Lufthansa Focuses on Low Cost, Takes a Page Out Of United’s 2003 Playbook

Lufthansa, Seats

You might think Germans would just be spending this week basking in the glow of their World Cup victory, but that’s not the case at Lufthansa. In a stilted press release, Lufthansa laid out its vision for the future this week. What’s the plan? Turn the focus to building and growing low cost carriers. Hmm, I feel like we’ve seen this plan before…

Lufthansa Group on the Run

Lufthansa isn’t new to the low cost carrier game. It previously bought Germanwings and decided that the airline would fly all European Lufthansa flights that didn’t touch the Frankfurt or Munich hubs. But seeing British Airways/Iberia-parent IAG purchase the big-and-growing Vueling must have made Lufthansa feel puny. It has decided to build its own big low cost operation under the master brand WINGS. That’s Germanwings minus the German and plus some serious overuse of capital letters.

Now this isn’t exactly like United’s ill-fated Ted adventure – this one will focus on point-to-point flying. But, the impact on the main airline could be the same.

From what I can tell, the Germanwings name isn’t actually going away. Lufthansa is just going to throw Germanwings, a transformed-Eurowings, and possibly a new long haul carrier under single management. The new amalgamation will be called WINGS.

Germanwings will grow to 60 airplanes and will be responsible for all short haul flying touching Germany as long as it doesn’t touch Frankfurt and Munich. In addition, Eurowings, a regional operator currently flying regional jets for Lufthansa, will trade those in for up to 23 A320s. I think those will be flown in the Munich and Frankfurt hubs otherwise I don’t know the difference between Germanwings and Eurowings, but I’m a little fuzzy on that. Eurowings will then grow into Switzerland, Austria, and Belgium as well, but that should be outside the main hubs. The first Eurowings base will be in Basel with 2 to 4 airplanes.

But wait, there’s more.

Lufthansa is also going to bring the WINGS brand into the long haul game. Oh boy. This one will have 7 767s or A330s for now, and it’s possible that it’ll be a joint venture with Turkish, maybe. That seems like a very small operation. This will be entirely focused on the leisure market, or the, uh “private” market as the press release notes. There’s also another 9 A340s in the Lufthansa fleet that they say can only be operated if they can get lower costs.

In the end, all these changes mean that the company will see its “new businesses, our new platforms and our service companies” grow from 30 to 40 percent of total group revenue. You can read the very dry press release yourself if you’d like. But the real question here is… why is this all happening?

The rationale is pretty clear. Within Europe, Lufthansa is getting smoked by all the low cost carriers. On long haul, especially heading east and south, the Gulf carriers are eating Lufthansa’s lunch. So how does Lufthansa fight it? The same way legacy airlines always fight these things… try to cut costs to find a way to be competitive. And of course, the biggest cost to cut is labor.

Or, as Carsten Spohr, Chairman and CEO of Lufthansa, puts it:

But in the dynamic and highly price-sensitive market segments, our current platforms only enable us to exploit the growth potential to a limited extent, in view of their sometimes over-rigid cost structures.

There is a big problem with this, of course. Ideally what an airline would like to do is find a way to reduce labor costs throughout the entire system. But labor groups won’t stand for that. So airlines think they’re getting smart by creating new airline subsidiaries that check off all the buzzwords. They’ll be more efficient, have more productive labor, and open up new markets. It’s all about growth right?

What really happens is that these low cost carriers become distractions. Legacy airlines don’t do a very good job of starting up low cost carriers. The best they can hope for is to acquire one that’s successful and then try hard not to screw it up. (That has to be IAG’s plan with Vueling.) But is this effort really likely to beat the low cost carriers within Europe? No.

WINGS is not going to get its costs below Ryanair, or one of the other big players in Europe. And on long haul, will Lufthansa really beat the Gulf carriers with 7 airplanes flying to leisure destinations? No. It could be part of the long term plan to just reduce costs throughout the entire company. That’s what Jetstar seems to be for Qantas. But if that’s the case, then it’s just a sneaky end run that tries to avoid problems instead of addressing them. And in the meantime, the core airlines suffer from lack of attention.

Maybe I’ll be proven wrong. Maybe some legacy carrier will start a successful low cost carrier. (Jetstar may be the closest though its success is debatable at best.) Is Lufthansa going to be that airline? I wouldn’t bet on it.

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21 comments on “Lufthansa Focuses on Low Cost, Takes a Page Out Of United’s 2003 Playbook

  1. I don´t fully agree but think that there is some potential to this, however this also came from a limited number of options.

    First of all, Ryanair, Wizzair and, to some extent, Easyjet are Ultra-LCCs that won´t be able to capture all of the market. See Spirit in the US, that has its own profitable niche. Then, LH did learn from recent experiences and the Germanwings product is very customisable. With a basic offering resembling intra-European business class (put into quotation when comparing to real business class), network carrier coach and LCC they can serve a wide range of markets (except the ULCC) in one aircraft, at costs lower than the parent company. Then you can go and pay for food, luggage, seat reservations, extra legroom seats, flexibility, etc.. Indeed, they seem to be seeing some success on that by the end of the year.

    As there is equivalent to hopping under chapter 11, they need different ways to get labour costs (there are others, but this is the main concern) down. The pilot strike this spring showed just how much the unions are willing to compromise so far (the pilots were the only group not yet affected by the last round of cost cuttings and refused to take part now that the results are improving as a result of that). With that in mind, Eurowings should be a sensible platform to a) provide European LCC-type service and improve the condition on the competitionally weak routes and b) build some pressure for union negotiations. The Germanwings concept does have a few aspects not yet present in the European LCC market, so if they transfer that, it´s at least worth a shot.

    The goal for these two is likely to approach what the product and prodution conditions are like for US-domestic flights, minus a real business class (US-domestic first is nothing else) that.

    Lastly, their Tourist-/World-/Leisure-/whatever-they-may-call-it-WINGS, that is the most interesting, but also weakest part. Yes, the 343s they have have very low ownership costs right now as they´re fully writting off and 767s can be had cheap. Still, that´s the ultra price-sensitive market segment and even if they get labour costs under control, there are still EK/EY/QR competing with a good product, much cheaper staff and basically a free tank of gas halfway to anywhere. In the end, it would be similar to the high density configurations that BA, AF and KL run to all those islands their countries hang on to, lacking a legacy market, but having lower cost.

    The problems here are likely rather if the concept itself will work instead of organisation. Already, they have a bit of a zoo in the group but it seems to work well overall with even OS, the largest problem so far, seeming to improve. Some differentiation is also necessary, I believe, to address the different national (e.g. the Swiss still prefer LX as “their national airline”) markets as well as appeal to the low cost market. LX/LH are still perceived as premium and expensive, even though intra-EU fares are often comparable with Easyjet, at the same they don´t want to dilute the brand. Of course, the question could be why not integrate Euro- and Germanwings, but I believe we will see some close integration there in any case.

    To conclude: They did start a successful LCC for flights to/from Germany, are likely to do it for Europe, but let´s see about long-haul.

    I realise this is a long post, but feel I should add the perspective from over here in Europe – thanks if you kept reading up until here ;)

    PS: 4U as LCC was basically a LH-brainchild all along since back in 2002, founded by a largely LH-controlled EW that was completely taken over in 2011. It just became the vehicle for reforming all their non-hub flying in 2012.

    1. Great post I mostly agree with! However, I have to respectfully disagree with you regarding EasyJet. EasyJet has in the past couple of years stepped away from ultra-LCC model and turned more towards “legacy-light” concept. For example, they allow seat pre-selection and their flexi fares offer many add-ons bundled together (1 checked bag (20kg) + priority boarding + rebooking within a month for free) at the price that is very competitive with “normal” fares from legacies (where you get a checked bag). With their fares being available through GDS and multiple daily flights between big cities in Europe, they are now very appealing to business travelers (and spoiled leisure traveler like myself).
      I might be biased (being based in GVA), but I really like what LX is doing with “gva light” fares that start from 39chf one-way (~40 dollars) for short-haul flights (up to 2.5hrs). At the price that is very competitive to EasyJet you just lose an item of checked baggage and maybe seat choice (you still get the snack and drink). I do not feel like this dilutes the LX brand and would prefer model over any flavor of “swiss wings”.

    2. Hermann – Thanks for the detailed thoughts.

      The problem is that while Spirit is in a niche in the US, it is no niche in Europe. Last I checked, it was something like half of the intra-Europe flying touching the UK was on a low cost carrier. And it’s something like a third in all of Europe. It’s no niche, it’s the new normal. And these airlines are moving further and further into the regular airline space. easyJet is bulking up its appeal to business travelers, even starting to participate in global distribution systems. Ryanair is courting the business traveler too. This is taking over the Continent.

      It’s very true that Lufthansa’s labor groups aren’t interested in seeing this new reality, so the only way Lufthansa can try to compete in this space is by doing a different venture. But my point is that they aren’t going to win in this space with the venture they have. Germanwings costs aren’t going to get down to the level of competitors. Legacy airlines just don’t do a great job at building LCCs.

      What are the aspects of Germanwings that aren’t present in the LCC market so far? To me it just seems like another LCC attempt that isn’t much different, but maybe I’m missing something. But anything they do creatively can be implemented at Lufthansa. The only thing they can’t do is get labor costs down at this point.

      1. In the end, I fully agree that it´s very much about labour right now: Get the costs down, find somebody to pay for it or go out of business. So it´s only logical that they try to move everything that´s low yield to a low labour cost platform.

        As for 4U, I think the most striking thing is that they offer a product resembling intra-EU business class. The size of that class is flexible as it´s only blocked seats on the hardware side, but if they can get the extra revenues, that´ll help. Then they have the mid-tier offer which is basically what legacy carrier economy is like and also the no-frills service in the back. Lastly, they do transfers and interline with LH-Group and (I think) Atlantic-Plus-Plus carriers, providing some extra loads. So they try to serve three market segments with the same aircraft and get some extra feed. Compared to traditional LCCs, their cost don´t need to be all the way down to the same level to compete and LHs last quarterly report hinted that the 4U results do look quite promising.

        As for the European LCC market: It´s huge, very true, however much of that is also leisure traffic (Jet2, Tuifly,..) that was never really served by the legacies. Then, Ryanair has an image problem and nowhere near the product, service, route network or schedules to appeal to business travellers.

        That being said, Easyjet is different and they very actively try to move up and they do the right things – that´s the real threat.

        In the long term however, I think we will see a convergence of cost as has been the case in the US. The (let´s call them that for now) premium LCCs will see costs creeping up slowly while the legacies will either go out of business, be kept alive by Etihad or manage to reduce costs.

        1. Hermann – I like the long, detailed comments. If you have the time to write them, I have the time to read them!

          Regarding the intra-Europe biz class, that’s something that is sort of offered by several airlines but usually restricted to the bulkhead and exits. Vueling has the Excellence fare where you even get the middle seat blocked. Of course, if it does work well, they can expand that product.

          This all reminds me of the old Maersk, which I flew back in 2004. They had small, medium, large, and extra large classes. That was fun.

          But regarding interline and all that, this is supposed to be point to point service outside the hubs. So interline shouldn’t really help all that much. There could be limited feed in a place like Dusseldorf but that’s about it. And if someone is connecting over that, it’s probably only because it’s cheaper than going over Frankfurt or Munich.

          All great points in your last paragraph. Europe needs fewer airlines for sure, and Etihad is a big problem right now. But the legacies will have to find a way to get their costs down. They need that for the whole airline, not for some LCC offshoot. And while costs will climb for existing LCCs, there’s always another LCC waiting to be born to take advantage of the opportunity if it’s there.

  2. Whatever happened to Condor? For awhile back in the ’90’s, they were flying a number of LH’s low-yield markets.

    1. Jeremy – It’s all the same basic idea. The premise is that the main airline can’t profitably serve some markets so it decides to create a low cost airline to do that job. Some, like, Ted, really failed at even getting low costs. As mentioned below, the pay rates were the same as at United. So it really was just a silly branding exercise.

  3. The only way(s) I see this really helping them is that if they develop a set of work conditions and labor costs that are lower, and are then able to persuade their unions to come close to matching those in order to preserve jobs and/or prevent more flying shifting to the lower cost model. It is a lot of complexity which is why UA (Shuttle and Ted) and DL (Song) ended up reintegrating it into the core.

    They need to lower costs across the board, not just in a low cost operation. And the leisure long haul business case makes relatively less sense since flights carrying a mix of leisure, business and cargo are the most sustainable model and the least subjected to seasonal variability. Else it is hard to make those leisure aircraft productive Sept-Nov and Jan-Mar, even Jan-May

  4. Interesting how everyone watched U.S. carriers start low cost units and fail, but in Europe the big guys think they can do it in an area that has so many more low cost carriers already and in an area where any E.U. carrier can fly anywhere in the E.U.

    Seems a small company can think big, but a big company can never think small.

    1. IIRC Ted had UA crews at UA pay rates – that´s a big difference and an advantage that Vueling, Germanwings, Transavia and a few others seem to have succeeded on getting. In Asia/Australia Scoot, Nok and Jetstar seem to be doing well with the separate company within a company concept. SilkAir and Dragon Air, while not classical LCCs also fare not too bad. ThaiSmile is too new to really judge here.

  5. LCCs within a legacy carrier don’t work. Period. Not only does it distract management from running the core business, it confuses customers who think they’re booking on the legacy but end up on something they’ve never heard of. At United, Ted’s goal was to win back market share. But as we all know now, it’s not about market share. It’s about making money. As Cranky said, I hope they prove us wrong, but this is a train wreck waiting to happen.

    1. Leslie – Well, it could put a little more pressure on Air Berlin if Lufthansa decides to go on overlapping routes in places like Dusseldorf and Berlin. But I don’t think we really know yet.

  6. I think LH is crazy to ignore Berlin with their hub strategy. It’s perfectly understandable that LH is trying to build up competitive pressure to the rigid Unions with their core product so that they can negotiate more favorable rates or at least not these crazy 6% pay increases every year. It’s also pretty remarkable that the German government is blind to LH’s problems with Gulf carriers and how they really can’t compete fairly with their lack of pension obligations or labor laws.

    But as a buyer of many tickets a year I refuse to fly Germanwings on routes where LH is converting flights from Berlin. At that stage I’d rather buy Easyjet tickets.

    LH can start all the discount airlines they like but Star Gold benefits/Lounge access should be carried over for any airline in their group. Even if mileage earnings are restricted/nonexistent as they are for LH metal flights. This is a crucial mistake they are making in my opinion.

    From my perspective it’s either Star Alliance or not. And if it’s not Star Alliance I will out of principle spend my money on a non-aligned LCC like Easyjet.

    1. On the one hand, LH cannot afford to have more hubs. They are already splitting their own traffic between MUC and FRA, and via the subsidiaries they have hubs at VIE ZRH BRU and even GVA. TXL isn’t well suited to a hub anyway. And it’s unclear when the new airport will open, and whether it will already be at capacity when it opens.

      On the other hand, I find it very customer unfriendly that the Wings operation won’t belong the Star Alliance and you won’t get your Star Gold privileges. And I agree with you, it makes me not want to fly it.

      I think LH would be well served to reconsider and let its elites keep their earned privileges. The marginal costs cannot be that high.

  7. I wonder if doing this helps them make a credible thread to LH’s unions: Get in line with lower costs, or we’ll do at LH what we did at Austrian: Shut the mainline operation down and turn the planes over to a wholly-owned regional subsidiary (Tyrolean) to operate the flights under the mainline brand at a lower pay scale.

  8. The long haul proposition is lunacy. They’re going to create something that has higher costs than Qatar with lower brand equity than Ryanair and, I’ll wager, poorer service than Condor.

    Since the first tentative steps Ryanair made into Frankfurt Hahn, Lufthansa has consistently underestimated the willingness of their customers to endure inconvenience in order to save money. Assuming they can cover costs in this area by matching the economy fares offered by Emirates and Qatar, I still think most Germans will tolerate a stop in the Middle East in preference to a product positioned as “low cost” on a twelve hour journey to Phuket or Bali.

  9. A real screw up by Lufthansa in leaving Dusseldorf. The prices for flights on GermanWing, a supposedly low cost airline, are as high when Lufthansa was the name on the planes. Only now there are no Star Alliance privledges. Crap check in somewhere in the terminal, no lounge access, nasty reservations agents all lead to finding another carrier. To summarize, same prices but way less service.

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