The Crisis at Air Madrid: A Low-cost Carrier Battered by Long-distance Routes

According to the experts, the failure of Spain’s Air Madrid suggests that it is, indeed, impossible to operate cheap flights on long-distance routes. Air Madrid tried that, but at the expenses of squeezing its small fleet of nine planes, which made marathon 15-hour flights to amortize their time as much as possible. One brief delay because of a technical problem or the weather, and it spread through the rest of the network, multiplying in impact. Eventually, this pattern provoked the greatest crisis in the history of Spanish commercial aviation. Can this situation affect the appeal of low-cost aviation?

 

Continual delays and cancellations at Air Madrid, and the resulting suspension of its flight certification by Spain’s civil aviation authorities, struck a blow to the ambitious growth plans of Air Madrid, the airline headed by José Luis Carrillo. The carrier announced its bankruptcy on December 15, leading to the government’s decision to suspend flights. Air Madrid had hoped to register a profit last year, according to its business plan. Only two years have passed since the company was launched.

 

Carrillo used to say that his company “offers fair prices,” referring not to his airline’s low prices or regular flights, but to the fact that its business model made it truly a rare bird in this sector. Air Madrid was the only airline that offered cheap trans-Atlantic tickets, enabling it to gain market share very quickly. In Europe, just Virgin Atlantic, on one specific route between London and New York, offers tickets at prices that can be considered economical. Its low prices were the only thing about Air Madrid that was similar to Ryanair, which also offers cheap flights. In every other respect, the two companies had nothing in common. Air Madrid offered its tickets through travel agencies. It had a business class, and it operated in every segment of the market. It flew to Latin America and Europe, and between cities in Spain. No other carrier attempting to maximize its costs as much as possible did any of those things.

 

Air Madrid, which enjoyed one of the fastest growth surges in the history of aviation, had planned to earn 4.66 million euros ($5.9 million) in 2006, compared with losses of 13.2 million euros in 2004, according to official data collected by the Spanish government. When the airline collapsed, 120,000 people were stranded, most of whom were Latin Americans. The company had served Ecuador, Colombia, Argentina, Chile, Panama, Costa Rica, Brazil, Mexico and Peru. It also served other destinations such as Romania. Felix Cuesta, professor at the Instituto de Empresa business school, puts it this way: “Its public consisted of travelers who had little purchasing power but, thanks to [Air Madrid’s] reasonable prices, gained the mobility to travel by air to their countries of origin. For them, the airplane had gone from being a luxury to a service that was necessary and popular.” Cuesta says that the crisis “will have only a minimal effect on low-cost air travel, and only during a short period, except for the flagship carriers that are able to adapt their offerings to the services provided by low-cost companies.”

 

Josep Francsec Valls, professor of marketing management at ESADE, also believes that the shutdown will not have any direct impact on the image of low-cost aviation for the additional reason that “Air Madrid’s model was not based purely on low costs.”

 

Iberia, the Big Beneficiary

The collapse of Air Madrid is going to have one clear beneficiary – Iberia, the only carrier that has comparable routes in Latin America. The rest of the carriers with regular flights between Spain and Latin America – Air Europa, Air Plus, Aerolíneas Argentinas, Lanchile and Aeromexico — only compete on a small number of routes. Iberia is the dominant leader, with an 18.5% market share of connections between Europe and Latin America.

 

The collapse of Air Madrid and its uncertain future have enabled Iberia to rid itself of an irritating competitor. Air Madrid was hoping to transport almost one million passengers to Latin America in 2006, compared with Iberia’s four million passengers.

 

The crisis of Air Madrid also coincided with the recent success of Iberia, largely in its trans-Atlantic flights. Between January and November 2006, Iberia transported 3.54 million passengers on these routes, amounting to almost 10% more than it carried during the same period in 2005. In November, the increase was 17% on a year-to-year basis. In coming months, Iberia will review its management plan and renovate its long-range fleet. The aviation market is beginning to believe that the collapse of Air Madrid could influence both of those initiatives by Iberia.

 

Changing the Business Model is a Key to Resurgence

Before its collapse, Air Madrid’s strategy was clearly to offer very cheap flights — at prices up to 50% lower than those of Iberia – in order to attract the enormous demand from immigrants who fly to their countries of origin, and to tourists looking for cheap tickets. In part, the company managed to do just that. Air Madrid, which operated in nine Latin American countries, began to rack up market share in a long series of routes where Iberia had operated as a monopoly. On some routes, such as from Spain to Santiago de Chile, Air Madrid won a market share of about 15%.

 

The key to achieving rapid profitability was to maintain a similar number of planes (it began with only one plane but expanded to nine), and to simultaneously increase its routes and frequencies, in order to get a better return on its fleet. In 2005, Air Madrid managed to transport 395,000 passengers. Last year, it carried 1.2 million.

 

Nevertheless, Air Madrid must change its business model if it wants to revive, says Valls. “Whichever company wants to re-launch the airline, or if the same Air Madrid is to get out of this mess, the company should take into account four fundamental things: It must capitalize the company; set up a very clear business model; revive public confidence, and inform the public [about its activities],” he notes.

 

According to Cuesta, it is absolutely essential to take a very close look at the company because “some factors can be traced back to management’s lack of rigor and [others] stem from issues with its relationship with the Ministry [of Development, which oversees the civil aviation authority]. As a result, [the company’s] resurgence is quite problematic. I think it is more appropriate to sell [Air Madrid, than to revive it],” he suggests.

 

Out of sheer necessary, those people who were affected by the collapse — mostly Latin Americans — will need to trust Air Madrid once again. “The only difference is that now they will choose the company, and not let themselves be won over by the lowest-price flight. They will put their trust in more serious brands that instill greater confidence,” explains Valls. “Man is the only animal who stumbles twice on the same stone.”

 

Despite its contractual obligation to passengers, Air Madrid has decided not to take responsibility for the fate of its customers. However, the Ministry of Development has demanded that it assume responsibility. For the moment, the suspension of activities does not mean that management will formally shut down Air Madrid, although the company has not ruled out such a decision in coming days.

 

Strategically speaking, says Cuesta, a change in the company name is fundamental if it is to recover. “The quicker that people forget this Christmas and the name of the company, the better it will be,” he says. Valls disagrees, arguing that a change in name may not be the most appropriate approach. “To me, it seems like a last-ditch solution, a rescue plan. If Air Madrid clearly establishes its conception of the business, capitalizes the company, recovers public confidence and lets people know about all that, then it could recover without needing to change its name.

 

The Workers Want to Take Control

Spain’s Civil Aviation agency, the supervisory body under the Ministry of Development, has accepted the viability plan presented by a group of Air Madrid workers. The supervisory body, which revoked the flight license of the airline after months of serious deficiencies in the maintenance of its airplanes, has carefully analyzed the rescue plan put together by Pablo Morera, the manager of Air Madrid who presented it to the Ministry. The rescue plan can count on the approval of the president of the airline, who is ready to give its workers 100% ownership in order to save the company and the jobs of its 1,200 workers.

 

The presentation of the plan took place after the Ministry of Development revealed that the air carrier had been under the watchful eye of the government since last May. In recent months, seven flights had been suspended because of problems with aircraft maintenance.

 

“A viability plan needs to be a document that is deep and technical on every level, and not [merely] a declaration of intentions,” says Cuesta. “Often, the hard part is not knowing what has to be done but knowing how to do it.”

 

Following Air Madrid’s decision to suspend its operations on December 15, its various competing creditors have stated their case. However, for no justifiable reason, the decision-making process has been delayed by Air Madrid’s management. At the moment, the airline cannot make any further flights because of the decision of the civil aviation authority to revoke its flight certificate on December 16.

 

For their part, Air Madrid’s creditors have moved forward and sued the company in a Madrid commercial court. They demanded an open process very similar to [what happens in] an old-fashioned suspension of payments. If a judge decides to open such a procedure, it would eliminate any chance of re-launching the airline without going through a judicial process. “Human capital is the most valuable part of a company,” says Valls. “If they [the airline’s staff] handle things right, they could save [the company].” Nevertheless, Cuesta does not believe that the best solution would be for the workers to acquire 100% ownership of the company. “Experience tells us that a good employee, even if he is a good manager, has no reason to be a good businessman. If we analyze the earnings of companies whose owners were their own workers, we see that there are some very bad experiences, including even when those owners came exclusively from various levels of [the company’s] management,” Cuesta says.

 

The managers of Air Madrid continue to search for a buyer from one of several companies that have shown interest. Following the breakdown of negotiations between Air Madrid and LTU [International Airways, a low-cost carrier], the managers of Air Madrid anticipate meetings with other companies, according to Efe, the Spanish news agency. The list of interested parties includes Gestair, a carrier that rents out private jets; an [unknown] investment fund and Swiftair. Any sale would face a series of problems, such as meeting the Spanish civil aviation agency’s [stringent] requirements for operating again, the airline’s suspension of debt payments, and the price [of the sale], which would be about 120 million [euros].

 

A Decisive Week for the Solution to Air Madrid

This week will be decisive for the future of the company, which could suspend its debt payments, leading to a contest among its creditors. The judge in Madrid’s commercial court, where the airline’s case is under consideration, will decide whether to accept the demands of a group of Air Madrid customers who were unable to fly. If the judge agrees to begin such a procedure, the court could decide to remove Carrillo and his management team from their positions, as generally happens in this type of procedure. The same judge also has on the table a voluntary suspension of payments plan presented by the airline some days earlier.

 

However, the court has yet to set a day to review the case because of problems in the documentation presented to it by the company. Among other things, Air Madrid has not demonstrated documents concerning its relationship with all of its customers who were affected by the suspension of its operations and who have become its creditors, according to Iureabogados, the firm that represents Air Madrid customers. In such a case, managers usually keep their jobs, but they would work under the control of court-appointed administrators.

 

“I do not think that passengers have been aware of the risks that can exist in the area of global air operations, from airplane maintenance problems to air traffic control,” says Cuesta. “In addition to equipment problems, there are those due to human failure. However, you cannot leave your house every day, thinking about all the bad things that can happen to you.” Low-cost companies give lower-income people the opportunity to fly. “As a result,” he adds, “I believe that the regulatory and controlling bodies must be very strict in their missions, and must not allow themselves to be influenced by any sort of pressures, either those that result from politics or those that result from business competition.”

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