The influence of differing market characteristics on Lufthansa's strategies and operations

Table of Contents

1. Introduction

2. Industry Overview

3. Lufthansa Company Profile

4. The European Union and North Atlantic Markets
4.1. Differences and Similarities
4.2. Lufthansa on the North Atlantic
4.2.1. Managing Fuel Expenses
4.2.2. Offering a Premium Product
4.3. Lufthansa in Europe

5. Lufthansa in the Chinese Market
5.1. Air Transport in China
5.2. Lufthansa’s Focus on Partnerships

6. Conclusion

References

1. Introduction

The airline industry has historically been an extremely volatile and in general unprofitable industry. According to financial reports compiled by the International Air Transport Association (IATA) and the International Civil Aviation Organization (ICAO), aggregate industry-wide operating losses for the period 1985 – 2003 totaled $11.7 billion.^[1] Not all airlines, however, have been responsible for this poor overall performance. In the past ten years, Lufthansa German Airlines (Deutsche Lufthansa AG) has transformed itself from a struggling state-owned carrier into one of the most profitable airlines worldwide by positioning itself in the upper echelon of the lucrative premium travel market. Serving as an indicator for this successful transformation, Air Transport World – the leading monthly magazine covering the global airline industry – selected Lufthansa as its “Airline of the Year” for both 1994 and 2000.

This paper will analyze Lufthansa’s award-winning business model by focusing on the airline’s position in its three major markets: the European Union, the North Atlantic and China. After briefly outlining the current state of the airline industry in general and presenting a short company profile of Lufthansa, it will look into the following questions: In what way do differing economic, political and social conditions influence Lufthansa’s strategic decisions in its home market – the European Union – in comparison to the North Atlantic market? When giving answers to this question, the paper will focus particularly on competition distortion stemming from heavy U.S. government involvement in the airline industry and what measures Lufthansa has taken in order to gain a competitive advantage over its U.S. counterparts. It will then turn its attention to Lufthansa’s home market by evaluating the impact of the recent entry of low-cost carriers and analyzing Lufthansa’s reaction to this challenge. Finally, the paper will assess the airline’s potential in the Chinese market. In what way does this market differ from the ones examined before? Has Lufthansa been able to take advantage of the ample business opportunities China has to offer or have governmental regulatory obstacles hindered Lufthansa from maximizing its potential in this region? The paper will conclude by suggesting that Lufthansa will need the involved governments to tackle infrastructure and regulatory shortcomings in order to fully exploit its potential and cement its position as an industry leader.

2. Industry Overview

The aviation industry is not only one of the world’s largest industries, with annual revenues exceeding $300 billion, but also one of the most sensitive to cyclical fluctuations. After suffering from a severe downturn, provoked by the second Gulf war and the global recession in the early 1990s, airlines posted healthy profits during the period 1994 – 2000. After the turn of the millennium, however, the industry was hit with a series of events that had a profound and lasting impact on the further development of air travel. The most severe repercussions were felt from the terrorist attacks of September 11, 2001, which caused industry-wide traffic in 2001 to plummet by over 6% compared to the year 2000.^[2] Compounding matters were the outbreaks of both the SARS virus and the third Gulf war in early 2003. Continued troubles in Iraq have been largely responsible for the dramatic rise in fuel costs over the past one-and-a-half years. While the price of jet fuel stood at $0.72 a gallon in May 2003, it had more than doubled to just over $1.52 a gallon by October 2004.^[3] All of these factors have contributed to the aviation industry losing over $22 billion in the period 2001 – 2003 and shedding more than 500,000 jobs in the process. By the first quarter of 2004 it seemed as though airlines had turned the corner, with traffic rebounding strongly to exceed pre-9/11 levels by more than 6.5%.^[4] However, this strong passenger growth is deceiving since average yields have dropped considerably and most of the growth reflects the strength of low-cost carriers only.

3. Lufthansa Company Profile

Employing over 93,000 people, the Lufthansa Group posted operating revenues of $21.48 billion in the year 2003, which ranked it second among all airlines worldwide, trailing only the new Air France-KLM linkup.^[5] However, the airline only ranked ninth worldwide in terms of Revenue Passenger Kilometers (RPK), the most commonly used indicator for the size of an airline’s core business operation. This significant difference in rankings is attributable to the highly diversified business strategy Lufthansa follows. Lufthansa’s Passenger Business Group accounted for only 65% of operating revenues, with the company’s logistics (Lufthansa Cargo), maintenance, repair and overhaul (Lufthansa Technik), IT infrastructure services (Lufthansa Systems), catering (LSG Sky Chefs) and leisure travel (Thomas Cook) units accounting for the remaining 35%.^[6]

In the subsequent analyses of the European and North Atlantic markets, this paper will focus mainly on Lufthansa’s core passenger business. The spectrum will be broadened to include some of Lufthansa’s other business units when examining the airline’s operations in China in order to take the important role of this market for the individual units into consideration.

4. The European Union and North Atlantic Markets

4.1. Differences and Similarities

In the aftermath of September 11, 2001, airlines on both sides of the Atlantic have faced severe economic difficulties. Europe has seen traditional carriers such as Sabena and Swissair disappear, while the current financial state of Alitalia and Swiss (Swissair’s successor) are a cause of great concern. In North America, meanwhile, four of the eleven largest carriers – United Airlines (2nd), US Airways (6th), Air Canada (7th) and, most recently, ATA Airlines (11th) – have filed for bankruptcy protection. Both Air Canada and US Airways have since been able to emerge from Chapter 11 after reorganizing their operations under protection from their creditors. However, in September 2004, US Airways had to file for bankruptcy protection for the second time in two years after concluding that its cuts in operating costs were not sufficient to compete with the rest of the industry. Two other industry giants, American Airlines and Delta Airlines, narrowly escaped bankruptcy after agreeing to multibillion-dollar labor-cost reductions with their respective labor unions.

In addition to suffering from the repercussions of the terrorist attacks in 2001, network carriers on both continents have had to deal with the emergence of low-cost carriers. However, low-cost carriers have thus far limited their operations to only the European and North American markets and are therefore not a factor in the North Atlantic market. Since Lufthansa does not offer service within the United States, this means that it faces two different kinds of competition: Across the Atlantic the airline competes almost exclusively against other network carriers, while in Europe its competitors are more diverse. Ever since their entrance into the German market in 1999, Lufthansa has felt increased pressure from low-cost carriers. Furthermore, competition from other European network carriers still plays an important role, as does competition from high-speed train operators due to Europe’s extensive rail infrastructure.

[...]

^[1] IATA (2002) and ICAO (2004)

^[2] ICAO News Release (2001)

^[3] Air Transport World and Associated Press (2004)

^[4] Air Transport World (2004)

^[5] Air Transport World (2004)

^[6] Lufthansa Annual Report (2003)