While airline alliances and partnerships have been common practice for decades, new strategies and innovations are necessary for their continued growth and sustainability. Is cross-border ownership the wave of the future, perhaps superseding some of the conventional alliance models?
For decades, cooperation among airlines was a necessity because longer-range aircraft were less common. Many international aviation markets weren’t lucrative enough to support many intercontinental routes. Protectionist treaties governed who could fly where, how often and even with how many seats.
Consequently, cooperation was routine. But to a great extent, it was kept at an arm’s-length type of cooperation, focused on interline ticketing and baggage agreements. Occasionally, there were special corporate agreements.
While codesharing dates back to the 1960s, it only became common in the early 1990s. Airlines started with block-space agreements, in which a marketing carrier sold a “virtual aircraft” portion of the space on a flight operated by another airline. These arrangements quickly yielded to “free-sale” arrangements, in which the marketing airline had access to the entire inventory of the aircraft. Inventory was controlled by the operating carrier.
This reduced effort on the marketing carrier, as well as reduced spoilage and levels of partner competition that undermined the entire rationale of cooperation. This allowed for the expansion of codeshare agreements to many more markets.
The beginning: Northwest Airlines and KLM
The launch of the modern era of airline global alliances began with the large-scale codeshare agreement between Northwest Airlines and KLM in 1989, which could be considered a bilateral alliance ahead of its time. KLM also invested 25 percent in Northwest, a now-common arrangement between partner airlines.
Throughout the 1990s, Northwest Airlines was the fourth-largest U.S. airline, lagging American Airlines, United Airlines and Delta Air Lines by most measures. KLM occupied a similar position in Europe versus British Airways, Lufthansa and Air France. The signing of an open-skies agreement between the United States and the Netherlands in 1992 accelerated the growth of the alliance.
Both Northwest Airlines and KLM had limited options to expand their network footprint into a stronger position. In the United States, the federal government was still enjoying the consumer benefits afforded by deregulation and opposed many airline mergers. In the Netherlands, Europe’s Single Aviation Market allowing European carriers to expand outside of their home market in Europe would not be effective until 2006.
Northwest Airlines and KLM exploited their relative weaker positions through a singularly effective strategy. While other airlines were just beginning to explore codeshare agreements, much less launch global alliances, Northwest and KLM went a step further. In 1992, they created a 50/50 joint venture, in which they agreed to share bottom-line profits and losses (P&L) on all of their trans-Atlantic routes.
The significance of this step is twofold:
- More than 20 years later, full P&L joint ventures are still relatively uncommon among global alliance partners.
- Northwest and KLM were able to exploit their collective strengths to grow larger together than either of them could have achieved alone.
For example, during the peak of the Northwest-KLM alliance, the airline partners collectively operated as many as five daily flights between Detroit and Amsterdam, as well as double-daily Memphis-Amsterdam flights. Neither Detroit nor Amsterdam are among the largest U.S. and European markets for trans-Atlantic traffic.
This city pair was able to support a higher-than-economically-justifiable level of service for two reasons. First, the competitors agreed to cooperate instead of compete. This took advantage of the antitrust immunity conferred on them by the U.S. government. Second, the partners fully exploited the geometric expansion power of dual-hub cooperation. For the first time in airline history, it was possible to book a flight on a single marketing code from dozens of points via Amsterdam, as well as to and from dozens of points beyond Detroit.
A key factor enabling this was the early decision by both parties to focus on a joint venture in which each partner had a fixed claim on the profits, revenues and costs. Therefore, there was little incentive to game the system or profit at the other’s expense. Instead, they focused their energies on targeting other airlines, which allowed both airline's to grow beyond the size of their hub markets.
Alliances go global
This success did not go unnoticed. With the launch of Star Alliance in 1997, airlines entered the era of the branded global alliance. These alliances expanded swiftly, with the three major global alliances growing to include carriers on every continent. Alliances are an affordable means to access new markets, legitimize emerging brands in a global market and provide incremental growth through the alliance's cooperative mechanisms.
Alliances offer an affordable means to access new markets, legitimize emerging brands in a global market and provide incremental growth through the alliance's cooperative mechanisms.
However, nearly 20 years after the launch of the first global alliance, it's not clear whether the benefits of global alliances been shared equitably among all members. And equally unclear is whether or not these arrangements lead their members into the (profitable) future of global aviation.
Friends with benefits — or a marriage of unequals
The benefits of global alliances have not been shared equitably. While 50/50 was an appropriate choice for Northwest Airlines and KLM, a fair distribution of benefits is not necessarily equal among all airline partnerships.
A fair distribution may be achieved over a range of levels, but must meet two requirements:
- It must acknowledge the relative investment of each partner. Each partner must be rewarded in rough proportion according to the ASKs they operate.
- A fair distribution must provide each partner with an opportunity to benefit more by working together than they could apart.
The second point is obvious, and yet widely ignored in alliance recruitment activities. As such, alliances stress the benefits of the brand, market access, and various abstract benefits. Yet the alliances routinely ignore the needs of junior partners. These smaller airlines provide the “dots-on-the-map” market access alliances crave, often without any meaningful growth opportunities.
Yet the alliances routinely ignore the needs of junior partners. These smaller airlines provide the “dots-on-the-map” market access alliances crave, often without any meaningful growth opportunities.
Ensuring that an airline receives its fair share of alliance benefits can be a complicated negotiation. Considerations can include analyzing value-sharing mechanisms, as well as setting the right geographic and financial scope. In addition, duration/termination rights and break-up fees, as well as legal and regulatory considerations, including competition law, audit rights and governance, are among the many factors that must be considered and negotiated to support the business objectives of all partners. Failure to do so can undermine the very purpose of the alliance.
Other factors include duration/termination rights and break-up fees, as well as legal and regulatory considerations (including competition law, audit rights and governance). Each must be considered and negotiated to support the business objectives of all partners. Failure to do so can undermine the very purpose of the alliance.
Today, most major innovations by global alliances have been in place for years. The three main global alliances have successfully recruited most of their targets and now represent every major market in the world.
Back to joint ventures as global alliance growth stalls
For airlines seeking to participate in the benefits of an alliance, the three main alliances offer similar advantages. Most airlines choose based on a comparison of the perceived advantages of cooperating with partners in each alliance.
Meanwhile, a promising trend toward cross-border ownership has accelerated. Among U.S. carriers, Delta Air Lines has taken the lead in underpinning its joint-venture agreements with major equity investments in Virgin Atlantic, Aeromexico and Virgin Australia. With both joint ventures and equity stakes, the goals may be similar — to promote commonality in the bottom line and to establish the certainty of a long-term, contract-driven commitment.
Historically, equity stakes cemented ties between partners making long-term commitments. But the aviation industry of the future may reward a single company offering a single brand promise can serve customers’ needs anywhere in the world. Three examples of this truly global brand promise are Etihad Aviation Group, LATAM Airlines Group and Avianca Holdings.
It is too early to tell if this model is the wave of the future. One thing is clear: absent the ability to share growth opportunities across national borders, global alliances have reached a point of only modest growth and cooperation.
This article was adapted from Ascend magazine.