Dealing with low-cost competition in the airline industry (B):

The foundation of Germanwings

Urs Muller

Francis Bidault

Introduction

Three years later, it seemed that Lufthansa’s decision to create a low-cost subsidiary called “Germanwings” was a success. The Lufthansa’s board of management had considered various options to confront the disruptive business model of Ryanair, easyJet, and others. After looking carefully at the key building blocks of this model, they decided that Lufthansa could certainly apply the model to a largely independent low-cost subsidiary and thus tame the pressure of these voracious competitors.

The decision

A decision was made in the summer of 2002 to convert an indirect subsidiary of Lufhansa, “Eurowings Flug GmbH,” into a low-cost airline under the brand name of Germanwings. That brand name used to

This case study was prepared by Urs Mu?ller and Francis Bidault of ESMT European School of Management and Technology. Sole responsibility for the content rests with the author(s). It is intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation.

Copyright 2015 by ESMT European School of Management and Technology, Berlin, Germany, www.esmt.org.

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This document is authorized for use only in Dr. Greg DeYong's BA 598 - Business Policies - 03232018 course at Southern Illinois University - Carbondale, from March 2018 to September 2018.

ESMT–315–0166–1 Dealing with low-cost competition in the airline Industry (B): The foundation of Germanwings belong to a German high-quality airline that went bankrupt in the 1980s. Lufthansa acquired the right to use the brand name as part of the liquidation of the company. The positioning of the new company was to be “low cost” but “few frills” (as opposed to the “no-frills” concept of classic low-cost carriers) to match Germanwings’ reputation of quality.

Eurowings Flug GmbH was formerly a charter airline – but demand for charter airlines was struggling after 9/11 and the burst of the Internet bubble. Eurowings Flug GmbH was a 100 percent subsidiary of the regional carrier “Eurowings Luftverkehrs AG” that was in turn a 24.9 percent subsidiary of Lufthansa (which it had acquired in 2001). Lufthansa thus only indirectly controlled a minority of the shares, but had an option to gain more control over Eurowings in the future. Plus Lufthansa wanted Germanwings to develop independently, as a new venture with a culture compatible with its low-cost competitors – as opposed to setting up just another subsidiary under full control. As an expression of Germanwings’ independence and operations focus, the decision was taken to set up the company next to the airport in Cologne (see Exhibit 1), for instance, intentionally not close to Lufthansa’s main location Frankfurt. The new Germanwings was a very small company in terms of human resources and assets. So the launch of its new business (scheduled “low-cost” flights) was akin to a “green-field” investment rather than the radical conversion of an existing business.

A major decision was to entrust the launch to managers from outside of Lufthansa. From the start until 2005 Dr. Joachim Klein served as the first general manager after having worked for Rhenus and Schenker in the logistics industry before joining Eurowings in 2000. And the founding deputy general manager, Dr. Andreas Bierwirth, who took this job at the age of only 31, was a trained professional pilot but had only limited airline experience after having served as the managing director for Westair GmbH (an airline with small aircrafts) for about one year. The management team applied an unconventional human resources policy: Most of the new employees had never served in a full-service airline and many were even recruited directly from colleges and high schools.

The business model of Germanwings

The new airline applied many of the business concepts that were invented by the American founders of the low-cost airline business model, Southwest and People Express.

Germanwings’ aircraft fleet minimized variety: Initially it exclusively flew Boeing 737s which were later replaced by the workhorse Airbus 320s with a view to facilitate the maintenance and allocation of machines between the different routes. Germanwings served selected cities in a point-to-point mode back and forth (the so-called ping-pong model). When possible, it chose inexpensive airports (see Exhibit 2) like Schoenefeld (SXF) in Berlin rather than Tegel (TXL) which Lufthansa used. Boarding operations were handled so as to minimize expenses with rugged waiting rooms with no freebees (see Exhibit 3) and passengers walking on the tarmac to reach the aircraft. Flight tickets

This document is authorized for use only in Dr. Greg DeYong's BA 598 - Business Policies - 03232018 course at Southern Illinois University - Carbondale, from March 2018 to September 2018.

Dealing with low-cost competition in the airline Industry (B): ESMT–315–0166–1 The foundation of Germanwings could only be purchased directly from the airline via Internet, bypassing travel agencies. There was no business class and no loyalty program for frequent flyers. Seats were not assigned and boarding was sequential, with a ranking order according to the sequence of boarding – thus minimizing late passengers and speeding up the on-boarding of the aircraft (see Exhibit 4).

Lufthansa’s support to Germanwings

Although Lufthansa had decided to give its subsidiary much autonomy, it provided many of the numerous services that any airline needs.

Lufthansa, like most flag-carriers, was a fully integrated operator with its own maintenance services (Lufthansa Technik), its own IT infrastructure (Lufthansa Systems), its own ground services (GlobeGround of which it owned 51%), its own catering (SkyChefs), etc. (see Exhibits 5 and 6). So as to ease the launch of Germanwings, the decision was made to let the new airline be supported by this set of services.

Germanwings’ take-off

Germanwings started operations with eight Boeing 737s based in Cologne. At the end of 2002 it made 28 daily flights to 19 destinations and employed 180 persons. Only one year later, it had passed the mark of one million passengers flown and had reached 291 employees.

In 2004 Germanwings already offered flights to 45 destinations in 20 countries. Its staff had grown to 419 employees. It was then elected the “best low-cost carrier” by the German business magazine Capital. That same year, Lufthansa increased to 49 percent its shareholding of Eurowings, the company that operated the Germanwings brand.

In 2005 Germanwings continued to experience strong growth with revenues of €400 million. By then it had 681 employees and 22 aircrafts with 144 seats each. It was the market leader in Cologne, its home base, with 35 percent and took the decision to establish a new base in Hamburg. It transported one million passengers in that year. Lufthansa did not report separate financial results for its Germanwings subsidiary.

What’s next?

It seemed that Lufthansa’s bet to create a low-cost airline subsidiary had succeeded. The future looked promising and it was time to consider what Germanwings’ strategy should be for the next five years and whether it should be more integrated with its mother company or be allowed to further cannibalize its parent company’s core business in Germany.

Was Lufthansa’s decision to launch Germanwings the best choice? What other options were available and how would you evaluate the feasibility of these alternatives relative to the Germanwings launch?

1. What was Lufthansa’s goal in launching Germanwings?

2. Lufthansa chose to spin-off a close competitor with considerable autonomy – was this strategy appropriate?

3. What risks does Lufthansa now face (in 2005) with this dual strategy of a full-service and low-cost business model?

4. What risks does Lufthansa now face (in 2005) with this dual strategy of a full-service and low-cost business model?