Global alliances as the airline system metamorphoses: A view to 2025
The international aviation world will look very different in a decade. The big US airlines are re-emerging from their shells as prosperity (and slow growth in their mature domestic market) prompts them to go forth internationally.
China is inevitably and remorselessly stamping its shape on global markets; the Gulf carriers continue to expand and attract the ire of those who prefer the status quo; and low cost carriers proliferate and metamorphose.
And all this while, sadly, airlines look like remaining confined to the 1940s’ archaic ownership and control rules. Within this confinement, they continue to struggle to find new ways of expanding their geography – and, in some cases, of restricting others’. International markets have another drawback. They tend to be much more competitive, in diverse ways, than nationally protected domestic markets.
Airlines favour bilaterally tailored solutions
So bilateral, market-tailored partnerships have become inevitable and are spreading rapidly, some with equity purchases, others without. The US majors, seeking protection from open markets, are preeminent in these new directions.
Airline partnerships have come a long way since KLM and Northwest demonstrated the diversionary power of joining two airline hubs and exploiting their mutual beyond connectivity. While it remains largely true that the role of multilateral global branded alliances is to divert traffic from other airlines onto their collective “networks”, airlines today have evolved greatly in their thinking. It has become more granular and specific market focused.
This is perhaps made possible by their reliance on the global alliances to secure global branding, but it is also the case that that same granularity disrupts the wider picture.
Almost every regulatory innovation in international aviation has the goal of reducing the negative impact of foreign ownership limits. In a previous issue of Airline Leader (#7, Jun-2011) CAPA quoted the former US bilateral negotiator John Byerly who had identified the real issue confronting and inhibiting the airline industry – that of foreign ownership restrictions. In his words, “If I have one big regret during my tenure as Deputy Assistant Secretary, it is that, despite all the talk, we really have not had the sort of meaningful, respectful, future-oriented conversation that’s needed on this important and difficult subject.”
Nothing has changed in that respect over the past five years, although there have since been numerous examples of airlines acquiring equity shares in foreign carriers and of establishment (mostly by LCCs) of equity driven joint ventures across borders.
This equity trend – and it does appear to be a trend – may in the long term serve to undermine the high barriers to cross-border operations.
Branded global alliances have established themselves as the most influential force
But meanwhile, the role of the branded global alliances continues to be the most influential driving force in achieving at least a limited form of multilateral access.
This is achieved in two ways, one more obvious than the other. First, it extends geographic reach where an individual airline cannot go, as it is restricted to out-and-back services; the other is, as a by-product, to enhance the power of the stronger airlines. The weaker ones have little to offer the alliances, so have to go their own way, sometimes shielded by their government.
So, while IATA has over 260 airline members (and CAPA’s airline database includes over 2,500 operating airlines), only a select 63 passenger carriers enjoy global alliance privileges. And, of those, a much smaller number is entitled to participate in the increasingly important immunised JVs.
The impact of restricting cross-border ownership of airlines is to prevent consolidation. The corollary is that airlines proliferate. Under this scenario it is implausible that more than a handful of the competitors can achieve investment-grade status. As it is, the number of airlines worldwide that are regarded as solid investments can be counted almost on the fingers of one hand. This, in an industry which has high capital costs and is exposed to myriad external shocks.
Given that fact, it is hard to believe that the collective genius of the world’s regulators has been unable to dent this archaic bilateral system in 70 years. As a consequence, all but a handful of the world’s 200 airlines are valued only as speculative plays – not unlike betting on a horse race when there is not even the guarantee of a winner. But, despite this unfathomable inertia, it is essential for airlines to keep asking how the system can be improved.
Where regulators have failed them, airlines have had to push the boundaries
In the absence of enthusiasm by regulators to disrupt the status quo, it has indeed been left largely to airlines themselves to find ways around the problem. The biggest step in that direction was the creation of branded global alliances. It has not been the only one, but it was undoubtedly the boldest and most expansive attempt to overcome the constraints of national ownership restrictions. By creating a global brand, linking FFPs and facilitating a range of other cooperation, the three alliances took a giant step towards rationalisation.
Yet, although each member airline is now required to brand a certain number of its aircraft in alliance colours, seamless travel between airlines and limits in reservations systems can still make passengers wary of connectivity claims.
There have been many other manoeuvres, from the various group structures to be found in Air France-KLM, IAG, the Lufthansa Group and LATAM, to the cross-border JVs which are so popular in Southeast Asia among LCCs; from codeshares to more intricate JVs and, at the pinnacle so far, the anti-trust immunised closed JVs.
These JVs are the ultimate in terms of coming close to a merged airline – but they are limited to the specific routes where anti-trust immunity is granted; also, the US, at one end of most of them, requires a full open skies regime to exist before approval will be granted.
Sometimes these JVs occur within the confines of one alliance; more often they cross the boundaries. As airlines increasingly seek protection from brutal international competition, they are forced to rely increasingly on bilateral market-based partnerships. This is creating a global network of strategic and tactical alliances, JVs, codeshares and other forms of cooperation that come to resemble a three dimensional wiring diagram on steroids.
While for now the global alliances remain at the core of most relationships, reinforced in parts by the exclusive closed JV subsets, multiple cross patterns of bilateral partnership are woven into a cacophony of selective interests.
Cross-alliance bilateral partnerships make for greater complexity of allegiance
A stark example of this appears in oneworld. Qantas, under siege by the Gulf carriers on its Europe-Australia routes, formed a close (non-equity) partnership with Emirates; the move proved transformational for Qantas. More recently British Airways/IAG persuaded Emirates’ near neighbour Qatar Airways to join oneworld (the only Gulf carrier to join a global alliance) and is strengthening the IAG ties, as Qatar invests in IAG and codeshares with Vueling.
Also the Cathay Pacific-Qantas rivalry is one of the deepest in the industry – to the extent that Qantas partners with some of Cathay’s biggest competitors, SkyTeam’s China Eastern and China Southern.
Meanwhile, more of prosaic than practical significance, both British Airways and Qantas have substantial JVs with American Airlines, which is – at least nominally – a voice in the loud chorus of some (but not all) US airlines' opposition to the Gulf carriers.
The Etihad Alliance is a novel model, cementing equity links with satellite airlines
The Etihad Alliance is another innovation of the past decade, sculpted to avoid the need for organic growth and the time and expense it entails. By acquiring minority – but influential – equity shares in a range of airlines in its key markets, Etihad has been able to expand virtually, establishing a whole new form of airline club. Its advantage, with one very dominant member, is that commercial matters like joint purchasing and central control of Frequent Flyer Programmes (not subject to ownership and control rules).
Also, unlike the global alliances, Etihad is independently able to select which airlines it wants to bring into the stable, thereby avoiding a lot of the overlapping interests that can afflict the larger global alliances in particular.
In the course of its operations some competitors raise the flag of “control”; here it does bump up against the boundaries of the septuagenarian restrictions, as do the cross border JVs in Asia.
But these bumps can only be steps in the right direction for those who would seek a more rational airline industry.
The alliance partners can become a refuge when things get tough
These developments do not by any means sound the death knell of the alliances – although they will progressively decline in importance. There is another strain of the evolution. Singapore Airlines for example, a highly successful sixth freedom carrier, has previously been reluctant to codeshare with its Star Alliance partners on its online trunk routes, for fear of traffic diversion onto the larger hub carrier partners.
But Gulf carrier and LCC competition has prompted a declining SIA to dip its toe in the water with (still-cautious) new codeshares with United on the Pacific and with Lufthansa on Europe.
LCCs are belatedly now joining alliances
It has taken a surprisingly long time for LCCs to share in the global partnerships. JetBlue was introduced into IATA via Lufthansa’s equity share some years ago, but until Star Alliance made the move, LCCs remained outside the big boys’ clubs.
Star’s “Connecting Partner Model” was launched at the end of 2015, with South African Airways LCC subsidiary Mango the first member. Star has not yet announced a second CPM member but has been discussing potential membership with several airlines including Air India Express, Brazil’s Azul, China’s Juneyao and Greece’s Olympic Air. Juneyao was confirmed as a partner in Oct-2016.
There are many examples now where LCCs codeshare with other LCCs and with full service airlines, but there are good reasons why they have not
become involved in uniquely LCC-based alliances.
The major global alliance members are international operators, with long haul fleets, allowing connections between regions. By definition of their short haul and point to point characteristics, neither inter-LCC nor trans-regional operations have been considerations for LCCs.
Two new LCC Alliances, establishing wider “networks”, aggregating traffic, selling through each other’s sites: UFLy and Value Alliance
The Value Alliance consists of a range of independent and FSC Group airlines, whereas the U-Fly Alliances consists only of HNA member airlines and of one other, non-Chinese LCC Korea's EastarJet.
The Value Alliance allows customers “to book fares on flights with any member airline in a single transaction from each partner website”.
The Alliances use technology developed by Air Black Box (ABB), allowing customers to book flights with any member airline in a single transaction from each partner website. The system also allows sale of ancillary products, worth up to 20% of revenues.
The Value Alliance is also using ACE, which ABB claims to be the first dedicated multi-carrier interlining and booking system.
Both alliances can be expected to grow further – and to offer a model for others to follow.
U-Fly Alliance: Formed in Jan-2016
Value Alliance: Formed in May-2016
Each of these factors is evolving, especially in Asia. LCCs are flying, on average, longer sector lengths and they are increasingly mimicking the hub network profiles of full service airlines. One factor that is a significant and distinguishing enabler for most LCCs is the widespread use of new generation, simplified reservations systems – mostly Navitaire based.
Although these systems were not designed for collective inter-airline functionality, the very fact of their compatibility is a great enabler. Combined with the Air Black Box system, it appears that much of these connectivity issues will be resolved relatively simply.
Two groups of Asian LCCs have this year established their own alliances, the UFly Alliance and the more recent Value Alliance. Significantly, these are establishing in the face of the growing trans-Asian power of AirAsia and AirAsia X. It is a highly competitive sector – there are 53 LCCs in the Asia Pacific region - although overlaps in city pair services are still more the exception than the rule.
Indications are that big changes could be in the air - or not
All of these developments point to a decade of substantial change in alliance and partnership activity. The current situation is poised in a highly unstable equilibrium. Clearly it must and will change, perhaps much faster than many expect.
John Byerley’s regret at a lack of breakthrough in changing the ownership and control rules may eventually turn to something more joyous.
But that more rational outcome is unlikely to be the result of “meaningful, respectful, future-oriented conversation” – rather of steady market driven revolution and brute force as the stronger emerging commercial forces demand it.
Call it anarchy, but where reason and respect become powerless in the face of such an obviously necessary change, the vast majority will welcome that sort of disruption.
This analysis first appeared in CAPA's Airline Leader, Issue 36, Oct-2016.
For this and earlier issues: Airline Leader. The strategy journal for airline CEOs