The European Airline Industry - Lufthansa in 2003 - Case Study Example

The European Airline Industry: Lufthansa in 2003

• Industry: Lufthansa is in the Aviation passenger business and operates both domestically and internationally.
• Category:
  • Logistics (Lufthansa Cargo)
  • Maintenance, repair and overhaul (Lufthansa Technik)
  • Catering (LSG Sky Chefs)
  • Leisure travel (Thomas Cook AG)
  • IT Services (Lufthansa Systems)
  • Service and financial.
• Type of Company: private company
• Founded: 1953
• Commenced operations: 1955
• Headquarters: Cologne, Germany
• Currently active in: 197 destinations across Africa, Americas, Asia and Europe)
• Competitors: the main competitors are British Airways, Air France, Alitalia, Easy Jet, SAS and Ryan air.
• Substitutes: the airplane industry does not have a direct substitute with the only substitutes being not major and these are the use of trains and ferry.
• Current diversifications:
• The Lufthansa Company focuses on merges, acquisitions and partnership with other related companies
• Strategic joint ventures so as to resist the growing competition in the industry especially from Gulf based airlines
• The use of vertical integration method
• The use of the multi-hub strategy (Ghoshal et al. 529).

History of Lufthansa

The history of the company can be traced back in 1926 when it started operations in Berlin as “Deutsche Luft Hansa Aktiengesellschet” but went down during the Second World War. However, it resumed operations after the Second World War in the year 1955. Currently, Lufthansa is the leading airline not only in German but also in the world with more than 197 destinations across Africa, Americas, Asia and Europe. It has over 400 auxiliary bodies cross the world and covers six areas namely: passenger service, cargo service, aviation food, and maintenance of airplanes, IT services and tourism. Looking back at its history, Lufthansa can say that it had both glorious moments as well as challenging moments. However, the company has always been learning and renewing itself in various ways as discussed in the paper and this has enabled it to maintain a competitive edge in the international airline business (Ghoshal et al. 530).

Key issues and problems

Deregulation

Lufthansa relies mostly on its incumbent airline business as the core business. However, after deregulation, Low Cost Airlines (LCC) came into existence and this has become a threat to incumbent airlines such as the Lufthansa. Governments used to back and support incumbent airlines before the deregulation. LCC causes threats to Lufthansa’s incumbent airlines through the loss of their bigger share in the market as well as yielding pressure in the industry. Before the deregulation, Lufthansa used to enjoy very high profit margins as higher prices could be set for the airline. After deregulation, LCC has grown in numbers and in routes as well as gaining more market share and this forces incumbent airlines such as Lufthansa to cut down costs, lower process, and cut down some jobs so as to maintain profitability.

Increased competition

The growing LCC competition has been and is still a threat to the Lufthansa Company especially from main competitors such as easyJet, Ryanair etc. who are now targeting business travelers with high yields, who have been vital for the increased profitability at Lufthansa. Lufthansa also faces stiff competition from three major Gulf airlines which are the Emirates, Etihad and the Qatar Airways. Germany wings, the main Lufthansa’s brand in LCC is not as competitive as required and this increases competition from Europe’s leading LCCs (Ghoshal et al. 535).

Economic downturns

The economic recession that occurred in the 1990s followed by other economic downturns have impacted negatively not only in Lufthansa itself but also on the whole industry. Economic recession causes the market to shrink causing airlines such as Lufthansa to look for alternatives so as to maintain its competitive edge.

Cannibalization

Another hat affects Lufthansa is the issue of cannibalizing its customers by creating a LCC sub-brand meaning that customers can start using the cheaper brand if the routes allow. This means that Lufthansa can lose its main clientele from the main and expensive service to the cheaper LCC sub brand (Ghoshal et al. 528).

Concepts that Lufthansa applies

• The Kernel of Good strategy

After deregulation in 1992, any airline company with majority shareholding in Europe was free to fly and own an airline and use any route between the EU nations. This meant that there was new competition and Lufthansa could no longer set higher prices as people had alternative choices. Lufthansa had to act since it was clear that they would no longer be the market leader in Europe and still wanted to maintain market share. The company had to cut down costs so as to offer cheaper trips through LCCs. In 2001, Lufthansa Company was able to acquire 24.9 percent of Euro-wings who had been a major LCC competitor. Through this, Lufthansa was able to retain its market share.

• Porter’s five forces

Porter’s five forces

• Porter’s five forces is composed of:
• Threats of new entry
• Competitive rivalry
• Supplier power
• Threat of substitution
• Buyer power

Lufthansa had to apply the Porter’s five forces after deregulation and the entry of LCCs in the aviation industry.

Threats of entry

Before the deregulation in 1992, the aviation industry was only dominated by just a few, big and partially government owned airlines with Lufthansa being one of them. However, deregulation came with decreased threats of entry and many airline firms were able to enter the market leading to price wars and this forced Lufthansa to change its pricing strategies.

Buyer power

Before deregulation, Lufthansa used to charge 20 percent more for its airlines on domestic flights in comparison to other airline companies. Lufthansa could take advantage of the fact that the market was either a monopoly or duopoly. Nonetheless, after deregulation and the emergence of LCCs, Lufthansa had to lower down the prices of its services to even twice the original price.

Threat of substitutes

Before deregulation, Lufthansa had only few competitors such as British Airways and Air France so there was no much threat in terms of substitutes. There were no alternatives for the company and its price. However after deregulation, Lufthansa had to adjust in terms of price reduction so as to help deal with the increased competition.

Supplier power

Before deregulation, Lufthansa enjoyed market leadership as it was the largest airline company within Europe. After deregulation, these powers were reduced and the company had to adjust its price downwards so as to keep up with its productivity.

• Restructuring so as to focus on core capabilities

With the increased competition as a result of many airlines entering into the business of LCCs and the economic recession in 2001, Lufthansa’s financial status went down steeply. In the financial year 2001-2002, the company reported pretax losses amounting to 200 million ponds. This was a crisis since the company had made a profit of 150 million pounds in the previous year (Ghoshal et al. 532). Lufthansa blamed this poor performance to the process of deregulation that forced airlines to change towards the LCCs. Since then, the company decided to restructure its operations and focus on the core business and limit their involvements in LCCs. Since then the company has been making good profits despite the increased competition in the industry brought about by new entries.

• Focus on cost reductions

Before the deregulation, Lufthansa used to enjoy very high profit margins as higher prices could be set for the airline. After deregulation, LCC has grown in numbers and in routes as well as gaining more market share and these forces incumbent airlines such as Lufthansa to cut down costs, lower process, and cut down some jobs so as to maintain profitability. The company at that time was under the reign of Ryanair as the CEO and the target was to achieve cost reduction of 25 to 40 percent. The company was able to trim about 3,600 jobs from the workforce of 25,200. Lufthansa was also able to make a radical move of dropping the business class on intra-Scandinavian flights (Ghoshal et al. 529). These concepts helped to boost the company’s productivity during those hard times and that why the company still exists as one of the greatest airlines in the world.

• Launch of Germany wings

This concept did not solve fully the problems that faced Lufthansa but it opened up some new profitable options that added into the productivity of the airline especially during the period of economic downturn (Ghoshal et al. 539). However, this was just considered as a short-term strategy aimed at counteracting the effects brought about by deregulation.

• Mintzberg’s Six Basic Parts of The Organization

Lufthansa deals not only in passenger business, but also in other aviation related activities which are logistics, repair and overhaul, maintenance, catering, IT services, leisure, travel and financial services. All these ensures that the company still remains competitive despite the issues and problems such as economic downturns, competition etc. as discussed above. In Lufthansa, the structure of management plays a key role and ensures that everything is managed properly and this has helped the company maintain a competitive edge in the industry despite the hard times. The company’s coordinating mechanism is output standardization whereby it focuses on forecasting economic changes, study of competition and effective strategy implementation for new goals.

In addition, Lufthansa uses a horizontal form of decentralization where decision making is decentralized between the airline main business and other aviation related activities. All the departments and businesses are managed at their own levels with different levels of management.

• High quality, innovative and world-leading aviation services

In addition to its flying activities, Lufthansa has diversified its operation in other areas such as catering, Information Technology, etc. These new lines of business have enabled the company remain competitive despite the increased competition and low economies. LSG SkyChefs in the catering industry and MRO (Lufthansa Technik) are the biggest in the world in their respective sectors (Ghoshal et al. 531).

Alternative courses of action

Lufthansa is in an industry that is concentrated and competitive and for the company to still maintain or increase its competitive edge in the industry, it has to consider applying various courses of action.

• Lufthansa can increase its market share in the market by increasing its share of Eurowings. The industry is very much concentrated with various airline companies and this calls for Lufthansa to consider investing further in the emerging LCC business. This will allow the company to have more control in the market and enhance its competitive edge.
• Lufthansa can consider launching a new subsidiary in the LCC sector and control it fully. This means that the company will come up with a separate and new LCC airline firm with a new management. Some airlines have tried this with some succeeding and others failed.
• Lufthansa can consider refocussing on its full service, rather than involving itself in LCC segments. This will mean that it sells its shares in Eurowings and help put the company in its old roots of the incumbent airline segment.

Course of action

Alternatives

Pros

Cons

Weight

Choice/course of action

a) invest further in emerging LCC

-increased market share

- increased control

- Growth in market share

- Easier to grow established brand

- costly

4.5/5

Option A can be considered as the best option because Lufthansa is already an established bran and this means that it will be easy to buy a new LCC. This would also avoid any cannibalization since Lufthansa can never match them in their low prices. Lufthansa would continue with its incumbent segment while its LCC Eurowings would be serving different short destinations for different audiences.

b) Launch new LCC subsidiary

- Full control

-brand interchanges

- Costly

3/5

Option B can be considered as the second best choice as it is more or less as option 1. However, option B may be more costly than option 1 and time consuming as well. There are also potential negative outcomes such as brand confusion that occurred with couple of Lufthansa’s competitors.

c) Limit involvement in LCC

- the use of vertical integration business model

- Expansion of aviation services

- more market share is lost to LCC’s

- Will not be able to compete in prices

- Cutting jobs had worked against Lufthansa previously

2/5

Option C can be considered as the last option since it would mean going back to their old business model where they rest as incumbent airlines and continue with investing in different aspects of aviation industry. That would mean they would keep losing market share to much cheaper growing LCC airline firms. The same problem that made them to change could also arise.

Action plan

In conclusion, Lufthansa should consider buying out more shares of LCC Eurowings and this would mean that it dominates the Germany domestic market as well as the international market especially in LCC segments. It should start with the Germany market before going out of the country. This project is expected to come with lower prices, new routes especially the popular ones and a very customer friendly timetable. This should be done in the short term with the other two options coming maybe later in the long term.