By Rhys Jones
LONDON (Reuters) - European airlines will have to cut costs at existing short-haul businesses to compete with budget airlines or struggle to stay aloft, IAG boss Willie Walsh said.
So-called legacy carriers such as IAG, Lufthansa (LHA.DE) and Air France-KLM (AF.PA) are cutting jobs, renegotiating staff contracts and dropping uncompetitive routes to get costs on a par with budget carriers, such as market leaders Ryanair (RY4B.IR) and easyJet (EZJ.L).
They are also replacing older, fuel-thirsty planes and streamlining back-office operations.
"We're focused on reducing out cost base and making our short-haul business more efficient ... those that don't will struggle to survive," Walsh said on the sidelines of the World Low Cost Airlines Congress in London on Tuesday.
"We have Vueling and I think every airline should aim to have an independent low cost arm."
In current cut-throat market conditions, even some of the budget airlines are finding it tough. Ryanair earlier this month warned it could its miss annual profit target due to lower demand across Europe. Fast-growing budget carrier Norwegian Air (NWC.OL) also said revenue per passenger fell in August, partly due to competition.
British Airways and Iberia parent IAG bought Spanish discount carrier Vueling for $180 million in April to help stem losses in Spain, where Iberia's short-haul business has been hit by competition from low-cost airlines and high-speed trains.
British Airways previously tried to run a low-cost airline, Go, alongside its mainline carrier but sold it to private equity group 3i in 2001 after it under-performed.
"There was a lot of management interference in Go and it started cannibalizing BA to some extent so we have left Vueling as a separate, independent airline," said Walsh.
"Alex Cruz (Vueling CEO) is running Vueling the way he always has and we're not changing his business model."
IAG, Europe's third-biggest airline by market value, has spent almost $1 billion to lower the cost base at Iberia and also set up Iberia Express last year to operate short-haul routes from Madrid to feed into Iberia's long-haul network.
"Costs at Iberia Express, excluding fuel, are 40 percent lower than they were at Iberia's short-haul business," said Walsh. "To compete you need a lower cost base, it's simple."
In August, IAG said Iberia, Europe's biggest carrier to Latin America, had started to turn the corner, despite reporting a loss of 35 million euros in the three months to June 30.
Earlier this year, Air France-KLM formed a new French regional airline unit called Hop! to respond to competition from low-cost rivals, while Lufthansa is transferring its domestic and European non-hub flights to its low-cost arm Germanwings.
Recent research from KPMG shows it costs a low-cost carrier $12,000 less to operate a return service between London and Rome than it does for the average legacy airline.
"The concept of customer loyalty to a brand is becoming obsolete as the service now being offered by low cost and legacy carriers is more or less the same," said James Stamp, a partner at KPMG's Global Aviation Team. "Price has become the key factor for customers when it comes to choosing a short haul flight."
IAG's Walsh also said he would not shirk from taking on unions opposed to reforms at Iberia but that there was no agreement yet with Spanish pilots' union Sepla. He said in June that more than 3,000 job cuts were just the beginning.
Walsh said IAG was unlikely to take part in any more European airline consolidation and sees more interesting opportunities outside Europe.
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(Additional reporting by Sarah Young and Paul Sandle; editing by Jane Merriman)