Was joining IAG a strategic error for Aer Lingus?

In 2008, before Aer Lingus was acquired by International Airlines Group (IAG), the airline ordered nine A350 aircraft from Airbus.The A350 planes, which were designed to replace older long-haul aircraft, were about 25 per cent more fuel efficient (per passenger) than the A330 aircraft that Aer Lingus was using – almost exclusively – on its North American routes.The savings would have been big. Operating A350s in and out of Los Angeles for a single year (on Aer Lingus’s current flight schedule) saves roughly €5 million in fuel costs compared with using the older A330s. Maintaining older aircraft is also more costly.The nine A350 aircraft, however, never made it into the company’s fleet. READ MOREIAG, which was in control when the aircraft were delivered, transferred most of them to other carriers within the group. Most went to Iberia in Spain. Aer Lingus continued with the less fuel efficient A330s.The point of retelling this forgotten Aer Lingus aircraft deal is that the airline is now being pressured by its parent to achieve more stringent financial targets which insiders say are “unrealistic” precisely because of the group’s ageing fleet. Last month, the airline announced plans to cut 500 jobs and discontinue several North American routes in a bid to achieve a 12-15 per cent profit margin target set for it by IAG.In 2025, Aer Lingus achieved a profit margin of 11.1 per cent, better than the previous year, but bottom of the IAG stable, which also includes British Airways, Iberia and Spanish low-cost carrier Vueling. Instead of supplying Aer Lingus with the newer aircraft to achieve this target, IAG is adopting a carrot-and-stick approach.[ Aer Lingus loses €34m in first half ahead of planned cuts in staffOpens in new window ]Unless Aer Lingus delivers financially it won’t get the new aircraft, hence the aggressive cost-cutting agenda in the midst of near-record profits and as the passenger cap at its Dublin hub is lifted. “We will not allocate capital to Aer Lingus, because we have other places [where] they are generating that margin, and it’s best to invest in that [those] places for our shareholders,” IAG chief executive Luis Gallego told the Business Post recently.IAG has ordered 21 newer model A330s but it is unclear how they will be allocated across the group.Another reason cited by insiders as to why IAG’s financial imperative is unfair on Aer Lingus is the seasonal nature of Ireland’s aviation market. Less than 20 per cent of Dublin’s annual passenger traffic occurs in the first quarter of the year, resulting in a very lopsided financial year.“We’re a tiny market in the context of the IAG operation but Aer Lingus faces fierce competition from Ryanair [which has particularly low unit costs on all of the European routes from Dublin],” said one analyst.“And on the transatlantic routes, the big US carriers can pick and choose when they want to come in [to Ireland] ... so they come in for the summer and largely disappear for the winter ... whereas Aer Lingus maintains its operation for the winter,” he says.When IAG acquired Aer Lingus in 2015 ... the feared scenario was that BA or Iberia would absorb Aer Lingus’s valuable Heathrow slots and the island’s connectivity would be compromised.If Aer Lingus was a bigger airline it could spread its cost base across more routes but the IAG strategy focuses the different airlines on different markets. “Iberia is focused on routes to South America, so that’s closed to Aer Lingus ... BA is focused on Africa and the Far East, so that’s closed to Aer Lingus, while Vueling dominates the Spanish domestic market,” he says.Because Aer Lingus doesn’t operate daily out of many long-haul routes, it also incurs much higher crew costs.IAG has also invested in premium economy in both BA and Iberia, now a strong revenue stream for both airlines, but, so far, not in Aer Lingus. Chief executive Lynne Embleton has signalled premium economy seats will be introduced on transatlantic routes from next year. Aer Lingus’s operating margin (11 per cent) is ironically the same as Ryanair’s – which analysts say is a good performance in the context of these negative factors and when the airline is not being given access to modern aircraft.[ Aer Lingus executives fastening their seat belts for a bumpy ride aheadOpens in new window ]When IAG acquired Aer Lingus in 2015, advocates argued the airline would benefit from being part of a larger group with greater financial muscle and a bigger global network.The Irish airline needed investment in the form of new aircraft and IAG could buy them at better prices.The feared scenario was that BA or Iberia would absorb Aer Lingus’s valuable Heathrow slots and the island’s connectivity would be compromised.To get the deal across the line, IAG gave the then Irish government (which held a 25 per cent stake in Aer Lingus) a quasi guarantee (it was time limited) that Aer Lingus would maintain the slots, a promise that has so far held.The year before the deal (2014), Aer Lingus made an operating profit of €72 million. Last year it made an operating profit of €282 million. But that has a lot to do with increased demand for air travel generally.And being a smaller cog in a bigger wheel may now be hurting the airline.