“The goal of the Lufthansa Group is to be the first choice in aviation for customers, employees,

shareholders and partners. Going forward, the Lufthansa Group therefore intends to continue
playing a significant role in shaping the global aviation market. In this context, the strategy aims
to systematically develop the Group based on the three pillars of network airlines, point-to-point
airlines and aviation service” (https://investor-relations.lufthansagroup.com/en/fakten-zum-
unternehmen/group-strategy.html)

The company

Deutsche Lufthansa AG (Lufthansa) is one of the world's largest airlines, with multiple business
areas including passenger traffic, logistics, maintenance, repair and overhaul, catering and IT
services. The airline, which was partially owned by the German government until 1997, is now
owned exclusively by private investors. Lufthansa is headquartered in Cologne, Germany. The
Lufthansa group (including its minority stake in Brussels Airlines) has five hubs which are
located relatively close to one another in the center of Europe: Frankfurt, Munich, Zurich, Vienna
and Brussels. Through the coordination of schedules and pricing, this allows it to offer a wide
range of destinations and frequencies. It also allows it to develop its network from each hub with
a particular geographic focus. The company is also one of the founding members of the Star
Alliance program, the world's largest airline alliance. In 2016, Lufthansa employed more than
124,000 employees and offered service to more than 300 destinations in more than 100 countries.

Lufthansa did manage to increase its revenue in 2016, though its operating margin fell short of
expectations and profitability is a major concern. Like other players in the Global Airlines
industry, Lufthansa's operations have been constrained in recent years by substantial declines in
the world price of crude oil that have lowered fuel purchase costs, forcing many industry
operators to eliminate fuel surcharges and reduce passenger ticket prices to remain competitive.
Moreover, modest economic growth in Europe has limited demand from the company's primary
customer base, despite overall increases in global per capita income and consumer spending.

The airlines within the Lufthansa group occupy positions across a range of market segments, both
in terms of product/service offer and national geographies. The Lufthansa brand includes
premium and economy cabins, long- and short-haul and offers a full range of services.
Germanwings is in the short-haul point-to-point lower fares segment. However, Germanwings is
not sufficiently low cost and its pilots are covered by the same collective wage agreement as the
mainline pilots. The growing Eurowings subsidiary, with lower unit costs than Germanwings,
aims to extend the group's presence in the budget segment, both short haul and long haul, with an
emphasis on leisure routes. Still, the main source of Lufthansa's revenue is passenger
transportation, which accounted for 74% of the group's results.

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The core strength of Lufthansa is its brand image which is generally associated with high quality.
Lufthansa follows mainly a differentiation strategy which offers full service mostly using a hub-
and-spoke route system, comprise the so-called legacy carriers. Differentiated airlines usually
offer more routes than low-cost, point-to-point airlines. Low cost carriers generally serve mainly
small airports with high block hours, low service on board, one type fare and no cooperation with
travel agencies while full service carriers serve small and large airports with high frequency, on
board service and fares for each target group. In terms of target groups, Lufthansa also has a
strong reputation in the business travel segment with around 40% share of sales from corporate
travel businesses in 2017. The revenue from first and business class made up 39% of the results,
and for long-haul flights, the premium share was 50%. Only Singapore airlines, its Star Alliance
partner, could boast a similar share.

Lufthansa aims to increase the proportion of its revenues generated outside its core hub-based
flying operations from 30% today to 40% by 2020 (this includes revenues from its growing point
to point flying operations).

Lufthansa has developed a strong position in its use of joint venture agreements with United
Airlines, Air Canada and All Nippon Airways. Such arrangements, when approved by
competition authorities, allow the participants to coordinate schedules and prices and typically
provide significant unit cost enhancements. In September 2016 Lufthansa signed a joint venture
with Air China. The two groups plan to coordinate their schedules, offer common fares and
improve their offers to corporate clients and frequent flyers under the arrangement.

The environment

The Global Airline industry is characterized by a low level of market share concentration, and the
industry's four largest players are expected to account for 22.1% of the industry's total revenue in
2017 (see Figure 1). Despite recent merger and acquisition activity on the part of the industry's
major companies, the level of concentration within this industry has actually declined slightly
over the past five years. The global scope of this industry makes it extremely difficult for any
operator to gain a large market share. Furthermore, anti-monopoly regulations and anti-
protectionist policies help prevent a single carrier from completely dominating certain routes.
Moreover, most airlines primarily serve routes in and out of their home country, which makes it
difficult for operators to expand into new markets. Additionally, growing demand for passenger
and cargo transportation in Asia and the Middle East has encouraged these regions to further
develop their own aviation sectors. Qatar Airways, Etihad Airways, Emirates Airlines and China
Southern Airlines have all become increasingly important players in the sector, siphoning market
share from encumber major players such as Lufthansa and Air France. For example, Emirates
Airline, the main subsidiary of Emirates Group, now has an estimated market share of 3.9%
while Air France-KLM SA has an estimated market share of 3.8%.

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Figure 1: Major players (market share)

Source: IBUS world

Overall, the airlines industry exhibits high barriers to entry. Start-up costs, which include initial
expenses on hangar and airfield space, skilled labor, highly specialized machinery and adherence
to stringent safety requirements, are extremely high for operators in this industry. Additionally, a
wide network of industry contacts, a proven safety record and the demonstrated ability to deliver
projects on time and on budget are often essential to succeed in this industry. As a result, new
entrants could struggle to win business even after massive initial capital outlays. Moreover,
existing major players can use economies of scale to win business by consistently undercutting
smaller players on price and speed of delivery. It is also important to note that products offered
by airlines are highly perishable. Seats that remain unsold prior to an aircraft taking off are lost
and cannot be recovered.

Government regulations, licensing requirements and reporting standards also restrict the number
of new participants in this industry. Airline agreements involving landing rights can determine
the number of aircraft designated to operate on each route, acting as a barrier to entry for
undesignated airlines. These agreements also set capacity limits for each country and impose a
volume quota on airline services on a country-by-country basis. Countries that have privatized
their national airlines often have slightly lower barriers to entry, as these regions rely on market
forces and competition to manage the industry. However, while several countries have highly
liberalized air transportation markets, many businesses that serve airlines, such as airports,
remain largely insulated from the competitive pressures of deregulation, enabling these industries
to charge high fees for airline-related services (e.g. landing and parking fees).

Many major airlines also rely on aircraft management, promotions and open skies agreements to
increase revenue and market share in this industry. Most routes are determined by supply and
demand factors, which are usually volatile. Many network routes are established or suspended
because of demand. Therefore, having a large fleet of aircraft to maximize load and capacity,
combined with a competitive pricing policy, is vital for airlines to achieve profitability and
sustain their operations. As a result, incumbents generally have code-sharing agreements in place
and belong to networks with other airlines. By selling seats on a flight operated by another
carrier, code-sharing enables an airline to make direct cost savings by rationalizing services or
establishing market presence on a route without actually operating on it. Thus, both airlines may
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be able to save on fuel, labor and other variable costs, in addition to making more effective use of
aircraft and other capital assets. In recent years, low-cost business models operated by no-frills
airlines have proven to be an effective model for new entrants in the Global Airlines industry.
However, the market for low-cost airlines is becoming increasingly saturated due to the
substantial number of players already in existence.

Many nations are also engaged in open skies agreements, which aim to improve operating
efficiency among global airlines by limiting government restrictions on industry operations. For
example, the United States and the European Union (EU) are engaged in an open skies agreement
that gives airlines from the United States and EU member states open access to each other's
markets, with freedom of pricing and unlimited rights to fly. This agreement has significantly
increased passenger and cargo traffic between the two regions.

In addition, the Global Airlines industry has a high level of competition, though government
restrictions on foreign ownership and market entry can reduce the level of competition within
some countries. Airlines compete for customers on the basis of price, flight frequency and
capacity, route offerings, loyalty programs, promotions, rewards programs and quality of service.
Industry operators must also attract customers from substitute modes of transportation such as
cars, trains and buses.

The European market

In the current European market environment, Lufthansa has to deal with several challenges.
Economic crises in Europe leads to less business travel and replace meetings by conference calls
while at the same time the oil price increased. The short-haul segment has been in trouble to be
profitable following the entry of low-cost airlines in Europe at the end of the 1990s. With its new
business model, Ryanair and Easyjet, turned the European airline industry upside down. Ryanair
is an Irish low-cost point-to-point airline. It flies to 165 cities mostly across Europe. Sometimes
Lufthansa also has troubles with the quality of the few local catering services and the few
suppliers of aircrafts (e.g., Airbus and Boeing) and jet-engine manufacturers (GE, Rollys-Royce,
Pratt & Whitney).

The European civil aviation industry had been under strong pressure in the last decade due to
strong overcapacity in the market, which resulted in lower revenues per passenger. As a result of
intense competition amongst airlines, a high consolidation wave begun at the turn of the
millennium, beginning in Europe with the merger between Air France and KLM in 2004 and
British Airways and Iberia in 2010 which created the International Airlines Group (IAG) holding
company. IAG and its subsidiaries serve around 200 worldwide destinations. Air France–KLM
was categorized as one of World's 10 safest airlines in August 2011 and they offer flights to 225
destinations in the world. Yet, the so-called nationality clause present in bilateral air service
agreements, which only granted an airline traffic-rights if residents of that particular country held
a majority stake in the airline, prevented economically worthwhile cross-border mergers as well
as access to urgently needed foreign capital. Nevertheless, a sign of liberalization is in sight, the
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so-called Open Skies Agreement between the US and the EU, which allowed access to any
airport in a particular country as long as slots for take-off and landing were available.

The European airline industry, and in particular German airlines, has also been marred by labor
strikes staged by cockpit staff, cabin crew, air traffic controllers and ground personnel. The
aviation tax introduced by the German federal government in 2011 ignited a storm of protest in
the industry. In addition, the introduced European Emissions Trading Systems for climate
protection was also viewed as distortive because it put heavy burdens on European airlines.
Furthermore, the industry has to deal with the reduction of fuel burn and noise level, regulation
about carbon emission level, immigration and various security requirements.

Demographic changes also impacts the airline industry since aging population means that lots of
people in that life stage have more income to spend. At the same time there is a higher number of
commuters and the demand of lower cost carriers increases. Nevertheless, customers require
opportunities to visit new and interesting, often long-haul, destinations.

Recently, a new challenge has emerged from the Persian Gulf region. Emirates, Etihad Airways
and Qatar Airways are now threatening Lufthansa on the traditionally profitable long-haul
segment. These Gulf carriers offer very competitive rates, as they operate at lower costs and offer
great service and they own hubs in Dubai, Abu Dhabi and Doha. In particular, there is an
announcement by primary competitor, Emirates, of its plans to further expand the Dubai airport
into an international hub. Furthermore, Turkish Airlines enjoyed rapid growth in recent years,
following privatization and strong governmental support. As of 2016, it operates scheduled
services to 296 destinations in Europe, Asia, Africa, and the Americas, making it the fourth-
largest carrier in the world by number of destinations. It serves more destinations non-stop from a
single airport than any other airline in Europe. Turkish Airlines flies to 119 countries, more than
any other airline.

In addition, Lufthansa faces strong competition from competition such as Ryanair, International
Airlines Group (IAG) which was formed in 2011 after a merger between British Airways and
Iberia, Air France-KLM, SAS Scandinavian Airlines, EasyJet and Norwegian Air Shuttle and
their subsidiaries. Recently, airlines such as Pegasus from Turkey and Wizz Air from Hungary
which are the most important low-cost carriers in Middle and Eastern Europe, also gained
strength. Norwegian airline operates 500 routes to 150 destinations in 35 countries on four
continents. The SAS Group airlines serve 180 destinations in 35 countries on 4 continents.
Pegasus Airlines flies schedule services to 72 destinations, with a total network of 105
destinations, in 40 countries. Figure 2 provides an overview over the top 20 airline groups in the
European market by share of scheduled seats in winter 2016/2017 and their seat growth versus
winter 2015/2016.

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Figure 2: Overview over the top 20 European airline groups

Source: https://centreforaviation.com/insights/analysis/european-airline-seat-capacity-growth-
accelerates---perhaps-too-quickly-outlook-for-winter-201617-310109

Questions:

1. Which macro-environmental factors are the most salient for Lufthansa?

2. Looking at Porter’s five forces model, how would you assess the profit potential of the
European Airline industry? What implications would you suggest how Lufthansa should
compete in the European / Global Airline industry?
3. Draw a strategic group map for the European airline industry. Draw circles proportional to the
share of seats. What is your recommendation for Lufthansa?

Sources:
https://www.washingtonpost.com/business/the-rise-of-the-aerostate-us-carriers-scramble-as-
persian-gulf-rivals-emerge/2016/04/29/a14da5f6-0b2c-11e6-a6b6-
2e6de3695b0e_story.html?utm_term=.53cb6e2508c2
http://www.flugrevue.de/zivilluftfahrt/airlines/lufthansa-und-air-china-unterzeichnen-joint-
venture/699510
https://investor-relations.lufthansagroup.com/en/fakten-zum-unternehmen/group-strategy.html
http://www.businesswire.com/news/home/20121114006447/en/Turkish-Airlines-1-World-
Flying-Countries-Worldwide
https://www.ibisworld.com/
https://en.wikipedia.org/wiki/Lufthansa
http://www.anna.aero/2016/08/17/klm-has-third-biggest-international-hub-in-europe/
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