The Future of Strategic Alliances in the global airline industry

Transcription

1 NORMA SMURFIT LIBRARY NATIONAL COLLEGE OF IRELAND The Future of Strategic Alliances in the global airline industry - Destination? Laura Murtagh National College of Ireland B.A. European Business Studies and Languages 2002

2 Table Of Contents Section Page No. Declaration 4 Acknowledgements 5 Abstract 6 Chapter 1 Introduction 1.1 General Introduction Objectives of Research Research Questions 10 Chapter 2 Literature Review 2.1 Change Management Globalisation National Airlines _ Regulatory Policy Deregulation Mergers and Acquisitions Strategic Alliances The Nature of Strategic Alliances in 26 the Airline Industry 2

3 Section Page No. Chapter 3 Research Hypothesis 3.1 Deduction of Theory Hypothesis 29 Chapter 4 Research Methodology 4.1 Methodology Choosing The Sample Body of Research Research Limitations 32 Chapter 5 Research and Findings 5.1 Data Presentation Analysis of Research Data Other Observations 35 Chapter 6 Conclusions 37 Glossary 38 Bibliography 39 Appendices 41 3

4 Declaration I declare that this dissertation contains my original work. Data from other sources is outlined in the bibliography and appendices. Laura Murtagh April

5 Acknowledgements This dissertation was submitted as part of the requirement for the Bachelor of Arts course, European Business Studies and Languages in the National College of Ireland, I would like to thank my research supervisor Mr. Ed Dennehy, Dr Cedric Chau, Dr Ian McLeod and Dr Gabriel Byrne for all their advice and assistance with the dissertation. 5

6 Abstract The Future of Strategic Alliances in the global airline industry - Destination? This dissertation aims to examine the current trends of strategic alliance in the global airline industry. It will examine how the development of alliances will affect the future of the airline industry and why airline companies move towards this type of strategy. The airline industry operates in a very complex, dynamic and competitive external environment. For this reason, change within the industry has a significant impact on all airlines, and indeed many other businesses around the globe. The different areas of management and business theory including change management and globalisation are outlined in the context of the airline industry. Regulatory policy is of particular interest as this issue has implications for international companies operating in trans-national markets. The report also reviews competitive trends and the changing nature of competition in the sector as airline companies rationalise. This dissertation aims to provide an insight into the 'destination' of the airline industry and considers where the current trends in the industry will lead. 6

7 Chapter 1 - Introduction 1.1 General Introduction There are numerous limitations for companies operating in both national and international markets. For example, some of the limitations faced include; economic trends, operational efficiency, market share and retention and customer service issues. The airline industry is one that is particularly sensitive to its external environment. It is highly competitive and airlines must deal with limitations and respond to change. This is particularly so for smaller airline companies in Europe today as they are faced with increasing competition from the major international airline companies and a changing business environment. To overcome these limitations the company must restructure and grow. There are a number of different ways a company may expand its operation effectively. It may be achieved through capital investment, mergers, cooperative strategies or strategic alliance or a combination of these approaches. Alliances are very relevant in the business world today, particularly as doing business across many international borders becomes more commonplace. Over the last decade there has been an increase in alliance activity within the airline industry. This is an interesting trend in an industry that is traditionally very fragmented.: The reason this study was undertaken was primarily the authors lifelong interest in the aviation industry. The airline industry has always been a fast moving and exciting industry, in terms of business and technological advances. However in recent times it is facing dramatic change and at a faster rate than ever before. The changes have been accelerated due to the recent political situation after the USA terrorist attacks in September The airline industry was directly affected as security was evaluated and consumer confidence decreased. The airline industry is a very important part of the economy and it certainly something that we will never be able to do without. The value of the airline industry highlights the importance of understanding how this industry will change, and how it can change for the better. This is a very current topic and one that will have an impact on the airlines of the future. The research will add to the body of knowledge at National College of Ireland. It will be of interest to students of business and those wishing to study alliances and their impact on the airline industry. This research will be of benefit to airlines operating in a current, highly competitive climate and industry analysts. It will also be of interest to partner airlines from One World as they explore the future of the alliance. It will also be of use to the Department of Public Enterprise. This government department responsible for national policy in the transport sectors. This institution faces numerous challenges in relation to the current performance of Aer Lingus. The company has suffered huge profit losses and has now reached an unprecedented crisis situation due it's economic position and internal industrial relations problems. This study is especially significant, as Aer Lingus has full membership of the "One World alliance group and the ownership policy of the company is in question. 7

8 Chapter one contains a general introduction to the topic. The author also outlines the objectives of the study and the research questions. Chapter two contains the literature review. The researcher read this literature in preparation for the research study. The literature review presents topics which explain the background to strategic alliances and why management use this strategy in modem business. The topics included in this section include change management, globalisation, deregulation and the nature of strategic alliances in the airline industry. In chapter three the theory is deduced and the research hypothesis is stated. Chapter four outlines the methodology for the study. The author explains the procedures used to complete the main body of research and outlines the limitations of this research. Chapters five and six present the main body of research, findings and conclusions. Chapter five includes tables to illustrate the findings. The researcher compiled written data on a number of airlines and this section can be found in the appendix, (Appendix 3) Chapter five contains an analysis of the findings and how they relate to evidence obtained from other secondary research. The final conclusions are presented in chapter six. The remaining sections of the dissertation contain the bibliography, glossary and appendices. The reader is referred to the appendices for further understanding of the research data. 8

9 1.2 Objectives of Research The primary objective of this research is to study the current trend of strategic alliances the airline industry and the impact this will have on the future of the industry. To evaluate if consolidation will occur in the industry and how this will develop.

10 1.3 Research Questions 1. Will the current trend of strategic alliances between airlines lead to consolidation of the industry and why? 2. Are airlines engaged in strategic alliance agreements more likely to be involved in acquisitions and / or changes in ownership?

11 Chapter 2 - Literature Review 2.1 Change Management The whole area of change and change management has become one of the most important issues in the field of management and strategy. (Camall 1990) It has become an important issue for managers due to the nature of the business environment Organisations are now faced with a complex, uncertain and dynamic environment, all of which demand change. Change occurs at a faster pace than ever before, and it is more fundamental in some cases. Pressure to change can come from two major sources; internal forces and external forces. According to Tieman et al (19%) internal forces, such as a change in management, tend to be heavily influenced by developments in the external environment For this reason many theorists focus mostly on factors from the external business environment. These factors will vary slightly from industry to industry, however they are broad enough to cover the main aspects forcing a change in strategy. The factors forcing change are shown in the table below. Globalisation Technological Developments A changing work force A move away from labour intensive industries Change requires management to focus on current strategies and to examine if they can be improved and how. It is important to implement strategy that will help the organisation to cope with change and to grow. Of all the factors, globalisation is one which affects almost every industry today. 11

12 2.2 Globalisation A company competing in a select number of foreign countries is an international competitor. A global competitor competes on most continents and in almost all of the world's major countries. Globalisation is due largely to worldwide economic development and the opening of new markets to foreign firms. Liberalisation of the marketplace is evident in countries of Eastern Europe and Asia, as political thinking responds to cater for economic development Changes in political rules in such countries, make it easier for firms to enter the market there. They may enter markets they never attempted to venture into before. Deregulation also opened up the markets in the USA and within Europe. Thompson and Strickland (2001) argue that companies will expand outside their domestic market for any of the following major reasons: to gain new customers, to become more competitive, to capitalise on core strengths and to spread business risk across a wider market base. Companies who only operate in a domestic market have found it increasingly difficult to sustain market share and market growth. They must now consider targeting foreign markets. When companies do enter foreign markets, it becomes necessaiy for them to spend more time and money improving their marketing positions abroad The changes outlined above now demand that companies must consider their competitive strategy and structure in a new light The strategy to operate globally is very different from the strategy used in a home market Cateora and Gauri (2000) state that a company should consider the global market and foreign customer demands. They need to examine market activity abroad. Foreign customer demands may be very different to customer demands on the home market. Organisations need to consider the culture of the country in which they operate and what impact this has on the market. Organisations must also consider their foreign competitors. They must consider cooperating with foreign companies, particularly in markets that are difficult to break into. The trend towards globalisation means organisations must now consider their competitors both at home and abroad and develop strategy to suit. Above all, the global strategy needs to be forward thinking and flexible. 12

13 2.3 National Airlines Most countries have traditionally had one airline; the national flag carrier Airlines are often seen as a symbol of their nations qualities and independence. Much national pride is often derived from the company. The flag and some symbolism from the home country is usually very central to the corporate identity of a national airline. National flag carriers in partnership with their respective governments have helped create the modem aviation industiy. De Wit and Meyer (1996) note that national airlines are an important public service and central to the economy. As a result, the national airline is often government owned. Therefore there is a dual role of regulator and owner. This dual role will obviously effect policy and regulation as the government keeps the interests of the company in mind. Government involvement in airlines is largely responsible for heavy regulation and restriction of competition in the airline industry worldwide. However the role of air transport in society has changed fundamentally in recent times. Many people view air travel as a basic need, particularly for business travel. As changes in economies occur there will be changes in the demand for air travel and the kind of air transport required. The most recent trend is the increase in demand for high frequency, cheap and reliable air transport services. These issues have an impact on the extent of competition faced in the industry. Many traditional flag carriers have found it increasingly difficult to compete in this style of competitive environment. Newkirk and Corrodi (2001) note how the public service' history of a flag carrier makes it difficult to implement change within the company, therefore making it more difficult to make commercially beneficial decisions. The culture of many organisations make it difficult for them to be flexible. The "civil service" culture within many state airlines means they have encountered problems such as industrial relations disputes, difficulties in controlling costs and using strategy that was designed for a very different business environment. Whether airlines become privatised or float on the stock exchange in order to compete effectively, maintain profits and control costs, the pattern of ownership is set to change. 13

14 2.4 Regulatory Policy All organisations operate with the broader community of society. (Thompson and Strickland 2001) How an organisation operates is always restricted by what is legal, what is ethical, compliance with government policy and regulatory bodies. Societal concerns also effect the activities of an organisation - for example concern over job losses or the environmental impact of business activity. There are many restrictions and requirements affecting business conditions and the operation of an organisation. There are general legal requirements and standards which organisations much adhere to. However, some requirements are industry specific and only relate to the particular activities of a certain industry. All of these regulations and requirements form part of an organisations business environment. The business environment can be broken down into several categories- Regulatory policy forms part of the Macro environment and the Task environment. The Macro environment consists of factors which affect all organisations and includes the international environment, political environment and economic, social or technological environments. Tieman et al (1996) state that regulatory policy is shaped especially by the political environment. Governments have a large impact on economic policy, trade policy, competition policy and laws governing business practice. The task environment is a sector of the business environment which consists of factors that are directly relevant to an organisation. Regulatory bodies control and regulate certain aspects of specific industries. They are usually state organisations. However regulators do exist on both a national and international level. As regulators deal with specific issues, there may be several organisations for one industry. Because they are specific, regulators form part of the task environment. 14

15 Regulatory Issues in the Airline Industry There are many regulations and policies regarding air transport. Naturally, many relate to the operational, technical and safety issues of running an airline. For example, air traffic control, crew working hours, crew licensing and airworthiness regulations. These are normally controlled by an aviation regulatory body for a certain country or region, such as the J.A.A (European Joint Aviation Authority), LA.A (Irish Aviation Authority) and F.A.A. (US Federal Aviation Administration) i However there are other policies which have resulted in the structure of the airline industry we see today. Authors De Wit and Meyer (1996) pinpoint international regulations as a major factor in the control of the airline industry. As a result of 'state owned* airlines being essentially protected by the government, there are often restrictions on foreign airline activities. There are certain ownership policies in some countries, where a limit is set on the percentage of a company that can be acquired by a foreign investor. An example in the airline industry itself is the situation in the USA. Foreign ownership of US airlines is limited to 25%, This is one factor which limits the international expansion of airlines, through growth that is often seen in other industries. Restrictions may also be put in place in relation to cross-border airline services. An airline may be restricted from opening up new routes into and out of a country. An example of this (Ref. Flight International 2001) is the restriction on Delta Airlines when providing flights to China. Currently, the airline does not have "route authority" to serve China directly from the USA. Instead it operates a "code share" agreement with China Southern Airlines. This is currently its only method of serving the Chinese market. In order to lift restrictions on the routes airlines operate it is usual that a bilateral airline service agreement would be reached. This is an agreement between two countries on the nature and details of an airline service between them. Before the agreement can be reached, many issues must be considered in relation to national economic interests, flag carrier interests and in some cases even national security. The inclusion of these issues makes securing agreement on aviation services a very complex task. An agreement may include very strict clauses, limiting the kind of service provided and how often the airline can operate flights. i \ The capacity of major airports in handling flights is an issue which has prevented a major increase in lifting restrictions transatlantic routes in particular. Airlines must purchase 'slots' at major airports. Slots are essentially places in the airport timetable for airlines to schedule arrivals and departures. There is high competition for slots at extremely busy airports such as London Heathrow. There is restrictions on the number of slots one airline can hold at one airport. 15

16 International airlines are also governed by the International Airline Transport Association. (IATA) Membership of this organisation is voluntary. However most world airlines are members of the organisation, whose objective is to promote the interests of its members. IATA provides data to members, sets standards and in the past has regulated air fares. The International Civil Aviation Authority (ICAO) is an intergovernmental body regulating in relation to operational and technical safety in the airline industry.

17 .. «* Lt&hkiii NATIONAL COLLEGE OF IRELAND For many years governments played an important role in establishing vital industries and services. This was particularly evident in the new emerging states in the 1900s. As national economies grow stronger, the role of state involvement in the provision of manufacturing industries, utilities and infrastructure services has diminished. In almost all European countries, nationalised industries have been sold to the private sector and now compete in both national and international markets. This process of deregulation and opening of national markets to external players further increases competition. Deregulation is the process of removing restrictions on trade and activity within particular industries. Thompson and Strickland (2001) note that change in regulation and government policy is one of the most common driving forces in industry today. The driving forces in an industry are the major underlying causes of changing industry and competitive conditions. The authors state that such changes can often force a significant shift in industry practices and strategic approaches. Examples given by the authors include the banking, telecommunications and electric utility industries in the USA. Deregulation in the Airline Industry Traditionally, the airline industry has been heavily regulated throughout the world. The concept of the flag carrier and the national airline remained very central to airline strategy over the years. Governments strongly defended the market position of their national carrier by heavily restricting new entrants to their market and by determining the routes carriers were allowed to fly. Many governments even went so far as to regulate flight frequency, capacity, air fares and the type of service provided - scheduled or charter. These trends in the industry have generally restricted competition. 1 Doganis (2001) recognises that the strict regulatory environment of the airline industry is evolving. It may not disappear entirely but change is certainly an issue. Doganis puts forward the theory that deregulation will spread gradually, and already we can see evidence of gradual liberalisation in Europe. The first major issue to come under pressure from deregulation is the ownership policy of airlines, where they are substantially owned by nationals of their country of registration. Deregulation would make it possible for cross border acquisitions and mergers to take effect 17

18 Deregulation in the United States of America The United States has the largest passenger air transport market in the world. It accounted for 36.5% of total traffic in (IATA World Transport Statistics - AEA Report 1998) In 1978 the US domestic market was deregulated. Fare pricing, routes and capacity was fully liberalised for US domestic airlines. Competition rapidly increased, air fares were reduced in the wake of fierce competition and this change in the market inevitably led to a change in the way airlines did business. They needed to change in order to survive. Many airlines either collapsed (in the case of Pan Am) or became involved in mergers and acquisitions as they could not maintain profit levels or market share alone. Many of the carriers struggled back to profitability by differentiating their product through Frequent Flyer Programmes and using central computer reservation systems. They also refined the hub-and-spoke system to establish more efficient routes, where possible. The hub-andspoke system allowed airlines to serve less profitable routes using smaller aircraft feeding into a central hub. The larger more expensive aircraft were then used to maximum capacity on high volume routes out of the hub. Examples of this business model include, the Delta Airlines hub at Atlanta Hartsfield airport and the Northwest Airlines hubs at Detroit and Minneapolis. Such advanced deregulation policy has not been seen in Europe as yet. However, De Wit and Meyer (1996) refer to the 'Open Skies' agreement of 1992, between the USA and the Netherlands The agreement allows Dutch airlines to fly into any city in the USA, and in return US airlines may fly into any city in the Netherlands. This open skies policy was the first of its kind between Europe and the USA. It was seen as a major step in promoting free competition in such a marketplace. This agreement also saw KLM Royal Dutch Airlines develop a hub and spoke system at Amsterdam's Schipol airport similar to those seen in the USA. Deregulation in Europe In 1986, the European Court of Justice ruled that the competition articles of the Treaty of Rome also applied to air transportation services within the European Union. This meant that the airline industry was required to compete freely, just as other industries in Europe. De Wit, Meyer and Kwok (1996) note that governments throughout Europe disagreed on the methods to develop competition in Europe. The governments of the UK and Netherlands favoured a rapid deregulation policy, but other governments favoured a slower paced liberalisation. This was due to fears of damaging side effects if the changes occurred rapidly. It was decided to introduce gradual liberalisation. Entry into intra-eu markets was made easier, capacity restrictions were eased and pricing was more liberally regulated. Introduction of the liberalisation policies was staggered over a ten year period, from 1987 to

19 There were three major areas of liberalisation : Air Fares : The freedom to set fares without government interference. Market Access : No member state is able to limit capacity on the basis of nationality of the airline, although the right to appeal remains. This covers the practice of 'cabotage' - where an airline operates a route that does not originate or end in their home country. Licensing of Air Carriers : Airlines are required to satisfy common European financial, technical and safety standards. They must meet these standards annually. Any carrier meeting the standards is entitled to an operating licence. 19

20 2.6 Mergers and Acquisitions A merger occurs when two companies come together. They are often of a similar size. An acquisition is the purchase of one company by another. The acquirer is usually larger than the company purchased. It absorbs the operations of the newly acquired company. Mergers and acquisitions are very similar. The main difference between them can be seen in the accounting practices and regulations. Therefore, the differences relate more to the details of ownership, management control and financial arrangements than to strategy and competitive advantage. Resources and capabilities will generally be similar regardless of whether a merger or an acquisition takes place. Reuer (1998) analysed the close links between a strategic alliance and an acquisition. He states that many of the benefits companies find as a result of strategic alliance are very similar to the benefits of an acquisition. Many of the justifications that companies give for alliances, for example synergy and shared use of resources, could equally apply to acquisitions. According to author, managers should therefore carefully compare these strategic alternatives before embarking on an alliance. Many theorists consider alliance strategy to be a stepping stone towards mergers or acquisitions. Thompson and Strickland (2001) suggest that acquisitions are the optimum solution in situations where alliances do not go far enough in providing a company with access to needed resources and capabilities. Lorange and Roos agree that taking strategic alliances further, to develop cross - ownership arrangements, have particularly strong stabilising effects on an established cooperative network. Advantages of Acquisition Market expansion - Acquisition of a firm with an established market share brings mutual benefits in costs and skills. High speed access to resources Restructure operating environment - In an industry where overcapacity is a concern, acquisitions can help to consolidate the industiy. For example, overcapacity in the car industry and the need to reduce it was one of the driving forces for a wave of car manufacturer mergers. Reduce new market risk and entry costs Overcome cultural and trade barriers 20

21 Disadvantages of Acquisition Cultural mismatch - If the culture between two companies is very different it may be very difficult to complete an acquisition smoothly. Mismatch of managerial salaries - as seen in the merger of Daimler-Chrysler. Knowledge of the organisation acquired - There is added risk in an acquisition where one company does not have extensive knowledge of the other company. This risk is reduced where companies have been working together before the acquisition or where features of the competitive environment are known. Disposal of Assets - Government restrictions, such as EU competition laws, may force a buyer to dispose of some assets it had prior to making an acquisition. 21

22 2.7 Strategic Alliances Strategic alliances are defined as a relationship between two or more companies involving the sharing of resources for carrying out activities of strategic importance. (Finlay, 2000) They are cooperative agreements between firms that go beyond normal company to company dealings, but fall short of a complete merger with formal ownership ties. Thompson and Strickland (2001) comment that "alliances have become so essential to the competitiveness of companies in many industries that they are are core element of todays business strategies." Thompson and Strickland (2001) also note that collaborative alliances are almost always an evolving' relationship. They involve mutual learning, cooperation over time and adapting to change over time. Strategic alliances are an attractive, flexible and cost effective way for companies to gain access to missing technology, efficiency, expertise and business capabilities. A competitive advantage emerges from an alliance when a company has additional capabilities and resources that it would not otherwise have on its own. This is one of the main reasons companies forge an alliance with another suitable company. Another main reason for an alliance is to build a global presence. A strategic alliance is a safe and cost effective way to expand on the international market. International strategic alliances occur when companies collaborate with foreign partners and as a result have an international presence. The foreign partner will already have a share in that market and experience of operations in that particular country. An alliance is an excellent way for a company to expand internationally if it has difficulty in doing this independently. Lorange and Roos (1992) examined this theory and cite SAS Scandinavian Airlines as an example. The authors state that many companies are often at a major disadvantage because of their small home country and home market. SAS has a small home market and operates from a peripheral home country. (Norway, Sweden and Denmark) The airline is a tri-national airline but has a very strong global strategy. The authors note how SAS developed this strategy by putting together a series of strategic alliances and creating a greater network. It exceeds what they could achieve alone, by working in tandem with SAS own established network. At the time, this network development would be otherwise impossible due to resource limitations (the size of the SAS fleet) and regulatory constraints, such as restrictions on operations within the Middle East and Asia. 22

23 Types o f Alliance There are three main forms of alliance, Joint Venture, Strategic Investment in a partner and Consortium. Joint Venture A joint venture is where two or more independent firms establish a legally separate company. The parent organisations initially provide finance, management and other services, but the joint venture usually becomes entirely separate over time. Strategic Investment in a partner This type of alliance is where a firm takes a minority equity stake in another firm. It is an alternative to investing in new plant and equipment, technical development etc. Finlay (2000) states that in some circumstances this type of investment will lead to full acquisition in the longer term. This is suitable for situations where full acquisition may not currently be possible due to factors including government or legal restrictions, market conditions or lack of funds. Consortium This is a collaboration between a number of partners for a very specific purpose. This is usually. a project, where the collaboration runs for the duration of the project. For example, the Airbus aircraft manufacturing consortium between companies from several European countries. Consortia tend to be joint ventures. An example of this type of collaboration is the Airbus aircraft manufacture consortium. Several aircraft manufacture companies from around Europe, including British Aerospace and CASA Spain, established this consortium in the 1990 s. i Strategic Alliances are an effective strategic option for organisations today for several reasons. They offer a flexible way of increasing competitive advantage, market share, customer satisfaction and can increase the quality of the product or service offered. Finlay (2000) highlights the main reasons why management consider strategic alliances: Globalisation - Through an alliance, a company can operate on an international scale, even if it does not have the resources do achieve this alone. Political requirements ~ In some countries, such as India, there is a requirement for a certain percentage of local ownership in foreign companies. An alliance with a local company is an excellent way for a foreign firm to comply with this requirement* while at the same time gaining knowledge of local business practice. 23

24 LT - The growth in LT (Information Technology) makes it easier for companies to collaborate even if they are not operating in the same country or region. This is evident in the tourism sector, where a network of reservation systems are in place between airlines and hotel groups. Access to Resources - An alliance allows a company to gain access to the resources of it s partner in the alliance, depending on the extent of the agreement Resources would include vital equipment (for example aircraft shared between airlines), staff, marketing tools or maintenance facilities. Market Access - An alliance is an excellent way for a company to expand its share of a foreign market and accelerate the building of global market presence. Some of the problems associated with strategic alliance agreements include : High Costs - The high cost of preparation for alliance and great management involvement Goals - Problems may arise if an alliance partner has different business goals and objectives. Establishment - It may be veiy costly if it takes a long period of time to establish and develop the alliance. 24

25 Partner Assessment Finlay (2000) highlights the most important factors to consider when choosing an alliance partner. These factors apply to organisations in any industry. These factors include : Compatible goals - If alliance partners do not have similar, goals, the alliance is unlikely to be successful. Degree o f risk - It is important that all partners in an alliance hold a similar degree of risk. This ensures the motivation of all partners is at a similar level, and managerial input is similar as a result. Cooperative culture - Bureaucratic organisations may insist on a high amount of control. Complementary skills - It is important to assess an.alliance partner's strengths and weaknesses and plan the alliance accordingly. Competence in alliances - Does a potential partner organisation have experience in.alliances? Was the alliance a successful venture or was it terminated? (And why?) 25

26 2.8 The Nature of Strategic Alliances in the Airline Industry Competition in the airline industry is heavily influenced by airlines' ability to fully utilise their capacity. (De Wit, Meyer and Kwok 1996) Major costs, such as fuel or landing fees, are independent of the number of passengers on board. As a result, it is vital to airlines that they have high seat occupancy - or a high load factor. Major airlines of today use the hub and spoke system to develop a network. This offers the customer more choice, wins more customers and therefore helps the airline increase the load factor. This highlights the importance of an airline network. If an airline cannot provide this network alone it must cooperate with another company to do so. International strategic alliances are one of the most favoured methods of doing this. From the late 1980 s to the present day, one of the most significant developments in the airline industry has been the growth of alliances. These have evolved from cooperation between two or more airlines to alliance groups. Typically, the alliance agreements only go so far as having cooperation in flight scheduling, frequent flyer programmes, marketing, ticket purchasing for passengers and sharing of airline facilities, at airport terminals. Strategic alliances between airlines are generally designed to strengthen the network operations of all partner airlines and provide high quality customer service. Cooperation is usually between.partners operating in complementary markets. As outlined in the AEA report (1998), alliance agreements substitute for organic growth and growth by mergers which characterise global expansion in other industries. The benefits of alliance agreements are largely synonymous with the benefits of expanding services and rationalising operations on an international scale. A strategic alliance involves agreements among the airlines in terms of operations, marketing strategy, customer service and occasionally maintenance resources. The main issues to be considered in the airline industry are: The Network, Customer Service and Operational Factors. The Network A study of the airline market by the AEA (1998) pinpoints that the two most important factors when a customer chooses an airline are network size and schedule. Ref Appendix No. 2 Alliances between airlines from different countries expand the route network for the alliance partners. A 'Codeshare' agreement usually takes place. This is a practice whereby an airline markets the services of another airline as if it were its own. Customers can therefore make a booking in with a partner airline. For example, an Aer Lingus passenger can make a booking in Dublin with Aer lingus (to transport them to the 'hub' airport) and a partner airline. Aer Lingus does not operate a direct route from Dublin to Hong Kong so, passengers could transfer to a British Airways flight to Hong Kong at London Heathrow. Coordinated schedules is another very common aspect of airline agreements. 26

27 Customer Service For most major airlines full service customer care is a very important element of the product they offer. In a strategic alliance there is an ability to share resources to benefit customers. These include; being able to make bookings across the network, access to a partner airline's passenger lounges at other airports and a combined 'Frequent Flyer Programme' where a passenger earns points for every flight on the network. 'Seamless Travel* initiatives between airlines can improve customer service by offering coordinated baggage handling and check-in services. Some alliance agreements also involve ground handling and catering cooperation, (de Wit, Meyer and Kwok 1996) Operational Factors Airline partners may share fleet equipment, aircraft, crew and services. This reduces costs and improves operational efficiency and economies of scale. Other Reasons for Alliances De Wit, Meyer and Kwok (1996) state that as the acquisition of foreign airlines is often forbidden or politically difficult, alliances have become a favoured method for building a global network and providing a high quality service. Often these alliances are sealed by the purchase of a small equity stake by one company in another. The importance of a global presence is highlighted by reports from analysts in the industry journal, Flight International. (2001) Analysts report on the attempt by Delta Airlines to find other partners for their 'SkyTeam' alliance. In 2001 they had 5 member airlines. Negotiations took place between airlines from strategically important regions. Leo Mullin, the chairman and chief executive of Delta Airlines states: "The perfect number is between 8 and 10 members. Obviously we have a deficiency in South East Asia and we would love to have a Brazilian partner, and maybe one other in Europe. These would be our principal targets. It is clear from this statement that airlines thoroughly consider which regions they want to gain entry to and negotiate with an airline company in the chosen region. It is important for alliance groups to have members from various countries in eveiy continent, to develop a global network of routes. However, if several airlines enter one market overcapacity can occur. This is where supply of air transport exceeds demand. This drives profits down, as airlines have low passenger load factors but high fixed costs. For this reason it is vital that airlines carefully consider the markets they choose to operate in and the competition they face. Appendix number 2 contains a table of the major strategic alliance groups in the airline industry today. 27

28 Chapter 3 - Research Hypothesis 3.1 Deduction of Theory There has been a definite trend towards international strategic alliances within the airline industry in recent years. The number of alliance agreements between airlines has increased. Alliance agreements are at the forefront of airline operations. They tend to be heavily advertised and it is clear that public awareness of alliance activity is a top priority of many airline carriers* In other industries alliance strategy, more often than not, leads to consolidation of the industry. However the airline industry has been slow to move towards consolidation. This research study will examine the extent to which alliances are a driving force towards rationalisation and consolidation. 28

29 3.2 Hypothesis Regardless of alliance activity in the airline industry, there is a need for consolidation of the industry. This is especially important as overcapacity becomes a problem and economic conditions become more difficult. 29

30 Chapter 4 - Research Methodology N 0 rtm 'A i;,w T 7 j L i, 4.1 M e, ^, 0f R LAND The reading to prepare for research of this subject was carried out using a range of books and other publications relating to strategic alliances in business as a whole. The author researched the general theory and thinking behind strategic alliances. Relevant theories and models on the subject of strategic alliances are introduced and then evaluated in the context of the overall plan. It was important to analyse and understand the concept of a strategic alliance, in order to later _apply it specifically to the airline industry. Specific information relating to the airline business was gathered from books, specialist journals for the industry, airline press releases and leaflets and from electronic media. The author also gathered research information from an airline industry report, as listed in the bibliography. This report was published at a time when two of the largest airline alliances were finalising more member airlines to join their network. Both alliances, Star Alliance and One World, are still two of the strongest groups today with partners worldwide. The author then completed a research study, which is explained below. 4.2 Choosing The Sample In order to choose a sample for the research it was necessary to find a database list of all registered passenger airlines. A database such as this was not freely available on the LATA Internet site. The researcher used an industry journal, which over 3 issues, provides an annual World Airline Directory This includes all airlines which are operating at the time of publication. This data can be found in "Right International" magazine as listed in the bibliography. Over several issues this journal compiled a database of all operational airlines in the year Each entry contains information about the airlines' parent organisation and any strategic alliances it may be involved in. It also details any stake that the airline has in another airline. A brief company history is also provided in the data. Further information was also obtained from airline information web sites, press releases and company data. 30

31 The criteria for inclusion in the "Flight International1 directory are as follows. The airline must have operations with one or more aircraft with 19 or more passenger seats. Where justified by importance of service or national carrier status, the directory includes some airlines operating 19 or fewer seats, and also cargo operations. For the purpose of the study, the researcher only considered airlines who operate scheduled or charter passenger services. Any cargo only carriers were excluded from the random selection process. All entries in this directory are correct up to and including January The names of all airline carriers were compiled and the researcher picked 50 sample airlines at random. 4 3 Body of Research After the random selection of the sample, the names of the airline carriers were listed The next stage of the research was to analyse the situation of each of the selected airlines. The ownership situation and any alliance agreements the airline had were then determined. It was established if there was any relationship between the ownership status of the airline and alliance agreements it participates in. This analysis was in relation to the airline company listed and did not relate to any of its subsidiaries or companies it holds shares in. The data was then classified into three categories. The categories are as follows: 1. Mergers or Acquisitions following alliance agreement 2. Mergers or Acquisitions by non-strategic partners 3. Other Situations Category one describes the situation where an airline company has an alliance agreement with another airline company and subsequently makes an acquisition. Category two is used to classify new mergers or acquisitions where there was no previous relationships between the two airlines. The category listed as 'other situations is used to classify airlines which are wholly state owned, publicly owned or privately owned. Airlines listed in this category may also have many alliance agreements with other airlines. However, the. alliance agreement will not have had any impact on the ownership of the company. This category may also include carriers which are subsidiaries of their parent airline company. Further secondary data will also be examined in the research and findings section. This data was obtained from other sources as outlined in the bibliography and appendices. 31

32 4.4 Research Limitations The scope of this subject is very broad. There are approximately 200 registered airlines worldwide and it was impossible to determine the situation for every company. For this reason, it was decided that a sample of 50 carriers would be indicative of trends. The 2002 issue of the World Airline Directory in Flight International was not published at the time of compiling the research. The researcher used the 2001 edition of the directory. IATA provides statistics on the industry but this data is very expensive to obtain..for confidentiality reasons, corporate details on some airline Internet sites was very limited. In some cases it was difficult to determine the exact time-scale of their alliance and acquisition activity. In this case, an estimate was used, based on media reports and marketing material from the airline. (For example, details and history of alliance based Frequent Flyer Programmes which are available in flight timetables.) Secondary data obtained from internet websites is subject to a number of risks and limitations in terms of its accuracy, validity and credibility. Therefore the following criteria must always be considered in relation to internet data and sites; source, author, authority, date and range of data. These issues were considered in selecting websites. j 32

33 Chapter 5 - Research and Findings Introduction As outlined in the methodology, the sample population was analysed and organised into three categories. The total number of airline companies in each category was then determined. This data was then used to measure the proportion for each category. 5.1 Data Presentation The table below shows three categories which are outlined in Chapter 4. The total number of airlines in each category is shown as Total'. The company number corresponds to an airline carrier. The list of companies and their corresponding numbers can be found in Appendix number 3. (p.45 to 48) This appendix contains an explanation of the parent company or shareholders of each airline. This was the basis for classifying each company. For example, company 1 (Air Botnia) had an alliance agreement with SAS, before SAS acquired the company. Therefore Air Botnia was classified into the first group, "Alliances to Acquisition." Fig 5.7 See Appendix 3 Alliances to Acquisition Total 9 Company Nos. 1, 8, 14, 16, 20, 31, 32, 39, 49. M erger or Acquisition, non-strategic partners Total 16 Company Nos. 2, 4, 7, 12, 17, 18, 21, 22, 23, 24, 25, 33, 36, 37, 43, 46. Other Total 25 Company Nos. 3, 5, 6, 9, 10, 11, 13, 15, 19, 26, 27, 28, 29, 30, 34, 35, 38, 40, 41, 42, 44, 45, 47, 48, 50. After classification of the airline companies it was possible to calculate the percentage in each category. The results are as follows : Total Sample = 50 Alliances to Acquisition : 9 = 18% Merger / Acquis, with non strategic partner : 16 = 32% O ther: 25 = 50% 33

34 Fig Alliances to Acquisition 18% M erger & Acquisition ( Non-Str. Partners) 32% O ther 50% 5.2 Analysis o f Research Data It is clear from the study of the sample population that in the majority of cases, acquisition of (all or part of) an airline was by a non strategic partner. Airlines who had no previous strategic cooperation, often develop an alliance agreement after one company buys a stake in the other. R ef commentary in Appendix 3 18% of airlines were involved in an alliance with a stake holder before the acquisition took place. Half of the sample population are involved in other terms of ownership. But the research shows that almost all of these companies have an alliance agreement with one or more airlines. This suggests that acquisition is an activity airlines will participate in, regardless of whether or not they have an alliance established. The nature of airline alliances is different to other industries. They tend to be very customer focused. The emphasis is on providing competitive advantages through developing a better service, with more benefits for the customer. The network is established through international alliances and customer loyalty schemes are operated in cooperation with alliance partners. The fact that airlines involved in acquisition will develop an alliance agreement either before or after the change in ownership, shows that alliance strategy is more often a method of refining the business rather than a strategy to kick-start1acquisitions. 34