A Magazine for airline executives
2016 Issue No. 4

Alliance Partnership Models: New And Traditional

The Continuum Of Alliance Cooperation

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 available; international aviation markets weren’t lucrative enough to support many intercontinental routes; and restrictive, protectionist treaties governed who could fly where, how often and even with how many seats.

Consequently, cooperation was routine, but to a great extent, an arm’s-length type of cooperation, focused on interline ticketing and baggage agreements and, occasionally, special prorate agreements.

Codesharing, a practice that dates back to the 1960s, became common in the early 1990s, first via 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, but in which inventory was controlled by the operating carrier. This reduced effort on the part of the marketing carrier, as well as reduced spoilage and levels of partner competition that undermined the entire rationale of cooperation. Consequently, this allowed for the expansion of codeshare agreements to many more markets.

Northwest Airlines and KLM made a footprint in aviation history in 1989 with their large-scale codeshare agreement. In 1992, the airlines deepened their agreement by creating a 50/50 joint venture, in which they agreed to share bottom-line profits and losses on all of their trans-Atlantic routes. This move was significant considering that nearly 20 years later, full P&L joint ventures are rare among global alliance partners.

Northwest Airlines-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. The signing of an open-skies agreement between the United States and the Netherlands in 1992 accelerated the growth of the alliance.

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.

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.

However, 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:

  1. More than 20 years later, full P&L joint ventures are still relatively uncommon among global alliance partners.
  2. It is abundantly clear that 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. Considering that 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 level of service in excess of what the local market sizes justified for two reasons:

  1. The nonstop competitors agreed to cooperate instead of compete, taking advantage of the grant of antitrust immunity conferred on them by the U.S. government.
  2. 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 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 joint-venture’s profits and in which all relevant revenues and costs were pooled. 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, and their growth beyond the size of their hub markets validates the effectiveness of this strategy.

Alliances Go Global

With the launch of Star Alliance in 1997, airlines entered the era of the branded global alliance. Since that time, the three major global alliances have expanded to include carriers on every continent.

Throughout every region of the world, airlines have embraced global alliances as a means to access new markets, legitimize their brand in an increasingly global market and provide incremental growth and profitability through the cooperative mechanisms of the alliance.

However, nearly 20 years after the launch of the first global alliance, there are a couple of questions worth asking:

  1. Have the benefits of global alliances been shared equitably among all members?
  2. Are these arrangements capable of leading their members into the future of global aviation?
Benefits Sharing: A Marriage Of Unequals

The benefits of global alliances have not been shared equitably. And while 50/50 was an appropriate choice for Northwest Airlines and KLM considering the position each was in prior to their joint venture, 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:

  1. It must acknowledge the relative investment of each partner. In simple terms, each partner must be rewarded in rough proportion according to the ASKs they operate.
  2. A fair distribution must provide each partner with an opportunity to benefit more by working together than they could without the cooperation.

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 but routinely ignore the needs of junior partners to be rewarded for the “dots-on-the-map” market access they provide by supporting them with meaningful growth opportunities.

Ensuring that an airline receives its fair share of alliance benefits can be a complicated negotiation in which considerations can include analyzing value-sharing mechanisms, and 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.

Europe has also seen true cross-border mergers and major equity investments, including the Lufthansa Group, International Airlines Group and Air France- KLM. However, these are considered domestic mergers due to Europe’s Single Aviation Market.

Global Alliance Growth Stalled

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, representing every major market in the world.

For airlines seeking to participate in the benefits of an alliance, there have been three broadly similar options, and most have chosen their alliance based on a comparison of the perceived advantages of cooperating with the leading partners in each alliance.

New Partnership Opportunities

Meanwhile, a promising trend toward cross-border ownership has accelerated. Airlines taking equity stakes in one another is nothing new. 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 — promoting more commonality in the bottom line, establishing the certainty of a long-term commitment and creating mutual formal obligations supported by an agreement that serves as a guide for the partnership.

In Europe, there have also been true cross-border mergers and major equity investments, including the Lufthansa Group (with Swiss International Air Lines, Austrian Airlines and Brussels Airlines) and International Airlines Group (with British Airways, Iberia and Vueling) and Air France-KLM. But these are effectively domestic mergers because of Europe’s Single Aviation Market.

Among true cross-border initiatives are the Qantas-Jetconnect and Lufthansa-SunExpress partnership, the latter a 50/50 joint venture between an E.U. carrier and a Turkish carrier.

Historically, and in the preceding examples, equity stakes served the purpose of cementing ties between partners that were willing to tie themselves to each other for the long term. But three examples today bear closer scrutiny as potential harbingers of a future in which global markets demand the same thing from airlines that truly global companies have known for decades: that a single company offering a single brand promise can serve customers’ needs anywhere in the world. These include Etihad Aviation Group, LATAM Airlines Group and Avianca Holdings.

In the case of Etihad Aviation Group, the equity stakes serve to more effectively promote greater integration and decision-making based on common interests.

It is too early to tell if this model is the wave of the future. However, it is clear that the global alliances have grown to a point where their opportunities are limited to relatively modest growth and cooperation in the absence of the ability to share growth opportunities across national borders.