Reports in the press have confirmed that Lufthansa is looking into setting up a low-cost long-haul operation. Given the Lufthansa brand, one would be hard pressed to visualize an version under the Lufthansa name.  But people felt the same about Singapore Airlines, and yet its LCC operation called Scoot is doing fine.

Many details have yet to be finalized and announced, but we have managed to obtain some insight into  the company’s current thinking.

It turns out that the company was not in quite as robust a condition as the new CEO, Carsten Spohr, was led to believe. A profit warning recently sent the shares downward by around 30%.   The market reaction is rational, because it was thought the cost cutting exercise at Lufthansa was making good progress.  But,  as most senior executives know, there is a limit to how much cost-cutting can be done. Companies are sustained through efficiency, but rebuilt by growth.

The Lufthansa today derives approximately 70% of its revenues from passenger traffic. In the view of the new CEO, this is too high. While he wants to see revenues grow, he would like to see ancillary services grow even faster, cutting the passenger traffic metric to around 60%.   The Lufthansa Group is a broad-based business, with interests in many related sectors. For example, it owns LSG Sky Chefs the airline caterer. It also owns the world’s largest, and some say best, MRO, Lufthansa Technik (LHT). Carsten Spohr wants to see these two operations, and others in Lufthansa Services Group, grow considerably and drive down the passenger division revenue impact on overall performance.

Just looking at the LHT side of the business, this goal is feasible. Airlines, especially smaller low cost carriers, don’t have the resources to set up their own MRO. Today, these carriers are being pursued by the airframe OEMs for “by the hour” service contracts that do not require establishing a sophisticated maintenance capability.  On the face of it, these contracts are appealing, but what only becomes apparent later is that when the airline wants to put out an RFP to re-negotiate maintenance contracts, they have no data to provide bidders, as the OEMs keep the data. Signing a deal once may mean a form of penury. There is a competitive opportunity for LHT, as they can also offer “by the hour” deals, with the advantage of operational experience that the OEMs cannot acquire since they do not operate airlines. Consequently we may see LHT more aggressively marketing and educating the numerous small airlines that could be seduced with OEM by the hour contracts. The message that having LHT handle your MRO not only provides you services equivalent to the OEM, it also provides the experience and nuances that only an airline understands. A strong opportunity exists.

The envisioned LCC is likely to be focused on leisure markets. While media reports indicate the acquisition of used 767 or A330, we believe to start quickly the airline will deploy Lufthansa’s A340-300s, which are fully paid down. Their second hand values are not worth selling or retiring, and. LHT keeps them in top condition. Rumors that Lufthansa wants to partner with Turkish have been denied. Rather the deal is likely to include Turkish via a jointly own airline brand, Sun Express. The aircraft will have first class removed, a reduced business class section (~20 seats), a premium section and a large economy section.

Initial destination may include Tampa and Las Vegas, two leisure markets. But the focus will quickly add beach destinations. Origin airports are likely to include Dusseldorf, Berlin and Cologne. The flights will be non-stop and will clearly compete with airBerlin and Condor. Norwegian is also on the competitive radar.

A key challenge to be faced as the services is introduced will be how to overcome high EU-labor costs. LCCs and the Gulf carriers have taught EU legacy carriers some hard lessons. German pilots are already bristling at the manifest threat this means for them.   The practices Norwegian is developing have to be front and center for EU-based crew, and. are not a pleasant prospect. Clearly Lufthansa will squeeze costs, and the biggest of these is labor. This could, of course, result in the LCC is based outside the EU, or at least outside of higher cost Germany.

Lufthansa management feels the company has lost its innovative streak. There is talk if an “Innovation Hub” to be based in Berlin. As stated before, no company grows through cost cutting. Watching where Mr Spohr turns up, visiting companies, is likely to better guide industry analysts as how the company’s thinking is evolving.   For example, visits to Seattle and the Bay area are feasible precisely because these are innovation hubs.  But once a culture begins to stifle innovation, it is difficult to bring it back, which Lufthansa needs to successfully compete against Gulf and LCCs.

Lufthansa’s new CEO is taking decisive action. This,  in itself, speaks to the company seeking to regain the industry leadership position it once held.  While still respected technically, Lufthansa is no longer the innovator in cabin design, seats, and in flight services that it once was, and is now looking up to the Gulf carriers in that regard.   While introducing an LCC may be a competitive necessity, so will be rebuilding the main brand, and restoring the culture that once propelled Lufthansa to the top to begin to re-gain competitive advantage and preference.

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