Air France-KLM shocked the air transport sector recently by admitting that it lost €700 million ($930 million) in its European network last year. Things are not quite as bad for the Lufthansa Group, but it, too, has come to the conclusion that it is high time to act.

Lufthansa convened its top 1,000 executives here last week to kick-start the “Score” cost-savings program. CEO Christoph Franz told his staff at an all-day meeting that costs need to come down by €1.5 billion within the next two years to restore the airline's competitiveness. Participants report that in an emotional speech he urged his colleagues to accept that change is desperately needed.

The group is still doing well, compared to many other European airlines that are on the brink of collapse or have already stopped flying, such as Spanair or Malev Hungarian Airlines. In 2011, Lufthansa posted an €876 million operating profit, but it concedes that it will not be able to reach that level of profitability in 2012. The group is facing a huge amount of capital expenditure over the next few years: It has ordered 160 aircraft to be delivered in the next seven years. At list prices, that alone amounts to €16 billion in investment, and even given the usual discounts, it will add up to well over €10 billion. Not included are long-overdue infrastructure upgrades, such as a new cargo center or a second Airbus 380 maintenance facility at Frankfurt Airport.

Lufthansa's former CEO and current board chairman, Juergen Weber, warns that at the current level of profitability the airline cannot fund its planned investments without “an unacceptable increase in indebtedness.”

Air France-KLM and Lufthansa, the biggest and in many ways most successful of Europe's airlines, are therefore finally realizing their business model is no longer working. It took them years to view low-fare carriers as serious competitors, and while they have faced that bitter reality now, the two market leaders still believe they can cross-subsidize large triple-digit losses in short-haul and European networks with long-haul route profits. Air France-KLM and Lufthansa are concerned, however, that the strategy will no longer work, at least in parts of their markets, given the strong growth of Persian Gulf carriers that can afford to offer much lower fares and better service levels.

As can be expected, Lufthansa is confronting problems internally convincing staff of the necessity to cut back. But the need to become more efficient also has consequences for the setup of the entire group.

Lufthansa's airline division consists of the Lufthansa-branded unit, Swiss International Airlines, Austrian Airlines, Germanwings, Brussels Airlines and BMI, although the latter is in the process of being sold. So far, these carriers have run relatively independently, with little integration. That is about to change, as Franz highlights procurement and information technology as two key areas where more integration must be paramount.

However, company officials indicate that Franz will have to overcome considerable internal opposition. Highly profitable and successful units such as Swiss or Lufthansa Technik do not see the need for more integration; in fact, they are arguing that it is their relative independence that makes them so strong. They are concerned about losing key responsibilities for their own businesses. Industry insiders note that others, such as Austrian, are in serious financial trouble and worry that added costs and complexities of the larger group will make it even more difficult for them to turn around.

Independent observers also question how much centralization would actually help. “In theory, integration is a good thing, but in reality, you may not gain as much as projected,” one senior airline consultant says. The more difficult—but ultimately more promising—approach would be to change work rules and cut down on Lufthansa's substantial overhead costs, he says.

Separately, the SAS Group is accelerating its cost-savings program, 4Excellence, after posting another loss in 2011. SAS will cut 300 administrative positions and seek 1 billion Swedish kronor ($149 million) in reduced staff costs. SAS is targeting $754 million in cuts overall in the next two years. Unit costs are to be reduced by 3.5% annually. Questions persist about its long-term viability as a standalone business, although its sale would be highly political, with the governments of Sweden, Denmark and Norway owning parts of SAS.

SAS posted a net loss of $250 million last year, a slight improvement over the $332 million loss a year earlier, but still a disappointment, as the company's investor guidance had said it would return to profitability. SAS had to take a $256 million charge after Spanair filed for bankruptcy. SAS holds a 10.9% stake in the Spanish carrier.