Air France-KLM: Attempting to rearrange the deckchairs while pilots remain on full steam ahead


Air France-KLM's latest strategic project, 'Trust Together', follows its Transform 2015 and Perform 2020 programmes. In fact, it complements Perform 2020, rather than replacing it, at least until fuller details are announced in 2Q2017. After years of financial under-performance and market share erosion by Gulf airlines on long haul and LCCs on short/medium haul, CEO Jean Marc Janaillac aims to regain the offensive with this project.

But, in the absence of a substantial change of heart by the group's unions, there is little to suggest any "new" initiative will have a greater impact than its predecessors. The mere fact that Mr Janaiiac is forced to deny that the new long haul airline, codenamed "Boost", will be positioned as "low cost" is a clear enough indication of the task ahead. Indeed, to consider establishing anything else would be irrelevant in today's world.

Presumably so as not to rock the union boat plans are for only an ineffectual 10 aircraft by 2020. Just as with its short/medium haul LCC, Transavia, the scale and scope of the new long haul airline are likely to be subject to negotiation with Air France pilots. Transavia itself will now focus on routes from France and the Netherlands, implying an end to the troubled plans for Transavia Europe.

Mr Janaillac hopes to establish trust at the heart of Air France-KLM's relationship with all stakeholders, but before his plans can start to take effect, the crucial task of negotiating with unions must be undertaken. But there is little to suggest Air France's recalcitrant pilots will be any more transformed or trusting than they have been in the past.

Trust Together builds on the group's Perform 2020 targets

Air France-KLM's Trust Together project represents Mr Janaillac's initiative to build on the group's Perform 2020 programme that was announced in Sep-2014. It is the result of his deliberations after his first few months as group CEO.

The new project extends the group's annual unit cost reduction target from a range of 1% to 1.5% for 2015 to 2010 to a reduction of "in excess of" 1.5% pa between 2017 and 2020.

It continues to impose discipline over capital investment, with an annual target of EUR1.8 billion to EUR2.2 billion for 2016 to 2018 (similar to the EUR1.9 billion to EUR2.2 billion range set for 2015 to 2017). A priority is to generate positive free cash flow before disposals each year (ie cash flow from operations after deducting capital investment) and to continue to reduce debt.

Unlike the original Perform 2020 plan, Trust Together does not include any profit targets. There is still much detail to be discussed with unions and this may help to explain management's coyness over long term financial goals. However, it has still not issued a profit target for 2016, even after the publication of 3Q2016 results.

Trust Together does have a revenue target of around EUR28 billion in 2020. The group also aims to carry 100 million passengers with a fleet of 435 aircraft (excluding regional aircraft) in 2020.

By way of comparison, in 2015, Air France-KLM had revenue of EUR26 billion, carried almost 90 million passengers and had 403 aircraft in operation at year end (excluding regional).

Air France-KLM's Perform 2020 plan was analysed by CAPA in Sep-2014: Air France-KLM's new plan to grow LCC Transavia has taken too long; a union confrontation looms

Nine strategic priorities to address three major challenges

Air France-KLM has identified three major challenges faced by the group. These are to capture its share global of air transport growth, to reinforce its competitiveness and operational efficiency and to enhance customer experience. In order to address these challenges, Trust Together is based on nine strategic priorities, set out in the box below.

Priorities 1, 3 and 9 are the most eye catching and will form the focus of this report. In addition, priority 4 is also worth a mention. Finally, recent management changes will also be discussed.

Air France-KLM's nine strategic priorities
1. Regain the offensive in long haul
2. Improve the efficiency and connectivity of the hubs
3. Develop the point-to-point markets on departure from the French and Dutch home markets
4. Strengthen the growth of the maintenance business
5. Defend the Cargo business in support of the Passenger activities
6. Reinforce competitiveness and the utilization of aircraft
7. Further develop the customer relationship to create more value
8. Optimize organizational structures and gain agility to facilitate the initiatives and accelerate innovation
9. Pursue lobbying initiatives in Europe and France directed at more equitable competition

Priority to regain the offensive in long haul, but growth below market rate

At the group level, Air France-KLM is targeting long-haul capacity growth of between 2% and 3% pa through to 2020.

Its initial Perform 2020 targets, covering the period 205 to 2017 and announced in Sep-2014, included long haul growth of around 2%, so this new target is a very modest increase. However, this is less than the long haul market growth forecast by Air France-KLM to be around 5% pa.

By contrast with the stated challenge to capture its share global of air transport growth, this suggests that it intends to lose market share. Importantly, at least as a sign of intent, Air France-KLM says that its growth must be profitable and so a relatively modest growth target is welcome.

Initiatives in the long haul area are concentrated in two areas, identified as being at the levels of revenue and cost. Each of these is discussed below.

Development of alliances and partnerships

At the revenue level, Air France-KLM aims to develop its alliances and commercial integration with partners.

Its announcement is a little short on specifics, but it refers to the deepening of alliances modelled on its partnership with Delta. It intends to "reinforce its commercial integration with its principal partners to benefit from an expanded market position, leverage joint distribution networks and be able to offer customers a global proposition in each market."

This suggests a wider use of joint venture style partnerships, of the type that Air France-KLM has with its SkyTeam partner Delta on the North Atlantic. With the approval of competition authorities, these revenue sharing JVs enable the partners to coordinate schedules and pricing, helping to shield them from the dilutive impact on unit revenue that results from strong competition in many markets.

Air France-KLM has more limited JVs with SkyTeam's China Southern and China Eastern. Although its statement does not mention either, it has been looking for ways to deepen its relationship with its Chinese partners for some time and this must be an ongoing goal.

In addition, it may be looking to add further JV agreements, perhaps starting with existing codeshare partners. Between them, Air France and KLM have codeshare agreements with all the other 18 SkyTeam airlines. Beyond SkyTeam (and other group airlines), they have codeshare agreements with a further 46 airlines.

Clearly, the majority of these will not make suitable JV partners, but this indicates that Air France-KLM has a large number of counterparty airlines with which it has regular contact and discussion.

In the past, it had been thought that the group was looking to develop a joint venture with Etihad, with which both Air France and KLM have codeshare agreements. This has been stalled by Air France-KLM's ongoing anti-Gulf rhetoric and, apparently, by Etihad's strategic pursuit of minority equity investments in a number of airlines, including airberlin, Darwin Airline, Air Serbia and Alitalia in Europe.

Another mooted potential JV partner is Singapore Airlines, with whom Air France has reportedly held talks about a close commercial relationship.

See related report: Air France-Singapore Airlines partnership talks highlight lack of Gulf airline penetration in France

A new lower cost long haul airline is planned at CDG: 'Boost'

Perhaps the most interesting element of Air France-KLM's announcement about initiatives in its long haul activities, is its plan to establish a new airline. Part of what it calls ongoing measures to improve the competitiveness at the cost level, the new airline project has been given the name 'Boost' (not necessarily to be the airline's trading name).

The new long haul airline will be part of Air France and intended to boost its growth from its Paris CDG hub. Air France-KLM describes it as "the Group’s response to the Gulf State airlines which are developing at low production costs on key markets".

It hopes to regain market share from the Gulf airlines with Boost.

It will focus on "ultra-competitive markets" on routes that have been structurally loss-making for Air France. The group hopes that Boost will allow it "to go on the offensive by opening new routes, re-opening routes closed due to their lack of profitability and maintaining routes under threat".

It also aims to use the new airline to return to previously loss-making routes that have been closed. By 2020, it expects 30% of Boost's operations to be on newly created routes, implying that the majority of routes will be transferred from Air France, or routes that had been closed.

Boost will be lower cost, not low cost

In spite of previous musings by Air France-KLM that it was considering launching a long haul low cost airline, Boost will not be positioned as low cost. To some extent, this may be semantics and it will certainly need to aim to operate with a lower unit cost than that of Air France. Moreover, the statement says that the new long haul operation will "propose a simple, modern and innovative offer".

Nevertheless, it will include both business and leisure destinations and will have standards "comparable to those of Air France in terms of product quality and the professionalism of the crews".

This chosen model, between a low cost airline and the existing Air France product, may partly reflect the reality that the group's hands are tied by pilot agreements when it comes to setting up a true low cost long haul operation. Its launch is, at least in part, a response to new low cost competition on long haul routes to/from France by the likes of Norwegian and French Blue.

See related report: Air France-KLM: long haul low cost airline could be part of new CEO's vision as French Blue enters

If done properly, the new airline should provide Air France-KLM with an opportunity to do things differently, not only in terms of better cost efficiency, but also in terms of fostering a culture of innovation. The group sees it as a "laboratory" for its ability to innovate "in terms of products, digital and technology, catering, cabin design, services and the customer experience, as well as for working methods".

Boost to have a mere 10 widebodies by 2020

The only operator that will increase long haul fleet numbers for 2020 will be the new Boost airline (although Air France hopes to achieve some ASK growth through increased utilisation). Boost aims to have 10 long haul aircraft by 2020, but Air France-KLM's announcement does not specify the aircraft type or whether they will come from the existing widebody fleet.

At the end of 3Q2016, Air France had 105 widebodies and KLM had 68, so the new operation will represent less than 10% of Air France's long haul fleet and less than 6% of Air France-KLM group's long haul fleet.

This compares with Lufthansa's target of seven wide body aircraft in its Eurowings LCC brand by 2017. This represents only 5% of the total of 146 widebody aircraft in the Lufthansa Group fleet (as at 3-Nov-2016, source: CAPA Fleet Database).

See related report: Air France-KLM, IAG, Lufthansa LCC strategies: denial, submission, retreat, now counter-attack

Nevertheless, in the context of making a serious response to LCC and Gulf carrier competition, 10 aircraft in 2020 would be no more than irrelevant. Both groups are really only dipping their toes in the water of low cost/lower cost long haul operations, by comparison with operators such as Norwegian. With 12 wide bodies in operation at 4-Nov-2016 and a further 41 on order for delivery by 2020, Norwegian's long haul low cost activities alone are significantly larger.

Pilot agreement will be critical to Boost; the precedents are not encouraging

The staffing of the new airline, and the cooperation of labour groups over new working practices, will be critical to its chances of success. Air France aims to negotiate the details of the employment framework of Boost "in the coming weeks".

However, it is moving in a direction that suggests it is anxious not to provoke Air France pilots. Boost will use pilots from Air France only on a voluntary basis, but aims to develop its own working conditions in accordance with its competitive positioning.

The devil will be in the detail when it comes to talks with pilot unions on how this will work in practice.

However, this approach indicates that Air France pilots will have a significant say in the development of the new airline, as they do over the development of Transavia. This may help to explain the modest scale of the Boost fleet plan.

Recruitment of new pilots from elsewhere would have allowed a completely fresh start, but existing Air France pilot agreements would be a major obstacle. Moreover, the by-passing of Air France pilots for the new vehicle would probably be seen as highly provocative by their unions.

It seems that Air France expects to have greater flexibility regarding the new airline's recruitment and development of cabin crew. For flight attendants, there will be an "independent career path" enable Boost to operate with costs at the market level.

Ground operations for the new airline will be handled by Air France.

See related report: Air France-KLM: long haul low cost airline could be part of new CEO's vision as French Blue enters

Priority to develop point-to-point markets from France and Netherlands

Hop and Transavia to be only two point to point brands in France

Currently, Air France-KLM operates point-to-point short/medium haul routes with four brands: Transavia, Hop, Air France and KLM. In the French market, the group will rationalise its brands from 2017, so that its French regional airline Hop and its LCC Transavia will be the only two brands in point-to-point.

If this means that some routes will be transferred from Air France to Transavia, this is a welcome move. Under agreements with Air France pilots, this has not been permitted, with the result that Transavia's French operation has grown either by creating entirely new routes, or by flying alongside Air France on a number of routes.

See related reports:

Transavia part 1. Pilots agree vital growth in France; Air France to rue end of pan-Euro LCC plan

Transavia part 2: still constrained by unions and forced into high degree of overlap with Air France

A change to this situation would require a change the agreement with Air France pilots. Conversely, it may also mean that some Air France routes will be transferred to Hop, but this would blur the relative clarity that Hop is purely a regional airline.

An additional nuance is that the statement refers to the regional airline as 'Air France Hop', rather than simply 'Hop'. This suggests that it feels the need to reinforce Hop's association with Air France.

However, it is not clear if this represents a formal rebranding (nor whether it is a step on the way to dropping the Hop name altogether).

Transavia to focus on France and Netherlands, possibly ending Transavia Europe plans

For the Group’s low cost brand, Transavia, the priority will be growth in the French and Dutch home markets. This seems to signal the end of previous ambitions for Transavia to develop a fully fledged third arm, Transavia Europe, which would set up bases in countries outside the Netherlands and France.

It made a first step in this direction with the establishment of a base in Munich in Mar-2016, operated under the auspices of Transavia's Dutch arm.

See related report: Transavia: Munich to be first base outside home markets, but Air France-KLM's LCC still lacks scale

This base did not perform in line with Air France-KLM's expectations in its initial weeks and months, but management told analysts on a conference call to discuss 3Q2016 results and the Trust Together programme that performance had improved in the peak the summer months to "breakevenish".

The future of Transavia in Munich is to be reviewed, but the clear statement that the brand will focus on French and Dutch markets indicates that this experiment may prove to be short-lived.

In France, Transavia will focus on routes from Paris Orly to Europe and from the French provinces to Europe. It plans to reinforce its position on some routes to compete with the high speed train and the low cost carriers.

Increased coordination between Transavia and Air France-KLM's other airlines

Air France-KLM also says that commercial coordination between Transavia and the Group’s other airlines (Hop, Air France and KLM) will be stepped up to expand the offer to customers. No further details have been given in this area, but it seems sensible to attempt such coordination.

Ground operations at Paris-Orly and French regional airports are to be redefined on a station-by-station basis.

Priority to pursue lobbying directed at "more equitable competition"

The ninth strategic priority identified by Air France-KLM is worth a mention. The group places significant emphasis on lobbying at the European level "to establish equitable competition with the Gulf State and low-cost carriers". In France, it focus is on lobbying to reduce taxes and fees.

Certainly, it is in the interest of all self-respecting businesses to devote some time and resource to influencing governments and regulators.

However, it is striking that Air France-KLM has made a point of including lobbying alongside its plans for a new long haul airline, improving hub efficiency, developing its point to point operations and other self help initiatives. This indicates that it has not fully embraced the need to find its own internal solutions to the challenges it faces.

In particular, it is always going to be difficult to compete successfully with long haul airlines from the Gulf and with LCCs on short/medium haul with a mindset that still clings to the idea that what these competitors do is somehow unfair.

With a receptive French government, this inertial strategy has so far proven almost the only effective response to Gulf carrier competition. But in reality this can only be a delaying position. Even governments lose the enthusiasm to raise the level of entry barriers. At some stage, unless the needs of consumers and national economies are met by the incumbents, the pressure to provide the public with high quality products (including expanded route options and frequencies) and competitive prices will prevail.

Maintenance division review

The group also plans to review the business model of its maintenance division, although it is clear that it will continue to invest in this business. Air France-KLM's MRO segment is profitable and is the global number two in the market. Its review will include considering the possible 'corporatisation' of the maintenance unit.

This could give it greater focus, accountability and visibility and could also pave the way for a potential sale of a minority stake, which Air France-KLM may hope will be beneficial to the group's overall valuation.

Management changes may smooth industrial relations

The day before Air France-KLM's Trust Together announcement, it announced some key senior management changes at Air France and at the Group. Frédéric Gagey, previously Chairman and CEO of Air France, has become the Chief Financial Officer of Air France-KLM, as replacement for the departing Pierre-Francois Riolacci.

Mr Gagey's role at Air France has been split into two. The new CEO of Air France is Franck Terner, who was previously Executive Vice President Engineering and Maintenance for the Air France-KLM group. The role of Chairman of Air France has been assumed by group CEO Jean-Marc Janaillac.

These changes bring Air France more closely under the control of the Air France-KLM boss. They may also help to accelerate progress in industrial relations at Air France.

In Oct-2015, the industrial relations climate sank to a low point when there were well publicised clashes between some employees and Air France managers. Although there has been some progress since then, pilots have still to agree to changes in working practices that the group set out as part of its Transform 2015 plan.

See related report: Air France: Seven years of losses before Works Council clash reveals a cracked mirror

Mr Gagey had probably become too closely associated with the period when negotiations ran into difficulty, even if he was not directly held responsible. His move to the group CFO role returns him to the finance function where he had previously spent much of his career.

Mr Terner has spent his entire career with the group, mainly in the maintenance and engineering functions. Coming from outside the mainline passenger business, he may provide the opportunity for a fresh start to industrial relations at Air France. Moreover, Mr Janaillac, who only joined the group as CEO in Jul-2016, is seen as having taken a more conciliatory approach to labour issues.

Real change is still needed - and support at government level will be crucial

However, although confrontation may not always yield the desired results, compromise often stores up problems for the future. Air France-KLM has persistently been the weakest of Europe's big three legacy airline groups in financial results over many years.

IAG has been the most profitable of the three, to a large extent because it confronted the need to improve labour productivity earlier than the other two. In some ways, the environment in which Air France-KLM operates is more challenging politically, culturally and from the point of view of employment legislation. Whereas the French government's resolve typically turns to water once Air France's attempts to achieve change become politically threatening, British Airways had the full support of the UK's political leaders.

However, this is also an argument for even greater determination from management to bring about change that leads to improved labour productivity. As Mr Janaillac said in the Trust Together announcement, "The status quo is not an option".

Air France-KLM's Trust Together project includes some eye-catching points, most notably the plan for a new long haul airline with lower costs than Air France. However, its lack of scale echoes the lack of ambition that CAPA has previously flagged concerning the development of Transavia in short/medium haul. Moreover, Air France-KLM's strategic plans continue to be subject to the conditionality of union consent.

Fuller details of Trust Together will be presented by Air France-KLM in early 2Q2017, following detailed labour negotiations. The group's 3Q2016 results showed its operating margin starting to decline and the outlook for European airlines is that the cyclical upswing is ending.

The time for excuses is running out for Air France-KLM. Real change is still needed. Whether it is any more likely to happen than it was four CEOs ago is not obvious.

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