Strategic partnership in airline industry

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Strategic alliances are common to any industry. Their presence is felt quite significantly in the airline industry. Starting in the US in 1978 deregulation of airline industry has since brought about sea changes in functioning of the industry. This paper attempts to understand the developments and strategic alliances that have occurred in the airline industry since deregulation. These strategic alliances exist in various forms and differ widely in scope and no consensus on classification was found. The advantages and disadvantages of strategic alliances with respect to the airline industry have been discussed. It is felt that the industry is getting increasingly concentrated. However, no conclusive remarks can be made about consumer welfare.

"Airline Business Alliance Survey of 2000 reports that there are 579 alliance agreements in place, up from 280 agreements (more than double) in 1994 when the survey was first conducted. Five major alliances (Star, Oneworld, Qualiflyer, Sky Team, and Wings) account for some 60 percent of all air travel." (Mason, 2002)

The lines above make the issue important enough to understand the phenomenon that is guiding the industry. Almost a decade back Oum, Taylor and Zhang (1993) argued that the airline industry will be marked by strategic alliances and these alliances will be global in nature. The guiding factors will be several that include formation of blocs, resource scarcity, limits on foreign ownership and limitations imposed by bilateral agreements. They further forwarded the argument that to be a part of an alliance will become a necessity for an airline to survive in the future.

As we look today around us, there are alliances of various types all over. An effort is being is made to understand the literature on alliances in the global air transport industry.

The air passenger transport industry has been one of the major drivers behind rapid globalization of the world businesses and the consequent shortening of the distances on the planet. The face of the industry as we see today has a history of its own. Starting in 1909 on a relatively insignificant note with the invention of an airplane, it has come a long way in less than 100 years. The technological developments made till the end of the Second World War made it possible for airplanes to become capable of flying passengers and goods across continents in a short span of time. However, the most noted use(s) of the aircraft may best be termed undesirable and unfortunate, still there is no doubt that the airplanes took the world by storm since Second World War. With the Chicago convention of 1944, a structure to govern international air travel started taking place. Today 1.83 billion passengers fly nearly 3.3 trillion RPKs. The aviation industry employs 1.77 million people directly and 17,650 aircraft (including freighters; Airbus puts the passenger plane number at 10,349 at the end of the year 1999) are in service (data as of 2001).


Starting off in the US in 1978, the deregulation of the air passenger transport industry brought sea changes in the industry. European countries emulated the steps within next 10 years. With deregulation setting in, there was freedom to choose routes to operate on, set the prices as demanded/ told by the market with no government intervention on the prices. In other words, deregulation was aimed at bringing in total welfare of the consumers using air-transport. Initially, the freedom led to increased competition in the market place following new entry in the business leading to lowering of prices in the markets that put further pressures on the bottom lines of the

airlines companies' balance sheets. Subsequently, the focus shifted on economising the operations so as to reduce the costs and arrest the price increases so as to boost the margins and keep the airlines in business. Still some majors (like Pan Am in the US) of the pre-deregulation era found it difficult to survive and went out of business selling off their rights for domestic and international routes to different buyers.

The cost cutting efforts led to rationalization of route structures. The efforts to gain efficiency led to formation of hub and spoke networks wherein the "traffic feed" was brought in to a central place (the hub) from other areas in the vicinity of the hub (the spokes). The flights from the hub took off for their destinations with the passengers sorted and boarded on a flight leaving for their destination. This did result in some discomfort to some passengers as they might have to change the aircraft at the hub, still there were benefits like that of single ticketing and lower fares to most of the passengers. This tilted the balance in favour of hub-and-spokes networks' approval by public at large. This hub and spoke network led to maximum utilization of the resources and elimination of duplication of efforts was greatly saved that resulted in substantial savings to the incumbent airlines. This hub and spoke network is prevalent today all over the world. Globally, New York, London, Amsterdam, Dubai, Singapore and Tokyo are the best examples of the hub wherein passengers flow in from all corners of the region and again take off for their respective destinations. Over period of time these hubs have developed into fortress hubs i.e., a particular carrier or family of carriers dominates the hubs. For example, airports at Charlotte, Denver and Washington Dulles are dominated by US Airways/ United Airlines to the monopoly levels (above 70 percent as per US standards) (Cooper, 2001).

Owing to the continuous drive towards achieving better margins through cost cutting there has been a gradual and steady decline in the real value of airline yields all over US and the Europe (Doganis, 2001, p.9); i.e. the average revenue per passenger-km (RPK) has declined. In a study on the after effects of deregulation in the US, Thirer (1998) noted that air travel has increased steadily since deregulation and the fares in

997 were 40% lower than the 1978 levels (1982 constant dollar yield). The consumer benefits at the 1993-dollar prices were estimated to be $19.4 billion (Crandall and Ellig (1997) as quoted in Thirer (1998)). Also the number of passengers flying has increased by almost 140% from approximately 250 million in 1978 to nearly 600 million in 1997.

Also the creation of fortress hubs that integrated domestic and international routes resulted in enhanced international competitiveness of the US carriers, as they were now able to leverage huge feeds available for their international operations. This achievement of critical mass by the US airlines in their domestic market forced them to look for opportunities outside the US market. The need to find foothold in other markets in the regime of (mostly) restrictive bilateral agreements gave rise to another thoughtful idea of "Open Markets" policy by the US in 1978. Pustay (1992) has also noted that the move towards "Open Markets" initiated by the US was also responsible for changing the structure of the international air travel industry. The open market policy was aimed at providing maximum consumer benefits of competition in the market place. Not only there was freer market access for both foreign and US carriers, but multiple designations of airlines from both sides were also made available. Still, there were some nationality requirements of the ownership of the designated airlines. The capacities were set to 'unlimited', and double disapproval of tariffs (i.e. filed tariffs chargeable unless both governments disapprove) was enforced. In 1978, US efforts towards "open market" were initially seconded by the Netherlands. Then due to market dynamics, Germany and Belgium also signed "open market" agreements with the US (Doganis, 2001, p. 23-25). Europe also gradually moved away from traditional bilateral air service agreements (ASAs) that were restrictive in nature as they allowed limited number of routes to be operated on with very few fifth freedom rights. Single designation and capacities were also agreed upon in advance and double approval for tariffs was required. (Though some of these features were revised in the Bermuda agreement, still there were large restrictions on the operating airlines. Notably, most of the world's ASAs are still of traditional types as noted by Doganis,

2001, p.21). In 1984, UK and Netherlands signed an "open market" agreement that resulted in effective deregulation of air services between the two countries. Later somewhat similar agreements that ensured freedom of air services were signed with Germany, Luxembourg, France, Belgium, Switzerland and Ireland. Some important restrictions placed were of nationality of the airline ownership and limitation of the fifth freedom rights that, however, were less restricting on the US airlines. Also, while there were limitations on the number of gateways available to the foreign airlines in the US, the US airlines had the freedom to fly from any point in the US to the foreign country.

Similar moves towards deregulation of air services took place in other parts as well. Japan Airlines' virtual monopoly on international routes was broken with the international operations allowance to All Nippon Airways in 1986. Similarly, new airlines like EVA Air in Taiwan, Asiana in Korea, Ryanair in Ireland and Lauda Air in Austria were allowed to operate international flights.

In some cases these "Open Market" agreements were renegotiated to "Open Skies" agreement. These new agreements inaugurated the first phase of international deregulation. US-Netherlands was the first pair of countries to sign the Open Skies agreement. Later Germany, Belgium, Switzerland, Singapore, Korea and Japan joined the league. It is important to note that these agreements had some variations as per demands of the negotiating countries. The "Open Skies" agreement marked an end to the disparities that existed in the earlier Open Market agreements. Now the airlines from both the signatory countries had the freedom to fly to any desired point in the other country. Also granted were unlimited fifth freedom rights and multiple designations of airlines with no restrictions on frequency or capacity. The fares were to be in line with the market conditions and there was full freedom for making commercial agreements. (Doganis, 2001, pp.: 30-32).

These activities were not limited to US alone. Other countries like New Zealand were quite active in entering into similar agreements with other countries. It signed Open

Skies pact with the US, Singapore, Brunei, Malaysia, the UAE and Chile. It also signed for a single aviation pact with Australia, which in turn signed its first Open Skies agreement with the UAE. The notable feature of the pact was that Australia was willing to give Seventh Freedom Rights for a stand-alone air services between the bilateral partner and a third country on a case-by-case basis. However, domestic cabotage was not possible.

With changes in the US and the formation of single European aviation market since 1993, there is a shift in favour of market-based approaches in the air travel industry (Brueckner and Whalen, 1998; Yergin, Vietor and Evans, 2000). Pustay (1992) also puts forth the conclusion that these efforts made other countries emulate the US policies as these measures resulted in tightening of control of the US airlines on their domestic feed to the international flights. This undoubtedly increased the international competitiveness of the US airlines.


It has been pointed out earlier that US airlines found the US market place too crowded to fight the competition. Doganis (1994) observed that in 1989 the six largest US carriers generated 84% of US domestic passenger kilometres, as per year 2000 data, the top 6 airlines in US in terms of RPKs, have a share of over 72% of the total US RPKs. Europeans took a cue from the US experience and found that the size was necessary not to get the economies of scale, but to attain economies of scope with deeper and wider reach in the market. To achieve the desired economies of scope, alliances were a handy solution as the cross-border alliances or mergers had the potential for generating traffic feed between an airline and its partner.

European airlines threatened by the US moves to garner large shares of the transatlantic air passenger market decided to enter into marketing alliances. However, these marriages of convenience proved to be short-lived and less beneficial to the partners. The alliances between United Airlines and British Airways and that between Air France and Lufthansa were such examples (Doganis, 1994).

In order to achieve desired economies of scale, European carriers came up with a three-pronged approach (Doganis, 1994 and 2001). The first step of this approach was to make sure that the airlines had a dominant position in its home market. This was done through purchasing the smaller airlines in the market (e.g., KLM buying into shares of Netherlines and a charter carrier, Transavia) or by increasing the shares through launch of new airlines that cater to a different market segment. As in the case of British Airways which merged its wholly owned subsidiaries, British Regional Airlines and Brymon Airways in March 2002 to British Airways Citi Express. Its 2001 acquisition of British Regional airlines group further strengthened its position in the UK domestic market.

The second step was to gain foothold in other major European markets. The major constituents of the European market are the UK, Germany and France. SAS did this by purchasing shares of British Midland's parent company in 1988. British Airways acquired majority stakes in Deutsche BA in Germany. It also bought equity in Air Russia. As discussed above, recently the launch of British Airways Citi Express also made it garner a larger share in the European pie. It has now increased its share in the European air passenger market.

The third strategic option was to establish a global presence through marketing alliances with other non-European airlines or making share purchases in them. The point was to enter the markets that were under-represented by the incumbent airline. Obviously, the market choice for the European carriers was the American market and the Asia-Pacific market as they are the largest markets outside the European Common market for air passenger traffic. With this aim British Airways purchased stakes

within 2 months in Qantas in 1992 and in US Air in 1993. These purchases made some room for British Airways in the Pacific and the US market.

de Wit (1996) makes similar observation when he identifies that European airlines are restructuring their networks to increase their competitiveness. The airlines in Europe are entering into alliances of all sorts by way of equity purchase, code share agreements, block-space arrangements, wet leases, franchising agreements and joint ventures. Transnational alliances as in case of SAS and Swissair, BA-Deutsche BA, TAT and Maersk Air, KLM and Air UK were also observed. These alliances were expected to lead to network economies and the reinforcement of home base, thereby ensuring increased feed and formation of fortress 'Euro' hubs, similar to those in US. Sabena, SAS, KLM and Lufthansa have reportedly developed such hubs at their respective home bases.
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KLM, Lufthansa, Swissair (now Swiss) and SAS, all followed similar three pronged strategies during late 1980s and the 1990s. BA, however, was the first to develop a clear plan of taking 3 steps to gain the market. It continuously increased its stake in various airlines. BA bought 40% share in Brymon Airways in 1987 and subsequently purchased it outright in 1993. Its moves of taking over of British Celadonian in late 1987; 1992 acquisition of principal European and domestic scheduled routes of Dan-Air which eventually helped it to strengthen its hold on Gatwick Airport; 1993 franchisee arrangements with ...

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