The Looming Fall of Amsterdam?
For KLM, there’s no time like the present. The problem is the future.
During the second quarter, no European airline performed better. KLM by itself, excluding its sister airlines Air France and Transavia, earned a hearty 9.4 percent operating margin. Not even Swiss Air or Ryanair did quite that well. KLM’s springtime success enabled it to repay more than $1 billion borrowed from banks and the Dutch government during the two-year-long Covid crisis. During the second quarter, furthermore, it stopped receiving government payroll support (though it does still owe a lot in deferred tax).
Don’t for a second think that KLM’s second quarter was problem-free. High fuel prices, escalating labor costs, Russia’s airspace closure, lost Asian business, low asset utilization — this was no time to celebrate. Operations at Amsterdam’s Schiphol airport, meanwhile, were an absolute mess during the period. Nevertheless, KLM enjoyed a resurgence in passenger demand while continuing to earn outsized profits from its large cargo operation. In fact, it flew nearly as many cargo ton miles as Air France, despite Air France being the much larger airline. More generally, KLM performed well this spring — and likely this summer — thanks in large part to its Amsterdam hub, one of the world’s best for connecting people and freight to scattered points across the earth.
But just as Schiphol is instrumental to KLM’s success today, the airport — or the Dutch government’s airport policies more precisely — cast a foreboding shadow over the airline’s future. At the moment, KLM’s frustrations are with the airport itself. Unable to properly staff security lanes, Schiphol, in July, imposed a hard cap on the number of passengers carriers are permitted to handle each day. In late September, the airport extended the caps until at least March 2023 (with a possible review in January), evoking the ire of its largest tenant. By KLM’s count, airlines including itself will have to cut their local Amsterdam enplanements by 22 percent this winter season, after an 18 percent cut this summer. KLM called it a “hopeless situation, lacking any perspective.” It alleges the flight caps to date have cost it more than $125 million.
The Dutch airline was already livid about the airport’s imposition of sharply higher charges in the coming years. But KLM and airport at least agree on one thing: Both are equally furious about a new government policy — announced by the Dutch cabinet in June — that caps the number of annual Schiphol flights at 440,000 starting next November. For perspective, the current limit is 500,000, just a tick above the airport’s actual number of flights (497,000) recorded in 2019. In 2018, Schiphol handled more than 499,000 flights, underscoring the point that Amsterdam’s airline market was already held back by the current cap. Now, the airport and KLM will be forced to shrink.
Make no mistake, this poses a meaningful threat to KLM’s longterm prospects. An airline unable to grow is an airline destined to incur higher non-fuel unit costs, especially during times of labor and aircraft inflation, not to mention Schiphol’s escalating charges. Oh, and then there are the higher aviation taxes the government is imposing. If KLM and Amsterdam are two golden geese of the Dutch economy, government officials are doing their utmost to strangle them.
Why? Because of an uncomfortable tradeoff the entire developed world increasingly faces: Use aviation as a tool to foster economic growth, or curtail aviation as a means to fight climate change. In Amsterdam’s case, the matter is also one of noise and overtourism, two quality-of-life issues affecting the city’s residents.
KLM could, to be clear, still grow passenger and cargo volumes longterm — the government cap pertains to just the number of flights. British Airways and Virgin Atlantic know all about that, living for years with slot controls that have limited London Heathrow flight activity far below demand. Their approach: Larger aircraft enabling more passengers per flight. Look for KLM to take this same approach in response to Schiphol’s new flight caps. It’s already opted for the largest version of the Boeing 787 (the -10) as well as the largest versions of Embraer’s E-Jet-E2 family. The large order it recently placed for Airbus narrowbodies will no doubt include the large A321neo variant. More interestingly, KLM has 31 Boeing 777 widebodies to replace, making it a candidate to buy the next-generation 777X that Boeing is now selling (however unsuccessfully so far). Airbus will surely try and sell KLM some A350-1000s. Don’t forget though: Amsterdam is a much smaller origin and destination market than London — it depends much more on connections, which in turn depends on lots of flights flying in and out from lots of destinations.
British Airways, of course, didn’t just respond to London’s capacity constraints by upgauging. It also shifted growth to sister airlines within International Airlines Group — the infrastructure available for growth in Madrid, Barcelona, and Dublin were key reasons why British Airways, and later IAG, merged with or purchased Iberia, Vueling, and Aer Lingus, respectively. KLM could similarly see growth shifted to Paris, despite the Air France-KLM’s preference for Amsterdam, which does after all produce higher profit margins. Growing Transavia from bases other than Amsterdam will likely become a priority for the group as well. The government did propose opening nearby Lelystad airport to commercial flights, as an alternative to Schiphol for low-cost and charter shorthaul flights. But any decision on that was postponed until at least 2024.
Oddly enough, Schiphol is expanding its infrastructure. It’s constructing a new concourse, albeit behind schedule, featuring seven new gates technologically equipped to handle up to eleven aircraft simultaneously. The ballooning cost of the project, incidentally, is a reason why Schiphol feels the need to raise its airline fees. Schiphol certainly doesn’t have a Heathrow-like runway shortage; it has six of them. KLM’s longterm dilemma, alas, is not infrastructure. It’s government policy.
After the government’s flight cap pronouncement in June, KLM immediately warned about the future viability of its hub. Note by the way that Schiphol, largely thanks to KLM’s passenger and cargo flights, was Europe’s busiest airport during much of the pandemic. This was true (not counting Istanbul) as recently as the third week of September, according to the latest Eurocontrol data. And it speaks to the power of KLM’s hub, the utility of which has only increased as carriers around the world removed many of their international nonstops. Without much of a domestic market, KLM does at Amsterdam essentially what Singapore Airlines does in Singapore, or what Emirates does in Dubai. Longtime CEO Pieter Elbers, who recently left to run India’s IndiGo, once gave the example of someone flying from Billund, Denmark, to Little Rock, Arkansas. No airline will ever fly that nonstop, but KLM’s hub can conveniently connect those two cities with one stop. Multiply that by the thousands of other smallish city-pairs that require a connection, and the roots of KLM’s hub success become clear.
With Schiphol-like scale, KLM’s cost of adding a new route becomes less and less relative to the extra revenue it can produce for the whole network. Which is why KLM is so disappointed that it soon won’t be able to make net additions to its route map. Under new CEO Marjan Rintel, KLM is warning the government that flight caps will force it to cut about 30 routes. That’s roughly a fifth of the total it offered this summer. According to De Telegraaf of the Netherlands, destinations KLM might cut include Belgrade and Porto in Europe, along with long- and medium-haul routes to Boston, Edmonton, Guangzhou, Montreal, Osaka, Taipei, Tel Aviv, and Xiamen. As De Telegraaf wrote: “The connecting role between Europe and China that KLM and Schiphol played before the corona crisis seems to have come to an end.” It might soon be writing something similar about more than just the Europe-China market.
KLM will perhaps sue to stop the flight cap policy. Assuming it does take effect next year, however, the whole Air France-KLM group has a major growth problem on its hands. Paris can accommodate growth, but Air France was, is, and likely will forever be a higher-cost airline than KLM. No wonder why the group’s management has been so adamant about growing Transavia — even at the risk of a nuclear-grade confrontation with pilots. And no wonder why executives seem so keen on consolidation. They were interested in Spain’s Air Europa, for example, sensing growth opportunities in Latin America. And now they appear interested in Brazilian champion TAP Air Portugal, its own Lisbon growth obstacles notwithstanding.
In sum, KLM is producing muscular profits today, albeit squeezed by temporary airport constraints. Tomorrow, those profits could disappear altogether, erased by a government policy that could cripple its hub, one of the world’s best.