The Müller plan: realism strikes Sabena September 2001

In early August, Sabena chief executive Christophe Müller bluntly told employees that their company was “close to bankruptcy”. Müller pointed out that Sabena had just lost €113.6m in the first half of 2001, bringing total losses over the past 25 years to €1.7bn. No earth–shaking news there since Sabena has been living under a dark cloud as long as anyone can remember. What was different though was the length Müller was prepared to go to explain how the airline got into this mess.

Since 1995, when Swissair acquired 49.5% of Sabena, the airline’s capacity has increased rapidly. The fleet (Sabena plus DAT plus dedicated CityBird and Virgin Express aircraft) grew from 58 medium haul and eight long haul aircraft in 1995 to 79 medium haul and 13 long haul aircraft in 2001. Sabena has hired almost 4,500 people in the last four years.

Not only has the fleet outgrown Sabena’s natural market, it is also of the wrong composition (737s, A320 family, BAe146s), and the aircraft are too large on average, according to Müller: “Brussels is a second tier hub. At other second tier European hubs, say Amsterdam or Munich, the main carriers use somewhat smaller aircraft than Sabena does in Brussels.”

One consequence is that Sabena load factors remain low (now 67% against the AEA average of 74%), despite a sharp recent increase in passenger numbers, and passenger mix is poorer — the split between business and economy was 28/72 in 1995 whereas today it is 18/82.

Another negative trend is the relative decline in O&D traffic, which usually brings in a higher yield than transfer passenger, from 62% in 1995 to 53% in 2000. The yield achieved from price–sensitive transfer passengers is insufficient to cover DOCs.

At the same time as average yield has been eroding , both internal and external costs have been inflating; for example, aircraft costs have risen by 18% since 1998 and crew costs by 4% in the same period. This deadly combination has reached the point where, even if Sabena’s load factor were up to AEA’s average, the airline would still lose money. Müller estimates that one third of Sabena’s predicament is a revenue problem and two third comes from operating costs.

So what to do?

Before embarking on a recovery plan, the shareholders had to put an end to their squabble, which paralysed management for over a year. Or as Müller put it, “when Swissair was changing CEO and strategy every other month, we wasted a lot of time.”

The new agreement signed in early August cancelled the January 2001 agreement whereby Swissair committed to increase its holding to 85%. Swissair’s share will be kept at 49.5%, for now. The Swiss airline will take over nine A320s from Sabena over a period of time, providing a much needed decrease in capacity. Both airlines will continue their commercial cooperation (but for how long?) and both agreed to withdraw legal action against the other. And last but not least, the Belgian state and Swissair agreed to inject together €430m in new capital, subject to an agreement for labour peace with the unions.

The plan

The buzz points of the new business plan (also called the Müller Plan) are:

• Refocus on core airline activity;
• Right–size medium and long haul operations;
• Review work practices and increase productivity; and
• Cut costs and enhance revenues. According to Müller, no second tier hub in Europe can support a global intercontinental strategy. Brussels may be only big enough to support selected destinations on the US East Coast and some African destinations triggered by ethnic traffic.

Continuing this theme, very large aircraft such as the 747–400 or ultimately the A380, which have a huge seat cost advantage, can only be operated profitably from first tier hubs. This gives a significant cost advantage to first tier carriers against second tier carriers such as Sabena. Therefore, it has to be anticipated that only first tier carriers will attract price–sensitive long–haul passengers and make money at it.

As a result of this analysis, Sabena will reduce excess capacity. All A340s will be sold and only A330s will be flown. The number of long haul aircraft will be reduced from 13 to 11. Tokyo and Washington will be cancelled.

Müller also believes that in European markets, high–yield time–sensitive customers can only be attracted with competitive travel times against ground transport (rail and road). Such routes must offer between four to seven daily frequencies. And the number of frequencies must inversely proportional to the aircraft size used. This is where much smaller aircraft, regional jets, come in. Sabena will need to focus on local traffic between secondary cities and Brussels, and use potential transfer passengers in the time–sensitive market segment as marginal contribution.

Sabena will introduce 50–seat aircraft in mainline service. The cost disadvantage of smaller aircraft will be offset with true cost cutting in all areas, according to Müller. The airline will maintain high frequency services to second tier markets (Marseilles, Bordeaux, Gotenburg) and not compete head on with major hubs.

Müller explained that Sabena planners had examined five “network and fleet” scenarios.

1. 1. Maintain existing fleet;
2. 2. Cut number of aircraft down to 66;
3. 3. Decrease capacity by moving to smaller types but maintain the current number of aircraft;
4. 4. Increase frequencies with 98 smaller aircraft (on average); and
5. 5. End hub strategy, and keep 15 aircraft

The strategy consists of a combination of 2 and 3. Sabena will increase frequency where additional business can be attracted and decrease or cancel services where mostly leisure passengers are flown (Faro, Beirut, Verona, Catania, Belfast will be dropped.) However, there has been no indication as yet as to where Sabena will obtain its RJs, and the purchase or lease of such types will depend on prior union agreement.

Optimism still

Once Sabena has right–sized its long and medium haul networks, load factor is expected to rise to 71% on medium haul and to 77% on long haul, against a 2000 average of 67%. Revenue per ASK is expected to rise to €0.11 on medium haul and €0.04 on long haul.

The airline will revisit its commission policy (traditionally very generous to agents). It will make a big drive to develop Internet bookings. It will to reduce overhead and renegotiate contracts with suppliers.

The latter might prove difficult, as the recent legal move by Virgin Express shows. Virgin is trying to stop Sabena from unilaterally modifying a long–standing agreement under which Sabena buys blocks of seats on flights operated by Virgin Express on its behalf. Sabena wants to reduce the number of seats it must now buy from Virgin Express. The price is too high, said Müller. The agreement is the result of Sabena asking Virgin Express in earlier times to operate certain routes (London Heathrow, Barcelona and Rome) because the latter had much lower operating costs. Under a complicated arrangement, Sabena would sell business class seats and Virgin Express economy. Sabena, now downsizing, really wants the whole business back.

But the contract only ends in 2005. Virgin Express, which is heavily dependent on Sabena’s business for its own survival, will not let go easily. There is another twist: Virgin is a significant customer of Sabena Technics that is up for sale. Any significant damage to Virgin Express could reduce the value of Sabena Technics to a potential buyer and thus backfire on Sabena Group.

Success in a Regional Jet operation generally depends on two factors — relatively high yields, which Sabena hopes it will achieve by targeting business traffic to/from secondary cities and and relatively low flying crew costs, with pilots employed on different contracts from those flying mainline (50– or 70–plus seat ) aircraft.

So, unsurprisingly, the business plan has met with strong union opposition and major battles lie ahead, particularly with the pilots. A major plank of the restructuring plan is to improve cockpit crew performance. According to a local observer, pilot seniority rules and privileges are such that Sabena employs 30% more pilots than needed.

The pilots will make or break the business plan, or so they believe. Yet they are not only fighting the so–called “Müller plan”, they are divided within Sabena itself, torn between the interests of mainline pilots who sit on top, and those of the pilots at the DAT regional subsidiary. If this was not complicated enough, Virgin Express and Sabena pilots are represented by one union (the Belgian Cockpit Association).