final capstone project (1)

Running head: LUFTHANSA GROUP’S ACQUISITION OF BRUSSELS

Assignment #3: Capstone Project

Lufthansa Group’s Acquisition

of Brussels Airlines and Future Strategy

Travis Cook

Benson Giang

Celia Glowka

Melinda Jackson

Jennifer McRae

Kevin Schultz

Santa Clara University

Fall 2016

LUFTHANSA GROUP’S ACQUISITION OF BRUSSELS i

Table of ContentsI. Executive Summary....................................................................................................1

A. Introduction............................................................................................................1B. Strategic Move......................................................................................................1C. Major Issues..........................................................................................................1D. Motivation for Final Recommendation...................................................................2

II. External Analysis.......................................................................................................3A. Industry Definition..................................................................................................3B. Six Forces Industry Analysis.................................................................................3

i. Level 1 Analysis.................................................................................................3ii. Level 2 Analysis.................................................................................................3iii. Level 3 Analysis/Overall Attractiveness of the Industry.....................................5

C. Macro Environmental Analysis..............................................................................6i. Global Climate...................................................................................................6ii. Technological Trends........................................................................................6iii. Social Climate....................................................................................................7iv. Government/Political Climate.............................................................................7v. Economic Climate..............................................................................................8vi. Demographic Trends.........................................................................................8vii. Ethics and Social Responsibility......................................................................9viii. Summary of Macro Environmental Effects.......................................................9

D. Competitor Analysis............................................................................................10i. Top Competitors..............................................................................................10ii. Primary Competitors........................................................................................10iii. Competitors’ Strategic Positions......................................................................13iv. V - C Analysis..................................................................................................17v. Comparative Financial Analysis.......................................................................18vi. Section Summary............................................................................................20

E. Industry Dynamics...............................................................................................21i. Industry Evolution and Lufthansa’s Position....................................................21ii. Competitive Dynamics.....................................................................................21

F. External Analysis Conclusions............................................................................22III. (A) INTERNAL ANALYSIS - Lufthansa...................................................................22

LUFTHANSA GROUP’S ACQUISITION OF BRUSSELS ii

A. Organizational Analysis.......................................................................................22i. Goals & Objectives..........................................................................................22ii. Organizational Policies, Values, Culture, and Innovation................................23iii. Ethical & Social Responsibility.........................................................................25iv. Organizational Structure..................................................................................25

B. Strategic Position................................................................................................25i. Corporate Level...............................................................................................25ii. Business Level.................................................................................................26iii. Partnerships, Alliances, Joint Ventures and Acquisitions................................26iv. VRIO, Value Chain & BCG Matrix Analysis.....................................................28

III. (B) INTERNAL ANALYSIS - Brussels Airlines......................................................28A. Organizational Analysis.......................................................................................28

i. Goals & Objectives..........................................................................................28ii. Organizational Policies, Values, and Culture...................................................29iii. Ethical & Social Responsibility.........................................................................30iv. Organizational Structure..................................................................................30

B. Strategic Position................................................................................................31i. Corporate Level...............................................................................................31ii. Partnerships, Alliances, Joint Ventures and Acquisitions................................31iii. Business Level.................................................................................................32iv. VRIO & Value Chain Analysis:.........................................................................32

IV. ACQUISITION ANALYSIS.......................................................................................33A. Ally or Acquire?...................................................................................................33B. Porter’s Tests......................................................................................................33

i. Industry Attractiveness Test.............................................................................33ii. Better-off Test..................................................................................................33iii. Cost-of-Entry Test............................................................................................33

C. Combined Resources & Capabilities, V-C, and Industry Conditions...................34D. Linking Corporate to Business-Level - Part C and D (Scenario analysis, NPV

calculations)........................................................................................................35i. Discounted Cash Flow Analysis.......................................................................35ii. “Worst, Better, Best Case” Scenarios..............................................................36

V. RECOMMENDATIONS.............................................................................................37A. Short-Term Recommendations...........................................................................37

i. Revise Eurowings’ Product Mix to Learn From and Mimic Brussels................37

LUFTHANSA GROUP’S ACQUISITION OF BRUSSELS iii

ii. Standardize Eurowings Fleet to Improve LCC.................................................38iii. Revise Offerings to Support FSC Operations..................................................39

B. Long-Term Recommendations............................................................................39i. Convert Eurowings to Hybrid Model & Merge with Brussels............................39ii. Fold Brussels into Eurowings to Expand LCC Model.......................................40iii. Fold Brussels into Lufthansa to Expand FSC Model........................................40

C. Strategy Implementation.....................................................................................41i. Short-Term Implementation.............................................................................41ii. Long-Term Implementation..............................................................................43

D. Corporate Social Responsibility and Ethical Decision-Making............................44VI. CONCLUSIONS.......................................................................................................45VII. BIBLIOGRAPHY.....................................................................................................46VIII. MAIN APPENDIX...................................................................................................52

Exhibit A – Industry Diagram...................................................................................52Exhibit B – Six Forces Analysis (Levels 1 and 2)....................................................52Exhibit C – Six Forces Analysis (Level 3)...............................................................63Exhibit D – Distribution of FSC versus LCC Market Share in 2013.........................63Exhibit E – Market Share of European Based Airlines............................................64Exhibit F – Key Characteristics of Full and Low Cost Air Carriers..........................65Exhibit G – Lufthansa’s Primary Competitors.........................................................66Exhibit H – Porter’s Generic Business Level Strategies: Competitors....................67Exhibit I – VRIO Analysis: Competitors*.................................................................68Exhibit J – Comparative Financial Metrics..............................................................75Exhibit K – Lufthansa Business Unit Financial Analysis.........................................79Exhibit L – V-C Analysis: Competitors....................................................................80Exhibit M – Lufthansa BCG Matrix Analysis............................................................82Exhibit N – Lufthansa Eurowings V-C Analysis (Supplemental Information)..........82Exhibit O – Lufthansa Value Chain Analysis...........................................................83Exhibit P – Brussels Airlines Value Chain Analysis................................................84Exhibit Q – Ally or Acquire Framework...................................................................85Exhibit R – Synergy Analysis..................................................................................86Exhibit S – VRIO Post Merger Analysis..................................................................88Exhibit T – Cost of Entry Test.................................................................................90Exhibit U – Post Merger V-C Analysis.....................................................................90

LUFTHANSA GROUP’S ACQUISITION OF BRUSSELS iv

Exhibit V – Lufthansa's Revenue Growth Rate.......................................................91Exhibit W – Lufthansa Weighted Average Cost of Capital Analysis........................91Exhibit X – Lufthansa’s Free Cash Flow Derivation................................................91Exhibit Y – Lufthansa Discounted Cash Flow Analysis...........................................91Exhibit Z – Brussels Airlines Revenue Growth Rate...............................................92Exhibit AA – Brussels Airlines Free Cash Flow Derivation......................................92Exhibit BB – Brussels Airlines Discounted Cash Flow Analysis..............................93Exhibit CC – Combined Firm Valuation (Worst Case)............................................94Exhibit DD – Combined Firm Valuation (Better Case)............................................95Exhibit EE – Combined Firm Valuation (Best Case)...............................................96Exhibit – Timeline for Short-Term Recommendation..............................................97Exhibit – Timeline for Long-Term Recommendation..............................................97

IX. FINANCIAL APPENDIX...........................................................................................98

LUFTHANSA GROUP’S ACQUISITION OF BRUSSELS v

(Wall, 2016)

LUFTHANSA GROUP’S ACQUISITION OF BRUSSELS 1

I. Executive Summary

A. Introduction

Tourism. Business Trips. Family Visits. They all contribute to Europe’s bustling

airline industry. This industry has changed immensely since the first commercial flights

started just over a hundred years ago. Wild inventions, technical advancements, and

modern machinery have built a system that millions of people rely on to travel every

day. With the European airline industry growing increasingly mature, recent history has

found success in new strategies as well. This paper’s scope will be limited to Europe’s

passenger airline industry and will analyze an acquisition currently taking place.

Lufthansa Group owns a small handful of passenger airlines, and is sizably

invested in a couple others. Among them are Lufthansa, a large full-service European

airline, Eurowings, a low-cost airline, and most recently, Brussels Airlines, a hybrid

between the two. Brussels Airlines is a customer-focused, low-cost airline operating out

of its hub at the Brussels Airport in Belgium since 2002. A number of other competing

European airlines ensure a low concentration in the industry along with intense

competition. The market appears to be growing steadily as global air travel becomes

increasingly more popular.

B. Strategic Move

Lufthansa recently announced its plans to acquire the remaining 55% of Brussels

Airlines (Wall, 2016). This purchase will cost up to €250 million, and will add twelve

more destinations to Lufthansa’s network. The acquisition of Brussels’ 49 aircraft (Fleet,

n.d.) brings the number of passenger airplanes in Lufthansa Group’s aggregate fleet to

630 (The Fleet, 2015). While Lufthansa has not yet disclosed details of what it plans to

do with the new additions, they have hinted at the possibility of adding some of

Brussels’ airplanes to the Eurowings fleet. However, the public will have to wait to see

exactly what Lufthansa does with Brussels Airlines after the acquisition is complete. As

a parent company owning multiple separate airlines, there are numerous ways to

handle the acquisition.


C. Major Issues

A major issue with this acquisition is the state of one of Lufthansa’s subsidiary

airlines, Eurowings. The low-cost carrier has greater costs than Brussels, which

provides drastically more value to customers, for less (Error: Reference source not

found). Although low-cost, no frill flights are what Eurowings specializes in, they don’t do

it well. This makes brand management an issue as Lufthansa expands its fleet and has

the opportunity to expand Eurowings. Brussels Airlines is viewed more favorably by

customers and provides higher value with its customer-centric strategy. Managing

consumers’ perception of Eurowings will prove critical if Lufthansa wants to commit

some of the new assets to the sub-par brand. Regardless of the decision Lufthansa

makes, it is clear that the value and brand loyalty Brussels Airlines currently has should

be preserved and not diminished in this transaction. The transition strategy must be

managed to minimize disruptions or inconsistent experiences for customers while

promoting customer education and retention.

D. Motivation for Final Recommendation.

With such strong competition in the European airline industry, turning a profit is

important and can be difficult. We recognize that addressing Eurowings’ poor

performance must be a high priority. Hybrid airlines, those that combine quality service

and low cost, appear to be on the rise. With this growing market that provides high

value to the customer while maintaining a low price, Lufthansa could benefit by

prioritizing this strategy. We recommend Eurowings try to learn from Brussels and use

their operations as an inspiration to revamp their business model. This means

Eurowings will overhaul their operations and emerge a hybrid airline. This change would

be implemented in stages with campaigns to educate the public. The end goal for our

recommendation looks like a successful, strong hybrid airline made up of Eurowings

and Brussels Airlines. This merged company would be modeled on the success of

Brussels and would increase Lufthansa Group’s market share in the hybrid market.


II. External Analysis

A. Industry Definition

We are defining our industry of focus as Scheduled Air Passenger

Transportation, similarly modeled after the North American Industry Classification

System (NAICS) 2016 Code 48111. This industry definition is derived from the overall

Air Transportation industry classification (481111 Scheduled Passenger Air

Transportation, 2016), and concentrates on passenger travel via commercial airlines in

Europe. Since our firm of study is the Lufthansa Group (hereinafter, Lufthansa), industry

points of perspective manifest as commercial airlines, further categorized as full-service

carriers (FSCs) and/or low-cost carriers (LCCs) where appropriate. As most recently

reported, the industry is worth €110 billion (Air: Internal Market, n.d.) with a growth rate

in Europe of 2.7% (Air Passenger Forecast Shows Dip in Long-Term Demand, 2015).

(See Error: Reference source not found for a diagram of the industry)

B. Six Forces Industry Analysis

i. Level 1 Analysis

A detailed Level 1 analysis of the Six Forces is presented in Error: Reference

source not found.

ii. Level 2 Analysis

Level 2 of the industry analysis considers the weight of each of the Six Forces:

Barriers to Entry/Threat of Entry, Threat of Rivalry, Buyer Power, Supplier Power,

Threat of Substitutes, and Threat of Complements. The following sections describe

critical factors influencing the strength of each force. A detailed Level 2 analysis is

provided in Error: Reference source not found.

Barriers to Entry/Threat of Entry

Industry profits are encouraged by several favorable factors deterring entry

threats, but dampened by factors that detract from other profit opportunities. Of

particular note are industry-favorable high capital costs, dedicated assets, and the


importance of achieving supply-side economies of scale as well as industry-unfavorable

customer switching costs and low differentiation among airlines.

Capital costs for airlines are high, involving the purchase/leasing of aircraft,

equipment, facilities, services, and other expenses related to airport access. For

example, the cost of an Airbus A320 aircraft, a popular aircraft for short-haul flights,

runs approximately €92.5 million; and the Airbus A380, geared towards business and

leisure, is to the tune of €408 million (Airbus, 2016). With these price tags, it is not

unreasonable to infer that economies of scale are necessary for airlines to make a

profit. Additionally, threat of entry is further discouraged by the current capacity of

central airports, with consistently filled airport “slots” and scarcely available gates for

airlines.

Threat of Rivalry

The concentration for commercial airlines is low, with CR5=47% including

Lufthansa, Air France-KLM (AFK), International Airlines Group (IAG), easyJet, and

Ryanair (Lufthansa Group, 2016, p. 22). This is likely fueled by low product/service

differentiation among airlines servicing respective segments of the industry (business,

leisure, low-cost), as well as regulations prohibiting monopolies. At the same time, ticket

pricing is becoming a more pronounced differentiator, as low-cost carrier market shares

are increasing while maintaining comparable performance (Israel, 2015). Exit barriers

also pose an unfavorable factor for the industry as it is difficult for an airline to exit the

industry, considering large sunk costs, service agreements with airports, and cost of

layoffs.

Buyer Power

The primary buyer group for the Scheduled Air Passenger Industry is air

passengers. Buyer power is particularly boosted by low switching costs between airlines

as travel is paid for on a per flight basis. Low differentiation between airlines also

contributes to buyer power, thus consumer decisions are dominated by cost and

schedule preferences (Shankman, 2014). And with a CR5=47% (Lufthansa Group,

2016, p. 22) as mentioned earlier, travelers have a wide selection of airlines from which

to choose.


Supplier Power

Within the industry, there are numerous suppliers for commercial airlines, but

supplier groups with the heaviest influence are airports, aircraft manufacturers, and fuel-

related suppliers. Supplier power for these groups tends to be heightened by large

demand distributed to few suppliers. For example, aircraft manufacturers, Airbus and

Boeing, make up a duopoly in the market (C., 2014). Airports are essential to airline

operations and the desirability of certain airports and limited gates add to the group’s

power as a supplier. Fuel suppliers, with hedging contracts providing benefits or

disadvantages depending on the market, are a force to be reckoned with due to

fluctuating oil prices and the fact that fuel can make up more than 30% of an airline’s

operating expenses (Commercial Fuel Policy, n.d.).

Threat of Substitutes

The main substitutes for air travel are other modes of transportation (such as

train and automobile) or internet methods (for web-conferencing or virtual exploration).

Air travel provides unique value at comparable costs for most modes of transportation,

further detailed in Error: Reference source not found. While the option of web-

conferencing for business could pose a threat to the industry, it is not a viable substitute

in all cases of air travel.

Threat of Complements

Threat of complements is generally a weak force in the industry because

complements do not greatly influence pull-through of demand, except in the case of

tourist attractions (Error: Reference source not found). Additionally, complements do not

embody credible asymmetric integration threats at this time.

iii. Level 3 Analysis/Overall Attractiveness of the Industry

Considering the effect of the six forces on the present-day industry, overall the

Scheduled Air Passenger Industry is moderately unattractive (Error: Reference source

not found). The strongest forces skewing industry unattractiveness were Threat of

Rivalry, Buyer Power, and Supplier Power, mostly due to the saturation of nominally

differentiated firms, consumer choice, and dependence on a few suppliers. However, it


should be noted that air passenger growth is expected to increase significantly in the

next 20 years with slow expansion of airports (Airport Capacity & Airport Slots, n.d.), a

combined phenomenon that could impact the attractiveness of the industry at a later

time.

C. Macro Environmental Analysis

i. Global Climate

Terrorism in Aviation

Although terrorism targeting the aviation industry has been apparent since the

1960s, it was not until the September 11, 2001 attacks that airline terrorism was brought

to the forefront on an international scale (Azani, Lvovsky, & Haberfeld, 2016). In 2016

alone, Europe experienced two tragic aviation-related attacks: one at the Brussels

Airport in Belgium and another at Ataturk International Airport in Turkey. The advent of

internet connectivity spurs knowledge-sharing among terrorist organizations and as a

result the industry continues to heighten security measures, driving up costs. The

events that have occurred and the potential for them to occur are deterring forces for air

travelers (Alderman, 2016), slowing industry demand with each occurrence.

The “Hybrid” Carrier

While FSCs and LCCs are now common in the industry, a new breed of airline is

being born: the “hybrid” carrier. The hybrid provides the purposeful option to re-bundle

many of the amenities and services that LCCs stripped. A hybrid carrier may also cater

to different customer segments by offering premium services on one flight, but function

as an LCC for another. This new designation further blurs the line between FSCs and

LCCs, as it is starting to change the landscape once dominated by mature airline

business models (Ros, 2016). This presents even more challenges for differentiation

and will increase competition (and corporate strategy) in the industry.

ii. Technological Trends

Air Traffic Management


Europe sees 27,000 flights with a total traffic of 2.27 million passengers daily

(European Aviation Environmental Report, 2016). Technology has fostered

interconnectivity so that aviation operations can be optimized. The air traffic

management system is currently being improved and will provide benefits towards

accommodating more air traffic while increasing overall aviation network performance

(EASA, et al., 2016). The industry will benefit from streamlined operations and

increased capacity to serve demand, which will result in more favorable experiences for

travelers.

Aircraft Sustainability

Aircraft inputs and outputs, including part materials, fuels, and technological

systems, continue to be innovated, producing faster, safer, more fuel-efficient, and more

environmentally-friendly airplanes. Such technological advancements reduce costs,

lessen environmental and human health impacts, and improve operations (EASA et. al,

2016) -- ultimately escalating profits for the industry.

iii. Social Climate

Labor Strikes

The industry is no stranger to compensation-based labor strikes from numerous

labor groups (such as air traffic control, pilots, and flight attendants), each time severely

impacting airport and airline operations. From the start of the year through September

15, 2016, air traffic controller strikes in Europe alone resulted in an aggregate delay of

one million minutes (almost 23 months) and over 3,000 flight cancellations in Europe

(Economic Performance of the Airline Industry, 2016). In addition to major operational

losses and human resource implications from labor strikes, the EU mandates that

airlines are required to refund unused tickets as well as cover lodging expenses until a

replacement flight can be provided (Trend, 2016) -- further impacting the industry’s

profitability.

iv. Government/Political Climate

Single European Sky


The Single European Sky (SES) initiative began in 1999 in an effort to better

integrate the European airspace by way of legislation for improvements to air traffic

management and air navigation services (Thomas, Air Transport: Single European Sky,

2016). In 2011, the impacts without SES were seen in €13.49 billion lost as a result of

flight delays, inefficiencies, wasted costs, emissions, and more (McNamara, 2013).

While progress has been made under SES, if all goals are achieved by 2035, benefits to

the industry could be on the order of 1 million new jobs and €245 billion added annually

to Europe’s GDP (News Brief: European Air Traffic, 2016).

The United Kingdom Exiting the European Union (Brexit)

On June 23, 2016, the UK voted to leave the EU; an event coined as “Brexit.”

While it is not entirely clear how Brexit will affect the airline industry as a whole, from a

regulatory standpoint, the UK relinquishes much influence over aviation regulations. As

a non-Member State of the EU, the UK would need to negotiate agreements to operate

in the EU aviation market, possibly impacting the operations of known carriers with

home stakes in the UK such as IAG and easyJet. Converse agreements would also

need to be made as the UK could develop their own regulations and policies for the UK

market, affecting the rest of Europe. While, there are many non-Member State airlines

that operate successfully, the UK’s airspace is particularly critical for Europe (Erkelens,

Briggs, Phippard, Boström, & Bell, 2016). The industry faces some complexity in the

future; with increased regulation, and possibly negatively affected industry profits.

v. Economic Climate

Oil Prices and Exchange Rates

Although crude oil, and in turn jet fuel prices have been increasing since the

beginning of 2016, the industry still enjoys low fuel prices (around €50 per barrel in

November 2016, in contrast to almost €100 four years ago). Also, playing a part in

economic factors are currency exchange rates, where the Euro has depreciated by 20%

against the US Dollar since the beginning of 2014 (Macquarie, 2016). This has

diminished the fall in oil prices for Europe over the years, but also reduces foreign

currency deficit obligations for international airline operations (Buecking & Oxley, 2015).

The current state of oil prices and exchange rates are favorable for European airlines,


resulting in opportunities for high profitability. Airlines may choose to pass cost benefits

along to the consumer in the form of reduced fare pricing and/or more flight offerings,

however, the companies must remain conscious of long-term implications given the

unpredictable economy.

vi. Demographic Trends

Internet Savvy Levels the Playing Field

The multitude of travel websites bringing side-by-side comparisons of flights

makes scheduling and flight selection much easier for the internet-savvy consumers.

Instead of enlisting the help of a travel agency, travelers can now perform a quick web

search of accommodations catered to their exact preferences. Loyalty might be harder

to gain from an informed consumer who can assess all available flights, service,

reviews, and pricing differences on one computer screen.

vii. Ethics and Social Responsibility

Flight Safety

Safety is a top concern in the airline industry, spanning from operational abilities

of aircraft (encompassing performance of materials, weathering, and proper

maintenance) to the abilities of pilots. The Germanwings Flight 9525 crash in March

2015 spurred discussion of mental health screening for pilots and spotlighted a new

safety concern in the industry (McHugh, 2016). Safety issues also surround labor shifts

for pilots and flight attendants, especially concerning long-haul flights.

Environmental Obligations

In an effort to batten down environmental emissions, the EU has integrated

aviation emission regulations into the EU Emissions Trading System (ETS). The EU

ETS mandates a 20% greenhouse gas emission reduction between 2008 and 2020. Air

travel accounts for over 3% of emissions produced in Europe (EASA et al., 2016).

Market-based mechanisms also play into this goal with airports charging airlines for

noise and greenhouse gas pollution. This requires airlines to update their fleets with


more environmentally-friendly aircraft, as well as scrutinize operations and flight

schedules, which effectively increases costs and decreases industry profits.

viii. Summary of Macro Environmental Effects

There are numerous macro environmental factors that can affect the air

passenger industry and the challenge is that they are often unpredictable. Global,

economic, social, and government/political factors are the most unpredictable and can

result in significant detrimental impacts (loss of profitability). However, the industry can

also derive great benefit (more profit) from other factors, as is currently the case with oil

prices and foreign exchange rates.

D. Competitor Analysis

i. Top Competitors

The European passenger airline market is fragmented. As discussed, the five

largest European airlines: Lufthansa Group, IAG, AFK, Ryanair, and easyJet - make up

47% of the total market in terms of revenue (Lufthansa Group, 2016, p. 22), and 54%

(List of Largest Airlines in Europe, n.d.) in terms of market share by passengers flown

(see Error: Reference source not found). The next 10 largest companies by passengers

flown are comprised of: Turkish Airlines, Aeroflot, Air Berlin, SAS, Norwegian, Alitalia,

Pegasus, Wizz, TAP and Aegean Airlines. As per the aforementioned exhibit, more than

half of competing companies have 1% market share or less (List of Largest Airlines in

Europe, n.d.).

ii. Primary Competitors

As noted above, the European airline industry is composed of FSCs and LCCs,

with firms adhering to either platform, or a hybrid of the two (see Error: Reference

source not found). Important to note is that LCCs generally offer only point-to-point flight

segments, without transfer capabilities, to reduce cost. Thus, they generally focus on

short-haul flights. However, short-haul is not limited to LCCs, as FSCs also offer short-

haul segments.


Since Lufthansa competes in the full service category, as well as in low cost

through its subsidiaries, the company has several primary competitors: AFK and IAG

(traditional FSCs, which also own low cost subsidiaries), Ryanair and easyJet (low

cost), and Air Berlin (hybrid). As per Error: Reference source not found, Lufthansa has

defined their primary competitors in their 2015 annual report.

International Airlines Group

IAG is comprised of the airlines Aer Lingus, British Airways, Iberia, and Vueling.

Headquartered in London, IAG offers the 95 million customers it flew in 2015 a total of

274 destinations. The group’s major cities are London, Madrid, Barcelona, Rome, and

Dublin, and European destinations make up 20% of its available seat kilometers (About

Us, 2016). British Airways offers customers a global, full-service experience (including

full business and first class), focusing largely on long haul routes.

Vueling offers short haul low-cost flights, focusing strongly on the Spanish

market, with some focus on the rest of Europe (and a few North African cities). While it

is an LCC with unit costs close to that of easyJet, it offers access to VIP lounges and a

rewards program (which is not compatible with those of other IAG subsidiaries). Aer

Lingus strives to provide the “best product in the Irish airline market at a competitive

price,” making it an LCC with focus on some extras (Aer Lingus: Company Profile,

2016). It flies almost exclusively in Europe, with a strong UK presence, but has recently

added long haul flights to ten North American locations.

Iberia focuses on full service flights (albeit stripped down) between Europe and

Latin America. Further, IAG also provides cargo services and, through its Avios

program, offers customers a global “currency” rewards program which includes partners

such as hotel chain Marriott and Avis rental cars (International Airlines Group, n.d., p.

26).

Air Berlin

Based in Berlin, the company offered its 30.3 million passengers a choice of 138

destinations in 2015 (Air Berlin, n.d., p. 16). It is the second largest airline in Germany,

following Lufthansa, and its main routes after German-speaking countries include

Europe, parts of North Africa and the Middle East, and the U.S. In the past, Air Berlin


has positioned itself as an LCC flying to primary hub airports, but is now taking a hybrid

approach, expanding long haul and business class offerings, as well as its Topbonus

loyalty program (Lucky, 2016). It is also part of the Oneworld frequent flyer codeshare

program which includes a host of other international carriers. Moving into 2017, Air

Berlin also plans to create a new business unit for leisure, non-business short haul

flights, and drastically reduce destinations served by 77%, including consolidating hubs

(The New Airberlin | Analyst Presentation, 2016).

Air France - KLM

Headquartered at Charles de Gaulle Airport in France, AFK carried 89.8 million

passengers in 2015 to 320 destinations (in 114 countries), of which 183 are in Europe.

79% of revenue comes from its passenger network, with the remaining derived mostly

from cargo (Martinair subsidiary) and maintenance. It offers loyal customers rewards

through its “Flying Blue” program. Air France and KLM act as traditional FSCs, and Air

France especially has increased exclusive offerings in business and first class (Air

France-KLM, 2016). The group also owns two low-cost, short haul carriers, Hop! and

Transavia. Hop! includes some extras: a snack, seat choice and miles earnings. It

focuses on intra-France travel, with only 10 flight legs dedicated to other European

destinations (Network, 2016). In contrast, Dutch-based Transavia’s destination list is

similar to that of other LCCs focused on Europe, but with a greater focus on Portugal

and Spain. It also offers “Flying Blue” miles, but provides few “frills” (Transavia, 2015).

Ryanair

Based in Dublin, short-haul Ryanair carried 90.6 million passengers to over 200

destinations in 33 countries (exclusively European, in addition to Morocco and Israel) in

2015 (Facts and Figures, 2016), making it the largest short haul carrier in Europe.

Ryanair flies almost completely to secondary, remote airports, and this, along with a

host of other cost-cutting measures and lack of “frills” (point-to-point flight segments,

snacks and beverages for purchase, bag fees, low overhead, and high aircraft

utilization), makes it a leader in offering incredibly cheap airfare. Often shocking the

public, Ryanair’s proposed cost-cutting measures have included such ideas like

charging passengers for bathroom use, though the company has recently announced a


shift to improve customer service (“Always Getting Better”), and initiated a sparse

business class program (McGreevy, 2009). Ryanair was the most profitable European

airline in 2014 by operating margin (Who has the Right Model for European Aviation?,

2015), and it plans to expand aggressively in Germany (Reuters, 2016).

easyJet

Headquartered at London’s Luton Airport, easyJet is the second largest short

haul air carrier in Europe, having flown over 70 million passengers to 136 destinations in

31 countries in 2015. Routes are European, with the addition of Egypt, Israel, and

Morocco (easyJet, n.d.). easyJet is an LCC with several cost cutting features similar to

Ryanair. Unlike Ryanair, however, easyJet flies to primary and secondary airports, has

a strong focus on customer service, and offers business class and has a frequent flier

program.

Lufthansa

Lufthansa is Europe’s largest airline and is headquartered in Cologne, Germany.

In 2015, the Lufthansa Group flew 107 million passengers to 297 destinations, through

its subsidiaries Eurowings, Swiss, and Austrian Airlines, as well as the Lufthansa brand.

Lufthansa also has equity agreements in SunExpress and Brussels Airlines, and 44% of

passenger revenue is derived from European ticket sales. Additionally, the company

operates catering and maintenance business units, as well as cargo operations

(Lufthansa Group, 2016). Lufthansa, Austrian and Swiss Airlines are FSCs, with a focus

on hub airports. The two latter carriers have a strong hold in each of their respective

markets. Brussels Airlines also offers customers a full service experience, with several

routes to Africa from its Brussels hub. Eurowings and Sun Express are LCCs, operating

more point-to-point routes, with some growing focus on long haul (Lufthansa SWOT,

2015). Lufthansa offers a “Miles and More” loyalty program, including a credit card, and

is part of Star Alliance. For more information, see section “Lufthansa Internal Analysis.”

iii. Competitors’ Strategic Positions

Business Level


As per Error: Reference source not found, and as described in the profiles above,

competitors have various business level strategies. Ryanair offers an extreme cost

leadership strategy, based on keeping input costs extremely low. The resulting low fares

create broad appeal. easyJet also focuses on cost leadership. However, in providing

more included services, and by flying to some primary airports and offering business

class, the company starts to move towards slightly higher cost and somewhat more of a

niche market. Air Berlin has recently announced a shift in direction away from a more

low-cost, broad focus, and will prioritize business travelers, while reducing destinations.

The resulting transition puts Air Berlin between cost leadership and broad

differentiation, leaning slightly more towards broad differentiation. AFK, Lufthansa, and

IAG offer a hybrid strategy, due to the fact that the three groups are traditional FSCs,

but all have ownership of LCC subsidiaries. For example, Air France focuses in

between broad and focused differentiation, due to its higher costs as a legacy carrier

with full service, and a focus on expanding the premium market (for example, an

improved business class with luxurious amenities). However, the company also owns

the subsidiary Hop!, which, as an LCC focusing almost completely on France, practices

a focused low cost strategy.

Corporate Level

According to Rumelt’s corporate strategy classifications, Air Berlin and easyJet are both single businesses, since their annual revenue is derived at greater than 95%

from passenger traffic (Air Berlin at over 90%, easyJet at 98%). Ryanair, with 25% of

revenue derived from ancillary services such as booking of ground transport to/from

Ryanair’s remote airport locations, and the remaining 75% from airfare, can be

classified as a dominant business. Within the category of dominant, Ryanair can be

further classified as dominant-constrained: “Any dominant firm which diversified by

building on a single strength or resource associated with the original business”

(Christensen, p. 15). In this case, Ryanair is leveraging their air passenger booking

platform to drive further revenue. AFK, IAG, and Lufthansa can also be classified as

dominant-constrained. Each has greater than 70% of revenue from passenger air travel:

Air-France at 79%, IAG at 89% and Lufthansa at 74%. Further, each company has used

their strength in the passenger airline industry to leverage revenue from similar but not


necessarily vertically related sources, in cargo, maintenance, and catering (Annual

Reports, 2015).

Achieving a Strategic Position

The following summarizes the main findings from the VRIO Analysis (see Error:

Reference source not found for the complete listing of advantageous resources and

capabilities).

Ryanair

Ryanair achieves a sustained strategic position through two means, the most

important of which is its cost-reduction know-how. As the first carrier in Europe to take a

low-cost approach, and modeled after Southwest, Ryanair has cut unit costs to the bone

(Ryanair SWOT, 2014). Due to its first-mover advantage, strong network of only

secondary airports, and continued extreme low-cost innovations, the synergies

achieved are difficult to imitate. Further, Ryanair’s unique leader, Michael O’Leary,

provides strong and extremely focused leadership to carry out this strategy (Facts and

Figures, 2016). Low overhead and salaries, hard for full service but not low cost carriers

to imitate, provides a temporary advantage.

Air France - KLM (AFK)

As an intangible resource, AFK’s brand strength is difficult to imitate, acting as a

source of competitive advantage. The AFK brand ranks highly, and has for decades (the

company was established in 1934); thus, it has high value. Further, through the merger

of two flagship carriers, Air France and KLM (based in The Netherlands), not only was

the brand strengthened, but large economies of scale have been achieved. The group is

now one of the largest in Europe, and maintains control of two of the top five hubs in the

region (Air France-KLM, 2016). AFK also has a well-balanced presence around the

globe, helping insulate it from downturns in any one market.


Like AFK, IAG’s British Airways brand is very strong, and having been ranked the

UK’s leading brand in 2015, will continue to provide a source of sustained competitive

advantage (Macalister, 2016). Other sources of sustained advantage include IAG’s


internal shared platform, through which back-office, IT and finance functions,

procurement, and digital synergies are shared among subsidiaries. This leads to large

reductions in redundancies, and better economies of scale, while being difficult to

imitate in terms of size, scale, and specialization. Furthermore, IAG has an extremely

global network, serving most continents, which is incredibly difficult for all but the largest

carriers to maintain (International Airlines Group, n.d.).

easyJet

One of easyJet’s main sources of sustained competitive advantage is its better-

than-average employee relations. Not only are easyJet employees happier than

average, but customer service is improved (Cox, 2014). Since it is not easy to create

good employee relations, especially in the case of an LCC, this can be seen as a

sustained advantage. Additionally, easyJet maintains a highly-specialized and -

integrated web, mobile and CRM system. This system is both internal and customer-

facing, and results in a better understanding of customer needs and added cost

reductions. While the company has several advantages such as low overhead, strong

low cost strategies, good airport contracts and a new fleet, these provide easyJet with

temporary, but not sustained, advantages.

Air Berlin

Air Berlin exploits its control of two main hubs in Germany to maintain a strong

presence in the country. It hopes to use this control to further build out its business

class network. Air Berlin has also developed an internal digital revenue management

system, which has increased revenue, and is difficult to imitate in its specific forecasting

abilities. The company recently fired 80% of top management; next steps are widely

being watched in the European market (The New Airberlin | Analyst Presentation,

2016).

Lufthansa

Lufthansa has been Germany’s flagship carrier since its founding in 1953 and

has used its strong brand reputation and this historical context to create a sustained

competitive advantage. In 2016 Lufthansa was awarded first place as Europe’s ‘Best

Airline Transatlantic’ and ‘Best Airline in Western Europe’ based on 18 million user &


passenger survey responses, demonstrating continued positive public opinion (K,

2016). Lufthansa also maintains its sustained competitive advantage through a

dominant presence at the Frankfurt and Munich hubs, Europe’s fourth and seventh

busiest airports respectively. Lufthansa’s acquisition of Brussels Airlines will further this

dominant presence, adding Brussels Airport to the list. Lufthansa solidifies its strong

positioning with a large and continuing investment in its human capital through the

Lufthansa Business School (Graduate Programs, n.d.).

Brussels Airlines

Brussels Airlines’ strong brand and market-dominating position at its Brussels

hub help the company achieve a sustained competitive advantage. Because of its deep

ties with Brussels Airport, Brussels Airlines has also been able to develop an extensive

network in Africa, a key differentiator from other European airlines and a driving factor in

Lufthansa’s acquisition decision (Brussels Airlines Reinforces Presence in West Africa,

2015). Additionally, Brussels Airlines has been able to secure a unique partnership with

Tomorrowland, the world’s largest Electronic Dance Music festival in Belgium (Boni,

2015). In order to boost customer retention, Brussels Airlines launched its LOOP loyalty

program which already has over 50,000 registered members (Sciot, Daenen, &

Lemmes, 2016).

iv. V - C Analysis

Methodology

The eight value drivers used in our Competitor V-C Analysis, and subsequent

descriptions, can be found in Error: Reference source not found. These include

categories such as in-flight comfort, customer service, perceived value for money, and

premium services. Value drivers were given weights of importance, then multiplied by

how well airlines perform in each category, producing a weighted score. Each score

was then multiplied by 100. This comparison between airlines is based on one flight

segment. As it was not possible to find one route flown by all airlines, the two routes

chosen were Paris-London and Frankfurt-London (except for Brussels, where neither of

the two chosen routes were available), and an average of the kilometers traveled was

taken, then multiplied by each airline’s cost per available seat kilometer (CASK) to


calculate cost. CASK is defined as operating costs divided by available seat per

kilometer. Price was the price paid by each passenger for the route in question.

Selected Results

According to our analysis, Brussels Airlines has the highest perceived value to

buyers. All references for this section can be found in Exhibit L. This can be attributed to

the fact that the airline is positioned more as an FSC, with a solid standing across the

board in most all value driver categories, while showing similarities to an LCC by

maintaining a high perceived value for money. As such, we consider this to be a hybrid

carrier as well. However, the value the company receives, is the second lowest, for

most likely the same reasons: higher costs due to more full service expenditures,

offered at lower prices.

easyJet has the highest value among Brussels’ competitors. This is due to strong

customer service, a good brand reputation, and a high perceived value for money. P-C

is relatively low. This is similar with Ryanair - it creates a large amount of buyer value in

relation to its cost. The surplus it receives from price - cost is extremely small due to

Ryanair’s extremely low fares, yet Ryanair likely compensates this with high volume.

The company sells a large volume of tickets, carrying about 90 million passengers last

year. AFK’s Transavia subsidiary is able to generate more value than IAG’s Vueling due

to its codeshare agreements (codeshare agreements can be defined as partner airlines

offering flight segments to final destinations, and the ability to earn miles on several

airlines). Customers can earn AFK’s “Flying Blue” miles while flying with Transavia

(which may be used on any AFK brand flight), but Vueling does not offer miles which

are redeemable beyond Vueling. Costs are similar, both likely benefit from scale

economies through their global parent companies, though Vueling is able to grab a bit

more value than Transavia. While Air Berlin creates a high total value, the buyer value

is the smallest of the group, and customers’ perception of value as compared to price is

much lower than that of other competitors. Air Berlin is squeezing customers on price,

and while it looks like the company is gaining a large surplus on P-C, prices on other

routes may not be as high. Lufthansa’s Eurowings also offers buyers a lower perceived

value than that of the other LCCs and Brussels Airlines. Its CASK is one of the highest


in the industry, and as such, it will need to better determine its place in the industry

(Eurowings Develops Innovative Partnership, 2016).

v. Comparative Financial Analysis

Profitability Metrics

A summary of all comparative financial metrics can be found in Error: Reference

source not found. Profitability from operations was assessed using two metrics: gross

margin and profit margin. Contrary to general trends, a healthy gross margin is not

necessarily indicative of a margin for profit in this industry. Gross margins varied

between 21% and 54% with IAG leading the industry, Air Berlin lagging behind all

competitors, and Lufthansa performing strongly with margins greater than 40%. A

comparison of profit margins reveals that remaining consistently profitable has been a

challenge in the airline industry. Air Berlin, IAG, and AFK have suffered losses in recent

years. Lufthansa has performed relatively well by at least breaking even in each of the

past five years and easyJet and Ryanair have performed very well by capturing the

largest profit margins. Only easyJet and Ryanair managed to surpass the industry

average for global airlines.

Return Metrics

Two return metrics were chosen to compare performance relative to resources

available to each firm: return on assets and return on equity. As seen in Error:

Reference source not found, and similar to the comparison of profit margins, Air Berlin

and AFK perform relatively poorly. Lufthansa and IAG remain slightly positive overall.

easyJet performs the best according to this metric despite Ryanair having a higher profit

margin, informing us that easyJet is putting their assets to use most efficiently. In terms

of return on equity, AFK’s losses cause them to perform very poorly, Air Berlin is not

assessed in four out of the five years due to a negative or near zero equity balance.

easyJet and Ryanair remain the top two consistent performers, but Lufthansa holds the

top spot for return on equity in two out of the last five years.

Liquidity and Leverage Metrics


Three relevant metrics were utilized to determine the relative liquidity position of

each firm: current ratio, quick ratio, and debt to equity ratio (Exhibit J). A comparison of

the firms’ current ratios shows that Ryanair is best able to meet its current obligations,

Lufthansa’s ability to meet current obligations is relatively similar to that of its average

competitor, and no firm is in a substantially poor position. The quick ratio analysis

reveals that Ryanair is most capable to fulfill its measured ability to meet current

obligations due to the liquidity available within its current assets and Lufthansa is slightly

above average. The debt-to-equity ratio shows that Air Berlin and AFK are operating

with the most leverage relative to their competitors. A large amount of leverage is able

to multiply a firm’s profits and losses, which could partially explain why these two firms

have presented such volatile financial metrics. Air Berlin and AFK are not assessed in

three of the five years and two of the five years, respectively, as they presented

negative or near zero equity account balances. Lufthansa and IAG operate with similar

leverage and easyJet and Ryanair operate with the least leverage. It appears less

leverage is correlated with higher returns on a percent basis.

Industry Operating Metrics

Five industry operating metrics common to each competitor were identified and

analyzed to determine the relative efficiency of various operating aspects of each firm:

passenger load factor, passenger revenue per available seat kilometer (RASK),

passenger cost per available seat kilometer (CASK), revenue generated per employee,

and compensation per employee (Exhibit J).

Lufthansa’s passenger load factor of 80.4% (Exhibit J) is weak relative to its

competitors, while easyJet leads the market with levels above 90%. This means that

easyJet is the most efficient at filling all seats on a flight.

Lufthansa is the leading firm in terms of the RASK and CASK metrics, indicating

that they can generate the most revenue per available seat; possibly because they

provide a lot of perceived value to customers and have slightly higher ticket prices, but

either way their profits are average due to higher costs. Ryanair and easyJet perform

relatively lower in terms of RASK and CASK which is indicative of them being LCCs. For

revenue per employee, Lufthansa operates below the €310,000 industry average, at


€268,000, while easyJet and Ryanair lead the market with €590,000 and €478,000

respectively (Exhibit J).

Lufthansa pays employees an average of €67,539, which is above the industry

average of about €53,000 (Lufthansa Group, 2016). AFK pays the most in this market at

€84,148 average salary (CITE AFK Annual Report), while the highly profitable Ryanair

and easyJet pay around the industry average. This indicates Ryanair and easyJet may

be benefitting from a “Southwest” effect, because they can generate the most revenue

per employee while paying their employees the least.

vi. Section Summary

Lufthansa faces continuing threats from LCCs. Ryanair has a hold on extremely

low unit costs, and easyJet has a strong low-cost position with good customer service.

Companies like AFK and IAG are also moving into the LCC market through airline

purchases of their own. The airline market remains fragmented, with the opportunity for

further consolidation. It remains to be seen how many LCCs can profitably compete in

broad, low-cost markets while maintaining some sort of competitive advantage

(geographic, or a strength like customer service, etc.). While most profits in recent years

have come from the LCC market, some carriers, such as Air Berlin - which has been

struggling with a hybrid approach - are moving upstream towards more premium,

business-focused differentiation. Meanwhile, FSCs are expanding their premium and

loyalty offerings. Lufthansa will have to find its place as a group, and for each of its

brands, in an increasingly polarized and diverse market.

E. Industry Dynamics

i. Industry Evolution and Lufthansa’s Position

The air passenger industry has evolved to maturity. At this stage, there is low

differentiation among airline service segments and innovation is sustaining. The mix of

FSCs, LCCs, and hybrid carriers effectively cater to the spectrum of business, leisure,

and cost-conscious traveler needs. Innovation at this time is incremental, focusing on

aspects valued by prevailing customer segments, signaling a rise in buyer experience.

Airlines thus evaluate their strategies and re-position to best compete. This suggests


that although in the mature stage of industry evolution, this industry is not necessarily

stable. Additionally, market growth is largely a function of the buyers’ ability and

willingness to pay, which is greatly affected by macro environmental conditions (such as

economic health or a rise in terrorism).

Following the trend of the industry of modifying service offerings in order to serve

more customers and/or customer segments, Lufthansa, an FSC with an LCC subsidiary,

has chosen to add to its low-cost portfolio by fully acquiring Brussels Airlines.

Considering the stage of the industry, Lufthansa could choose to hone its FSC

capabilities to appeal to more business and comfort-minded customers. However,

because FSC market share has been diminishing as a result of LCC popularity (Error:

Reference source not found) (Israel, 2015), Lufthansa has decided to strengthen its

stance in multipoint competition by expanding its low-cost flight offerings.

ii. Competitive Dynamics

While regulatory requirements are strict, mainly advocating for the protection of

passengers, operating licenses, financial health, and safety regulations, Europe’s Single

Aviation Market bars monopolistic endeavors, enabling new entrants into the industry

(Thomas, Air Transport: Market Rules, 2016). Evidence of this can be seen in the low

industry concentration of CR5=47% (Lufthansa Group, 2016) and multitude of airlines

operating in Europe. As described in Competitor Analysis, many large competitors are

shifting to strengthen their positions in multipoint competition (FSC and LCC segments)

while some airlines continue to focus solely on one segment. Accordingly, airlines

provide different degrees of value to the customer (Error: Reference source not found).

In the late 1980s through the 1990s, the airline industry experienced disruption, first by

deregulation (Single Aviation Market) and then by LCC business models. However,

competitive dynamics today focus on service strategies that face little threat of

disruption in the foreseeable future.

F. External Analysis Conclusions

After an analysis of the environment surrounding Lufthansa, it may be a good

strategic move to strengthen its position in the LCC market with Brussels Airlines. The


industry is moderately unattractive in a stage of maturity, which works to Lufthansa’s

advantage as the largest airline in Europe. Macro environmental factors add complexity

to the airline industry, as do the fact that maintaining consistent profit margins is

challenging, but for now European airlines derive substantial benefit from low fuel prices

and low foreign currency deficits. Additionally, Lufthansa currently operates in both FSC

and LCC segments, making it an incumbent in both markets with solid financial

performance. Although Lufthansa’s position in the industry is diluted by the number of

competitors providing various levels of customer value, as an airline with one of the

largest market shares, it has options to diversify and/or add to its offerings.

III. (A) INTERNAL ANALYSIS - Lufthansa

A. Organizational Analysis

i. Goals & Objectives

According to Lufthansa’s 2015 Annual Report, the company’s main goal is to be

the “first choice in aviation for customers, employees, shareholders, and partners”

(Group Strategy, n.d.). In 2014 the company launched a long-term initiative to more

clearly define this overall goal and break it down into main objectives. The initiative is

called “7 to 1 - our way forward” and identifies seven fields of action that have been

applied to every individual business segment across the group. The Lufthansa Group

aims to be customer-centric and quality-focused, explore new concepts for growth, and

intentionally focus on innovation and digitalization. The group and all of its segments

should be effective and lean, and consistently work toward improving efficiency. Finally,

the group aims for strong culture, leadership and “value-based steering” (Lufthansa

Group, 2016, p. 15). Lufthansa’s overall strategy is to remain flexible and rely on their

ability to adjust capacity and resources to maintain a strong position as market

conditions change. The company aims to maintain a solid financial position and efficient

cost structure. Lufthansa expects faster than average growth in the low cost airlines and

service markets and are betting on these spaces for future growth (Lufthansa Group,

2016, p. 88).


Lufthansa sees the success of this initiative and strategy relying on three strong

pillars: their hub airlines, the Eurowings Group, and aviation services. The hub airlines

aim to provide marginal improvement based on their renewed cabin layouts, service

upgrades, optimized route network, fleet and strategic partnerships, and new

personalized offerings for customers. These actions are increasing value for customers

in the FSC market. The Eurowings Group and aviation services aim to provide profitable

growth moving forward. Eurowings has been positioned as a point-to-point offering in a

target market focused on price-sensitive customers. Lufthansa has structured

Eurowings to be scalable such that they have the flexibility to easily integrate new

partners into the group with the goal of becoming the third largest provider of point-to-

point flights in Europe, perfectly aligning with their acquisition of Brussels Airlines. The

company’s aviation services are actively exploring growth in cargo, MRO (maintenance,

repairs & overhaul services), catering and the financial services market. Lufthansa

believes that these business segments provide strong synergies with the rest of the

group and help buffer the cyclical nature of the airline business (Lufthansa Group, 2016,

pp. 8-9).

ii. Organizational Policies, Values, Culture, and Innovation

Lufthansa has 120,000 employees and uses a value-based approach to support

this workforce in continually increasing the company’s value across business cycles.

This value-based management system is seen as an integral part of the company’s

management, planning and controlling processes. Managers are given performance-

related pay that is directly linked to the company’s performance. The company’s human

resource department boasts: “Think the future. Dare to be different. Assume

responsibility” (Lufthansa Group, 2016, p. 62). Pilots, flight attendants and staffers are

all members of employee unions and the company aims to make long-term agreements

with these unions to support predictability and security for both the company and its

employees. However, since 2014 there have been thirteen union strikes by the pilot

union alone over a desire for higher pay, maintaining retirement benefits and a hope to

prevent low-cost expansion. The focus on preventing the expansion of Lufthansa into

the low-cost market was outside of the unions’ right to strike and the courts ruled them


illegal in September 2015 (Maushagen, 2015), but this clearly demonstrates a

misalignment over perceived value creation between employees and management.

Overall, employees on GlassDoor.com rate Lufthansa 3.4 out of 5, based on its culture

and values, work-life balance, senior management, compensation and benefits, and

career opportunities (Lufthansa Reviews, n.d.).

An intentional focus on innovation is identified as one of Lufthansa’s core

objectives; thus, research and development is supported at each individual business

segment (Lufthansa Group, 2016, p. 19) and also in a group-wide unit called the

Innovation Hub. However, it is unclear how much actual innovation results. According to

individual employee feedback, the decision making process is extremely lengthy and

bureaucratic, which greatly limits the ability to innovate. The company’s large size and a

lack of communication and cooperation between different airline groups and levels of

management also creates a traditional environment of “managing the status quo” and

prevents localized problem-solving (Lufthansa Reviews, n.d.). On a group-wide level,

the Innovation Hub is driven by the Strategy and Controlling departments who identify

opportunities during their regular strategy and planning processes. The hub uses

detailed strategy analysis and return on investment calculations, paired with a formal

risk management system, to assess opportunities (Lufthansa Group, 2016, p. 70). This

hub may lead to successful innovation, but the extensive and systematic risk

management process makes is unclear if the true space will truly support repeatedly

trying and failing. From the information publically available, it does not seem as though

Lufthansa’s policies and structure truly support the innovation it desires to achieve.

iii. Ethical & Social Responsibility

Lufthansa has a comprehensive corporate social responsibility (CSR) plan,

including community engagement, economic sustainability, corporate governance and

compliance, and climate, environmental, social and product responsibility. Further,

Lufthansa has committed to a United Nations Global Compact to support collectively

responsible company management. The group has a strategic environmental program

that aims to reduce emissions and have been involved in alternative fuel source and

climate change research for over twenty years. Lufthansa focuses on social and


humanitarian projects, providing relief in times of crisis and using their cargo business

unit to partner with emergency aid alliances, including Aktion Deutschland Hilft and

World Vision Deutschland (Lufthansa Group, 2016, p. 67). Finally, the group has

purchasing guidelines that require suppliers to fulfill various standards and make the

comfort and safety of their customers, crew and staff the utmost priority. These policies

tightly align with Lufthansa’s objective of using “value-based steering” and may help

lead to the development of alternative fuel sources and a competitive advantage in the

future.

iv. Organizational Structure

B. Strategic Position

i. Corporate Level

Lufthansa’s business portfolio consists of Passenger Airline Groups, Logistics,

MRO, and Catering. The Passenger Airline Groups consist of both hub and point-to-

point airlines. Lufthansa Cargo is Europe’s leading freight airline and is focused on

increasing simplification and digitalization of the logistics space (Lufthansa Group, 2016,

p. 50). MRO focuses on civilian commercial aircraft and is working on organic growth

and strategic partnerships (Lufthansa Group, 2016, p. 54). Catering covers the catering

of food in addition to in-flight sales and entertainment, in-flight service equipment,

consultancy services and the operation of lounges. The company is increasingly

focusing on adjacent markets (Lufthansa Group, 2016, p. 57).

A five-member executive board is responsible for managing the entire company,

and uses integrated financial management. Using a dominant-constrained corporate

strategy, the company is diversified around its dominant strength in the passenger

airline sector (See Competitors Business Level Strategies and Error: Reference source

not found for more details). The diversification of Lufthansa’s business portfolio results

from using a strategy-driven approach, as the units share numerous links and

synergies. Lufthansa uses its hub airlines as a cash cow, aviation services (including

MRO, catering and logistics) as star performers with a high market share in a high-

growth market, and hopes to shift Eurowings from a question mark into a star performer

(Error: Reference source not found). Financially, all of the company’s cash flows are


collected, centrally managed, and optimized for the company as a whole, ensuring that

they always have sufficient liquidity. The “7 to 1” initiative is implemented in all business

units and they are each managed accordingly.

ii. Business Level

Refer to Competitors Business Level Strategies for more information.

The Passenger Airline Groups are central to Lufthansa’s value creation and

consist of Lufthansa’s passenger airlines, Eurowings and now Brussels Airlines, Swiss

Airlines, and Austrian Airlines (Lufthansa Group, 2016, pp. 48-49). The business unit

has a shared goal of meeting the customer demands of safety, quality, punctuality,

reliability and professionalism. There are extensive synergies amongst the group, with

standardized and synchronized core processes, a uniform network and fleet

management system for all hub airlines, and joint decisions on capital-intensive

products. The Eurowings brand was established in August 2015 and is positioned to

target the price-sensitive, point-to-point leisure travel market in Germany, Austria,

Switzerland and Belgium (Lufthansa Group, 2016). Lufthansa has the goal of growing

Eurowings into the third largest point-to-point carrier in Europe (Lufthansa Group, 2016).

The overall business unit offers a lot of flexibility to customers (Lufthansa Group, 2016).

iii. Partnerships, Alliances, Joint Ventures and Acquisitions

As exhibited by their extensive reach and multi-faceted business portfolio,

Lufthansa has engaged in many partnerships, alliances and acquisitions in its 63-year

history (As Time Flies By, n.d.). For the purpose of this analysis, we will focus in on one

recent acquisition and their current alliances, joint ventures, and internal alliances within

the passenger airline group as a broader context for their acquisition of Brussels

Airlines.

Lufthansa has largely focused on building alliances, joint ventures and

partnerships as a means of expanding its network to improve customer experiences,

flexibility and incentives. Lufthansa founded the Star Alliance in 1997 to reduce costs

and utilize synergies. The alliance enables customers to make connections from one

airline to another for ease of travel, as well as having shared lounges, shared check-in


stations in the same terminals, and increased collective bargaining power (Star Alliance,

n.d.). Today there are 28 member airlines in the Star Alliance, including Brussels

Airlines.

Lufthansa has also developed Joint Ventures in other regions of the world to

expand its reach, including in North America, Japan, China and Southeast

Asia/Southwest Pacific. These entail such close coordination that Lufthansa must get

antitrust immunity from local competition authorities to proceed. The group works

together on capacity and price planning, joint marketing of flights, and revenue

management. These joint ventures allow Lufthansa to utilize the strength that their

partners already have in their respective markets (Lufthansa Reviews, n.d.). Finally,

Lufthansa has developed partner airlines that engage in codesharing agreements and

the honoring of each other’s frequent flyer programs, including Air Astana, Air Malta,

BMI Regional, Jet Airways und LATAM (Partner Airlines of Lufthansa, n.d.). These

partnerships expand Lufthansa’s reach into the Middle East, Northern Africa, India and

South America. Through the use of partnerships, joint ventures and alliances Lufthansa

has created a global flight network and positioned itself as the leading choice for air

travel in Europe (Excellent - Awards Won, 2016).

Under the Passenger Airlines Groups, Lufthansa acquired the majority ownership

of Germanwings in 2009 (Deutsche Welle Staff, 2008), similar to its recent move with

Brussels Airlines. In 2013 they began to transfer all of their non-hub traffic to

Germanwings, and Germanwings reported a positive EBIT for the first time in 2015,

seen as a great success by the Lufthansa Group (Lufthansa Group, 2016). Lufthansa

allowed the airline to continue functioning as an LCC in the market until they decided to

incorporate Germanwings into Eurowings in October 2015 (Airline Route, 2015). By

early 2016 the Germanwings airline was fully operating under the Eurowings name and

branding. The Brussels Airlines acquisition may be modeled after this experience,

increasing fleet size and flexible services to customers, while possibly being folded into

the Eurowings brand and operations. Brussels Airlines will also enjoy the benefit of

Lufthansa’s Joint Ventures and Partnerships that it did not previously have access to as

an independent airline company.


iv. VRIO, Value Chain & BCG Matrix Analysis

For Lufthansa’s VRIO analysis, refer back to Section II.

Lufthansa has created a sustained competitive advantage through its tightly

integrated complementary business units, strong brand reputation, dominant hub

presence at Frankfurt and Munich Airports, and investment in human capital. Through a

strong firm infrastructure (Error: Reference source not found) and domain expertise in

the passenger airline industry Lufthansa has expanded into the high-growth market of

complementary aviation services (Error: Reference source not found). The company

has used extensive partnerships, alliances and joint ventures to develop their hub

airlines into a cash cow, while being able to support new investment in Eurowings and

the rapidly expanding LCC market (Error: Reference source not found). Within this

space Lufthansa is working hard to standardize its fleet and take full advantage of the

economic efficiency opportunities and economies of scale that this enables, reducing

their overall costs. Lufthansa believes that Eurowings has the potential to become a star

performer and seems to be focusing current investments within this space.

III. (B) INTERNAL ANALYSIS - Brussels Airlines

A. Organizational Analysis

i. Goals & Objectives

Brussels Airlines looks to position itself as Europe’s hybrid carrier, offering low-

cost services with superior customer service through tailored product offerings.

Operating out of Brussels Airport (BRU), Brussels Airlines flies primarily in Europe,

Africa, and North America with its fleet of 49 aircraft (Fleet, n.d.). Staffed with over 3,500

employees, Brussels Airlines runs approximately 300 daily flights (Pressroom, n.d.) and

leads in its home hub in BRU with over 33% seat market share (Brussels Airport:

Ryanair Tests Itself, 2015). In 2014, Bernard Gustin, CEO of Brussels Airlines,

announced the airline’s strategy to compete through flexible, modular product offerings

and thus allow the customer to choose for themselves, thereby “differentiating,

segmenting and putting the customer at the heart of everything” they did (Brussels

Airlines Responds to Consumer, 2014). As cited in a presentation by Gustin, the four


pillars of Brussels’ commercial strategy can be described as products, loyalty, web

environment, and competitiveness, all supported by an emphasis on quality service

(Gustin, 2014). The company’s position as a low-cost, high-value airline helped the

company turn a profit in 2015, marking success to their hybrid strategy (Sciot, Daenen,

& Lemmes, 2016).

ii. Organizational Policies, Values, and Culture

Brussels Airlines reiterates its customer-focus culture in its mission statement

that reads: “We want to be the most personal airline, bringing people together and

making travel a pleasure” (Our Mission and Values, n.d.). This is supported by four

values: human, enabling, pleasure, and agile. Gustin highlights these values in the

organization by pushing on the “spirit of an SME” (small and medium-sized enterprise)

and their motto to “be number one, behave as number two” (Borstlap, 2014). Citing their

continuous and transparent communication through tools like Yammer, b.meeting,

b.gazette, and asktheceo, Brussels Airlines’ culture looks to resemble a smaller, more

decentralized organization. Through what Gustin calls their “credible leadership style”,

the company encourages fair feedback and no-blame policies, team empowerment, and

work floor managers. Such decentralization and transparency looks to support

innovation by enabling feedback from the bottom. From its Glass Door profile, all 18

reviews approve of the CEO, and the overall company score sits at a 3.8. These ratings

coincide with Gustin’s claims that many employees enjoy the work but cite it as “hectic”

and “hard work”. One comment states: “Most of the colleagues are giving 200% of

themselves, doing everything to give the passengers a great time.” Another review

comments that “innovation and creativity skills can be used” while another mentions the

company’s “great cost consciousness” (Brussels Airlines Reviews, n.d.). These

responses support directives that service is at the heart of Brussels Airlines’ strategy

and culture—the high-value side of the strategy. On the other hand, employees’ cost

awareness supports the company’s low-cost strategy. Together, employee activities

jointly support the direction set out by Brussels management.

iii. Ethical & Social Responsibility


In addition to their tight-knit culture, Brussels Airlines’ corporate social

responsibility programs include and encourage customers and employees to support

the African population and environment through its b.foundation, Bike For Africa, and

b.green programs. In 2009, Brussels Airlines was awarded the Environmental Award

from Brussels Airport for the airline’s leading role in creating a collaborative decision

making process at the airport, reducing air traffic nuisance (b.green, n.d.). Through its

Bike For Africa program, employees and volunteers raise funds on a mountain bike

excursion throughout parts of Africa (Bike for Africa, n.d.). These funds have been used

towards humanitarian projects that have assisted with maternity and childbearing units

in Muriel Africa and across the Gambia. Additionally, through the b.foundation,

employee charity initiatives are bundled with those of the company, allowing employees

a platform to support their causes. Customers are also able to contribute funds through

designated donation envelopes on long-haul flights (Creating Value for the African

Society, n.d.).

iv. Organizational Structure

The organizational structure at Brussels Airlines appears to be a traditional,

functional structure with a CEO, CIO, CCO and other C-level positions. Based on

employee reviews and Gustin’s presentation, Brussels Airlines’ autonomous culture has

helped create a dynamic and open environment, enabling it to respond quickly to

customer demands. As Gustin has strongly emphasized a need to adapt to customer

demands, this autonomous structure allows the company to adapt to changing trends

and closely embraces the SME spirit (Brussels Airlines Responds, 2014). The downside

to this organizational structure is that it may make it difficult to coordinate new

objectives or discover issues in the field, though this is countered with the company’s

communications tools and culture of transparency.

B. Strategic Position

i. Corporate Level

Brussels Airlines operates as a single business serving the European passenger

airline market and is owned by SN Airholding, a holding company for top-level


companies in the air transport sector. Prior to Lufthansa’s acquisition, SN Airholding

was 45% owned by Lufthansa AG, which the latter purchased in 1999. As part of this

transaction, Brussels Airlines gained access to the Star Alliance group, allowing its

customers to benefit from shared frequent flyer points and an improved destination

network (Star Alliance, n.d.). Similarly, the partnership with Lufthansa helped provide

Brussels Airlines “profit from additional customers for the connections” out of the

Brussels hub. With Lufthansa’s expansive network, the destinations offered to “Brussels

Airlines customers will rise by 133” after the acquisition (Organisation, n.d.). These

offerings help boost Brussels Airlines’ perceived value to customers, a major

component of Brussels’ service strategy.

ii. Partnerships, Alliances, Joint Ventures and Acquisitions

Through other partnerships, Brussels Airlines has been able to create added

value for customers. In one notable case, Brussels Airlines partnered with ID&T (a

Dutch entertainment company) to provide service to Tomorrowland, the world’s largest

electronic music dance festival located in Belgium. From this partnership, six A330

Airbus planes were branded with the Tomorrowland logo, outfitted with an external

sound system, and staffed with a live DJ. Over 17,000 flight packages were sold

targeting young, high-income passengers and helped Brussels Airlines garner over 266

million YouTube views from event videos (Boni, 2015). This partnership helped the

airline gain global brand exposure and attract a new customer segment.

Additionally, Brussels Airlines has teamed up with Microsoft in developing “The

Loft” at Brussels Airport, a premium, digital business lounge featuring a suite of

Microsoft’s latest products (Brussels Airlines Launches, 2014). With the introduction of

the new lounge, revenues for the facility increased by 65% and helped draw in 6,500

more guests per month. As part of the company’s desire to reposition its brand as high

quality without compromise, Brussels has made big strides using its partnerships.

iii. Business Level


Brussels Airlines focuses on a high-value, low-cost position by offering a broad

suite of flight packages and a growing network of destinations, differentiating itself as a

hybrid carrier. Flying primarily in Europe and Africa, Brussels Airlines also flies to North

America and India. On its European routes, Brussels Airlines offers four products:

check&go, light&relax, flex&fast, bizz&class (Brussels Airlines Unveils, 2014).

Check&go targets price-sensitive customers by providing flights as low as €69 but does

not include checked baggage or modifiable tickets. Light&relax targets the next tier with

reserved seating and checked baggage. Flex&fast, the next tier up, includes priority

check-in and seating along with onboard food and refreshments. Bizz&class, the

highest tier, gives passengers access to the Brussels Airlines lounge along with a fine

dining experience and a free middle seat. This range of products allows Brussels

Airlines to compete as a low-cost carrier in the European market but also differentiate it

through its broad line, customization, and quality value drivers.

Similarly, on its long-haul flights, Brussels Airlines has three products targeted

toward different customer preferences: Economy Privilege, Economy, and Business

(Economy, n.d.). In order to provide further value, Brussels Airlines want to broaden its

market scope by adding new destinations (a key part of its growth strategy). In 2015, 14

new routes were launched and another 9 were added in the summer of 2016.

iv. VRIO & Value Chain Analysis:

For Brussels Airlines’ VRIO analysis, refer back to Section II.

Customer service and increased value drivers are at the core of Brussels

Airlines’ value chain (Error: Reference source not found). Brussels Airlines continues to

add additional destinations year after year, constantly improving the travel convenience

it provides to customers. In its efforts to offer high-value service at the same price,

Brussels Airlines taps into its Belgian partnerships to fortify its position as the country’s

flagship airline, offering healthy local food and Belgian beer on its flights (Brussels

Airlines Teams Up, 2016).

IV. ACQUISITION ANALYSIS

A. Ally or Acquire?


As demonstrated in Error: Reference source not found, this analytical framework

recommends acquisition.

B. Porter’s Tests

i. Industry Attractiveness Test

Brussels and Lufthansa are already functioning within the same industry. Based

on our industry analysis (Error: Reference source not found), the scheduled air

passenger industry is moderately unattractive. However, because Lufthansa is already

a major player in the still-growing industry, it is justifiable for Lufthansa to further expand

in it. Consolidation for Lufthansa increases its overall market share, which is critical in

the highly-competitive LCC market. The additional 49 aircraft from Brussels Airlines will

increase market scope for Eurowings and allow it to offer extensive service across

Western Europe, making it the third largest point-to-point carrier in the region (Weiss,

2016). Brussels Airlines’ prime access to Brussels Airport adds an additional

competitive advantage as airlines compete for gate space at the main European hubs.

The acquisition of Brussels Airlines also expands Lufthansa’s flight offerings with

access to the African market.

ii. Better-off Test

Based on our analysis of the most likely synergies (Error: Reference source not

found) and the post-acquisition VRIO analysis (Error: Reference source not foundError:

Reference source not found), we believe that both Lufthansa and Brussels airlines will

be better off after the acquisition.

iii. Cost-of-Entry Test

The acquisition price of Brussels Airlines is linked to performance-related factors,

but the price ceiling for the acquisition is set at 250 million Euros (Lufthansa Takes a

Strategic, 2008). Assuming Lufthansa pays the maximum possible amount for the

remaining 55% of Brussels Airlines, 250 million Euros, our calculations show that this

acquisition will still pass Porter’s cost of entry test (Error: Reference source not found).

Based on a 250 million Euro acquisition price, the derived fair value of Brussels would


be 454 million Euros (Exhibit T) while the total fair value of Brussels’ equity based on a

discounted cash flow analysis is 565 million Euros (Exhibit AB). Based on discounted

cash flow analysis, the fair value of 55% of Brussels’ equity is €310 million (Exhibit T).

This analysis was performed before factoring in any synergies. Further, the fair value of

equity represents a conservative valuation measure relative to enterprise value,

because debt borrowings are subtracted in order to calculate value available to

shareholders. Since 310 million Euros is greater than the maximum acquisition price of

250 million Euros, this acquisition passes the cost of entry test.

C. Combined Resources & Capabilities, V-C, and Industry Conditions

Through a combined VRIO analysis, Lufthansa will be able to leverage its

existing market presence and fleet size to expand its scope into Africa, a gap in its

current network. Brussels Airlines offers a strong position at the Brussels hub in which

its existing partnership with the airport has secured it the largest airport market share

and gate access.

Based on the BCG Matrix analysis (Error: Reference source not found),

Lufthansa may use the acquisition of Brussels Airlines to move Eurowings from a

question mark to a star performer. The missing piece for this move is Eurowings gaining

a large market share and the combination of their two fleets enables Eurowings to meet

its desired goal and move into the star performer category. This is based on the

assumption that Lufthansa decides to fold the majority of Brussels’ fleet into Eurowings

and that the low-cost, point-to-point market continues to grow at a high rate. However, if

Brussels Airlines is entirely folded into Lufthansa’s offerings, Lufthansa risks losing the

added brand recognition and positive public opinion that Brussels Airlines brings to the

acquisition (Error: Reference source not found). Eurowings is not perceived very

favorably in the market, rating 4 out of 10 for overall reputation based on customer

reviews (Eurowings Customer Reviews, n.d.). On the other hand, Brussels Airlines has

a rating of 6 out of 10 and also has won several awards for best short-haul airline

(Brussels Airlines Customer Reviews, n.d.). This tradeoff is something that Lufthansa

should critically think about when deciding their short- and long-term strategies for the

acquisition.


Based on our V-C Analysis of Lufthansa after the acquisition of Brussels Airlines

(Error: Reference source not found), the overall value that Eurowings brings to

customers increases. The acquisition of Brussels will provide greater travel convenience

by adding flight destinations in Africa and increased offerings throughout Western

Europe. The acquisition may also increase Eurowings’ premium service offerings

because of Brussels’ more flexible product packages, including business class services.

Overall, the post-acquisition analysis shows Lufthansa’s Eurowings (with the acquisition

of Brussels Airlines) as offering greater value to customers at the same price. In our

analysis we assumed that price would remain unchanged for Eurowings as a worst case

scenario. However, due to expected synergies, the acquisition would likely lead to

decreased costs, enabling Eurowings to drop its price and make its positioning even

more competitive.

D. Linking Corporate to Business-Level - Part C and D (Scenario analysis, NPV calculations)

i. Discounted Cash Flow Analysis

In order to assess the value of Lufthansa’s acquisition of Brussels Airlines, a

discounted cash flow analysis was used to calculate both standalone valuations for

Lufthansa () and Brussels (Exhibit AB), and a combined firm valuation (Exhibit AC - EE).

The combined firm valuation is presented in three different scenarios. First, the

combined firm valuation is calculated under a “worst case”, “better case”, and “best

case” scenario. Furthermore, each case scenario is assessed over a variation of five

different discount rates (Exhibit AC - EE). The base discount rate, weighted average

cost of capital (WACC), is assumed to be equal to Lufthansa’s WACC of 5.12%

because Brussels represents a relatively small acquisition in comparison to the size of

Lufthansa. The first step in determining the WACC was to calculate Lufthansa’s capital

structure, which was found to be 55.38% debt and 44.62% equity (Lufthansa Group,

2016). Next, Lufthansa’s cost of equity was found to be 8.32% using the capital asset

pricing model (CAPM). Lufthansa’s annual report provided the rate of debt as 3.4% and

tax rate as 25%, which allowed us to fill in the remainder of the WACC equation and

arrive at 5.12% (Lufthansa Group, 2016). For Lufthansa, the forecasted revenue growth


rate was determined using the average of the historical compound annual revenue

growth rate, professional analyst estimates, and the projected economic growth rate for

the European region. For Brussels, no analyst reports were available since Brussels is

privately held, so only the firm’s historical compound average revenue growth rate and

the projected economic growth rate for the European region were used to determine the

forecasted revenue growth rate. Other line items were projected as a percentage of

revenue.

There are multiple equations that exist which estimate a firm’s free cash flow. To

determine the method of arriving at an estimated free cash flow for each firm in this

case, the limited information available for Brussels had to be considered to select an

equation which could be derived from published data. To estimate free cash flow, we

started with earnings before taxes, added back net interest, taxes, depreciation,

amortization, change in working capital, and net capital expenditure.

Once Brussels is acquired, four likely synergies were identified which would

benefit the combined firm (Error: Reference source not found). We expect up to a

0.75% reduction in combined firm operating costs due to fleet standardization and

reduced selling, general, and administrative expenses due to Brussels sharing costs

with Lufthansa. Access to new markets is expected to provide a base increase of up to

1.5% and route optimization will provide revenue synergies of up to 0.5% of combined

firm revenue.

ii. “Worst, Better, Best Case” Scenarios

In the “worst case” scenario, it is assumed that a combined firm will operate at a

level equivalent to that of Lufthansa and Brussels operating separately. A WACC of

5.12% is assumed, but none of the identified synergies are expected to be realized.

This represents a bare minimum of what Lufthansa can expect to extract from this

transaction, in terms of firm value. This scenario provides a combined firm enterprise

value of 19.888 billion Euros and a total fair value of equity equal to 13.447 billion Euros

(Error: Reference source not found). We estimate the likelihood of this outcome as 15%.


Our estimates indicate that the most likely scenario will be what we define as the

“better case” scenario. The “better case” scenario assumes a WACC of 5.12% and that

50% of the identified synergies will be realized. This imputes a 0.375% reduction in

combined firm operating expenses, a 0.75% base increase, and a 0.25% increase in

combined firm revenue. This leads to an estimated combined firm enterprise value of

27.163 billion Euros and a total fair value of equity equal to 20.722 billion Euros (Error:

Reference source not found). We estimate the likelihood of this outcome as 75%.

The “best case” scenario represents what we foresee as the best possible

outcome, which is within reason, based on current estimates. This scenario assumes a

WACC of 5.12% and 100% of the identified synergies are realized. If 100% of identified

synergies are realized, the combined firm’s operating costs decrease by 0.75%,

revenues increase by 0.5%, and there is a base increase of 1.5%. This is representative

of the most aggressive estimates that would be justifiable by Lufthansa’s management

team. The combined firm grows to an enterprise value of 34.439 billion Euros and the

total fair value of equity is equal to 27.998 billion Euros (Error: Reference source not

found). We estimate the likelihood of this outcome as 10%.

V. RECOMMENDATIONS

The acquisition of Brussels Airlines and its assets gives Lufthansa a variety of

strategic opportunities. The following analysis summarizes Lufthansa’s most suitable

short- and long-term options, and explains which strategy we recommend and why.

A. Short-Term Recommendations

As Lufthansa operates in both the LCC and FSC spaces already, the soon-to-be

acquired airplanes, labor, and other resources can be used in very different ways. Our

short-term recommendations align with the different strategies Lufthansa could pursue,

and are as follows.

i. Revise Eurowings’ Product Mix to Learn From and Mimic Brussels

This recommendation addresses Eurowings’ poor performance by having the

company mimic Brussels Airlines’ best practices. Brussels has significantly lower


operating costs, all around, and we expect Eurowings to be able to save a lot of money

by learning from them. In the short-term, Eurowings would formally change its company

values and operations to focus on providing more value for the price. In actions, this

would mean great customer service and a seamless booking and flight experience. This

would also mean synchronizing certain offerings between Brussels Airlines and

Eurowings to increase consistency and variety for consumers. Brussels employees can

host training sessions for Eurowings staff during this time of product mix revision, and

managers from both organizations can meet and learn from one another.

The recommendation to assimilate Eurowings’ products and services to match

Brussels Airlines is aimed at having two high-performing low-cost airlines instead of

one. This recommendation could help streamline operations and a merger down the

road.

ii. Standardize Eurowings Fleet to Improve LCC

The second recommendation expands upon Eurowings’ LCC strategy.

Eurowings, has the worst CASK of its competitors and needs to overhaul their

operations (Error: Reference source not found). With new airplanes being acquired

through the purchase, Lufthansa could choose to use them to focus on their LCC

strategy instead and standardize their low-cost fleet. Eurowings currently operates four

different types of aircraft from three different manufacturers: Airbus, Boeing, and

Canadair (Eurowings Fleet Details, 2016); 26 of their 36 aircraft are Airbus A320s and

A330s. Brussels similarly operates a variety of aircraft, with a total of 18 of their 50

aircraft being A320s and A330s (Brussels Airlines Fleet Details, 2016).

This acquisition gives Lufthansa the ability to standardize Eurowings’ low-cost

fleet by trading planes between the carriers. Brussels Airlines would swap some of its

A320s and A330s for Eurowings’ non-Airbus aircraft, completing the set. This change

would ideally have little to no impact on value, but should reduce Eurowings’

maintenance, training, and purchasing costs after standardization is complete. As every

process in an LCC is scrutinized to reduce waste and optimize performance, having a


standardized fleet is critical. This could reduce required inventory of spare parts, and

minimize interruptions caused by aircraft delays, unscheduled maintenance, layovers,

or issues of flight crew familiarity of the aircraft. This recommendation would require

Brussels to accommodate substituting airplanes, but otherwise would not include any

other changes to the company.

iii. Revise Offerings to Support FSC Operations

Alternatively, the third short-term recommendation would allow Lufthansa to

focus on their FSC model by assimilating Brussels’ offerings to match Lufthansa’s.

Lufthansa is a dominant player among the European FSCs, and acquiring market share

through an acquisition is both difficult and a smart move for this crowded industry. This

recommendation would attempt to capture more of the FSC segment by revising

Brussels Airlines’ product and service mix to compete with FSCs alongside its parent

airline Lufthansa. Brussels staff would learn about Lufthansa’s operations and best

practices through information sharing. In the short term, some of the longer Brussels

routes can be outfitted with first class and business class. The sooner this happens, the

sooner Brussels can start accepting first class fares. Customer service improvements

and a greater variety of in-flight amenities and food choice would also be strongly

encouraged. This recommendation could also help streamline a merger in the future.

B. Long-Term Recommendations

The hub and aircraft Brussels Airlines adds to Lufthansa Group can be devoted

to any of Lufthansa’s existing airlines. The three long-term strategies follow suit with the

main focuses of the respective short-term strategies.

i. Convert Eurowings to Hybrid Model & Merge with Brussels

This recommendation expands on the hybrid strategy, once Eurowings is more

profitable and reputable, by folding Brussels Airlines into the Eurowings name. Merging

the two companies would expand the fleet size of Lufthansa Group’s hybrid carrier, and

thereby is investment in the strategy.


This move would fully optimize and combine operations, reducing operating costs

and increasing value to consumers by expanding the rewards program, adding

destinations, and increasing service capacity. With a focus on the hybrid airline model,

Lufthansa stands a good chance of increasing its overall market share post-acquisition.

This recommendation also involves consolidating routes to minimize

unnecessary and redundant flights.

ii. Fold Brussels into Eurowings to Expand LCC Model

The second recommendation focuses solely on the LCC strategy in the long

term, instead of a hybrid. Merging Brussels into Eurowings will simplify Lufthansa

Group’s portfolio of current strategies. The aircraft from Brussels Airlines would be

rebranded and operated by Eurowings, in a lean, low-cost environment.

The temptation to invest heavily in LCCs is strong because of the higher average

profit margins (See Profit Margins in Error: Reference source not found). However, this

recommendation doesn’t completely build on the value-providing expertise of Brussels

Airlines; Eurowings will be competing to become a price leader, thereby cutting less

important, low-value-adding expenses. However, LCCs are taking more of the market

share away from FSCs recently. Evidence shows the LCCs’ market share is still

expanding, having nearly doubled between 2005 and 2013, from 17% to 32% (Error:

Reference source not found). This recommendation seeks to invest in the LCC strategy

more to capture grab more new customers who value inexpensive fares.

iii. Fold Brussels into Lufthansa to Expand FSC Model

The final recommendation folds Brussels Airlines into Lufthansa’s full-service

airline. This would help Lufthansa expand its route offerings and capacity, thereby

increasing its market share in the FSC sector. This option could slightly increase

Lufthansa’s value to customers with the new destinations and added capacity. This

recommendation also takes advantage of the recent popularity and great performance

of the Lufthansa airline (Error: Reference source not found)

One main objective would be to take advantage of Lufthansa’s economies of

scale to save even more on costs while increasing their fleet size and further distributing


their overhead costs. Brussels’ operations would be integrated into Lufthansa and

streamlined where possible to implement any possible synergies; like joint corporate

training seminars, centralized HR, accounting, and finance. These cost savings would

be realized after Brussels’ aircraft have been rebranded and converted to mimic

Lufthansa aircraft. This recommendation is necessary to keep the Lufthansa brand

competitive and growing in the FSC segment. With the FSCs’ share in Europe’s

passenger airline market shrinking each year, though, (Error: Reference source not

found), we don’t choose this as the best recommendation.

C. Strategy Implementation

i. Short-Term Implementation

We recommend that Lufthansa pursue short-term recommendation one to have

Eurowings learn from and mimic Brussels Airlines. We believe Brussels’ strong

reputation and V-C positioning presents greater opportunity than Eurowings with the

LCC strategy. Lufthansa is an expert at being a full-service carrier and has not been

able to achieve true low cost through its attempt at an LCC in Eurowings. The hybrid

model seems better aligned with Lufthansa’s core competencies and has greater

potential for success.

Execution

To implement this recommendation, Eurowings will formally change its vision,

values, and processes, soon after the acquisition, to mimic the way Brussels works and

operates. Brussels provides lounge access at their hub airport and engages in

temporary partnerships to boost sales and reputation, like their Tomorrowland flight

package (Boni, 2015).

To execute, Eurowings would also change the different seat packages, benefits,

and products that Eurowings sells to mimic Brussels’ offerings, like adding the

Bizz&class ticket fare with lounge access and fine dining. Additionally, certain staff and

managers would meet and absorb knowledge and insights from the other company’s

practices related to employee training, customer service responses, customer purchase

experiences, and supply chains. Eurowings will be tasked with pursuing some of the


easiest-implemented synergies quickly to reduce costs and replicate the product mix.

With synchronized operations and inter-organizational learning, Eurowings’ brand

loyalty and perceived value is expected to rise.

Also, as discussed previously, Brussels has a better reputation than Eurowings,

and provides much more value to consumers. Mimicking Brussels’ success in the hybrid

carrier space seems like a strong move forward and, this hybrid strategy is flexible

enough to allow Lufthansa to pivot strategies if the market changes in the future. This

recommendation provides Lufthansa the most flexibility while not jeopardizing Brussels’

current success or changing the customer experience. It simply prioritizes easy cost-

cutting measures and supports the hybrid model offerings.

Timeline

See Exhibit AF for a visual timeline. Employee workshops and knowledge

sharing will commence within the first couple months after the acquisition is finalized.

Senior management will communicate the product mix changes to all employees, and

train everyone to the same standards. Training is expected to finish within six months of

the communication, so that measurable changes to value and cost drivers should be

apparent within a year of the acquisition date. Airplane modifications and infrastructure

changes, like onboard screens and the online booking system, will take place during the

six-month employee training period as well.

Three months before these new changes take effect, a press release will be

published to explain the nature and extent of the coming changes. This information will

be published in a way that is simple for customers to understand, and changes will only

apply for new tickets booked after the effective date. All new advertising will

communicate the added value and variety these changes bring to Eurowings

customers.

Special attention will be given to ensure a consistent and satisfactory customer

experience, so as to retain as many customers as possible through this change. We

expect Eurowings’ operations and performance to be similar to Brussels within two

years of the acquisition date.


V-C Changes

The addition of more varied flight offerings and better customer service in the

hybrid model is expected to yield more positive booking and flight experiences for

customers. Thus, these changes will increase the perceived value to the customer.

Implementing these changes will increase costs at the outset because some

investments in fleet modification and operational changes are necessary. These will be

one-time costs, though, and should not increase typical operating expenses. As

Eurowings succeeds to cut costs and improve its reputation over time, the company’s V-

C disparity will also improve. Performance metrics (like profit margin and CASK from

Error: Reference source not found) will be monitored during the full two years to

evaluate the short-term success of revamping Eurowings as a hybrid.

ii. Long-Term Implementation

We recommend that Lufthansa Group pursue long-term recommendation one

because the hybrid model utilizes the core competencies of both the Brussels brand

(with its low-cost operational efficiency) and the Lufthansa brand (providing quality

service and high value). In the short-term Eurowings adopted the values that made

Brussels Airlines successful, including quality customer service, competitive prices, and

a diverse product mix. If marketed properly in the first two years of the acquisition,

consumers’ perception of Eurowings will become more favorable as the company

provides the same value that customers have come to appreciate and expect from

Brussels Airlines. Once Eurowings’ brand perception has recovered, Eurowings will

absorb Brussels.

Execution

To execute this strategy, Eurowings and Brussels will publicly announce a

merger of the two companies. A new marketing campaign will inform the public that the

operations of the two carriers will be combined along, with their fleets. It will explain the

nature and extent of the coming changes in addition to the benefits customers can

expect to notice, like reduced costs, consistent flight experiences, and shared rewards

programs between airlines.


Core operational staff, like accounting, finance, sales, and customer service, will

all be relocated to one location where staff can work with and learn from each other,

and the company can maintain consistent training and standards.

Timeline

See Exhibit AG for a visual timeline. Performance metrics will be monitored for

the first two years before merging the companies, just in case Eurowings isn’t operating

cost-effectively yet. The merger will be drawn up and announced within two and a half

years of the initial acquisition date, contingent on positive brand recognition. The two

airlines should not merge until Eurowings’ brand perception is on par with Brussels.

Once announced, the merger will be executed within the following year. During this

time, Eurowings and Brussels Airlines’ previous routes will be analyzed and

consolidated to maximize performance and selectively eliminate redundant or under-

performing flights. Final route timetables and popularity will be monitored and adjusted

as needed for the following year, as will the number of staff needed to operate

effectively.

V-C Changes

This recommendation fundamentally expands Eurowings to streamline

operations and costs. Centrally-managed operations will help save money and reduce

fares, while the focus to provide more value to consumers continues. These synergies

would reduce training costs and increase efficiency as employees would be cross-

trained to provide support for both airlines. Thus, we expect a measurable reduction in

C and perhaps a slight increase in V. The expanded destination network, optimization of

routes, and focus on customer service should provide more value to customers, though

estimating the change is difficult.

D. Corporate Social Responsibility and Ethical Decision-Making

As stated in the prior Corporate and Social Responsibility Sections, both

Lufthansa and Brussels Airlines partake in a number of social and ethical initiatives. As

such, the acquisition of Brussels Airlines may lead Lufthansa to carry forth existing

causes that the firm champions. These are most notably programs to support


humanitarian projects in Africa and, uniquely, charities chosen by Brussels Airlines’

employees. The recommendations that follow aim to preserve and build upon each

firm’s legacy, with regard for the current state of the industry.

In the short term, Lufthansa should highlight its commitment to the United

Nations Global Compact, striving for responsible company management. With the

acquisition, Lufthansa will endure a period of scrutiny from many sources, including its

internal affairs, Brussels employees, regulatory entities, and the public, making it

imperative for the firm to practice good management. In an effort to promote unity, and

in light of tragic events involving plane crashes and/or terrorism, Lufthansa may benefit

from launching a company-wide campaign on safety. This campaign would re-affirm

every employee’s commitment to safety and serve as a reminder to customers that

safety is the company’s top priority. Because safety is also at the forefront of each

passenger’s mind, Lufthansa may also gain goodwill by promoting this message.

In the long term, Lufthansa could consider expanding its social cause platform.

Brussels Airlines currently has a program where passengers can contribute to causes

via donation envelopes on long-haul flights (Creating Value for the African Society,

n.d.). Lufthansa could easily employ a similar practice on their flights, with interactive

displays that passengers can peruse to learn about the charities and social initiatives

that Lufthansa supports. Passengers would then have the option to donate to the cause

of their choice, all done in the duration of a flight. This endeavor embodies many

benefits. Lufthansa could achieve a more socially-responsible reputation, raise more

money for the causes, educate the public, and possibly become a preferred airline for

its initiative. For those interested, it might also help customers pass the time in flight

more quickly, learn about global perspectives, and feel good that they are helping a

worthy cause.

VI. CONCLUSIONS

Lufthansa is a major name in the European airline industry and generally has a

good reputation among consumers. This acquisition will potentially allow the company

to expand its market share in one of three sectors: FSC, hybrid, or LCC. Based on the

industry trends and competitor performance, purchasing Brussels Airlines is a good


move for a dominant player at this point in time. Due to Lufthansa’s large commitment

and presence in the airline industry, their next natural step is expanding their operations

to take market share from their competitors. As the shift in passengers’ demands

gravitates toward the hybrid model, and as global air travel is still a growing market,

Lufthansa is well positioned to expand and succeed in capturing new customers. As far

as the value for investors, we don’t see the stock price increasing significantly, but we

would be cautiously optimistic for high returns.


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VIII. MAIN APPENDIX

Exhibit A – Industry Diagram

Exhibit B – Six Forces Analysis (Levels 1 and 2)

Levels 1 and 2 Analyses for Barriers to Entry

Factors Underlying Barriers to Entry

Effect on Industry

Score (1-

5)Weigh

t RationaleLimit Pricing Moderately

Unfavorable4 0.1 In the low-cost carrier industry, incumbent firms are

already operating at low prices. At this time, incumbents are not known to be utilizing limit pricing, as incumbents are focused on grabbing market share from full service carriers.

Capital Costs Favorable 1 0.15 The total European airline industry (full service carriers and low-cost carriers) is estimated to be around €110 billion in 2014 (Air: Internal Market, n.d.). The return on invested capital stands at 9.8% in 2016 (News Brief, 2016), a high since 2000. That being said, capital costs are high as costs include purchase/leasing of planes, services, and technology, as well as gates at airports. For example, an Airbus 320 aircraft, popular for short-haul flights, is on the order of €92.5 million (Airbus, 2016).


Factors Underlying Barriers to Entry

Effect on Industry

Score (1-

5)Weigh

t RationaleIncumbent Dedicated Assets

Moderately Favorable

2 0.15 The most critical asset that incumbents may tie up is airport channels. The IATA and EU have developed methodology and regulations to fairly allocate slots to airlines. This results in the inability for a single airline to monopolize the most critical asset. Another critical asset is the availability of commercial aircraft for purchase. As of mid-2015, Airbus and Boeing (the largest commercial aircraft manufacturers) are at a 9-year backlog (Trimble, 2015), making it difficult for a newcomer to purchase planes.

Restrictive Government Policy


2 0.1 The aviation industry is highly regulated. There are several regulatory entities and programs including the European Commission, EU, IATA, Single Aviation Market, and others. Regulations revolve around operating licenses, price transparency, public service obligations, distribution or air traffic between airports, environmental and emissions, etc., however, allow for any commercial airline to enter the aviation market, subject to rule compliance.

Supply-side Economies of Scale

Favorable 1 0.15 Economies of scale are critical for success in the aviation industry. Looking at passenger transportation across the board, achieving high utilization capacities per plane in flight is necessary to offset expenses incurred from capital expenditures, fuel, labor, technology, maintenance, taxes, and airport fees.

Barriers Independent of Scale

Unfavorable 5 0.1 There is low differentiation amongst airlines, further exemplified by the encroachment of low-cost carriers into the market share of full service carriers (Israel, 2015).

Customer Switching Costs

Unfavorable 5 0.15 Customer switching costs are low as each flight can be booked independently.

Demand-side Benefits of Scale (Network Externalities)

Moderately Unfavorable

4 0.1 The effect of network externalities is present to a degree - mainly from travelers in groups who want to stay together. However, the benefits are short-term as the buyer’s willingness to pay as a result of network externalities for a certain airline does not necessarily imply loyalty for his/her next flight.

Overall Barriers to Entry Effect on Industry

Neutral 2.85 1 More favorable factors such as capital costs and supply-side economies of scale are balanced by unfavorable customer switching costs and low differentiation.

Levels 1 and 2 Analyses for Threat of RivalryFactors Underlying Threat of Rivalry

Effect on Industry

Score (1-

5)Weigh

t RationaleIndustry Concentration

Unfavorable 5 0.15 The industry concentration for the airline industry as a whole is a low 47% (Lufthansa, Air France-KLM, International Airlines Group, easyJet, and Ryanair) (Lufthansa Group, 2016, p. 22). This low concentration suggests a strong threat to industry profits.

Industry Growth Rate & Demand


2 0.15 The industry demand is expected to grow by 6.9% in 2016, along with an anticipated capacity growth of 7.1% (Airlines Continue to Improve, 2015). This puts


Factors Underlying Threat of Rivalry

Effect on Industry

Score (1-

5)Weigh

t RationaleConditions capacity growth slightly ahead of demand, thus

ensuring that there is enough capacity to meet demand. It should also be noted that demand has been growing at an increasing rate in the past few years (Airlines Continue, 2015). However, demand has also been projected to increase by 50% by 2035, with estimates of 12% demand unable to be met (Airport Capacity, n.d.).

Exit Barriers Unfavorable 5 0.1 Exit barriers are high due to presence of unions, sunk costs, service agreements with airports, cost of layoffs (as well as inability to lay off key members of the workforce - flight and maintenance crews). The likely “exit” method for an airline would be acquisition by a larger airline.

Commitment to Preserving Market Positions

Unfavorable 5 0.15 Rivals are very committed to maintaining and growing market positions.

Diversity of Competitors

Unfavorable 5 0.1 Firms have different strategies when competing, however, regulations mandate playing by the same set of rules.

Degree of Product Differentiation

Unfavorable 5 0.15 Product offerings can be differentiated in terms of luxury versus cheap/no frills. However, within these service segments there is low differentiation across the board.

Fixed Costs/Variable Costs Ratio

Unfavorable 5 0.1 Variable costs for airlines are low. Fixed costs account for the bulk of an airline’s operations, such as aircraft purchase, maintenance, fuel per plane, amenities, airport fees, etc. Thus, the ratio of fixed costs to variable costs is high.

Is capacity added in large increments?

Favorable 1 0.1 Capacity for an airline is dictated by the number of aircrafts housed under the firm, as well as the frequency of flights. Capacity is typically added per plane, but airports are a big regulator of capacity. Due to the Worldwide Slot Guidelines (Worldwide Airport Slots, n.d.) seeking to distribute and maximize capacity utilization and efficiencies at airports, airports present a bottleneck to capacity. Thus, capacity is not added in large increments.

Overall Threat of Rivalry Effect on Industry


4.15 1 Low industry concentration, low differentiation among competitors, exit barriers, and competitor commitment to preserving market positions drive unfavorable score.

Levels 1 and 2 Analyses for Buyer Power Buyer Group: Air PassengersFactors Underlying Buyer Power

Effect on Industry

Score (1-

5)Weigh

t Rationale

Buyer Group: Air PassengersConcentration Ratio

Unfavorable 5 0.2 The concentration ratio of air passengers in the air passenger industry is 100%, greater than the industry concentration of 47% (Lufthansa Group, 2016, p. 22).


Factors Underlying Buyer Power

Effect on Industry

Score (1-

5)Weigh

t RationaleMarket Growth Rate

Unfavorable 5 0.15 The market growth rate for Europe is projected to be 2.7% (Air Passenger Forecast, 2015), a slower growth rate compared to other regions in the world.

Are there a few high volume buyers – evaluate the % of Supplier’s Product Sold to the Buyer

Favorable 1 0.05 The industry is projected to be on the order of 1.4 billion passengers in Europe during 2016 (Air Passenger Forecast, 2015). It can be inferred that sales are distributed amongst many buyers.

Strategic Importance of Buyers to Suppliers

Neutral 3 0.05 Airlines are somewhat dependent on the concentration of buyers within a region, to make decisions for route demand.

Strategic Importance of Suppliers to Buyers


2 0.15 Airlines are important to air passengers due to added value over other modes of transportation (car, train, bus, etc.).

Is capacity added in large increments?

Favorable 1 0.05 Capacity is not added in large increments, mainly due to Worldwide Slot Guidelines (Worldwide Airport Slots,n.d.) and bottlenecks at airports.

Threat of Backward Integration

Favorable 1 0.05 Air passengers do not pose a backward integration threat to airlines.

Switching Costs Unfavorable 5 0.15 Switching costs are very low for air passengers. Travel is paid for on a per flight basis.

Differentiation of Products/Services

Unfavorable 5 0.15 There is low differentiation within segments of full service carriers and within low-cost carriers.

Overall Buyer Power Effect on Industry


3.85 1 Buyer power is driven by low switching costs and low differentiation among airlines.

Levels 1 and 2 Analyses for Supplier Power Supplier Groups chosen for Analysis: Airports, Aircraft Manufacturers, Maintenance and Repair Operations (MRO), Fuel-related Suppliers, and Other Service SuppliersFactors Underlying Supplier Power

Effect on Industry

Score (1-

5)Weigh

t Rationale

Supplier Group: AirportsConcentration Ratio


2 0.1 In the top five airports with the highest passenger traffic in the first two months of 2016 (Heathrow - London, Charles de Gaulle - Paris, Frankfurt Main, Schiphol - Amsterdam, and Barajas - Madrid) totaled 25% of passengers flying in Europe. This represents a lower concentration ratio than the industry


Factors Underlying Supplier Power

Effect on Industry

Score (1-

5)Weigh

t Rationaleconcentration of 47% (Lufthansa Group, 2016, p. 22).

Strategic importance of the supplier group to the industry (and vice versa)

Neutral 3 0.05 Airlines are very important to airports. They share a symbiotic relationship.

Switching Costs Unfavorable 5 0.15 Switching costs are high, due to the loss of traffic/business an airline would experience if it terminated agreements with certain airports.

Threat of Forward Integration

Favorable 1 0.1 Airports do not pose a credible forward integration threat.

Differentiation of Supplier’s Products/Services

Unfavorable 5 0.3 The most critical differentiator for airports is geographic location and size.

Substitutes for Supplier’s Products/Services

Unfavorable 5 0.3 For an airline, there is no substitute for an airport.

Individual Supplier Power Effect (Airports)


4.2 0.3 Airports are essential to airline operations.

Supplier Group: Aircraft ManufacturersConcentration Ratio

Unfavorable 5 0.3 The leading commercial aircraft manufacturers, Boeing and Airbus, present a duopoly in the marketplace (C., 2014). It should be noted that China and Russia have entered into a joint venture to develop wide-body commercial aircrafts in an effort to take on Boeing and Airbus (Bloomberg News, 2016) as well as others in Brazil and Canada (C., 2014).


Neutral 3 0.05 Purchasing/leasing of commercial aircraft is critical to airlines’ business, but the aircraft manufacturers also depend on airlines for revenue.

Switching Costs Moderately Unfavorable

4 0.15 Switching costs are moderate as different aircraft house different controls, thus crews would need to retrain with every aircraft. However, as the Commercial aircraft industry is seen as a duopoly, there are not many options to choose from.


Favorable 1 0.05 Aircraft manufacturers do not pose a credible forward integration threat at this time.


Favorable 1 0.15 Differentiation between Boeing and Airbus’ products is not significant.



Effect on Industry

Score (1-

5)Weigh

t RationaleSubstitutes for Supplier’s Products/Services

Unfavorable 5 0.3 For an airline, there are no substitutes for aircraft.

Individual Supplier Power Effect (Aircraft Manufacturers)


3.95 0.3 Aircraft manufacturers make up a duopoly and aircraft is essential to airline operations.

Supplier Group: Maintenance and Repair Operations (MRO)Concentration Ratio


2 0.15 MRO services for commercial aircraft is a market that is increasing with the growth of the airline industry. The landscape for MRO sees newer aircraft needing less maintenance, consolidation of firms, and more original equipment manufacturers (OEMs) providing MRO services (Shay, 2016). That being said, there are a number of MRO firms competing in the space and the MRO supplier concentration ratio is likely lower or than the industry concentration.


Neutral 3 0.15 MRO is critical to safe and operational aircraft and MRO firms depend on airline contracts to survive.

Switching Costs Moderately Favorable

2 0.15 Switching costs are likely low as there are many MRO firms in the business.


Favorable 1 0.1 MRO firms do not pose a credible forward integration threat to airlines.


Favorable 1 0.2 MRO firms are differentiated across maintenance expertise for differing aircraft parts; however, maintenance itself is not differentiated.


Unfavorable 5 0.25 There is no substitute for maintenance and repair.

Individual Supplier Power Effect (MRO)

Moderately Favorable -

Neutral

2.6 0.1 There are a multitude of firms performing MRO, additionally OEMs are starting to get into the market.

Supplier Group: Fuel-related SuppliersConcentration Ratio

Unfavorable 5 0.3 In terms of fuel suppliers, a quick search on airport-suppliers.com shows 20 fuel-related suppliers, suggesting that there is a high concentration ratio. However, the IATA campaigns commercial fuel policies that seek to regulate fuel costs, supply reliability, and industry best practices. All that being said, jet fuel makes up almost 30% of airline operating expenses so fluctuations in price can heavily impact



Effect on Industry

Score (1-

5)Weigh

t Rationalethe firm. (Commercial Fuel Policy, n.d.)


Unfavorable 5 0.2 Fuel handlers often supply other types of fuel for endeavors outside of the commercial airline industry. Thus, airlines are dependent on fuel suppliers but not necessarily vice versa.

Switching Costs Neutral 3 0.15 Switching costs are likely low unless there are hedging contracts requiring termination.


Favorable 1 0.15 Fuel suppliers do not pose a credible forward integration threat to airlines.


Favorable 1 0.1 There is low differentiation among aviation fuels.


Unfavorable 5 0.1 Outside of varying compositions of aviation fuels, there are no substitutes. However, in the future there may be alternative fuels to power commercial aircraft.

Individual Supplier Power Effect (Fuel-related Suppliers)


3.7 0.2 Fuel makes up 30% of an airline’s operating expenses (Commercial Fuel Policy, n.d.) and prices are subject to fluctuating oil prices.

Supplier Group: Other Service Suppliers (technological systems, food/beverage catering, etc.)Concentration Ratio


2 0.15 For brevity, service suppliers for flight operations, including technology suppliers, food/beverage suppliers, and others, have been consolidated into the “service supplier group.” There are typically many choices for suppliers in these fields, thus concentration ratios are not likely high.



4 0.25 These flight services are generally essential to flight operations.

Switching Costs Favorable 1 0.15 Switching costs are likely low.


Favorable 1 0.15 Service suppliers do not pose a credible forward integration threat.



2 0.15 There is low differentiation among other service suppliers.

Substitutes for Supplier’s Products/Service

Unfavorable 5 0.15 There are no substitutes for these services.



Effect on Industry

Score (1-

5)Weigh

t Rationales

Individual Supplier Power Effect (Other Service Suppliers)

Neutral 2.65 0.1 There are a multitude of service suppliers from which to contract with.

Overall Supplier Power Effect on Industry


3.71 1 High supplier power is driven by airports, aircraft manufacturers, and fuel suppliers.

Levels 1 and 2 Analyses for Threat of Substitutes Substitute Groups chosen for Analysis: Trains, Automobiles, and Web-conferencingFactors Underlying Threat of Substitutes

Effect on Industry

Score (1-

5)Weigh

t Rationale

Substitute Group: TrainsBuyer’s propensity to substitute (closeness of the substitute)


4 0.6 Air travel is typically used to traverse a long distance in a short amount of time. Thus, a critical substitute for distance and time may be trains. Trains also provide the traveler with unoccupied time during travel (in contrast to automobile, where the driver would be occupied by driving), similar to air travel. Trains also have more stations than airports have hubs, thus trains may be more easily accessible for travel. Train and air travel provide different experiences, but the function of each is similar.

Price/Performance of the substitute

Neutral 3 0.4 For a brief comparison, travel by train from London to Paris can range from €66 to €404 (standard to business premier class) (Eurostar, n.d.) with a train travel time of approximately 2.5 hours. Travel from London to Paris by air would incur a cost of €40 to €328 (economy to business class) (Brtish Airways, n.d.) with an air travel time of less than 1.5 hours. (Fares were compared for travel on the same day, December 14, 2016). Based on pricing and travel time, air is a more attractive option with a shorter travel time and cheaper fare.

Individual Threat of Substitutes Effect (Trains)


3.6 0.5 Trains can provide many of the same benefits as air travel.

Substitute Group: AutomobilesBuyer’s propensity to substitute (closeness of the substitute)

Favorable 1 0.6 Air travel is typically used to traverse a long distance in a short amount of time. Thus, a critical substitute for distance and time may be automobiles. Automobiles offer the convenience of immediate accessibility, privacy, and custom interior. However, deterrents from this mode of transportation for distances otherwise traveled by air include long drive times, traffic conditions, and being occupied by the act of driving (in contrast to unoccupied time sitting


Factors Underlying Threat of Substitutes

Effect on Industry

Score (1-

5)Weigh

t Rationaleon an airplane).


Neutral 3 0.4 For a brief comparison, travel by automobile from London to Paris would incur a travel cost of approximately €66 (toll, fuel consumption, and road tax) with a travel time of 5.5 hours (Maps & Route Planner, 2016). Travel from London to Paris by air would incur a cost of €40 to €328 (economy to business class) (Brtish Airways, n.d.) with an air travel time of less than 1.5 hours. Based on pricing and travel time, air can be a more attractive option.

Individual Threat of Substitutes Effect (Automobiles)


1.8 0.25 Air travel provides unique value over the inconvenience of automobiles for long distances.

Substitute Group: Web-conferencingBuyer’s propensity to substitute (closeness of the substitute)


2 0.4 Web-conferencing as a means to avoid business travel may be a reasonable substitute for airlines. The World Travel and Tourism Council cites that in 2014 business-related travel contributed to 22.3% of Europe’s Gross Domestic Product (GDP), with leisure making up the remaining amount of the travel and tourism pie (World Travel & Tourism Council, n.d.). This illustrates that a minor portion of existing business travelers could consider web-conferencing (assuming that business travelers would have made the switch by now) - thus, implying that web-conferencing does not pose a serious future threat to the aviation industry.


Neutral 3 0.6 Price is very attractive as web-conferencing saves time and money (only need existing information technology services). However, users may experience decreased performance if more value is derived from visits in person (such as building relationships, site visits, etc.).

Individual Threat of Substitutes Effect (Web-conferencing)


2.6 0.25 Web-conferencing cannot be substituted for air travel in all cases.

Overall Threat of Substitutes Effect on Industry

Neutral 2.9 1 Air travel still provides unique value over substitutes.

Levels 1 and 2 Analyses for Threat of ComplementsComplement Groups chosen for Analysis: Airports, Travel and Content Agencies/Websites, Hotels/Lodging, and Tourist AttractionsFactors Underlying Threat of Complements

Effect on Industry

Score (1-

5)Weigh

t Rationale

Complement Group: AirportsRelative Concentration


2 0.2 In the top five airports with the highest passenger traffic in the first two months of 2016 (Heathrow - London, Charles de Gaulle - Paris, Frankfurt Main,


Factors Underlying Threat of Complements

Effect on Industry

Score (1-

5)Weigh

t RationaleSchiphol - Amsterdam, and Barajas - Madrid) totaled 25% of passengers flying in Europe. This represents a lower concentration ratio than the industry concentration of 47% (Lufthansa Group, 2016, p. 22).

Relative Switching Costs


2 0.2 As travelers are more likely to depart from airports closer to their location base, it is easier to switch across airlines at an airport than to switch airports.

Ease of Bundling Favorable 1 0.15 Travelers cannot board commercial airlines without traversing through an airport.

Differences in Pull Through (Influence on Demand)

Favorable 1 0.15 Commercial airlines pull demand through airports.

Asymmetric Integration

Favorable 1 0.1 With current regulations, it is difficult for airlines or airports to invade each other’s’ industries.

Rate of growth of the profit opportunity

Favorable 1 0.2 Because the aviation industry is growing (Air Passenger, 2015). Size of the value pie is therefore growing at an increasing rate for airlines and airports.

Individual Threat of Complements Effect (Airports)


1.4 0.3 Airlines cannot operate without airports and vice versa.

Complement Group: Travel and Content Agencies/WebsitesRelative Concentration

Favorable 1 0.1 There are numerous travel agencies and content websites - on the firm-, independent-, and just-for-fun- levels. Thus, the concentration ratio is likely less than that of the industry.


Favorable 1 0.15 Switching costs are low for both airlines and agencies/websites. However, a user may peruse more travel websites than airlines when booking a trip.

Ease of Bundling Favorable 1 0.15 Travelers can book flights and plan trips without using travel agencies and content websites.


Neutral 3 0.3 Travel agencies and content websites have a hand in influencing tourism, however it is arguable whether they play a greater role in the pull-through of demand.


Favorable 1 0.1 Travel agencies and content websites are not likely to enter the airline industry.


Favorable 1 0.2 Because the airline industry is growing (Air Passenger, 2015), travel agencies and content websites may see more opportunities for profit.

Individual Threat of Complements Effect (Travel and Content Agencies/Websites)


1.6 0.2 Travel websites do not drive demand nor is there a risk of asymmetric integration.

Complement Group: Hotels/Lodging



Effect on Industry

Score (1-

5)Weigh

t RationaleRelative Concentration

Favorable 1 0.15 Based on hotel room data in Europe from Eurostat and Hospitality On, the total number of hotel rooms in Europe totaled 6,622,628 (Tourism Statistics, 2015) and the number of hotel rooms by the top five hotel groups amounted to approximately 557,000 (Hospitality On - Think Tank, 2014). From these numbers, it can be inferred that the hotel concentration is on the order of 8%, which is less than the airline industry concentration of 47% (Lufthansa Group, 2016, p. 22).


Favorable 1 0.2 Switching costs are low for both airlines and hotels.

Ease of Bundling Favorable 1 0.15 Flights and lodging can be booked independently.


Favorable 1 0.2 Hotels have little pull-through influence on the aviation industry.


Favorable 1 0.1 Hotels are not likely to enter the airline industry.


Favorable 1 0.2 Because the airline industry is growing (Air Passenger, 2015), hotels may see more opportunities for profit.

Individual Threat of Complements Effect (Hotels/Lodging)

Favorable 1 0.2 Hotels/lodging do not drive demand nor is there a risk of asymmetric integration.

Complement Group: Tourist AttractionsRelative Concentration

Favorable 1 0.1 There are many reasons to engage in non-business travel, thus the concentration ratio is low.


Favorable 1 0.1 Switching costs are low for both airlines and tourist attractions.

Ease of Bundling Favorable 1 0.1 Booking flights and engaging in tourist attractions happen independently of one another.


Unfavorable 5 0.4 For non-business travel (77.3% contribution of travel and tourism earnings into Europe’s GDP (World Travel & Tourism Council, n.d.)), tourist attractions may greatly influence the demand for air travel.


Favorable 1 0.1 Tourist attractions are not likely to enter the airline industry.



2 0.2 Tourist attractions and airlines both benefit from growth in their linked industries.

Individual Threat of Complements Effect (Tourist Attractions)

Neutral 2.8 0.3 Tourist attractions drive demand, however, there is no risk of asymmetric integration.



Effect on Industry

Score (1-

5)Weigh

t RationaleOverall Threat of Complements Effect on Industry

Favorable 1.78 1 With the exception of tourist attractions, complements do not drive demand nor do they pose a risk of asymmetric integration.


Exhibit C – Six Forces Analysis (Level 3)

ForceScore(1-5) Weight

Barriers to Entry 2.85 0.2Threat of Rivalry 4.15 0.25Buyer Power 3.85 0.2Supplier Power 3.71 0.2

Airports 4.2 0.3

Aircraft Manufacturers 3.95 0.3

MRO 2.6 0.1

Fuel-related Suppliers 3.7 0.2

Other Service Suppliers 2.65 0.1

Threat of Substitutes 2.9 0.1Trains 3.6 0.5

Automobiles 1.8 0.25

Web-conferencing 2.6 0.25

Threat of Complements 1.78 0.05Airports 1.4 0.3

Travel and Content Websites/Agencies 1.6 0.2

Hotels/Lodging 1 0.2

Tourist Attractions 2.8 0.3

Overall Attractiveness of the Industry 3.5Moderately Unfavorable

Exhibit D – Distribution of FSC versus LCC Market Share in 2013


Source: Israel, M. (2015) AirlinePROFILER

Exhibit E – Market Share of European Based Airlines

Number of Passengers (2015)


An asterisk (*) indicates numbers based on 2014 data. Source: Wikipedia, 2015.


Exhibit F – Key Characteristics of Full and Low Cost Air Carriers

Full Service Carriers (FSCs) Low Cost Carriers (LCCs)

Full transfer capabilities, resulting in an offering of short haul flights, as well as an expanded offering of long haul segments

Focus on primary “hub” airports Greater global reach and destinations Various aircraft models Complimentary services such as in-

flight meals, newspapers, no baggage fees

Business and first class, including lounge access, free food and alcoholic drinks, and lounge-to-flight private car services

Code sharing and greater focus on loyalty programs, including

Various fare offerings Often engage in cargo/MRO

Point-to-point flight segments, which do not allow passengers to transfer; thus, most flights are short-haul, and provide less access for business travelers

Focus on secondary, more remote airports

High aircraft utilization and load factor Quick airplane turnaround High punctuality Purchase only one single model of

airplane Lower overhead Fees for all services and extras beyond

airfare (meals, baggage, etc.) Single class configuration, resulting in a

greater percentage of “leisure” travelers as opposed to business

Often engage in offering ancillary services such as hotel room booking

“Business” class, if offered, is extremely limited: it is generally comprised of an assigned economy seat with the reduction of baggage fees and a snack

Loyalty programs may be limited to that one airline, as opposed to sharing with codeshare partners


Exhibit G – Lufthansa’s Primary Competitors

*Source: Lufthansa Annual Report,2015


Exhibit H – Porter’s Generic Business Level Strategies: Competitors


Exhibit I – VRIO Analysis: Competitors*

Ryanair

Resource / Capability

Details Valuable? Scarce /

Rare ?

Difficult to Imitate?

Exploited by the Firm?

Competitive Implications

European pioneer in cost reduction know how and innovation

Fly only to secondary airports, impose fees for everything beyond airfare, high plane utilization, high passenger load, quick turnaround, in-plane ads

Yes Yes YesExploitation of organizational

capabilities and resources, first

mover advantage

Yes Sustained Competitive Advantage

Low overhead Lower pensions and salaries

Yes Yes No Yes Temporary Competitive Advantage

Young fleet of uniform aircraft

Strong purchasing power since buying in bulk

Yes No No Yes Parity

Understanding of the ancillary (hotel / ground transport) services market

Important since Ryanair flies to secondary airports often far from city centers where transport is needed


Strong, unique leadership

Michael O’Leary, quite a character, has been CEO since 1994

Yes Yes YesSocially complex

resources


Further Explanations: Due to Ryanair’s hold on secondary airports, in combination with a host of pioneered and innovative cost reducing strategies, we believe that difficulty in fully imitating Ryanair exists. Low overhead costs are difficult for full service companies to achieve, due to generous pension and salaries established in decades prior (major recent and numerous personnel strikes at Lufthansa and Air France show the difficulty of reducing employee compensation), yet are easier for low cost carriers to attain.

Air France - KLM



Rare ?




Brand strength 2016: KLM voted “Best Airline” by a panel of Dutch consumers, Air-France group was voted #3 in

Yes Yes YesCausal

Ambiguity



Fortune’s “World’s Most Admired Companies,” Air France established 1934

Brand variety (within one group)

Hop! and Transavia subsidiaries


Cleaner fuels Major investments in biofuel


787 Dreamliner purchases

One of the newest, quietest planes on the market


Control over two leading European hubs

Both Charles de Gaulle and Schipol are two of the top 5 largest EU airports

Yes Yes YesHistorical


Reputation for culinary excellence in business / first

Creation of menus by Michelin starred chefs


Well balanced global presence

Protects the company in case of regional downturns

Yes Yes YesOrganizational

capabilities


Economies of scale

Realized through combination of two major flagship carriers

Yes Yes YesExploitation of

resources


Further Explanations: In terms of brand variety, few airlines are large enough to buy air subsidiaries. However, the effects of brand variety can also be achieved by offering code-share agreements, allowing other airline carriers to act as partners (for example, a customer can earn miles on Lufthansa if flying with United, or a long haul flight will include a local transfer through a partner), thus imitation is occurring. Economies of scale are difficult to imitate, as only a few airline groups of this size and scale exist in Europe. Fuel efficiency measures (clean fuels, consumption, etc.) are in place at several airlines, thus imitable.




Rare ?




Brand variety Aer Lingus, British Airways, Iberia, Vueling


Autonomous subsidiaries

Independent brands are more agile and able to

Yes No YesOrganizational

capabilities

Yes Parity


adapt to their markets

R&D in flight fuel consumption management systems

Investing in data analytics technology to both save fuel and lower CO2 emissions


Brand strength 2015: British Airways wins “UK’s Leading Brand” title

Yes Yes YesCausal

ambiguity


Internal IAG Platform

Synergies and economy of scale realized through shared back-office functions, IT, procurement, finance

Yes Yes YesExploitation of a

resource


Extremely global presence

Reach a wide geography of customers

Yes Yes YesOrganizational, exploitation of

resources


Further Explanations: Like with Air France, brand variety can be imitated by smaller airlines who partner with other airlines. Developing and investing in internal platforms such as the IAG Platform, and in a heavy global presence, takes tremendous effort (time, cost, employees, restructuring), leading to a high imitation barrier.

easyJet



Rare ?




Integrated web/mobile/CRM system

Customer facing and internal benefits


resource


Cost savings know-how

High fleet utilization, quick turnaround


Low overhead Less costly pensions

Yes Yes No Yes TemporaryCompetitive Advantage

Focus on employees

Better relations to staff than many low cost competitors, can also translate to better customer service (happier employees)


resources



Long term contracts with primary airports

Lowers cost and ensures access to hub airports


Young fleet of uniform aircraft

Strong purchasing power since buying in bulk


Further Explanations: easyJet’s low cost know-how lags that of Ryanair’s, due to less usage of secondary airports and less innovative (and controversial) cost cutting. Long term airport contracts are valuable but can be negotiated by others.

Air Berlin



Rare ?




Two key hubs in Germany

2nd largest airline in Germany



Etihad Airlines: 29% ownership of Air Berlin

Codeshare and partner possibilities


Internal PROS revenue management system

Digital distribution, forecasting capabilities


resource


Managerial turnaround

80% of top managers were replaced

Yes Yes YesOrganization

Remains to be seen

Parity

Airline leasing No ownership of planes. Less risky, covers lack of capital (The Economist, 2012).


Extensive employee training

In-house only Yes No YesOrganization,

socially complex resources

Yes Parity

Fuel efficient technology

12% better than the average consumed by German airlines


Further Explanations: Internal systems, such as Air Berlin’s PROS or the IAG Platform, developed specifically for those carriers, are thus scarce and difficult to imitate. Air Berlin’s radical change of management poses an uncertain outcome. Airplane leasing is often recommended for younger or smaller firms who lack cash or unwilling to take on debt; however, purchasing is cheaper in the long term (over 30 years).

Lufthansa

Resource / Details Valuable? Scarce Difficult to Exploited Competitive


Capability / Rare ?

Imitate? by the Firm?

Implications

Brand variety (within Passenger Airlines group)

SWISS Airlines, Eurowings, Austrian Airlines


Complementary Business Units

Logistics, MRO & Catering


Brand Reputation Germany’s flagship carrier - long history & well established



Positive public opinion: Awarded first place in two categories at Skytrax World Airline Awards 2016

‘Best Airline Transatlantic’ and ‘Best Airline in Western Europe’ based on 18 million user & passenger survey responses(Excellent – awards won by Lufthansa, n.d.)

Yes Yes YesCausal

ambiguity


Dominant Presence at Frankfurt & Munich Hub Airports

Holds ~60% of flights and seats at the 4th (Frankfurt) and 7th (Munich) busiest airports in Europe(List of Busiest…, 2016)(Airline Analysis, 2009)



152 aircrafts from the A320 family

Economical and reliable planes - large set enables economic efficiency opportunities and economies of scale, reducing overall cost


Ownership of Airbus 380s for long-haul routes

Largest plane on the market (526 passenger capacity) + customized gates to accommodate; quieter and more fuel efficient than older models; < 10 yrs old


Lufthansa Corporate Yes Yes Yes Yes Sustained


Business School - investing in human capital (knowledge & culture)

university that offers courses to employees on interdisciplinary topics, on the job training and customized executive education(Deutsche Lufthansa, 2010)

Socially complex

resources

Competitive Advantage

Further Explanations: Lufthansa creates a sustained competitive advantage through its strong brand reputation, dominant presence at popular hub airports, and strong investment in human capital.

Brussels Airlines



Rare ?




Strong control and relations with Brussels Airport

Brussels Airlines has largest passenger seat market share at Brussels Airport and strong contractual ties to enable fleet and destination growth (“Brussels Airlines Invests”, 2015).



Brand strength Awarded “Best Short Haul Airline” by Travel Magazine in 2014 for 11th time and 3rd most respected Belgian brand in 2016 (“Once Again”, 2016).

Yes Yes YesCausal

ambiguity


Access to African destinations from Europe

Brussels Airlines serves over 14 destinations in Africa. “It boasts one of the most extensive long-haul networks to Africa of any European airline” (Kjelgaard, 2015)

Yes Yes YesHistorical,

exploitation of a resource (network)


CEO and Leadership

100% of employee Glassdoor reviews approve of CEO. Bernard Gustin awarded


resources



“Entrepreneur of the Year” Lobby Awards 2014

Tomorrowland Partnership

Partnership and brand association to young and hip event that draws global attention


resource


Excellent wine served

Won “Wines on the Wing” award for 3rd time in a row


Product selection Four European product options: check&go, light&easy, flex&fast, and bizz&class targeted to different customer preferences.


Further Explanations:

*Sources from 2015 Annual Reports, unless otherwise noted.


Exhibit J – Comparative Financial Metrics

Lufthansa Group


Air France-KLM easyJet Ryanair Air Berlin0.00%

10.00%20.00%30.00%40.00%50.00%60.00%

Gross Margin

2011 2012 2013 2014 2015

Lufthansa Group


Air France-KLM easyJet Ryanair Air Berlin

-15.00%-10.00%

-5.00%0.00%5.00%

10.00%15.00%20.00%

Profit Margin

2011 2012 2013 2014 2015

Lufthansa Group



-35.00%-30.00%-25.00%-20.00%-15.00%-10.00%

-5.00%0.00%5.00%

10.00%15.00%

Return on Assets

2011 2012 2013 2014 2015


Lufthansa Group International Airlines Group

Air France-KLM easyJet Ryanair Air Berlin0

0.5

1

1.5

2

2.5

Current Ratio

2011 2012 2013 2014 2015



0.20.40.60.8

11.21.41.61.8

Quick Ratio

2011 2012 2013 2014 2015



5

10

15

20

25

Debt to Equity Ratio

2011 2012 2013 2014 2015


Lufthansa Group


Air France-KLM easyJet Ryanair Air Berlin70.00%

75.00%

80.00%

85.00%

90.00%

95.00%

Passenger Load Factor

2011 2012 2013 2014 2015

Lufthansa Group


Air France-KLM easyJet Ryanair Air Berlin€ -

€ 0.0200

€ 0.0400

€ 0.0600

€ 0.0800

Passenger Revenue per Available Seat Kilometer (RASK)

2011 2012 2013 2014 2015

Lufthansa Group


Air France-KLM easyJet Ryanair Air Berlin€ -

€ 0.0200

€ 0.0400

€ 0.0600

€ 0.0800

€ 0.1000

Passenger Cost per Available Seat Kilometer (CASK)

2011 2012 2013 2014 2015


€ -

€ 200,000.00

€ 400,000.00

€ 600,000.00

Revenue per Employee

€ - € 20,000.00 € 40,000.00 € 60,000.00 € 80,000.00

Compensation per Employee

Lufthansa Group



-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

Profit Margin


Exhibit K – Lufthansa Business Unit Financial Analysis


Exhibit L – V-C Analysis: CompetitorsN

umber

Value DriversIncludes

Importance

(0-100%)

Rating (1 to 5)

Weighted Value

Rating Weighted Value






Rating (1 to 5)

Weighted Value

1In-flight com

fortLegroom

, seat comfort,

cleanliness7.50%

30.225

30.225

20.15

20.15

30.225

30.225

20.15

30.225

2In-flight offerings

Food and bev, entertainment

system, age of fleet

5.00%2

0.12

0.12

0.12

0.12

0.11

0.051

0.052

0.1

3Custom

er ServiceCheck-in and boarding service, in flight service

15.00%2

0.33

0.453

0.453

0.453

0.454

0.62

0.32

0.3

4Perceived value for m

oneyPrice, fees for checked bags, seat assignm

ent, etc.30.00%

30.9

41.2

30.9

20.6

30.9

41.2

51.5

30.9

5Travel Convenience

Routes, destinations, frequency, airport location, travel tim

e, transfer capabilities

20.00%4

0.83

0.62

0.42

0.43

0.62

0.41

0.25

1

6Prem

ium Services

Business class, lounges and prem

ium extras, variety of fare

options7.50%

20.15

30.225

20.15

20.15

40.3

30.225

10.075

30.225

7Rew

ard ProgramCodeshare agreem

ent, loyalty program

10.00%4

0.44

0.44

0.42

0.23

0.32

0.21

0.14

0.4

8Reputation of brand

Perception of safety, environm

ental practices, em

ployee relations5.00%

30.15

30.15

30.15

30.15

30.15

40.2

20.1

30.15

Sum100.00%

3.0253.35

2.72.2

3.0253.1

2.4753.3

RyanairEurow

ings + Brussels

Eurowings

BrusselsAir France - KLM

(Transavia)

IAG (Vueling)Air Berlin

Easyjet


*For Lufthansa Eurowings value driver weight explanation, see Error: Reference source not

found.


Exhibit M – Lufthansa BCG Matrix Analysis

Exhibit N – Lufthansa Eurowings V-C Analysis (Supplemental Information)

Value Drivers: Eurowings Value Add:

In-flight Comfort Airbus A330, Airbus A320, Airbus A319 and Bombardier CRJ900 NextGenSeat comfort: 3 out of 5 stars(Eurowings Customer Reviews, n.d.)

In-flight Offerings In-flight magazine“Travel media” - daily news you can download on your smartphone/tabletFood offerings:

Basic: nothing - can purchase food or drink on the flightSmart: “hearty snack”, water bottle and one drink of choiceBest: special a la carte catering selection - choose snack & drink for free

1.7 out of 5 stars(Eurowings Customer Reviews, n.d.)

Customer Service Basic Accommodations:Quick notification of any changes, delays, cancellationsDeliver bags on time (goal)Issue ticket refund within 7 days (when applicable)Accommodates all passengers - including disabilities & special needsConsistency of service with code sharing partners(Customer Service Plan, n.d.)

Perceived Value for Money

Goal - offering the lowest fair3 out of 5 stars(Eurowings Customer Reviews, n.d.)

Travel Convenience Currently all short-haul routes within Europe (with intention to expand)130 + destinations(Route Network, n.d.)

Premium Services Offer BASIC, SMART and BEST fares

Reward Program Boomerang club (10,000 miles then a free flight)Miles & More: connected with Lufthansa reward program (Frequent Flyer and awards program in Europe)

Hotels, rental cars, private jet travel, earn points and can use them for rewards in any of these spaces

Reputation of Brand Strong - Eurowings is newSinking based on customer experienceOverall 4 out of 10


(Eurowings Customer Reviews, n.d.)


Exhibit O – Lufthansa Value Chain Analysis


Exhibit P – Brussels Airlines Value Chain Analysis


Exhibit Q – Ally or Acquire Framework

Dimension of Analysis Recommended Strategy

Types of Synergies

Reciprocal SynergiesAccess to new marketsFleet standardizationRoute optimizationReduced SGA

Acquisition

Types of Resources

Both hard and softHard: Added airline fleet, hub dominanceSoft: Brand, reputation, knowledge, human capital, partnerships

Acquisition or Equity Alliance

Market Conditions

Low/medium market uncertainty. Consolidation of airlines has been slow in Europe compared to in the U.S. However, high fragmentation of the European market begets inevitable consolidation (Canelas & Ramos, 2016). Air traffic is projected to grow by 50% by 2035 (Airport Capacity & Airport Slots, n.d.), subject to unforeseeable macro environmental factors.

Acquisition

Conclusion: The synergies and market conditions strongly recommend acquisition.


Exhibit R – Synergy Analysis

Synergy Benefit Type Synergy Type Worst Better BestAccess to new markets: better end-to-end flight offerings (routes/destinations), including much stronger presence to Africa from Europe

Base Increase

Reciprocal 0% 0.75% 1.50%

Fleet standardization: 40 added planes are all Airbus A320s, an economical and reliable plane, ideal for short to middle length flights

Cost Reduction Sequential 0% 0.125% 0.25%

Route optimization: greater control of Brussels airport, better scheduling and gate assignments, opportunity to use Brussels as a hub / synergy with LH's strong present at FRA and Munich

Revenue Increase

Reciprocal 0% 0.25% 0.50%

Reduced SGA Cost Reduction

Sequential 0% 0.25% 0.50%

Base increase calculated as % of combined FCFRevenue increase calculated as % of combined RevenueCost Reduction calculated as % of combined Operating Expenses

Synergy Analysis

2016F 2017F 2018F 2019F 2020FLufthansa Revenue 32,830€ 33,623€ 34,435€ 35,267€ 36,119€ Brussels Revenue 1,319 1,365 1,413 1,463 1,514 Combined Revenue 34,149€ 34,988€ 35,848€ 36,730€ 37,633€

% Applied 0% 0% 0% 0% 0%Value of Revenue Increase Synergy - - - - -

Lufthansa Operating Expenses 34,260€ 35,088€ 35,935€ 36,803€ 37,692€ Brussels Operating Expenses 1,291 1,336 1,383 1,432 1,482 Combined Operating Expenses 35,551€ 36,424€ 37,318€ 38,235€ 39,174€

% Applied 0% 0% 0% 0% 0%Value of Cost Reduction Synergy - - - - -

Lufthansa FCF 592€ 607€ 621€ 636€ 652€ Brussels FCF 18 19 19 20 21 Combined FCF 610€ 625€ 641€ 656€ 673€

% Applied 0% 0% 0% 0% 0%Value of Base Increase Synergy - - - - -

Synergy Value Breakdown By Year (Worst)



% Applied 0.25% 0.25% 0.25% 0.25% 0.25%Value of Revenue Increase Synergy 85.37€ 87.47€ 89.62€ 91.82€ 94.08€


% Applied 0.375% 0.375% 0.375% 0.375% 0.375%Value of Cost Reduction Synergy 133.32€ 136.59€ 139.94€ 143.38€ 146.90€


% Applied 0.75% 0.75% 0.75% 0.75% 0.75%Value of Base Increase Synergy 4.58€ 4.69€ 4.81€ 4.92€ 5.04€

Synergy Value Breakdown By Year (Better)


% Applied 0.50% 0.50% 0.50% 0.50% 0.50%Value of Revenue Increase Synergy 170.74€ 174.94€ 179.24€ 183.65€ 188.16€


% Applied 0.75% 0.75% 0.75% 0.75% 0.75%Value of Cost Reduction Synergy 266.63€ 273.18€ 279.89€ 286.76€ 293.80€


% Applied 1.50% 1.50% 1.50% 1.50% 1.50%Value of Base Increase Synergy 9.16€ 9.38€ 9.61€ 9.85€ 10.09€ Worst case defined as no synergies realizedBetter case defined as 1/2 of identified synergies realizedBest case defined as full amount of identified synergies realized

Synergy Value Breakdown By Year (Best)


Exhibit S – VRIO Post Merger Analysis

Lufthansa (after merger with Brussels Airlines)


Details Valuable ?

Scarce /

Rare ?

Difficult to

Imitate?



Brand variety (within Passenger Airlines group)

SWISS Airlines, Eurowings, Austrian, Brussels Airlines


Complementary Business Units

Logistics, MRO & Catering


Brand Reputation Germany’s flagship carrier - long history & well established

Yes Yes Yes Historical conditions


Positive public opinion

‘Best Airline Transatlantic’ and ‘Best Airline in Western Europe’ based on 18 million user & passenger survey responses(K, 2016)Brussels Awarded “Best Short Haul Airline” by Travel Magazine in 2014 for 11th time and 3rd most respected Belgian brand in 2016(Brussels Airlines Customer Reviews, n.d.).

Yes Yes Yes Causal ambiguity


Dominant Presence at Frankfurt, Munich & Brussels (acquired) Airports

Holds ~60% of flights and seats at the 4th (Frankfurt) and 7th (Munich) busiest airports in Europe + 33.8% at the 21st busiest airport in Europe(List of the Busiest Airports in Europe, n.d.)(Anna.Aero, 2009).

Yes Yes Yes Historical conditions

+ acquisition



192 (152 + 40 acquired) aircrafts from the A320 family

Economical and reliable planes - large set enables economic efficiency opportunities and economies of scale, reducing overall cost.


Ownership of Airbus 380s for long-haul routes

Largest plane on the market (526 passenger capacity) + customized gates to accommodate; quieter and more fuel efficient than older models; < 10 yrs old.


Lufthansa Business School - investing in human capital (knowledge & culture)

Corporate university that offers courses to employees on interdisciplinary topics, on the job training and customized executive education(Deutsche Lufthansa AG, 2010).

Yes Yes YesSocial

Complexity


Access to African destinations from Europe

Brussels Airlines serves over 14 destinations in Africa. “It boasts one of the most extensive long-haul networks to Africa of any European airline.”

Yes Yes YesHistorical conditions

+ acquisition

Likely Yes Probable Sustained

Competitive Advantage

Further Explanations: Blue text indicates changes in VRIO analysis with the acquisition of Brussels Airlines. Lufthansa’s main resource gains through the acquisition are access to African destinations, dominance at Brussels Airport and increased point to point offerings. The realization of benefits from these resources will be dependent on Lufthansa’s short- and long-term strategies following the acquisition.

Exhibit T – Cost of Entry Test


Maximum acquisition cost 250,000€ % of Brussels acquired 55%Derived current fair value of firm based on acquisition price 454,545€ Total fair value of equity based on DCF 565,016€ Fair value of % acquired based on DCF 310,759€

Acquisition cost is linked to performance-related factors, but price ceiling is 250m Euros

Cost of Entry Test (in thousands)

Exhibit U – Post Merger V-C Analysis

*See V-C Competitors for methodology.


Exhibit V – Lufthansa’s Revenue Growth Rate

See Financial Appendix.

Exhibit W – Lufthansa Weighted Average Cost of Capital Analysis


Exhibit X – Lufthansa’s Free Cash Flow Derivation



Exhibit Y – Lufthansa Discounted Cash Flow Analysis

2012

20132014

20152016F

2017F2018F

2019F2020F

Total Revenue30,135

€ 30,027

€ 30,011

€ 32,056

€ 32,830

€ 33,623

€ 34,435

€ 35,267

€ 36,119

€ Changes in Inventories and W

ork Performed by Entity and Capitalised

113

158

212

203

184

188

193

198

202

Other O

perating Income

2,785

2,043

1,890

2,832

2,559

2,621

2,684

2,749

2,815

Cost of Materials and Services

(17,946)

(17,498)

(17,283)

(17,640)

(18,914)

(19,371)

(19,838)

(20,318)

(20,808)

Staff costs

(6,741)

(7,356)

(7,335)

(8,075)

(7,920)

(8,111)

(8,307)

(8,508)

(8,714)

Depreciation, Amortisation and Im

pairment

(1,839)

(1,767)

(1,528)

(1,715)

(1,841)

(1,885)

(1,931)

(1,977)

(2,025)

Other O

perating Expenses(4,885)

(4,756)

(5,088)

(6,106)

(5,585)

(5,720)

(5,858)

(6,000)

(6,145)

Return of Equity Investm

ents Accounted for Using the Equity Method

31

91

77

111

83

85

87

89

91

Result of Other Equity Investm

ents63

33

44

10

41

42

43

44

45

N

et Interest(372)

(346)

(256)

(170)

(309)

(317)

(325)

(332)

(340)

O

ther Financial Items

(48)

(83)

(564)

520

(57)

(58)

(60)

(61)

(63)

EBT1,296

€ 546

€ 180

€ 2,026

€ 1,070

€ 1,096

€ 1,123

€ 1,150

€ 1,177

€ N

et Interest (+)372

€ 346

€ 256

€ 170

€ 309

€ 317

€ 325

€ 332

€ 340

€ (1 - Tax Rate)

1,251

669

327

1,647

1,035

1,060

1,085

1,112

1,138

Depreciation and Amortization (+)

1,839

1,767

1,528

1,715

1,841

1,885

1,931

1,977

2,025

Change in Working Capital (-)

(1,302)

(1,460)

(774)

(1,271)

(1,302)

(1,333)

(1,365)

(1,398)

Net Capex (-)

(499)

(1,263)

(1,083)

(1,012)

(1,037)

(1,062)

(1,087)

(1,114)

Free Cash Flow635

€ (868)

€ 1,505

€ 592

€ 607

€ 621

€ 636

€ 652

€

Lufthansa G

roup - Discounted Cash Flow Analysis

WACC

5.12%Line Item

NPV Forecasted Cash Flow

s € 2,676

Changes in Inventories and Work

Performed by Entity and Capitalised

Terminal Value

21,273 O

ther Operating Incom

ePV of Term

inal Value 16,569

Cost of Materials and Services

Enterprise Value € 19,245

Staff costs

Total Borrowings

(6,370)Depreciation, Am

ortisation and Im

pairment

Total Fair Value of Equity € 12,875

Other O

perating ExpensesTerm

inal Growth Rate = 2%

Return of Equity Investments

Accounted for Using the Equity M

ethodResult of O

ther Equity Investments

Net Interest

Other Financial Item

sChange in W

orking CapitalN

et CapexN

egative percentages represent expenses

Average % of Revenue

Assumptions

-3.08%-3.87%-0.17%-0.94%0.12%0.25%

-17.01%-5.61%

-24.12%-57.61%7.79%0.56%

Enterprise Value and Equity Value Calculation


Exhibit Z – Brussels Airlines Revenue Growth Rate


Exhibit AA – Brussels Airlines Free Cash Flow Derivation



Exhibit AB – Brussels Airlines Discounted Cash Flow Analysis

20112012

20132014

2015E2016F

2017F2018F

2019F2020F

Revenue1,036.48

€ 1,113.48

€ 1,138.16

€ 1,138.16

€ 1,274.00

€ 1,318.76

€ 1,365.10

€ 1,413.06

€ 1,462.71

€ 1,514.10

€

EBITDA(79.18)

(79.54)

(15.64)

6.69

70.24

42.06

43.53

45.06

46.65

48.29

Depreciation and Am

ortization(7.66)

(12.21)

(12.53)

(15.68)

(13.74)

(14.23)

(14.73)

(15.24)

(15.78)

(16.33)

EBIT

(86.85)

(91.75)

(28.17)

(8.99)

56.50

27.83

28.81

29.82

30.87

31.95

EBI42.38

20.87

21.61

22.37

23.15

23.96

N

et Interest(0.20)

(0.01)

(1.93)

(1.71)

(1.08)

(1.12)

(1.16)

(1.20)

(1.24)

(1.29)

N

et Income

(87.05)€

(91.77)€

(30.10)€

(10.70)€

41.30€

19.75€

20.45€

21.16€

21.91€

22.68€

20112012

20132014

2015E2016F

2017F2018F

2019F2020F

EBIT(86.85)

€ (91.75)

€ (28.17)

€ (8.99)

€ 56.50

€ 27.83

€ 28.81

€ 29.82

€ 30.87

€ 31.95

€ EBI

(65.14)

(68.82)

(21.13)

(6.75)

42.38

20.87

21.61

22.37

23.15

23.96

Depreciation and Amortization (+)

7.66€

12.21

12.53

15.68

13.74

14.23

14.73

15.24

15.78

16.33

Change in Working Capital (-)

(41.02)

38.48

(26.35)

(11.12)

(11.51)

(11.91)

(12.33)

(12.77)

(13.22)

Net Capex (-)

(21.80)

(1.83)

10.13

(5.22)

(5.40)

(5.59)

(5.79)

(5.99)

(6.20)

Free Cash Flow(119.42)

€ 28.05

€ (7.29)

€ 39.78

€ 18.19

€ 18.83

€ 19.49

€ 20.17

€ 20.88

€ N

umbers for 2015E are not offi

cial, but were backed into based on lim

ited available data.

WACC

5.12%N

PV Forecasted Cash Flows

104.98€

Terminal Value

681.67

PV of Terminal Value

530.95

Enterprise Value635.93

Total Borrow

ings(70.92)

Total Fair Value of Equity

565.02€

Line ItemAverage %

of Revenue

Depreciation and Amortization

-1.08%N

et Interest-0.08%

Forecasted EBITDA3.19%

Assumptions

Brussels Airlines - Discounted Cash Flow Analysis

Enterprise Value and Equity Value Calculation


Exhibit AC – Combined Firm Valuation (Worst Case)


Exhibit AD – Combined Firm Valuation (Better Case)


Exhibit AE – Combined Firm Valuation (Best Case)


Exhibit AF – Timeline for Short-Term Recommendation

Exhibit AG – Timeline for Long-Term Recommendation


IX. FINANCIAL APPENDIX

Exhibit V – Lufthansa’s Revenue Growth Rate

20062007

20082009

20102011

20122013

20142015

AverageCAG

RTotal Revenue

19,849€

22,420€

24,842€

22,283€

26,459€

28,734€

30,135€

30,027€

30,011€

32,056€

Growth %

12.95%10.80%

-10.30%18.74%

8.60%4.88%

-0.36%-0.05%

6.81%5.79%

5.47%Source: Luft

hansa AR 2007 - 2015

2015A2016F

2017F2018F

AverageCAG

RKepler Cheuvreux

32,056€

30,981€

31,850€

31,850€

Growth %

-3.35%2.80%

0%-0.18%

-0.21%Credit Suisse

32,056

31,299

31,633

32,567

Growth %

-2.36%1.07%

2.95%0.55%

0.53%M

organ Stanley32,056

30,967

31,212

31,999

Grow

th %-3.40%

0.79%2.52%

-0.03%-0.06%

UBS

32,056€

31,541€

31,942€

31,973€

Growth %

-1.61%1.27%

0.10%-0.08%

-0.09%0.07%

0.04%

20152016

2017Average

Euro Area Projections2.0%

1.7%1.5%

1.73%Source: IM

F World Econom

ic Outlook

Historical CAGR5.47%

Analyst Estimated CAGR

0.04%Average Euro Projection

1.73%Average

2.42%

Average

Analyst Estimates

Lufthansa Group - Consolidated Historical G

rowth Rate

European Economic O

utlook

Lufthansa G

roup - Estimated

Future Grow

th Rate


Exhibit W – Lufthansa Weighted Average Cost of Capital Analysis

Exhibit X – Lufthansa’s Free Cash Flow Derivation


Exhibit Z – Brussels Airlines Revenue Growth Rate

Exhibit AA – Brussels Airlines Free Cash Flow Derivation

2011 2012 2013 2014EBIT (86.85)€ (91.75)€ (28.17)€ (8.99)€ (1 - Tax Rate) (65.14) (68.82) (21.13) (6.75) Depreciation and Amortization (+) 7.66€ 12.21 12.53 15.68 Change in Working Capital (-) (41.02) 38.48 (26.35) Net Capex (-) (21.80) (1.83) 10.13 Free Cash Flow (119.42)€ 28.05€ (7.29)€ Tax Rate Assumed to be 25%

2011 2012 2013 2014Current Assets 334.85€ 389.48€ 375.99€ 467.85€ Current Liabilities 246.15 259.76 284.75 350.26 Working Capital 88.70€ 129.72 91.24 117.59 Change in Working Capital 41.02€ (38.48)€ 26.35€

Capital Equipment 31.13€ 52.93€ 54.77€ 44.64€ Net Capex 21.80€ 1.83€ (10.13)€

2012 2013 2014 AverageChange in Working Capital 3.68% -3.38% 2.32% 0.87%Net Capex 1.96% 0.16% -0.89% 0.41%

Brussels Airlines - Free Cash Flow Derivation

Brussels Airlines - Change in Working Capital and Net Capex

% of Revenue