faster than their French counterpart – BA is already reducing costs at double the rate.
It seems that the carrier's real ambitions lie elsewhere. Shortly after taking over, Spinetta announced a major fleet expansion programme, arguing that after years of capacity constraint, imposed by financial difficulties and restrictions tied to the EC's state-aid approval, Air France had to catch up. But one year on, airlines are revising their growth downward, and the French appear too bullish. While analysts point out that Air France is not as exposed to the troubled Asian markets as its rivals, they also believe that the bearish traffic outlook, particularly across the Atlantic and for the premium cabin, means Air France's yields will fall, if the company grows too fast.
Yields fell 2.7% in the six months to September, largely due to an expansion in long-haul capacity, but Gourgeon says the company will be able to hold them steady this year despite growing at twice the rate of the market. "If the market grows by 2%, we will grow by 5-6%. If it grows at 5%, we will grow by 9-10%. Next year we will keep increasing market share," he pledges. "We had to abandon market share in past years even in France and Europe. If we come back in those same markets, markets that are at hand, we will naturally get back the market share."
Gourgeon's optimism also stems from the airline's growing use of lower cost capacity. A low cost subsidiary is not on the drawing board, he says, but Air France is increasingly contracting out routes. "We will increase the use of franchises in the future," he says. This year the company will boost the number of routes it outsources by 50%, and on the routes Air France already flies, it will double the number of frequencies under franchise. For example, this year the carrier will boost the number of UK routes it franchises from eight to 12.
Some 60% of Air France's feed into Paris Charles de Gaulle(CDG) is already provided by franchise partners, according to analysts, and under their new contract, pilots have agreed to allow the company to expand franchising from the current 0.7% to 5% of systemwide seat capacity ASK. "It is specifically tailored to satisfy our most optimistic growth target for the next three years," he says. "The franchises will feed the CDG hub and this will create growth for long haul traffic," says Gourgeon.
If there is much cynicism about Air France, nobody denies that CDG is its greatest asset. With a third runway opening in March and a fourth in 2000, the airport's capacity will grow by 50%. With half the slots already in its hands, Air France not surprisingly stands to gain the most out of the expansion.
"This is the best airport in Europe," says one London-based airline analyst. "It has the same defensive qualities as Heathrow - no competitor is going to set up base there. It has a strong origin and destination (O&D) market - the company has boosted non-stop services to 80%of the total in the last five years - and should produce good yields compared to Schiphol and Frankfurt,"he says. He adds that CDG has boosted transfer traffic from one-third to a half of total traffic in the last fours years and is now drawing traffic away from KLM's Amsterdam base, while the airport now offers more frequencies to locations within Europe than any other hub.
Gourgeon likens CDG to an aspirateur, a vacuum cleaner sucking up traffic. "If we have a more powerful engine we will have a better performance and more passengers," he says.
Alliance strategy?But despite an improvement in efficiency, the strength of its hub, Air France has one crucial missing link. For while it can boast a multitude of bilateral tie-ups, the company has no global alliance in place.
This is certainly not due to labour opposition. Captain Hughes Gendre, president of the SNPL pilots' union believes that the lack of an alliance is "a very serious problem".
Nor is Air France an unattractive partner to US carriers. Both Delta and Continental, with which the carrier signed transatlantic codeshares last year following the signing of a more liberal bilateral, are waiting in the wings. The fact that the state plans to retain a controlling stake in the company is "not an issue" for these US partners, claims Gourgeon. "When we tell them that our IPO is in a few months, that is enough for them. They put a lot of value in the fact that we are listed and feel a lot better with a minority stake on the stock market than if the government sold 100% of the capital to three or four banks and a strategic airline investor," he adds.
Nor does Air France believe it can go it alone. "In the future of the air transport world the fight will be among alliances. We have to engage in this alliance scheme," says Gourgeon.
He argues that Air France is moving as fast as it can, and appears relaxed about the late start. The airline will decide on its global alliance this year, he says, adding: "Our position is strong enough in Europe to allow for a cautious approach. It is not a matter of hurrying up but there is not point in delaying it."
He argues that an earlier global tie-up would have been overly optimistic. "In the past Air France was not in a good enough economic situation to negotiate a big alliance with other carriers," he says, also pointing to the necessity of retaining a protective Franco-US bilateral while Air France put its house in order. With that in place there was little prospect of signing up to a full transatlantic alliance.
"The first milestone was to ensure that a new Franco-US bilateral was signed," he says." You cannot talk about alliances without a bilateral agreement which will give you an alliance. It is not very consistent to announce a big thing if you are not in a position to do it. British Airways and American Airlines thought their existing [bilateral] agreement was enough to help them develop their alliance."
Global impact"We have done our homework," he adds. "We are learning about codeshare agreements, frequent flier extensions and operating our fleet with another airline's fleet."
Like other airlines, Air France will pursue a multi-hub strategy in Europe, as well as in the USA, he says, but the priority is to get a US partner under its belt. "No global alliance system can exist without a US partnership. This will be done with Delta or Continental - and when I say Continental I obviously mean with Continental and Northwest Airlines," says Gourgeon, who is quick, however, to add that an alliance with one of the two "does not necessarily exclude" cooperation with the other.
Delta Air Lines has been tipped as a more suitable USpartner, given that its long-running tie-up with Swissair/Sabena has still not blossomed into a major alliance force. "Delta is not too bothered about Europe - the two partners could pursue a pretty low level of cooperation," says one London based analyst. They also warn, that if working with the Swiss carrier poses difficulties, it is even harder to see effective co-operation between Air France and KLM - Europe's third and fourth largest airlines.
Effectively, Northwest-Continental (assuming their tie-up is approved) could have to make a straight choice between pursuing their existing KLM/Alitalia link or leaving to join with Air France. The prospect of access to the sizeable French market and potential to expand at CDG (compared with continuing restrictions at Amsterdam Schiphol) is a potential lure, but would have to be weighed against the 10-year commitment that binds Northwest Airlines to KLM. Gourgeon refuses to comment on specifics but does not indicate that there would be any problem working with Europe's majors.
"We will obviously have to take into account the partnerships we already have with a number of other airlines and we will probably bring into the alliance a number of these partners, probably as associated members," he says, confirming that Air France would also be prepared to "get together" with the US, European and Asian airlines which a new transatlantic partner may bring.
So what will the architecture of Air France's alliance be? Gourgeon rejects the prospect of a tight knit alliance structure, rejecting the KLM/Alitalia model and stressing the need to retain a clear brand identity for Air France. "We are seeking an alliance along the lines of Star," he says.
Gourgeon does not exclude the possibility of an Asian partner, but argues that the region's carriers have no incentive to tie themselves down to any particular international alliance given the fact that they still largely operate in restricted national markets. He believes that the style of close co-operation being pursued by the likes of KLM/Alitalia only makes sense within the context of a single air market.
Gourgeon is well aware of the impact that Air France will have when it finally chooses a global alliance. "We will modify the landscape," he says, adding that Air France holds the balance of power in the bid to create a third global alliance to rival the Lufthansa and BA led groupings. "We will define the alliance that will compete with Star or oneworld," he says.
But in truth, Air France has always had enormous potential as a world power. The problems have come in attempting to exploit it. With the government and unions now apparently embracing the logic of private ownership, improved efficiency and strategic partnerships, there is a real chance for the management to push through change.
What remains to be seen is just how far and how fast the airline's managers will be allowed to go.
Source: Airline Business
