Hand-picked two years ago to succeed Xabier de Irala as chairman of Iberia Airlines, Fernando Conte took the controls of the Spanish flag-carrier at the end of one of the most lauded turnaround stories in commercial aviation.

A dowdy, loss-making state monolith in the mid-1990s, by 2003 Iberia was a 95 per cent privatised, profitable company in which British Airways had a 9 per cent stake. Fleet management had been tidied up, unprofitable routes shed, and the workforce trimmed to adjust to competition and a series of industry shocks. The company last year posted a 50 per cent year-on-year surge in profits to €220 million.

Most analysts agree that Conte has hardly put a foot wrong since taking over. Iberia has invested heavily in its high-margin business class service, further trimmed costs in economy class and entered the final phase of a programme to simplify its fleet around a two-family Airbus structure.

However, the next 12 months will also test Conte. Surging fuel costs are squeezing already tight profit margins, while fierce competition from local operators such as Spanair and Air Europa has cut heavily into its domestic market share. The roll-out of Spain's high-speed train network means further competition.

Low-cost carriers have made life difficult in the European tourist market and lowered forever what short-haul economy flyers expect to pay for a seat. Ryanair and Easyjet are now considering competing on domestic services, and the latter may even buy some of the new capacity created by the enlargement of Madrid's Barajas airport, due for completion early next year.

Conte sees the near-doubling of terminal space and runway capacity at Barajas as a double-edged sword. Iberia has won a legal battle to take over, with its Oneworld alliance partners, a new terminal.

This will allow it to cut costs associated with moving staff and baggage around the massive complex and provide scope for adding flight capacity where needed. Easier connections for travellers, too, should help the company shore up its client base.

However, its move into the state-of-the-art Terminal Four will also free up space for competitors.

"In an enlargement like this, the rules of the game in slot allocation will ultimately favour the newcomers," Mr Conte said.

Vital to Iberia's strategy, according to executives, is the resolution of a six-month impasse with pilots and other workers over collective bargaining.

Staff pilots, however, say the company wants to redraft the rules on contract negotiation and have refused to discuss details until an acceptable bargaining framework has been established. Industrial action threatens to disrupt the peak summer holiday season, although some observers say pragmatism may win out.

"The challenge at Iberia, like any legacy carrier, is to keep chipping away at the labour unit costs accumulated during years of state management," says Mike Powell, airlines analyst at Dresdner Kleinwort Wasserstein in Madrid.

Conte admits that "a lingering public service mentality" among staff has not only restricted scope for cost savings, but hampered efforts to shed the company's reputation for poor service, both on the ground and in the air.

A push into electronic ticketing and business customer profiling has helped address this shortcoming, while the airline has also made giant strides in punctuality.

"Our record in this respect has gone from bad to better than average," he says.

Details such as these are important, he stresses, in today's competitive environment, although probably not enough to guarantee the survival of any airline.

Talk of closer links - or even a merger - with British Airways never ceases, and executives have watched Air France's merger with KLM with interest.

For now, however, Iberia has sufficient financial muscle and the brand name to battle on.

"We've yet to see a situation in the industry where a big healthy airline buys or merges with another big healthy airline," says Conte.