Air Berlin's Pricey Contract with Vacation Firm TUI Costs Company Millions

When Air Berlin CEO Hartmut Mehdorn was asked where his financially strapped airline is saving money, the 69-year-old rattled off the entire program, saying that even he and his fellow executives only drive small company cars these days. Coffee and cookies, he added, are no longer being served at meetings, while internal documents are now only printed in black-and-white.

Such actions are meant to show that Mehdorn, in office for just under a year, is doing everything possible to return Germany's second-largest airline to profitability. But there is still one expense that Mehdorn, who succeeded company founder Joachim Hunold, has left oddly untouched.

That expense is the contract that Hunold negotiated with the TUI Group in the fall of 2009. The agreement, which is confidential and only known to a small group of people, costs the airline more than €100 million ($123 million) a year, including a predetermined 4 percent share of profits charged by TUI. In return the Berlin-based airline receives only about a dozen jets, complete with crews.

While Mehdorn ought to prematurely terminate or renegotiate the contract, which doesn't expire until 2019, he has shied away from doing so. He is perhaps reluctant to clash with TUI CEO Michael Frenzel. Mehdorn and Frenzel tangled with one another years ago when Mehdorn ran Deutsche Bahn and Frenzel, as head of the supervisory board, monitored him.

Frenzel had once wanted to get into the budget airline business, and in 2002 he even established the subsidiary HLX for just that reason. But HLX never turned a profit, and in 2007 it was merged with the company's vacation airline Hapagfly to form TUIfly. About two years later, the company transferred its money-losing domestic German and European city connections to Air Berlin and, in return, bought about 10 percent of the airline.

Absurd Inequalities

What the two partners agreed to at the time is now proving to be a very heavy legacy for Mehdorn. The old deal also creates absurd inequalities between the two airlines, which has Air Berlin employees up in arms.

Under CFO Ulf Hüttmeyer, who is still in office, the companies agreed that Air Berlin would lease a total of 14 jets, together with the corresponding crews, from TUIfly at its own risk. Since then, Air Berlin has assumed all ongoing operating expenses, such as fuel costs and airport fees. TUIfly pays for the personnel and for the maintenance of the jets, but in turn charges its customer Air Berlin exorbitant prices.

According to the contract, the base leasing fee alone is €10 million ($12.3 million) a year. On top of that there are other fixed payments for the minimum use of the TUIfly jets determined in advance. The payments are even due if the aircraft are used significantly less than planned. All in all, Air Berlin employee representatives have calculated that every year the contract costs the company about €100 million, which Air Berlin sends to TUI headquarters in the northern German city of Hannover.

Late last week, an Air Berlin spokesman was unwilling to comment on the amount and other details, but he did stress that his company generally has a good, cooperative relationship with TUI, and that both partners benefit from the cooperation. Besides, the spokesman added, Air Berlin has managed to "significantly expand" its "route profile" by taking over the TUI city network.

Concerned About Their Own Money

The critics aren't just concerned about their employer's money, but about their own, as well. Although they wear the same uniforms and fly under the same company logo, the pilots and flight attendants on loan from TUIfly earn up to a third more than their Air Berlin counterparts. For instance, a longstanding TUIfly captain can make up to €210,000 ($258,000) a year, a salary that even rivals the pay at Lufthansa. At Air Berlin, however, the pay scale for pilots ends at €160,000 ($197,000).

Because Air Berlin is in a crisis, canceling many routes and taking aircraft out of circulation, it would make sense for them to start with the relatively expensive leased TUIfly jets. But under the contract Air Berlin also incurs significant fixed costs if the aircraft are left idle. As a result Mehdorn and his team have no choice but to try to utilize the leased TUIfly aircraft as much as possible, even if it comes at the expense of their own aircraft.

The Air Berlin spokesman insists that "all things considered," the operating costs for the Air Berlin and the TUIfly aircraft are "comparable," but he doesn't provide any details on how he arrives at his figures. In any case, tourism giant TUI is the main beneficiary of the paradoxical pact.

Perhaps the penny pinching Mehdorn will still use a back door to achieve at least a few improvements in the expensive lease. According to a clause in the English text of the agreement, Air Berlin can demand subsequent negotiations if salaries at TUIfly rise at a significantly faster rate than at comparable other German airlines. However, Mehdorn's advisors would first have to prove that is happening. A TUI spokesman denies that this is the case.

If the attempt fails, the Air Berlin CEO can still legally argue that the basis of the contract no longer exists. He could certainly have a case, given that the company has lost more than €450 million ($554 million) since the contract was signed.