The KLM Approach to Alliances

BYTeam No : 10 1. Meka Manga Rao 5. Sushant RoyAPSL 01 , IIM Lucknow 2. G.Satyanarayana 6. Ankur SharmaMumbai 3. Sandeep Mahimkar 7. Harmeet Singh28.09.2013 4. Prashant Thakur

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A Case Analysis

The Global Airline Industry at Glance

The Global Airline Industry has always attracted attension from Governments, Businesses, the Media and Citizens as it is primary mode of long-distance travel.

In 2006, Airlines Carried 2 billion Passengers and 2/3 took Domestic Flights and 1/3 took International Flights.

Despite of downturn due to Sept 11, 2001 Attacks in US , Industry posted Compound Annual Growth of 6.5 % in Passengers and 8.7% in total Market Value since 2002.

As 2006, the Industry is valued at $ 345.7 billion, half of it attributed to Americas and 28.4 % and 21.1% was in Europe and Asia –Pacific Respectively.

In 1997, five major Airlines – United, Lufthansa , Scandinavian Airlines Systems ( SAS) , Air Canada and Thai Airways International- came together to form Start Alliance.

Oneworld and Skyteam Alliances followed in 1998 and 2000 respectively. The aim of each Alliances was to strengthen each airline’s position, allowing

passengers to benefit from the expanded network and to receive benefits ( Such as collecting points for Frequent Flier Program ) .

In Europe, load factor was 69%, though Airline’s Breaks Even at 75 % Load Factor as a Thumb Rule.

KLM’s History of Alliances

KLM started Airline Operations

Dutch Govt. buying into KLM and listing in US

stock exchange

KLM purchased Flying Tigers (US cargo based

airline)Intention: increasing

shafe in North Atlantic traffic

1919 1946 - 50 Late 1980s

Main objective during 1980s: • Creating hub & Spoke system in

Schiphol• Increase mkt. share to sustain

competition against big competitors• Offering services from secondary cities

to Schipol

KLM’s History of Alliances contd…

KLM acquiring 20% of NW Airline through LBO for 400 m$.Objective: Secure trans Atlantic partnership.Limitations: max 25% foreign ownership as per US law

KLM & NW Airlines signs commercial agreement to operate as “Seamless One Airline”

Creation and Breaking of Alcazar: Alliance of KLM with Swiss Air, Austrian Airlines & Scandinavian Airlines system. Each had separate tie with US airlines

1989 1992 1993

Virtual JV between KLM & NW Airline – Enhanced code sharing. Assets owned separately.

Objective: To overcome antitrust competition law and push for deregulation to allow flights between US & Netherlands

KLM’s History of Alliances contd…

26% Ownership in Kenyan Airlines at 26m$

KLM attempting takeover of NW Airline. Poison Pill adopted by NW Airline Revenue contribution in the Alliance : KLM’s = 3 times NW Airline.This Alliance gave KLM 30% of its profit

10 yr JV (no formal LE, but 50:50 capacity split) along with share buyback of NW Airlines (1.2 b$ over 4 years span)

1996 1994-97 1997

Resignations of 3 KLM executives and 2 lawsuits filed by KLM on NWA. Negotiation process started

Contribution margins was splitted 50:50. Exit clause included in contract

Virtual JV Model

Virtual Merger with Alitalia. JV between KLM & Alitalia by signing Master Cooperation Agreement. With plan to completely merge after Italy govt. 53% divestiture.

Attempt of Alliance with British Airways: KLM’s ownership being 26% in merged entity.Called off due to disagreement in KLM brand and national identity

Cooperation agreement with China Southern. Code sharing & blocked space agreements. Leveraging with only designated carrier for most used Amsterdam Beijing/ Shanghai routes

1997-2000 2000 2001

April 2000: KLM pulled out of alliance as Malpensa-Milan airport being developed as major hub and delay in privatization process.KLM paid 250m Euro to Alitalia

KLM’s History of Alliances contd…

The Northwest Alliance (1994-1997)

The KLM-NorthWest North Atlantic joint venture had produced a doubling of trans-atlantic traffic for both carriers and an additional contribution of $150 m per year for KLM and $50m per year for NorthWest.

The alliance provided an estimated 30% of KLM’s profit. In 1997, the alliance operated 16 routes producing revenues of $1.7 billion. But the relationship hit a number of dramatic tension points as NorthWest board members

adopted a ‘Poison Pill’ Strategy to make the purchase price unattractive. To help in the negotiation process and facilitate KLM’s alliances with other airlines, KLM

Alliances was formed. The negotiations were centered on formulating a long term commitment, resolving KLM’s

ownership in NorthWest and further integrating both airlines. The key negotiating teams were made up of six key managers from each side led by the

commercial directors. The negotiations went on for several months and the executives resolved a buy back plan of

NorthWest stock at $40.125 per share in a deal valued $1.2 billion over a four year period. In coordination with the share buy back, the airlines cemented a 10-year joint venture

agreement. The joint venture was based on a 50/50 capacity split for balanced governance, and to avoid

objections from the pilots’ unions. Costs were deducted from each airline’s revenues to derive a contribution margin.

The Northwest Alliance - Virtual Joint Venture Model

Success factors for the virtual Joint Venture Model.

Split based on a 50/50 capacity makes it much easier. Both airlines can sell each other’s flights without having to worry about who will benefit. Splitting it based on capacity makes it fair, quick and straightforward. An exit clause was included in the contract, which required that either side give three years

notice before winding up the venture. The notion was to expand the network from 16 to 23 routes and take revenues from $1.7

billion to $2.2 billion in 1998. The joint venture called for the combination of sales, administration and reservations

offices. Sharing of Passenger Name Record (PNR) – data detailing a passenger’s reservations , fares

and payments in order to improve the integration of service for a traveller. Due to long term nature of the contract the fears of the employees were addressed. To govern the Joint venture, an Alliance steering Committee (ASC) was formed with a total

of 12 top executives from NorthWest and KLM from Alliance , Network, Marketing, Sales, Operations , Cargo and Finance Depts .

The ASC met every quarter to review strategic, financial and operational details. In addition to the ASC, there were initially between 10 and 12 coordinating groups for specific tasks

The Northwest Alliance-Cultural Differences

• Some observers commented on the cultural differences. Though the US and Dutch cultures are not as far apart as many others, differences still exist.

• NorthWest’s executive force averages between 5-6 years in position while KLM’s managers have between 15 -18 years’ experience.

• Management styles differ as managers are ‘born in KLM and die in KLM’

KLM- The failed merger with Alitalia• During the successful launch of KLM’s long-term commitment with Northwest,

KLM management was eager to merge with another major European airline.• In 1977, KLM began talks with Alitalia to step up collaboration.• Together, the airlines embarked on joint scheduling, sales offices and a

standardization of policies and procedures in anticipation of future hook-up.• In November 1999,KLM and Alitalia kicked off a joint venture with a Master

Cooperation Agreement for both passenger and cargo operations.• The plan Was to eventually merge completely upon the Italian government’s

divestiture of 53% of the airline .• However , in April2000, KLM pulled out of the alliance citing ‘unacceptable

business risk” arising from doubts over the development of the Malpensa-Milan airport as a major hub and the delay in the privatization process.

• KLM asked that Alitalia repay €100 million that it had invested in Malpensa airport.• Alitalia refused to repay the amount and sued KLM for € 250 million for pulling out

of the agreement.• Through arbitration ,KLM paid the € 250 million to Alitalia.

• Withdrawing from the agreement was what KLM CEO said was the most difficult decision of his career.

• Another executive commented on the learning garnered from the failed merger: We tried to do the integration as a big bang. We merged very quickly, in fact too quickly.

• We learned that’s not the way to do it because there were many issues with Malpensa and other local airports.

• Some of the problems were naturally outside of the control of Alitalia, but perhaps at that time , KLM misjudged its ability to implement such a quick integration.

• However on a positive note ,KLM was able to restore its operations after the de-merger. Within a month things were pretty much back to normal.

KLM- The failed merger with Alitalia

Strategic Alliance with Kenya Airways in 1996

Salient Features :

In 1996, The Kenyan Government short-listed three foreign Airlines to take over 26 % stake in National Carrier , Kenya Airways.

KLM was selected as the Winner having bid $ 26 m for Ownership and Additional $ 3 Million in services and training.

Final Capital Structure the Kenya Airways as follows : * KLM – 26 %, Govt.-23 % , Foreign Investors -14 % , * Employees – 3 % and Domestic Investors – 34 %. Ownership in Kenya Airways facilitated the negotiation process to set up joint

code-sharing routes and operational integration. De Graauw commented on the negotiations : “ After the shareholding deal ,

the commercial agreement negotiations were quite fast-probably five or six meetings over a period of a few months . The scope of the relationship was smaller so it was a more straightforward negotiation ”

Success Story:

The agreement called for Kenya Airways to add three flights per week between Nairobi and Amsterdam. KLM had four flights per week from Amsterdam to Nairobi and as part of the

accord, all seven flights were operated as joint code-sharing flights. As a part of coordinarion, Kenya Airways restuctured its European routes by

eliminating routes to Copenhagen , Stockholm , Zurich and Frankfurt and adding a route to Amsterdam. Kenya Airways implemented KLM’s check-in and revenue management

systems as well as its “ Flying Dutchman”, Frequent Flyer Program and for its part KLM Implemented Training Programs for Kenya Airways.

The joint code-sharing flights proved immediately beneficial to both airlines : revenues more than doubled within two years.

Strategic Alliance with Kenya Airways in 1996

Salient Features :

Like Most airlines , KLM passed through a difficult period after general downturn following September 11, 2001.

The Company’s revenue fell from high of € 7 billion in its 2001 ( year ending with March 20112 ) to € 6.5 billion in 2003.

It began conversations with Air France, one of the few airlines which had maintained profitability during the downturn – on a possible merger.

After a year and half, on Sept 30, 2003, the two carriers formally announced their plans to merge to create World’s largest airline in terms of revenues (€ 19.2 billion ).

Air France-KLM would keep both brands and their respective hubs and operations. Air France would won 81% and KLM 19% of the new group. Air France’s CEO , Jean-Cyril Spinetta, was to become the group’s CEO and Chairman

and Leo Van Wijk would continue as KLM’s CEO and assume the role of Vice Chairman on the Board of Directors.

Analysts were divided, one side argue consolidation was

necessary and inevitable in the long run and others suspected

Integration of two distinct cultural approaches.

The Air France – KLM Merger

Success Story : Third largest in terms of revenue passenger per kilometers ( RPKs ) behind American

and United Airlines. The combined group 225 destinations with its fleet of 538 aircraft carrying 66.3 million

passengers. The merger was seen to be “ a soft , pragmatic merger.” as both sides combined their

frequent-flier programs , consolidated sales representations and made minor network adjustments.

The Key Focus was on “ feeding one hub – either CDG ( Charles De Gaulle ) in Paris or Schiphol in Amsterdam – until traffic flow builds up ”.

Both Sides understood each other well because similar situations in Continental European Business Environment unlike Anglo Saxon way of doing business, such as the relationship between unions and management.

For the fiscal year ending on March 31,2007, Air France – KLM had realized savings of € 525 m, putting them ahead of target of their planned €400-€500.

Revenues had grown at a CAGR of 6.7% over the past three

years to € 23.1 billion and operating income at a CAGR of 31.1 %

to 1.2 billion.

The Air France – KLM Merger

KLM’s Six Phases in Managing Alliance

Screening Scoping Contracting

Screening results of possible Partners.

In other cases, airlines approach KLM directly to propose the possibility of working together

Main Targets for Alliance

Choice of Partner

Memorandum of Understanding ( MoU).

Targets for Negotiation. Legal staff would be

brought in to identify any legal and cross-border issues.

Commercials Agreement

Agreements cover the scope of the partnership, the responsibilities of both sides, the governance structure, renewal,

Exit clauses and termination.

Handover to daily M

anagement

KLM’s Six Phases in Managing Alliance

implementing involves putting the contract into action and working through the necessary changes to kick-start the cooperation Specifications fully implemented.

Changes to organisation, Processes ,etc

Stringent review od Business Results .

Going for additional Agreements to resolve specific issues.

Inviting the staff of other Airline to develop the relationship.

the managing stage is an ongoing process to ensure that the alliance is delivering the expected results.

Both Commercial and Financial results

Developing

ManagingImplementing

Future Outlook for KLM

Alliances have transformed how Airlines, Governments , Businesses and Travelers think about Air Travel.

KLM and Northwest have been credited with taking a pioneering role in making alliances an essential element in operating a long-haul airline.

As of April 2008, exciting changes to the future of KLM were underway: The Long-term Agreement with Northwest continued to flourish

and observers believed that only further synergies could be gained if Delta and Northwest were to merge.

Beyond the US and Europe, KLM was expected to form a long –term venture with China Southern for Cargo in the near Future.

Conclusions - Key Takeaway Lessons from Case

KLM is Oldest Player and First to recognise the Consolidation is the Order of the Day to survive and thrive in the Aviation Industry .

KLM Airlines was the first to kickstart a wave of Alliances in the Industry with the Northwest collaboration in 1989 to Air France Merger in 2004 .

KLM had participated in over 100 different alliances with airlines and related firms ranging from one-city pair collaborations to large-scale Joint Ventures.

KLM had developed a very Structured and Pragmatic six step process for Alliances Viz. Screening , Scoping , Contracting , Implementing , Developing and Managing.

Inspite of high tensions between high level negotiating teams from both sides, Tight-knight Cordial Relationship between Commercial Heads, Viz.AB.van Luyk of KLM and Michael Levine of Northwest lead to Operational Success, thus paved the way for 10-year joint venture agreement.

Though, KLM had a enormous experience in Alliances, but it failed in Merger with Alitalia in 2000 due improper Assessment of Overall Alliance Proposal and ultimately paid € 250 m to pull out this Agreement.

With Great Learning Curve from Alitalia, it ultimately forged Wonderful

Merger with Air France, which ultimately became third Largest Airline

in the World.

Thank You

For

Your Kind Audience…..

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