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(originally published by Booz & Company)


Friendlier Skies

At the same time, even as Europe’s low-cost carriers (LCCs) continue to gain market share, they will also suffer in a downturn. As fuel prices rise, it will be critical for LCCs to consolidate to create the greatest economies of scale possible and to make further gains against the flag carriers, especially since they have already squeezed every possible savings out of their operations.

The second factor is the changing competitive dynamics of the international air travel business. Pending consolidation among U.S. airlines will strengthen their position on routes to Europe, and airlines in emerging markets, such as Air China and Emirates, are seeking greater access to European markets. Looser regulations — most notably the recent Open Skies agreement between the U.S. and the European Union, which permits U.S. and European airlines to make transatlantic flights between any two airports in each region — mean the European flag carriers are facing greater competition. That will lead to more transactions like Lufthansa’s recent purchase of 19 percent of New York–based JetBlue, which is expected to give Lufthansa more feeder routes into its transatlantic system. If successful, this deal may encourage European flag carriers to take minority ownerships in U.S. airlines.

The Shape of Things to Come
Given these trends, any number of smaller European airlines, both flag carriers and LCCs, may find themselves on the auction block in the coming years. The three major LCCs — Ryanair, easyJet, and Air Berlin — together offer more than 60 percent of the LCC seats available in the European market. They will likely seek to acquire other niche LCCs as they drive to capture new routes and markets.

Similarly, although initial negotiations between Air France KLM and Alitalia broke down, the three major flag carriers will likely eye deals with smaller flag carriers, including Alitalia, as well as airlines such as Iberia and Austrian Airlines: Most of these small lines are undercapitalized, unprofitable, and burdened with suboptimal networks and legacy cost structures. Already, British Airways is exploring an expansion of its minority stake in Iberia. Lufthansa would most likely be open for discussions with its fellow members of the Star Alliance, such as BMI (British Midland Airways), Austrian Airlines, LOT (Polish Airlines), and SAS (Scandinavian Airlines).

We also think it likely that the factors encouraging the coming consolidation will promote deals across industry categories, leading to convergence among intercontinental network carriers and LCCs and creating innovative hybrid models with the potential to generate higher rates of return. Lufthansa and Germany-based travel tour operator TUI have already signed a letter of intent to set up a new LCC to compete with Air Berlin. Meanwhile, Air Berlin recently acquired the long-haul German charter carrier LTU and is in the process of acquiring Condor, another German LCC, in hopes of creating an international network based in Germany that would combine a strong European network with a growing number of intercontinental destinations; indeed, Air Berlin recently announced plans to begin regular flights to China. Other LCCs, including Ryanair and Italy’s Air One, are also looking beyond their discount European business to a greater international presence.

A Blueprint for Success
The difficulty in any airline merger, of course, lies in overcoming the numerous obstacles — financial, political, cultural, regulatory — that stand in the way, and then successfully capturing the potential value inherent in any such transaction. The merger of Lufthansa and SWISS has cleared those hurdles and thus far exemplifies a successful transaction.

Despite its proud history of customer service, the venerable Swissair fell into bankruptcy in 2001, due to a failed expansion strategy and the air travel downturn that followed the 9/11 attacks. After a painful restructuring, the airline was reborn as SWISS, but that experience provided the motivation for both management and employees to enter merger discussions with Lufthansa, and the close cultural fit — created by a mutual drive toward quality and a strong technology footprint — between the two airlines further smoothed the path.

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  1. Dan Milmo, “Open Skies Deal Leaves Airline Merger Hopes Lost in the Clouds,” The Guardian, April 6, 2007: A useful, if slightly outdated, analysis of the effect of the Open Skies agreement on the potential for increased M&A activity in Europe.
  2. Wole Shadare, “Airline Merger: Route to Global Survival,” The Guardian, March 14, 2008: A more recent look at global airline merger activity that takes a more optimistic view of the future prospects.
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