Virgin Atlantic’s track record of losses: Delta should help, but what about SkyTeam?

See related report: Virgin Atlantic Airways track record of losses: Partnerships should help. Cost cutting would

Radical step

The independent-minded Virgin Atlantic took a radical step last year in entering into a new relationship with Delta Air Lines. The most important element of this is the planned joint venture on North Atlantic routes between Virgin Atlantic and Delta, which now also owns 49% of its British partner. The JV has tentative approval from the US Department of Transportation and is expected to be fully approved in a matter of weeks. A secondary decision for Virgin Atlantic is whether or not to dilute its independence further by joining one of the branded global alliances.

If Virgin Atlantic does choose to join an alliance, its close association with Delta would make SkyTeam the obvious choice. It is unthinkable that it would join oneworld for a host of reasons, including history, culture and competition issues. As for the Star Alliance, this also now looks a very unlikely move for Virgin. Although Virgin Atlantic codeshares with a number of Star members, its long period of being partly owned by Singapore Airlines did not lead to alliance membership and the Delta relationship signals a further distancing from Star.

The impact of Virgin Atlantic on SkyTeam

Virgin Atlantic's entry into SkyTeam would increase the alliance's share of global seats from 17.2% to 17.4%, keeping it the number two alliance and barely eating into the gap to the Star Alliance's 24% (week of 16-Sep-2013, source: Innovata). It would make little difference to its second ranking in Europe, North America and keep it almost level-pegging with Star in Asia-Pacific.

It would have a more significant impact on SkyTeam at London Heathrow, more than doubling its share from 6.5% to 13.5%, but keeping it behind oneworld (53%) and Star (20%).

What could SkyTeam do for Virgin Atlantic versus its existing partnerships?

From its point of view, If Virgin Atlantic joins SkyTeam, it will move from ploughing a lone furrow with 5% of seat capacity on Europe-North America to being part of a team with a 30% share. On UK-US, it will move from a 21% share of seats to being in a JV with 28% (source: Innovata database 29-Jul-2013 to 4-Aug-2013).

However, it gains most of the benefit on the North Atlantic just from its JV with Delta, which is expected to receive full approval within weeks, and so it is the potential benefits in other regions that are more likely to drive its decision on whether to join SkyTeam. Virgin Atlantic also has a number of bilateral codeshare agreements with other carriers, in particular in Asia-Pacific, and it will need to assess whether SkyTeam membership could improve upon the competitive position that it achieves through this series of relationships.

See related report: Delta's Virgin Atlantic 49% purchase prises open the valuable London Heathrow hub - for SkyTeam?

Virgin Atlantic Airways codeshare partners

Partner	Route/area covered by codeshare	Route operated by Virgin Atlantic?
Air China	London Heathrow to Beijing	No
Air New Zealand	Destinations in New Zealand	No
All Nippon Airways	Destinations in Japan	Tokyo Narita only
Cyprus Airways	Larnaca	No
Delta Air Lines	Destinations in USA, Caribbean and Canada	Delta codeshare adds a significant number of destinations not operated by Virgin Atlantic
Jet Airways	Mumbai	Yes
Singapore Airlines	Singapore and destinations in Australia	No
South African Airways	Destinations in South Africa	Johannesburg only
Transaero Airlines	London Heathrow to Moscow	No
Virgin Australia	Destinations in Australia	Sydney only

Source: CAPA - Centre for Aviation, Virgin Atlantic Airways and Innovata

The table below shows Virgin Atlantic's existing rank by seats from the UK to each of the major global regions, based on current schedules (week of 16-Sep-2013, source: Innovata). It also shows the rank of the leading member of SkyTeam operating between the UK and each region and, finally, the rank of Virgin Atlantic's most important current codeshare partner to the region.

The table demonstrates that Virgin Atlantic's existing codeshare partners are better placed than the leading SkyTeam members in Africa and Asia-Pacific, but that it would gain higher-ranking partners through SkyTeam in Europe, Latin America and the Middle East. The greatest benefit to Virgin Atlantic in joining SkyTeam would probably come in Europe and, to a lesser extent, in the Middle East, where it has no presence and which could add feed to its long-haul network.

Virgin Atlantic Airways and partner airlines' rank by seats from UK to main global regions

Region	Virgin Atlantic rank by seats from UK to region	Leading SkyTeam member rank from UK to region	Highest ranked existing VA codeshare partner from UK to region
Africa	3	7 Kenya Airways	5 South African Airways
Asia Pacific	3	14 Korean Airlines	2 Singapore Airlines
Europe (ex UK)	-	9 KLM	35 Cyprus Airways
Latin America	2	5 Aeromexico	-
Middle East	12	6 Saudia	-
North America	2	6 Delta	6 Delta

Note: based on seat capacity for week of 16-Sep-2013
Source: CAPA - Centre for Aviation and Innovata

Virgin currently benefits from special prorate agreements with IAG

Against any benefits of SkyTeam membership, Virgin Atlantic needs to consider the potential negative impact of losing favourable terms under so-called Special Prorate Agreements ("SPAs") with IAG. As part of the European Commission's approval of the IAG acquisition of bmi, IAG was required to offer favourable interline rates to competing airlines on services linking relevant short-haul points with relevant long-haul points. (IAG was also required to concede slots at London Heathrow to allow competitor entry on domestic routes - this will be covered in part two of our report).

See related report: British Airways plans two phases to bring bmi, and its London Heathrow slots, to profitability

EC's deemed relevant cities: Mar-2012

Category	City
Long-haul	Category I: Boston, Chicago, Houston, Los Angeles, Miami, New York, San Francisco, Washington, Calgary, Edmonton, Halifax, Montreal, Ottawa, St John's, Toronto, Vancouver, Cape Town, Johannesburg, Sydney
Long-haul	Category II: Beijing, Delhi, Doha, Dubai, Hong Kong, Lagos, Singapore, Tokyo
Short-haul	Any point in Europe; outside Europe: Addis Ababa, Agadir, Almaty, Amman, Amritsar, Baku, Beirut, Bishkek, Cairo, Casablanca, Damascus, Dammam, Freetown, Jeddah, Khartoum, Marrakech, Moscow, Riyadh, Tbilisi, Tehran, Yerevan

Source: European Commission

IAG entered into a commitment to offer these SPAs to non oneworld airlines operating long-haul services via London Heathrow for traffic with a short-haul origin/destination as defined in the table above and a long-haul destination in either of the two categories shown in the table. For each long-haul destination, the airline requesting a SPA may select up to 15 relevant behind/beyond short-haul cities and may also select the fare class(es) to which the SPA applies. Carriers are assured of securing similar rates to those they previously had with IAG or bmi and SPAs are valid for five years with rolling one-year extensions.

This requirement was aimed at ensuring that IAG did not abuse its strengthened position in the short-haul feeder routes into Heathrow to disadvantage long-haul competitors operating from London. Virgin Atlantic, with no short-haul routes of its own until it launched three UK domestic routes earlier this year using remedy slots from IAG, has always been a largely point to point carrier. Nevertheless, feed from bmi and from British Airways has made a material contribution to its long-haul network. The SPAs are beneficial to Virgin Atlantic in this respect.

Joining an alliance would compromise feed from IAG

However, the European Commission's ruling stipulates that the SPAs with IAG shall lapse automatically in the event that the other airline joins an existing alliance, or is controlled by a member of an alliance, with hubs at both London and a Category I long-haul city; or if it joins an alliance, or is controlled by a member of an alliance, with a hub at a Category II long-haul city. The Commission's definition of 'Alliance' is 'The Star Alliance, the SkyTeam Alliance, the oneworld Alliance, or any other similar airline alliance that may be developed' and so Virgin Atlantic's joint venture with Delta does not appear to be covered by this.

Virgin Atlantic would lose the benefit of the SPAs with IAG if it were to join SkyTeam, however, since Virgin Atlantic's hub at London and Delta's hub at New York would then both be part of SkyTeam. It is not clear whether Virgin Atlantic could extend its partnership with Delta on the North Atlantic to become part of the wider joint venture between Delta, Air France, KLM and Alitalia without joining SkyTeam, nor whether the European Commission would be satisfied by this.

Delta JV is more important, but SkyTeam at least worth considering

Virgin Atlantic remains very much an international long-haul airline, with only 18% of its seats operating in the domestic market (week of 16-Sep-2013, source: Innovata). Moreover, 61% of its international seat capacity is to North America. Its Atlantic alliance with Delta Air Lines is a more important strategic development than any decision to join one of the branded global alliances.

Nevertheless, after reporting a wider underlying operating loss for the year ended Feb-2013 and amid signs of declining load factors in recent monthly data (see part two of our report), any additional moves to increase feed must be worth considering.

The Delta JV will provide benefits across the North Atlantic and Virgin Atlantic already has strong bilateral partners in Asia-Pacific, but SkyTeam membership could improve its position in Europe and the Middle East. The key considerations for Virgin Atlantic in deciding whether or not to join SkyTeam would seem to revolve mainly around its short and medium-haul feed.

If it joins, it must weigh the negative feed impact of losing its SPAs with IAG against the positive impact of gaining SkyTeam partners in Europe and the Middle East. It must also consider whether a better option is to remain outside SkyTeam, thereby preserving the IAG feed, and seek opportunities to generate incremental feed through additional bilateral relationships outside the SkyTeam alliance. The latter would seem to be the more pragmatic and flexible strategy, at least for now.

Either way, cost-cutting will be crucial to stem its losses. We examine Virgin Atlantic's financial track record and network strengths in part two.

See related reports:

• The North Atlantic: the state of the market five years on from EU-US Open Skies
• Delta's Virgin Atlantic 49% purchase prises open the valuable London Heathrow hub - for SkyTeam?