Deutsche BA: turning the corner at last? November 1997

The next 12 months are likely to be crucial for Deutsche BA — British Airways' attempt to establish itself in the most important European market outside of the UK.

Ever since BA and three German banks bought Delta Air in 1992 and renamed it Deutsche BA, the airline has faced a series of problems. Most were of its own making. Deutsche BA was conceived as a low–cost, high quality airline, but although costs were indeed low relative to Lufthansa (DBA’s employees, for example, account for just 12% of total costs), until 1996 the airline made three crucial mistakes — an over–complicated fleet, an over–ambitious route strategy, and a reliance on BA as DBA’s sales channel within Germany. Inevitably, Lufthansa was provoked by DBA’s decision to target business customers and expand rapidly both at home and internationally, and its response was predictable. Although Lufthansa’s unit costs were an estimated 30% higher than DBA, the German flag carrier was quick to cut fares on routes it flew against DBA.

The effect on DBA was severe. BA reveals as little as possible about DBA’s results, but the mere fact that it has never made a profit tells the whole story (DBA’s declared target was break–even by the end of 1993). Passenger growth has been steady — in fact it has absorbed almost all the growth in the domestic market — but that has never translated itself into the bottom line.

Restructuring, combined with the weakness of the Deutschmark and the weak German economy, sent Deutsche BA to its biggest ever loss in 1996/97 (estimated to be around Dm60m, or $35m).

Significantly, perhaps, the last time BA’s quarterly report included any figures for DBA was for October–December 1996, when it claimed DBA’s revenue increased by 21% compared to the previous year’s corresponding quarter, due to a 13% increase in passenger numbers and a load factor up 3% to 50%. BA is usually not reticent in revealing success, so it is fair to assume that revenues and load factors have come under increasing pressure since then.

The inevitable refocus

Lufthansa’s price–cutting forced BA to rethink its Deutsche BA strategy. Thus in 1996 DBA’s management team was changed. In January 1997 a major refocus on the German domestic market was announced, with new routes from Munich to Hamburg and Cologne. All the remaining unprofitable international routes were dropped, leaving just the Hamburg, Munich and Berlin feeder routes to London Gatwick.

A decision was also made to sell the airline’s turboprops and to concentrate on 737s. As recently as June 1996 DBA’s fleet of 21 aircraft included just nine 737–300s, but the last of the Fokker 100s will go by the beginning of 1998, when DBA will have an 18–strong 737–300 fleet.

Also in January the two–class system was axed in favour of single class service, and a "transparent pricing service" was introduced, with three fare levels depending on how far in advance a ticket is purchased. Significantly, for the first time DBA created its own German domestic market sales force (sending the total DBA workforce to 800 in the third quarter of 1997), and in June came a corporate design revamp. In July 1997 BA increased its stake in Deutsche BA from 49% to 65%.

Today Deutsche BA competes on most of the key German domestic routes, and according to Michel its share of passengers varies between 30–50% on each route. Until recently, the path towards further domestic expansion had appeared firmly blocked by Lufthansa, which kept a keen grip on Frankfurt, the key to the remaining city pairings that DBA would like to fly. DBA, ironically, has experienced the same slot problems at Frankfurt that other airlines experience at London Heathrow. And after Lufthansa withdrew from the Berlin- London Heathrow route at the end of October 1997, citing "poor slot times at Heathrow", it seemed likely that Lufthansa would retaliate by continuing to keep Deutsche BA away from peak slots.

However, surprisingly, DBA has just started a Frankfurt–Munich service. DBA applied for slots both for this route and Frankfurt–Berlin, and, in the words of Carl Michel, the new CEO, it received an assorted "bagful" of slots. It was just enough to allow DBA to then "cobble together" an eight frequency a day service on Frankfurt- Munich. DBA will undoubtedly aim for its traditional target of 40% of route frequencies.

The winning of just enough slots at Frankfurt may be an indication that Lufthansa’s grip on the airport may be lessening. Michel believes political and consumer pressure may be mounting on Lufthansa to at least allow some other carriers into Frankfurt at peak times of the day.

The future

The installation of a dedicated sales force, the axing of most international flights and the switch to just one aircraft type will help the airline reduce its losses. But will these measures alone be enough to drive the airline into profitability? DBA currently forecasts it will reach its first profit in 1998/99, which doesn’t leave it with too much time to effect a successful turnaround.

As with the slot question, however, Michel is optimistic that Lufthansa may be coming under pressure to change its outlook on domestic routes. Up until now Lufthansa’s pricing policy in Germany has been all over the place, claims Michel. On Frankfurt–Hamburg — a Lufthansa monopoly route — fares are high, but on routes where DBA competes, fares are low.

"Lufthansa reduces its fares when competition turns up," says Michel, "and that simply lacks credibility." Lufthansa also cuts prices across the board, claims Deutsche BA, even when 75% of its traffic is business, which is relatively price insensitive. Whether Lufthansa’s new shareholders will agree with selective fare reductions remains to be seen, but Lufthansa cannot keep making losses domestically forever.

Michel does not believe that other low–cost competitors will have a significant effect on the German domestic market, for four reasons, First, there are the high infrastructure costs, as well as a lack of slots at Berlin Tegel, Frankfurt, and peak times at Munich. This would force low–cost carriers into flying mainly to secondary airports in Germany. Second, many low–cost airlines depend on low–cost, "clapped–out" aircraft, which are unacceptable in safety–conscious Germany. Third, the low–cost carriers would need different distribution channels to those they are used to. Direct sales account for just 5% of Deutsche BA’s tickets, and Germans are not used to booking over the telephone by quoting credit card number. And finally, the low–cost carriers need leisure traffic; they cannot survive on business traffic alone. Yet Germany is not an inward leisure destination.

From British Airways' point of view, it still claims that German market presence is required to be a successful pan–European airline. However, DBA’s feed is into Gatwick, not Heathrow, so benefits of feed are reduced.

Far more realistic than feed to/from the UK is a vision Michel has of Germany and Deutsche BA being a stepping stone to the north, east and south via code–sharing and alliances with other airlines. As Deutsche BA’s core problem is that it makes plenty of profit on its peak business flights, but a loss on off–peak flights, one solution would be to provide feed throughout the day into international flights departing from the main German airports. Ideally these would be BA flights. Indeed, intercontinental flights from Germany would be very attractive for BA. At present, however, Deutsche BA would be happy to code–share with any airline other than a main rival of BA. American Airlines, Qantas and Iberia are the most likely candidates. DBA is particularly keen to encourage long–haul routes into Munich, which would neatly fit into DBA’s network. Deutsche BA claims that under an existing code–share deal with USAirways on Munich–Philadelphia, up to half of that flight’s passengers are generated by DBA.

Codesharing may just be enough to send DBA into profit by its target date of 1989/99. Michel claims DBA’s direct operating costs are now as low as any of the new low–cost airlines, and that as long as this situation continues the airline will be relatively robust, whatever the external environment. And that too, is changing for the better, given that the German economy is gradually improving after five years of poor performance. The unknown factor is Lufthansa, currently losing an estimated Dm100m a year domestically. If it sticks to its low fare policy against DBA, the domestic market will continue to be marginal. If fares start to rise, then both airlines may benefit.