When Willie Walsh needs a break between meetings or a reminder of what brought him into the airline industry, he has two options: He can simply look out the window, or walk downstairs and across the street to a little stand built for aircraft spotters to watch the activity at London's Heathrow Airport.

The CEO of International Airlines Group (IAG) can see the functioning part of his empire at Heathrow. There are not more British Airways aircraft taking off than before, but at least the airline has stopped shrinking after 10 turbulent years and, following the acquisition of BMI, it has a bit of room to grow at one of the world's most congested airports. That stands in stark contrast to the other half of Walsh's empire, Spain's Iberia, which is in accelerated decline with no clear turnaround in sight.

The name of the BA and Iberia parent is apt—it is indeed an international group of airlines—though for now it is a European airline group that will soon include Vueling. IAG was not an early promoter of airline consolidation in Europe. Air France and KLM got together in 2004, followed by Lufthansa's deals with Swiss International Air Lines, Austrian Airlines and Brussels Airlines. It was not until after those deals that IAG was formed in 2011. A little more than two years into its creation, reviews are mixed.

Of course, like Air France-KLM and Lufthansa, IAG is about consolidation the European way. It is distinctly different from the big mergers in the U.S., where two formerly separate entities have melded to form one. In Europe, the airlines are put under one umbrella, and everything that can be done jointly will be handled by the parent company to exploit synergies, but much remains separate. This approach has its limits. The day when brands can join across European countries and air operator certificates (AOC) can be combined is still a very long way off, it seems.

The creation of IAG looked like a great idea. BA was struggling with growing competition from low-cost carriers (LCC) and increasingly dependent on the functioning of its Heathrow hub. It was one of the world's great airline brands, but with almost all of its eggs in one basket: North Atlantic operations. Iberia was also being challenged by LCC competition and was specialized in long-haul services to Latin America. It appeared that the two would complement each other well, and the target was to achieve €500 million ($650 million) in synergies by 2015.

While that target may or may not be achieved, IAG needs to find answers for two fundamental questions: Will there be a future for Iberia? And how can the financial bleeding be stopped quickly?

“If you want a future for Iberia, you are going to have to change,” Walsh tells Aviation Week at IAG headquarters. “If you want to hold on to what you have, what you have is going to be smaller and smaller. For Iberia to have a future, Iberia has to be efficient.”

That is the message Walsh is delivering to the Spanish trade unions. But the April 15 deadline to reach a negotiated solution passed, and as Iberia proceeds with deeper double-digit pay cuts for pilots and cabin crew, as well as mass layoffs, it is doing what Walsh predicted: becoming smaller and smaller. Iberia called on pilots to start the talks, but so far, the Spanish pilot union, Sepla, is refusing to come to the bargaining table.

Walsh says he is not surprised. “I have dealt with the unions in several countries. I don't see much difference between them,” he says. “It is always going to be difficult.” One factor in the equation that could make a difference is Walsh himself. “I guess the difference between me and many other airline CEOs is that I have determination to tackle these issues and some others don't,” he says.

His track record is impressive. After working his way up through the ranks at Aer Lingus to become a Boeing 737 captain, he started his management career in the late 1990s as a turnaround specialist at leisure carrier Futura, an Aer Lingus affiliate in Spain. He became Aer Lingus chief operating officer two years later and subsequently helped rescue the Irish carrier. That success earned him an offer to take over as BA CEO when Rod Eddington left in 2005. BA's health is due in large part to Walsh's insistence on cutting costs and improving efficiency, although at the expense of strained labor relations.

The two airlines are now run by Keith Williams and Raphael Sanchez, respectively, but Walsh is still deeply involved in anything strategic.

And the turnaround of Iberia is strategic for IAG. “It was clear that Iberia needed to restructure its cost in relation to pilots and cabin crew and that it did not have an efficient short-haul operation,” Walsh says. “The bit that was different to what most people expected was the depth of the recession in Spain and the eurozone crisis. The cyclical problems are certainly deeper than I had expected.”

IAG created Iberia Express as a separate operation responsible for short-haul feed for the Madrid hub. “Iberia Express has shown what can be done. It has non-fuel unit costs that are 40% lower than Iberia's. It is not just more efficient than Iberia, it has a lower unit cost base than Vueling,” Walsh points out. “It demonstrates that the short-haul part of a network airline can be profitable.”

That is, if it is allowed to operate. The Spanish government has imposed a mediation process to resolve a dispute between the airline and its workers over pay and work conditions. Iberia could very well be forced to discontinue its successful affiliation next year.

“They should not have gotten involved in the dispute,” Walsh contends. “This is the bit that I don't understand when I look at Spain. There is 26% unemployment, 53% youth unemployment, jobs are not being created, and we set up a vehicle that actually created jobs and had the opportunity to grow.”

Despite these problems, IAG still wants to invest in Spain. Its offer for the highly profitable low-fare carrier Vueling, which it raised to €9.25 from €7 per share, was recommended by Vueling's board and accepted by the airline's shareholders. Following the transaction, IAG will hold more than 90% of Vueling's shares. CEO Alex Cruz, like Sanchez and Williams, will report to Walsh.

“Vueling is a great airline and will be a welcome addition to IAG, where it will benefit from the group's financial strength,” Walsh says.

But Vueling is not intended to become the solution for Iberia's problems; it will continue to follow its own intra-European point-to-point model. “Europe is a big market and there are different horse races. The beauty of IAG is that we have created a group that allows us to do that—multibrand, multinational. We can have several different brands in the group and you can operate in several different markets,” Walsh says.

IAG is not looking to acquire other carriers for now. “We don't see anything that would represent additional value to us. Therefore, it is unlikely we would do anything in the short term,” Walsh says.

That is also because the approach to consolidation is changing. “Unlike previous consolidation strategies, where it was all about getting bigger, we are very clear that this is about the right partners to make you stronger rather than bigger,” he notes. “Size has some relevance, but as we have seen before, it does not necessarily guarantee success.” And IAG serves as a good example, inadvertently.

The acquisition of BMI gave BA access to high-value Heathrow slots, and if another similar opportunity arises, Walsh says he would consider it. “An airline that had additional slots at Heathrow may represent additional value to us. But there are not many airlines left, to be honest with you.”

One of the most important tasks IAG performs on behalf of its subsidiaries is fleet acquisition. And there is a lot to do: In the medium to long term, almost 100 widebodies need to be replaced at British Airways and more than 30 at Iberia. The process has started, but crucial decisions still lie ahead.

Last week, IAG took the process a step further, signing a memorandum of understanding for 18 Airbus A350-1000s and 18 options. All of the aircraft are earmarked for BA. IAG also agreed with Airbus on commercial terms and production slots for an additional batch of aircraft to be allocated to Iberia. But that part of the deal is dependent on the Spanish carrier reducing its cost base beforehand. IAG did not reveal how many more aircraft would be required. However, the airline is flying 15 A340-300s and 17 A340-600s that are no longer economical to operate.

BA has only once before ordered Airbus widebodies. The carrier is taking delivery of its first of 12 A380s this year, almost at the same time as the first Boeing 787 arrives. The airline operates 112 A320-family aircraft and has no outstanding narrowbody orders. In the medium term, BA must begin replacing its aging Boeing 737 fleet, but that decision will likely come only after the widebody replacement is done.

The A350-1000 plus 18 787 options that IAG plans to convert for BA into firm orders will serve to replace the Boeing 747-400 fleet. The order does not mean the proposed Boeing 777X is being ruled out.

“Based on what I have seen, it is almost inevitable that that is an aircraft that we will have in our fleet at some stage, whether that is something we would decide on now or at a later stage,” Walsh says.

It makes sense for the group to operate different types of aircraft, he notes, given the variety of missions that are needed. In addition to the Iberia A340s, IAG must replace 46 Boeing 777-200ERs at BA.

Walsh is pleased with the performance of the 777-300ERs BA has integrated at a relatively late stage, saying, “if I'm honest, the regret I have is that we did not get the 777-300ERs earlier.” BA is operating the -300ER in a 297-seat configuration; its 747-400s only have two additional seats.

On the other hand, Walsh believes that “as good an aircraft as the 777 is, it is going to be overtaken by the next generation of aircraft, the A350-1000, the 777-9X or versions of the 787.” And IAG clearly intends to be among the early operators of those.