For the past few years German flagship carrier Lufthansa has been caught between a rock and a hard place. Or more specifically, between the premium and low-cost markets.
But that is set to change. The airline intends to intensify its focus on the low-cost end of the market in the hope of turning around its business.
Its new “Wings” project is a significant break with Lufthansa’s old image of being primarily a premium airline. The Frankfurt-based company is hoping to expand into both the short and long-haul markets with a cheaper brand.
The driver for change at Europe’s third-largest international carrier is its new chief executive, Carsten Spohr, as part of his attempts to keep the company afloat in an increasingly competitive market.
In June, the German airline group lowered its 2014 profit outlook and scrapped its 2015 earnings target, citing overcapacity, falling prices and disappointing sales.The company is now banking on a new strategy to turn things around.
Next week the company’s non-executive supervisory board is due to meet to sign off on the ambitious plan. It is already clear that “Wings” will be much more than a side project for the company. In fact, Lufthansa has big plans for the expansion of its low-cost concept, which is currently operated by its subsidiary Germanwings.
We are well positioned in our home markets, but our rivals are significantly bigger. Thomas Winkelmann, Chief executive, Germanwings
Germanwings chief executive Thomas Winkelmann has been pushing for a greater emphasis on the low-cost market. “This platform has to have the potential to grow,” he told Handelsblatt.
Lufthansa is currently fighting on two fronts: In the long-haul market is it competing against state-supported Arab companies like Emirates and Ethiad, while on the shorter flights it faces powerful rivals in budget airlines Ryanair and Easyjet.
This has hit the company’s bottom line. In 2012 it saw net profits of €1.2 billion ($1.49 billion) but by last year these had shrunk to just €300 million. Analysts predict a slight recovery for this year to around €500 million.
The decision to expand into the budget market is based on the realization that Germanwings is currently too small to seriously compete against Ryanair and Easyjet, the European market leaders.
While Lufthansa’s subsidiary has just 85 aircraft carrying 18 million passengers a year, Easyjet has 230 planes and 60 million passengers while Ryanair has 300 planes carrying 80 million passengers.
“We are well positioned in our home markets, but our rivals are significantly bigger,” Mr. Winkelmann said.
The company had already started expanding its low-cost subsidiary two years ago. Germanwings was set up in 2002 but for many years it was neglected for fear it could eat into Lufthansa’s premium market.
Since then, however, it has taken over most of the parent company’s Germany and European routes, with the exception of those serving its Frankfurt and Munich hubs. And the company is also about to switch its Düsseldorf-Berlin route to Germanwings.
The company’s low-cost model attempts to meet various needs. Those who pay the basic flight cost have to pay top-ups for everything else, from better seats, to food and drink and shorter check-in queues.
The expansion plans include taking on the European routes of Lufthansa subsidiaries such as Swiss and Austrian Airlines, and its part-subsidiary Brussels Airlines, as well as moving into long-haul tourist destinations such as the Seychelles or Mauritius.
If the supervisory board, which oversees the company’s executive and has to sign off on major strategic decisions, agrees with the plans then the airline’s fleet will grow “significantly,” the company says.
In general, analysts welcome the plans. It is “the only right answer to the competition from above and below,” said René Steinhaus, aviation expert at the AT Kearney consultancy firm. “Finally the competition is being attacked on their own territory.”
The Wings project does not only envisage expanding the budget business, but also creating an entire new platform alongside the Lufthansa brand, including bringing the à-la-carte approach to long-haul flights.
The strategy is not without risks. There is the danger that valuable business passengers will end up booking the cheaper flights and then expecting premium services. And those who have paid all the extra costs can still end up sitting next to backpackers, which is not always going to go down well.
Up to now the industry has struggled to come up with a convincing model for cheap long-haul flights, though budget airlines like Norwegian and Air Asia X are making their first forays into the market.
Lufthansa plans to start off with beach destinations, where there are likely to be fewer business passengers.
Another important factor in the success or failure of the plan will be whether the company manages to operate more efficiently.
“We still have gaps when it comes to costs,” admits Mr. Winkelmann.
Germanwings’ costs are currently 20 percent lower than at Lufthansa, not because of lower payroll costs, but due to lower operational costs, for example in sales and marketing. Another subsidiary, Eurowings, does have lower payroll costs, as it is not covered by the same wage agreement that applies to Lufthansa and Germanwings. As such it has managed to reduce costs to 20 percent lower than those at Germanwings.
One option could be for the company to switch Germanwings routes to Eurowings routes. This could also fit into Mr. Spohr’s attempts to get around the expensive wage agreements.
For a low-cost platform in Germany, Lufthansa needs the labor unions. Gerald Wissel, Airborne Consulting analyst
However, that could cause conflict with powerful, well-organized trade unions at the company. Without the staff’s goodwill, the ambitious new plans are doomed to failure, warned Gerald Wissel, an analyst with Airborne Consulting. “For a low-cost platform in Germany, Lufthansa needs the labor unions.”
What is clear is that the company is convinced that there is no alternative to expanding into the low-cost market.
The success of the current expansion of Germanwings has convinced Mr. Winkelmann of the wisdom of the plan.
“Next year we will have eliminated over €200 million of Lufthansa’s losses on the decentralized European routes.”
Jens Koenen leads Handelsblatt's coverage of the aviation and IT industries and is bureau chief of the Frankfurt office. To contact him: [email protected]