Failure of SWISSAIR

Learning From Corporate Failures

Final Project Report

Submitted to

Prof. P.D. Jose

Submitted by ABHILASH KUMAR SETHI (1111323) RACHANA DONGRE (1111366) KUNDAN MAL VERMA (1111350) DANIEL BOCHNITSCHEK (11E6102) LEELA BHARATH G (1011032)

Dated: 16 January 2013

CONTENTS
Case Summary........................................................................................................................................................................... 2 Introduction ............................................................................................................................................................................... 3 Swissair (SAirGroup): Company Profile ......................................................................................................................... 3 Chronological Overview........................................................................................................................................................ 5 Evaluation: Reasons of Failure........................................................................................................................................... 8 Flawed Strategy ................................................................................................................................................................... 8 Conflict Swissair vs. Crossair ......................................................................................................................................... 8 Influence of Publicity and Media .................................................................................................................................. 9 Governance and Personalities ..................................................................................................................................... 10 Bad Execution..................................................................................................................................................................... 10 Financial Analysis .................................................................................................................................................................. 11 Takeaways and Conclusions ............................................................................................................................................. 12 Appendix ................................................................................................................................................................................... 13 References ................................................................................................................................................................................ 14

Table of Figures: Table 1: Swissair growth at a glance (1931-2000).................................................................................................... 4 Table 2: Choronology of events ......................................................................................................................................... 7 Table 3: Financials for five years .................................................................................................................................... 11 Table 4: Breakdown of EBIT by business unit........................................................................................................... 11 Table 5: Sairgroup company structure ......................................................................................................................... 13 Table 6: Swissair's equity stakes in other airlines ................................................................................................... 13

CASE SUMMARY
The failure of Swissair, one of the most renowned national airlines worldwide, was the inevitable result of an overoptimistic alliance strategy which was executed by a management that was incapable to realize the point when it was necessary to switch course. This mismanagement over years combined with the external shock of the 9-11 terror attacks finally led to the grounding of the entire Swissair fleet in November 2011. The small Swiss national airline refused to join the large airline alliances which formed in the industry in the early 1990s as a junior partner and tried to build an alternative model by acquiring small local airlines across Europe and companies in related business fields such as hospitality and catering. Even as it became clear that none of the expected network effects became reality the company stuck to the course. Further, it was not able to effectively coordinate its own operations with those of Crossair, its regional subsidiary. Weak governance structures and high turnover on top management level were compounded by a strong public discussion about the strategic future of the national carrier. Media played a major role by favoring individual executives and their course and thus making them untouchable for the supervisory board. Finally the involvement of the Swiss state made decision making from a pure business perspective more complicated.

INTRODUCTION
2nd October, 2001, a very strange incident happened in the global airline industry. The entire Swissair fleet was grounded due to lack of liquidity with its parent company, the SAirGroup to pay to the fuel suppliers. Subsequently, a couple of days later, Swissair along with some of its subsidiaries filed for chapter 11 bankruptcy seeking protection from their creditors. A month later, Belgiums Sabena also has to declare bankruptcy in which SAirGroup had 49.5% stake. To prevent the permanent closure of the airlines, to prevent the loss of the valuable slots and gates at Swissairs Zurich hub and other destinations, to reallocate jobs and assets to a new national airlines and to keep the connection lines open to and from Switzerland, the Switzerland government and two of the largest banks of Switzerland, UBS and Credit Suisse had pumped in around 4.25 billion Swiss Francs(CHF) (600 CHF per person in Switzerland) to replace SAirGroup with SWISS, countrys new national carrier. SWISS was developed around the most commercially profitable wing of Swissair and the largest regional airline of Europe, the Crossair. It began its operations on 31st March 2002. The Swissair collapse is an exemplar in many ways. It was the very first European flagship airline to get grounded. More importantly, although the depreciating financials of the company made its decline pretty obvious, but the speed at which it was grounded was exceptional. For many decades, before the early 1990s, Swissair had boasted to have one the industrys strongest financials due to which the company has earned the reputation and nick name of Flying Bank internationally. However, before its collapse, SAirGroup has completely lost its equity count and its equity ratio was plummeted to 2.55% in August 2001. In the last financial year of its existence ending on December 2000, SAirGroup has increased their liabilities because of incessant borrowing by 40% to 18.86 billion CHF as compared to the previous year and registered negative PBIT for the first time in their career of the order of 2.59 billion CHF. Through this paper we would like to elicit the various reasons that had led to the failure of such a giant organization such as incompetence of both the top management and board which has led to faulty groups alliance strategy and internal coordination failures along with various external factors.

SWISSAIR (SAIRGROUP): COMPANY PROFILE

Schweizerische Luftverkehrs AG, or more famously known as Swissair was formed on 26th March 1931, from the merger of Zurich based Ad Astra Aero AG and Basler Luftverkehr (Balair). The company since its formation has won many accolades including the Best Airlines award in all decades to come due to its high quality strategy stressing on safety, reliability, passenger comfort and punctuality. Swissair was also considered to be a trendsetter in many fields of European aviation which included introduction of high speed Lockheed Orion aircrafts in 1932 and many other aircraft carriers in later years as well like Boeing 747-300 etc. It was also the first airline in Europe to employ air hostesses on its passenger flights in 1934. Swissair was considered analogous to premium comfort and pride by its passengers and a brand of Switzerland. After World War II, Swissair has adopted the path of fast growth and had become

one of the worlds major international airlines both in terms number of passengers carried and passenger miles available. From its formation till its grounding in 2001, the airline has firmly secured the rank of 20 among all airlines globally. But the high focus on quality and lack of competition has given rise to the problem of more manpower, who are highly paid for their work at Swissair. Manpower costs, at a time reached a peak of 39% of the total operating cost of the company, which has increased the breakeven load factor for the company. 1931 13 64 10282 20 1946 16 789 62378 15 1970 35 13280 3.9 million 75 49% 2000 161 71900 19.2 million 218 75%

Size of Fleet Number of Employees Number of Revenue Passengers Number of cities covered Break Even Load Factor

TABLE 1: SWISSAIR GROWTH AT A GLANCE (1931-2000)

Until early 1990s, Swissair was very risk averse as far as the financials were concerned which provided Swissair with one of the strongest balance sheets in the industry and an excellent credit rating. Two factors were mainly responsible for this, one being the company policy of having a maximum 1.2:1 debt to equity ratio. But Swissair has always maintained a better figure than this and only once in all its year of operation has it reached close to the figure of 1.2:1. Secondly, a very conservative depreciation policy helped the company generate a healthy cash flow and reserves. However after the formation of European Union, where 50.3% population of Switzerland vetoed against joining the union, the entire company structure changed for Swissair. Swissair has taken many steps to maintain its ranking in the European aviation industry. This included diverging from its core competency and investing into non-aviation activities like maintenance and repair, ground handling, catering, aircraft leasing, duty-free, hotels etc. (Appendix 1 & 2), all of which ultimately by 2001 were accountable of half of SAirGroups employees and most of its profit. Swissair was the very first airline to seek close ties with other airlines. The very first alliance was KSSU group (KLM, SAS and UTA) for joint maintenance activities of wide body aircrafts. Again the economic pressures created after formation of EU, led Swissair to go for further alliances such as: 1. European Quality Alliance: Sabena, Austrian Airlines, SAS, Finnair 2. Atlantic Excellence: Delta, Austrian Airlines, Sabena 3. Global Excellence: Delta, Singapore Airlines However, the failure of the Alcazar project (Swissair, KLM, SAS and Austrian Airlines) to compete against the big three European airlines, Air France, Lufthansa and British Airways and

when most of the previous partner airlines left the alliance to solicit partnership with other big players of European market, prompted Swissair to reevaluate its alliance strategy.

CHRONOLOGICAL OVERVIEW
Swissair did not fail from one day to the other. It was a series of internal and external events accompanied by severe management mistakes over a period of several years that brought the once innovative and stable airline down to bankruptcy in 2001. The following table gives a chronological overview 1 of the main events from 1990 onwards and sets the stage for the analysis of failure in chapter four. Year 1990 1990 Event Economic Downturn 2nd stage of liberalization of air traffic in Europe Description High oil prices due to the Gulf war induce an economic downturn. In 1990 the so-called second package of liberalisation measures allow all European airlines to carry passengers to and from their home countries to other EU Member States (3rd and 4th freedoms). Also 5th freedom flights, i.e. intra-European flights with stop-over in a third country and the right to pick-up and drop-off passengers during the stopover, are allowed to a greater extent. Fare and capacity restrictions are further abolished. This results in an overcapacity of air traffic and competition on price. The Swiss people vote against a membership in the EEA. As a consequence Swissair cant extend its services to Greece or takeup passengers in Italy. Details of a planned fusion between Swissair (30%), KLM (30%), SAS (30%) and AUA (10%) are revealed to the public. After a controversial debate on national levels (Swissair must stay Swissair) in all four states, the fusion fails due to national discrepancies and public pressure. After the failure of ALCAZAR Swissair has three options. 1) Continue operations as a single player (difficult due to small domestic market) 2) Merge with a large player such as Lufthansa or British Airways (financially the best option, but emotionally not applicable after the ALCAZAR attempt)

1992

Switzerland votes against EEA membership ALCAZAR Alliance fails

1992/ 1993

1993

Strategic decision to form European System under Swissair leadership

All used sources listed in References.

3) Build a European System / Alliance under Swissair Leadership Swissair Executives decide to go for version three. In their decision they frame risks as challenges, and identify the potential take-over opportunity of the Sabena Airline as once-in-alifetime opportunity. 1995 Swissair acquires 45% stake in Sabena Philippe Bruggisser joins Swissair as COO McKinsey proposes Hunter Strategy New senior management team joins Swissair 1998 1999 Formation of the Qualifier Alliance Delta cancels Swissair collaboration and partners with AirFrance AUA exits Qualifier Alliance Swissair acquires equity stakes in the Belgian airline Sabena which has little chances to survive on its own in this very competitive European market and is in a catastrophic financial state. The Swissair board has little confidence in the current CEO and therefore creates the new position for P. Bruggisser as COO to manage and implement the growth strategy. Swissair aims to grow and gain significant European market share by acquiring small national airlines with a string foothold in their respective domestic market. Among others Swissair acquires the German airline LTU which was in severely negative financial conditions. A new senior management team joins Swissair. Together with Austrian Airlines (AUA) and its subsidiaries Swissair forms the Qualifier Alliance. Along with a leadership and strategy change, Delta Airlines exits the collaboration with Swissair and partners with Air-France in order to establish a Europe hub in Paris. Swissair rejects to join the Delta - Air-France Alliance as a junior partner. AUA exits the Qualifier Alliance to join Star Alliance under Lufthansa leadership. As a consequence Swissair is isolated in its small domestic market. Nevertheless, management sticks to its course and neglects the offer to join the One-World alliance under the leadership of British Airways. Before resigning as president of the Swissair Board, Hannes Goetz signs a contract with the Belgian government increasing the Swissair stake in Sabena to 85%. Eric Honegger becomes president of the Swissair board without

1996

1996/ 1997

1999/ 2000 2000

Increase stake in Sabena Eric Honegger becomes new

president of the board Summ er 2000 Nov 2000 McKinseys Shield study reveals severe financial situation Board stops further acquisitions and CEO Bruggisser has to leave

relevant experience in the airline business. A study of McKinsey gives complete transparency on the severe financial situation of Swissair. Management does not take action but ends the engagement of McKinsey instead. Further acquisitions are planned. The board stops the acquisition course. After discrepancies between CEO and board, Mr. Bruggisser has to leave the company. The media praise him as a manager who fought for the sovereignty of the Swiss national airline. Moritz Suter (CEO of Crossair, 2nd largest Swiss airline) takes over. After discrepancies with the board about the further development of the Airline Moritz Suter leaves Swissair after a few months. The entire supervisory board resigns after two independent consultancy reports document the severe financial situation of the firm. Mario Corti (Nestle) takes over. After joining the struggling airline Mario Conti tries to restructure the airline with his program Change 01 As a result of the 9-11 terror attacks, air travel declines by 30%. Major US Airlines lay-off people. Lufthansa grounds 43 of its 300 planes. Also Swissair is affected by drastic decline in demand. Its financial situation becomes worse. Swissair in unable to pay the required fuel. UBS refuses a credit increase. As a consequence, Swissair had to ground all airplanes and cancel all flights. 39.000 passengers stranded at airports worldwide, their tickets were not recognised by other airlines.
TABLE 2: CHORONOLOGY OF EVENTS

Mar 2001

CEO Moritz Suter as well as the entire supervisory board resigns

Mid 2001 Sept 2011

Restructuring program Change 01 9-11 Terror Attacks

2nd Nov 2011

Grounding of all Swissair planes and cancellation of flights

EVALUATION: REASONS OF FAILURE

FLAWED STRATEGY Swissair was the first European airlines which tried to collaborate with other regional airlines in other continents to make its presence felt there. It made partnership agreements with Delta, SAS and Singapore Airlines etc. to get its hold in other important markets as well. But it failed to understand the importance of European market for its very survival as it was the firm base from which it operated. In 1992, Switzerland declined entry into EEA (European Economic Area). This hit Swissair badly. Instead of operating freely in key European destinations, it had to go for individual cooperation treaties with regional airlines of respective countries. It led to cumbersome renegotiation process which deprived it of its early advantages. To counter this negative impact, Swissair decided to go ahead with its Alcazar project. Alcazar project (Alone Carriers Zigzag At Random) was a secret negotiation among Swissair, SAS, Austrian airways and KLM to form an unprecedented alliance. It was to start with a greater level cooperation where merger of all entities to form a large airline was the ultimate motive. But there were lot of organizational issues, negative media coverage, ownership problems and political pressure which finally led to termination of this project. This failure resulted in significant loss of time and efforts on Swissairs part. Insight: Swissair put all its eggs in one basket without worrying about other alternatives. At last, it could not sustain the ambitions of other partners in the project. The failure of strategy resulted in time and efforts loss for the management of Swissair and this gave some advantage to rivals. So an organization should not concentrate all its efforts on one initiative; it should diversify the risk so that it does not fall flat in case of failure. CONFLICT SWISSAIR VS. CROSSAIR Crossair was established in 1978. It started as a regional carrier but slowly it went on expanding its routes in Europe. Swissair acquired a minority stake in Crossair which it increased to majority stake later. As Crossair was operating on some of the same routes where Swissair was already present, it gave Swissair an opportunity to consolidate both airlines on such specific routes to lower operating costs and increase efficiency. It required cooperation from both airlines. But Swissair top management never cared for going ahead with such strategy. This led to both airlines running parallel strategy with same kind of implication. While Swissair was pursuing its Hunter strategy, Crossair was working on its Eurocross strategy. This resulted in Crossair competing with Swissair in its small Swiss market. Cooperation between the two could have provided them with much large economies of scale and potentially save Swissair from its collapse.

Insight: In capital intensive industries like airlines, full utilization of resources alone can give competitive advantage. Cooperation instead of competition should be the moto in such industries for all the players to be profitable in these kinds of markets. INFLUENCE OF PUBLICITY AND MEDIA The fact that Swissair was a national airline raised the attention of the media and publicity extraordinarily. Swissair executives were constantly under pressure having to comment on the companys shape and further development. This short chapter will certainly not argue that this was a main cause of the companys failure, but it is worth to recognize the media-induced pressures executives of large and prominent firms are exposed to whenever there is a crisis and they are responsible to make the final call. In particular Der Blick, a newspaper comparable to the English yellow press with a high national circulation, went beyond its pure information function and gave the discussions a clear spin towards national interests and sentiments. Two examples shall demonstrate this issue. The first example relates to the plans on forming the ALCAZAR alliance. During the debate, the newspaper made it hard for the companys managers to take a free, non-biased decision. In the article2 Swissair muss Swissair bleiben (Swissair must stay Swissair) the chief editor of the paper stated: In the planned wedding between the four airlines, Swissair is not just the most beautiful bride. It is the prey. Through such comments, a pure business decision is radicalized and lifted to the level of politics. Supporting the option to join the alliance is framed as treason. The second example points out how the media (again Der Blick) tend to personalize news coverage. When it became clear that CEO Bruggisser had failed with the Hunter Strategy and the supervisory board stopped his course and even considered selling the airline, Der Blick again provoked national sentiments by stating: Philipp Bruggisser fought like a lion. There a too few people like him even if he should fail, at least he tried: creatively and persistent. He is a hero, a management hero. 3 Although the statement is completely unqualified from a business perspective, it makes it hard for members of the supervisory board to find convincing arguments supporting the change in strategy. Both examples demonstrate how big the pressure of public awareness can get and one can image that sound decision making certainly becomes very difficult if the reaction of publicity and media always needs to be considered. In the case of Swissair there were many similar incidents. This shall not count as an explanation why the company failed, but public pressure on individual managers and management teams certainly limits their freedom in decision making and contributes to bad management choices.

2 3

http://chronik.geschichte-schweiz.ch/swissair-debakel-grounding.html http://chronik.geschichte-schweiz.ch/swissair-debakel-grounding.html

GOVERNANCE AND PERSONALITIES Swissair went for Hunter strategy of acquiring small players instead of seeking for alliances. This strategy stemmed from the need of political control of this organization which represented Swiss national pride. Many times management took rash decisions which were motivated by political and social compulsions rather than economical ones. Many political appointees who had little knowledge of aviation industry spoiled the chances of any growth by making illogical decisions. For example, Swissair CEO Phillippe Bruggisser came under attack from outsiders for taking an acquisition strategy instead of that of making regional alliances since whatever new airlines Swissair had acquired were having serious financial difficulties and operating in lower market segments. This significantly degraded Swissair brand name. It was CEOs decision which even board members were also not happy with. They thought that Bruggisser was playing power control game instead of worrying about companys profitability and image. National symbol and pride became more important than shareholders interests. Corporate governance of Swissair was also ruined by intervention of Swiss law. The day-to-day decisions were taken by executives but the real power rested with board which was mostly appointed by political elites. There was no clear segregation of power between management and board. Board members were often chosen because of their political or banking connections. This allowed entry of non-professional into Swissair which led to bad decisions and ultimately its collapse. Apart from that, system of corporate governance in Switzerland at that time was such that political and societal norms were given priority over financial and economic norms. Addition to this, Swiss government had 30% stake in Swissair which allowed it to decide who the CEO was and how he was to conduct business. This compelled management to work in congruence of political and societal agenda of Swiss government which ignored economic implications. At last, this led to failure of organization Insight: public sector enterprises should give more emphasis on meritocracy within the organization. Strength of corporate governance decides the effectiveness of checks and balances in the system. If organization wants to avoid failure, it must push for strong corporate governance within the organization. BAD EXECUTION Bad Execution of Hunter Strategy has led to the failure of Swissair. Swissair in desperate attempts to capture market share, kept in pouring more money (4.1 billion CHF when the maximum was set to 300 million CHF), took unnecessary risks of alleviating the financial condition of the members of the alliance and also targeted some of the bigger players in the aviation industry (Italy). This has put more pressure on Swissair financials which has ultimately led to its failure. They should have implemented the strategy at a slower pace with pilot studies in between to know the effectiveness of the strategy.

FINANCIAL ANALYSIS
From the financial data it can be seen that, the EBIT for the company has seen a sudden depreciation in 2000. Before that, Swissair enjoyed a very strong financial status and is considered as the flying bank of the world. The huge amount of loss caused in the FY2000 can be accredited to the widespread equity based alliance forming Hunter Strategy adopted by Swissair, with an aim to capture 20% of the market share in Europe. The Hunter strategy was adopted in 1997 and was implemented in 1998 when the Qualifier alliance was created. Till 1999, Swissair spent around 4.1 billion CHF for purchasing significant shares in variety of airlines. Swissair also was forced to pump in liquidity to keep many of its financially struggling airlines afloat so that the alliance is maintained. In September 2000, Swissair realized that the hunter strategy has failed and the board has to strategize the exit scenario of several of its loss making investments. In fact, majority of the investments made by Swissair during this period were making huge losses. Even worse for Swissair was that, in all its alliances, the pride of being the national airlines of Switzerland and the hunger to capture European market share has led Swissair to take full responsibility for its partners financial obligations, which has led to huge cash outflow from Swissair. Moreover, the alliance with low cost airlines just to capture market share, led to the dilution of brand image of Swissair as well as it also eradicated their ability to charge price premium from their consumers, who had always considered Swissair as a premium airlines. All this factors along with the terrorist attacks had led to consumers not opting for Swissair which had caused SAirGroup to see negative EBIT (111 million CHF) for the first time in the FY2000.
In million CHF Total Operating Revenue EBIT Net Profit(loss)/year Liabilities Shareholders Equity EBIT by division (million CHF) SAirLines SAirServices SAirLogistics SAirRelations SAirGroup SAirLines Investments Total EBIT 1996 8212 344 (497) 1997 10556 658 324 1998 11297 700 361 1999 13002 643 273 13673 4181 2000 16229 (2592) (2885) 19055 1160

Liabilities and Shareholder Equity 9708 10191 11181 2109 2439 3549

TABLE 3: FINANCIALS FOR FIVE YEARS

1997 264 127 43 181 43 658

1998 354 145 33 153 15 700

1999 188 165 6 269 95 (80) 643

2000 35 162 99 300 68 (3256) (2592)

2001 138 (6) 17 56 (111) (137) (43)

TABLE 4: BREAKDOWN OF EBIT BY BUSINESS UNIT

TAKEAWAYS AND CONCLUSIONS

The case of Swissair can be considered as an amalgamation of corporate faulty decision making and a collusion of many external factors as well. There are a lot of things to learn from the case of Swissair: 1. Managerial Hubris: Managerial hubris is one of the main reasons of a lot of corporate failures. The pride of being the national carrier of Switzerland has made the management over confident about the airlines. That is the reason they did not accepted the alliance with bigger airlines like Ari France and Lufthansa with the fear that they will be treated as a feeder airlines. Instead they went in and created alliance with several smaller airlines where they could be treated as the undisputed leader. But as is the case in front of us, the strategy failed miserably creating a situation where the airline was not even able to fund refueling of its fleet. 2. Proper implementation of strategy As per the Hunter Strategy suggested by the consulting company, Swissair was supposed to target only the small countries and the maximum investment was set to a maximum of 300 million CHF. But Swissair took the risk and pumped in 4.1 billion CHF into the Hunter Strategy and also targeted bigger economies like Italy. Thus proper implementation of strategies is a key driver in success. 3. Proper brand communication and strategizing accordingly Swissair is positioned as a premium brand in the mind of the consumers. When the company started forming alliance with low cost struggling airlines, the perception of the brand changed among consumers. The regular consumers of Swissair, who are the business class people who generally are ready to pay more money for better services, started dumping Swissair for other airlines. Thus brand communication and a good brand image is very much necessary for success. 4. Grab opportunities When the big airlines approached Swissair for alliance after the formation of EU, Swissair denied forming the alliance and instead chose to compete against them for market share, knowing that it is a very small airline considering the liberalization of European aviation sector where Switzerland is not a member nation. This has led Swissair to make desperate attempts to gain market share and was grounded completely. 5. Prevent cannibalization Swissair managers allowed Crossair to set up another hub at Basel and start its operations independently. It cannibalized the operations of Swissair which had hub in Zurich. Instead Swiss air should have worked in association with Crossair in developing their business.

APPENDIX

TABLE 5: SAIRGROUP COMPANY STRUCTURE

TABLE 6: SWISSAIR'S EQUITY STAKES IN OTHER AIRLINES

REFERENCES
BBC News: Swissair grounds all flights, URL: http://news.bbc.co.uk/2/hi/business/1574658.stm BBC News: Thousands stranded in airline crisis, URL: http://news.bbc.co.uk/2/hi/europe/1577609.stm European Commission: History Market Integration, URL: http://ec.europa.eu/transport/modes/air/internal_market/integration_history_en.htm Jud, Markus: Das Swissair Dabakel, URL: http://chronik.geschichte-schweiz.ch/swissair-debakelgrounding.html (German) Knorr, A. and Arndt, A.: Swissairs Collapse An Economic Analysis, Materialien des Wissenschaftsschwerpunktes Globalisierung der Weltwirtschaft, Bd. 28, September 2003 Manager Magazin: Der Absturz der "fliegenden Bank" - eine Chronik, URL: http://www.manager-magazin.de/unternehmen/artikel/0,2828,160189,00.html (German) Wikipedia: Alcazar, URL: http://en.wikipedia.org/wiki/Alcazar_(airline) Nwabueze, U. and Mileski, J.: The challenge of effective governance: the case of Swiss Air, in Corporate Governance, Vol. 8, No. 5, 2008