Business Week International Cover Story
FLYING HIGH AT KLM (int'l. edition)
It was a daring move, executed with marketing panache. Even though the Western powers were recognizing communist China, KLM Royal Dutch Airlines decided in 1983 to become the first European carrier to serve China's archenemy, Taiwan. To launch Amsterdam-Taipei service, the airline flew in 10,000 tulips, which Taiwanese authorities auctioned off for charity. The move paid off: For nine years KLM was the only European carrier to serve Taiwan. It still beats all other European rivals for the island's lucrative traffic--and the Taiwanese still remember those tulips.
Imaginative marketing and risk-taking have worked wonders for KLM. Now, with its Taiwan gamble paying off, the Dutch carrier's risky alliance with Northwest Airlines Inc. is emerging as the first successful model of the strategic tie-ups that every airline covets as the industry struggles to globalize. KLM and Northwest are skirting legal and cultural constraints that have stymied other airborne alliances and are pooling resources in the closest thing to a merger their industry has seen.
Their success is not only churning out profits for both partners at a gloomy moment in airline history but is also proving to be a testimonial for deregulation. KLM and Northwest have been able to meld their operations mainly because of a Dutch-American "open-skies" treaty, which lets airlines of both countries fly freely into each other's markets. Because they won exemption from U.S. antitrust laws, the two carriers can set prices together, market jointly, and may even adopt a single name in a few years. Executives of other allied airlines, such as British Airways PLC and USAir Inc., would set off regulatory alarms if they did such things. "We're the only airlines that are building a tight global alliance," boasts KLM Chairman Pieter Bouw.
Because of Bouw's embrace of open skies--and his own skillful touches in cost-cutting and marketing--KLM has emerged in the big leagues of international aviation. Together, KLM and Northwest are the world's third-largest carrier in revenues, after American and United, a fact that rivals have begun to notice. "They're taking revenues from us," gripes Hans Mirka, vice-president for international services at American Airlines Inc.
Despite such complaints, Washington is convinced more open-skies treaties will ultimately benefit U.S. carriers. So federal regulators plan to use this Dutch-American alliance as a major talking point to pry open other markets. Next month the U.S. will launch negotiations with nine small European countries, from Switzerland to Sweden. Those that buy open skies can also hope for antitrust immunity if they can team up with America's airlines. The U.S. hopes these small carriers will form a flying wedge to crack the protectionist shell of big countries--in Asia and Latin America, and also Europe.
Meanwhile, KLM pursues its winning strategy. For its fiscal third quarter, the Amsterdam-based airline reported, on Feb. 2, a fivefold profit increase, to $49 million. The earnings widely beat out analysts' expectations. Overall earnings for the year could quintuple, and sales are expected to rise 11%, to $5.5 billion. KLM is also enjoying double-digit growth in Asia and Latin America. That lessens its dependence on the brutally competitive North Atlantic routes.
NECESSARY JOLT. At the same time, KLM's global connections are helping it fly rings around its European competitors at home. As Europe's fastest-growing carrier, its market share inside Europe has doubled, to 7%, as it pulls in passengers to connect with North American and Asian flights. Moreover, with $2 billion in its coffers, KLM will be a key player in purchasing controlling stakes--or outright ownership--of other European carriers as deregulation winnows out the losers. Bouw also has big plans to steal market share from Heathrow Airport and channel it to KLM's home base at Schiphol (box, page 38).
KLM's success stands in stark contrast to such rival carriers as Air France, Iberia, Sabena, Alitalia, Olympic, and Aer Lingus, which are kept aloft only by huge state subsidies. They simply have not been able to respond to the pressures of recession, gradual deregulation, and new competition. KLM, though, is close behind British Airways and ahead of a restructuring Lufthansa in such key indicators as revenues per mile and overall efficiency.
Bouw has a bit of advice for his floundering rivals: Accept change as inevitable. Friendly and soft-spoken, Bouw has been preaching that gospel at industry conclaves and leading the fight--so far unsuccessfully--to end subsidies for rivals. Open competition may hurt at first, he admits, but it's a necessary jolt to become efficient. If airlines wait, he warns, "they're going to lose out in the global battle that everyone faces."
Like many of its rivals, the 75-year-old KLM used to be a coddled, government-owned carrier, bred for a colonial empire that's now extinct. The state still owns 38% but keeps its hands off. KLM's transformation is largely the work of Bouw, 54. A 28-year veteran at the carrier, he became its boss in 1991, then cut costs and launched a potent growth strategy. He has added service around Europe and "waves" of connecting flights at Schiphol, in tandem with Northwest, to create a hub with fast, easy connections to the U.S., Asia, and Africa.
LABOR HARMONY. Along the way, Bouw has rolled up his sleeves and done plenty of grunt work himself, even working out the arcana of flight traffic. "This is my hobby," says Bouw--only half-joking--as he bends over a stack of Schiphol flight schedules, searching for more efficient connections. Yet for all his attention to detail, Bouw takes pains to explain his strategy to employees and press them for suggestions on improving performance. "We're more democratic than other European airlines," says Benno Baksteen, head of KLM's pilots' union.
By nurturing a partnership with employees, Bouw was able to effect work-rule changes that have boosted the efficient use of the airline fleet. One example: Pilots agreed to move more easily from one type of plane to another, without demanding the different pay scales for different aircraft in effect at most airlines. Employees also quickly agreed to a two-year halt in pension-fund contributions that has saved KLM $300 million--twice as much as what management had originally requested.
As a result of KLM's reduced expenses and employee flexibility, Bouw has achieved a minor miracle in Europe's airline industry: He has avoided eliminating a single job. Instead, with the same number of employees--about 24,000--he has boosted passenger traffic almost 50% since 1990, thanks in big part to putting more flights through the Schiphol hub. The Dutch carrier's costs are now among the lowest in Europe--and continue to drop.
But Bouw's most important move has been the alliance across the Atlantic. In 1992, three years after buying a 20% stake in Northwest, KLM signed the experimental open skies accord with the U.S. Thus, KLM has the right to fly to any U.S. city it wants to, while U.S. carriers can do the same in the Netherlands. In return for this deal, KLM and Northwest won their unique U.S. dispensation to act as one airline, free of antitrust scrutiny. "We sit down and conspire, we set prices, we share routes--it's wonderful," says Michael E. Levine, executive vice-president for marketing at Northwest.
Other airlines envy KLM's success but still refuse to open their skies themselves. "It's easy for KLM to open its home market--it doesn't have one," snipes an Air France official. For Japan Airlines Co., open skies is a "self-serving American policy," says an official. He thinks the Americans want to grab fast-growing Asian markets yet give up little at home. Foreign carriers can't legally fly inside the U.S.--only to and from it. KLM cleverly skirts that problem by using Northwest as a surrogate.
Bouw cheerfully ignores such grousing. He predicts each partner will realize $150 million a year in extra revenues and savings. Their deal lets them cut costs and jump forbidden borders. Rome, for example, is off-limits to Northwest. So KLM, through its European Union privileges, serves Rome on Northwest's behalf--despite Italian government protests. Because of KLM's route system to the Middle East, Africa, and Southeast Asia, Northwest's Levine is selling tickets from Des Moines to Bahrain, "places that weren't on our route map before."
TERRIBLE TIMING. After focusing at first on their transatlantic connections, KLM and Northwest also want to tighten their cooperation in the Asian market. Northwest is a major presence in North Asia, thanks to its command of a considerable chunk of traffic to Tokyo's Narita Airport. KLM, which first flew to Indonesia 60 years ago, has strong route systems in Southeast Asia. And despite the fact that KLM chose Taiwan over China, it can still generate traffic from Beijing and Shanghai via Northwest.
For that reason, the two carriers have a solid geographic match. "Our partnership with Northwest has definitely helped our business in Asia," says Guy Wittich, KLM regional marketing communications manager in Taipei. The two carriers also share VIP lounges at Asian airports, have technical cooperation for airplane maintenance, and do joint ads. Every month, the partners hold joint marketing meetings in Taipei or Hong Kong.
This worldwide blossoming of the relationship is proving the wisdom of KLM's risky purchase of its first Northwest stake in 1989. It was terrible timing--the U.S. airline market tanked the following year, and Northwest almost went under, thanks to its own overrich leveraged buyout by a team of outside investors. But KLM persevered, although it had to write off its $400 million investment. Northwest's ruthless cost-cutting plus $50 million in extra operating income from the KLM tie-up have put it in the black. On Jan. 19, Northwest reported a towering $296 million profit for 1994--topping American Airlines. Says Paul L. Gretsch, director of international aviation at the U.S. Transportation Dept.: "Without the KLM deal, I'm not sure Northwest would still be around."
BLENDING CULTURES. Ironically, Bouw's success may have paved the way for greater competition directed against his own airline. Like KLM, airlines from other nations could gain unlimited access to the U.S. if they open their home markets to American carriers. Delta Air Lines Inc would likely be a major beneficiary, since it could build a tight alliance with its partners, Swissair, Sabena, and Austrian Airlines. If Britain ever joined the open-skies club, British Airways could also make much more of its USAir alliance. As it is, despite all the headaches, BA expects an extra $100 million in operating profits this fiscal year thanks to the USAir connection.
Thus to Bouw, generating even faster growth from his Northwest partnership is essential, since he sees only seven or eight global airlines operating in 10 years, with just two or three in Europe. "We intend to be one," he says.
So KLM and Northwest need to hustle to make the most of their marriage. "They still don't have much product visibility" as a common entity, says Nick Cunningham, analyst at Barclays de Zoete Wedd Ltd. in London. They also need to standardize service on both carriers, so passengers are willing to fly either interchangeably. As it stands, Northwest's planes are much older than KLM's, and some think its service is poorer.
Their cultures also are still quite different. KLM gives tiny china houses filled with Dutch gin to business-class passengers. Northwest passes out rock-and-roll CDs. Dutch cabin attendants are formal; Northwest's are too "enthusiastic" for European tastes, says a KLM executive. Bouw hopes to train crews together and mix nationalities onboard for a happy medium.
The partners are trying to blur other differences. Last spring, they launched a common business class, with identical seats, food, and service on international flights. Despite the $30 million spent advertising the class, some travel agents in Europe say they're not aware of the joint product. This summer, the carriers may introduce a common economy class internationally. It may have video screens in every seatback, with a choice of movies and games and eventually a newswire. KLM and Northwest would be the first major airlines to offer this perk in economy.
KLM could clearly use the experience it has gained in the Northwest alliance to help it manage a takeover in Europe. A stock sale last spring swelled Bouw's war chest to $2 billion, making it one of the industry's fattest. Why the equity sale? "You want cash when you're at a bargaining table," says Rob J.N. Abrahamsen, a former airline banker who became KLM's chief financial officer a year ago. KLM brass won't say more, but analysts predict a European acquisition in a year or two. Struggling Iberia and Alitalia are possible targets, as is SAS. KLM and SAS were to merge in 1993, with Swissair and Austrian Airlines. But the deal fell apart because Swissair clung to its partnership with Delta, and Bouw stood by Northwest.
While eyeing other deals, Pieter Bouw has boosted KLM's Northwest stake to the 25% legal maximum. He says he would happily buy more if U.S. law should loosen, as some in Washington have proposed. Whether or not that happens, KLM is engaged in the airline industry's first strong effort to prove the merits of global partnering. If the alliance continues to work, it could force the hand ef envious competitors around the world.
AIRLINE ALLIANCES: WHY KLM STANDS OUT
KLM Owns 25% of Northwest Airlines. Best of transatlantic deals, with both carriers profitable and marketing operations tightly meshed.
AIR FRANCE Backed out of talks with Continental, dumped a Czech partner. Loose marketing pact with Air Canada. May be negotiating with American Airlines.
BRITISH AIRWAYS Owns 24.6% of USAir, which is losing millions. Stakes in Australia's Qantas, France's TAT, and Germany's Deutsche BA more promising.
LUFTHANSA Began code-sharing in 1994 with United. Has new venture with Thai Airways International.
SAS Wrote off its Continental Airlines stake but still links some flights. Owns shares in British Midland.
DATA: BUSINESS WEEK, COMPANY REPORTSBy Stewart Toy in Amsterdam, with Susan Chandler in Chicago, Robert Neff in Tokyo, and Margaret Dawson in Taipei