Bargaining power between Lufthansa and Amadeus - who has the upper hand?

Industry supply chains connect different industries through the flow of goods and services. An industry's profitability is partly determined by the bargaining power between the the focal industry and the supplying industries. The scheduled air passenger transportation supply chain is a great example of theory in action.

Bargaining power of suppliers

Figure 1 shows the profitability of the airline industry in red and eight supplying industries in blue. All the supplying industries have higher profitability. A large explanatory factor is the simple fact that all the supplying industries are more concentrated. Globally, there are only three manufacturers, maybe ten large lessors (and two huge ones), only one airport company per destination, a handful or two of airline catering companies, three customer reservation systems, (Data on travel agents and freight forwarders not complete, only large companies surveyed.) And how many airlines? Well, at least 125 airline groups with more than 40 planes.

Figure 1. Return on capital employed, average 2004-2011. Source IATA

Danger of listening to consultants and academics

Many airlines have over the years outsourced much of their activities, e.g. ground services, fuel price variability, ownership of aircraft, computer reservations, designing of airline seats, catering, selling of tickets, etc. This makes for a streamlined airline, but an unprofitable airline. Often management consultants and business school academics have been cheerleaders for mindless outsourcing. If you outsource activities be sure (1) that you do not create powerful suppliers that later will strangle you and (2) that you do not become complacent in managing the activities that you do not outsource. Finally, the world is complex and some activities are better outsourced, but never think that you can have a long-term win-win relationship with your suppliers. What looks like a win-win relationship today will look very different in ten years time. The suppliers often have a great strategy letting the airline managers buy peace of mind. What incompetence.

Running a business is not about peace of mind. It is about making money. Mr. Kirana of Lion Air, a very successful low cost airline in Indonesia, got it right "I do everything on my own ... in the first and second years it's tough, but in the end it will be economically cheaper". There you have a business man, as opposed to an airline manager, talking. However, note that Mr. Kirana's statement is only correct for the low-cost strategy, not for the differentiation strategy.

Lufthansa's bargaining with Amadeus

Lufthansa recently announced that it was adding a fee (EUR 16) on tickets booked through Amadeus, a customer reservation system company. It is about time that airlines understand the idea of bargaining power, one of the first lessons of capitalism. Lufthansa was one the four founders of Amadeus back in 1987. The company went public in 1999. The four founding airlines were collectively valued at EUR 11b (value of non-listed Iberia assessed to EUR 2b) and Amadeus at EUR 18b last week. Lufthansa's announcement made Amadeus drop 9.7% in value, but Lufthansa's value also dropped with 0.7%.

We do not know whether Lufthansa just wants to put some tactical pressure on Amadeus to get a better price or whether Lufthansa is serious about going after and systematically reduce the power of its suppliers. The stock market is not yet convinced. Time will tell, but the direction is promising.

What else can be done relating to bargaining power?  Well, Lufthansa is certainly not the worst in class. A few comments:

• Lufthansa is part of the Star Alliance, the world's largest alliance of airlines. The natural solution would be for Star Alliance to have its own exclusive booking system only showing Star Alliance flights. Amadeus and other booking systems can continue to be used for less price sensitive (and less loyal) customers.
• Lufthansa has already cut down the number of leased aircraft so it is not in the hands of the big aircraft leasing companies.
• Lufthansa is still hedging most of its jet fuel cost. Unless they thing they are good oil traders, they should probably stop hedging. (But here the stock market might be a bit irrational, actually liking the smoothing of profit that hedging enables.)
• Lufthansa already has its own very profitable maintenance and repair business unit as well as an airline catering company.

I am not against Lufthansa having taken part in creating Amadeus in the first place. Creating new business units in new industries is absolutely essential for any large differentiated company. However, it should at least have kept half of the equity it invested. Amadeus would rip off all airlines and Lufthansa would get some of it back as dividends. It could also be argued that distribution is so important that it does not make sense to sell such a unit at all, but that is another discussion.