Reshuffling the Decks: Can code-shares bring détente to Gulf and Europe?

reshufflingBack in 2015, Lufthansa CEO Carsten Spohr was hard-pressed to find something pleasant to say about Gulf carriers. At that time, airlines in the Persian Gulf region, like Emirates, Qatar Airways and Etihad, were fighting the storied German airline and other legacy European carriers tooth-and-nail for passengers in a skirmish for market share that ultimately saw Lufthansa abandon Abu Dhabi. Accusations of illegal subsidies and unfair business practices were lobbed in all directions. There was talk of rescinding well-established open-skies agreements over the feud. Lufthansa, like other legacy carriers IAG and Air France-KLM, had underestimated the sheer will to grow and the deep capital backing of the Gulf carriers – and now the Gulf upstarts were demanding to be taken seriously.

But it’s now 2017, and the current mercurial sociopolitical climate, often creates strange bedfellows. Low oil prices have state-owners of Gulf carriers (including Etihad, which is owned by the Abu Dhabi government) scrutinizing budgets with increasing attention. With Etihad CEO James Hogan stepping down later this year, it appears that fiscal discipline is the new watchword in Abu Dhabi. Hogan’s equity-sharing strategy was successful in directing passenger flows through Abu Dhabi in Etihad aircraft, but investments in Alitalia and Airberlin have yet to turn a profit.

On the cargo side, Etihad Cargo carried 592,700 tonnes in 2016 – flat, year-over-year, despite adding a slew of new markets. In addition, the Centre for Aviation (CAPA) predicted that the weekly capacity of Etihad’s partners into Abu Dhabi will fall to 2013 levels this June, well below June 2015’s high of about 37,500 seats-per-week.

Meanwhile in Germany, Lufthansa has been in cost-cutting mode, rolling out new products on both the passenger and cargo sides in an effort to bring its costs under control – with only middling success. Adjusted EBIT for the first three quarters of 2016 was down 0.9 percent, and down 6.3 percent in the third quarter. Somehow, the two adversaries decided they might work better as partners than as rivals.

And so it was that Spohr found himself surrounded by Etihad’s leadership in Abu Dhabi last December, announcing a code-share deal with Etihad. At the event, he praised the United Arab Emirates as “one of the world’s leading aviation centers.” By the start of 2017, Spohr and Etihad announced yet another deal, this time a $100 million partnership covering catering and the potential for MRO cooperation in the future. Both carriers quickly scuttled rumors of an equity investment by Etihad, but the tone had been set.

Spohr’s embrace of this sea change in aviation immediately raised speculation about what the code-share meant for the bottom lines of both carriers, but it also raised questions about what had changed to bring these once bitter rivals together. Analysts and the media rushed to answer these important questions, and their answers generally had dollar signs in them. Instead of viewing the competition in regional terms – i.e., Mideast vs. Western Europe – the carriers were now focusing on the use of each other’s networks to better compete with their more traditional rivals for the best global routes – i.e., the code-shared Lufthansa-Etihad network vs. the combined IAG-Qatar Airways network.

But one dynamic lost in the noise was the implications of the deal for the cargo side of the business. After all, most of the long-haul routes offered by Gulf and European carriers involve cargo-friendly widebody passenger aircraft. How could this partnership make use of this pairing up of extra belly space and create new airfreight business for forwarders?

What it means

First of all, 3PLs must understand that any airfreight benefits will take a back seat to passenger dynamics. “Most Gulf airline partnerships are driven by passenger, not cargo strategy,” explained Will Horton, CAPA’s senior analyst. “Lufthansa needed a solution to Airberlin and there was limited interest in Germany for endless protectionism for Lufthansa. Gulf airlines had been trying for a number of years to partner with Lufthansa.” For Lufthansa, potential partnerships, and perhaps joint ventures, place the carrier beyond the reach of its recalcitrant unions, which tend to prefer the status quo. Etihad, however, is union-free.

Still, there may be secondary cargo benefits that can be found. Teaming up with Etihad increased the German carrier’s penetration into the far east. Gulf airlines, including Etihad, are heavily represented in the Asia-Europe market. “They have ample widebody space on far more frequencies to and from Asia and to and from Europe than European or Asian airlines,” Horton said. “Almost all services are widebodies and not weight-restricted, meaning ample room in the belly… And when there is a need for dedicated freighter service – Hong Kong, Shanghai, Zhengzhou, etc. – there are some [widebody freighters]. Otherwise the number of destinations Gulf airlines serve with passenger flights, and resulting cargo space, is more than competitors.”

Therese Puetz, CEO of Karavan Management Consulting saw a similar opportunity for Lufthansa in the Etihad deal, noting that one strength of their cooperation could be its volume of widebody-to-widebody connections from secondary-to-secondary markets. “If Lufthansa Group airlines were to use existing Etihad widebody flights or add flights from Europe to Abu Dhabi, they could connect cargo to other widebody capacity to the far east, providing customers with a better, faster offer from their hubs and secondary markets.”

In numerical terms, the deal increases the number of destinations that European forwarders can reach in Asia through Lufthansa’s agents and facilities, and presumably creates similar opportunities for their Asian counterparts. And, with IATA’s 2016 numbers underscoring the global demand for German manufacturing output, and the euro devalued, the timing is fortuitous. IATA reported that cargo volumes for European carriers in 2016 rose by 7.6 percent.

Setting a precedent

When asked what the cargo-side of the Lufthansa-Etihad code-share might look like, David Kerr, Etihad’s senior vice president for cargo, pointed to Etihad’s cooperation with Avianca, which opened the market between Italy and Colombia, on a twice-weekly basis. “All of the market data would indicate that all the volume from Europe was heading into Brazil, farther south on the continent,” he said. “But we built a bridge to Bogota, the northern cone of South America.”

Although Etihad is already connected to several cities in Germany, and throughout Europe with their widebody fleet, the impending partnership has the potential to increase Lufthansa’s E.U. connectivity to the Gulf and beyond. Etihad’s ability to partner with Avianca allowed the Gulf carrier to offer end-to-end service in an unrealized gap in the market. “That allowed us to be more relevant to a broader audience,” Kerr said. “We’ve become more of a global carrier.”

Closer to home, Etihad’s partnership and capacity arrangements with Airberlin, are another indicator that Kerr pointed to – specifically traffic, “into and out of Abu Dhabi and across the Atlantic, as well as Alitalia, where we have an ongoing capacity arrangement.” He said that these arrangements “bring growth and choice in our network while supporting the other carrier, and the growth in our network brings more choice to our customer base.”

While Etihad has added capacity through minority stakes and partnerships, it reduced capacity within its organic network in 2016. However, Kerr said that Etihad has plans to “grow the capacity” this year, as a result of the partnership.

Strategic shifts
Etihad embarked on a strategy of operational partnership with a number of carriers, however it was their equity investments that “really put some skin in the game,” Kerr said. The two arrangements – operating partnership and equity investment – allowed Etihad to operate as a “virtual airline,” with capacity sold by other partners or minority stake airlines. That strategy has allowed Etihad to grow its cargo business platform in a way that extends the network’s choices. Freight booked on Alitalia, for example, could just as easily move in Etihad belly holds or freighters.

Qatar Airways pursued a similar strategy with its 15.67 percent minority investment in IAG, which had abandoned freighters in 2014. But one month after Qatar upped its stake, IAG Cargo was selling capacity aboard Qatar Cargo freighters. “Our freighter partnership model with Qatar Airways has worked very well,” said Steve Gunning, CEO of IAG Cargo at the time. “We are able to support our customers where they need us and drive network growth in an asset-light way.”

Etihad’s commercial partnership with Avianca is the most significant partnership outside of the minority-stake group, according to Kerr. The two carriers cooperate on southbound and northbound operations from Italy into South America. This relationship allows the two airlines to increase capacity and provide a one-stop-shop for airway bills, reporting, back-office support, customer service and – on the front line – to reap the benefits of Etihad’s global sales team.

The cargo side of the Lufthansa-Etihad deal is in a similar vein; an effort to leverage a platform that Etihad has built up over the better part of the last decade. “That brings benefits to our partner carriers, and our equity carriers, and we look beyond that for partnership at all times,” Kerr explained. Now he is focusing on the deal at hand. “We’ll obviously consider what opportunities there are on the cargo side. There’s no template that we’re seeking to impose or follow.”

With every new development, the notion of “strange bedfellows,” loses credence in favor of an understanding that deals such as the Lufthansa-Etihad agreement can reveal untapped synergies. Neither carrier can afford to pass up potential cargo or passengers, and the competition of the last decade has left European carriers with no choice but to assess partnerships based on competitive route structures, rather than on geography.

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