Flying High

It was a daring move, executed with panache. Even though the Western powers were recognizing Communist China, KLM Royal Dutch Airlines decided in 1983 to become the first European carrier to serve China's archenemy, Taiwan. To launch Amsterdam-Taipei service, the airline flew in 10,000 tulips, which Taiwanese authorities auctioned off for charity. The move paid off: For nine years, KLM was the only European carrier to serve Taiwan. It still beats its European rivals for the island's lucrative traffic--and the Taiwanese still remember those tulips.

Imaginative marketing and risk-taking have worked wonders for KLM. Similarly, the Dutch carrier's risky alliance with Northwest Airlines Inc. is emerging as the first successful model of the strategic tie-ups that every airline covets as the industry struggles to globalize. KLM and Northwest are skirting legal and cultural constraints that have stymied other alliances and are pooling resources in the closest thing to a merger their industry has seen.

Their success is not only churning out profits for both partners at a gloomy moment in airline history but is also proving to be a testimonial for deregulation. KLM and Northwest have been able to meld their operations mainly because of a Dutch-American "open-skies" treaty, which lets airlines of both countries fly freely into each other's markets. Because they won exemption from U.S. antitrust laws, the two can set prices, market jointly, and may adopt a single name in a few years. Executives of other allied airlines, such as British Airways PLC and USAir Inc., would set off regulatory alarms if they did such things. "We're the only airlines that are building a tight global alliance," boasts KLM Chairman Pieter Bouw.

TAKING NOTICE. As a result of its gutsy moves, KLM has emerged in the big leagues of international aviation. Together, KLM and Northwest are the world's third-largest carrier in revenues, after American and United, a fact that rivals have begun to notice. "They're taking revenues from us," gripes Hans Mirka, vice-president for international services at American Airlines Inc.

Despite such complaints, Washington is convinced more open-skies treaties will ultimately benefit U.S. carriers. So federal regulators plan to use this Dutch-American alliance as a major talking point to pry open other markets. In March, the U.S. will launch negotiations with nine small European countries, from Switzerland to Sweden, to seek similar open-skies agreements.

KLM also is demonstrating how to make money in a deregulated climate. For its fiscal third quarter, the Amsterdam-based airline reported, on Feb. 2, a fivefold profit increase, to $49 million. The earnings widely beat analysts' expectations. Overall earnings for the year could quintuple, and sales are expected to rise 11%, to $5.5 billion. KLM is also enjoying double-digit growth in Asia and Latin America.

KLM's global connections are helping it fly rings around its European competitors at home. As Europe's fastest-growing carrier, its market share inside Europe has doubled, to 7%, as it pulls in passengers to connect with North American and Asian flights. Moreover, with $2 billion in its coffers, KLM will be a key player in purchasing controlling stakes--or outright ownership--of other European carriers as deregulation winnows out the losers.

KLM's success stands in stark contrast to such rival carriers as Air France, Iberia, Sabena, Alitalia, Olympic, and Aer Lingus, which are kept aloft only by huge state subsidies. Bouw has a bit of advice for his rivals: Accept change as inevitable. Open competition may hurt at first, he admits, but it's necessary to become efficient. If airlines wait, he warns, "they're going to lose out in the global battle that everyone faces."

Like many of its rivals, the 75-year-old KLM used to be a coddled, government-owned carrier, bred for a colonial empire that's now extinct. The state still owns 38% but keeps its hands off. KLM's transformation is largely the work of Bouw, 54. A 28-year veteran at the carrier, he became its boss in 1991, then cut costs and launched a potent growth strategy. He has added service around Europe and "waves" of connecting flights at Amsterdam's Schiphol airport, in tandem with Northwest, to create a hub with fast, easy connections to the U.S., Asia, and Africa.

NURTURING. Along the way, Bouw has rolled up his sleeves and done plenty of grunt work himself, even working out the arcana of flight traffic. "This is my hobby," says Bouw--only half-joking--as he bends over a stack of Schiphol flight schedules, searching for more efficient connections.

Yet for all his attention to detail, Bouw takes pains to explain his strategy to employees and press them for suggestions on improving performance. By nurturing a partnership with employees, Bouw was able to bring about work-rule changes that have boosted the efficient use of the airline fleet. Bouw also has avoided eliminating a single job. Instead, with the same number of employees--about 24,000--he has raised passenger traffic almost 50% since 1990. The Dutch carrier's costs are now among the lowest in Europe--and continue to drop (charts).

But Bouw's most important move has been the alliance across the Atlantic. In 1992, three years after buying a 20% stake in Northwest, KLM signed the open-skies accord with the U.S. In return, KLM and Northwest won their unique U.S. dispensation to act as one airline, free of antitrust scrutiny. "We sit down and conspire, we set prices, we share routes--it's wonderful," says Michael E. Levine, executive vice-president for marketing at Northwest.

Their deal lets them cut costs and jump forbidden borders. Rome, for example, is off-limits to Northwest. So KLM, through its European Union privileges, serves Rome on Northwest's behalf--despite Italian government protests. Because of KLM's route system to the Middle East, Africa, and Southeast Asia, Northwest's Levine is selling tickets from Des Moines to Bahrain, "places that weren't on our route map before."

After focusing on their transatlantic connections, KLM and Northwest also want to tighten cooperation in Asia. Northwest is a major presence in North Asia, while KLM has strong route systems in Southeast Asia. And despite the fact that KLM chose Taiwan over China, it can still generate traffic from Beijing and Shanghai via Northwest.

This blossoming of the relationship is proving the wisdom of KLM's risky purchase of its first Northwest stake in 1989. It was terrible timing--the U.S. airline market tanked in 1990, and Northwest almost went under, thanks to its own overrich leveraged buyout by outside investors. But KLM persevered, although it had to write off its $400 million investment. Northwest's cost-cutting plus $50 million in extra operating income from the KLM tie-up have put it in the black. On Jan. 19, Northwest reported a towering $296 million profit for 1994--topping American Airlines.

Bouw sees only seven or eight global airlines surviving the current consolidation. So KLM and Northwest intend to make the most of their marriage. "They still don't have much product visibility" as a common entity, says Nick Cunningham, analyst at Barclays de Zoete Wedd Ltd. in London. They also need to standardize service, so passengers are willing to fly either carrier interchangeably.

HAPPY MEDIUM. Their cultures also are quite different. KLM gives tiny china houses filled with Dutch gin to business-class passengers. Northwest passes out rock-and-roll CDs. Dutch cabin attendants are formal; Northwest's are too "enthusiastic" for European tastes, says a KLM executive. Bouw hopes to train crews together and mix nationalities for a happy medium.

The partners are trying to blur other differences. Last spring, they launched a common business class, with identical seats, food, and service on international flights. Despite the $30 million spent advertising the class, some travel agents in Europe say they're not aware of the joint product. This summer, the carriers may introduce a common economy class internationally. It may have video screens in every seatback, with a choice of movies and games. KLM and Northwest would be the first major airlines to offer this perk in economy.

While consolidating the alliance, Bouw has boosted KLM's Northwest stake to the 25% legal maximum. He says he would buy more if U.S. law should loosen, as some in Washington have proposed. Whether or not that happens, KLM is engaged in the industry's first strong effort to prove the merits of global partnering. If the alliance continues to work, it could force the hand of envious competitors around the world.