When discussing airline strategy in the 21st century, the first thing that comes to mind is probably the issue of alliance membership. Indeed, intensive, multilateral cooperation between airlines is a relatively new phenomenon that arose out of significant changes in the carriers' operating environment. Since the liberalisation of air transport, airlines have lost the protection of their markets, which increased competition between carriers; many a former state-owned carrier has been privatised, and to a large number of flag carriers there is new obligation to operate under a real profit motive. In this situation, airlines find themselves facing two challenges simultaneously, they have to compete in terms of service levels, but also face pressure to lower the fares and consequently have to strive to reduce costs. The reaction of the participants in the newly liberalised markets was to consolidate on some fronts to avoid the potentially detrimental effects of over-competition. An airline needs to find a way to increase its scope without having to incur the costs of serving all desirable markets by itself. At the same time, it must strive to excessive vulnerability from the uncertainties of loose, shorter-term cooperative agreements with other carriers. This leads to a setting where the airline has to manage a ‘trade-off between autonomy and survival'.[Pfeffer, J. And Salancik, G.(1978), the external control of organizations. New York: Harper and Tow] (Book1)
As has been the case within other industries, airlines need to give very careful consideration to their alliance strategies as tools for growth or at least for survival. In addition, airlines differ so much from each other- for example in terms of size, mission, infrastructure, objective, company culture. (Book1)
In management research, quite a bit is known about alliance forms such as bi- or trilateral consortia, R&D cooperation, or joint ventures. Typically, these alliance forms involve (a) a very limited numbers of partners, and (b) often have a definite boundary, be it in temporal or operational terms. (Book1)
The alliance groups that airlines have been building among themselves, however, are a different form of cooperation: they involve many partners, they concern the whole firm, and they are mostly of indeterminate duration. (Book1)
Alliances are generally a strategy that companies use when acquiring another company or when internal development as a means of growing is not an option. Although there have been cross-borders mergers in most other industries, the restriction in foreign ownership in aviation is still maintained, which has led to a rapid move towards the formation of alliances in the industry. The restrictions on who may own and control a national airline, and the right of a country refuse or accept the designation of an airline under bilateral air services agreement if that airline is not majority owned and controlled by citizens of the country of designation, have hindered airline cross-border mergers or takeovers. Of course these rules have been relaxed in the EU, and it is intended to gradually remove nationality clauses from bilateral air agreements following the decision of the European Court of Justice to that effect. (Book1)
The industry has witnessed the exit of members from global alliances due to clashing cultures, business conflicts and competition. The problem arises from the nature of the loose partnership between airlines. In effect, each partner is an individual organisation with a separate management board and financial accounting. Ultimately, each airline is concerned with its own results, and wishes to ensure a positive balance sheet for its own shareholders. (Book1)
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. (Book1)
Economic characteristics of the airline industry
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. (Book1)
First, studies on the cost structure of airlines have shown that this industry is highly sensitive to variations in external factors such as fuel prices, wage levels, and demand. The sensitivity has increased in recent years as the average yield per RPK (Revenue Passengers Kilometre) has been dropping continuously. Profit margins are small and competing in the airline industry is costly and risky. There have been, especially in the first five 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. This move triggered a price war between two competitors. Normally the larger incumbent airline which eventually won the war: they could sustain extremely low (and if needed even unprofitable) fare levels on a route for the time it took to drive the competitor out of that market by cross-subsiding that market with funds from other, more profitable routes. After the beaten competitor withdrew, fares went up to previous levels. (Book1)
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). (Book1)
Three generic airline strategies(Book1)
Each of these has certain limitations, which push airlines towards establishing some alliance links.
The first option is organic growth of airline. This refers to growth without mergers and acquisitions. The viability of the option is, however, severely limited, due to the following main restrictions to organic growth of an airline:
- Regulatory: in a number of markets, access is still governed by bilateral agreements where only designated carriers can serve a route. This means that an airline is not always free to decide on which markets to expand.
- Infrastructure: even in a deregulated market, a newcomer might face significant slot restrictions at airport.
- Market capacity: a market only supports a certain capacity.
- Economical: there is a limit to the degree of internalisation possible. One reason is that beyond a certain size, a firm may become inefficient. Another reason is that (hypothetical) cost of organic growth is significantly higher than the cost of teaming up with a partner.
- Competition dampening: by alliancing with an airline, this carrier becomes a partner. In the case of organic growth into the carrier's market, it would have been a competitor. (Book1)
Another growth option would that be of mergers, or the acquisition of a controlling stake in another carrier. The main obstacle to this kind of growth is financial. Because demand for air travel is derived demand, the airline industry is highly cyclical and significantly impacted by outside events. The provision of air travel is cost intensive with a high amount of fixed costs and low margins. (Book1)
Focus is pursuit of a niche strategy. The airline can focus either on a certain geographic market or on a customer base. In the case of focusing on a geographic niche, an alliance with other carriers is a feasible option in that it provides the niche carrier with feed for its market, by having the partner airlines connect the specialist to the world. The other niche strategy, one which appears to be impervious at least to the current alliance movement, is that of financial differentiation, for example, that of low-fare, no frills services, and we currently see no low-fare carrier participating in the big alliance game. One reason for this is the need for a more or less homogenous fare structure as well as partners. (Book1)
Lastly, there is the lowest cost-choice, which means a concentration on high load factors, minimum operating and overhead costs, and a standardised fleet. This in practice refers to scheduled low-fare carriers, and also to non-scheduled carriers serving tourist destinations under contracts for tour operators. These airlines do not carry connecting traffic, which implies that allying with other airlines will carry very limited benefits. Some benefits might, however, arise in the field of cost reduction, and we can observe a tentative alliance formation between several European charter carriers. It seems that, currently, a true lowest-cost strategy is difficult to pursue if the airlines wants to uphold features that would make it structurally compatible with current alliances, as these features refer to sales infrastructure and passenger amenities. (Book1)
Cases of failed airline alliances
Political reasons and unwillingness to cooperate (e.g. KLM/ Alitalia; KLM British Airways)
In 1998, Dutch KLM and Alitalia announced a full merger of their activities. This merger was approved by the EU competition authorities on the grounds that it involved little overlap between partners. Apart from having to give up a relatively small numbers of slots in Amsterdam to open competition on routes between the Netherlands and Italy, the partners were very free to create a merged airline. KLM provided financial assistance to Alitalia, mainly to help that airline setting up operations at its newly opened - and at the time poorly performing - hub at Milan-Malpensa airport. The Malpensa hub was seen to be one of Alitalia's main strategic assets. After several months of preparing the deal, however, KLM announced that they would cancel the proposed merger. Officially, this was on the grounds that Alitalia had failed to restructure its internal organisation. (Book1)
In 1980s and 1990s, the deregulation movement in the USA and liberalisation in Europe had greater and greater effects on the character of the airline industry and the negotiation of bilateral ASAs. (Book3)
Another characteristic of the period was anew bout of financial instability in the airline industry. This was largely to do with an international economic recession, but conditions were exacerbated in the USA by the cut-throat competition of the deregulated market and because of Chapter 11 bankruptcy protection, which allowed companies to continue to trade under artificial market conditions. In this recession in the airline market, a lot of airlines disappeared altogether, including great names as Pan Am and Eastern, while others went technically bankrupt, but continued to operate under Chapter 11 protection, which helped to depress further and put more pressure on successful carriers. Others sought outside injections of money through investment deals, or by selling off routes or other assets to tide them over or to help strengthen themselves for when the revival in the airline market arrived. (Book3) pg 199-200
Furthermore, BAs code sharing arrangements with UA - made in December 1987 in an attempt to develop US feeder system for its gateways - was undermined because UA now competed directly with BA at HR. However, BA still had an important card to play: money. (Book3) pg 214
BA was the only major world airline to make substantial profits in the deepening recession. US airlines in contrast were sinking into debt and were desperate for injections of cash to offset this: Delta, AA and UA together amassed losses of $1.4 billion in 1992. After numerous approaches from US airlines, BA finally agreed to deal with US air. In return for an investment of $750 million, BA would get a 25 percent voting share, a US feeder system, and veto rights over company policy. (Book3) pg 214
1993 was the testing time for the fortunes of the airline industry, and that, generally, had adverse implications for the regulatory reform movement. Hardly any major airline made a profit in 1992 and the recovery rate in 1993 was slow and patchy. (Book3) pg 221