`The Carnival Is Over'

It's 3 a.m. in Paris, and Air France Chairman Bernard Attali is wide awake, staring at a home-computer screen. Attali, a night owl who rarely sleeps more than three or four hours, has worked until midnight. Now, with a few moments to relax, he's indulging his passion for chess, playing against a computerized version of world champion Garri Kasparov. Pondering his next move in these early-morning hours, however, Attali surely has much more than chess on his mind.

That's because Air France and Europe's other airlines are facing the stormiest period of their postwar history. Thirteen years after deregulators turned the U. S. airline industry topsy-turvy, Old World carriers are bracing for a similar jolt. As they head into the fateful year 1992, European Community planners are attempting to knock down borders, promote freer competition, and push protected airlines out of their cozy, nationalistic nests. Simultaneously, Europe's airlines face an uprecedented onslaught from America's mightiest carriers--American, United, and Delta. Asian airlines, too, are swooping in.

The inefficient Europeans risk losing out. While deregulation was whipping U. S. airlines into fighting trim, monopolistic routes and government coddling kept most European carriers fat and stodgy. Today, the pampered airlines badly need the discipline of greater competition. Their ability to slim down--and team up--will determine whether such proud old names as Alitalia, SAS, and Air France can maintain a credible presence against their competitors. At the moment, nearly all are losing market share and losing money (chart). The Europeans aren't likely to adopt the winner-take-all kind of deregulation that the Americans embraced in a burst of free-market fervor. Europe's governments, still sorting out how much they'll give up to pan-European control, are opening the skies to competition in gradual steps. Fares will fall, but not in the wholesale frenzy that hit the U. S. a decade ago. And there are still competing visions of what Europe's deregulation will ultimately look like.

MERGER WAVE. But whether it's France, advocating a go-slow liberalization even as it funnels subsidies to Air France, or Britain, with its faith in laissez-faire, most Europeans agree that "we're at the beginning of a vast restructuring movement," as Attali says. Of Europe's two dozen major airlines, the majority will disappear, says Giovanni Bisagnani, chief executive of Italy's Alitalia. As he told senior managers recently: "Gentlemen, the carnival is over." Already, a merger-and-alliance wave is building as worried European airlines scramble to make their strategic moves. Air France, which last year absorbed its major French rivals, now is eyeing a stake in Sabena Belgian World Airlines. Germany's Lufthansa is talking with USAir and Japan Air Lines about tying its routes to theirs with marketing agreements. Alitalia has already inked similar accords with USAir and Iberia Air Lines.

Giant British Airways PLC, probably Europe's most competitive airline, has much grander moves in mind. It's discussing tight links with KLM Royal Dutch Airlines, a sort of near-merger. Such a deal would give Britain's privatized carrier access to both KLM's hub in Amsterdam and its 20% stake in America's Northwest Airlines Inc. The resulting powerhouse would vault past Air France as Europe's biggest carrier.

With a few exceptions--British Airways is one--European airlines are state-controlled symbols of national pride. When passengers don't fill their coffers, taxpayers do. This year, Belgium is promising $270 million to state-owned Sabena. Despite foes in Brussels, Air France won EC approval in November to haul away $370 million from the public trough. European governments also tolerate cartel-style fares on such routes as Paris-Brussels, a mere 155-mile flight that costs $465 round-trip.

As European leaders sit down this month in the Netherlands to begin the next round in the quarrelsome process of forging a unified Europe (page 56 25 ), it's easy to see how airline deregulation could get tangled in conflicting national priorities. Protectionists are fighting free-marketers on a host of fronts, from antitrust to government purchasing. Even the most pro-competition airline chiefs wonder whether it's fair to push open skies as long as tax levels, labor costs, and social benefits differ among countries. Europe's skies are fast becoming a key test of just how unified the Europeans want their vaunted single market to be.

Last summer, EC officials wrote tough new rules that, pending approval next spring, will significantly change Europe's airways. By Jan. 1, 1993, any EC airline will be free to fly any international route between two EC countries. On the key issue of fares, an airline will be able to charge whatever it wants, unless the governments at both ends of the route say no. Currently, one side alone can kill a fare. By 1996, no government will have a say in fare-setting. And cabotage rights--carrying passengers within a single country--will expand.

BOLD STRATEGY. Although opponents may manage to slow the timetable, even they admit open European skies are coming. A major goal is to strengthen inefficient carriers--something they badly need. The winners of U. S. deregulation--Delta, American, and United--are quickly replacing their weak sisters Pan Am and TWA, which gave the Europeans only modest competition. Stalled by slow growth at home, the newcomers are lured by the promise of 1992 and by the need to strengthen a key link in their global route systems.

With great fanfare last month, Delta launched a new Frankfurt hub and plans to fly to 27 European cities. By next summer, Delta will boost transatlantic service by 35%, to an impressive 266 round-trips a week. United is planning a Paris hub, and American is tackling the French and British markets. In 1985, two U. S. airlines flew to Paris. Now, Attali competes with eight. As a result, Air France's market share on the North Atlantic has plunged from 48% to 31%.

The Americans have one huge advantage. Air treaties signed after World War II let them fly between many European cities: Paris to London and Brussels to Munich, for example. Generally, they can't haul passengers within a single country. But their border-hopping privileges mean they can build feeder networks inside Europe, while European airlines have no such rights within the U. S. Early next year, United Airlines Inc. will fly traffic into a new Paris hub from five cities on the Continent--for starters. U. S. carriers may also pull European regional airlines into their orbits. Aero Lloyd, Germany's biggest charter airline, is offering itself to an unnamed U. S. carrier as a "Trojan horse" inside a deregulated Europe, says Aero Lloyd official Ronald Schmidt.

The Europeans are crying foul about what they regard as unequal treaties. "The Europeans have no rights at all in the U. S.," complains Karel Van Miert, transport commissioner of the European Community and deregulation's godfather. In the hands of Pan American World Airways Inc. and Trans World Airlines Inc., many U. S. rights lay dormant. Now, stronger Americans are activating them. That could touch off a political air war, with Europe threatening to revoke its old treaties unless the U. S. opens up to the Europeans.

For now, many European officials--such as the Germans--are more focused on keeping the Americans out. The reason is simple: Like their U. S. rivals in this recession year, most Old World airlines are losing money and will lose more. As competition grows, marketing costs will rise. Frequent-flier programs, unknown in Europe, are arriving and will become common. And Europe's sky-high air fares are gradually going to fall as government protections are lifted. "Profits will be under great pressure, no doubt about it," says KLM Chairman Pieter Bouw. This year's profits are suffering from weak traffic during the Persian Gulf crisis and the economic downturn that followed.

Such problems weigh heavily on Air France's night-owl chairman. His experience shows how arduous it is pushing a state-owned carrier out of the nest. Excess employees, high wages, and aging planes all help bloat Air France's costs. Precise comparisons are tough, but under one measure--operating expenses per available seat-mile--Air France shells out 20.8~, vs. 14.4~ for BA, Europe's cost leader. The big three U. S. carriers pay less than 10~ -- although that will rise in Europe because of stiff landing fees and infrastructure costs.

SLOW GOING. So far, the 48-year-old Attali is tiptoeing toward a modest restructuring that would cut staff by 5% over the next two years. He has placed major airplane orders to overcome shortages of planes. He is hacking away at a managerial maze of up to 18 decision-making levels. And he is improving Air France's in-flight service, which even the airline's executives admit has slipped.

Multiply Attali's problems by two dozen airlines, and you have an idea of Europe's challenge as deregulation looms. If U. S. experience is any guide, Europe's airports will be littered with losers. Even the U. S. newcomers, today flying so boldly into Europe, may find their new routes bumpier than expected. British Airways could give them serious competition. A rejuvenated Air France might, too. It has vast routes and an image of French luxury to exploit: It's the world's largest buyer of champagne. But the survivors will emerge far stronger. "We'll have turmoil for four or five years," predicts deregulator Van Miert. "But the dynamic airlines will take advantage of it and grow."

Revitalizing Europe's airline industry will be a grueling process, in part because of Europe's own ambivalence about liberalization. On the one hand, the EC favors greater competition to lower fares and give travelers more choice. But that clashes with Europe's need to build financially stronger carriers that can face the onslaught from abroad.

As the Europeans attempt to ualk a fine middle line, free-marketers are growing impatient. "Things are moving much too slowly," complains Robert Ayling, BA's director of marketing and operations. He is resigned to Europe taking far longer than the U. S. before its airlines hit the crosswinds of competition. Still, that day is coming. And it will bring heavy shock waves as Europe struggles to put aside national prestige for more efficient skies.

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