The owner of British Airways and Iberia announced a wholesale restructuring of the underperforming Spanish airline as it tumbled to a first-half group loss and cut its full-year earnings guidance.
Willie Walsh, the head of International Airlines Group, said the Iberia reorganisation would mean shedding jobs and reshaping its network.
"Iberia's problems are deep and structural and the economic environment reinforces the need for permanent structural change," Mr Walsh told reporters. "The plan should be completed by the end of September and will encompass every aspect of Iberia's business."
Against a background of soaring fuel costs, Iberia made an operating loss of €263 million in the first half of 2012, compared with a £13 million profit at BA.
"It's been a tale of two airlines and two cities with BA and London doing well and Iberia and Madrid struggling," said Davy analyst Stephen Furlong.
"Iberia has been hit by tough economic conditions in Spain, it has a high cost base and labour costs, Spanish airport charges have risen and it is struggling to compete with low-cost airlines."
European airlines are being hit by slower spending on air travel amid the euro zone debt crisis as well as by high fuel prices, and many have responded by shutting down unprofitable routes and limiting their spending.
IAG's European peers Lufthansa and Air France-KLM have embarked on cost cutting programmes, trimmed profit forecasts and slashed plans to expand capacity and fleets this year after results were battered by high fuel costs and weakening consumer demand.
In recent years - amid weak economic growth, high unemployment and an uncertain outlook - companies and consumers have changed their attitudes on how much service and comfort they are willing to pay for, with many switching to low-cost airlines such as Ryanair and easyJet.
But even budget carriers have had a tough time. Ryanair plans to ground 80 planes in the face of weaker demand.
Earlier this year EasyJet said it planned to cut flights to and from Madrid by 20 per cent after ceasing to base aircraft and employees there.
BA and Iberia sealed an $8 billion merger in 2010, a move that helped the pair stem huge losses following the worst industry downturn in decades.
IAG, which earlier this year predicted it would break even in 2012, expects to make a small operating loss for the year because of restructuring costs and the short term earnings drag from the bmi acquisition.
IAG reported a group operating loss of €253 million in the six months to the end of June compared with a profit of €88 million in the same period a year ago. Group revenue rose 9.8 per cent to €8.53 billion.
IAG said its fuel costs rose 25 per cent to just under €3 billion, while non-fuel costs jumped 9.5 per cent to €5.8 billion.
Earlier this year IAG predicted its annual fuel bill would rise by €1 billion. Combined with €90 million worth of restructuring costs stemming from its acquisition of bmi, Mr Walsh said IAG would struggle to make any money this year.
Reuters