Reaching Higher, Higher, Higher
By Cathy Buyck, Air Transportation World | Aug. 09, 2006
Four years of cost-cutting at British Airways has resulted in a leaner more profitable carrier, but new CEO Willie Walsh wants more.
By most financial measurements, British Airways stands at or near the top of the airline industry. Its operating profit of ?705 million for the financial year ended March 31 was in absolute terms the highest of any passenger airline in the world, according to ATW's World Airline Report (7/05, p. 37), while its net result of ?451 million was the second-highest, trailing only that of Air France-KLM Group, which enjoys a revenue base that is almost 75% larger than its cross-Channel rival.
Its operating margin of 8.3% puts it on a par with Asia's best-performing network carriers and well ahead of peers in North Americaas well as those in Europe such as AF-KLM, Lufthansa, Iberia and SAS with which it is most likely to draw comparisons. Yet CEO Willie Walsh, who took over from Rod Eddington 10 months ago, is far from satisfied. "The results are good, but we still have more to do. We have committed to achieve an operating margin of 10% in the financial year ending March 2008," he stresses. "To get there, all parts of our business have to be profitable."
Best known as the man who led the rescue of Aer Lingus and transformed it into a low-cost carrier, Walsh, 45, is keenly aware that BA's competitors come in all shapes and sizes. "In the past you could have taken a lot of comfort out of looking at statistics that made you look good relative to a basket of full-service carriers, but we don't just compete with them. We probably compete directly with over 100 airlines. For example, on the short-haul we compete with the Ryanairs and easyJets. Therefore, yes, we're very, very focused on our cost. There is still more that we can do, and the competition never stands still either."
He has set some ambitious targets. As part of its two-year business plan announced in March, BA aims to save ?225 million in the year to next March 31 and a further ?225 million in FY08. Walsh says rising fuel prices have not led to an increase in these goals but acknowledges he is seeking to "accelerate" the savings. "Fuel this [financial] year will represent about 25% of our total costs, so there are still 75% of our costs that we can influence," he comments.
The search for efficiency is taking him into every corner of the company. "In the past, when people talked about BA there was a fixation on employee costs; it is an important part of our cost base but only one," he explains. "We have made great progress on our sales and distribution, and we will continue to do so. We are looking at our property portfolio. Everything, every single aspect of the cost base, is under scrutiny. It might be a couple of thousand pounds here, a couple of hundred thousand pounds there, a couple of million pounds there, tens of millions somewhere else. It's the combination of everything that will help to drive a more competitive cost base."
Still, employee costs rank high on his lista few months after taking over, he announced plans to cut the ranks of senior and middle management by 35% by March 2008and his self-proclaimed biggest issue is directly related to labor. That is BA's ?2.07 billion shortfall in its main retirement fund, the New Airways Pension Scheme. "We must address our pension deficit. If we do not, it does seriously undermine our long-term viability. This is our number one priority," Walsh tells ATW. Following three months of talks with its unions, the company tabled a set of proposals that would see the retirement age for cabin crew rise to 65 from 55 and for pilots to 60 from 55. Pension increases would be capped at 2.5% each year and pensionable pay increases would be no more than inflation. After unions accept the proposed changes, BA will make a payment of ?500 million into the fund.
Walsh acknowledges this is "a difficult and sensitive issue, but we're not unique. At the end of the day, even with the changes we propose we still will have a pension scheme that is very attractive. I think people recognize that. They look at what is happening in the US, where most of the airlines just terminated their plans."
Summertime Blues
Not everybody, though, is prepared to accept the changes, at least not yet. In particular, pilots and cabin crew have been vocal in opposing them and flight attendants also are getting crabby over the introduction of new rostering, which the union claims has resulted in chaotic and unfair work rotations. Flightcrew have threatened to strike this month over the proposed pension reforms. If they do, it will mark a fourth consecutive summer of discontent for BA and its customers, who suffered through a wildcat walkout by check-in staff at London Heathrow in 2003, an operational meltdown in 2004 attributed to shortages of staff and aircraft and a sympathy strike by baggage handlers and ramp loaders in 2005.
Walsh, however, is "confident we will manage through this summer without any difficulty." He argues to this magazine that, "Yes, people are getting nervous, but they equally understand we're trying to sort it out. The timetable we have set out [for the pension discussions] will take it probably through the summer." Last month, trustees for the plan reviewed the first cut of the actuarial review that was completed in June. The final evaluation will be available sometime in the autumn.
In tandem with its continued cost-cutting, BA is aiming to boost revenue, particularly in top classes. It has announced investments in service upgrades totaling nearly ?200 million including a new Club World (business class) seat and installing AVOD in all cabins. "We had 11 months of growth in premium traffic, only August [2005] showed decline as a result of the industrial action," Walsh says. For the fiscal year, premium traffic rose 8.1% and the trend has continued in the current year, with a 3.8% improvement in April compared to April 2005, 13% in May and 11.7% in June. Equally, the new one-way pricing model that the carrier put into the market on its short-haul fares in April also is showing some pleasing initial results.
At the end of March, BA served some 148 destinations in 75 countries with a fleet of 284 aircraft flying an average of just over 10 hr. a day. Including codesharing with other oneworld members and franchise arrangements, flights with BA's code served some 340 destinations in 107 countries.
With the recent restructuring of its BA Connect regional operation into a low-fare carrier in response to LCCs, some wonder whether BA will import the model into its short-haul mainline operation at London Heathrow and Gatwick. Walsh says no. "I would argue we are most likely seen as the leading full-service network carrier and we are absolutely committed to maintaining a full-service product within British Airways," he states without hesitation. "It is significant that for the first time in ten years we have made a profit on our short-haul operations. Go back two or three years ago, probably even last year, [and] you would have heard people arguing that BA should pull out of short-haul. It is important that all parts of our business are profitable. There aren't too many network carriers around that can say that today."
The short-haul operations, which account for roughly two-thirds of passengers and one-third of revenue, posted an operating profit of ?7 million last year compared to a deficit in excess of ?300 million in 2000. However, only the Heathrow segment made money. Gatwick operations and the regional business still showed red ink, with the latter losing ?20 millionalthough this represented a reduction from an operating loss of ?27 million in FY05on revenue of ?357 million.
"Psychologically it is nice to be back in profit on short-haul, but the level of profitability is nowhere near acceptable," acknowledges Walsh. "We have now three different programs running to address the three different parts of our business, all with a view to improving profitability. We have three short-haul businesses. It is important to differentiate between them. In the past, we would have adopted the one-size-fits-all approach to the problems that existed there. And we are very clear that you can't do that."
The regional operations, formerly known as BA CitiExpress, received a total makeover with the start of the summer schedule, including rebranding as BA Connect and a low-fare model. The 50 aircraft, consisting mostly of 50-seat regional jets with a smattering of larger RJs and smaller turboprops, now operate in a single-class configuration with paid-for catering.
"Coming in fresh from the outside, it's easier to take an independent view and make a quick decision," Walsh explains. "What I saw was a business that provided no passenger feed into our long-haul network, that was poor in terms of its commercial and financial performance and that was operating in a market dominated by low-fare carriers." With characteristic candor, he notes that while BA Connect has adopted an LCC model, it is not a low-cost carrier: "I would be fooling myself saying it is low cost, but it is competing in a low-fares environment." He has declared that the segment must return to profitability in the year ending March 31, 2008.
Gatwick still struggles from legacy costs associated with previous efforts to develop the airport as a second hub, which did not work. "We're in the process of stripping a lot of these costs out," stresses Walsh. The concentration of the network now is largely point-to-point leisure and does not require high frequency. Moving its 33 737s, which operate to 43 short-haul destinations from LGW, into a single-class configuration was under consideration: "I had questioned whether it was sustainable to keep a premium product at LGW. Interestingly, the analysis showed there was still a demand for it and that we could continue to provide that serviceand we committed to doing so. It is something we will continue to review. However, I'm very clear in my view that at Heathrow the premium product, two-class service on short-haul, is here to stay."
Fit for Five
Terminal 5 is Walsh's favorite topic. He eats and breathes it and knows to the second how long BA still is from moving to its new facilities at LHR in spring 2008; "633 days, 17 hours and 55 minutes," he laughs. "It will really transform the customer's perception and reality of traveling with [BA] at Heathrow . . . [and] it will be a much more efficient operation for us. We will also get the benefit of scale, combining the operations of T1 and T4 into T5. We get the benefit of technology; the terminal is being designed with self-service in mind. We get the benefit of schedule integration, having our short-haul and long-haul around the same counters. We get the benefit of a more efficient terminal operation. There are no cul-de-sacs so we don't have the problems we have today where aircraft are delayed getting into parking stands until aircraft get out."
He also points out that management is making progress with trade unions and staff in terms of altering work practices to get the most out of T5's efficiency potential. However, he declines to disclose any kind of cost/benefit assessment. "We're investing ?300 million in T5. A big part of our capex is associated with T5, and that investment is justified," he says.
The group's annual capital expenditure program has been limited over the past several years, scaled back to a fraction of its high of ?1.43 billion in FY01 at a time when BA was a significantly larger carrier in terms of revenue and aircraft. In fact, it operates 76 fewer aircraft today than it did four years ago. Capital spending in FY06 amounted to ?310 million. It rises to ?500 million in the current and next fiscal years (2007-08).
Some argue the airline is failing to invest in the renewal of its long-haul fleet, comprising 57 747-400s, 43 777s and 14 767s, but Walsh disagrees. "The average age is 10.5 years. The oldest 747 we have will be 17 years this year; the youngest one is 8 years. And our 777s [are] very young." He stresses that BA "is no hurry" to place an order for the 787 or A380. Earlier this year it took 10 options for 777s with deliveries after its move to T5.
Over the past couple of years capacity (ASKs) has grown by about 2.5%-3% annually. A similar growth level is scheduled for the current year, whereas FY08 will see a reduction in ASKs as BA reconfigures some of its 747s to install additional premium seats. "We believe it's the right thing to do because we see demand for premium product continuing. The options on the 777s will give us the choice to grow with about 3% per annum over that three-year period 2009-2011," Walsh notes.
Not such a long time ago, BA was Europe's largest carrier. This is history because of its own downsizing to reduce debt, which amounted to ?5.7 billion at the end of 2001it's below ?2 billion nowand boost financial performance, but equally because it has not followed its counterparts into mergers and acquisitions. After Air France and KLM, and more recently Lufthansa's acquisition of Swiss, isn't BA lagging behind?
Walsh professes disinterest. "I'm not concerned about the size because we have been much more focused on profitability and sustainability, and if you look to the US, size is no guarantee to success. The largest also go on record as being able to claim the largest losses ever generated by an airline. So I think the approach we take, making sure we're efficient, profitable and viable in the longer term, is the right one. We will be engaged when consolidation becomes an option. But it isn't an option today because of the regulatory environment in which we operate."