Unlike the other US expatriots called in to take over the running of two of Europe's more progressive airlines, Frederick Reid stands apart in that he already is an insider.
His fellow countrymen at Swissair and Virgin Express may have found the different business culture and way-of-life a shock to the system but Reid's biggest step, after taking over as president and chief operating officer of Lufthansa's airline division in April this year, was to move his family across the Atlantic. After almost six years at Lufthansa, most of them spent in the US as senior vice president for the Americas, this Pan Am veteran is no stranger to the airline. Indeed, Reid is fluent in German - a rarity for a native English speaker in this line of business. But that doesn't mean he has swapped his more relaxed American demeanour for a Teutonic suit of armour.
The full privatisation of one of the country's largest and most high-profile companies - with the DM4.5 billion (US$2.5 billion) disposal of the remaining government controlled 37.5 per cent stake - is a significant event in German corporate history, but for Reid it is merely the culmination of a process that started with the initial public offering in 1994. Questions on the subject of how a fully privatised Lufthansa will change corporately elicit only the usual mantra about protecting shareholder value. The fact is that to all intents and purposes Lufthansa is already run as a private enterprise. Nevertheless, it is worth noting that the region's largest carrier becomes only the second airline in Europe, after British Airways, to complete the transformation from a government-owned to a fully privatised entity.
Reid's lengthy responses to most questions are a mix of a candid assessment of the challenges facing the carrier and a reticence to discuss specifics looking forward. The solution: read between the lines.
He expects to have his 'hands full' finding the remaining 30 per cent of the DM1.5 billion savings sought under the Programme 15 cost reduction project. But beyond that he is not prepared to comment, despite the concerns of the financial community that Lufthansa will be left behind by British Airways and KLM as its two nearest rivals continue to push costs down. 'Programme 15 is unlikely to be sufficient to reduce Lufthansa's costs below those of major competitors like British Airways and KLM,' suggests Andrew Light, London-based analyst with Salomon Brothers, in his extensive research report on the carrier. He estimates that Lufthansa's costs are still 10 per cent 'higher than best practice in Europe.'
Reid also admits that the carrier's unprofitable domestic network is still causing unease among management, despite a 6 per cent cut in capacity. Paribas estimates the carrier is losing DM200 million annually in its home market and analyst Chris Avery suggests in his report that things are 'getting worse' for Lufthansa, in contrast to an improvement at its main tormentor, Deutsche BA.
But Reid rejects suggestions that Lufthansa is planning to relaunch a low-fare concept as 'intense speculation', although he hints that management is considering a mix of a stand-alone Shuttle by United-type operation and more use of franchise partners along the lines of the US model. After the confusion caused in the market by Lufthansa's first attempt at a low-cost subsidiary - in the form of Lufthansa Express - the cautious approach is understandable.
Reid saves his most virulent denial for the suggestion that Thai is set to be dumped from the Star Alliance. 'There is no dissatisfaction with Thai as a partner,' he says, running contrary to all the rumours doing the rounds in southeast Asia.
Singapore Airlines is the latest prospective Asian partner rumoured to be in discussion with Star. SIA's membership could only come at the expense of Thai Airways, while Lufthansa's main partner United Airlines has made no secret of its desire to pull Cathay Pacific in. Predicting how Star will develop in the volatile environment of airline alliances may seem foolhardy, but trying to coordinate a common strategy across six airlines with different corporate cultures looks like a mighty challenge. Reid merely refuses to rule out anything.
Airline Business: In the run-up to the sale of the remaining state holding, analysts reacted with strong endorsements of Lufthansa stock. To what do you attribute this thumbs-up?
After that we realised that obviously it's a moving target and we announced a plan, known as Programme 15, which has to do with reducing our unit costs down to 15 pfennigs per seat km flown by making about DM1.5 billion in required savings in the next four years - that was started last year so I would say now in the next three years. That programme so far has brought savings in the area of DM600-800 million. We've got identified savings that take us to about DM1.1 billion and we're working on the next DM400 million.
The profit drivers, besides more consciousness on the cost side for Lufthansa in 1997, have included higher than expected performance on the long-haul routes, and the retention of a premium market share of full-fare business travellers. This is largely due to Lufthansa's continued ability to attract the business traveller through high quality service. We are continuing to improve the product and will be advising our passengers of some new initiatives towards the end of this year. The service quality is strong now. We are investing many hundreds of millions of marks in a complete renovation of our Frankfurt terminal hub, and we are putting a lot of money into making that a better product and a better functioning connecting hub.
We also did a number of things to redesign our network and tighten up the connectivity in both the Frankfurt and the Munich hubs. We will continue to work on our network strategy, focusing on strong intercontinental routes. We will focus on profit as our priority and not on retaining a symbolic presence in markets. We dropped services on unprofitable routes where we saw no prospects of a recovery. In fact inside Germany we reduced our capacity by about 6 per cent, and we've maintained our market share: with a 6 per cent reduction in capacity we've only lost 4.5 per cent of passengers.
We have deliberately given up capacity inside Germany and on some short-haul European routes and we have planned further steps in that area if the numbers drive us to do that. We think there is room for competition and we think it is illusory to think that we should be the only airline offering service inside Germany. In fact I would welcome more competition, because the more people get to compare airlines the more I am confident Lufthansa will hold a premium share of the market. If you are the only game in town people tend to become critical and I think it's great when they fly other airlines so that they can come to the appropriate conclusion. And all of our experiences have shown that where we compete vigorously with other airlines - the North Atlantic is one example - we hold our own.
While it is sensible to give up unprofitable markets, it is not sensible to continue to ratchet down your offering continuously until there is nothing left. There is a definite point of diminishing returns. All airlines basically have three options available to them. They can give up markets without replacement. They can do defensive or offensive flying with commercial agreements, franchise agreements, where they participate financially in markets but the flying is done by other entities. BA Regional is a good example, or the Cityhopper concept from KLM or our Team Lufthansa. I would call those regional alliances or franchise agreements.
The third option, which has been used by some carriers, is to operate a separate airline division or even a separate company and meet these low-cost carriers on their own ground by offering carriers with much higher productivity, quick turn times, simple pricing mechanisms, higher amounts of direct sales, etc, etc. EasyJet, Virgin Express, there is a number of growing examples. So what I am trying to say is we would be irresponsible not to evaluate all three of these clearly, and ultimately I think we could see ourselves doing a combination of those things.
On the East coast in Washington, United Airlines works with Atlantic Coast Airlines, in which it has no equity but which it does provide considerable support to feed its Washington hub. On the West coast United has chosen to meet and greet the competition of Southwest Airlines by the Shuttle by United which operates as a division, but from a process and productivity point of view it is quite different from the mother ship.
In the case of Lufthansa, we have already cut capacity to totally unproductive routes, which has made a significant contribution to our profit improvement, that's option number one. We are working with franchise partners, Augsburg Airways to name one example. We have regional deals with Contact Air and with Air Littoral and with VLM out of Rotterdam. And we have considered what the implications would be of a low-cost carrier.
But I wish to stress, and that is the most important thing that I would like to say to you today, that there is needless speculation about our plans in this area because we have thought about it, and we are still thinking about it and we have no fixed plans to do so. In our corporate culture, forgetting momentarily German law, it's not the kind of thing we would even think about doing without the full support of our employees and our trade unions.
That is to say we have opened up the benefits to our key core group of most frequent flyers to one another and we exchange reciprocal benefits for them. I am not talking about your normal flyer but your road warrior, that key, strongest element, and that involves giving up a bit of your independence, our theory being that by doing that we will win the hearts and souls of Air Canada, Varig, Thai and SAS passengers and United and vice versa.
So the first step we are doing is to concentrate on priorities which benefit the customer. We have all kinds of harmonisation of procedures and if a customer has a problem with one airline, any airline can handle it on the behalf of the other. And the frequent flyer the lounge access is a big plus, because if you do fly a lot and you end up in a lot of funny airports in the world at three in the morning, it is a very nice oasis to be able find a partner lounge if your own isn't there.
There are other things that we can do within the framework of anti-trust immunity and without the framework of antitrust immunity obviously we don't enter into discussions on any topic without checking on the legality of it. But there are all kinds of synergies in purchasing and joint facility use and there is no fixed depth to which we are willing to go. There is no fixed limit on what we want to achieve, we are just taking it step by step. It's time consuming to get a consensus and find a way to move forward to benefit six carriers, but it's worked so far.
We are not unhappy with Thai, not in the least. If we talked to other carriers we would only do so in consultation with our partners at Thai Airways. I would really like to stress that any speculation that we are unhappy with Thai and looking to replace them is inaccurate. As to how long it will take to finish discussions [with other potential partners], I don't know. That is like saying when will our airline strategy be ended. It's never ending - every day is a new challenge.
The second thing is that we have a project leader in charge of all the necessary steps that have to be made and they are quite momentous - we are a global company, we sell and receive in so many countries. We actually fly to 90 countries, but it's 130 countries. We will be prepared at the time that monetary union comes to raise invoices in the new currency. We will have to make adjustments to our yield management system to address the values but we are fully prepared.
The fact of the matter is that it's just a little bit contradictory to say that European air transportation is completely deregulated. It really has become an integrated, highly competitive air transportation system, where traffic is flowing in terms of hubs and feeds and has nothing to do with political borders any more.
So as time goes on there is a contradiction in trying to square individual consumer and marketing laws in a given geographical country, where in the airline business there is no geographical distinction except within the larger borders of the European Union. I think that rules are going to have to be redefined so that people can compete fairly. That's our answer to the European Commission and that's our answer to the Kartelamt. You have to continue to work with them on an ongoing basis until the matters of jurisdiction are more clear.
When we feel that we are in contradictory situations wherein a competitor operating from another country to and from Germany in large mass has a competitive advantage over us, which is deleterious to our ability to perform financially, we have to deal with that. I see it very practically.
Source: Airline Business
