Af kl-adapting to survive cannesairlinesforum-2005-eng

Adapting to surviveSolutions implemented by  ”legacy carriers”

Jean-Cyril SpinettaCannes Airlines Forum – 28 October 2005

With an average price estimated at 57 dollars per barrel in 2005, the airlines’ fuel bill has rocketed

2005 ResultsEstimate

Net income, USD bn

$47*$38

Average oil price

0

Source : IATA

* : May 2005 scenario

** : September 2005 scenario

$38.30

9/11

SARS, Iraq war

$57**

1

+ 54% to 97 billion euros

What differentiates the legacy carriers?

351

226

368

-855

-38

205

-462

-1 794 -4 683

-337

-576

-143

-1000

-900

-800

-700

-600

-500

-400

-300

-200

-100

0

100

200

300

400

500

AF-KL LH BA SK IB AZ AA UA DL NW CO US AS

Of which ~ -1270m€ in cancellation of tax

credits and ~ -1340m€ in asset revaluation

and ~ -360m€ in restructuring costs

Of which ~ -610m€ in restructuring

costs

Net income per airline (€m) - IATA 04-05

-8 885 million €

+545 million €

CO

DL

UABA

IB

AZ

AF-KL

LH

SK AA

NW

AS

US

+945 million €

A contrasted situation A stricken industry

EUROPE

USA

Organization by hub

1980s: USA 1990s: Europe

1980Atlanta

1986Washington

USA Hub modelMedium-haul/Medium

haulDomestic Hubs

Atlanta, Chicago, Dallas, etc.

European Hub modelLong-haul/– Medium-haul

Intercontinental HubCDG, Frankfurt,

Schiphol

Middle East Hub model

Long-haul/Long- haulDubai

1991Schiphol

1992Frankfurt

1996CDG

1981Dallas

A recent model

The economics of density

2000s: Gulf

2000-01Dubai

Basically, a hub is a model of cost reduction

Flight connections generate 50-150% of additional traffic

Increased frequenciesand/or aircraft capacity

A more attractive product / lower unit

costs

Point-to-point trafficConnecting traffic

The economics of density

Hubs: an efficient use of resources

59 medium-haul flights arrive21 long-haul flights depart

Air France Hub at CDGSummer 2005

1,319 origin-destination combinations

Medium-haul flights arriveBefore 0930 local time

Los AngelesMarseille

Bordeaux

Dublin

Tel Aviv

MadridCincinnati....

Paris

Atlanta

Mumbai

Long-haul flights departBetween 1015 and 1100

...

The economics of density

100

105

110

115

120

125

130

135

320 420 520 620 720 820

N° of seats (equivalent Economy-class seats)

Co

st p

er s

eat

mil

e

Bigger aircraft thanks to traffic complementarity

Three-class configuration – compared to “economy class” seatLeg length of 5,000 NM

+30 %

A 380

The economics of density

A 330Between the A380 and

the A33030% difference in seat

cost

Base 100

The intercontinental hub,a model with a future in Europe

55

100

70

115

2003a 2013e

Dynamic growth prospects for both connecting and point-to-point traffic

Outcome: stronger intercontinental hubsConnecting

passengers

Point-to-point passengers

~215 m passengers

~125 m passengers

Growth on international market+5.5% per year

source: BCG estimates

With hubs at CDG and AMS,Air France-KLM is well-positioned

to profit from this growth

The economics of density

How has Air France fared?… since 1996

Air France’s growth has mainly come from increased frequencies…- Number of aircraft: +71% - Number of seats: +46%- Number of frequencies: +82%

… designed to improve network quality

73%

94% 7.2

Simplify: more direct flights(% of direct flights)

Densify: more frequencies(average number of weekly frequencies)

Summer 96 Summer 05 Summer 96 Summer 05

4.6

The economics of density

280

290

300

310

320

330

340

S05 S06 S07 S08 S09 S10

• Growth will stem from aircraft capacity rather than from additional frequencies…

• …linked to a reduction in unit costs of the A380 and the B777-300

Average size of

long-haul aircraft

+ 11% capacity => - 3.5% in unit costs *

* Theoretical curve, long-haul seat costs DB.FL

What type of growth for the future?

The economics of density

A cost reduction strategy forms part of an overall strategy

Diametrically opposed strategies among the biggest European carriers … whose consequences are already very significant

2 500

5 000

7 500

10 000

avr-98 oct-98 avr-99 oct-99 avr-00 oct-00 avr-01 oct-01 avr-02 oct-02 avr-03 oct-03 avr-04 oct-04 avr-05

KLM

Air France

British Airways

Lufthansa

Traffic levels

RPK long-haul, April 98-Sept. 05

Croissance du trafic (PKT long-courrier)Iata 98-99 à Iata 04-05

Air France British Airways KLM Lufthansa

45% -10% 6% 50%

Traffic growth (RPK Long-haul) IATA 98 IATA 2004

Air France has resolutely opted for growth

Growth in long-haul demand is structurally robust…

… and there is no excess capacity in overall supply

Long-haul capacity from/to Europe – annual average 2006-2010

European airlines Non-European airlines

+4-5 % +6-7 %

~ +6%

… and this is borne out by our seat load factors:

from 79.4% to 81.5% from 2001 to 2004

Because the supply and demand environment allows this

and 83.4%, April-September 05 Air France long-haul

~ +6%Long-haul to/from EuropeAverage year growth 2006-2010

Air France has resolutely opted for growth

Because we have scope for growth at Roissy… which is not the case at the other major European airports

To win market share…and offer an increasingly attractive network

To generate the necessary productivity gains

Air France – KLM’s strategy of “profitable growth”

Balanced growth integrating the 2 parts of the equation

PROFIT REVENUE COSTS= -

Nor unrestrained growth

Uncontrolled growth likely to lead to cost slippage

Neither downsizing

Brings results in the short term, but difficult to sustain over the longer term

Which until now has borne fruit

Operating profit (€ million)

(before aircraft disposals)

Turnover (€million)

Degree of cooperation

Synergies

Trend in Alliance models

Commercial partnership

ATI(large-scale price harmonization)

Joint venture (on joint network components)

Low Moderate High Total

(FFP, Lounges etc.)

Commercial alliance(code-share: free-flow, seat blocks etc.

Revenue and costs sharing

Revenue sharing

European majors are gaining ground

500

2 500

4 500

6 500

8 500

Sept-01 Mar-02 Sept-02 Mar-03 Sept-03 Mar-04 Sept-04 Mar-05 Sept-05

and a 3% drop in traffic (RPK) over 4 years for smaller European airlines

KLM

Air France

British Airways

Lufthansa

Iberia

SwissAlitalia

27% more traffic (RPK) in 4 years for the 4 European majors...

Long-haul RPK, seasonally adjusted

Air France – KLM, an effective combination…

Long-haul Medium-haul

AF-only destinations

KLM-only destinations

49

32

30

111

57

45

24

126

Summer season 2005 schedule

Because Air France and KLM are remarkably complementary

45%

33%

22%34%

45%

21%

2005-2006 2009-2010

Revenue

Network

Costs

€295m €610m

… offering scope for implementing major synergies

Rationalization of the network without “sawing off branches”

Fluidity between the 2 networks via fare combinability (+42 million euros in 2005-2006)

Powerful frequent flyer programme (10 million members)

Synergies

… while strengthening our positions on our respective domestic markets

19%

5%

51%

23%

9%

0%

20%

40%

60%

80%

100%

120%

140%

Lima

Kilim

anja

ro

Nairo

bi

Taipei

Quito

60%

25%

46%

110%

18%

0%

20%

40%

60%

80%

100%

120%

140%

Port H

arco

urt

Bogota

Mia

mi

Ho Chi M

in

Hanoi

KLM - increased revenue on the French market Air France – increased revenue

on the Dutch market

Top 5 KLM-only destinations: +19% Top 5 AF-only destinations : +48%

2nd quarter 2004-05

100 171295 395

714

996

1373

1817

2328

2905

3549

0

500

1000

1500

2000

2500

3000

3500

4000

1997 1998 1999 2000 2001 2002 2003 2004 E. 05 E. 06 E. 07

Nu

mb

er o

f tr

ansa

ctio

ns

(19

97=

100)

The Internet increases and speeds the need for cost cuts

• Before: a counter agent in front of a GDS screen= 40 transactions per booking

• After: Expedia search engine connected to GDS= 1,500 transactions per booking (average 400 at Worldspan, etc.)

Explosion in queries for GDS with the emergence of search engines

0%

5%

10%

15%

20%

25%

30%

An outstanding opportunity to:

Satisfy our customers who want to choose their service or product themselves, in real time

Lower our costs

Internet: where do we stand?

Share of flight coupons sold on the web to domestic low-yield passengers in France

Instant sensitivity of our market share to the slightest shift in prices

-40

-30

-20

-10

0

10

20

30

40

August September October November December January February

%

Air France and industry sales on Italy-North America routes in 2004-2005, monthly data

All airlines

Air France-14€/ticket

-20€/ticket

Source: BSP

Successive cost-cutting plans at Air France …

1998-99 1999-00 2000-01

2001-02 2002-03 2003-04

2004-05 2005-06 2006-07

Target (€m)

Achieved (€m)Performance 2003

Three Billion Plan

Competitiveness 2007

84102

313331

457 463

70 88

176 186

280 300

200 215

590 *

800 *

* Includes gross savings on costs linked to switch to zero commissions

… combined with large-scale productivity gains

Overall productivity at Air France from September 01 to September 05

180

200

220

240

Sept-01 Dec-01 Mar-02 Jun-02 Sept-02 Dec-02 Mar-03 Jun-03 Sept-03 Dec-03 Mar-04 Jun-04 Sept-04 Dec-04 Mar-05 Jun-05 Sept-05

+21% productivity in 4 years

(seasonally adjusted)

EASK/EPT 000s

Air France costs

… have kept costs under control

Net costs per EASK excl.currency

5,50

6,00

6,50

7,00

1997

1998

1999

2000

2001

2002

2003

2004

ct e

uros

/eas

k

Excl currency &at constant oilprices

Excl currency,non-oil, non-inflation

… have kept costs under control

Net operating costs / EASK (Air France) (ex currency, inflation, oil prices and fees)

2001

-02

= 1

00

A widespread trend … but different methods

After a drastic “Future Size & Shape” restructuring plan (end-March 2004) …•13,082 job cuts / £869m cost-cutting /£900m in asset disposals

… additional initiatives worth £750m in IATA 2004-2006

•£450m: purchasing gains and cost cuts via e-services (to end-March 2005, target reached)

•£300m: cuts in personnel costs to end-March 2007 (15% cut in workforce with move into Terminal 5 at Heathrow in 2008 ** )

“Director Plan 2006-2008”: Targeting a €600m improvement in margin *•Network restructuring: €126m

•Additional revenue: €163m

•Productivity gains: €142m

•Cuts in personnel costs: €68m

•Other initiatives: €91m

A cost-cutting plan designed to save €1.2bn in 2004-2006: €606m savings by end-June 2005

•Internal suppliers (€203m): optimization of maintenance, optimization of short-haul flight product etc.

•External supplier (€205m): changes in travel agent commission model, optimization of ATC/airport infrastructure and procedures

•Production processes (€170m): restructuring of regional business unit, improved ground-handling at Frankfurt, increased use of medium-haul fleet

•Personnel: improved productivity / new wage deal

* In relation to an ongoing scenario

** Source: Press

Are we doing enough to counter the low-costs?

Tracking traffic peaks • Business• Hub waves

A differentiating product• More space in premium

65% of total differential on unit cost

Comparison of unit costsBase 100

0

20

40

60

80

100

Legacy carrier Low Cost

24

18

9

100

49

Aircraft use

Aircraft configuration

Other

The hub acts as a rampart against the low-costs Example of the Paris – Geneva route

AF AF

LX

U2U2

Evolution du nombre de fréquences sur Paris - Genève

0

2

4

6

8

10

12

S3 à W04-05 S05

AF AF

LX

U2

U2

AF: N° of frequencies stabilized

easyJet: cut from 4 to 3 frequencies

Swiss: services discontinued

Frequencies on the Paris – Geneva route

Summer 2005Summer 2003

We cut our costs… but cost of jetfuel rises

(€m)

1 406

3 4203 3703 320

2 960

1 975

3 210

3 070

2 630

2 180

1 761

1 302

2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

Jetfuel spend before hedging

Jetfuel spend after hedging

+459

+419

+440

Hyp: 61,9 $/bl 1 € = 1.24 $

65,6 $/bl 1 € = 1.25 $

63,4 $/bl 1 € = 1.25 $

61,9 $/bl 1 € = 1.25 $

+450

+140% of turnover( )

(13%)

(15%)

(21%) est

(15%) est

(22%) est

(18%) est

Forward priceat 26/08/05

(10.5%)

(11.5%)

Air France Group

Jetfuel hedges: a temporary cushion

Price of Brent$ / barrel

Forward priceat 7/10/05

30

35

40

45

50

55

60

65

04-05 05-06 06-07 07-08 08-09 09-10

Market price

Real price after hedging

Taxes and fees have also risen sharply!

Taxes and Fees 2000-2004

9,41 9,9710,63 11,11 11,48

5,006,007,008,009,0010,0011,0012,00

2000 2001 2002 2003 2004

Euro

s/00

0 Es

ko

In 4 years, Air France’s total bill has risen by + 40%

EASK = ASK + 2.36* ATK

+ 22% for EASK

Like for like, ADP is 20% more expensive than LHR or SCH. Fraport is 15% more expensive but with a pricing structure that is more beneficial for the hub

8,1

10,29,6

7,4

11,410,8

12,311,5

12,5 12,3

16,8

14,9

Schiphol Heathrow Fraport ADP

€ / Pax

Ratio of costs / Pax 2004

Fees/ Pax Fees + security/ Pax Like-for-like/ Pax

Note: Traffic Pax 2004, 2004 figures estimated except for Schiphol and Fraport (Annual report 2004)Source: BCG analyses

Pax 2004 44.3 66.4 51.1 75.3Benchmark BCG

7