|Seeking for Partners: Lufthansa’s International Collaboration 1953-2000
Hans-Liudger Dienel, September 18, 2004
How big does an airline has to be to survive in the international market? Today, we have dozends of low cost airlines in Europe, 28 alone in four European countries, some of them being very small. (Slide of low cost airlines in four European countries, including Ireland, GB, Italy and Germany. Obviously, airlines can be fairly small in order to grow.) In recent years, we had some crashes of airlines because of they believed in economies of scale: Swissair and Sabena are such cases.
After WW II, the situation looked different to European airline managers. Many of them thought that their airlines were too small to stand the overmighty American competition on the long run.
In this paper, I will look into discussions in the management boards of Lufthansa and some partner airlines and the respective transport ministries about the necessity and problems of closer collaboration and mergers.
My main focus is the struggle for an European Airline called Air Union between 1950 and 1969, when the idea was finally burried. Second, I will compare this history to the technical collaboration ATLAS since 1967 between the Air Union partners and the strategic alliance Star Alliance since 1997. At the end, I will sum up some conclusions about the history of Lufthansa’s seeking for partners.
My paper tries to explain, why and how Air Union failed in a time of national flag carries and how Star Alliance managed to structure international markets that its partner airlines can grow. In more general terms my paper is about the oscillating ideology of economies of scale and of mergers and how they shaped the strategies of the airline management and the respective transport governments.1
2 Lufthansa and Air Union, 1950-1969
After WW II, the United States was leading commercial air transport. The rest of the Western world, especially Western Europe, was looking for ways to keep control over a share of the business with a two folded strategy, to limit free market and to merge to a competitive size.
In the two conferences, which outlined the international post war air transport business (Chicago 1944 and Bermudas 1946), the Europeans successfully limited free market competition to prevent American supremacy on all markets. According to the ICAO rules, international air transport only was possible in the framework of bilateral agreements between governments who had to name airlines, to carry out the business. These bilateral agreements were in fact pooling agreements or regional cartels between the governments and their chosen airlines, which were called national flag carriers. In nearly all countries, there was only one national airline chosen by the respective government.2 This system existed more or less unchanged up to the late 1970s when deregulation approached Europe from the US, though some elements exist till today.
The second European strategy against US hegemony was a merger of European airlines. In 1946 three (four) Scandinavian Airlines merged to the Scandinavian Airline System. Because the international commercial air transport was organized along diplomatic agreements between nations, the three airlines continued to exist. Four years later, this successful merger was a model for the president of Air France, Max Hyman, when he suggested to set up an European Airline, called it Air Europe, to show that it should beat the American predominance. Martin Bongers, the commercial air transport consultant of the West German government since 1951 and first CEO of the re-established Lufthansa in 1955, agreed upon the idea already in 1951, and two years later, in July 1953 (almost two years before Lufthansa officially was re-established), German Parliament (Bundestag) voted for a plan to ask European neighbours to jointly found an European Airline.3
So, the idea was already in the air, when in April 1958 representatives of Lufthansa, KLM, Air France and Alitalia met to discuss a merger. (Sabena joined the group in November 1958 KLM left it in April 1959) Between December 1958 and June 1960 the Presidents of the Airlines met 19 times in a “Comité Exécutif”, making it the focus time for the Air Union project. On May 27, 1959 the four airlines formally founded Air Union with headquarter and offices in Paris.4 The four airlines made serious attempts to get the Airline off ground. For some times, also KLM and Swissair were involved in the plans and others knocked on the door.5
The main reason that the project took of in the late Fifties, was coming of the jet age. The decision of PanAm to purchase 25 B707 and 20 DC8 to be delivered in 1959 pushed all major airlines to order jets too although they feared overcapacities (These fears were wrong as we know in retrospect, for most airlines came out of the reds exactly because of the jet age) But in the late Fifties, jets were considered to be too big for most routes of national flag carries (for the 707, offered two times more seats and was two times faster than the biggest propeller aircraft). A merger of airlines should solve this capacity problem. Fear for the jets made the airlines react so quickly and seriously.
At the same time (while all four airlines had the goal to catch up with the Americans and solve the capacity problems) the special interests of every airline and the respective government remained: The German and Italian Airline were big supporters of the idea of a European Air Union, for they still were looking for international recognition and legitimation after WW II and the forced break in Germany. Air France was still trying to organise an airline under French control and both Air France and Sabena wanted to keep their relative strength against the newcomers.
Since December 1959 the transport ministries stepped into the negotiations and took over the initiative in late 1959. Governments had to step in for a least two reasons:
In the ICAO world only governments could sign bilateral agreements on routes and services. It was a precondition for the success of Air Union, that it was accepted as Airline of the four countries, for instance by the US government.
Second, the ministries were not prepared to stay out. Especially the French government (not the transport ministry but the Quay d’Orsay) insisted upon a having the last word on all agreements and would not accept a marked oriented Air Union company.
To do so, two treaties were prepared and more or less agreed upon in May 1960, the
Pact d’Association between companies and the
Convention relative à la constitution d’Air Union between the respective governments.
The two treaties outlined the structure of Air Union. It should not replace the national flag carriers but should exist additionally as a semi governmental company with the following functions and departments:
a joint sales department (city offices and airport offices should merge) and a joined flight operation department (including route planning, frequencies, fleet employment)
joint ground services and Catering (outside the national respective market)
a purchasing and obtaining department for materials and services (Technical collaboration was a major problem. The composition of the Air Union fleet was so inhomogeneous that joint maintenance was a technical problem. France would not allow Air France not to buy French aircraft.)
joint aircraft procurement (Though all aircraft should remain in the ownership of the four partner airlines, a standardisation of procurement was claimed aim.)
Two committees were set up to steer Air Union:
The executive committee (comité Ecécutiv) should consist of eight General Directors/Presidents (two of each airline), which has the executive power. Important decisions had to be taken unanimously. However, the committee installed 9 subcommittees with a more pragmatic decision making by majority vote and a General Secretariat in Paris.
The General Council (Conseil Général) with 20 members (five of each airline) should act as control body. All important decisions hat to be approved additionally by the four involved governments.
To facilitate work, Air Union should organise part of its work in subsidiaries, for instance the catering. Here, collaboration would be more direct and thus the merger of the four airlines should come from the periphery (the subsidiaries) to the center (the General Assembly).
Already during the summer of 1960, the German airline lost interest in Air Union. The head of the German delegation, Kurt Weigelt, confidentially told the German Transport Ministry in August 1960 that “we might not be interested any longer in Air Union but we want to leave the role of killing the idea to the other side”.6 At the same time, the German government just discovered its big interest in the European Airline and tried to persuade the French Government, who blocked. Two times, the German minister of Transport, Hans-Christoph Seebohm convinced Chancellor Adenauer to ask De Gaulle to go forward with Air Union (6.7.1962 and 11.9.1962). Besides, he invited his French colleague Roger Dusseaulx for a long private meeting on July 10, 1962. But, the French Government could accept the structure of Air Union as it was outlined by the committees.
Why did Air Union fail?
One main obstacle for Air Union was the debate about the distribution of quotas on the transport business. All partners agreed that there should be fixed quotas for every participating airline on the transport business of Air Union on the long run. Air Union a joint company should operate the airlines system and distribute the flights to its partners according to their quota. However, airlines and ministries had problems to agree on fair quotas, because Air France and Sabena on one side were more established and were looking to save their bigger share while Alitalia and Lufthansa as latecomers had not taken up their full market potential in the organized airline world so far. So, the realists (Air France, Sabena) tried to preserve the relative status quo, while the potentialists (Lufthansa, Alitalia) claimed to distribute shares along the future prospects (according to GNP etc.).
(Slide: Market shares in 1958, 1959 and quotas agreed upon in 1960).
Lufthansa argued that its share of the international air transport market should equal the already again fast growing German share of international trade. The regulated international airline market of the 1950s enabled Lufthansa to argue in this way.
Second, the Network of the four partner airlines did not complement each other but did overlap. (Slides: Network of Air Union). To make things worse, the airlines wanted to keep their special strength out of Air Union that was the African Routes of Sabena and the francophon network of Air France. Lufthansa, without any colonies to fly to, was free to favour a commercial route policy which was not typical for other European flag carriers.
We see that most European airlines in the 1950s considered the North Atlantic route to be the central market. Lufthansa estimated it in 1959 to be four times bigger than the whole European and domestic market. This overlap is appropriate for technical collaboration (maintenance of aircraft) but not for building an international network. Exactly for this reason the four partner airlines set up the successful maintenance network ATLAS (to service the Jumbo Jets) in 1967 but no partner of Air Union joined the Star Alliance of Lufthansa.
Thirdly, the partner airlines did not merge but remained competing institutions (contrasting to SAS). The four partners were called member airlines as if Air Union were a network. Especially, the national governments claimed for national flag carriers. Air Union should not become a merger, because national interests and pride claim for a national flag carrier and only international business should merge (with some exeptions, especially for Air France and their African routes).
Fourth, Air France and Sabena tried to keep the status quo, while Lufthansa and Alitalia were growing fast. In 1960, decolonisation weakened especially Sabena, which lost one third of its market. Air Union became less interesting for the fast growing Lufthansa which started to make profits for the first time after WW II in 1963. The business culture of the four airlines differed. Air France and Sabena were more or less nationalized companies with a decisive governmental influence on aircraft procurement and route policy. Alitalia and Lufthansa acted as private companies. The strong governmental influence was a reason for KLM to step out as early as April 1959.
Fifth, the shift to jet age was less fundamental as anticipated (Since 1963 nearly all airlines were profitable. Small jets emerged.
Last not least, US supremacy lost a bit of its threat in the 1960s, because Western Europa managed to have bigger annual growth rates.
For some reasons, the idea of Air Union was almost dead already at the end of 1960, for others it passed away during the 1960s. Companies lost interest, because the aims of Air Union were not attractive any longer. Some governments, however, remained protagonists of the merger. They had more political than economic aims. But, the differences between the involved governments remained so big that they could not proceed. The signature under the treaty had to be postponed several times, from Mai 1961 to well into 1962, but at the end the pact was never signed. In 1963 Air Union got a new kick for a short moment when Airlines argued they needed the European Airline for a joint investment into supersonic flight. In March 1964, Kurt Weigelt, now already 80 years old, stepped down as spokesman of Lufthansa within Air Union (he died 1968).
In one respect, Air Union made sense for the four partners: in maintenance. In the regulated ICAO/IATA-world with fixed ticket fares and mrket shares (via pooling agreements), the only way to make money, was to push down production costs.
In June 1967, Air France invited 10 European Airlines to cooperate in maintencance (Montparnasse Committee), but in April 1968, only the four Air Union airlines decided to found the Airline Maintenance Cooperation ATLAS, which existed well into the 1990s. In March 14, 1969, it was officially founded, in 1972 Iberia joined the cooperation. In its first year (1970) ATLAS was limited to technical cooperation in maintenance of ten Jumbo Jets. Up to 1976 these figures had substancially risen to more than 75 aircraft (32 747, 20 DC-10, 10 Airbus 300 and 4 Concordes.). Every partner was general agent for some devices, the turbines, the cell, and so on. Costs were divided along the principle: no profits, no losses. In the following years, more and more aircraft types became part of the ATLAS maintenance program.
A similar technical cooperation was KSS (between KLM, Swissair and SAS).
ATLAS turned out to be a pragmatic version of Air Union, and did successfully navigate the partner airlines, through the jet age.
3 Lufthansa and Star Alliance
ATLAS a maintenance network was industrial cooperation. In 1993, with a new CEO Jürgen Weber, Lufthansa switched from the industrial cooperation in ATLAS to a customer oriented service cooperation and participated in the emerging Airline cooperation “Star Alliance”, which was officially founded on May 14, 1997 when Air Canada, Lufthansa, SAS, Thai Airways International and United Airlines launched the Star Alliance network.
(Slides: Milestones of Star Alliance)
In October 1993 Lufthansa and United announce a comprehensive marketing agreement including code-sharing (first flights in June 1994). In May 1995 SAS and Lufthansa announce a far-reaching strategic alliance including code-sharing (first flights in February 1996). In October 1995 THAI and Lufthansa began code-sharing and in March 1996 Lufthansa and Air Canada followed (first flights in June). In 1996 United, Lufthansa, and SAS received anti-trust immunity for their alliance and on May 14, 1997 together with Air Canada and Thai Airways launched the Star Alliance network. In October 1999 they opened the first Star Alliance City Office in Paris (15 other offices followed) and in September 2000 the StarNet-IT solution to link computer systems of the member airlines. In March 2001 their Global e-service initiative went public and in June 2001 Jaan Albrecht became CEO of Star Alliance.
Star Alliance quickly became the biggest international airline collaboration. The joint activities include code-sharing, schedule coordination and joint marketing. Star alliance is seeking for partners for a physical world wide airline web. The customer should fly everywhere within the network. In fact, it acts as a service trust although the legal construction managed to be awarded anti-trust immunity by the involved national departments of transportation. It aims at sharing regional strength or even regional monopolies with partners on a mutual basis. By doing this, it more and more becomes a global company with company structures, budgets, and personnel. It is a solution for horizontal integration without mergers. But, maybe it will start to purchase airlines in order to round off its network.
No old Air Union or ATLAS partner became a member of Star Alliance. The reason is simple. The star alliance partners had similar route networks as Lufthansa. There were not interesting as partners for the alliance.
4 Comparisons and Conclusions
Air Union started with great enthusiasm in the late 1950s but failed because
Partner airlines did not merge but did compete (contrasting to SAS)
National governments claimed for national flag carriers
Routes of partner airlines did not complement each other but overlapped (most important)
Some airlines tried to keep the status quo, while others quickly grew
US supremacy became less threatening in the 1960s. In other words, the fears before the US turned out to be exaggerated. The ICAO-system guaranteed and secured every national flag carrier its survival.
However, it survived as technical maintenance network ATLAS, as a possibility to push down production costs. It was the only way to rise profits in the regulated ICAO/IATA-world with fixed ticket fares and market shares. By ATLAS, the big investments into personal relations finally payed off.
In the deregulated 1990s, the new threats and challenges made Lufthansa switch from industry to service or from a production network to a service network.
Star Alliance is a horizontal integration which makes sense for scheduled airlines, while charter airlines integrated vertically to become full service tourist companies (but that is another story not for today).