The constraints of national ownership requirements and a deep rooted preference for protectionism to promote national flag carrier interests have for decades moulded the ungainly shape of an inefficient and largely unsustainable airline industry. It is a model designed for the conditions of post-war 1945, yet it has somehow survived for 70 years with only modest changes.
That it has been perpetuated for so long is the product of the network of bilateral agreements that, like a cobweb produced by hundreds of spiders, is beyond the power of one or two willing parties to change.
The meticulous construction of this unwieldy but impenetrable fabric over decades has effectively meant that individual states cannot change it. The only solution was through multilateral agreement and the few modest attempts at that have invariably resulted in failure.
The following article is extracted from the March/April 2013 #16 issue of CAPA's Airline Leader journal.
An intricate web of bilateral agreements has enabled the continued survival of an archaic, inefficient and largely protectionist airline industry model
One successful exception has been the North Atlantic liberalisation between the US, Canada and the European Union, although even that retains large overtones of protectionism – quite apart from the fact that it paved the way to bestowing special privileges on a limited number of major airlines.
Meanwhile some attempts to circumvent national ownership rules through international cross-border mergers have occurred; in Europe, Air France-KLM and British Airways-Iberia have formed holding company structures; in Latin America a more integrated model has been developed, notably by LAN and in the LATAM acquisition; while – mainly in Asia – LCCs have used cross-border joint venture companies to get around prohibitions against local establishment.
The whole rationale for establishing the Branded Global Alliances was to provide a way for non-merged airlines to be able to portray an image of a much more global marketing capability. Although remaining confined to their own geographic bases, member airlines could advertise themselves as able to provide access to most points in the world through their partners.
The three major brands, oneworld, SkyTeam and Star Alliance, are very different in their own specifics and sizes; and thanks to the insertion of the Gulf carriers across the grain of the alliance directions, these differences are set to magnify.
But however important they may be, these are just the technical manifestations of an emerging environment. The really fundamental shifts that make these changes possible – and are about to reshape the industry – are the new underlying government attitudes towards liberalisation. For many governments, protectionism of flag carriers is becoming secondary to a new perception of the national interests, in terms of improved transport access. How that access is provided is now less important than making sure it is there.
The new 'radial' alliances – egocentric, covering specific geographic needs
This brief review looks at how the recent moves are likely to reshape the airline industry and at the nature of some of the evolving formulae for partnering. This involves a much more egocentric model than the more diffuse (and hierarchical) relationships that characterise the global alliances. That the new models are essentially bilateral in nature helps explain why Qatar Airways could migrate to an alliance in oneworld, where this would probably not work within the other, more “multilateral” alliances. oneworld is a much looser grouping than the more structured and centrally-orchestrated Star and SkyTeam.
There is no formal structure to these partner formulae, but they do have a common pragmatism that is directed towards meeting very specific geographic and market goals. The models involve airlines establishing their own, tailored, constellations of partners in radial formation. Each partner is carefully selected, with one or more goals in mind.
In tracing the origins of this next generation of partnerships – and where it might evolve – the respective evolutions of the Gulf carriers themselves are helpful. The three were born into and have developed, each in its own way, in a world where global alliances became increasingly powerful; but they were excluded from being part of that development – mostly because the established airlines saw the intruders as threats to that emerging status quo.
In retrospect, that was not an inaccurate assessment. Armed with a new willingness among (most) governments to remove barriers to entry, the three were able to expand much faster than their detractors would foresee. For example much – supposedly academic – hot air blew over the UAE’s ability to support two major network airlines with hubs only an hour’s drive apart. This entirely ignored the fact that the catchments for these airports embraced any populations within half a day’s flying – several billion people, many of whom were sufficiently affluent to travel. That they also now support two major LCCs as well is further testament to the integrity of the UAE’s airline strategy.
Leaving aside increasingly discredited suggestions of heavy government subsidy, arguments about Emirates’ ability to absorb the capacity in its massive order book have also become much more muted. When it requires two A380s to service one new route, the numbers move into focus. The typically long-haul-to-long-haul hub connections make for a new type of network format, absorbing much larger unit revenues from passengers in the process.
Thus the Gulf airlines evolved mostly outside the central legacy framework. But that does not mean they are as one. Like the global alliances, Emirates, Etihad and Qatar Airways are each different in their sameness. Emirates is the most developed, exclusively long-haul and has long passed the threshold where network power began to deliver growth in a near-algebraic way, as each new city pair route was added. Etihad, with its partnership strategy, and the larger Qatar are still on the brink of that sort of unpredictably explosive growth. But, throughout 2012, each was racing to engage with one or more members of the established airline industry.
Etihad is closest to being the germ of the new breed of partnerships. From its early days, starting when its neighbour in Dubai was already matured and a big force on the world stage, Etihad decided to rely much more on a strategy based around selected partnerships. Perhaps in recognition of the fact that the Abu Dhabi based “national airline” of the UAE would not be able to rival a well-established Emirates in terms of size, this was the logical way to go. Leveraging its position in national markets by a combination of commercial agreements and, often, equity shareholdings, Etihad set itself up as a unique model in global terms.
Emirates, by contrast, remained all the while more focused on individualism. In its earlier days, an equity share and management role in Sri Lanka’s flag carrier enabled it to gain valuable access to the Indian market (as Sri Lanka became protectionist India’s de facto international hub) and caused sufficient grief to deter Emirates from further investment or partnership links. That aversion lasted until the 2012 Qantas deal. The fact that Emirates saw it necessary (and possible) to strike such an arrangement with a hereto-conventional legacy airline should be seen as a pivotal moment in the industry’s evolution. Effective 31-Mar-2013, the shape of this arrangement quite probably entrenches the future direction of the airline industry.
Added to Qatar’s imminent membership in oneworld, the three have now combined to re-link into the overall system. As they do become an integral part of the established community, they bring with them the potential to spark even more far-reaching change.
This comes as smaller, or even large regionally based, airlines see value in using the “virtual” potential of such comprehensive airline networks to extract benefits from unused bilateral rights – in the process improving customer choice. As end-of-the-line Qantas has recognised, it is no longer capable in its own right of competing on level terms with powerful sixth freedom operators on long-haul international routes (and that is even before the Chinese airlines exploit their geographic and market potential).
For example, the Singapore Airlines (SIA) group has announced it will be operating 124 weekly services to Australia by the end of 2013. Using Emirates’ metal to access cities potentially all around the world, from South Asia, to Europe, Africa, South America and North America, is an entirely logical progression for Qantas.
Adopting this approach becomes even more rational when Qantas’ major – but much smaller – competitor in the domestic market, Virgin Australia, is using Etihad’s metal to access via codeshare a dozen or so European points that it would not otherwise be able to serve. Neither Australian airline would have the capital (or risk appetite) necessary to service these points in their own right.
Etihad in particular is now becoming the core of this new style of radial – or egocentric – alliance. In this frame, which contains nothing new in its individual details, but gains its identity from its intensity and scope, the central airline develops a complex of geographic coverage.
The personalised alliance structure developed in this way gives each core airline access to each of its key markets, also ideally allowing behind-gateway access. Thus it goes well beyond a simple basic bilateral codeshare.
Though none of the ingredients are unique, it is the combination and depth of these features – as well as the evolving integrated strategy behind the alliance type – that distinguishes it from earlier patterns. As such it offers a whole new direction from the one pursued by the global alliances, while possibly continuing to function in parallel (and possibly as well as being integrated with them).
The benefits of the bilateral partnerships include some very attractive revenue returns. According to Etihad CEO James Hogan, partner airlines now contribute around 19% of Etihad’s revenue – recently reported at USD4.8 billion for the 2012 year. Again, this flow through of benefits is not a new phenomenon, but the scope for expanding this aspect in the broader scale of tailored radial alliances would seem to offer exceptional upside for all concerned.
Because the new radial alliances are constructed around delivering specific needs – normally access to a certain geographic market or area – they should logically be more “sticky” than the broader ties that bind BGA membership.
Whereas global alliance membership delivers relationships with as many as 25 airlines, creating the possibility for a smallish airline in one region theoretically to establish a presence on the other side of the world – a diffuse and often limited value – radial, self-chosen links satisfy much more precise market access goals.
Moreover, this selectivity process also avoids the hierarchical nature of the BGAs, where small elite groups with metal neutral antitrust immunity have special privileges within each alliance. In the radial alliance, each selected partner is, in principle at least, equal. It can choose its role.
That is not to suggest that elitism is absent from the radial alliances. By their nature they are self-selected elites. Not every airline will be in a position to have attributes that allow them to trade up to a level where there is genuine equality. Such is the way of the world.
The egocentric nature of the radial agreement means that once the agreement is established there is much greater incentive progressively to deepen the relationship. This is especially so where it is endorsed by an equity investment and there is a high level of actual or potential reciprocal benefit to be achieved.
As a result of this personalised nature, a bilateral link forged between say Virgin Australia and Singapore Airlines has very specific goals: for SIA (like Etihad’s and Virgin’s other equity partners), it is to gain behind-gateway access to the Australian domestic market, along with better prospects for capturing international corporate clients; and on the other side it provides Virgin with the (SIA) metal necessary to allow the Australian airline to sell VA-branded flights into and from points across Asia. At its core this might be no more than a simple basis for creating a variety of codeshares. But where each carrier wants more from the relationship (and is conscious that others are hurrying to pair off, so options may diminish), they seek more comprehensive approvals from competition authorities. And so they may quickly evolve for example to price and capacity coordination, where necessary.
The rationale is succinctly described by SIA CEO, Choon Phong Goh, when he says: “Australia is a very, very important market for us. We intend to have 124 services a week to Australia by the end of this financial year and that of course includes all three airlines in the portfolio. (Ed note: these airlines are SIA itself and wholly owned subsidiaries, long-haul LCC Scoot and regional airline Silkair; SIA also has a minority interest in Tiger Airways, which serves Australia from its Singapore hub, as well as through its Australian subsidiary, Tiger Australia.)
“And I think one has to appreciate that within Australia, there are many secondary points and it’s important for us to reach those many secondary points to be effective and to provide that convenience for connectivity, both for our customers going to Australia, and also for our Australian customers coming out to other parts of our network.”
As a result there is apparent logic in Singapore Airlines’ wanting to take a share in Virgin’s equity: “Our investment in Virgin cements our relationship with Virgin Australia.
Virgin Australia is a partner that we’ve chosen to provide the kind of connectivity to the domestic points in Australia. And you can rest assured that the benefits one can expect from this very tight synergy that we can have with Virgin more than outweighs the investments that we put in there.”
Cross-border equity shares among full service airlines have not historically operated as “logically” as might have been expected. SIA itself is no stranger to the concept; it was one of the first to engage in this sort of endeavour – a small 2.5% joint cross-shareholding with Delta over two decades ago – and also fought hard to acquire a cornerstone holding in pre-privatisation Qantas in the mid-90s, then later a half share in the now-defunct Ansett. More tellingly it endured years of nightmares over a misjudged 49% investment in Virgin Atlantic in 1999 (acquired to gain access to the London-US market, before SIA was able to gain fifth freedom rights in its own name) – only finally being able to unload it last year when Delta relieved SIA of the share. (There would be few remaining in either airline to recognise the irony, 25 years on from SIA’s first foray into equity partnerships, with Delta.)
But these are different times. Virgin Australia in 2012 established a holding company ownership structure which caters to Australia’s liberal domestic ownership rules: 100% foreign ownership provided management and control is local, allowing for foreigners including airlines to invest, while at the same time avoiding conflict with international bilateral restrictions. As a consequence, founder Virgin Group owns 26%, Air New Zealand 20% and Etihad another 10% of the domestic entity; so Singapore’s investing in a 10% share becomestmore “logical”, if only to stake a claim in this crowded space. For Virgin Australia meanwhile, the holdings ensure its friends take a studiedly serious interest in its well-being. None has a board seat, other than Virgin Group.
In Etihad’s case, the now extended family of equity partners has prompted the carrier to describe the aggregation as the “Etihad Airways strategic equity alliance”. Virgin Australia might equally use a similar title for its aggregation, but its equity relationships come inwards rather than outwards.
Several LCCs or former LCCs have been experimenting with a form of this selective partnership for some time.
In their case the purpose had different roots. Firstly they were generally not invited into the hallowed halls of the global alliances; but more fundamentally, the process of integrating sales and ticketing – the actual process of code “sharing” – was technically difficult as the LCCs typically used simple, standalone reservations systems and IT platforms. These could not talk to the much more complex, but also more costly, Global Distribution Systems of the full service airlines. So, integrating the passenger experience was complex, both commercially and operationally. But standing outside the alliances often made them appealing as domestic feeders into hinterland markets for a range of international airlines. Thus, WestJet is a natural domestic partner for any internationaairline that competes with Air Canada and its Star Alliance partners;
Virgin Australia, likewise for non-oneworld/Qantas partners; GOL for competitors to TAM and Star (until TAM moves to oneworld under the new LATAM merger); and independent JetBlue and Virgin America in the US.
Brazil’s GOL at one stage was developing what it described as the “Gol Alliance”, seeing the value of feed from a range of international airlines that sought access behind Brazil’s key gateways. In GOL’s case, Delta made a small investment (USD100 million for 3% of equity – and a board seat) in late 2011, to entrench a codeshare position, but the LCC has since seemingly lost its way in terms of its overall strategy. In 2010 it was talking of joining oneworld, but fellow Brazilian TAM’s assumed transfer to the alliance this year would put a halt to that.
JetBlue’s powerful status at New York’s JFK was sufficiently alluring to Lufthansa to encourage it to invest USD300 million to buy 19% of the LCC in late 2007, even though United was the German flag carrier’s main US partner. The idea was perhaps a good one, but the essentially polygamous position of JetBlue subsequently saw it also forge close ties with American. Lufthansa has not yet sold out, but was not able to reap the potentially exclusive dividends of a substantial investment; this was more about a failure to recognise what JetBlue’s partnership goals would be than whether equity investments were a sound strategy. But it does make very clear that equity investments alone are not the tie that binds. If there is not a substantial mutuality of purpose, the equity becomes irrelevant.
However if both ingredients, of mutuality and equity, are present the prospect is that each will strengthen the other.
Then there is a further step, now tentatively being made, to interlink the radial links into 'constellations'.
That is, where radials of one central partner connect with radials of the other. This creates a form of linkage not enormously different from the way the GBAs work. In each case the relationship is (at first) bilateral, and to a large extent optional. One difference from the wider alliance approach is that this process is entirely optional, much more selective and is managed directly by the core partners.
An example of this framework is shown below.
As with any new development in a broadly unstructured evolutionary process, many variants are appearing. These are partly the result of the intervention of the Gulf airlines, but some striking new ones will certainly achieve their existence on the backs, as it were, of those carriers.
The prospect of virtual airlines has been talked about for decades, but few examples endured. Until today. Now, a combination of liberalisation and commercial reality is greatly enhancing the ability of one airline to use another’s metal to provide access to multiple markets.
In the past, codesharing has typically (although not always) occurred on third and fourth freedom routes, where both airlines operated side by side. By codesharing they could improve the range of frequencies for sale under their own code.
Under the archaic bilateral system, even this tiny step towards virtualism had to be specifically agreed between governments. The next step in the liberalisation progression was more controversial and has taken time to become reasonably widespread. This involves the concept of “third country codesharing” – where a foreign airline is permitted to carry a third country airline’s code (and traffic) between the foreign airline’s territory and the destination country.
Even where it is allowed, such carriage is only permitted where the second country has actually been granted access rights to fly its own aircraft between its home and the destination country. So what is happening is that another airline, acting as a third country “agent”, is actually intervening to provide the means of operating that route.
It is this next stage of liberalisation that thus makes it possible for Qantas to rely on Emirates to service its onward connections to Europe over Dubai, using the Qantas code – even though Qantas does not operate there with its own metal. Thus Qantas can withdraw its Frankfurt service, the only point other than London that it currently serves with its own metal, in future relying on Emirates to pick up Qantas’ passengers in Dubai and carrying them to the German airport.
This form of access enables an end-of-the-line carrier such as Qantas to make use of dormant bilateral rights which it has not been able to operate commercially for many years, since sixth freedom airlines began offering better products. In the case of more protectionist Italy for example (Australia has a large ethnic Italian population), Qantas and Virgin have been vying for capacity under the limited Italian bilateral – with Qantas using Emirates’ metal and Virgin Australia using Etihad’s, each on third country codeshares. The Italian justification for such restriction is buried in the mists of time (or perhaps in the interests of Alitalia’s GBA codeshare partners).
But, in the second phase of this global evolution almost every airline is in a position to gain access to the codeshare channels, or “pipes” offered by the Gulf – and other network – carriers. This will potentially greatly strengthen the financial position of any airline equipped and willing to perform the function. In some ways it can be little more than a form of sixth freedom operation; the difference is that the airline whose code is being used is not the sixth freedom operator. And, on commercial terms, there can be different, negotiated arrangements to govern risk sharing, pricing and capacity management.
Using the Gulf Carriers as channels or 'pipes' for virtual operations
A feature of Virgin Australia’s expansion has been the largely virtual nature of the carrier’s international profile. Recognising it could not quickly complement a shift to full service competitor – which expressly targeted corporate and premium traffic – to compete with long- established Qantas through organic means, Virgin rapidly went about securing close partnerships with airlines in the key geographical markets: effectively metal neutral third and fourth freedom arrangements with neighbouring Air New Zealand in Australia’s biggest international market, then with Delta on US routes and later with Etihad.
A broad codeshare agreement with Etihad followed. With the exception of Delta, each of these partners has acquired shares in Virgin. The Australian airline does operate some widebody metal of its own, on trans-Pacific routes and to Abu Dhabi, but otherwise all international services are codeshares on its partners. (A link to Singapore is also possible, to complete Virgin’s basic network.)
In fact Virgin’s neo-virtualism is a limited example of what is potentially available now, as regulatory regimes relax. Once third country codeshare is widely possible – and as the system becomes more liberal there is no strong reason to prevent this occurring – the possibilities for complete virtualism on international routes becomes a reality.
Whereas in Virgin’s case the operation is part of a quid pro quo partnership, the simple extension is for others simply to pay for the privilege where they otherwise have nothing valuable to offer. Here the Gulf carriers are very well positioned, able to provide extensive global access with only the signature of a new agreement. There are others too; the traditional network airlines have a similar but more limited potential. An example is Turkish, with its massive global coverage, albeit it does not have quite as ideal a geographic base as the Gulf trio.
Some partnerships are metal neutral, others have antitrust elements of mergers or acquisitions, but with a different financial model – relying on pro-rates.
A logical progression for this, aided by liberalisation/rationalisation and the receding value of protectionism, is to entrench relationships more deeply through the cultivation of ancillary revenue opportunities.
These opportunities will evolve around a combination of sophisticated use of Big Data (and quantum steps to improve the application of data analytics); expanded FFP/loyalty programmes; and the whole process of merchandising, particularly interactively.
Progressively, as the value of these mountains of airline data is (1) better understood and (2) more effectively exploited, so the intrinsic investment value – or lack thereof – of most airlines will be highlighted. Contrasted against the value of exploiting their data, the operational aspects of most airlines will consequently decline in significance.
The importance of this transition is not simply theoretical. Its effect will be to help rationalise the role of national airlines, as data analytics become better understood and as the global aviation market liberalises. Just as third country codesharing undermines the constraints of ownership and control restrictions, so the value of exploiting data will shift the focus of airline management thinking.
That process will be to recast airline ownership and operations into the roles where they can be most appropriately managed – as providers of transportation, not as tools to satisfy national pride. This evolution is just one of several developments which will reshape the new generation of airline thinking and operations.
One outcome of this reshaping will be cheerful acceptance that other airlines’ metal should be used to service most “non-specialist” routes, where “specialist” routes are the ones that the airline is best equipped to provide and has the scale and scope to service most effectively.
A good example of the need for specialisation is in long-haul operations. Typically these had been provided most extensively by the European network airlines, while American carriers focused mostly on their domestic activities. Asian sixth freedom operators were then able to develop similar hub structures as the first stages of liberalisation were (grudgingly) permitted. And, more recently, the Middle East airlines, exploiting new aircraft capabilities, holistic aviation strategies and another round of liberalisation, have turned the international world on its head. Later in this decade it will be the Chinese airlines which provide the next wave of long-haul service. The sheer numbers of tourists they deliver will enable them to dictate terms on market access.
By definition, any route that involves flying more than 5 or 6 hours is an expensive and high-risk operation. The mere act of flying long distances requires expensive capital and operational commitments, with a perishable product, uncertain and shifting global economics and the continued prospect of higher fuel costs. But now it becomes increasingly competitively risky as new, more specialised airlines emerge.
For the European airlines particularly, long- haul operations have provided a refuge from the impossibly competitive short-haul environment which feeds the shorter segments of their hub networks. European LCCs have shattered the dominance of the big network airlines at home. But long-haul’s higher entry barriers and the powerful marketing pull of global alliance membership has allowed many to remain profitable, cross-subsidising their loss-making short-haul operations.
The European network carriers were very much creatures of national ownership restrictions and rigidly controlled market access. The GBAs, likewise, had their roots in these two main confines. As the restrictive concepts are increasingly discredited – although remaining extraordinarily hard to unravel – other creative experimentation is changing the focus of regulatory and commercial practice. Etihad’s string of equity purchases is one of these motive forces, but there are many others, as creative minds look to exploit new conditions.
Meanwhile, US airlines, now consolidated and profitable at home, have been less adventurous internationally, also lacking the European airlines’ extensive opportunities to network. The heavily protected US domestic market suggests this equation is unlikely to change, further reducing US carrier influence internationally. More investments, such as Delta’s in Virgin Atlantic, could alter this assessment, but most thinking still seems to be directed to the stagnant Atlantic, rather than to the vibrant and less-understood, more challenging Asian markets.
As new long-haul entrants – notably the Gulf and Chinese operators – make further inroads, the protected long-haul vacuum is being filled. The worst hit by the realities of this new world were the end-of the-line airlines. Hence Qantas, after years of opposition to the inroads forged by the Gulf carriers, decided that it could not beat them and that joining was the only solution.
But the Europeans have already conceded too – mostly.
As IAG builds a bridge to Qatar Airways with oneworld membership and Air France- KLM (tentatively) allies with Etihad, a whole new dynamic is being established. The third of the big three, Lufthansa, has responded by tightening its links with fellow Star partner, Turkish, the nearest thing to a Gulf carrier outside the Middle East.
Long-haul operations to be delivered by a smaller number of large and efficient specialist airlines?
Where does all this lead? To the eventual proposition that long-haul operations will be delivered by a smaller number of large and efficient specialist airlines, with geocentric hubs and the resources to deliver a wide range of service. At the same time they will provide space to many other airlines. This concept, of wide usage of other airlines’ metal as channels or “pipes”, to be leased (codeshared) is little different from what occurs in the telecommunications industry or in liberalised rail systems.
Already, as partnering – both parallel and third country codesharing – has spread, this activity has become ubiquitous. And, as the virtues of virtualism become more apparent, this role will proliferate, of a few airlines providing these pipes for others to deliver their passengers along.
This is where the need for liberalisation of third country codesharing provisions becomes so central, lubricating the process.
When that stage is approached, all airlines can specialise in flying only the routes they fly best – meanwhile marketing and selling to customers they know well, using other metal as needed. And mining their extensive data much more effectively.
That will take some major rethinking at many levels of management (and government), but it opens the door to airline sustainability, to delivering a better product and to national economies.
The future of global alliances will be a hot topic for discussion at CAPA's upcoming Airlines in Transition Summit in Dublin on 11/12 April.
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