The magnitude of the global economic crisis-induced crash in the air cargo market is, by now abundantly clear to all. A 20 per cent free fall in volumes with only a five to eight per cent cut in industry capacity has seen precious yields drop by 20 per cent in the first half of 2009. The resultant impact vaporised nearly 40 per cent ofthe industry’s total revenue stream.

“When you are planning networks and capacity growth in 2008/09 and suddenly you are back at 2003 levels, you are hit hard,” says Michael Wisbrun, EVP KLM Cargo and chairman for AFKLM Cargo.

For Wisbrun and his Air France counterpart – Florence Parly, EVP Air France Cargo and deputy chairman AF-KLM Cargo – much of the problems cargo carriers now find themselves in is a result of simply being too slow and/or too reluctant to cut capacity deeply enough.

“We are not responsible for the crisis, but we do feel extremely responsible for how we react to it,” says Wisbrun to journalists in Amsterdam last month as he and his top cargo executives explained in detail the cargo group’s unique strategyfor dealing with the crisis.

Drastic capacity cuts
Parly, highlighting the need for greater industry discipline in managing capacity emphasises that the AF-KLM group were front runners in reducing capacity – taking action as early as the beginning of last winter and not waiting for the full impact of the downturn to do it.

Overall the group stripped out some 20 per cent of its capacity including a 40 per cent reduction of its full freighter fleet. “We used mainly the full freighter capacity as a kind of reduction tool which at -40 per cent is really significant,” Parly adds. Some of the capacity reduction on the freighter side was offset by the addition of B777-300s which have significant belly capacity.

She adds that the reduction was done in a coordinated way between AF, KLM and Martinair in order to makethe best use of the two hubs – Charles de Gaulle (CDG) and Schiphol (AMS)– and three carriers. And importantly,the reduction was done without touchingthe commercial footprint of the cargodivision, save one station – Osaka –whichwas dropped.

But these moves and other cost cutting measures like voluntary reductions in working hours and mobility plans across the company that were added in concert as the crisis deepened, were still not enough to halt the flow of red ink.

The group overall, lost US$288 million in the three months to June 30 compared with a $23.4 million year-earlier profit. Revenue plunged 41.5 per cent to $775 million as traffic tumbled 22.7 per cent from the same period in 2008 and yields were 25.1 per cent lower.

But why, if the carrier was so quick to cut capacity and initiate cost cutting, does it continue to bleed? Wisbrun points to the massive capacity the group brings to the market, along with its substantial Asian exposure, a market where demand plummeted very far, very fast. “Being big is good, but at the moment you are hit, you are hit hard and it’s painful,” he adds.

“The impact of what happened in the summer was far beyond our belief and our scenarios,” Wisbrun admits. “And so we had to tune our thinking into the idea that the world is more volatile and harsh to us than we thought in the first instance.” He adds that this is the story of the air cargo industry this year. “You have a vision, you make a plan and at some moment in April or May you come to the conclusion that the plan is nice, but it has nothing to do with reality.”

Clearly a new, bolder strategy was in order, one the group is actively pursuing along a couple of key lines. First it continues to work on capacity, not simply reducing it, but also using it more efficiently and extracting new synergies. Secondly, it is working hard at raising the revenues to a more sustainable level which involves substantial customer dialogue.

“We are trying to limit the bleeding and overcome this crisis,” says Parly, noting that the group is struggling to fill the belly and combi capacity, let alone the full freighters.

“We are very much focused on cash and trying to play a smart game between lower deck and main deck capacity first and also play a smart game between capacity and the need for improved revenues,” she says.

Factory AF-KLM
This is where the bold and innovative ideas become all-important – ideas that were already forming prior to the crisis, but got an important kick-start thanks to the market turmoil. It is what Wisbrun, perhaps not completely flatteringly, calls the ‘factory model’.

“We keep the brands of AF, KLM and Martinair in place,” Wisbrun explains, “but within the AF-KLM group, we make the factories more efficient.”

The plan then, is to continue on the KLM side with the fleet of combies and the passenger belly capacity while concentrating all the freighters in the “more efficient factory” of Martinair. This of course entails a reworking of the network to realise the efficiencies of such a move, he adds.

In practical terms this entails shifting the remaining two KLM B747-400ERFs to Martinair – the other two operated by KLM were temporarily shifted in June and July, but will now remain there.

“The freighters of the factory of KLM are to be operated by the factory of Martinair at Schiphol,” he says, adding that discussion with stakeholders – read ‘unions’, are now underway with the aim of completing the shift by later this year. The four KLM freighters will most likely be operated with ‘blue cockpits’ (KLM pilots).

As to why Martinair is more efficient Wisbrun says the all-cargo operator has the benefit of being more agile because it can make route and rotational changes day-by-day and is more of an ad hoc type of operation. Operating a cargo division underpinned by a vast passenger network implies a different set of rules, it’s a network schedule that is “set and forget” and inherently less flexible than Martinair’s, Wisbrun says.

Freighters stay at ‘Factory CDG’
Over at CDG, Air France will continue to operate full freighters, combies and the bellies of the substantial passenger fleet. As the largest operator of B777s, which are being replaced with B777-300s, described by Wisbrun as mini-combies because of their large belly capacity, AF contributes nearly 70 per cent of the group’s cargo capacity from its bellies.

And while there is no switch from CDG in terms of its five full freighters, Parly says the focus at CDG will be on the belly while making the most efficient use of the additional full freighter capacity on the main cargo trade lanes.

Currently AF has two B777 freighters – and is trying to defer delivery of three more – along with three B747-400ERFs(two more are grounded).

When asked why the AF freighters are not being similarly turned over tothe factory of Martinair, Wisbrun replies:

“The factory CDG and AF stays intact with the huge belly and tuned freighter fleet and in the future we will see what the rules of the game will be, but first lets learn on this side how does it work and is it successful.” There is of course another obstacle challenging such a move: French unions.

“What we are offering to the market is belly capacity across the entire AFKLM network with the option of main deck capacity produced by freighters and combies if volumes require it,” says Wisbrun.

In order to avoid duplication, the main deck network has been specialised, establishing for instance, an Air France full freighter specialisation on Mexico, West Africa, Middle East and Shanghai; a Martinair full freighter focus on South America and East Africa; and a KLM combi focus on the US, Southeast Asiaand Shanghai.

Combies are currently available on all AF-KLM destinations around Asia, as are Air France’s B777-300s. There is also dedicated AF main deck freightercapacity to Hong Kong and Shanghai.

Resuscitating the revenue
While August load factors improved substantially and reduced capacity overall, helped improve the load factors out of China, Wisbrun said it’s too early to tell if the up tick will continue.

In agreement, Jean Charles Foucault, SVP for sales and distribution at AFKLM, said the last few months have been about stabilization. “We have done our part in reducing capacity and optimising our network, but the level of the revenues we get today does not allow for a sustainable business, especially on the freighter side.

“So it is obvious we have to go to our customers, all of our customers, and explain the situation,” Foucault said confirming that AF-KLM had begun a dialogue with customers starting with a notice in a newsletter to customers that it was seeking a rate increase to a “fair rate level”.

“More than half of the pricing structure is based on add-on rates because the business is completely volatile. And that is not sustainable,” Foucault adds.

Only time will tell whether AF-KLM is on the right track, but Wisbrun is optimistic. “I am convinced we are on the right track,” he says.

“We will survive, we have been here for 90 years and we’ve had more storms, but this is the most severe. We will change with the customers – if the service is to stay – we will do our part and thecustomers will have to do their part.”

High stakes poker for Lufthansa
Lufthansa has twice warned recently that its freighter operations could become unviable. But is it really serious, or just adopting a tough negotiating position?

Apocalyptic noises are coming out of Lufthansa Cargo these days, though it is hard to know how seriously to take them.

Twice in the past few weeks the carrier has hinted that it might pull out of freighter operations altogether, though in both cases the threat was clearly also part of a negotiating ploy. Still, that a key bellwether of European air cargo even raises the possibility is a sign of the desperation among the continent’scarriers.

Rate hikes & night bans
Threat number one came in a letter to customers that was leaked at the end of August. In it Dr Andreas Otto, member of the executive board of Lufthansa Cargo, announced a 25 per cent increase in rates, predicting that if rates are not raised “in the medium term, the majority of the world’s freighter fleet will have to be permanently grounded”. As it is, Otto warned the proposed rate increase “will only partially compensate for the dramatic decline in rates in the last few months”.

Threat number two is the latest chapter in the long-running saga over night flights at Frankfurt once a fourth runway, now under construction, opens in 2011. Originally the new runway was supposed to be linked to a total night flight ban, but a compromise was reached where 17 a night would be allowed.

But in January the Administrative High Court of the state of Hesse, in which Frankfurt is situated, started to back pedal on this deal, expressing concern about this compromise, once again raising the possibility of a total ban. By September, the topic had become an issue in the German national elections, prompting Lufthansa Cargo to go into overdrive.

Carsten Spohr, chairman of the executive board of Lufthansa Cargo, warns that “the business model of Lufthansa and gradually its MD-11 fleet” would be threatened by a total night ban. Otto is even clearer, saying that it would mean the complete end of Lufthansa’s freighter operations.

“We would not be able to operate the freighters without night flights,” he says categorically. “It would be like asking a factory to stop a third of its production.” He rules out moving the freighters to another German airport either, saying none would have the belly connections Frankfurt has. “So if this time came, there would be no more Lufthansa freighter operation in Frankfurt.”

How seriously this threat can be taken is not clear, but Lufthansa is locked in a high stakes poker game with the German authorities and cannot afford to blink first. It does not even want to hint at compromise solutions – such as basing its freighters in Leipzig. Nor will Otto be drawn on whether it would accept a lower total of night flights.

What the carrier is hoping is that if it makes enough noise, it will get the support of the German federal government which has the power to overrule the Hesse court. But much here depends on the result of the German national elections due in late September.

Back with the proposed 25 per cent rate rise, and the implied danger of the fleet being grounded if forwarders do not pay it, Otto has to tread on eggshells. He declines to talk about rates at all or even confirm if the leaked letter is genuine for fear of breaking anti-trust rules. As carriers have discovered to their cost on the fuel surcharge issue, even a suggestion that they are signalling their rate intentions to the market can land them in an anti-trust court.

On the other hand, Lufthansa Cargo does not actively deny that the letter is authentic either, and Otto is happy to expand on his comments about the global freighter fleet. He points to first half losses from Lufthansa Cargo (€134 million), SIA Cargo (€151 million) and Air France-KLM Cargo (€362 million) and says these simply can’t go on.

“With these numbers, there is no way that any carrier can continue to fly freighters in the medium term,” he says. “No shareholder would want to invest money in a business with such aperformance.”

Carriers not cutting enough capacity
The real message here is that Lufthansa Cargo thinks other carriers are not doing enough to cut capacity. Otto quotes ACAS figures that show 15 per cent of the world’s widebody freighter fleet is now grounded, but he says this is still not sufficient. “Given the volume declines we have seen, this is still not a good performance. There is still far too much capacity out there,” he says.

Lufthansa Cargo itself claims to have grounded a third of its freighter fleet, but the calculation is actually not quite that simple. By the end of September, four of its 19 MD-11Fs had gone to the desert, and Otto claims the equivalent of another two has been removed by lower utilisation. 2.7 MD-11Fs-worth of wetleased capacity has also been returned to the lessor – or will have been once the last contract expires at the end of October.

Set against that is Lufthansa’s share of the capacity of the two freighters so far delivered to AeroLogic, its joint venture with DHL Express, and the capacity it uses on Jade International. The latter has been dramatically scaled back from 5.2 aircraft on average at the start of the year to three today, with plans to cut it to two by the end of 2009. But the remaining Jade capacity has not been taken out of the market; it is just being filled by the Chinese carrier itself.

The question also remains as to the extent to which Lufthansa Cargo has done what it is implicitly criticising other carriers for – namely cutting rates to fill excess capacity. Otto somewhat undermines his argument on capacity by pointing to various major markets where Lufthansa has increased its market share, and boasting that the carrier has increased its load factors above the market average.

And while on the one hand he says Lufthansa has been focusing on yield management and ensuring every shipment must be cash positive, he also admits that it is now taking cargo it would not have touched before. He declines to say how much Lufthansa Cargo had cut its rates this year before announcing the 25 per cent increase.

Other measures implemented to cope with the downturn, include putting staff on short time working and other such cost-cutting. Otto claims such measures have clawed back €394m, or 73 per cent of the €542m its revenue fell in the second quarter. Lufthansa has also become much more flexible in its freighter scheduling. “Once we used to Cargo Network Map019x13.5cm.indd 1 8/18/09 12:43 PM decide the schedule twice a year. Now we sit down every week to adjust it,” he says. Freighter destinations added by the carrier as a result include Hyderabad, Seattle, Guadalajara in Mexico, Curacao, Bogota, and Curitiba in Brazil.

A glimmer of hope?
Looking forward, there is the tiniest glimmer of hope about a possible upturn. Otto reckons there will be something of a peak season this year, albeit not as strong as last year, and he says China – particularly Hong Kong and Shanghai – and India are showing improvements in yields. The Japanese market, which was 50 per cent down earlier this year, is now only 25 per cent down, he adds.

On the other hand, he says the supposed green shoots in the German economy have not yet converted into an air cargo recovery, and in general he declines to predict any general upturn in 2010.

“From my personal perspective, I doubt we will see positive numbers in the next year, and we won’t see stability coming back to our industry any time soon,” he says. “But if there is one thing this crisis has taught us, it is that you can’t predict more than a few monthsahead.”