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KLM, Alitalia expand ties
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July 30, 1999: 10:53 a.m. ET
Airlines combine operations in move that could lead to merger
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LONDON (CNNfn) - KLM Royal Dutch Airlines and Alitalia agreed to expand their strategic alliance Friday in a move that could pave the way for the first cross-border merger between national European airlines.
The two carriers said the deal marked a "step-change" in their existing agreement and would see the companies combine passenger and cargo services under a single management structure from November, though both will still fly under their own names.
KLM, Europe's fifth-largest airline by revenue, is already a leading member - together with Northwest Airlines (NWAC) -- of the emerging Wings alliance, one of four global groupings that have emerged to dominate the global airline business.
Alitalia Managing Director Domenico Cempella said the deal "represents a completely new industrial model for air transport in Europe."
But KLM Managing Director Leo Van Wijk remained cautious about the prospects for a full merger. "We felt that the benefits of going for a full merger didn't outweigh the difficulties a merger would create," he told CNNfn.
KLM hopes to integrate Alitalia and Northwest partner Continental Airlines into the Wings grouping. "Continental is certainly the next issue on our list," said van Wijk, adding that the company was also seeking partners in Asia.
After signing up Alitalia, the number-six European carrier, as its main partner in the region last year, KLM was keen to expand the relationship. The Dutch carrier suffers from having a tiny domestic market, and relies on feeding passengers and cargo through its main hub at Amsterdam's Schiphol airport.
However, the airport suffers severe congestion after severe environmental constraints were imposed on take-offs and landings. The Alitalia deal will allow KLM to funnel traffic through the Italian carrier's hubs at Rome and Milan's new Malpensa airport.
The Italian government retains a majority stake in Alitalia, and KLM said last year that it would not be taking an equity stake in the airline, which is slated for partial privatization. The two companies plan to re-evaluate the ownership structure by April 2001.
Merger lessons
Analysts said the enlarged group, which is subject to approval from European competition authorities, would allow the carriers to compete better with the larger alliance groupings.
The deal represents the most extensive cross-border integration between European carriers, but the experience of mergers in the United States leads some observers to warn of difficulties in integrating systems and staff.
"What we have seen in the U.S. is that the operational planning [of these deals] is much more complicated than management tends to expect," said David Treitel, chief executive of New York-based SH&E, the world's largest aviation consultant.
Treitel warned that combining operations can lead to falls in service quality and missed profit opportunities. "Combining work forces and [pilot] seniority lists has also proven to be extraordinarily complex," he said.
However, he believed that KLM had the advantage of 10 years of experience with its Northwest alliance -- widely viewed as the most profitable of the airline groupings with which KLM and its partners compete.
These are led by the Star Alliance, headed by Lufthansa and United Airlines (UAL), and oneworld, led by British Airways and American Airlines (AMR). Air France, the third-largest European carrier, last month hooked up with Delta Air Lines (DAL).
The airlines said the expanded alliance would generate an extra 400 million euros ($427 million) in operating profits over the next three years. Around three-quarters of this will come from extra revenue through an integrated sales operation. The balance will come through cost savings, including the joint purchase of aircraft.
KLM and Alitalia plan to split profits 50-50, and will explore further integration that could lead to an outright merger in the future. The carriers will immediately make joint fleet decisions.
The airlines declined to outline how the venture will be managed, though company sources suggested a joint management board structure and a single chief executive.
KLM shares advanced 2.9 percent to 24.85 euros, while Alitalia added 2.35 percent at 2.61 euros. 
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