BA cost-control at heart of recovery

As British Airways chief Willie Walsh rose to discuss the airline's eye-watering half-year losses with analysts, it was tempting to recall another BA presentation made in early in 2005 by his predecessor, Sir Rod Eddington, at the company's Waterside headquarters near Heathrow.

It was the last BA investor day for Sir Rod, who was about to hand over to Mr Walsh, and the flag carrier was then the world's most profitable airline.

The title Sir Rod picked for his talk was far from gleeful, however: "Worst to First and First to Worst".

It was a reference to how BA had swung over the eight years to 2004 from having the highest operating profits of the world's top 21 airlines, to the lowest and back to highest again.

The message was clear: BA might look clever today, but it would not in a few years' time unless everyone understood that running an airline was a constant struggle to control costs and stay competitive. "You can never declare victory, because it's never over," said Sir Rod. "You sow the seeds of your demise in the good times."

Four years on, and the boom-and-bust parallells are evident.

BA went on to produce record profits after 2005 and finally reached its fêted 10 per cent profit margin for the first time in its history in the year ending March 2008, only to plunge to record losses last year, when it recorded a £401m pre-tax deficit. The latest results confirm that BA is heading towards two years of consecutive losses - or the most dismal results in more than two decades.

It is true, as Willie Walsh said on Friday, that "aviation remains in recession", meaning BA is caught in the middle of another of the famously cyclical industry's downturns.

Yet the question is, how well has the airline been able to control the costs Sir Rod spoke of in 2005, and what is its strategy for boosting revenues once this latest crisis is over.

As many analysts note, BA has made big inroads on costs and achieved an overall 8.7 per cent cut in operating costs for the six months to September 30.

Lower fuel prices helped a lot. Even so, the airline has found £79m in savings from suppliers and intends to cut winter capacity by 6 per cent - more than the 5 per cent cut originally planned.

It has also announced that it is delaying delivery of its Airbus A380 superjumbos and confirmed it had reduced its overall staff positions by 10 per cent.

"They really have taken out a lot of people," says aviation analyst Douglas McNeill of Astaire Securities. "It's quite remarkable and it's making a big difference of course."

When it comes to other structural cost cuts, however, the picture clouds over. For months, Mr Walsh has been trying to negotiate a reduction in the number of cabin crew from 15 to 14 on some long-haul flights. More importantly, he wants to make sure the cost of hiring cabin crew recruits in future is, as he said on Friday, "significantly lower than the existing costs".

But this has triggered the threat of industrial action in the lead-up to the Christmas season, a reminder of why large, formerly state-owned flag carriers such as BA often find it so hard to cut staff costs.

As for revenues, there are other changes afoot in its business model that are more worrying for BA: the steady decline in the airline's traditional business class, or premium, passengers on short-haul routes.

Short-haul premium contributes about £500m to BA revenues and Keith Williams, BA's chief financial officer says it is down at least 20 per cent from where it was a year ago, with no sign of improvement. "And that we see as a structural change within our business," he says.

That leads to the key questions hanging over BA for the past 18 months, on its ability to merge or form alliances. The biggest is whether it will be able to conclude the merger with Iberia (Madrid: IBLA.MC - news) it announced in July last year. And whether it will get approval from US and European authorities for a broad global alliance with Iberia and American Airlines.

On the latter, there is so far no final word from Washington or Brussels.

As for the Iberia merger, five weeks ago, Mr Walsh told reporters he believed a deal could happen before the end of the year "with a fair wind".

Asked on Friday if he still believed this timing was possible, he said: "It's a good agreement for British Airways (LSE: BAY.L - news) and for Iberia and everybody involved, my view on that has not changed."