IBERIA AIRLINES: REDESIGNING THEIR STRATEGY TO MEET NEW CHALLENGES
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DE1-161-I
IBERIA AIRLINES:
REDESIGNING THEIR STRATEGY TO MEET NEW
CHALLENGES
Original written by professor Rosario Silva Froján at IE Business School, with the collaboration of María
Eugenia Romagnoli, Research Assistant.
Original version, 2 October 2009. Last revised, 1 February 2010. Translated 29 April 2010.
Published by IE Publishing Department. María de Molina 13, 28006 – Madrid, Spain.
©2009 IE. Total or partial publication of this document without the express, written consent of IE is prohibited.
In September 2005 the Iberia Group Board was planning to meet to discuss the need for a strategic
1
reorientation. The progress of the low-cost carriers (LCCs ) in Spain was threatening Iberia‟s
position, not just in the European market, but also in the domestic market. The situation in
Barcelona airport was especially critical given that Iberia had lost market share for the last five
years, whilst the low-cost carriers had reached a 40%. Major airlines such as easyJet and Ryanair
were established in this market, as well as some new ones such as Vueling. This new airline had
experienced considerable growth in few months by starting to fly on major Iberia routes such as
2
Madrid-Barcelona, at prices fifty percent cheaper .
In the last few years Iberia managers had undertaken important strategic changes in order to face
up to the new competitive environment. Chiefly they had focused on achieving greater efficiency
and on consolidating their leadership in the European-Latin American market. These changes,
combined with others of great importance such as the privatisation of the company, the definition of
the new policy for alliances and the reconfiguration of the business portfolio, had led Iberia to enjoy
uninterrupted profits since 1996 and to obtain their best results ever in 2004.
The Chairman of Iberia, Fernando Conte had to take great care over the preparation of the
meeting. How was the growth of the low-cost carriers affecting Iberia? What alternative strategies
did Iberia have to face up to that threat? What was the best option?
THE AIRLINE SECTOR
EVOLUTION OF THE AIR TRAVEL SECTOR
The sector began its expansion after the Second World War. At that time, many private commercial
airlines were nationalised by the governments to create large airlines known as flag carriers - they
were known as that due to their close links with the state from which they operated. In November
1944 the Civil Aviation Conference was held in Chicago, where fifty two states signed an
International Convention that established the basic principles for the functioning of the air market:
each country could negotiate bilateral agreements with other countries in order to regulate the
market conditions that would govern air traffic. In the meantime, the domestic market would still be
regulated and controlled by the flag carrier of each country.
1
LCCs is the usual term used by members of the sector when referring to airlines that follow the low-cost model.
2
“Vueling takes off on the Madrid-Barcelona route”, Expansión, 24/9/2004.
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From 1945 until 1978 the flag carriers enjoyed an environment without competition thanks to the
bilateral agreements between airlines. IATA (International Air Transport Association) was the
institution responsible for establishing price conferences and setting capacity agreements between
3
companies and countries .
Throughout these years, the airlines‟ obsession was to grow, due to the pressure brought by
governments to create new routes. There was the conviction that the nation‟s prestige was
enhanced by the flag carriers, and that a larger fleet was a synonymous of greater international
recognition.
The deregulation process started in the United States in 1978 when the US Airline Deregulation Act
established that airlines were free to set prices, to open or close routes, and to merge in the
domestic market. As a result of this liberalisation, new companies arose with more simple cost
structures, such as Southwest. On the other hand, in Europe, this process was slower. In 1986, the
end of government subsidies to airlines and price deregulation were approved. The liberalisation
process was progressive until the full deregulation of the market in April 1997. From that time, any
airline could operate any route within European aerospace with the schedules, frequencies and
prices that it decided. Internationally, the bilateral agreements on traffic with other countries were
upheld.
Some new and very efficient airlines arose as a consequence of the liberalisation of the European
market. These new airlines, operating with a “point to point” model, initiated the “low-cost”
phenomenon. It was precisely in Europe where these companies expanded the most because their
birth coincided with the development of Internet, which facilitated the online sale of tickets for their
flights. On the other hand, progress in the United States had taken place beforehand but more
slowly because the ticket distribution depended on reservation systems, such as Sabre and Apollo,
controlled by the large and traditional American airlines.
The flag carriers responded to the increase in competition with the creation of powerful groups of
alliances: Star Alliance, SkyTeam and OneWorld. At the end of 2004, Star Alliance was the alliance
with the most traffic (29% share of international passengers), followed by SkyTeam (22%) and
OneWorld (20%). The airlines were able to achieve an increase in income and a reduction of costs
through co-operation.
In spite of liberalisation, the flag carriers continued to keep the majority of slots at their own airport
bases. Slots were defined as time bands for takeoff and landing of aircraft and were owned by the
airports. There were few available slots in the major airports of the European Union. For that
reason, there was a coordinator that received requests for slots from the airlines and assigned
them based on the criteria established in the regulations. The general rule was the assignment
based on seniority and on the offer of new destinations.
EVOLUTION OF THE MAIN BUSINESS MODELS
There were four main business models in the sector: network, low-cost, charter and regional.
NETWORK CARRIERS
Before the 1980s, the planning system used was basically “point to point”, that is to say, direct
flights from one city of origin to another of destination. Following the American deregulation and
with the aim of improving their efficiency, increasing their income base and generating economies
of scale, the traditional airlines began to adopt the hub and spoke system. Instead of planning
simple routes, they planned routes from and to the hub airports that came from or were going to
3
“Las alas de España”, Javier Vidal Olivares, 2008, PUV.
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other cities (spokes), creating connections and maximising the services offered for a specific
physical capacity.
The majority of European airlines gradually adopted this hub and spoke model: using the main
airports of their countries of origin as a base, they developed a system of short and long haul flights
fed by a network of multiple connections.
The network model involved careful synchronisation between flights, since it was necessary for
landings and takeoffs to occur almost at the same time so that connections could be made. For this
reason, any delay in one of the flights affected all the others with which it had connections and the
airport hub tended to be over-crowded. Apart from the complexity of the management, it was
4
considered that this model needed to have a fleet of at least 25 aircraft for it to be profitable . The
great advantage of the system was that it achieved greater take-up on flights and was able to offer
more frequent flights.
The airlines that operated this model offered different classes of tickets (tourist and business) VIP
lounges, assistance at the airport, in-flight service, frequent flyer programmes, etc. For their ticket
sales they relied on Global Distribution Systems or GDS such as Amadeus, Sabre or Galileo, that
provided full information on schedules, frequencies and prices to travel agencies. At the end of the
90s travel agencies made 75% of all flight reservations at the world level and the GDS were the
most used distribution systems. These companies were noted for their high profitability. Amadeus
was the leader in Europe, Sabre in the United States and Galileo between continents.
Europe had 31 major airline companies, which in 2004 had carried 307.1 million passengers,
5
meaning a growth of 7.2% with respect to the previous year . The top five airlines were: Lufthansa,
6
Air France, British Airways, Iberia and KLM .
In order to achieve international expansion, the airlines set up alliances between themselves, for
example, British Airways signed an agreement with Iberia. On the same note, Air France and KLM
merged in 2004 to create the largest company in the sector. Nevertheless, mergers were not
frequent due to the fact that airlines acquired by a foreign company could lose the bilateral flight
rights from their country of origin, and in addition, current regulations established that an airline
ceased to be considered as European if more than 49% of its capital was acquired by non-EC
investors. This limit was fixed at 25% in the United States.
Since 2000 the average profitability of the European major airlines was negative (Exhibit 1). In
2001 some European flag carriers went bankrupt, such as Swissair – the Swiss airline since 1931 –
and Sabena – the Belgian airline since 1923. The losses mounted up on the routes between
European cities under the increased pressure of competition, whilst the long haul routes were
generally profitable (Exhibit 2).
Apart from the increased competition, some events like the terrorist attacks of 11 September 2001
in the United States, the Iraq War, and the problems in the Asian market due to the outbreak of
Asian bird flu in 2003 had a negative influence on results. In 2004, the European companies were
experiencing a slow recovery in their growth and profitability figures due to an increase in demand.
LOW COST CARRIERS
In 2004, Europe had about 30 low-cost airlines that had carried some 100 million passengers as
7
opposed to 66 million the previous year . That same year 11 new low-cost carriers were created,
4
José Bolorinos, Director of Strategy for Iberia, interview with the case author in Madrid, 10 November 2008.
5
Analysis of the EU Air Transport Industry, 2004, p. 39. Author‟s note, this report considers that the network airlines are
those belonging to the AEA; page 8 of this report includes a list of these companies, there being 31.
6
IATA member‟s ranking 2004. World Air Transport Statistics 2005.
7
Analysis of the EU Air Transport Industry 2004, 2003.
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although many of these new companies failed after the first months of operations; for example, four
airlines had left the market in the last year.
easyJet and Ryanair, the LCC pioneers in Europe, dominated the market by carrying 25 million
passengers each. With a growth of 20% and 25% last year respectively, they continued to
demonstrate that they had a good nose for sniffing out opportunities. After them, Air Berlin was
8
number three in the sector with a volume of 12 million passengers carried .
Ryanair was outstanding as the airline that most strictly adhered to the low-cost model. These
airlines‟ key to success was the low cost of operating, thanks to a combination of factors (Exhibit
3):
They managed flights “point-to-point”, both scheduled and short haul.
They used regional airports that were cheaper and less crowded than the main airports.
Nevertheless, some low-cost carriers such as easyJet and Vueling also used main airports.
They had homogenous fleets that facilitated crew formation and saved on maintenance costs.
They offered one class only with high density seating and no in-flight service. For example, a
Boeing 737-300 operated by a low-cost carrier could have 148 seats instead of the usual 124.
They made sales directly by telephone and internet without issuing tickets.
They offered unnumbered seats on the aircraft so as to speed-up the boarding process.
So as to increase their revenue, they offered other supplementary services such as travel
insurance, car rental, etc. In addition, they charged for services that were free on other full-
service companies, such as, for example, in-flight service.
They subcontracted many activities such as ground assistance or maintenance.
The employees were not union members, and in many cases they were contracted for several
tasks. For example, flight attendants cleaned the aircraft and helped with boarding
passengers. The pilots‟ salaries could be 25% less than with a flag carrier.
A consequence of low-cost carriers being set up was the revitalisation of underused airports and
the economic revival of certain towns and regions. For this reason, public and private sectors were
prepared to grant direct economic aid to those low-cost carriers that set up in their area. Ryanair
was one of the companies that was most supported by these agreements to boost the launch of
their new routes. For example, in Spain, it had signed seven contracts to operate in secondary
airports and, although they did not publish the details, it was estimated that it could earn some 20
9
million Euros up to 2008 in this respect . In September 2005, the European Union approved a
regulation that established that airlines could receive subsidies to finance costs arising from the
opening of new routes, but only in airports with traffic of fewer than five million passengers.
10
The unknown factor in 2005 was if the low-cost model could be profitable for long haul flights . Up
to that time there were only a few airlines offering low prices on long haul routes, although with a
11
hybrid business model . For example, Air Madrid had recently started to offer transoceanic flights
at low prices, although it offered its tickets through agencies, flew to main airports and had
12
business class . Its constant delays and cancellations, together with its weak financial situation,
forebode a difficult future for this airline.
In order to respond to the threat from the low-cost carriers, the major airlines looked for better
quality positioning at the same time as they were trying to reduce their costs. For example,
Lufthansa added exceptional services to its loyalty scheme, such as an exclusive terminal at
13
Frankfurt airport, whilst cutting its costs by more than a thousand million Euros . At the same time,
8
Analysis of the EU Air Transport Industry, 2004. The growth data for easyJet and Ryanair also refer to passenger
numbers.
9
“Dinero público para cazar aerolíneas”, SAVIA, Dec. 2005, p. 14-18.
10
“Low cost set for the long haul”, Airline Business, 1/4/2005.
11
Las low cost de largo radio: un modelo de negocio que está por despegar. HostelTur, Julio 2007. [Low-cost long haul: a
business model that is about to takeoff]
12
Crisis de Air Madrid: Una aerolínea de bajo coste derribada por las rutas de larga distancia, Universia Knowledge at
Wharton, 10/1/2007. [Air Madrid Crisis: A low-cost airline brought down by the long-haul routes]
13
Low-Cost failure looms. Airline Business, Issue 7, July 2005.
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some airlines launched their own low-cost subsidiaries. British Airways had tried to compete by
setting up Go, KLM with Buzz and SAS with Snowflake, although none of them were successful.
Go was sold to the capital risk group 3i in 2002 and finished up shortly afterwards in the hands of
14
easyJet; Buzz was sold to Ryanair in 2003 and Snowflake ceased operations in 2004 . The
15
American airlines had made similar attempts to copy the Southwest model and all had failed .
In the case of British Airways (BA), it had tried to set up its subsidiary, Go, in 1998 to operate out of
London-Stansted airport. The new airline was managed completely independently of BA, although
the latter was its only shareholder. At the beginning, Go avoided direct competition with Ryanair
and easyJet by growing the routes that BA already operated from Heathrow and Gatwick airports.
When it started to compete with Ryanair in 2001 in Dublin, it suffered heavy losses that forced it to
withdraw from that market. One of the biggest concerns of BA managers was the cannibalisation of
traffic between both airlines: “We are investing money in a company that is stealing customers from
16
us and reducing our yield … it‟s madness. Go has to be closed or sold,” said a British Airways
17
manager to the press . In 2000, one of the first decisions taken by the new Chairman of BA, Rod
Eddington, was to sell Go: “The first airline that successfully manages a full-service airline and a
18
low-cost subsidiary should win the Nobel Prize for Economics,” said Eddington .
CHARTER
A charter flight refers to when an aircraft is rented to an airline for flights not coinciding with
scheduled commercial routes. In general this type of flight connected the major European cities
with the main tourist destinations, in many cases using secondary airports. In 2004, there were 85
charter airlines operating in Europe, mainly in the United Kingdom, Turkey, Spain, France and
Germany.
Almost 50% of the charter fleet was in the hands of the major tour operators that carried more than
70% of passengers in this sector. The main advantage of this type of airline was its greater
flexibility due to the fact that the times of the flights were not regular. Furthermore, they achieved
lower costs per kilometre of flight and a higher co-efficient of occupation compared with a
traditional company as the relationship with tour operators eliminated the need to have sales
departments and they used large aircraft on long haul routes to the major holiday destinations.
This model was facing even stiffer competition from the low-cost carriers that were offering greater
flexibility on short haul flight schedules. A growth in the number of passengers who preferred to buy
their own holiday package on the internet and fly with low-cost airlines was being observed. As a
result, in 2004, the demand for charter on major tourist routes fell, as for example United Kingdom-
19.
Malaga For their part, the charter airlines counter-attacked by creating their own low-cost
carriers, such as Air Berlin and MyTravel Group, whilst others decided to reduce their dependency
on short haul routes and focus on long haul.
REGIONAL CARRIERS
Regional airlines operated “point-to-point” flights with full service. They used medium and low
capacity aircraft on low density routes. Generally they only made domestic flights and rarely
international ones. They competed with flag carriers and also with low-cost carriers, which had
caused a decline in their per passenger income. For that reason, some regional companies
decided to go into partnership with flag carriers. As an example, Air Nostrum, one of the main
14
Wikipedia Go, Snowflake and Buzz.
15
“The European Airline Industry on a collision course”, Gimeno, J.; Cool, K., Buccella, A. and Fung, H. 2004. Case Study,
INSEAD.
16
The concept of yield is explained in Appendix I of this case.
17
Graham, B, & Vowles, M. 2006. Carriers within carriers: a strategic response to low cost airline competition. Transport
Reviews, Vol. 26, Issue 1. 105-126.
18
“Losses loom for European Airlines despite upswing in traffic, Aviation Daily, 2004, 356(48), p.1.
19
Analysis of the EU Air Transport Industry, 2004.
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European regional airlines, went into partnership with Iberia in 1997, although its capital continued
to be independent. This airline was one of the few regional companies that obtained positive
20
results . No new regional airline was created in 2004 and five companies closed down.
DEMAND
The number of passengers carried at the world level in 2004 rose to 1.9 billion, experiencing a
strong increase of 11.6% with respect to 2003. European airlines carried 26% of the world volume
of passengers, behind the Americans (39%) and just a short distance from the Asians (25%).
Demand was strongly influenced by the countries‟ GDP growth and the evolution of the GDP per
capita. Countries with a higher GDP per capita were the greatest consumers of air traffic. The
routes between Europe and the Middle East had experienced one of the biggest growths. A huge
increase in traffic to Asia (18.9%) was also noticed due to China‟s economic growth. Routes
between Europe and the South Atlantic grew at a good rate (17%), driven by the economic
recovery of Latin America. The International Monetary Fund estimated a 5.7% growth in the
region‟s GDP in 2004, the highest since 1980. Unlike the expansion of long haul traffic, domestic
21
traffic hardly grew (Exhibit 2).
In general there were fewer and fewer tourists who were buying a tour package, and more who
decided to buy their tickets on the internet after checking the transparency of prices and the low
prices offered by the airline web sites and online travel agencies. This kind of traveller chose the
airline mainly based on price, but also valued other attributes: convenience of schedules and
frequencies, good previous experience, a direct flight, etc. On the other hand, business travellers
were less sensitive to price and valued other attributes more such as schedules, frequency and
quality of service. Frequent flyer programmes had to a large extent managed to cultivate loyalty in
business traffic. Although this situation seemed to be changing, a survey carried out by Barclaycard
reflected an important growth in the number of British passengers who had chosen a low-cost
22
carrier for their business trips: from 28% in 1999 up to 69% in 2004 .
On short and medium haul routes, passengers were replacing the plane by other means of
transport, such as the car, coach or train. In the specific case of Spain, the development of the high
speed train, the AVE, represented a competitive challenge for the airlines on journeys of less than
600 km. For example, on the Madrid-Seville route, the AVE had achieved 80% of the market
23
share . On long haul trips, the competition was exclusively internal between airlines.
IBERIA, LINEAS AEREAS ESPAÑOLAS
Iberia was one of the oldest airlines in the world. With 26 million passengers carried in 2004, it held
th th 24
4 position in Europe and 13 in the world .
25
EARLY HISTORY 1927 - 1996
Iberia was founded by the Basque businessman Horacio Echeberrieta, who held the majority of the
company capital, and the German company Lufthansa, with a stake of 24%. During the 1930s,
Iberia was nationalised and integrated into a public company, virtually reducing all of its activity
until the end of the Spanish civil war. In 1939 it made its first international flight with the Madrid-
20
Analysis of the EU Air Transport Industry, 2004, quoting the ranking published in Airline Business.
21
AEA Market Research Quarterly, Issue 2, 2005.
22
Company Barclaycard, Business Travel Survey (1999-2005) Analysis of the EU Transport Industry, 2004.
23
El AVE deja en tierra al avión. Expansión, 16/2/2009.
24
IATA member‟s ranking 2004-Top fifty. World Air Transport Statistics, 2005.
25
Sources: Iberia official website. “Iberia from flag carrier to global services airline: 1950-2000”, Javier Vidal Olivares, and
“Las alas de España”, Javier Vidal Olivares, 2008, Ed. Publicaciones de la Universitat de Valencia.
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Lisbon route that would be followed in later years by connections with Rome, Paris and London. In
1944, Iberia was integrated into a holding of public companies called INI (Instituto Nacional de
Industria) and became the flag carrier of Spain.
From very early days, Iberia excelled with international expansion mainly oriented towards South
America. In September 1946 it became the first airline in the world to fly between Europe and the
Latin American region with a flight that connected Madrid with Buenos Aires.
The development of the company took place at the beginning of the 1960s, tied principally to the
growth in tourism coming from north and central Europe. Its excellent situation led the INI
management to design a strategy to open new routes to Latin America, Asia and Northern Europe,
and to make strategic agreements with Latin American airlines, supported and driven by the
26
Spanish Government . It is important to stress that the opening of new international routes was
established through bilateral agreements that in many cases had to be preceded by diplomatic
negotiations.
In the 1970s, the airline experienced its highest growth by tripling the number of passengers
carried from 5 million in 1971 to 15 million in 1980. The expansion of tourism also contributed to an
increase in competition from charter flights that connected European cities with the principal
Spanish tourist destinations.
In 1974, Iberia was one of the leading European airlines to start-up the system of flights without
reservations with the Madrid-Barcelona route, which over time would become the busiest air shuttle
27
in the world, ahead of routes such as Washington-New York . In that same year it started up the
telephone customer service line Serviberia, also a pioneer in Europe.
At the end of the 70s and during the first years of the 1980s, Iberia faced some structural and
28
temporary problems that caused losses during a period of thirteen consecutive years . The
increased price of oil, currency instability, the progressive deregulation of the air travel market and
the growth of charter companies worsened the company‟s financial situation. Furthermore, Iberia‟s
internal situation was difficult, with the burden of loss-making routes due to their historical public
ownership, and a disproportionate number of staff that enjoyed very high salaries compared with
29
the rest of workers in the country . The excess capacity was evident, but Iberia remained quite
30
inflexible to aligning the offer with the real market demand . Labour disputes were constant, with
continuous strikes that diminished the quality of service and contributed to increasing the
company‟s deficit. The culture of a publically owned company predominated at Iberia, and at
31
certain times it was obvious that political criteria outweighed financial ones in strategic decisions .
From 1986, greater stability in the price of oil and the injections of capital made by the INI improved
Iberia‟s prospects. Its active participation in the creation of new companies in businesses related to
the aviation sector was notable in the 1980s. In 1983 it founded Ibexpress, a “port-to-port” cargo
business. In 1985 it set up the catering company Iber-Swiss together with Gate Gourmet. In 1987 it
started up the Amadeus reservations consortia jointly with Lufthansa, SAS and Air France, that in a
short period of time became one of the main reservations systems in the world. Later it entered the
tourism sector with the world tourism operators Mundicolor and Club del Tiempo Libre.
Furthermore, it increased its presence in cargo freight with the companies Cargo Express and
Cargo Sur for the transport of large goods on long-haul. Strong competition from the charter
companies on tourist routes brought about its entry into that business with the company Viva Air,
having Lufthansa as a partner.
26
Las alas de España”, Javier Vidal Olivares, 2008, Ed. Publicaciones de la Universitat de Valencia.
27
“El ave deja en tierra al avión”, Expansión, 16/2/2009.
28
The losses occurred in 1975-1986.
29
“Las alas de España”, Javier Vidal Olivares,2008, ed. PUV, p.144.
30
Iberia obtained profits in the 1980s, in 1986,1988 and in 1989.
31
“Criterios políticos, antes que económicos han forzado a Iberia a comprar el Airbus”, [Political rather than economic
criteria forced Iberia to buy the Airbus] El País, Madrid 1/07/1978.
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At the beginning of the 1990s, with the aim of preparing for the deregulation of the airline sector in
the European Union, Iberia‟s expansion was oriented towards the Latin American market. It
acquired part of Aerolíneas Argentinas, the Venezuelan airline Viasa, and 35% of the Chilean
Ladeco (Líneas Aéreas del Cobre). The objective was to increase the size of Iberia in order to be
ready for possible mergers between the European flag carriers, but the result of these operations
was a failure.
In 1992 Iberia lost the monopoly of the domestic market due to the liberalisation of the sector. The
entry of new airlines such as Spanair and Air Europa gradually eroded Iberia‟s share in the
domestic market.
The accumulated losses led Iberia to a situation of technical bankruptcy in 1994. The INI assumed
the chairmanship of Iberia and set a plan in motion to reduce losses. In addition, it needed the
approval of the European Community authorities for an increase in capital from the Spanish
Government of 600 million Euros. The emergency plan consisted of making disinvestments and by
reducing salaries and staff. Following intensive negotiations, in November 1994 all the unions,
except the pilots, accepted an 8% reduction of their salaries. Iberia management initiated an
employment regulation procedure to reduce the pilots group, in the light of which the SEPLA union
called a strike. One day before it began, the management and SEPLA signed an agreement to
reduce the salaries by 8.5% (a plan that they called “key 104”) in exchange for rest days, phased
32
terminations and company shares . These negotiations marked the start of a transformation stage
in which Iberia had to change its strategy and establish a new business culture.
To adapt to the new scenario that would come with the full liberalisation of the airline market in
1997, Iberia managers designed a strategic plan called the “Plan for adaptation to the new
competitive environment 94-96”, the objectives of which were to reduce costs and carry out a
financial clean-up.
THE XABIER DE IRALA PHASE, 1996-2003
In 1996 the new Partido Popular Government established the privatisation of Iberia as one of its
objectives and entrusted the task to Xabier de Irala. He was an industrial engineer with extensive
33 34
international experience in multinational companies such as General Electric and ABB but no
experience in the airline sector. Irala placed one sole condition on accepting the job: he would not
consent to any political interference.
In July 1996, Irala assumed the chairmanship of the company and appointed Ángel Mullor, who he
had worked with during his time at ABB, as the new General Manager. Mullor had wide experience
35
in union negotiations having taken part in the restructuring of the Spanish iron and steel industry .
This manager stayed with Iberia for ten years, first as the General Manager (1996-2001) and then
as the Chief Executive (2001-2006).
From the time he took over its management, Xabier de Irala was sure that he had to use the same
criteria as for a private company and that his role in the company was “to satisfy the customer and
36
the shareholder” . Some years later he described his first steps in the following terms:
“I had a completely false image of a public company. I found some technicians and professional
people in Iberia who were much better trained and competent than in the average private
companies in the industry. In the end you realise that the problem Iberia had in 1996 was not a
technical one. There was sufficient know-how and competent people to resolve it. It was about a
32
Las alas de España, Javier Vidal Olivares, 2008 ed. PUV.
33
He was Vice Chairman and member of the Management Committee of General Electric in France. During his career he
also worked in GE subsidiaries in Spain, Portugal and the United Kingdom
34
He was Vice Chairman of ABB in Spain and subsequently in 1991, Chief Executive of this company.
35
“El piloto de la privatización de Iberia”, El Mundo, 18/4/2006.
36
“Un gestor con muchas horas de vuelo”, Carlos Humanes y Rafael Alba, Bolsa de Madrid, Agosto-Septiembre 2002.
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problem of changing the rules. What it was about was that previously in the airline sector planes
37
flew and now passengers have to be carried .”
In the same year as he started there, Iberia returned to a profit situation that it had not enjoyed
since 1989. The good results from the “Competitive Adaptation Plan”, the fresh capital authorised
by the European Union and the incorporation of new Airbus aircraft for long haul routes facilitated
the new Chairman‟s start.
Irala managed the company with a firm hand, reinforcing Iberia‟s strong points, such as the Latin
American routes, eliminating losses through the suspension of routes (e.g. Tokyo), shutting down
partner companies (e.g. Viasa, integration of Aviaco) and the withdrawal or transfer to Air Nostrum
of very short or low density domestic routes.
Irala drove two strategic plans forward to ensure the profitability of the company, guarantee access
to capital markets and improve its attraction for potential investors (Exhibit 4). The first of them, the
“Master Plan 1997-1999” set objectives for the reduction of costs and an increase in productivity,
obtaining far higher results than those envisaged. The second, the “Master Plan 1999-2002”,
proposed creating value through three objectives: profitable growth, increased productivity and
development of alliances. These objectives were also met. In 2001 Iberia was listed on the Stock
Exchange and in 2002 obtained the second best results in its history in spite of the difficult crisis
the industry was going through following the 2001 terrorist attacks. Iberia‟s strength was proven in
that it was the only European network airline, together with Air France, that obtained positive
results that fateful year.
In June 2003 Irala left the chairmanship. During his term of office, Iberia had experienced some of
the greatest changes in the whole of its history: it had become a private company that was quoted
on IBEX 35, it was one of the most profitable network airlines in its sector and it had achieved world
renown as a member of Oneworld alliance. In his farewell message, Irala is quoted as saying
“these have been the most intense seven years of my life and my one regret is not to have done
38
things more quickly .”
THE TRANSFORMATION PROCESS
During the Xabier Irala phase major changes were undertaken at Iberia with the objective of
adapting to the new environment of stiffer competition:
NETWORK MANAGEMENT
One of the principal changes undertaken by the new management team was the restructuring of
39
the network. Enrique Donaire, subsequently general manager of the airlines business unit stated :
“previously there was no clear strategic orientation. We were operating in all markets: we were the
leaders in the domestic market, Spain-Europe and Spain-Latin America, but we did not manage to
be profitable. The company was inefficient because it was serving routes with a public service
40
focus ”.
Iberia‟s business encompassed three large markets: domestic, Spain-Europe and Europe-Latin
America (Exhibit 5). The priority objective of the new management team was to consolidate the
leadership position in the traffic between Europe and Latin America, routes that were considered
vital for Iberia‟s future.
37
“Un gestor con muchas horas de vuelo”, Carlos Humanes y Rafael Alba, Bolsa de Madrid, Agosto-Septiembre 2002.
38
Expansión, 13/6/2003.
39
Enrique Donaire was appointed general manager of Iberia LAE in 2001; he had previously held the position of
Commercial Director of the Iberia Group.
40
Enrique Donaire, Director General Iberia LAE; interview with the case author, Madrid, 25 March 2009.
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In order to achieve this objective, the redesign of the Madrid hub began in 1997. Madrid airport was
number 5 in Europe by volume of passengers after those of London, Frankfurt, Paris and
41
Amsterdam . The entry into service of the new runway at Madrid-Barajas airport in 1999
represented an opportunity for Madrid to become the port of entry from Latin America in Europe. In
this respect, José Bolorinos, Director of Strategy for Iberia, said: “it was necessary to take a risk
and invest in a project that would bear fruit in the long term and that, if it turned out badly, could
42
interfere with the objective of privatisation .”
The management team then set out to increase direct flights to the capitals of South America,
increase the frequency and connections, and to revamp business class. Thanks to these measures
Iberia‟s market share on the Europe-Latin America routes increased (Exhibit 6).
Iberia was clearly the market leader in the domestic market with a share of 54.1%. During this
phase it undertook a reorganisation of domestic routes, since some were clearly inefficient. Many
routes had been conceived as a public service, operating with large aircraft and high frequency,
such as for example the routes between the islands (Balearics and the Canaries). Iberia lost money
on these routes as it did not have suitable cost conditions to operate them (Exhibit 7).
Nevertheless, it could not close them easily: social and institutional pressure could have been very
strong. In order to stop operating these routes it signed a franchise agreement with Air Nostrum in
1999, by which Air Nostrum flights were then operated by Iberia and it formed part of its network.
This airline followed a regional business model with salary conditions and resources more
appropriate to being profitable on short routes. This agreement was favourable for both companies:
Air Nostrum achieved a high volume and improved its profitability (e.g. in a few years it went from 6
to 60 aircraft), whilst Iberia managed to get rid of unprofitable routes without creating any social
unease.
Due to the fact that the Spanish domestic market had been one of the first European markets to be
liberalised and therefore with new competitors coming in, it was noted for stiff competition on the
main routes and very low prices compared with the rest of European countries. The priority
objective for the domestic market was to improve the yield (revenue per passenger and kilometre).
In order to achieve it, they pushed ahead with a selective increase in frequencies, increased
aircraft capacity and reinforced the network with the Air Nostrum regional flights. The agreement
with this regional airline enabled the Madrid and Barcelona hubs to be fed and increased domestic
market share.
Finally, in the Spain-Europe market, Iberia held a market share of 10.1%. These routes were of
strategic importance for Iberia because they contributed to feeding the traffic to Latin America.
Thus, more than 60% of long-haul passengers came from connections with other flights, mainly
43
from Europe . However, these routes were the ones most under threat from the low-cost carriers.
For this reason, the principle objective was to increase frequencies and direct flights instead of
opening up new routes.
FLEET PLANNING
In 1995 Iberia had an elderly fleet with ten different aircraft models. This fleet diversity was a
source of inefficiency for two reasons. In the first place, it complicated maintenance tasks and the
achievement of economies of scale in this activity, due to the need for a greater variety of spare
parts and qualified mechanics for each of the models. In the second place, flight programming was
made more complex and reduced company productivity given that the pilots could only fly one
particular model. For these reasons, the management team designed a renewal programme with
two objectives: homogenisation and flexibility.
41
“World Air Transport Statistics”, IATA; 2005.
42
José Bolorinos, Director of Strategy of Iberia, interview with the case author, 22 July 2008.
43
Enrique Donaire, Director General Iberia LAE; interview with the case author, Madrid, 25 March 2009.
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The very ambitious fleet homogenisation plan carried out by Iberia began in 1998 with a budget of
€3,500 million. The objective was to save operating costs by homogenising the majority of the fleet
in the various Airbus families. In this way, they were saving on fuel, maintenance and spare parts,
reducing training costs for pilots and auxiliary staff, and they could interchange the crew between
fleets, thereby increasing productivity. The crews could either fly on a long-haul A340-300 or A340-
600 and on short and medium-haul on the A319-A320-A321. Exhibit 8 shows the tendency towards
concentration on the Airbus A320 for short-haul and the A340 for long-haul.
In order to achieve the objective of being more flexible, they started to acquire the new aircraft
through operational leasing, that would enable acquisition between 5 and 10 years, with the option
to return them beyond the term. Furthermore, they introduced the „wet lease‟ method, by which
they rented both the aircraft and the crew. This method brought greater flexibility and enabled 5%
of the pilots to be outsourced. Thanks to the „wet lease‟ method, Iberia was able to adjust its
capacity following the 9/11 terrorist attacks, cancelling contracts for ten aircraft that were operating
under this scheme.
The use of various forms of fleet leasing distinguished Iberia from other major companies that
mainly resorted to the purchase of aircraft. Iberia assumed higher leasing costs but lower financing
costs compared with its competitors. This policy penalised Iberia‟s operating results as it included
the leasing costs in its calculations, but not the financial costs, and therefore it used the EBITDAR
(earnings before interest, taxes, depreciation, amortisation and rentals) in order to compare
44
profitability between airlines .
One of the factors that had an influence on the tardiness of the fleet transformation was the
existence of very rigid collective bargaining agreements. For example, the pilots agreement was
very strict and established that only those pilots who flew the previous model could obtain a licence
for a new aircraft model. This meant that every time new aircraft models were incorporated, the
company had to send the pilots from the lower scale on training course for 4-6 months and,
furthermore, a similar number of pilots for each model in the existing fleet so as to be able to cover
the positions left vacant in each of the lower scales. This immobilisation of pilots reduced the
productivity index during the first years of Irala‟s management.
REVENUE MANAGEMENT
The Iberia Revenue Management system had to meet the new challenge of consolidating Madrid
as the Latin America port of entry to Europe. This meant that the important thing was the
optimisation of the total income that a passenger contributed to the network and not so much the
income attributed to a specific flight. At the same time, the low-cost carriers were introducing far
simpler and transparent price-fixing systems than those that had been the norm in the traditional
companies. They did not have the complexity of optimising network income and in addition, the
expansion of the internet made direct access to end customers easier on a scale that had not been
seen before. This environment produced enormous pressure on Iberia‟s revenue management
system that had to incorporate very speedily new technology and processes.
SALES AND DISTRIBUTION
Like the other major companies, Iberia had traditionally relied on the distribution of its prices and
tickets through the channel formed by GDS and travel agencies. This policy meant transferring up
to €5 to the GDS (Global Distribution System) as a booking fee, plus 6.5% commission to travel
45
agencies .
44
Elena Baíllo, Director of Iberia Investor Relations, interview with the case author, Madrid, 30 January 2009.
45
José Bolorinos, Director of Strategy for Iberia, interview with the case author, Madrid, 10 November 2008.
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In order to reduce costs, Iberia adopted a policy of progressive reduction of commission to the
46
agencies, with the end objective of reducing the commission down to 1% in 2005 . This policy of
reduction of commission was also spreading to other European countries. At the same time it
promoted sales over the web at „Iberia.com‟, launched in 1996, and directly processed 16% of the
47
company sales . Through these actions it achieved a hefty reduction in commercial costs that
went from 15% to 10% of the total costs (Exhibit 9).
Furthermore, Iberia redefined customer service by introducing “pay for meals‟ in tourist class on
48
short and medium haul flights. This measure reduced costs by €40 million .
So as to differentiate the product, they opted to improve in-flight service in business class with new
seats, high tech equipment and more space for the passenger. The increase in market share in the
business sector was, from the outset, a priority for the management team and the results obtained
confirmed that they were achieving this objective (Exhibit 10). In addition, its loyalty card, Iberia
Plus, had more than two million members in 2004 who were collecting points that they could later
exchange for flights and other services.
CUSTOMER SERVICE
In the spring of 1999, the redesign of the Iberia hub in Madrid brought about by the opening of the
Barajas airport third runway, caused operations congestion and consequently a drop in the
49
punctuality indexes, which affected Iberia‟s image . Other factors such as pilots‟ strikes and the
lack of air traffic controllers increased the magnitude of the problem. That same year, the costs
arising from compensation to passengers increased significantly, contributing to the deterioration of
50
the results (Exhibit 11). Therefore, the second strategic plan „Master Plan II 2000-2003‟,
established customer service as one of its priority objectives. In 2000 specific programmes were
started to improve customer service, such as the Helpline for all baggage queries and the
Information and Reservations Helpline for Europe that enabled them to homogenise passenger
51
customer service . It also started up the „Strategic Plan for Training 2000-2002‟ to train employees
and improve both image and customer service.
Iberia signed the “Voluntary Commitment to the Customer” in 2001, together with the main
European airlines. This was a code of conduct that would establish the levels of service that they
52
undertook to offer to the customer before, during and after their trip . It also started up an
ambitious project for customer relations management (CRM). This management model embraced
all the processes of company activity in which the customer intervened and it was presented as a
long term project.
With a view to the future, it was considered that the opening of the new terminal T4 in Barajas,
planned for early 2006, would enable customer service to be improved. This new terminal had
been allocated by the Spanish airport management (AENA) to Iberia and to its partners in the
Oneworld alliance.
KEY EVENTS IN THE IRALA PHASE
Irala‟s management was marked by several important events that would determine the subsequent
course of the company: integration with Aviaco, disinvestments in Latin American companies, entry
46
Presentation Investor‟s Day, 27/10/2003, p.41.
47
Presentation Investor‟s Day, 29/10/2004, p. 17.
48
Presentation Investor‟s Day, 29/10/2004.
49
Iberia annual report 1996, p. 73 and 1997, p.67.
50
Iberia annual report, 1999 p. 72.
51
Iberia annual report, 2000.
52
Iberia annual report, 2001.
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into the Oneworld alliance in 1999, the privatisation of the company in June 2001 and the
management of the pilots strike that same year.
IBERIA-AVIACO INTEGRATION
Aviaco airlines was integrated into Iberia‟s structure in 1998. Aviaco was the only public airline
owned by Iberia and SEPI (Sociedad Estatal de Participaciones Industriales/ State Company of
Industrial Participations) that operated charter flights and scheduled domestic flights, directly
competing on other routes with Iberia. The purchase of its stake from SEPI enabled Iberia to use its
resources more efficiently and to increase productivity due to the elimination of low-occupation
flights and the repositioning of these flights on routes based in Madrid.
FOREIGN DISINVESTMENT
At the end of the 1980s the management of the INI convinced Iberia‟s management that the
acquisition of shares in the capital of airlines in Chile, Venezuela and Argentina was a good
53
opportunity . This strategy was advocated mainly for three reasons. Firstly, the liberalisation of the
European market forced Iberia to improve its competitive position. Secondly, the privatisation of the
public sector in Latin America meant there was an opportunity to gain presence in the region.
Finally at the end of the 80s, Iberia was in a better economic position that would enable it to commit
to investments abroad.
In 1990 Iberia acquired a stake in Aerolíneas Argentinas; in 1991 it acquired 35% of Ladeco
(Líneas Aéreas del Cobre, S.A., one of the two airlines that operated in Chile); and that same year
it bought 45% of Viasa, the flag carrier of Venezuela. In the case of Aerolíneas Argentinas its
integration into the group was attempted, but the internal problems of the Argentine airline and
management difficulties led to a situation of constant losses. The losses were also constant in the
other two companies due, amongst other things, to the hostility of the government partners,
pressure from the labour force and the poor conditions of the world environment following the Gulf
War at the end of 1991. In 1994 this strategy had proved a failure by taking Iberia to a situation
bordering on bankruptcy. The fact that Iberia was a public company had conditioned the action of
the Iberia managers.
The viability plan that started with the arrival of Irala in 1996 included selling off the Latin American
companies in which it held a stake. Irala had learned from his time at General Electric and from its
general manager, Jack Welch, that when a business does not work it had to be fixed, closed or
sold. After many difficulties, the stake in Ladeco was sold and it exited from Aerolíneas Argentinas
in an orderly fashion. An attempt was made to implement a strategic plan at Viasa, but in the light
of rejection by the unions, the company closed. In this respect, Enrique Donaire said: “It was a very
complicated time. One of the greatest supports at that time was that the Spanish Government
maintained a position of a private shareholder and did not interfere in the management, allowing us
54
to take decisions that at any other time would have been unthinkable .”
IBERIA’S ENTRY INTO THE ONEWORLD ALLIANCE
In 1999 Irala‟s team managed to get Iberia into the Oneworld alliance, founded one year
beforehand by American Airlines, British Airways, Cathay, Canadian Airlines and Quantas. One of
the main advantages of this alliance was the policy of „code share‟ between the member
companies. Iberia contributed connections between Europe and Latin America, whilst Cathay,
Quantas and British Airways kept the connections with Asia. Iberia had very close relations with
American Airlines and British Airways within this alliance. Starting in 1999, these companies
53
“Las Alas de España” Javier Vidal Olivares.
54
Enrique Donaire, Director General Iberia LAE; interview with the case author, Madrid, 25 March 2009.
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coordinated their international advertising campaigns. The three had complementary markets that
enabled Iberia to protect its Latin American market.
With its entry into Oneworld, Iberia shot up in terms of quality by increasing the number of
destinations and frequencies, whilst it also extended the frequent flyer programme to all members
of the alliance; it improved its in-flight service and gained access to 260 VIP lounges around the
world, as opposed to the 68 available up until then. In addition, the alliance offered it the possibility
to reduce costs through joint purchases, harmonisation of systems and procedures and the
55
provision of unified services at airports .
PRIVATISATION OF IBERIA
The first phase of privatisation began in 1999 when two industry partners, American Airlines and
British Airways, acquired 10% of the capital. One year later, in 2000, several institutional partners -
Caja Madrid, BBVA, Logista, El Corte Inglés and Ahorro Corporación – bought 30%. These
investors undertook to retain the capital for between three and six years, and that brought stability
to the company. Before being listed on the Stock Exchange, employees held 6.1% of the capital.
56
On 3 April 2001 Iberia floated the remaining 53.9% of its shares on the Stock Exchange , thereby
completing the second phase of privatisation.
The months following privatisation were marked by union negotiation, the weakening of the world
economy and the 11 September attacks, and Iberia‟s share price hardly moved. The industry‟s
reaction to the terrorist attacks of 9/11 was different from what had happened on other occasions.
Traditionally, at times of crisis, companies kept up their operations, however, following 9/11,
airlines cut back on their activity. For example, Lufthansa stopped 70 aircraft. At Iberia, this event
meant that the “Master Plan II” was dropped and a contingency plan was prepared quickly (Exhibit
4). The objective of this plan was to cut back on capacity and to delay the growth of the European
network. Iberia cancelled its „wet lease‟ contracts and applied all possible flexibility so as to reduce
costs.
“The adjustments made showed Iberia had behaved correctly by managing to be one of the few
airlines to present positive results that year.“ It was at this time when the market recognised Iberia‟s
potential and it began its take off on the Stock Exchange,” said Elena Baíllo, Director for Investor
Relations. Thus, between April 2001 and October 2002, Iberia stock gained 43% compared with
57
the general fall of the other European and American airlines .
PILOTS’ STRIKE 2001
Irala‟s chairmanship, the same as those of his predecessors, was marked by serious union
conflicts, especially with the Pilots union SEPLA. Up until the time of privatisation, the unions had
had a strong presence in the management of the company, so that of the twelve members on the
Board of Directors, four of them came from the main unions: SEPLA, CCOO, UGT and SICTPLA.
The more than twenty strikes recorded up to 2001 were a good indicator of the level of labour
58
tension . Irala had to confront five of them, although that called in June 2001 was one of the most
difficult.
The trigger for this strike was the “key 104”; a reduction of salaries that had been agreed in 1994
when the company was on the verge of bankruptcy. The pilots hoped to recoup these cuts when
55
“Ventajas estratégicas de OneWorld”, presentation to analysts 16/2/2001, p.82.
56
The public company SEPI (Sociedad Estatal de Participaciones Industriales) held 5,4% of the capital as a non-strategic
financial investment.
57
Market Capitalization Air Transport Sector: 3/4/2001 versus 28/10/2002. Presentation by Xabier de Irala in Investor‟s
Day, 28/10/2002.
58
Iberia-Sepla, otro capítulo de una relación de 30 años marcada por los conflictos, [another chapter in a 30 year
relationship marked by disputes] 11/1/2009 Gaceta de los Negocios.
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the company went into profit. In June 2001, following privatisation of the company, they began
negotiation with a demand for a 12% salary increase, that meant a cost of €28.8 million for Iberia.
These negotiations failed because management considered the salary cost could not be
assimilated. Angel Mullor said at that time: “Iberia would be bankrupt within four years if the pilots‟
demands were accepted. Iberia could commit to these demands now, but we would be mortgaging
its future”.
This demand from the pilots seemed to be in step with a more extensive strategy that had been
started in the USA, with significant increases in salaries at American Airlines, United and Delta, and
that had continued in Europe with tough negotiations between the pilots group and Lufthansa. In
the latter case, Lufthansa‟s Chairman, Jürgen Weber, had approved a 30% salary increase, exactly
59
what the pilots were asking, under threat of strike action .
In Iberia‟s case, on 12 July, and following several days of strikes, 90 pilots submitted their
resignations to Operations Management, on which airline safety essentially depended. The next
day, Irala took an unprecedented decision when he totally suspended activity for four hours,
justifying this drastic measure on the fact that the company could not guarantee the safety of
flights. His decision demonstrated that the airline was not prepared to give in under pressure and
could also stop its activity, something that up until that time only the pilots had done,” said the
60
Director of Strategy for Iberia . This situation caused the Government to intervene and the
authorisation of an enforced arbitration for the resolution of conflicts. In practice, this arbitration
made it difficult to call strikes whilst it was in place.
THE IBERIA GROUP
The restructuring plan started by Irala considered selling off the Latin American airlines in which
Iberia held a stake, and the creation of six profitable business units. The idea was that Iberia be
restructured into several legally separate units with independent management: passengers, cargo,
handling, maintenance and companies in which Iberia held a stake, such as Amadeus and Viva
Tours. Although this could not be fully achieved, a clear course was certainly marked out in the
sense that each business unit had to act according to the resources that were assigned to it.
The passenger carrying business was the main source of income for Iberia, representing 77% of
total sales. The rest of the business units, such as handling, cargo, maintenance and other
services represented a much lower percentage, by contributing 6.2%, 5.6%, 2.4% and 8.6% of the
total sales respectively.
During the last few years the value of Amadeus had increased considerably. In June 2000, Iberia
61
sold 6.7% of the capital for €390 million .
APPOINTMENT OF FERNANDO CONTE AS THE NEW CHAIRMAN IN 2003
In 2003 Fernando Conte took up the Chairmanship of Iberia, replacing Xabier de Irala. The new
Chairman, an Industrial Engineer and MBA from IE Business School, also came from ABB where
he had held the position of Chief Executive. However, unlike Irala, he knew the company well
having been a member of the Iberia Board for the last two years.
Conte found himself with a company that had had seven straight years of profits and that
nevertheless operated in an unstable environment due to the war in Iraq, the Asian flu crisis and
62
the increase in the price of crude oil .
59
“Lufthansa ganará hasta un 30% menos por el nuevo acuerdo salarial”, [Lufthansa will earn 30% less due to the new
salary agreement] Expansión, 14 June 2001.
60
José Bolorinos, Director of Strategy for Iberia, interview with the case author, Madrid, 22 July 2001.
61
Presentación a analistas 2000, p. 61.
62
Iberia Management Report, 2003.
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