While other belly space carriers and freighter operators dissect the pros and cons of following LCA's lead, the carrier has continued to establish hubs in strategic locations around the world and find new partners to serve markets to which its access is restricted.
A hub network is the only means for a freighter operation to fill its aircraft and establish a global network at the same time, explains Wilhelm Althen, chairman of LCA's executive board. 'For our customers who are global we have to go global, and to provide them with a global network you need hubs and partners,' he says. Althen adds that LCA's hub strategy is unique and cannot be copied by belly cargo carriers. 'You don't need a hub just to fill the belly of a passenger aircraft.'
Despite talk of cargo open skies, cargo remains strictly regulated in many parts of the world, most notably the booming Asia-Pacific region. The need to access these markets has been made all the more urgent by the fact that many key LCA cargo customers, including Siemens and Volkswagen, have moved operations out of Germany to cut costs. 'We have to expand our network overseas to catch them again,' says Althen.
At present the carrier's extensive hub network offers 500 destinations worldwide and connects six overseas hubs in Miami, Sao Paulo, Nairobi, Sharjah, Moscow and Bangkok to the main Frankfurt hub. Its partners include US carrier Challenge Air, which carries cargo between the Miami hub and South America; Aviatrans, which operates flights from the Moscow hub; South African Airways, which services Nairobi; Lufthansa's European partner SAS; and Lufthansa Cargo India - a new joint venture with Hinduja Group in which Lufthansa holds 40 per cent.
Lufthansa Cargo India will distribute cargo throughout India from the Sharjah hub, in the United Arab Emirates, offloading cargo from the B747Fs arriving from Frankfurt onto smaller B727s and DC-8s. The Sharjah hub, set up three years ago when India opened its skies for cargo, has proved a success both in terms of covering the market and cost-wise, says Althen. 'We did not expect the costs to be so low. The cost of building a pallet in Sharjah is 15 per cent of the cost in Frankfurt, so we try to build as many as possible there.'
In Asia, LCA is discussing with Thai International a similar joint airline concept to India, to service Asia-Pacific from the Bangkok hub. Boeing projects average annual cargo growth to be some 6.6 per cent worldwide between 1994 and 2014 but expects four markets to exceed that; three of them are linked to Asia. Ranked by growth expectations in that period, they are intra-Asia, North America-Asia, Europe-Asia/Australasia and North America-Latin America. 'With a hub in Bangkok we can cover the fastest growing region in the world,' stresses Althen.
The main hole in Lufthansa's global coverage is North America-Asia, the second fastest growth market. United Airlines, with which Lufthansa has an extensive codeshare agreement, is not a cargo player on the Pacific and instead LCA is discussing possible cooperation with Japan Airlines or another North American carrier, says Althen. The carrier has several sales offices through which it could offer its product by using belly capacity on other carriers, he adds. The other boom market is China, and Althen says he is due to spend time there assessing the market and meeting key local players.
In terms of economic growth, Europe is comparatively small (see chart), and LCA is covering intra-Europe demand through its B737-300 quick change operation. At present seven Lufthansa aircraft used for passenger operations during the day are transformed at night to allow for overnight express deliveries in Europe. Lufthansa currently has 40 aircraft in its passenger fleet which can be made available to LCA at night. As LCA's second largest market after the US and ahead of Hong Kong, the UK is a key part of the European operation.
While LCA's global strategy is relatively clear cut, it faces a number of challenges as it seeks to achieve stable profits and increase its 4 per cent worldwide market share. Not least of these are low rates across the cargo business, which mean cargo carriers cannot afford new aircraft and make cost-cutting and higher productivity essential goals. At the same time there is tough competition from the integrators and a requirement to respond to rapid growth in the quality door-to-door express market.
However, LCA has considerable strengths in its size - with over 5,355 million freight tonne km transported in 1994 it is by far the largest cargo operation of any passenger airline - and a strong home market with guaranteed longterm growth. In 1994, LCA's traffic increased by 17.4 per cent and between January and July of this year its average growth exceeded that of any rival. Add to that the advantage of being the world's only airline cargo spinoff able to control its own costs, product and strategy, LCA looks well set.
One of the chief obstacles is the worldwide fall in freight yields which are declining at a rate of 2.9 per cent a year, more than the average passenger yield decline of 2.5 per cent. 'We believe that this trend will continue and that we need to follow that by decreasing unit costs by at least 3 per cent a year,' says Althen. Productivity will be boosted through traffic growth without more staff and by placing growing numbers of employees on separate union contracts from Lufthansa. The 'mickey mouse rates' mean carriers cannot afford new freighters - a B747F costs $200 million - and are instead obliged to convert passenger aircraft. 'There are no orders for a B747F in production at present,' says Althen. Fortunately, Lufthansa still has some older passenger 747s which can be made available to LCA for conversion.
However, LCA is already pulling its weight in order to boost yields. This year it has successfully bet on customer willingness to pay for quality service by increasing its rates, and it has even been able to maintain them during the peak summer passenger season, when there was the usual short-term overcapacity problem caused by the increase in available belly space. Typically cargo rates drop every peak season and do not recover when capacity becomes scarce again in the low season. 'We kept our rates and maintained prices even in the high season and it worked,' says Althen. Customers, tired of fluctuating rates, are being offered contracted fixed rates.
At the same time LCA is now able to give free rein to competing with the integrated door-to-door express operators. Althen recognises the phenomenal growth in the higher yield express business - by far the largest air cargo growth area. 'The charter cargo business is dead and the airport to airport business just went over the top of the cycle.'
LCA's 40 per cent stake in DHL, whose business is growing 40 per cent every year, recognises the trend that will see the express business grow from 4.7 per cent of the global cargo business in 1994 to an expected 31.4 per cent share in 2014. LCA itself had projected that one third of its business would be express by 2000 but exceeded it in the middle of this year, says Althen.
Given this growth, the major challenge is to compete with the integrators' quality service. 'Our customers are used to the standards of the integrators. We need to transfer our business into express standards,' says Althen. In this respect LCA will continue working with the 'visionary forwarders' - the ones most likely to survive, says Althen. He is unconcerned at the overlap between the express and traditional cargo businesses, arguing that the airlines, integrators and forwarders are working together more, using each other's services where appropriate. 'DHL [for example] did not want to fly intercontinental, so we came together,' he says.
Althen's goal is to sell a stake in LCA to a partner carrier and list shares on the stock exchange in two or three years' time, though he stresses that LCA will always remain majority-owned by Lufthansa, 'because they need us and we need them.' There are no plans to sell a stake to a partner airline as yet though there is some interest, adds Althen. Nor is there a definite timetable for a share sale and by law the carrier will have to wait three years before going to the stock market. 'First we want to prove we can make a profit,' says Althen.
The carrier seems unlikely to achieve its original target of a DM100 million profit in its first year due to the unfavourable US dollar rate. Instead Althen expects a 1 or 2 per cent net margin on turnover of around DM3.5 billion (US$2.5 billion), or up to DM50 million ($35 million) in profits. In the nine months to September the carrier achieved a DM12.5 million profit but this excludes the high season which falls in the final quarter. Some 75 per cent of LCA revenue is dollar-related, compared to only 25 per cent of costs.
Fortunately, the spinoff into a legally separate company has armed LCA with some substantial weapons with which to compete in the cut-throat cargo industry. There are powerful arguments in favour of cargo spinoffs, even if they have so far convinced only Lufthansa to put them to the test.
First, a spinoff banishes the dilemma of how to allocate cargo costs at a stroke. 'With such a construction you see your real costs for the first time. No passenger airline presently has a method to define its costs which could not be successfully attacked,' says Althen. In 1994 Lufthansa's cargo operations represented 23 per cent of Lufthansa's revenue and it was held accountable for one quarter of the airline's total costs. This year LCA simply purchased the complete cargo hold capacity of the passenger operation for DM800 million ($567 million), a rate which is renegotiated each November.
Althen stresses that the DM800 million is crucial in helping the passenger operation achieve the profitability to which cargo has always been instrumental: 'There is not one intercontinental flight making a profit on the passenger side.' The purchase of all Lufthansa's belly capacity was a condition for the spinoff, though Althen says the rate is a fair one.
LCA also buys capacity from other airlines locally and from partner carriers such as Lauda Air and Condor, as well as operating its own all-freighter fleet of 10 B747Fs, five DC8-73Fs and one B737F. Its global network strategy means it could add on average one intercontinental freighter every year up to 2005, says Althen. Around 42 per cent of LCA's total tonne km is transported on passenger aircraft, though this is expected to drop below 40 per cent this year due to growth in passenger demand.
The second reason for hiving off cargo is the fundamental difference in customer demand and expectations. Lufthansa group's passenger market is over 73 million people a year, whereas just 40 big customers account for more than 60 per cent of LCA's traffic. And in Germany cargo is primarily a one-way export business, unlike the passenger market. This means a full outgoing cargo load on a passenger flight translates into a 50 per cent load factor on a round trip. With a few exceptions, such as carnation imports from Nairobi, there is no incoming cargo from Africa and South America, says Althen. Furthermore, as the high-yield express delivery business continues to grow, cargo customers are ready to pay for the quality only a separate cargo airline can offer: 'We can guarantee the arrival time and we know how much it costs,' he says.
Further justification - as if any more were needed - was found in using the spinoff to create a workforce of 4,800 cargo-oriented employees. Early retirement schemes were used to shift away from people used to dealing in both the passenger and cargo businesses, and a steep drop in average age brought a radical change in approach and 'helped us to solve problems we couldn't have solved in 10 years', says Althen.
The results - better cost control, increased flexibility to deliver a quality product, delegation of responsibilities to local markets, the ability to enter into alliances, and improved accountability for results - should not be sniffed at in a highly competitive business like cargo.
While the endemic problem of low yields continues to plague the industry, the spinoff of Lufthansa Cargo represents a major step towards retaining its dominance of the industry and competing with the integrators. Other carriers may follow Lufthansa's example - Japan Airlines, Cathay Pacific and KLM are reportedly considering cargo spinoffs - but implementation takes time and so will any attempt to slow LCA's rapid growth and erode its powerful competitive edge.
Source: Airline Business
