Strategic assessment of the Lufthansa Group's introduction of Eurowings and its associated new strategy

Table of contents

List of abbreviations

List of figures

1 Introduction

2 Introduction to the Lufthansa Group

3 Market Analysis
3.1 Low cost airlines
3.2 Premium airlines
3.3 Point-to-Point vs. Hub-and-spoke

4 Lufthansa's new strategy
4.1 Eurowings
4.2 Lufthansa

5 Competitive evaluation
5.1 Theoretical background
5.2 SWOT analysis
5.2.1 Strengths
5.2.2 Weaknesses
5.2.3 Opportunities
5.2.4 Threats

6 Conclusion

List of references

ITM - Integral Total Management

List of abbreviations

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List of figures

Fig 1: The structure of the LH Group

Fig 2: Seating capacity from South-East-Asia to Europe/Gulf-Region

Fig 3: Point-to-point model (P2P) (left) vs. hub-and-spoke-model (H&S) (right)

Fig 4: The setup of the LH Group: three strong pillars

1 Introduction

Within the last 15 years, the air passenger transport industry in Europe has changed radically. Whereas in the past in most parts of the world flying was a luxury only well-situated persons could afford, the introduction of the low-cost- business model led to a worldwide revolution in aviation. At the same time state subsidised Arabian airlines entered the market, providing high comfort and additional services at affordable prices. These airlines managed to establish a market leadership within the last 10 years in particular for flights from Europe to Asia, supported by their conveniently located home bases.^[1] From 1995 to 2016 revenue-passenger-kilometres (RPK), the common measure of airline passenger traffic^[2] increased from about 2200 billion to more than 7000 billion.^[3] Yet, the established airlines, such as the Lufthansa group, are facing increasingly competitive pressure and profit turbulences.

In 2014 the Lufthansa (LH) Group announced a new strategy in order to improve its competitiveness. The basis of this plan is the separation of the passenger transport segment into the premium hub airlines Lufthansa, Swiss and Austrian, and the low cost carrier (LCC) Eurowings. The purpose of this approach was to provide a competitive offer both in the low cost market dominated by Ryanair and easyJet and in the premium market dominated by the Gulf State airlines. In addition, Lufthansa planned to enter the low cost long-haul market with Eurowings.^[4]

The purpose of this assignment is to analyse this new strategy, evaluate the opportunities and the weaknesses of this concept, and to develop further recommendations for action.

2 Introduction to the LH Group

The LH Group is a global aviation group, which in the financial year 2014 was organised into the business segments: Passenger Airline Group, Logistics, Technique, Catering and Other business segments. All the segments occupy a leading position in their respective markets. In 2015, the LH Group generated revenue of EUR 32.1 bn and employed an average 119,600 employees. The biggest business segment in the LH Group is the Passenger Airline Group. Lufthansa Passenger Airlines, SWISS and Austrian Airlines are hub-network carriers (see 3.3) serving the global market and all passenger segments. Eurowings on the other hand operates direct flights within Europe and to a few worldwide touristic destinations. Investments in the Belgian network carrier Brussels Airlines and the German-Turkish charter airline SunExpress complete the airline portfolio (Fig. 1)^[5] The LH Group has about 600 long- and short distance aircrafts.^[6]

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Source: Lufthansa Group, StrukturLufthansa Group, n.d. Fig 1: The structure of the LH Group

3 Market Analysis

3.1 Low cost airlines

In the United States, the low cost business model was already introduced in the beginning of the 1970s by Southwest Airlines. In Europe, the Irish company Ryanair was the first airline that adopted the low cost model in 1992. A few years later in 1995, the British airline easyJet, today Ryanairs main competitor, was founded.^[7]

The business model is based on a combination of dynamic prices, high capacity utilization and low operating costs. The lower fares are achieved through the elimination of numerous conveniences and services: Booking is usually possible only online and the flight ticket must be printed out at home. If the passenger wants to reserve a seat of his choice or books any catering services, this is charged additionally. Furthermore, the general fare usually includes handbag luggage only. In addition, the fares change very dynamically based on the time period remaining prior to flight date and capacity utilisation. Another important factor is the operating costs of the airlines. Next to the already mentioned limited services, the use of secondary airports, short aircraft ground times, and the use of homogeneous fleets allowing standardize maintenance are important key factors.^[8]

Within the last few years the LCCs could expand their businesses and increasingly managed to lessen the perception of the distinctions to the established airlines. Ryanair for instance started its business in Germany by operating at small and cheap airports such as Weeze and Haan, which are located quite far away from metropolitan areas. In the meantime, the Irish airline has modified its strategy by expanding to the bigger airports such as Cologne and Berlin. In 2017 its first airplanes will depart from Frankfurt, Germanys biggest airport.^[9] At the same time, the renowned airlines have also begun reducing certain conveniences and on­board services.^[10] As a result, the LCC sector has become more attractive and the established airlines are facing increasingly competitive pressure.

3.2 Premium airlines

Next to the LCCs that endanger the larger airline companies especially on the European and the transatlantic markets, there are additional important competitors from the Gulf State region. Companies such as Emirates, Etihad and Qatar Airlines have taken over the market leadership for flights to Asia and Australia within recent years (Fig. 2).

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Source: Lufthansa Group, Politik Brief 2/2016, 2016, p. 1

Fig 2: Seating capacity from South-East-Asia to Europe/Gulf-Region

An important competitive advantage that these airlines have is their home base location between Europe and Asia. From their home bases it is possible to reach nearly every destination in the world nonstop. These Arab airlines can transport their customers from all over the world in large wide-body and comfortable long­distance airplanes to their home bases, from where they are then distributed to their final destinations all over the world (so called hub-and-spoke-system, see 3.3). While prices are often much lower than the European airliners, they usually offer higher seating comfort with more space and premium services such as gourmet- meals, a large selection of on-flight-entertainment and limousine chauffeur service to the airport for business customers.^[11] This development is strongly subsidised by their governments. In Dubai, the home base of Emirates, for example, several billion US dollars are invested in the expansion of the infrastructure every year. At the same time, Dubai's administration invests about 30 billion US dollars into the building of an additional airport, which could double Dubai's passenger capacity within the next 10 years.^[12] Furthermore, the current airport tax is lower by 75 percent than at average European and by 65 percent than at average US airports.^[13]

3.3 Point-to-Point vs. Hub-and-spoke

A frequent difference between LCCs and premium airlines are the different types of route networks utilised. The common systems are the point-to-point model (P2P) and the hub-and-spoke-model (H&S) (Fig. 3).

LCCs usually make use of the P2P-model. In this system, origin- and destination- cities are connected directly without a stopover. Passengers benefit from a faster nonstop-connection and the non-existent risk of missing a connection flight. The profitability of this system, on the other hand, strongly relies on a very high demand on both sides. In addition, it requires a larger number of flights in order to cover an entire region.^[14]

In the H&S-model, the airlines use one or a few central hubs, which serve as transit cities for most of their flight connections. The advantage of this system is that regions or connections with lower passenger demand, that usually would not be profitable, can be connected as well. Due to the centralisation of the company’s aircrafts at these hubs, it is possible for them to select appropriate sized airplanes based on the current demand. As a result, higher capacities can be offered with simultaneous good overall capacity utilization. The number of flights, furthermore,
can be much lower compared with the P2P-system with the same level of regional coverage. On the other hand this system requires complex and sophisticated planning and extends the overall flight-time for the passengers.^[15]

4 Lufthansa's new strategy

In order to improve its competitiveness, the LH Group released its new strategy program "7to1 - Our Way Forward" in 2014. The basis of this plan is the re­structuring of the company into three pillars: premium hub airlines, Eurowings group, and aviation services (Fig. 4).^[16]

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Source: Lufthansa Group, Annual Report, 2016 Fig 4: The setup of the LH Group: three strong pillars

4.1 Eurowings

Playing an important role in this strategy, the LH Group planned to build up a new competitor for the LCCs with the brand Eurowings. With greater efficiency, competitive costs and a point-to-point traffic model, the new airline should be positioned in the market of the price sensitive customers. Additionally to generating profitable growth by means of organic growth, the scalable company structure should enable the flexible acquisition and integration of new partners. The aim over the medium term is to become the third largest provider of direct connections in Europe.^[17]

Eurowings takes over all short- and middle-haul flights of the LH Group that are not operating via the hubs Frankfurt and Munich. Over the past few years this function was already performed largely by the subsidiary Germanwings. Entirely new are low-budget long-haul flight offers. As a new competitor in this sector, it reaches destinations in the United States, Dominican Republic, Thailand and the United Arab Emirates. Additional flights are already planned.^[18] Moreover, it enables access to the lucrative market of package tourism for the LH Group.

Similar to the competitors in the low-cost-sector, all Eurowings group flights offer three different tariffs. The BASIS-tariff offers the flight with handbag luggage only. In SMART and BEST additional bags, catering and conveniences are included at somewhat higher cost.^[19]

4.2 Lufthansa

While Eurowings is positioned in the LCC market, the LH Group's core brands Lufthansa and the subsidiaries Swiss and Austrian are placed in the premium airline market. Their competitors are especially the Arabian airlines, but in addition the other traditional hub-airlines in Europe such as AirFrance-KLM, British Airways

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^[1] see Lufthansa group, Politikbrief 2/2016, 2016, p. 1

^[2] see Massachusetts Institute of Technology, Airline Data Project, Glossary, n.d.

^[3] see International AirTransport Association, Outlook forairlinemarkets, 2016, p. 5

^[4] see Airliners.de, Lufthansa schickt Eurowings auf die Langstrecke, 2014

^[5] see Lufthansa group, Annual Report 2015, 2016, p. 14

^[6] see Lufthansa group, Annual Report 2015, 2016, p. 38

^[7] see Malighetti, P., Paleari, S., Redondi, R., Pricingstrategy, 2009, p. 1

^[8] see Malighetti, P., Paleari, S., Redondi, R., Pricingstrategy, 2009, p.1f

^[9] see Deutsche Welle, Ryanair, 2016

^[10] see Kauer-Berk, 0., Billigflieger, 2016

^[11] see Kiani-Kress R., Was die Golf-Airlines besser machen als Lufthansa & Co., 2009

^[12] see Lufthansa group, Politikbrief 3/2016, 2016, p. 7

^[13] see Lufthansa group, Politikbrief 3/2016, 2016, p. 7

^[14] see Rasch, S., Point-to-Point vs. Hub-and-Spoke, 2014

^[15] see Rasch, S., Point-to-Point vs. Hub-and-Spoke, 2014

^[16] see Lufthansa group, Group strategy, n.d.

^[17] see Lufthansa group, Group strategy, n.d.

^[18] see Lufthansa Group, Die neue Eurowings istgestartet, n.d.

^[19] see Lufthansa Group, Die neue Eurowings ist gestartet, n.d.