Founded in 1955, Lufthansa is Europe’s biggest airline with an annual turnover of €32bn and a fleet of over 600 aircraft. But history and scale count for little in an industry that is being battered by increased competition: low-cost carriers now control 25% of the global aviation market which continues to suffer from pressure on airfares. For the major airlines, bottom line growth increasingly has to come from internal operational efficiency and cost reduction to put them on a more competitive footing.
This is the background against which Alexander Pawellek, head of supply chain finance at Lufthansa, has implemented the airline’s first ever supply chain finance programme.
Charting the course
In early 2013, Lufthansa’s former CFO, Simone Menne, began a group-wide initiative to better manage working capital and ultimately reduce costs. One of the key projects for reaching these goals is the introduction of a supply chain finance programme. Menne’s core team included Pawellek.
“Over time, more airlines throughout Europe, namely Swiss and Austrian Airlines, have joined the Lufthansa Group,” says Pawellek. “The decision was that we either centralise everything to try and get the costs down as quickly as possible; or we retain the brands and the original organisation. It was actually decided to go for the latter.” This has resulted in Lufthansa’s operations becoming increasingly decentralised.
Upon launch of the working capital management project, the team turned their attention to “the basics” – data and performance metrics. Naturally, with a decentralised business model, financial reporting on working capital key performance indicators (KPIs) by each of the subsidiaries was different and non-comparable. By harmonising the KPIs – such that, for example, everyone was calculating working capital in the same way – the interests of the various business units were aligned and Menne was able to gain a greater understanding of overall performance.
Finance took the view that, for the most part, working capital management had to remain a decentralised task. “We cannot steer it from a group perspective. Operationally, it needs to be done in the subsidiaries themselves and I think it’s key that the responsibility for these measures actually remains with the subsidiaries,” he says.
One of the key challenges was that each business unit is quite different from the others: “We have a very diverse business model. For example, payment terms differ a lot. The catering business is extremely different from what we’re seeing in the maintenance section, for example,” he says.
A different view was taken on supply chain finance, however. “We thought: where we could add value from a group, centralised core team? And that’s where we, from a finance perspective, started thinking about supply chain finance. That’s something that we can implement on a centralised level and then roll out to the subsidiaries. Firstly, this saves analysis and implementation costs for the subsidiaries. Secondly, we can streamline processes by using one standardised solution group-wide and thirdly, we can leverage the supplier spend of the whole Lufthansa Group.”
Piloting through turbulence
Internally, Pawellek and team began the “multi-interface project” to start the process of supplier negotiation and onboarding. Key to the success of the project was the support and commitment of the procurement team who manage the supplier relationships. A significant concern for the team was that the aim of the project was in conflict with procurement’s goals “to just basically get cost decreases from the suppliers”, he says.
There was also concern to make sure that the supply chain finance project wouldn’t result in an excessively large increase in procurement’s burden of work.
To smooth the path, the team engaged the heads of procurement for all of the divisions of Lufthansa to demonstrate to them that the supply chain finance programme could strengthen working capital ratios and Lufthansa’s overall financial standing with minimal impact on the procurement managers.
“We coordinate [supplier onboarding] in a centralised manner,” Pawellek says. “Firstly, procurement doesn’t need to invest that much time [in the process]: they carry out the introduction to finance and they stand ready to take over the conversation. Secondly, it allows for detailed financial discussion to take place between Lufthansa and the supplier.”
The next challenge was to secure a supply chain finance provider, Pawellek recalls. “One of the cornerstones of our finance strategy is to look towards diversification; to basically not put all our eggs in one basket. We really had to ask ourselves, ‘How can we justify working with just one bank on something that is so important to the whole supply chain?’ On that basis, we looked towards multi-bank platforms – and then we ended up going with CRX Markets.”
At the time CRX Markets was a new entrant to the supply chain finance market. Internally, the prospect of a long-established business such as Lufthansa going with an unknown and unproven vendor caused some concerns. “But with CRX Markets, we had a brilliant proposition and that’s why we said, whatever the fight may be internally, we want to have this fight. We were absolutely convinced about CRX. That’s why we were quite happy pioneering with them.”
In terms of the finance, CRX Markets operates a multi-investor platform. “The big advantage here is that not only banks can participate in that programme, but non-bank capital market partners as well. This further supports our interest for diversification.” Pawellek explains.
Shortly after deciding for CRX, a proof of concept trade was conducted with the catering arm of the group. The aim of this was to prove that the CRX system actually works not just on paper but in practice. Initially, the priority was on suppliers with more than €1m of spend and based in Germany, so as to ensure process efficiencies and reduce legal hurdles.
The surprising pioneer
Lufthansa has now successfully onboarded its first supplier to the programme – but it’s not the usual sort of supplier more commonly found in supply chain finance programmes: mid-sized, cash-strapped, keen to benefit from the buyer’s greater balance sheet strength and cheaper cost of capital. Surprisingly, perhaps, Lufthansa’s first supplier on the programme has a better credit rating than Lufthansa’s BBB- (Standard & Poor’s).
“We had originally excluded every company that has a better rating than Lufthansa,” Pawellek recalls. “[We were] very conservative, focusing on that standard way of doing SCF: we were thinking that SCF would only work with companies that had a lower rating than ours so that the financing rates were attractive. But over time we have learned a lot. And actually, the program is developing nicely, even with the suppliers who have a better rating than us.”
Pawellek says that this makes total sense for a number of reasons. “[Better rated companies] can benefit from that uplift in their own working capital ratio. Because working capital KPIs are growing so much in importance over the last couple of years, and even though their rating may be better and they can finance themselves more cheaply than through SCF, it still makes sense for them because they get the benefit of improved DSOs [days’ sales outstanding].”
Pawellek added: “If they [suppliers] use supply chain finance, they’ll be able to get that money much earlier. That means that the DSO is now moving down to, let’s say, ten days. Basically, they’re taking a significant portion of the DSO away from their books.”
Pawellek says that many suppliers with better ratings have engaged with Lufthansa and are interested in the supply chain finance programme.
With the programme proving a success, Pawellek rolled out the programme to other Lufthansa subsidiaries including Deutsche Lufthansa AG and is working on bringing in the remaining German-based business units, including Lufthansa Technik, the aircraft maintenance subsidiary. Additional profitability analysis has shown that supplier spend thresholds can be lowered to €500k pa and still make supplier onboarding worthwhile.
While the focus within Lufthansa is now firmly on cash-generation, that wasn’t always the case, Pawellek says. Despite the competitive pressures, “We were actually jumping very late on that working capital train. Why? Because airlines are, in terms of working capital, the greatest companies you could have. If you fly three months from now, the airline is still going to charge you just days after purchase of the ticket. So we are getting prepayments from our customers. We actually have negative working capital in the airline industry.”
But think for a moment about what Lufthansa does with that money: it buys things like Boeing 777s and Airbus A350s – and they are not cheap. “Every euro that we generate out of working capital management is a euro that we don’t need to get externally. Obviously, there will be quite a need for cash. And therefore, we want to make sure that we generate cash out of our business model – from internal financing – rather than from external financing.” So as the supply chain programme takes off, Lufthansa seems sure to generate a cargo hold of extra cash.