Case study privatization in African airlines industry

Distr.: LIMITED TRANSCOM/1084 November 1996

ECONOMIC COMMISSION FOR AFRICA

TRANSPORT, COMMUNICATIONS AND TOURISM DIVISION

TRANSCOM/1084

CASE STUDY

PRIVATIZATION IN AFRICAN AIRLINES INDUSTRY

1. Establishment of African airlines

1. Immediately after independence, most of the African countries realized the important role that air transport could play in the economic and social development.

Consequently, except for the countries signatories of the Yaounde Treaty and members of Air Afrique, the rest of the African countries established individual national airlines .. Although established with the laudable objectives to provide linkage not only among the various regions of the country, neighbouring countries, with the colonial country and subregional but also profitability as such was not of major concern of the airlines operation. In fact, the airlines were often viewed as "flag carriers" and national pride.

2. These airlines are generally, small in size and operate in narrow markets, with aircrafts not adapted to the actual traffic need. There is also lack of cooperation among them, and they have difficulties accessing international markets. Their overall performance is often poor and most of them cannot fulfil their commitment such as assuring regular and safe flights.

3. For the past 30 years, the governments in practically all cases had to protect their national airlines in order to assist them in expanding their services. However, it was soon realized that this protection was not useful as it made, of most of the airlines, dependent on subsidies from the already fmancially stretched governments.

4. Since most of the African airlines established during that period are owned by governments, they have an obligation to operate on some on-profitable routes in order to satisfy their social development objectives. When these airlines were established, the private sectors, when they existed, were not ready or interested to invest in an enterprise operating for social development purposes only.

2. State of the African airlines industry

5. Although they benefit from protection from Governments, the African airlines are not perfonning very well, because until now they carry less than 3 plOD of the world's passenger traffic and most of them are not in a position to fmance the renewal

TRANSCOM/1084 CASE STUDY

PRIVATIZATION IN AFRICAN AIRLINES

1• Establishment of African airlines

1. Immediately after independence, most of the African countries realized the important role that air transport could play in the economic and social development.

Consequently, except for the countries signatories of the Yaounde Treaty and members of Air Afrique, the rest of the African countries established individual national airlines. Although established with the laudable objectives to provide linkage not only among the various regions of the country, neighbouring countries, with the colonial country and subregional but also profitability as such was not of major concern of the airlines operation. In fact, the airlines were often viewed as "flag carriers" and national pride.

2. These airlines are generally, small in size and operate in narrow markets, with aircrafts not adapted to the actual traffic need. There is also lack of cooperation among them, and they have difficulties accessing international markets. Their overall perfonnance is often poor and most of them cannot fulfil their commitment such as assuring regular and safe flights.

3. For the past 30 years, the governments in practically all cases had to protect their national airlines in order to assist them in expanding their services. However, it was soon realized that this protection was not useful as it made, of most of the airlines, dependent on subsidies from the already fmancially stretched governments.

4. Since most of the African airlines established during that period are owned by governments, they have an obligation to operate on some on-profitable routes in order to satisfy their social development objectives. When these airlines were established, the private sectors, when they existed, were not ready or interested to invest in an enterprise operating for social development purposes only.

2. State of the African airlines industry

5. Although they benefit from protection from Governments, the African airlines are not performing very well, because until now they carry less than 3 p 100 of the world's passenger traffic and most of them are not in a position to fmance the renewal

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of their fleet nor to expand their services. Many are small in size and are a burden on their national economy. Managed by political appointees, they suffer from government and political interferences in their day to day management. Furthermore, large number of the airlines operate with obsolete and uneconomic aircrafts on a lean and divided market, often in competition with well equipped foreign airlines managed by professional.

6. The employee productivity of the African airlines is among the lowest in the world, and their cumulative losses is very high. Consequently, most of them are not able to cover their operating costs and to service debt. The reasons for the poor perfonnance include, among other things, the thin traffic, low aircraft utilization, heavy competition, unclear government and management relations, over staffmg and inadequate funding.

7. In 1994, the African Airlines Association (AFRAA) reported the total losses of 19 of its members to be US$ 10 million, although nine (9) did declare net profit of US$ 70 millions. The total losses in 1993 was US$66 million.

8. Lack of cooperation and coordination of activities among them have further aggravated the weaknesses of the African airlines.

9. In preparing the UNTACDA II programme, the baseline assessment study undertaken on air transport sector revealed that between 1993 to 2010, African air transport industry will need more than US$34 billion to renew the -current fleet and to cater for traffic growth. This fmancial requirement obviously can not be provided by African governments as has been the practice. Therefore, for the survival of African airlinesit is necessary to look at other sources of fmancing, such as the private sector.

3. Globalization of the Airlines Industry

10. In 1978 the American government introduced a profound structural changes in its aviation policy called "deregulation^{II •} In so doing, they eliminated a lot of impediments to the access of the domestic market by American airlines and developed new policies for negotiation with other countries. In reaction to this, the European Union also revised its countries' aviation policies around four main areas: 1iberalization, harmonization, infrastructure and external policy. The objective of providing the structure for liberalization was to agree on common competition rules in view to

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creating conducive environment for the European air transport industry to compete with that of United States.

11. In their tum, African countries adopted a new air transport policy under the Yamoussoukro Declaration calling for cooperation and integration of African Airlines, better management and gradual liberalization of traffic right within Africa.

12. These profound changes in air transport policy have led to the globalization of competition which has pushed airlines to initiate mergers and alliances with airlines from the same country and/or registered in other regions. In this regard, many institutions such as the GAIT, WTO and DEeD believe that air services should be liberalized and rules in airline ownership should be changed in order to allow private sector participation.

4. Privatization of African airlines (i) African economic situation

13. In the face of persistent difficulties in economic development, the African governments starred to profoundly re-examine their policies and to redefme the role of the public sector in production and provision of services. The objective of this exercise is to save money and to get rid of non-profitable parastatal enterprises_~ especially those which were a drain on the country's meagre resources. Therefore.

privatization of African airlines become one of the solutions imposed or suggested to governments by fmancial institutions as a conditionality for assistance in the economic recovery. This imposed condition is a logic of the fmancial institutions for a continent with heavy debt (more than US$... billion in 199.) and looking for more than U5$34 billion to renew the fleet of ailing airlines.

(ii) Poor financial performance

14. There is a mounting belief on the part of many governments that the perfonnance of their national airlines will be improved simply through privatization.

They are ready to take any offer, because even if they have the necessary funds, they cannot continue to provide subsidies a practice which will be abolished under the WTO rules.

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15. It is probably more due to the above two main reasons (African economic situation and airlines poor performance) than the globalization of the industry that African countries are abandoning their national flag carrier concept and are starting to change their civil aviation regulation in order to allow private sector participation in their airlines. Privatization in African airlines is not viewed as the consequence of the developments in the industry nor as a genuine economic decision, but it is for the moment something viewed as imposed by the conditions for assistance inthe recovery of the national economy.

5•

Constraints to airlines privatization

16. The aviation industry resisted for many years the general trend of privatization1

as was seen in other industries, because of the following policy issues, among other things:

(a) Security and defence interest: Traditionally all countries viewed civil aviation as critical to their national economy, defense and security interest. In the United States, although the government refrained from government ownership of airlines, it imposed conditions on ownership especially with regard to the fact that the American Civil Aviation law stipulates that the country must maintain a Civil Reserve Air Fleet to assure emergency airlift during crisis.

(b) Flag carriers and prestige: Many countries established national airlines for prestige and as "flag-carriers". Those countries believe that privatization or relaxation of ownership might affect their primary concept of an airline.

(c) Ownership rules: Privatization of an airline may lead to the possible change of the airline ownership, but the bilateral agreement regulating industry until now which is based on the following rule: "airlines operating under bilateral agreement should be substantially owned and effectively controlled by nationals of contracting States, if not, operation may be refused or revoked." Although this rule is optional, most of the countries have in their national air transport policy the provision for national substantial/majority ownership and or effective control.

(d) Financial risk: The air transport industry has a very high degree of risks therefore private sector is not keen to participate init. A study undertaken by private consultant in America shows that in two years (1990, 1991), the air transport industry lost every thing it had gained in twenty years.

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6. Resistance to privatization

17. Airlines, especially the African airlines. were resistant to privatization because they feared to lose the following:

• relative ease of purchasing aircrafts with government's guarantee;

• assurance to survive as a national "flag carrier;"

• subsidies provided by government

• government protection especially in granting traffic rights and against labour union;

• jobs at all levels;

• national identity, therefore the transfonnation of national airlines to national or regional feeders for big carriers.

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(a) Generalities

18. Each privatization is justified by a specific reason, therefore technic and methodologies used in privatizing airlines differ. In 1995, there were more than fifty

(50) airlines around the world going under full or partial privatization (see table graph 1... in annex). The first wave of these privatizations, was pushed forward by governments following a free market ideological shift linking privatization closely with deregulation. Twenty six privatizations out of the fifty indicated above have been completed or are in progress. The analys is of these experiences shows both success and failure.

19. The privatization of British airways is very good example of success, because the airline succeded to attract many foreign invetors and is one of the most profitable airlines in the world while the Aeroleneas Argentinas case was, in the view of its

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workers, a failure. The airline was profitable between 1980 and 1981 before privatization in 1990. It even lent money to the national treasury. However, soon after privatization, the airline was rumoured to be losing up to U5$11 million per month. In 1992 its debt was estimated at US$800 million.

20. The privatization of airlines in other regions has been implemented with a lot of caution. Governments in most cases are still retaining a" golden share^It through their administrations or national citizens. This" golden share" exerts power or control on the decisions of the airline. For example, ownership ofany European Union airline by non-ED nationals is limited to 49 per cent. The United States of America, Australia and other countries adopted the view that, if foreign ownership was no more than 25 per cent, then effective control remained in the hands of their nationals.

Many governments reserve the right to buy third party shares of the airlines if national interest so required. These practices are guarantees for the governments to reflect their policies into the decisions of the airlines. In general, cOWltries have accepted changes inairline ownership, but they still have control or influence over them. The table below, summarizes some conditions imposed by government in the change of ownership or privatization of the airlines.

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Table: 1

Examples of requested conditions for airline ownership

A. United States • Not more than 25 per cent of

the voting right will be allocated to foreigners.

• The Chief executive and at least 2/3 of the board members and essential staff should be

American citizens

• The airline should be controlled by one or more American citizen

B. Europe

•

•

A maximum of 49 per cent of he share could be attributed to foreigners but no veto right could be attributed to foreigners The headquarters of the airline should be located in the

European Community

• At least 51 per cent of the airline equity must belong to the European citizen

• The airline should be effectively controlled by European citizens.

(b) Experiences in the privatization of African airlines

21. African governments have now abandoned the prestige or pride concept of their national airlines and are willing to privatize them. However, due to difficulties in attracting foreign investors and in mobilizing the necessary resources, many governments have slowed down the processes and concentrated their efforts on

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restructuring. In 1995 there were twelve (12) African airlines proposed for privatization: (Nigeria Airways, Air Malawi, Air Botswana, Uganda Airlines, South African Airways, Air Tanzania, Zambia Airways, Air Zimbabwe, Sudan Airways, Air Djibouti. Air Zaire and Air Afrique. Out of these 12, only one namely, Kenya Airways, has succeeded in attracting the full participation of the private sector, and a few, such as Zambia Airways, have been liquidated.

22. The success of privatization depends on the objectives and of the method adopted by the governments. The following, describe the case of Nigeria Airways which could not, until now, attract private investments and Kenya Airways, for whose privatization process has been completed with success.

23. In 1991, Nigeria Airways was no longer able to assure regular domestic and international services. Passengers avoided the airline for many reasons, such as delay, cancellations of flights, over-booking, lack of assistance from ground and flight staff, tickets issued by the airline not accepted by other carriers, etc.... The debt of the airline had reached a level which the government was not able or was reluctant to finance. The airline could not assure the normal maintenance of its fleet. It was noted that out of the 16 aircrafts nonnally used, only eight (8) were operational and the other eight (8) were grounded. Consequently, consumers started expressing concern about the security issue of the airline operations. Furthermore, the morale of the airline staff was low and they were not committed to the objectives of the airline.

Table:

DCI0

A310 - 200 B737 - 200A B707 - 320

Status of Nigeria airways fleet as of January 1992

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24. The government had to intervene in order to fmd a solutions for the airline's survival. In this regard, a Presidential Task Force was set up to advice the government. After the analysis of the airline's situation, the Task Force made the following recommendations for govememnt' s decision:

(a) Commercialize Nigeria Airways:

This was described by the Task Force as a process whereby Nigeria Airways will be managed in such a way that all decisions are based on "commercial" (market-oriented) criteria and objectives. In this regard, the key commercialization issues to be solved were:

•

^Activities

^•

International

•

^Domestic

•

^Management

^• _•

^Stability_Autonomy

•

^Revenue

^• _•

Other sources^{Air fares}

•

Infrastructure

•

Award of contracts

•

Personnel levels

•

Indigenous capability

•

Separation and privatization of international routes.

(b) Privatization of Nigeria Airways:

^A Technical Committee on privatization and commercialization .was set up with the following objectivesl/.

• improvement in the operating standards;

• increase in the nwnber of flights:

• increasing passenger demand:

• outside assistance:

• Expatriate

• Local

25. Based on the above objective, the Technical Committee proposed to the government the following approaches to the privatization of Nigeria Airways:

1/ Extract from Nigeria Airways prospective presented at AFRAA General Assembly

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• Sell shares in Nigeria Airways Limited OR

• Create new airline called "Air Nlgeria^{l l} with

• Foreign Airlines as technical partner

• public subscription within Nigeria and,

• "strategic" government share holding.

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26. In case that the government was not ready for the privatization of the airlines due to political pride and sovereignty reasons, the Technical Committee proposed also two alternatives scenarios for Nigeria Airways:

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27. This part, is a summary of the process used to privatize Kenya airways as described by the Managing Director of Kenya Airways at the 25th General Assembly of AFRAA held in Victoria Falls, Zimbabwe on 27th April 1994. It also gives the latest information published on Kenya Airways.

(a) Process

28. Following discussions between British Airways and Kenya Airways, it was agreed to ask Speedwing Consulting, an independent consulting arm of British Airways, to carry out a short study on Kenya Airways. The purpose of this study was to assess the operating performance of the Airline and to indicate the measures required to tum Kenya Airways into a viable private airline.

29. This study was carried out by a small team of experienced airline professionals over a six week period in March-April 1992. The key fmdings of the study were:

(i) The management skills, organisation and culture of Kenya Airways were not suited to a commercial, profit-oriented enterprise.

(ii) Operational performance was not measured or controlled.

(iii) Financial control was very weak with late and inaccurate reporting and poor accountability.

(iv) Existing computer systems did not support the business adequately .

(v) Marketing and revenue generation were a major area of weakness.

(vi) Technically, skill levels were good but poorly utilised.

(vii) Customer service standards were low with limited measurement and control of quality.

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(viii) Productivity was not routinely measured and appeared to be low.

(ix) In every function there existed an untapped source of expertise and enthusiasm, particularly at middle and lower levels.

30. These fmdings were presented to the Board of Kenya Airways together with a series of recommendations of actions required to prepare the Airline, operationally, for privatisation. The key recommendations were as follows:

• Appoint an airline experienced Chief Executive with a clear mandate to impl.ement the recommendations of the report.

• Carry out a radical restructuring of the management and organisation of the airline, including a detailed review of staffmg levels in each function.

• Introduce a Performance Improvement Programme to continuously improve the operational performance and reliability of the airline. Make managers clearly accountable for the performance in their areas of responsibility.

• Appoint an airline experienced Finance Director with a clear mandate to introduce new fmancial systems, control s and accountability. Develop proper budgetary planning, control and reporting systems.

• Create a new computer system department and carry out a complete review of the future needs of the airline and develop an implementation plan.

• Appoint an airline experienced Marketing Director and carry out a major overhaul of the sales and marketing activity.

•

•

^Carry out a comprehensive research programme designed to identify the needs and view of the airline's staff, travel agents and customers .

• Implement a comprehensive customer service training programme for all staff in the airline, based on the research, to achieve a cultural change within the airline.

• Introduce a customer service quality improvement programme.

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• Introduce productivity measurement and control and set standards based on internationally accepted levels of productivity.

31. Two additional recommendations were presented:

(a) If privatisation was planned within the next two years, start behaving like a private sector company now

(b) Prepare a five year business plan as soon as possible in order to demonstrate a track record of achievement against this plan ahead of privatisation and to form the basis for any negotiations with perspective investors.

32. The above proposals were approved by the Government of Kenya and decision was taken to restructure the airlines before its privatisation.

33. The first step to implement the above recommendations was taken in June 1991 when Kenya Airways entered into a service agreement with Speedwing Consulting to provide management expertise and consultancy services to implement the fmdings of the report. In this regard, the Kenya Airways Board interviewed a short list of candidates nominated by Speedwing Consulting. The interview led to the appointment in November 1992 of the Managing, Finance and Commercial Directors.

34. After this selection, the airline management structure concentrated its efforts on the improvement of decision making, creation of business oriented culture and a sharp reduction inbureaucracy. This has involved the clear defmition of the roles and responsibilities of each part of the organisation and the creation of a simple two level management structure under the Commercial Director, the Technical Director. the Finance Director and the Administration Director.

35. Following the preparation of job specifications and man-specifications for each senior management position, all of the posts were advertised internally.

36. The posts which could not be filled internally were filled using external recruitment.

37. The fmal step in the transfonnation of the management of the Airline involved the introduction of perfonnance related pay through a significant annual bonus based on the delivery of agreed objectives and targets, monitored on a monthly basis.

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38. The entire process, from design to completion, took only six weeks. It has achieved a dramatic change in culture and perfonnance and has removed at a stroke accusations of promotion through tribalism and political influences. It has also been possible to shift the emphasis within the organisation from self administration to customer service.

39. A two day trammg programme for all managers was conducted in order to reinforce the aims and values of the new management team and to emphasise the delivery of customer service through team work.

6. Result

40. Four years after the restructuring of the airline, Kenya Airways made a net operating profit of US$16 million in the fmancial year ended 31 March 1995 and was forecasting a US$22 million net profit for 1996.

41. Following the completion of the transformation and fmancial restructuring of the airline the basic shareholder structure was developed and agreed by the government. This change in ownership rules provides the following allocation of share 20 per cent for foreign airline partner, 23 per cent for the government, 14 per cent for international investors, 34 per cent for the Kenyan public and institutions; and 3 per cent for employees.

PROPOSED SHARE HOLDING STRUCTURE

Airline partner 26%

Kenya Govt.

23%

Kenya PUblic & Int.

34%

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42. The involvement of an international airline partner is key element to the long teon success of Kenya Airways. The airline succeeded in attracting many airlines among which KLM was selected at the level of 23 per cent of the share.

43. This partner will strengthen Kenya Airways through: links to global distribution systems and networks; on going technical and managerial expertise; and enhanced purchasing power in the process of fleet renewal. It would also strengthen investor confidence and increase the chances of a successful privatization. The successful process used to select the partner can be found in Kenya Airways presentation to the 28th General Assembly of AFRAA2/.

44. From the above experiences and others, it appears that the success in the privatization or change in airline ownership depends on many things among which are the following:

(a) Clear definition of the privatization objective

45. If the objective of the privatization is unclear. the result of the process will not be at the level of expectation. Clear objective of privatization is key to success and will assist policy makers to take appropriate decision.

(b) Planning of outputs

46. Time for output delivery in the privatization process has to be minimized. The more time the process will take, the more the privatization will lose its value. Long time frame wiH also allow external influence and lead to the abandonment of some objectives.

2./ Airline Alliances viewed fro mthe global and African Airlines Perspective. The practical aspects of selecting an airline partner.

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( C) Staff reduction plan

47. It is recognized that most African airlines are over staffed as compared to the airlines of other regions. Therefore, a well planned staff reduction, based on real assessment and not on presumption, is necessary. The reduction exercise should be performance and programme oriented and not be undertaken against specific people, but should be implemented in a fair manner necessitating the participation of the staff.

Decisions should be based on merit and staff capability to perform duties.

(d) Staff morale

48. The staff of airlines proposed for privatization should have good morale and therefore incentive measures should be introduced. The boosting of staff morale will enable good working environment to improve staff productivity and performance.

( e) lob description

49. To avoid confusion, it is necessary that the privatisation process includes clear defInition of role and delineation of responsibilities. This should be achieved through the defInition of jobs requirement and the preparation of necessary job descriptions.

(f) Restructuring

50. For an African airline to attract good investors, it is necessary that it should be viable, and therefore, restructuring of the airline should come fIrst. This will assist the government to make the correct evaluation of the asset of the airline. It is not wise to sell an airline for which the price is unknown and to leave the detennination of price to the potential buyers or partners.

(B) Government support

51. In the privatisation process, the government support is necessary. Government should not interfere in the selection of professional team, managers and middle level staff.

(h) Choice of restructuring or privatization team

52. The team to be assigned to conduct the restructuring and or privatization should be different from the airline staff. The team should be composed of people committed to the performance of the airline and not to any government

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representative. The team should not be political appointees and should have mandate to perfonn itsjob in line with the objectives set by the government.

(i) Baseline assessment

53. Before starting any restructuring and change in ownership of the airline, it is necessary to undertake a baseline assessments which should be precise and should provide precise actions to be undertaken . If the fmdings of the report are lousy or formulated with many alternatives, it will be difficult to take appropriate decisions.

(j)

Training

54. Training should be included in the restructuring process, because it is necessary for the change of work culture. Training will also make staff responsible for what they are doing. The training should cover all aspects of perfonnance including the impact on the airline performance of the job not well perfonned by a responsible staff.

55. Privatization is far from a panacea and it can in some case, lead to the failure of state owned airlin~.Privatization is being introduced in African airlines, not because of the requirement of the profound change of the air transport industry but as a result of the structural adjustment programmes with the objective to improve the efficiency of the airline. The reason is that, for governments under Structural Adjustment Programme, efficiency of an enterprise is linked to ownership. This concept of privatization is sometimes a misinterpretation because economic theory links the market structure. and not ownership per se, to economic performance.

56. Privatization of African airlines should be introduced as a necessity of industry globalization, because in a highly competitive or deregulated market, they are constrained by the presence of rivals to improve their services and to sell service at a price set by their competitors.

57. Itshould be noted that privatization conceived only for the reason of efficiency can be a misinterpretation. In fact, in United States during the period 1979 - 1991 the cumulated losses of the airlines (all of them being private airlines) was estimated at US$7. 7 billion. The difference between the case of United States airlines and of

"

•

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African owned airlines is that the losses are borne by the private sector and not the government.

58. Privatization of African airlines should be seen as a transfer of airlines problems from government to a different source of fmance such as the private investor. The privatization should be accepted as a necessity and guided by principles in order to give to the airlines the freedom to behave differently and to make profit.

59. Before privatization, it is recommended that African governments complete the reorganization of their airlines and pay attention to the following:

(i) Will the airline, once privatized, offer better services to users?

(ii) Will the utilization of national resources invested in the airline improve as a result of privatization?

(iii) Will it become easier, as a result of privatization, for the airline to mobilize resources?

(iv) (v)

(vi) (vii) (viii)

,

(ix)

.J

(x)

Is the timing of the sale appropriate?

What is the real cost of the airline?

What legal status might it adopt?

What role should the government have?

What regulation should govern the aviation industry?

What minimum share of the airlines should be maintained by the Government?

Is the national interest safeguarded?