International Airline Alliances, Coursework Example

Abstract

Since the 1990s, airlines worldwide have been joining one of the three current global airline alliances, OneWorld, Star Alliance and Sky Team. By 2011, airlines belonging to the three alliances transported over two thirds of all international traffic. This paper studies the reasons international airlines choose to enter into alliances, rather than mergers and acquisitions, to meet the challengers of the global economic and regulatory environment.

The evolution of alliances is described by the analysis of the size of these alliances, and the code share agreements among alliance associates during the period 2006-2011. The consequences of this study illustrate the differences between alliances and mergers and acquisitions. The analysis is matched with an evaluation of the speculative benefits of alliances and mergers and acquisitions to airlines. Mergers and acquisitions as an alternative to the alliance networks is examined as airlines struggle with increasing costs, regulation and international policies. Overall, this paper provides a view of the alliances as a model for network development versus mergers or acquisitions.

Introduction

Air transport is a major industry in the world economy on its own, with air travel revenues usually accounting for about 1 percent of national gross domestic product. Furthermore, since the 1980s global air traffic has experienced an average annual growth rate of over 5 percent, outpacing economic growth. According to forecasts of the two largest aircraft manufacturers, Airbus and Boeing, this trend will continue in the next twenty years (Boeing 2011). In addition, air transport has widely acknowledged impact on the development of world trade and tourism. The main operators of passenger air transport, the commercial airline, comprise a challenging industry characterized both in the U.S. and then rest of the world by low profits and high volatility in returns.

In the past two decades, rising concentrations through mergers, acquisitions, and bankruptcies has marked the airline industry. “The top airlines have gained greater control over markets since the mid­1990s through code sharing agreements with regional carriers, and more recently, through global marketing alliances,” according to Czerny (2009). Czerny defines code sharing as, “an agreement between two carriers whereby one carrier the operating carrier allows another carrier code share or marketing carrier to market and sell seats on some of the operating carrier’s flights” (Czerny 2009).

In the U.S., deregulation of the airline industry in 1978 has dramatically modified the market, which required the carriers to adopt the use of a “hub­and­spoke” system of airport networks (Forsyth et al. 2011). Control over hub airports has intensified the competition and contributed to big losses, mergers, and several major bankruptcies in the United States. Airlines derive most of their revenue from passenger fares. However, as Klein (2000) explains, they also earn ancillary revenues from transporting mail, shipping freight, selling in flight services, and from serving alcoholic beverages. The commercial airline industry concentrates its efforts on attracting the business traveler segment because it is the primary revenue for airline companies. Business travelers yield higher margins because they typically book flights that are paid for by their companies. Therefore, business travelers have a tendency to be price inelastic with regard to airfares. Consequently, airlines offer special deals to attract business travelers. These special services can include priority check in, expedited baggage handling, luxury lounges, and in flight amenities such as cellular phones, faxes, and outlets for laptop computer usage. In contrast, leisure travelers are highly price conscious (Klein 2000). They usually try to save money by using the Internet for comparisons, looking for discounted airfare, and accepting unusual flight schedules. A distinctive element in the airline business is that most of the largest carriers in the world are enrolled in one of the three existing international strategic alliances OneWorld, Star Alliance and SkyTeam which are often called the global airline alliances. These networks of airlines provide their members with a rich international route portfolio at a marginal cost that would be difficult to be reached through organic growth, merger or acquisition (Hemphill 2000).

This essay critically analyzes the main reasons why one airline might wish to enter into an alliance while another may prefer to choose a merger/acquisition. An analysis will be conducted of the reasons international airlines choose to enter into alliances or mergers and acquisitions to meet the challengers of the global economic and regulatory environment.

Literature Review

Domestic and international airline alliances were one of the most critical advents on the airline industry in the 1990s. By then, a rich and evolving literature had developed to understand the implications of alliances on airline management and end consumers. Considerable research work was on the scope of alliances, strategy alternatives or airlines within this framework and the economic impacts of alliances. With the change of the millennium, as the three Global Airline Alliances became predominant, one can observe more focus on empirical analysis of alliances’ impact on prices and competition, revenue and marketing innovations and airline operations. This section explains the most relevant works in several of the directions taken by the literature on airline alliances and mergers.

By the end of the 1990s, the work of Fernandez de la Torre (1999) provided a coherent overview of the different typologies of collaborative models between airlines. Morrish and Hamilton (2002) contributed with a rich, though concentrated, review of the findings of major studies on global airline alliances during the period 1986 2000. Iatrou and Oretti (2007) provided the most comprehensive text on the opportunities and challenges for airlines with regards to alliances and mergers. Their work includes a questionnaire to carriers’ executives in more than thirty airlines, becoming one of the very few insights available about the impact of alliances on member airlines.

Methodology

The Introduction has presented a brief overview of the current state of the industry, the basic concepts on alliances, motivation of the paper and its goal and a brief overview of the existing literature on airline alliances, mergers and acquisitions. The next section provides an explanatory framework of the particularities of the industry that bring airlines either to join alliances or merge. The following section focuses in the empirical analysis of the Global Airline Alliances. It presents the evolution of the alliances during the period 2006-2011 considering the use made of alliances by their members in their development of code sharing agreements. In the following section, the reasons airlines engage in mergers and acquisitions is explored along with issue presented by mergers. The conclusion summarizes the findings of this paper and draws conclusions from them.

Industry Particularities

Labor represents 35 percent of an airline’s costs. This amount includes costs for flight crews, flight attendants, ground service personnel, dispatchers, maintenance crews and customer service. Most airline personnel belong to a union in the United States. Most union negotiations last a year before a settlement is reached. Then, a settlement lasts for about three years (Kaps et al. 2012). Fuel costs are the second largest operating cost category, representing approximately 10 percent of costs. Some airlines hedge fuel prices by buying and selling futures on the commodity market. Weather can also affect airline costs and operations. Wind speed and air temperatures influence how much fuel an aircraft needs. Weather is the second largest cause of airline fatalities. The airline industry must obtain a detailed weather forecast that includes cloud height, horizontal visibility, wind speed, and direction. Aircraft itself represents about 10 percent of total costs. Airlines either buy or lease their fleet of aircraft (Kaps et al. 2012)).

Most airlines perform routine maintenance, but many outsource heavier repairs to firms that specialize in such business. Airlines are strictly regulated by government agencies (for example, the Federal Aviation Administration, or FAA, in the United States) for safety, labor, and operating procedures. As major airlines face the competition of group alliances in the global market, they are subject to competition in domestic markets by other major players and regional players. Graham (2012) writes:

Regional airlines have gained new ground with the development of newer, smaller jets that are faster than turbo­prop planes and that have greater ranges. The new regional jets have also made operating in previously underserved markets more cost efficient. Recognizing their potential, major U.S. carriers such as Delta Airlines, which owns regional carriers Delta Express, Atlantic Southeast, and COMAIR, and American Airlines, with its American Eagle, have sought to control all or part of the upstart regional airlines. There is a similar trend in Europe, where regional airlines are seeking partnerships with major airlines to more effectively gain access to certain hubs (Graham 2012, 45).

Major carriers merging with each other have not found an easy solution as they consolidate operations and fend off competitors (Graham 2012). They have encountered strict scrutiny by regulatory agencies in the United States and Europe, as has been the case with United Airlines’ bid for U.S. Airways. Similar efforts have been stymied in Europe, as was the failed merger between KLM and Alitalia.

Mirodout et al. (2010) stated that new entrants into the airline business operate under the absence of economies of density and scope that airlines usually exploit in their domestic networks and they might experience limited access to airport’s slots in foreign countries due to grandfather rights of incumbent airlines. In fact, these elements become primary natural barriers for airlines pursuing to enter a new geographical market due to the inability to replace their domestic business model. Odoni (2009) argues that a special attitude toward airlines can be caused by the government concerns on the use of air infrastructure in cases on national emergency or military needs, as well as the national pride of “flag carriers,” or even the fear of losing well paying jobs. Another variable of interest is the concentration of the air transportation sector. The airline industry is much more fragmented than a similar service industry like maritime transport or manufacturing sectors like motor vehicles or cell phone devices. This higher level of fragmentation of the airline industry is even more significant considering the low number of big player carriers existing in each country. (Porter 1980).

According to Graham (2012), internationalization of airlines represents another industry particular factor of the industry. Airlines around the world pursue different and evolving business plans. Despite the existence of similar exposure barriers to entry, this translates into diverse internationalization strategies. Historically, the main distinction among carriers has been between traditional incumbent legacy carriers and incoming low-cost carriers. On a network basis, similar discrimination can be made between carriers operating a hub to spoke network and point-to-point carriers. Towards the future, it could be argued that the main divergences among large carriers might be between aligned carriers in multi lateral airline alliances and those other carriers that remain unaligned. By any criteria, all the largest carriers in each side have a common denominator: the pursuit of international network expansion (Graham 2012, 50).

An important impediment to airline alliances is government regulation of the industry, states Odoni (2009). In every country, governmental agencies impose stringent control over the operations of airlines because of safety reasons. Moreover, in many countries, particularly in the United States and Europe–two major markets–the governmental agencies act like a watchdog for mergers, acquisitions, and alliances between airlines. Although alliances have been subject to less regulation than mergers and acquisitions, governments still interfere with alliance agreements if they feel that such agreements restrict competition (Odoni 2009).

Global Airline Alliances

Airlines want to expand their operations to new overseas markets by collaborating with domestic players that are already established in their respective markets. Liou (2012) states that for this reason, each of the major U.S. airlines has established links with another major European airline: For example, United Airlines with Lufthansa and SAS? American Airlines with British Airways? Delta Airlines with Air France and Continental Northwest Airlines with KLM and Italia. Such collaborations between airlines make it easier for both U.S. and European partners to penetrate each other’s market or to offer extended services. Most domestic markets have reached the maturity stage? Therefore, domestic carriers are seeking new horizons and markets. U.S. and European airlines again exploit their markets to an almost full extent so that there is no longer any room for growth. Under such pressure, major airlines look for opportunities in international markets (Liou 1012).

Global alliances present less risk than expensive takeovers. Through global alliances, airlines attempt to capture market opportunities without investing in aircraft, labor, support equipment, and expanded facilities. For example, U.S. airlines had a bad experience with expensive mergers and acquisitions in the past. Consequently, they are determined to not replicate the competitive race that cost the domestic industry $13 billion between 1990 and 1994. Liou (2012) writes, “During those years, one third total U.S. airline capacity filed bankruptcy and 100,000 employees were down­sized.” Forming alliances are not subject to the same strict government investigation and review process, which is a lengthy process and often ends up with non­approval in the cases of proposed mergers and acquisitions. The Department of Transportation and Department of Justice in the United States and the counterpart agency in the European Union closely review the merger and acquisitions proposals to assure competition in the marketplace and consumer interest. When rival airlines engage in global strategic alliances, others feel that they have to form their own network to avoid not being left out. Imitative behavior explains the emergence of SkyTeam and OneWorld as a reaction to the establishment of the Star Alliance group. Of these networks, some airlines have developed closer one-to-one relationships, but the most important ones are transatlantic (Liou 2012).

Liou (2012) give us a look at the make-up of airline alliances. The first alliance group was STAR, which was established May 14, 1997. The Star Alliance group consists of United Airlines, Lufthansa, SAS, Air Canada, Mexicana, Air New Zealand, British Midland Airways, Austrian Airlines, Lauda Air Luftfahrt AG, Tyrolean, Singapore Airlines, Thai Airways, All Nippon Airways, Varig, and Ansett Transport Industries. The Star Alliance group seems to be the most established and the largest alliance network, consisting of 15 airlines. It offers a wide range of flights in many countries. OneWorld consists of eight full members including American Airlines, British Airways, Cathay Pacific, Finnair, Aero Lingus, Qantas Airways, Iberia, Lan Chile, and 23 affiliates. Between them, they offer services to 550 destinations in 133 countries, with their 270,000 employees operating fleets of more than 1,850 aircraft, carrying some 210 million passengers in 2000. The alliance is largely restricted to sharing frequent flyer schemes, airport lounges, and some marketing. Because all the members of OneWorld have their own frequent flyer programs, OneWorld has created a set of symbols: OneWorld Emerald, Sapphire, and Ruby. Regulators refuse to let them make the next steps of selling seats on each other’s flights and coordinating schedules and prices. SkyTeam consists of Delta Airlines, Air France, Aero Mexico, and Korean Air. The SkyTeam airlines carry a combined 174.3 million passengers per year, trailing the Star Alliance (which is led primarily by United Airlines and Lufthansa). The group sees the Star Alliance as its only real competition (Liou 2012).

Mergers and Acquisitions

Airlines mergers and acquisitions are inevitable for several reasons. Samina Karim’s article for Reuters explains:

In many ways, the passenger airline industry is more like the music industry than the wireless-operator industry. In both airlines and music there is a long history of prolific entry of new rivals, and successful ones either grow or get gobbled up by the larger players. Most of us have heard the names of smaller music labels but many may not be as aware of the dynamic market of regional, non-legacy carriers. In general, large players are faced with competition by the focused, agile, competitive, smaller players and some of these large players don’t fare well. The usual reaction strategy is to try to achieve economies of scale and increase market power. So, with airlines we see consolidation and mergers (Karim 2013).

In his speech to the Arab Air Carriers Organization, Munawar Noorani (2008) proposes that mergers produce a greater level of synergy then alliances. He proposes that mergers afford access the higher value synergies, for example: cost control, revenue synergies and brand value. To achieve these higher levels of synergy integration at the core of the airlines operations is required. This integration includes combining sales forces, fleet management and corporate account management. As a scale driven industry, larger airlines are more capable of riding out cycles than smaller airlines. Other factors why airlines merge include access to new markets, increased market share, industry know-how, assess to scarce resources and consolidation of excess capacity. Perhaps, the principle reasons for merger and an acquisition is survival. Airlines see the major benefits as increased market power, enhanced purchasing power and access to more financial resources, risk diversification and the reduction of the cost of capital. Mergers and acquisitions can also fail due to weak acquisition strategy, managerial ego or unrealistic performance measurement criteria (Noorani 2008).

Conclusion

The goal of this paper has been to provide an explanatory framework that could identify the reasons airlines choose global airline alliances or mergers and acquisitions. Based on the findings, the following conclusions can be drawn on the choice of alliances versus mergers and acquisitions.

• The airlines will continue to explore ways to compete with new, lower-cost entries into the market.
• Membership in a global alliance for developing an international network has been adopted by the majority of the largest airlines in the world.
• The benefits of alliances for enrolled members are largely based on the economies of density and scope associated with code share agreements and collaboration in pricing.
• Alliances are less regulated than mergers and acquisitions.
• Global airline alliances are the preferred scheme for airlines in the development of an international code sharing network.
• Efficiency improvements and operational cost savings are only realized through mergers and acquisitions.
• Companies in trouble may try to merge to take advantage of achieving economies of scale and increased market power.
• Merger or acquisition allows for the reduction of excess capacity.
• Merger or acquisition offers a greater level of synergy.

The consolidation of the airline industry is gaining pace driven by over capacity, inefficiencies, pressure on profits and emergence of global airlines. Ultimately, every airline company will have to analyze their performance and decide whether alliances alone can provide them with the ability to be profitable. They may decide that their only choice for survival is to merge. Global airline alliances will continue to play a leading role in the future; however, mergers and acquisitions may ultimately replace the need for global alliances in the long term.

References

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Czerny, A. (2009). Code-sharing, price discrimination and welfare losses. Journal of Transport Economics and Policy, 43(2), 193-210.

Fernandez de la Torre, P .E. (1999). Airline Alliances: The Airline Perspective. Master’s thesis, Massachusetts Institute of Technology.

Forsyth, P., Niemeier, H. M. and Wolf, H. (2011) Airport alliances and mergers – Structural change in the airport industry? Journal of Air Transport Management, 17, 49-56.

Graham, Anne. (2012). Managing Airports. New York: Routledge Press, 45-55.

Hemphill, T. A. (2000). Airline marketing alliances and U.S. competitive policy: Does the consumer benefit. Business Horizons, 34.

Iatrou, K. and Oretti, M. (2007). The Airline Choices for the Future: From Alliances to Mergers. Ashgate Publishing, Ltd.

Kaps, Robert W., Hamilton, J., Scott Bliss, and Timm J. (2012). Labor Relations in the Aviation and Aerospace Industries. Carbondale: Southern Illinois University Press, 166.

Karim, Samina. (2013). Why airline mergers are inevitable. Reuters. Retrieved November 21, 2013, from http://blogs.reuters.com/great-debate/2013/10/09/why-airline-mergers-are-inevitable/.

Klein, S. R. (2000). Industry Trends. Standard and Poor’s Industry Profile.

Liou, J.J. (2012). Developing an integrated model for the selection of strategic alliance partners in the airline industry. Knowledge-Based Systems, 28, 59-67.

Mirodout, S., Sauvage, J., and Shepard, B. (2010). Measuring the Cost of International Trade in Services. Working paper. Groupe d’Economie Mondiale (GEM) at Sciences Po.

Morrish, S. and Hamilton, R. (2002). Airline alliances–who benefits? Journal of Air Transport Management, 8, 401-407.

Noorani, Munawar. (2008) The Future of Arab Aviation. Arab Air Carriers Organization.

Odoni, A. (2009). The International Institutional and Regulatory Environment (Chapter 2). In P. Belobaba, A. Odoni, and Barnhart, C., The Global Airline Industry. John Wilesy & Sons. Ltd.

Porter, M. (1980). Competitive strategy: Techniques for analyzing industries and competitors. New York: Free Press, 132.