Air France-KLM’s astonishing return to health

Air France-KLM’s latest investor day was a real surprise. Of course, it was clear that the Franco-Dutch group was doing better than in the past, but apart from insiders and a few very astute observers, it’s unlikely that the vast majority would have expected such a positive and offensive speech.

Air France was not far from collapse, certainly taking KLM with it. That was ten years ago and many have forgotten it, but in between crises of governance, long internal conflicts, repeated strikes that showed a real rift not only between certain categories of staff and management but also between these employees and customers, scenes of violence that were truly shameful, and a crash that tarnished the airline’s image, the airline had hit rock bottom and one had to be optimistic to imagine a rosy future for the Franco-Dutch group, and in particular for Air France, which was the lame duck of the story.

And yet this is what happens against all odds.

In this post:

Air France-KLM on the brink of collapse

Too many people imagine that their favorite national airline can’t disappear, but that’s not our case. Without going back as far as Panam or TWA, we need to remember Sabena, Swissair, the not-so-distant example of Alitalia or the present-day SAS (which is very much in the news) to be aware of what Air France-KLM could become in the 2010s.

2018 saw the appointment of Ben Smith. We welcomed this move, as it seemed impossible that the group would ever be managed by an airline professional with a wealth of experience abroad, and surrounded by people who are similar to him, instead of the usual bunch of technocrats who used to win a seat at Air France-KLM without any criteria of competence as a reward for services rendered, to make up for past mistakes or simply because they were available at the right time.

At the time, we listed the challenges Ben Smith was facing, and it was with undisguised joy that we saw at the end of 2019 that, for once, the management of Air France-KLM was talking to its investors about the real issues, without hiding anything or making false excuses. From our point of view, Air France-KLM had understood that it had everything to gain by adopting a challenger’s position, leaving behind a leader’s suit too laden with denial and complacency.

Hopes raised by Ben Smith dashed by COVID

A short-lived hope: a few months later it’s COVID. If all the airlines are now on the same footing, we feared the worst: when you enter a crisis weaker and more vulnerable than your competitors, you have little chance of emerging from it in a position of strength. With the end of the crisis in sight, combined with the inevitable consolidation of the sector, Air France-KLM looked more like a future prey than a potential predator.

December 2023: Ben Smith speaks to investors again, and if the names and logos of the Air France-KLM Group’s airlines weren’t mentioned all the time, a person who had stepped forward in time from 2018 would have a hard time guessing which airlines he was talking about.

What’s changed in 5 years? A non-exhaustive review of Air France-KLM’s presentation of current projects and future objectives at the meeting between management and investors.

Topics not covered here may be covered in subsequent articles.

Air France-KLM returns to profitability

While we were impressed by the speech given to investors in 2019, we had the same reservations about it as we have had about every announcement from the Group for over 10 years: ambition is all well and good, but you still need to have the means, i.e. the money.

You don’t have to look far to find out why the fleet was slow to renew, cabins were slow to be replaced, service quality was declining despite constant talk of moving upmarket, and external growth projects seemed unrealistic. All this takes money, and Air France-KLM was making little of it.

Ben Smith said it himself, in 2019:

Air France’s margin in 2018 was only 2 percent, compared to 9 percent for KLM, 10 percent for Lufthansa, 12 percent for British Airways and 18 percent for Ryanair. A 2% margin at Air France is not satisfactory. Five points can be explained by the costs in France. But two points are due to the complexity and inefficiency of the airline. It’s up to us to tackle it.

That’s easy to say when none of his predecessors ever achieved it. And yet.

Air France-KLM’s margin has risen from 5.1% to 7.8% in 4 years, despite the COVID. Or maybe because of COVID, since nothing beats a good crisis to really adopt radical measures.

This good news should be put into perspective: while Air France-KLM’s margins are now close to those of the European leaders, it has only narrowed the gap. Put another way, Air France-KLM is running faster than before…but IAG and Lufthansa Group are still running faster.

On the other hand, in terms of trends, the progress is noteworthy and can only be welcomed. It’s perhaps the subject that will least excite the traveler, but it’s on this that tomorrow’s service will largely depend.

Ben Smith remains reasonably ambitious, with a target of over 8% for the 2026-2028 period.

It’s very interesting to read between the lines. If we forget group logic and look at each airline individually, we get the following.

If we take the leading airline of each of the three major European groups, we see that Air France has moved ahead of Lufthansa, while remaining behind British Airways. It’s also the only one to make progress, which is only logical given its starting point.

But even more remarkably, if Air France’s margin is 9% and the Group’s 7.8%, this also means that for the first time in ages the French airline is more profitable than KLM. This may put a definitive end to certain internal quarrels and show that it is not the dead weight of the group!

All this is the fruit of an ambitious transformation plan based on 4 pillars. There’s nothing exceptional about these pillars, but there aren’t an infinite number of ways to improve profitability: what counts is less the plan than the ability to execute the plan. Remember the Transform 2015 and Perform 2020 plans…

Simplification (fleet, brands, organization)

Synergies (within and outside the group, within and outside alliances)

Initiatives to increase revenue ( we’ll be talking more specifically about the loyalty program)

– Cost savings.

And here’s how the margin is increased by 2 billion euros.

More than 50% of the plan has been implemented to date.

Last but not least, the Group currently has 8.5 billion euros in available cash.

A rationalized brand portfolio

Air France, KLM, Hop, Joon, Transavia… it wasn’t a portfolio of brands that Ben Smith found when he arrived, but an illegible jungle in which the customer was lost. One of Smith’s first decisions was to kill Joon and sound the death knell for Hop.

Today, a clear offering is presented through known and identified brands.

If marketing’s delirious and damaging creativity has finally come to an end, there are a few things that catch our attention.

For the first time, the “Premium Leisure” segment appears in its own right, and that’s a good thing. For a long time, we couldn’t understand why Air France – but not only Air France – had a marketing strategy based on an assumption as simple as “business travelers fly business class and tourists economy”.

From our point of view, this was totally erroneous, and our experience tells us that, depending on the airline, destination and time of year, business and first classes are filled by between 50 and 75% leisure passengers. Passengers who are not spoken to and for whom no offer exists. A pity in normal circumstances, and a disadvantage when you consider that leisure traffic picks up faster than business traffic.

Something Ben Smith recognized as early as 2021 when he said that “50% of First and Business Class passengers travel for pleasure“.

Acknowledging the existence of this segment means thinking differently and innovating to address it, which is an excellent thing considering we’re talking about the seats that generate the most margin!

On the downside, Air France’s stated positioning is clearly that of a premium long-haul airline, but its medium-haul experience is at best average (economy) and at worst well below the competition (business class). Not enough to make you want to try long-haul, and in general, there’s a real issue of medium-haul quality that deserves a specific action plan. But does Air France-KLM believe in medium-haul? Sometimes we wonder.

The second point that catches our attention, but we’ll come back to it later, is the appearance of Flying Blue among the Group’s brands, proof of the new role that the loyalty program will play in the Group’s future.

As for Transavia, its role is clear, but we shall also see below that its appeal to the Group’s loyal customers remains to be proven.

Transavia: the armed wing in the battle to win back short- and medium-haul business

Although Transavia’s early days were difficult, and its development limited for a time in terms of aircraft, the low-cost airline is set to play a major role in the Group’s strategy to win back its short- and medium-haul business.

Customer behaviour has changed, and short-haul business is hard to make profitable, especially on Air France’s domestic flights. While an airline can lose money on medium-haul routes that feed its hub, it cannot do so on point-to-point routes.

This is the logic behind Air France’s announcement, which we have already commented on, to abandon domestic flights from Orly in favor of Transavia.

An explanation that we only half buy, as we say in the related article. The fall in traffic is not as widely as announced at the time, and it’s more a case of Air France’s inability to address this market profitably, unlike British Airways and Luthansa, who intend to continue fighting in their domestic markets.

Transavia is therefore the best option for addressing what the airline calls “price-sensitive leisure and business demand” at Orly.

Yes, but…

As the airline suggests, there is a business clientele at Orly, to and from provincial cities, which benefits from the proximity between Orly and the city center, not to mention the future arrival of metro line 14 at the airport.

One of Transavia’s main criticisms to date has been its lack of integration in the Flying Blue frequent flyer program, which has deterred many loyal customers. A reproach that is now a thing of the past, as it is now possible to earn miles and XPs by flying Transavia.

But, at least for the time being, this is not possible with the cheapest Transavia fares.

In addition Flying Blue benefits end there since Transavia does not offer lounges, of course, and no fast tracks or priority boarding for elite members of the frequent flyer program, even though these are the most appreciated benefits, which mean that for roughly equal (not to say non-existent) service, these passengers prefer Air France to a low-cost carrier.

I’m not sure we’ll find all these customers on Transavia tomorrow if they find it cheaper elsewhere, with the same lack of service and without the things that make life easier for the frequent flyer.

So of course these passengers will just have to go to Roissy and take an Air France short-haul, with all the constraints that go with it.

Flying Blue: the new cash machine?

Flying Blue is now a brand in its own right, demonstrating its new role in Air France-KLM’s loyalty and revenue strategy.

And we were surprised to find that the trade press seemed to be making a great discovery! This is an opportunity for us to resume the educational work we regularly do on loyalty programs.

Contrary to popular belief, a loyalty program is not just a cost but can be a major source of revenue so much so that during the COVID U.S. airlines raised money through their loyalty programs, not their core business.

The key? Sell miles to partners who, in turn, distribute these miles to their customers to reward them for their loyalty.

These partners include airlines, hotel chains, car rental companies, retailers and, above all, credit card issuers. In fact, the more the customer is paying, the more the partner can afford to offer miles, and who do we give more money to than American Express, Visa and others?

As we recently wrote, the business model of a frequent flyer program is not to offer you free flights, but to sell miles to partners. Or even sell them to other programs as “common currency“, as IAG has done with its avios, now used in the frequent flyer programs of Qatar Airways and, more recently, Finnair.

This was no surprise to us when Air France-KLM began transforming Flying Blue into an independent subsidiary. This was the prerequisite for turning the loyalty program into a cash machine independent of the airline business, so we weren’t at all surprised when it was announced to investors.

This has the merit of being clear.

It may come as a surprise to many, but the sale of Flying Blue miles to partners today represents a figure of €371 million, with a target of €600 million by 2028, i.e. twice the expected growth in traffic. In 2022, Flying Blue’s contribution to Air France-KLM’s margin was 15%.

When you consider that in 2017 American Airlines earned $3.1 billion from its loyalty program, and that this year Delta will receive $7 billion from American Express, you can imagine the potential of this strategy.

Now let’s come back down to earth: for this strategy to work to the full, partners need to generate enough revenue from their customers to buy miles from Flying Blue generously.

However, the credit card business is far less lucrative for card issuers in Europe in general and France in particular than in other parts of the world, especially the USA. The reason is simple: on the one hand, you pay an annual fee and have a deferred debit card; on the other hand, you have a real credit card with interest rates that can reach 25%. Guess which customers get the most generosity.

But with 33% of customers in France and 72% in Europe, Flying Blue is far from having the potential of its North American competitors.

What reason would an American customer have for joining Flying Blue rather than Delta Skymiles (to stay with Skyteam), United Mileage Plus or AAdvantage? Unless he’s an expatriate or, like us, plays the game of seeking out the program that, within an alliance, enables him to easily achieve a status (which is a minority), this doesn’t represent much potential for growth.

So Flying Blue uses the levers at its disposal, namely the multiplication of non-airline partners like Amazon, agreements with airlines like Etihad, and more innovative things like Bilt in the United States to earn miles by paying rent.

In this respect, it has to be admitted that even though it has a handicap at the outset, Flying Blue is doing its utmost to develop, sometimes by being more creative than the others.

An excellent strategy that should be applauded without expecting miracles: with 22 million members, Flying Blue is a long way from the 115 million members of AAdvantage (American Airlines) and over 110 million of Skymiles (Delta)…

As for convincing, as IAG did, airlines to use Flying Blue miles as currency while keeping their program independent… it’s possible, as we’ve shown, but we can’t see who might be interested at this stage, except perhaps minor Skyteam airlines or Etihad.

We could also consider SAS, which we think should be allowed to keep its Eurobonos program, and simply require them to use Flying Blue miles.

But on the scale of Air France-KLM, the impact of even a billion in revenue would be excellent news!

SAS: a first step towards consolidation

Another subject on which we were waiting for Air France-KLM was its participation in market consolidation, because given the state of the Group’s finances only two years ago, this seemed more than complicated.

But if ITA has escaped its grasp, it’s finally SAS that could well fall into its lap. Could, because while the acquisition of SAS by Air France-KLM is certainly the desired outcome, it is by no means certain.

Our analysis is simple: this was an unexpected opportunity that Air France-KLM seized at low cost by taking a minority stake in order to block Lufthansa and see if the Scandinavian airline was capable of becoming profitable again on its own, leaving it to its own devices. That’s fine if it works, otherwise Air France-KLM will remain a minority shareholder or even exit the capital.

In fact, it takes up just one of the 123 slides in the presentation!

And with a clear mention: option for Air France-KLM to become a controlling shareholder after a minimum of two years (and subject to SAS’s financial performance).

It’s terse and lapidary, but in our opinion it reflects reality: “We did this deal on the cheap, we’ll see what happens, so much the better if it works and if it doesn’t, too bad for them“.

More interesting is the section on the Group’s acquisition strategy.

Ultimately, this applies very well to SAS, but when it comes to TAP, one of the Group’s stated targets, we’re more than a little skeptical. While the Scandinavian airline has more problems with costs than revenues, and operates very well, the Lusitanian airline is, as we have seen on many occasions, totally dysfunctional in terms of its operations, with integration costs that we imagine to be far too high. A panic-buy airline.

But we’ll have to wait and see when it’s officially put up for sale, an operation that has been postponed for a year due to the local political context.

The recipe for a successful transformation

When you look at the state of the airline in 2018 and think back to the COVID, seeing Air France-KLM as ambitious and healthy in 2023 is nothing short of miraculous.

A miracle we attribute to two totally rational causes.

The first, as we have already mentioned, is the choice of a true airline professional to head the company, even if he is a foreigner. But not only that: an executive committee that has also been professionalized and “defrancized”.

People chosen for their experience and knowledge of the sector, not for their experience in the civil service and government departments.

In our opinion, “defrancisation” also contributed to pacifying relations within the group, bringing competence considering how the French members were called, as well as a more multicultural approach. This Executive Committee has 12 members, including 6 French (3 Dutch, 1 Canadian, 1 Australian, 1 Albanian-Canadian), whereas, for example, the 2015 Executive Committee had 15 members, including 9 French (6 Dutch).

The second is the financial creativity with which the business has been able to recapitalize and finance itself, compared with previous practices. Numerous levers were used, as well as partnerships with investment funds, without which certain strategic projects would certainly not have seen the light of day.

Bottom line

This summer, we gave Ben Smith’s management a big thumbs-up since his arrival, and this communication to investors only confirms what we think of his tenure at the head of Air France-KLM.

The airline has undergone an unprecedented transformation, with an ambition that would have been considered illegitimate just 5 years ago.

Now, all this remains fragile in a world constantly on the brink of crisis and in a highly volatile sector, and all the plans that have been drawn up may find themselves swept away in 6 months’ time. But if this happens, everyone will be affected, and Air France won’t face the crisis any more fragile than its competitors.

Image : Air France et KLM aircrafts by Markus Mainka via Shutterstock.

Bertrand Duperrin
Bertrand Duperrinhttp://www.duperrin.com
Compulsive traveler, present in the French #avgeek community since the late 2000s and passionate about (long) travel since his youth, Bertrand Duperrin co-founded Travel Guys with Olivier Delestre in March 2015.
1,324FansLike
931FollowersFollow
1,272FollowersFollow
351SubscribersSubscribe

Trending posts

Recent posts