Commentary: How Italy Is Grounding Alitalia

It won't let the floundering carrier make desperately needed cost cuts

To many observers, Alitalia seems like yet another state-owned European carrier destined for extinction by shutting down, dwindling into irrelevance, or selling out to a more muscular carrier. After all, that's the fate that befell Sabena and Swissair -- both gone -- and KLM Royal Dutch Airlines, which Air France took under its wing on May 4.

Alitalia, meanwhile, lurches from one crisis to the next. On May 6, after strikes brought Italy's flag carrier to the brink of collapse, the government ousted management and deferred plans to cut 5,000 jobs. In exchange, unions agreed to a moratorium on strikes. Alitalia can't hold on much longer, though. It has burned through more than $600 million since January. Analysts say a reserve of $240 million will last until fall. As a midsize airline, it loses out to megacarriers Air France, Lufthansa (DLAKY ), and British Airways (BAB ) on long-haul routes, while discounters such as Ryanair (RYAAY ) and easyJet Airline draw customers on shorter flights.

Alitalia's condition doesn't have to be fatal if the state relents and lets the carrier make the cost cuts that could enable it to prosper. Despite the conventional wisdom that most of Europe's established carriers are doomed, well-run regional airlines still have a place in Europe, where travel habits are often shaped by history, language, and tradition. By cutting costs and focusing on profitable niches, a number of midsize flag carriers are emerging from the global aviation downturn in surprisingly strong shape.

Austrian Airlines, a partially privatized carrier, trimmed its workforce of 8,000 by 10% and cut pay and benefits. It also expanded routes in Eastern and Central Europe and set up a low-cost operation in Bratislava, Slovakia. Analysts expect Austrian to report operating profits of $60 million this year, up from $5 million in 2003, on projected sales of $2.5 billion. Its shares are up 70% since January. "The Austrian Airlines group is now firing on all cylinders," Chief Executive Vagn Soerensen says.

What about other carriers? Scandinavia's SAS Group is expected to return to profitability after slashing more than $1.8 billion in costs since 2003. Ireland's Aer Lingus, repositioned as a no-frills carrier, posted a 30% rise in operating profit last year. Spain's Iberia Airlines, restructured before it was privatized in April, 2001, has been profitable ever since.

Alitalia, by contrast, is a mess. Its pilots average fewer than 500 hours a year in the air, vs. 600 to 700 hours at most European carriers. More than half its 170 planes are aging McDonnell-Douglas models that cost more than twice as much to maintain as newer planes, according to the Milan-based Bocconi University Center for Research on Regional Economics, Transport & Tourism. The bottom line: Alitalia's costs are 30% to 40% above those of most European flag carriers. "It's patently obvious that Alitalia can't survive with its current cost structure," says Nick van den Brul, a BNP Paribas analyst in London.

What's next? European Union rules forbid a bailout. Officials suggest selling more shares to investors, but who wants part of an airline that has seen three restructuring efforts founder on opposition to job cuts? Certainly not Air France, which rebuffed Alitalia's request that it be brought into the KLM merger.

Yet a properly restructured Alitalia could work. One approach: spinning off a "new" Alitalia with the cream of the fleet, a few thousand staff, and a focus on profitable routes. The remainder of the company would be doomed -- an unpleasant prospect. But thriving in smaller form beats extinction.

By Carol Matlack

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