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Lufthansa’s Eurowings goes to America; will the pilots unions allow US DoT to issue an exemption?

On 16-Jul-2015, Lufthansa subsidiary Eurowings applied to the US Department of Transportation for a foreign air carrier permit to operate between Germany and the US. Eurowings is Lufthansa’s chosen low cost vehicle to operate on long haul routes.

The company, Eurowings Luftverkehrs AG, has applied to fly between Cologne, Germany, and Fort Lauderdale, Florida , commencing “on or about” 27-Mar-2016, next year's summer season.

A wrinkle to the application is that the Fort Lauderdale service will initially be operated as a wet lease by a subsidiary of Lufthansa-Turkish Airlines’ JV LCC, SunExpress. Pilots unions – whose opposition has been influential in blocking a similar long haul low cost operation by Norwegian Air International – will undoubtedly have reservations about this new entrant, especially operating under wet lease. No doubt EU officials, seriously miffed over the Norwegian approval delays will be watching closely to see whether Eurowings will have a similarly rocky road.

Lufthansa’s tortuous path to lowering its cost base. Eurowings is Lufthansa’s hope for competing on leisure routes and with Europe's LCCs and the Gulf airlines

The new incarnation of Eurowings, which was historically part of Lufthansa's regional feeder business, operated its first A320 flight, Hamburg-Prague, only on 1-Feb-2015 and is in the process of replacing its Bombardier CRJ900 fleet with Airbus narrowbody aircraft. Its planned fleet of 7 long haul A330s are gradually entering service and long haul operations will begin on 25-Oct-2015, initially to Dubai, Bangkok, Phuket and Caribbean destinations.

Eurowings has been a long time coming to its present role in the Lufthansa group. But it is much needed, both for short and long haul, as Lufthansa is among the highest cost operators of the European full service airlines. Like Europe’s other legacy airlines Lufthansa has suffered extensively at the hands of LCCs in the short haul market and the Gulf carriers on many long haul routes.

Despite establishing a powerful airline empire embracing not only the Lufthansa group’s German airlines, but also full service carriers Swiss International, Austrian Airlines and Belgian flag carrier Brussels Airlines, Lufthansa is faltering. Its own cost base is far too high and its hub operation is under siege from both long and short haul airlines. It still lacks a coherent and comprehensive long term strategy. Eurowings is a hopeful attempt to establish a leisure vehicle (for “private” travellers as Lufthansa puts it). It may have further uses - one of the things that worries legacy unions.

As Lufthansa’s DoT application describes it, Eurowings “is wholly owned and controlled by Deutsche Lufthansa AG ("Lufthansa") and is a member of the Lufthansa Group. Both Lufthansa and Eurowings are German-certificated air carriers.” Lufthansa believes that Eurowings has a cost base some 30-40% below that of Lufthansa.

Germanwings, another Lufthansa "low cost" airline, which in reality does not have particularly low costs, is also in the Lufthansa stable, also Germany-based. As CAPA has previously observed, in spite of owning its Germanwings subsidiary for many years, Lufthansa did not start to use the LCC aggressively until 2013. Moreover, Germanwings is now clearly not even the right vehicle, with its cost base ruling it out as a true LCC.

Lufthansa's decision now to transfer a large number of Germanwings' routes to Eurowings, which it will also use to expand its budget offer into Austria and Switzerland as well as long haul markets, highlights this point.

Eurowings' potential has not been recognised until now

Lufthansa has owned Eurowings for as long as it has owned Germanwings, but seemingly only recently woke up to its potential for improving cost efficiency. In 2012, Lufthansa made a strategic decision to transfer point-to-point European routes that do not touch its hubs at Frankfurt and Munich to Germanwings. This process began in 2013 and has now been completed.

However, as Germanwings is not sufficiently low cost and its pilots are covered by the same collective wage agreement as the mainline pilots, Lufthansa now plans to expand its use of Eurowings, which previously supplied regional jet capacity to Lufthansa. This, much lower cost operation, whose pilots operate outside the collective agreement has a unit cost some 20% lower than that of Germanwings, according to Lufthansa.

Eurowings will assume the operation of 55 Germanwings routes at the start of the winter season on 25-Oct-2015 and Lufthansa has so far indicated that Eurowings will take over a further five routes in summer 2016. Fort Lauderdale is to be one of them.

The expansion of Eurowings on both short haul and long haul is intended not only to provide the group with more cost competitive operations in point to point markets, but should also increase Lufthansa's bargaining power with labour groups over the reform of labour practices and terms in its mainline operations (although its mainline pilots continue to object strenuously to this).

Based in Cologne-Bonn, Lufthansa announced in Feb-2015 that Eurowings would also establish a base in Vienna, as part of its role in helping “the airlines of the Lufthansa Group secure their strong positions in their home markets of Germany, Austria, Switzerland and Belgium in the point-to-point travel segment, too, in the longer term.”

Group CEO Carsten Spohr has laid out the formula for the two “Wings” airlines: “As with the already-successful Germanwings concept, the new Eurowings long-haul products will offer customers a choice of ‘Best’, ‘Basic’ and ‘Smart’ fares. Home base for the new long-haul fleet will initially be Cologne/Bonn Airport; and Cologne will also be the home of the Wings carriers’ commercial management operations.”

It is something of an overstatement to describe Germanwings as a success, but clearly the hopes of the future are firmly pinned on the “Euro” part of the Wings. For Lufthansa – whose senior executives were decrying the long haul low cost model only a couple of years ago – this new intercontinental venture marks a new direction.

See related reports on Germanwings and Eurowings from CAPA:

Lufthansa SWOT: new low cost platforms are smarter strategy than resorting to protectionism

Germanwings has preserved Lufthansa's market share, but still has too many legacy issues for a LCC

Lufthansa's planned new lower cost long-haul airline must avoid legacy issues

The SunExpresss wet lease raises issues that seem to mirror the Norwegian International application

However, there is more to the Eurowings application than simply a new long haul operation. To the not so muted disappointment of the European Commission, a similar Irish-designated Norwegian Airlines International (NAI) proposal to operate between Ireland and the US has been placed on ice by the US DoT. This has seemingly signalled that any out of the ordinary application is in jeopardy, if that precedent is any indication.

In Dec-2014, visibly frustrated by the DoT's delay in moving on the application, the European Commission alleged that failure to grant NAI’s application violated the bilateral understanding, stating the Commission: “considers that there is a breach of the EU-US air transport agreement by the US authorities, regarding the application from Norwegian Air International to fly to the United States. The US authorities are taking too long to process the application and this delay is not compatible with the EU-US agreement.” There has still been no movement.

See related reports:

Norwegian Air Shuttle renews its attempt to obtain US rights for NAI. Part 1: the arguments

Norwegian Air Shuttle's attempt to obtain US rights for NAI. Part 2: Traffic impact on competitors

There are therefore grounds for expecting this new application for exemption to give rise to another round of differences.

As the Lufthansa/Eurowings application explains, “a Letter of Intent has been signed with SunExpress, a joint-venture company of Lufthansa and Turkish Airlines, under which the intercontinental services to be offered under the Eurowings brand will be flown under the air operator certificate (AOC) of SunExpress Deutschland and with SunExpress Deutschland cockpit and cabin crews.”

To complete the loop, SunExpress Deutschland – which will be operating the service as a wetlease to Eurowings - is actually a subsidiary of SunExpress. And pilots unions have a particular mistrust of wet lease operations.

SunExpress itself is owned 50-50 between Turkish Airlines and Lufthansa, potentially raising the issue of whether SunExpress is “substantially owned and effectively controlled” by an EU airline, Lufthansa. Turkey, like Norwegian’s home country, Norway, is not a member of the EU.

The US-EU agreement was intended to prevent disputes over designation

However, under the terms of the exchange of letters completed January 12, 2009, by the U.S.-EU Joint Committee, this ownership and control matter should arguably be moot.

As explained on the DoT’s website, the agreement contained in that exchange of letters requires the “aeronautical authorities of the United States and of the Member States of the European Union (Member States) (to) recognize fitness and/or citizenship determinations made by the other with respect to its air carriers. Under this arrangement, the U.S. Department of Transportation uses determinations made by aeronautical authorities of Member States on the fitness and citizenship of their air carriers, rather than basing these findings on detailed evidentiary submissions filed by applicant EU air carriers under 14 CFR Part 211 of the Department’s rules. “

On this understanding, “EU air carriers licensed by their homelands to serve the United States may file abbreviated applications for foreign air carrier permit and/or exemption authority under 49 U.S.C. 41301 and/or 40109, as applicable. The applicant EU carriers are relieved from complying with those provisions of 14 CFR §211.20 (and of 14 CFR §302.202) of the Department’s regulations that require the filing of information normally used in the Department’s determination of fitness and citizenship.”

In broad terms, this means that if an EU Member state designates an airline which is authorised to fly under its own rules, then the US DoT should in principle not question the “fitness/citizenship” of the airline. Yet that is what the DoT, under intense pressure from ALPA and Delta et al, have done by postponing any decision on allowing Norwegian to operate from Ireland.

Lufthansa itself had a few words to say about Norwegian International's application in 2014

Lufthansa was vocal in its opposition in Feb-2014 to the NAI application, aligning itself expressly with the views of the “Joint American/Delta/United Comments and the ALPA Comments”.

This filing noted “The dangers posed by NAI’s Application to a competitive US-EU marketplace with the ‘high labor standards’ secured by Article 17bis (of the US-EU Air Transport Agreement) were best expressed in the recent statement by the Norwegian Transport and Communications Minister cited by ALPA in its comments – ‘Discrepancies between national legislation within EU-EEA may result in a non-level playing field, both on operations within EU/EEA and on operations between EU/EEA and third countries. In addition, differences in interpretations, application and enforcement of harmonized EU/EEA legislation may result in unequal conditions’”

The filing continued: “ALPA observed, and the Joint EU Carriers (Lufthansa and SAS) agree, that ‘enforcement of national labor laws may be very difficult in cases (such as the NAS/NAI model) where an AOC may be issued by one Member State, personnel may be recruited in another country or countries and labor contracts may be governed by legislation in a third (possibly non-EU/EEA) country’”

The filing went on to cite a number of potentially drastic outcomes that could occur if the NAI application were approved. Under stiff pressure from ALPA and - at best - inertia from other parts of the US industry, the Administration and Executive - DoT has sat on its hands for many months, simply neglecting to take any position on the application.

Lower fares are "at the expense of the long-term survival of established US and EU carriers"

Lufthansa and SAS were also at pains in their filing to point out that the "unfair labor cost advantage" that NAI gained would be inconsistent with the US-EU Agreement. The resulting lower costs, despite perhaps benefitting "consumers in the short-run with cut-rate fares", would be "at the expense of the long-term survival of established US and EU carriers (and the service options they offer to the traveling public) and the employment conditions enjoyed by their pilots and cabin crews".

Of its nature this attitude that airlines and the DoT should determine what is best for the consumer is clearly inconsistent with any published aviation policy of the US or the EU. But it also begs the question: do any substantially lower fares - made possible by an operation like Eurowings with its lower cost base, supported by SunExpress - also threaten to undermine the status quo? Or if they don't, how low can costs and fares actually go before they become so patently unsociable?

While no two cases are ever identical in their detail, it would look on the surface at least that the proposed wet lease operation by a subsidiary of SunExpress of Turkey and Eurowings' low cost base, complete with its lower paid pilots and lower fares, has the potential to fall into the very same horror list outlined by Lufthansa and ALPA.

European and US pilot unions don’t approve of low cost airlines, especially on the North Atlantic

Lufthansa’s own pilots have wrought industrial havoc on the airline in recent months. Its other unions, including cabin crew, have also adopted seemingly uncompromising positions. Both the pilots union, Vereinigung Cockpit, and the cabin crew union, Unabhängige Flugbegleiter Organisation (UFO) are currently threatening further industrial action at, or even before, the end of Jul-2015. On 6-Jul-2015, following failure of talks with management, the pilots announced an earlier unilateral truce on striking was at an end and that "a renewed escalation of the conflict has thus become probable.”

And ver.di, which represents around 33,000 staff at Lufthansa, Lufthansa Technik, Lufthansa Systems, Lufthansa Cargo and LSG Sky Chefs, has suspended strike action only until 30-Sep-2015, pending resolution of disputes.

In all cases unions are pressing for pension and retirement conditions either to be improved or at least not amended at all.

But the real agent provocateur and the common underlying irritant for Lufthansa's unions is the introduction of low cost operations into the group.

In Jun-2015, group CEO Carsten Spohr was quoted in Bloomberg as saying there remains “a lot to be done” to make the company “a leaner organisation, a fast organisation”. Mr Spohr said: “Lufthansa has to regain its reputation for being the quality airline, the quality aviation group in this industry.” He is having difficulty convincing a reluctant workforce that the necessary changes are made to achieve his goal.

On the other side of the Atlantic, industrial action is not the issue - for the time being; many airline unions (not Southwest’s) have been placated by salary increases, bonuses and promises of better things to come. So now, in concert with their employers, they are focussing on ensuring that foreign competition not be allowed to rock the boat.

Exemplified by the loud campaign by ALPA and Delta et al to exclude NAI, this has succeeded in delaying indefinitely the DoT’s approval. ALPA has characterised the NAI application as an opportunist plan which is no different from the “flags of convenience” operations common in maritime trades. Like the best syllogisms it has some grains of logic, albeit the reality is nothing of the sort.

ALPA’s campaign against Norwegian

Says ALPA: “The clock is ticking for the U.S. Department of Transportation to make a final decision on whether to deny Norwegian Air International’s scheme to fly into the U.S. We’ve won the first battle in this fight, but we need your support now more than ever to put pressure on DOT, the White House and Congress to protect U.S. aviation jobs. ALPA members, engage today; join the Call to Action!”

ALPA has also been active in supporting Norwegian’s own short haul pilots who complained about work conditions.

The main goal – to prevent new competition on the North Atlantic, particularly where it involves low cost operations and any threat, real or perceived, to current salary levels. Will Lufthansa's new move give rise to a "DenySunExpress"? Hopefully not.

There is a longer term issue: the role of long haul low cost (network) airline operations

Eurowings, as the subsidiary of a notable European hub carrier, may in due course become part of a new travel formula. Despite consistent expert rebuttals of the potential for long haul low cost, new models continue to appear. Aside from the now numerous versions in Asia Pacific (there are 10 and counting), Europe has NAI and now Eurowings: Air Canada has established a subsidiary, rouge and competitor WestJet is moving in that direction; Brazilian LCC Azul is moving into long haul; there are more. And arguably the longstanding north-south charter and quasi-charter operations in Europe have operated long haul low cost for decades...

In many ways the Gulf carriers are also low cost long haul – their network model is long haul-to-long haul, delivering high utilisation, and all the unit cost efficiencies of long haul. But they add costs with their premium products; these added costs are more than offset by the higher yields that those products deliver, making them near-invulnerable to classic full service network operators.

But the same advantage may not necessarily apply once long haul low cost operations are established. The way the LHLCC model has evolved in Asia Pacific has been to mimic the full service network operators’ hub strategies, but with a lower cost base and adapting airport transfer process to simplify and reduce costs. For AirAsia X, over half of its passengers transfer over its Kuala Lumpur hub. As they become more mainstream too they target small business (and increasingly corporates) with a mid range “premium” product.

It is interesting to speculate where this model can lead, once it is better entrenched across geographies. The advent of new generation 787s, A350s, the A330neos, 737Xs and the like, many of them ordered by LHLCCs, add credibility to long haul low cost.

The fact that Germany is well positioned to offer a useful base for connecting the Indian market through to North America has a lot to do with Lufthansa’s battle with the Gulf airlines, whom they see stealing what is "rightfully" Lufthansa’s sixth freedom traffic. If Eurowings – listed to fly to the Indian subcontinent – can provide a similar network service over Cologne-Bonn off a 30% lower cost base, even Lufthansa can start to contemplate becoming disruptive!

But before leveraging its potential Lufthansa/Eurowings must overcome the forces of inertia

But there is more to resolve in the meantime. Lufthansa has first to navigate the treacherous rapids of its turbulent unions – and, by invading the new home of protectionism, the US, with a wet lease low cost operation, it risks stirring up a whole new flurry of white water.

Fort Lauderdale (much against its wishes) may prove impregnable for the time being.

And no doubt Lufthansa will have mixed feelings about being lumped in with Norwegian Air International when it fronts up to the US DoT as another disruptive force threatening the cosy new North America-Atlantic marketplace. This is not an accustomed role for one of the strongest proponents of the levelling playing field.