Jens Flottau Frankfurt

When British Airways and Iberia formed the International Airlines Group (IAG) with their merger early last year, the idea was to make both airlines stronger. But the IAG example shows that mergers don't help if flaws in the underlying business model are not addressed properly.

IAG finds itself in an awkward position. While British Airways is performing reasonably well under the current circumstances, Iberia is turning into a serious problem that has so far been underestimated and that does not seem prone to quick or easy solutions.

CEO Willie Walsh says that a “much broader and deeper restructuring” of Iberia is needed. The changes will be based on “a fundamental review of every aspect of the business.” That review is likely to lead to further downsizing and a reshaped network. The results are to be presented by the end of September, illustrating the urgency of the matter. Because of Iberia's troubles, IAG no longer expects to reach a breakeven result in 2012, but rather anticipates a “small operating loss.”

While British Airways managed to eke out a £12 million ($18.7 million) profit in the first half of 2012, Iberia posted a €263 million ($323 million) loss, almost twice as much as a year earlier. And as BA grew capacity (5.9%) and traffic (9.1%), demand for Iberia's services was down 3.6%.

What must be extremely worrying to IAG is that Walsh says that Iberia's long-haul routes, which historically have cross-subsidized the money-losing short- and medium-haul operations, are also part of the problem. “The long-haul cost base is unacceptable and completely out of line with the market,” Walsh concedes. “The historical levels of profitability are not sufficient.”

Iberia's long-haul network to Latin America is its core business. No other airline has a network between Europe and Latin America nearly as extensive. The entire Madrid hub is organized to feed European traffic onto the long-haul services. Iberia has limited exposure to North America, even more limited services to Africa and does not serve Asia with its own aircraft.