BA Just Made Ryanair Look Charming, Competent and Cuddly

(Bloomberg Gadfly) -- One of British Airways boss Alex Cruz's first acts was to commission a new feature in the staff magazine: “Mistake of the Month”. The airline's employees, Cruz complained, were reluctant to admit their errors.

Finding material for the magazine's next issue won't be hard. A computer failure forced BA to cancel hundreds of flights at the weekend. Thousands of passengers were stranded, struggling to find alternative flights or reasonably-priced accommodation.

Regardless of what caused BA's computer to break -- Cruz insists it had nothing to do with the airline's recent decision to outsource key IT functions to India -- the airline's back-up systems and crisis-management were shown to be woefully lacking.

It rounds off the picture of an airline that's prioritizing cost-cuts over customer service. BA has already abolished free food for short-haul passengers in economy and crammed in more seats. Meanwhile BA pays new cabin crew far less than long-serving employees.

In most industries, treating staff and customers well is a prerequisite for success. Like other airlines, BA has learned there's another way -- one that involves avoiding competition, scrimping on service while ensnaring passengers who might otherwise be tempted to take their business elsewhere.

The cancellations may deprive BA's parent, International Consolidated Airlines Group SA, of a low single digit percentage of operating profit this year, according to analysts. But IAG will live to fight another day. Even after Tuesday's 3 percent fall, IAG's share price is close to a record high.

Management seems to think decent returns are locked in: thanks to costs-cutting, the company expects operating profit margins to consistently exceed 12 percent until 2020. In February, it announced a 500 million-euro ($557 million) buyback.

Underscoring the impression that investors, not customers, are IAG's top priority, the company used an expletive-laden slide at the company's capital markets day last year to discuss its returns to shareholders.

How can investor and customer satisfaction be so misaligned? Ryanair has always treated customers like pondlife -- but customers kept coming back due to its low fares.

Legacy carriers like BA once tried to be nicer, but Cruz, who made his name at IAG's budget carrier Vueling, believes the economy cabin has become a commodity product. He's probably right: economy customers will put up with a lot so long as the fare is competitive.

Another reason why passengers don't simply shun IAG is its loyalty program. BA's Avios loyalty points generate repeat business, even if the passenger has had a poor experience or the fare isn't the lowest. Berenberg analysts estimate loyalty programs account for more than one quarter of operating profit at U.S. airlines.  

And, crucially, competition is lacking. U.S. airline margins have been fattened by mergers which have left just four carriers controlling two-thirds of domestic routes. No wonder IAG champions consolidation.

Though Europe's aviation market is more fragmented, that's not true everywhere. IAG controls 55 percent of Heathrow's slots (where new capacity is severely constrained) and 37 percent of all high-margin London to New York traffic, according to Exane. 

IAG's shareholders might not always be so fat and happy, though. Low-cost operators like Norwegian Air Shuttle ASA are beginning to make inroads into the transatlantic market. Though passengers have to fork out for meals, they seem to like the brand and its fancy new 787 planes.

In contrast, BA still flies a lot of aging 747s. IAG has responded with its own low-cost long haul airline called Level.

Secondly, Heathrow should one day get a third runway, which could increase competition there. And there's Brexit, which could upset European air regulation, to the detriment of BA.

Stranded passengers can at least console themselves that IAG shares trade on just 7.5 times estimated earnings, less than half of the multiple investors apply to Ryanair, the airline Cruz denies trying to copy.

That discount may be justified. Though it's protected now, BA may yet come to rue not being nicer to passengers. Rather than picking on his employees for mistake of the month, Cruz needs to look in the mirror.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

To contact the author of this story: Chris Bryant in Berlin at cbryant32@bloomberg.net.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net.