British Airways Continues to Dominate its Competitors

June 11, 2008— -- HOUSTON — British Airways officials shamelessly promoted their carrier as "The World's Favourite Airline" until 2001, when it stopped being even Europe's biggest, arguing that even if U.S. carriers were bigger, theirs was better by every measure of quality, and much preferred by travelers who had an option.

These days, CEO Willie Walsh might be tempted to bring that slogan back.

It is still just Europe's third-largest carrier, behind both Air France-KLM Group and Lufthansa, which also owns Swiss International Air Lines. But after a six-year makeover that has sharpened its focus on serving high-fare-paying first- and business-class international fliers, Walsh can make a good argument that BA has become the world's most successful international carrier. Its profit margins are bigger than either of its principal European rivals'. And BA continues to dominate the market at London Heathrow, Europe's biggest and most lucrative airport, despite a calamitous opening of its much-hyped Terminal 5 in spring.

Preserving — maybe extending — those advantages brought Walsh to Houston last month and could set up BA as an influential player in the rescue of the financially battered U.S. airline industry.

Ostensibly, he was in town to celebrate the transfer of BA's Houston-London service from Gatwick Airport to Heathrow, a move made possible in spring by the new "open skies" air services agreement between the United States and the European Union. But Walsh also met privately with Larry Kellner, CEO of Houston-based Continental, and several of his top lieutenants.

Continental has become the target of a quietly intense bidding contest after rejecting a merger offer from United. BA and its key partner, American Airlines, want Continental to join their Oneworld global alliance. Similarly, United and its strategic partner, Germany's Lufthansa, are courting Continental as a potential member of their Star global alliance.

Whichever team Continental joins would get a big boost not only from Continental's dominant position here in the booming capital of the oil industry, but also from its strong hub at Newark Liberty International Airport, where it has become the market leader in the hugely important metropolitan New York market.

"The possibility of bringing Continental into Oneworld is one that we found to be very interesting," Walsh said. "We've tended to take the view within Oneworld that quality is more important than quantity. It's a smaller alliance in terms of the number of airlines in it. But if you look at the quality of those airlines, they're all good-quality airlines. And we think Continental would fit in well with our members, because it is a very good-quality carrier, too."

Should U.S. law change and Continental — or American — need fresh capital to survive the industry's current financial nightmare, Walsh and his colleagues at BA admit that they would be very interested in owning a controlling stake in one or more U.S. carriers.

For years, French and German airline executives, and government leaders from those two nations, led in calling for the U.S. to let foreigners own more than a 25% voting stake and more than 49% of the total equity of a U.S. airline.

But there's no mistaking that the loudest voices these days behind the European Union's insistence on changes in that U.S. law all have a British — or in Walsh's case, an Irish — accent.

The first stage of the USA-EU Open Skies agreement is a "step in the right direction," Walsh says. "But it's a small step. I was disappointed we didn't make further progress, but I'm optimistic for the second-stage negotiations" underway.

Industry consultant Hubert Horan, a former executive at U.S. and European airlines, says it's understandable why BA, which had shown little interest in owning a U.S. carrier, now wants to strengthen its long-standing ties to American, and to establish ties to Continental.

A stronger link to American, perhaps sealed with a major equity investment, "would create a situation where they would own the entire U.S.-U.K./Ireland travel market, one of the biggest and very best international travel markets in the world. They could raise fares with impunity for at least 20 years," says Horan, an opponent of what he calls "megaconsolidation" among U.S. carriers and between U.S. and European airlines.

Rebuilding an airline

BA has come a long way since the late 1990s, when it seemed to lose its edge as it struggled with increased global competition, high costs and disenchanted workers.

In 2000, Rod Eddington, an Australian who had run high-class Cathay Pacific as well as Australia's Ansett airline, was brought in to fix things.

With a keen eye for reducing costs and matching capacity to market demand, he and his team resized and reshaped BA. They replaced giant Boeing 747s on some routes with smaller 777s or even 767s, making the carrier a little smaller in terms of seating capacity without abandoning any important international markets.

At the same time, they increased the number of "First" and "Club World" (business) class seats while reducing the number of available economy-class seats that typically were sold at steeply discounted prices.

In effect, Eddington began forcing travelers interested mostly in low fares to use mostly discount airlines or BA's more traditional rivals that continued to offer lots of low-priced seats in their large economy-class cabins.

That earned BA lots of public criticism. But it also won BA the undying loyalty of many high-end fliers.

"They have a product that's well appreciated in the market, not the least by people from your side of the Atlantic," says London-based aviation consultant John Strickland. Many American business travelers deserted their preferred U.S. airlines across the Atlantic because BA is "seen as having very high-quality service, especially in First and Club World," Strickland says.

In 2005, with BA's financial condition improving rapidly, the retiring Eddington recruited Walsh, another non-Briton, as his replacement.

Walsh had begun his airline career at age 17 as a cadet pilot for his native Ireland's flag carrier, Aer Lingus. Over the next 20 years, he worked his way up to captain, earned a master's degree in business and served as chief contract negotiator for the Irish Air Line Pilots Association before moving into operations management in 1989.

In 1999, the rising management star was put in charge of Futura, Aer Lingus' Spanish charter airline subsidiary. In 2000, he returned to Aer Lingus as chief of operations, before being named chief executive in October 2001.

Aer Lingus was staggering toward almost certain bankruptcy. Walsh is credited with saving it by selling off assets (including the company headquarters' art collection) and turning it into a low-cost/low-fare carrier. Walsh's changes elicited opposition from his former labor colleagues. Their objections to his plan to privatize the state-owned Aer Lingus led the government to scrap that plan at the last minute — and to Walsh's resignation.

Buying new jets

Since taking over at BA, Walsh has increased BA's investment in newer and better First and Club World cabins and beefed up the carrier's already substantial in-flight services. Last year, he committed BA to buying both the Boeing 787 Dreamliner and Airbus' giant A380.

Walsh has also been even tougher about controlling costs than was Eddington. Deep staff cuts since 2001 made the already unpleasant passage through delay-prone Heathrow a sometimes hellish experience. A group called the Airport Transport Users Council rated BA as the worst European carrier for baggage handling last year.

In late March, when the opening of BA's massive $8.6 billion Terminal 5 at Heathrow turned into a brand-damaging nightmare, Walsh's aggressive cost-cutting was singled out as a major factor. T5's new automated baggage system had not been thoroughly tested before the opening and wound up losing about 3,000 bags in each of its first few days in operation. Employees had had little spare time for training in the new facility, so on opening day, hundreds couldn't find parking spaces and failed to report to work on time. That left thousands of delayed, angry passengers roaming the huge facility looking for their bags and no staff to help.

The British media called for Walsh's head. He admitted that the T5 opening "was not our finest hour" and delayed the final shift of all BA international flights to T5 until fall. He also sacked two top BA executives in charge of planning T5's opening and paid his own penance by refusing a $1.5 million bonus.

Still, Walsh's short term at the helm thus far has produced more positives than negatives. BA has turned in two strong annual profits and achieved one of its most-longed-for and elusive goals: a 10% operating profit margin in the fourth quarter ended March 31. Its $1.7 billion profit for the fiscal year ended March 31 triggered employee profit-sharing payments and the company's first shareholder dividend in seven years. The company's balance sheet now has a net debt-to-capital ratio of about 29%, down from more than 58% in March 2003. Its once-troubled pension plan has been made almost whole.

'A strong team'

"BA is a great company with a strong team," Walsh says. "We're doing better because we've taken $4 billion out of our non-fuel-related costs in the past few years and because we've structured our business for the post-9/11 environment," he adds. "We're also doing better because we're seeing the benefits of the enormous investments we've made in making our products, particularly the premium products we have, better than what the competition offers."

He is not, however, satisfied.

Record high oil prices are a big concern, though his outlook is somewhat buoyed by BA's fuel hedges, the best in Europe.

Rather than lop off flying to save costs, as many U.S. carriers are doing in the domestic market, Walsh is keeping BA's focus on attracting premium international travelers.

Demand for BA's long-haul premium-class service is so strong that Walsh was willing to take on and defeat BA's powerful pilots union for the right to launch a new all-premium-class sub-brand carrier on routes from the European continent to New York.

Named, tongue-in-cheek, OpenSkies, the new BA subsidiary will fly Boeing 757s fitted with just 82 seats. Though a few economy-class seats will be available, most will be First or Club World seats equipped with all the latest features.

OpenSkies' first flight from Paris to New York arrives June 19. By the end of 2009, BA expects to have six 757s flying under the OpenSkies name to New York from Paris, Brussels, Frankfurt, Amsterdam and Milan. BA officials are trying to keep European rivals from stealing premium-class travelers flying between New York and the continent.

"I'm very comfortable with our ability to compete in what is a very competitive market," Walsh says. BA's premium-service product, he adds, "is significantly, vastly superior to that of any of our competitors."