Managing Strategic Airline Alliances

Birgit Kleymann, Hannu Seristö

• Publisher: Routledge
• Year: 2017
• eBook ISBN: 9781351920292
• Edition: 1
• Topic: Technology & Engineering
• Subtopic: Business General
• Index: Technology & Engineering

Strategic airline alliances are an important topic in airline management today, stimulated by poor access of international airlines to large domestic markets such as the USA and EU and the increasing importance of network scope. Outright mergers of international airlines have proved to be difficult for political, cultural and legal reasons, making alliances the best available form to strengthen strategic positions and streamline networks. However, there are a number of difficulties associated with an alliance such as long-term stability, political climate, cultural conflict and how much capital alliance partners should sink into the integration. The main purpose of the book is to convey in an accessible form to a wide audience, the results of recent academic research on strategic airline alliances. The authors systematically cover: policy, regulation and consumer issues; management, marketing and strategic issues; the mechanics of airline alliances; the airline alliance group as an organisation in its own right; different forms of alliances and clusters; success and failure factors of airline alliances. The book successfully: - provides an analytical framework for understanding the dynamics of airline alliance groups - examines both the level of the individual airline and the alliance group itself - applies recent insights from organisation theory. The readership includes airline managers, policy-makers, academic researchers and others interested in evolving multilateral alliances. It can also be used as a course book both in aviation management training and in more general modules on alliances for advanced students in air transport management.

Chapter 1
Characteristics of the Airline Industry and Alliances

The regulatory framework of air transport

The airline industry has traditionally been characterised by a high degree of regulation, not only on the technical, but also on the economic side. On international routes, airlines mostly operated within a very rigid framework set by air services agreements (in short ASAs), which are intergovernmental agreements concerning traffic rights between two countries. The regulation of air traffic stems from the Paris Convention of 1919, where it was recognised that each state is sovereign over the airspace above its territory and thus responsible for defining the nature and extent of air traffic serving it. In addition to heavy domestic regulation of air traffic in most countries, ASAs between nations regulated the international market in terms of fares to be charged, frequencies to be flown, and capacities to be offered. In practice, two countries that decided to set up air services between each other were to designate a specific airline (the so-called 'flag carrier') each to serve that particular market from their side. Except for the case of the United States of America, most flag carriers were government-owned. An airline enjoying flag carrier status was provided with route rights by its government, and did not face any competition except from the designated flag carrier of the country at the other end of the route. Even that competition was usually quite limited, since capacities and fares (and at times even the standard of in-flight services offered to passengers) were defined in the ASA. At the same time, flag carriers were not free to enter or exit routes on economic or operational grounds, because their status often dictated operations to serve public convenience and political considerations. Similar regulations governed the domestic services operated by airlines. This system did not encourage airlines to operate efficiently, but it assured a fairly stable and predictable operating environment.

The Oil Crisis of the 1970s triggered a call for more efficiency and an increased profit motive within airline operations. In the United States, a debate arose concerning the merits of the regulatory system. The main point of criticism was the obsolescence of rules, which were initially intended to protect an infant industry in the 1930s. Now it was argued that the airline industry had matured enough that it could operate in a competitive environment. The main new ideas were that air fare levels should indeed be decided in the marketplace, that there should be freedom for airlines to enter and exit a given market (a route or set of routes), and that competition should stimulate the drive for more efficiency in airline operations.

In 1978, the Carter Administration introduced the so-called 'deregulation package' concerning its domestic market. In 1992, deregulation was for the first time established at international level by a step-wise process that was initiated within the European Union, and which eventually moved towards full liberalisation of intra-EU air traffic. Eventually, air traffic within the EU would be considered domestic traffic, subject to very few restrictions. The key issues of this EU liberalisation package include the following:

• EU airlines will be free to operate from any airport within the EU (subject to infrastructure restrictions such as slot availability, noise regulations etc).
• A route can be operated by several carriers (the reciprocal two-carrier rule is thus eliminated).
• Cabotage¹ rights will be granted. That way, several national airlines lost their domestic monopoly.
• Increased freedom to set fares on economic grounds.
• Negotiation of traffic rights with non-EU countries will be undertaken by an EU-authority, rather than by the authorities of a specific county.
• Decrease and eventual termination of government subsidies to airlines.

Outside the (so far) unique EU scene, air transport between countries is sometimes governed by a specific type of air services trading arrangement, namely the so-called 'Open Skies' regime. The name is slightly misleading, since such an agreement does not provide for 'free flight' between two signatory states — genuine open skies only exist in Europe.² In reality, they are a significantly relaxed form of regulation. For example, an Open Skies agreement that a country might sign with the United States currently involves the following main points and limitations (which apply to both airlines from the signing nation and to US airlines):

• Full 5^th freedom rights (for a description of the freedoms of the air, see endnote³).
• No restrictions on capacity, fares or routings.
• Access to all points in each country.
• Unrestricted designation (i.e., no flag carrier status for any airline).

On the 'negative' side of points still impeding truly free flight, this agreement lays down

• No provision for the possibility of exercising 7^th or 8^th freedom.
• Strict national ownership and effective control restrictions.⁴

Typically, ASAs are of a bilateral nature, i.e., between two countries. There are currently thousands of bilateral air services agreements in place between some 180 nations. The extent of airline activities between these countries depends very much on the outcome of those negotiations. In a further step to simplify the negotiation processes, some countries agree on a multilateral Open Skies regime. In November 2000, one of the first such agreements on a significant scale was signed by the United States, Brunei, Chile, New Zealand and Singapore.

This increasingly liberalised, albeit not completely deregulated, regime of global air transport means that former flag carriers would lose their hitherto well-protected position. Being a national airline no longer suffices as a reason to be present in certain markets. The airlines' reactions to liberalisation and deregulation have, to some extent, been different on the two sides of the Atlantic. In the United States, where deregulation was introduced in a single step in 1978, there ensued fierce competition between the established carriers as well as against many a startup airline. This has left the market now, more than twenty years later, with a smaller number of contenders than were present in the initial phase, when the prospect of free market entry attracted (and created) many competitors. The airlines that still exist today owe their survival mainly either to their size and the resulting benefits of scope, density and market dominance or to their specialist position as feeders and niche carriers. In some cases, and where allowed by competition authorities, larger incumbents also purchased majority stakes in potential competitors and merged them fully into their own operations. As became evident in the cases of American Airlines purchasing TWA, and United Airlines investing in US Air, this process of consolidation did not always prove beneficial to the investing airline.

The reaction on the European scene has been different in that most airlines there aimed, at least from the outset of liberalisation, more at consolidation in the marketplace, rather than at direct confrontation with competitors. The main competitive advantage held by European airlines prior to deregulation, namely the dominance of their respective national home markets, is still held in many cases. This is partially due to the relatively slow, step-wise establishment of a deregulated regime in Europe. Start-up airlines have been gradually challenging some of these positions, mostly in low-cost niches. A few airlines have established operations outside their home country, but, so far, relatively few EU airlines make full use of their rights to fly cabotage outside their home country, or to serve routes between two countries other than their own. However, the scene is changing with increasing speed, and the question for an individual airline is now to re-define its role and to find a strategy that takes into account its specific resource endowment. It will be the exploitation and expansion of these resources, rather than pure government endorsement, which will become an airline's 'raison d'être'.

As to the possibility of consolidation through mergers and acquisition, this was and is still limited in the airline industry. It is mainly impeded by three factors: the first being the high cost associated with such a step, the second one being clauses that still require most airlines' shares to be held by a majority of nationals of their country of registration (this is true even within Europe), and the third being antitrust concerns. Antitrust issues even prevent or limit non-equity seeking cooperation between airlines. In some cases, the US authorities have granted antitrust immunity⁵ to alliances between a US airline and a foreign carrier, provided that the partner carriers' home government had signed an Open Skies agreement with the US. In Europe, authorities are unlikely to approve cooperation between two carriers in a market unless there are clear possibilities for competitors to establish themselves as well in that market.⁶ Indeed, airlines are nowadays operating in a competitive environment where regulation in some markets prevents full competition on one hand and full freedom of reaction to competitive pressures on the other. The regulatory situation is, however, in constant flux, with a clear tendency towards liberalisation. Full global liberalisation can however be considered to be a highly unlikely scenario,⁷ at least in the medium term, and it appears unlikely that even a — hypothetical — fully and globally liberalised air transport market would completely eliminate the need for alliancing.⁸

It will not be discussed here whether a (hypothetical) fully liberalised air transport market would lead to more efficiency or to lower cost for the consumer. There is a possibility that a fully deregulated air transport industry would move towards a small-numbers oligopoly (i.e., a few mega-carriers), with duopolies and monopolies in regional markets. If this is assumed, the current stand by antitrust authorities, which limits the possibilities for mergers or tight cooperation between airlines, could indeed be seen as a way to preclude some of these oligopolies and ensure some competition between firms.

Economic characteristics of the airline industry

Three passengers less per flight, costs increasing by two per cent, and ten DM [approx. € 5] less yield per ticket sold are all it takes to put us down to a zero in results.

(Senior Manager, Lufthansa)

The deregulation of the airline industry was an attempt to drive the industry towards the perceived ideal of perfect competition with its supposed benefits of pricing related to costs, optimal output and the disappearance of inefficient producers.⁹ However, even after the deregulation of air transport in the US, the European Union, and other parts of the world, markets are far from contestable.¹⁰ In most of the world's markets, one can observe a regional segmentation into geographically different market zones which are characterised by strong oligopolies where a set of weaker competitors have almost no significant individual market leverage. The reasons for the existence of these oligopolies might lie in the size and scope effects discussed further below, and in two salient characteristics of the airline industry.

First, studies on the cost structure of airlines¹¹ have shown that this industry is highly sensitive to variations in external factors such as fuel prices, wage levels, and demand. This sensitivity has increased in recent years as the average yield per RPK (Revenue Passenger Kilometre) has been dropping continuously¹² In other words, profit margins are small and competing in the airline industry is costly and risky. There have been, especially in the first years of deregulation in the US, small start-up airlines, which tried to attack the established larger carriers head-on by offering significantly lower fares on certain routes. Frequently, this move triggered a price war between the two competitors. For some time, consumers could benefit from airlines undercutting each other on a route or set of routes. However, it was normally the larger incumbent airline which eventually won the war: they could sustain extremely low (and if need be even unprofitable) fare levels on a route for the time it took to drive the competitor out of that market by cross-subsidising that market with funds from other, more profitable routes. After the beaten competitor withdrew, fares went up to previous levels.

Second, entry barriers to most markets are still considerable, be it due to airline-specific reasons such as market power (e.g. hub dominance, CRS ownership) or external factors such as infrastructure availability (e.g. airport slots) or remaining regulation in certain international markets (bilateral agreements limiting the number of airlines that can serve a route between two countries).

The airline industry can therefore be characterised as very sensitive to outside factors, highly cyclical, and featuring significant barriers to open competition. In addition, the fact ...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• Preface
• Foreword
• 1 Characteristics of the Airline Industry and Alliances
• 2 Alliancing Objectives
• 3 The Dynamics of Interdependence
• 4 Alliancing Life: Talking to the Practitioners
• 5 Competing with the Alliance: Strategy Options of Independents
• 6 Marketing Airline Alliances: The Branded Alliance
• 7 The Effect of Strategic Alliances on Performance
• 8 Extraction of Financial Benefits by Alliance Partners
• 9 Challenges to Federation Governance
• 10 Success and Failure Factors of Airline Alliances
• 11 A Look into the Future
• Index