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The motivational drivers of horizontal integration strategies
The Airline Business Case
Universiteit van Amsterdam Suzanne de Bruijne (6266320) Version: Final MSc Business Studies – International Management Supervisor: Drs. J.G. de Wit 16 September 2012
Table of Content
Abstract ..................................................................................................................................................................... 43 Introduction ............................................................................................................................................................... 54 Chapter 1. External growth and underlying theories ................................................................................................. 8
1.1 Transaction‐cost theory (TCT) .............................................................................................................. 10 1.2 Resource‐based view (RBV) ................................................................................................................. 11 1.3 Industry Perspective (IP) ...................................................................................................................... 12 1.4 Institution Based view (IBV) ................................................................................................................. 12 1.5 Social network theory (SNT), Path dependence and Resource dependency theory (RDT) ................. 13 1.6 How do the theories relate to the topic? ............................................................................................ 14
Chapter 2. Defining ‘horizontal growth in the value chain’ ....................................................................................... 15
2.1 Value chain ........................................................................................................................................... 15 2.2 Horizontal integration .......................................................................................................................... 17 2.3 Horizontal growth strategies ............................................................................................................... 18 2.4 Integrate or cooperate? ....................................................................................................................... 19
Chapter 3. Network Economies ................................................................................................................................ 22
3.1 Networks and airline consolidation ..................................................................................................... 23
Chapter 4. Consolidation in the commercial airline industry ................................................................................... 25
4.1 Why consolidate? ................................................................................................................................. 25 4.2 Industry developments since deregulation in Europe and the US ...................................................... 26 4.3 Alliance developments ......................................................................................................................... 30 4.4 Current state of consolidation ............................................................................................................. 34
Chapter 5. Conceptual model and business cases .................................................................................................... 37
5.1 Introduction Case 1 .............................................................................................................................. 40 5.2 Introduction Case 2 .............................................................................................................................. 46
Chapter 6. Research methodology ........................................................................................................................... 50
6.1 Data collection & analysis .................................................................................................................... 51
Chapter 7. Results ..................................................................................................................................................... 52
The motivational drivers of horizontal integration strategies The airline business case 2
7.1 Case 1: Airberlin joins oneworld alliance ............................................................................................. 52 7.2 Case 2: Southwest acquires AirTran ..................................................................................................... 61
Discussion and Limitations ........................................................................................................................................ 73 Conclusion ................................................................................................................................................................. 76 References ................................................................................................................................................................. 77 Appendix I: Overview US M&A .................................................................................................................................. 83 Appendix III: Summary of European airlines’ cross‐holding ...................................................................................... 85 Appendix IV: Overview overlapping airports ............................................................................................................. 86
The motivational drivers of horizontal integration strategies The airline business case 3
Industry consolidation or horizontal integration in the value chain has been a trend in the airline industry since its deregulation. Indeed, most of the national or legacy airlines flying today are a product of one or more mergers in the last decades. The need for consolidation in the airline industry is mainly attributed to the desire to offer a global and seamless service; many customers today (especially business passengers) demand a seamless service ‘from anywhere to anywhere’. Two types of strategies are used to achieve this goal: cooperative and integrative strategies. Although these two strategies share the same objective many different forms are being used within those strategies. The objective of this study is to find the motivational drivers behind these choices. The study is of qualitative nature and consists of two parts. The first part provides the theoretical background of the topic in order to create a conceptual model. The second part explains the differences in motivational drivers through the use of two business cases. This latter part tests the model of the first part. It appears that both strategies are motivated by drivers at the same levels (environmental, firm and relational) but the importance of the levels and the driving factors within those levels differ. In the first business case the alliance strategy seems to be chosen from a more defensive standpoint and out of necessity (competitive pressures and financial uncertainty), and the M&A strategy in the second case seems to be chosen from a more offensive point of view in order to increase market power. However, both strategies are motivated by the attractiveness of the assets involved, especially the route network and airports. An important drawback of this study is the extensiveness of the conceptual model, which in turn limited generalizability because only one case for each strategy could be tested.
The motivational drivers of horizontal integration strategies The airline business case
The deregulation of the airline industry started in the US in 1978. Since then more than 200 airlines have merged, allowing large efficiency gains in the industry. Indeed, most of the national or legacy airlines flying today are a product of one or more mergers in the last decades. This trend towards consolidation or horizontal value chain integration in the airline industry is not limited to the US; rather it is a global phenomenon as the European merger between British Airways and Iberia in 2010 shows. Whether this is a good or a bad development is questionable and opinions about this topic are divided. On the one hand, industry consolidation can increase efficiency and thus reduce prices for customers. On the other hand, industry consolidation decreases the number competitors and increases the chance of price collusion, which is generally undesirable because this decreases customer wealth. The need for consolidation in the commercial airline industry is mainly attributed to the desire to offer a global and seamless service and to gain market power. Many customers today (especially business passengers) demand a seamless service ‘from anywhere to anywhere’. However, no airline is able to provide this by its own at a competitive cost level. In order to meet customer demands as efficiently as possible, airlines look for partners to help them provide the network and service coverage required. Consolidation however, is not only limited to mergers and acquisitions. In many cases the government imposes restrictions on foreign ownership, which is one of the reasons why many airlines choose different forms of integration. Some airlines for example choose to purchase a minority stake in another airline only to gain access to new markets but sometimes with the long‐term objective to acquire a majority stake by acquisition. Other airlines choose to become a member of one of the three globally branded alliances. Even within and between these strategic alliances other forms of collaboration and integration take place. To summarize, increased collaboration and integration amongst airlines has been a major trend in the commercial airline industry, and strategies range from full mergers to small‐scale alliances (Evans, 2001). However, when compared to other, previously regulated industries, a different picture arises. Over the last decades a wave of cross‐border mergers and acquisitions has taken place in many major industries, such as financial markets, telecommunications, IT, and the automotive industry (Chan, 2000). The airline industry though, still retains a certain nationalistic character that has been slowing down full international growth compared to these industries (Chan, 2000). In a presentation at Airneth in Brussels by the vice president of business development of Star Alliance (2011), it was estimated that the four major players in the global telecommunications industry possess 61% of the market; in the PC industry the major players have a market share of 59%. According to the same estimations, the four major players in the global airline industry possess only 24% of the total market. This relatively low level of industry concentration seems to be directly related to the large variety of strategies that commercial airlines use to collaborate and integrate. This in turn is most probably due to restrictions on foreign ownership. But there might also be other factors influencing these strategic choices. Moreover, it would be interesting to see what the reasons are for choosing a certain strategy type over another. Therefore, the research objective is to find the answer to the question why an airline chooses a specific form of
The motivational drivers of horizontal integration strategies The airline business case 5
integration or collaboration, and what factors can explain these differences. Thus, this study is of both explorative and explanatory nature. This leads to the following research question and sub‐questions: What types of external growth strategies with regard to horizontal value chain integration can be identified in the airline industry and what drivers can explain the differences between them? 1. What is meant by the concepts of horizontal growth strategies and value chain integration? 2. What types of horizontal growth strategies can be identified and why may a firm choose a certain strategy or a combination? 3. What is the influence of network economies on industry consolidation, and how has it influenced the commercial airline industry? 4. How has the commercial airline industry developed with regard to horizontal growth in the value chain? 5. Which horizontal growth strategies can be identified in the two airline business cases and what are the driver factors behind that choice of strategy? 6. Which factors have been of most importance for each case and what theoretical explanation relates mostly to those factors? Past research with regard to horizontal integration and cooperation (consolidation) has mainly focused on either integrative or cooperative strategies. Hoffman and Schaper‐Rinkel (2001) were one of the first to develop a context‐dependent framework that clarified the choice between the two strategies. Their framework however, is of generic nature and does not apply to one industry specifically. Which is why in this study their framework will be applied and extended to the commercial airline industry. When looking at past research about consolidation in the commercial airline industry, much research has focused either on mergers and acquisitions or on alliance formation and especially their outcome on consumer welfare or from the perspective of anti‐trust concerns. Other research presents an overview of consolidation developments since the deregulation. In this study I will take the outcome on consumer welfare and the matter of anti‐trust concerns for granted, and I will solely focus on the different forms of consolidation that are used by airlines (two business cases) and the motivation behind that choice. Besides the wider context of market integration where general economic factors explain horizontal concentration in the value chain (consolidation), I will also specifically look at the consolidation in the airline industry where these general factors and industry/firm specific factors come together. First I will provide an extensive theoretical background that identifies these generic and industry specific factors based on relevant literature and desk research, these chapters also provide an explanation of the concepts used in this study.
The motivational drivers of horizontal integration strategies The airline business case 6
Starting off very broadly I will narrow it down to the specific case of the airline industry, where after I will test these generic and industry specific factors of consolidation with two business cases. The two cases I will use in this study are: Southwest’s acquisition of AirTran and Airberlin joining the Oneworld alliance. I will study these business cases using a combination of quantitative and qualitative data ranging from database analysis to secondary sources such as annual reports and newspaper articles. From these cases I will try to find an explanation for the differences between the types of consolidation. It would be interesting to see whether there are also new factors, besides the ones identified in the theoretical background, that explain differences in consolidation strategies. The theoretical background is structured as follows. First, the concept of external growth and its underlying theories are presented. Second, the topic of integration in the value chain is explained. Next, I will discuss the different modes of horizontal integration and I will make a distinction between integrative and cooperative strategies. Moreover, I will present an existing framework that explains the choice between these different types of strategies. In the third chapter I discuss an important characteristic that is of great influence on the choice of strategy for airlines, namely networks. Having started off in a more general sense, this third chapter already starts to focus more specifically on the commercial airline industry. The fourth chapter will be totally devoted to the commercial airline industry itself, and current trends and developments will be presented with regard to the consolidation. After this sound theoretical background I will present a conceptual model that provides an overview of all the generic and industry specific factors that possibly come to play in the horizontal concentration in the airline industry. The second part of this study involves the testing of this conceptual model.
The motivational drivers of horizontal integration strategies The airline business case
Chapter 1. External growth and underlying theories
In this first part of the study I will start off with a broad introduction to the general topic of horizontal growth through an extensive literature review, and I will slowly narrow this down to the specific case of the commercial airline industry. The objective of this literature review is to identify existing generic motivations that drive the choice between horizontal growth strategies and to identify those that are specific for the commercial airline industry. Moreover, I will also explain and clarify the concepts used in the research question. In this first chapter the concept of external growth and its underlying theories are presented in order to get a better understanding on why a firm would engage in consolidation in the first place. For a firm to capture the highest profits and maximize shareholder value it can either grow its revenues and/or minimize its costs. To achieve this, a firm can choose to use internal or external growth strategies that can be used individually or in combination with each other. Internal growth strategies refer to (re)investments of firms in existing businesses to increase its own assets or output. External growth strategies on the other hand, provide firms with access to external resources that help to fill up the gaps of their existing businesses. External growth strategies vary from cooperative strategies such as marketing based alliances to mergers or full takeovers (acquisitions), and can increase firm size, market share and firm value. In this study I will distinguish between mergers, acquisitions and strategic alliances as external growth strategies, and I will elaborate more extensively on these concepts in chapter 3. External growth strategies are popular because they deliver results more quickly than internal growth strategies that are characterized by their slow pace. Especially in a world where economies become more interconnected through globalization, internal development becomes more complicated and external growth strategies offer quick solutions (Hoffman & Schaper‐Rinkel, 2001). Figure 1 explains the concepts of internal and external growth for firms in a schematic overview.
Figure 1: Schematic overview internal and external growth
The motivational drivers of horizontal integration strategies The airline business case
In this study I will focus on external growth strategies because the airline industry is characterized by high fixed costs (which complicate internal growth) and hence also by the need for economies of scale, scope, and density which is mainly achieved through external growth (Vasigh et al., 2008). I will elaborate on this motivation in chapter 4. When growing through external strategies a firm can choose to expand either vertically or horizontally in the value chain. The value chain is a concept that can be interpreted in many ways. In this study I will use the concept value the way it was developed by Porter (1991). Porter (1991) explains the value chain as a set of activities for a firm operating in a specific industry. Products or services pass through all the different activities of the chain and customer value can be obtained in each activity (Porter, 1991). When the value chain is applied to an entire industry, Porter calls this the value system. In that case a firm can either move upwards or downwards the value chain (vertical integration) by integrating other firms that execute different activities than the focal firm. Or a firm can integrate another firm that either executes the same kind of activities or activities that differentiate the focal firm’s current products/services but on the same level in the value chain (horizontal integration). Both forms of external growth are driven by different motivations even though both have the final objective to increase profit. Figure 2 illustrates which activities create value for one firm throughout the total chain (Porter, 1991). Note that this figure only represents one link in the value system or industry value chain; the industry chain is made up from many different firms, each with their own value chain, linked together to produce a certain outcome. In chapter 2 I will explain the concept of the value chain more thoroughly.
Figure 2: Porter’s value chain
Source: Porter, M. E. (1991).
In the next section I will discuss several theories that underpin a firm’s need to grow externally and explain how they affect either vertical or horizontal growth. First, both the transaction‐cost theory and resource‐ based theory explain the firm’s existence, boundaries and inter‐firm linkages. Second, the firm’s position within a value chain can also be explained from an industry perspective. Third, institutional theory brings in the distinctive aspect of external growth on an international level. Fourth, resource dependency theory, social network theory and path dependency are three other theories that focus on contextual factors influencing the motivation for
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external growth strategies. Most of these theories are not mutually exclusive and can be used in combination with each other because they all explain different factors influencing the choice for external growth strategies.
Transaction‐cost theory (TCT)
The main rationale behind the TCT in explaining the existence of firms and their external growth is to minimize transactions costs (Hennart, 1988). Transactions costs are those related to establishing and governing exchange relationships between firms that are subject to bounded rationality and opportunism. Examples of these costs are associated with: negotiating, writing contracts, contract breach and monitoring performance of the partner (Ireland et al., 2002). This theory recommends choosing a strategy that minimizes these transaction costs which mainly depends on the threat of opportunistic behavior, the relative costs of integrating the other firm versus the expected synergies, and the level of asset specificity (Williamson, 1981). By investing in specialization (or asset specificity) transaction costs increase because with increased asset specificity comes more complex governance structures (Williamson, 1981). The choice of governance structure does not only influence transaction costs but also the incentives to engage in value creating activities (Dyer, 1997). Thus, due to differences between firms, different strategies are employed with regard to both the level of asset specificity and the choice of governance (Dyer, 1997). This theory has been effective in explaining and predicting vertical integration in the value chain between
suppliers and buyers in mature industries such as the automotive industry and also in explaining the use of equity (mergers and acquisitions) as a governance mechanism (Eisenhardt & Schoonhoven, 1996). Vertical integration can increase a firm’s value added margins for a particular part of its value chain and economies can be gained from shared facilities and resources (Harrigan, 1985). More importantly, vertical integration (backwards and forwards) minimizes the risk of opportunism from buyers/suppliers and can act as a safeguard mechanism (Rindfleisch & Heide, 1997). However, as Ghosal and Moran (1995) note, this theory is most relevant to static efficiency and routine situations and does not explain many other strategic advantages besides transaction cost minimization. Both in horizontal as in vertical integration, internalization strategies such as mergers and acquisitions are preferred when transaction costs of an exchange are high because these strategies control transactions costs effectively (Das & Teng, 2000). Strategic alliances combine characteristics of both M&A and market exchanges; hence contracts are needed in combination with joint coordination (Das & Teng, 2000). Thus alliances are preferred when the transaction costs of an exchange are intermediate and not high enough to justify integration and thus can be viewed as semi‐internalization strategies (Das & Teng, 2000). Or as Kogut (1988) puts it: ”The answer of why firms choose for cooperative strategies lies in the diseconomies of M&A which arise due to the costs of divesting or managing unrelated activities”. Thus, a necessary condition for an alliance is that the production costs achieved through M&A is significantly higher than external sourcing for at least one of the partners (Kogut, 1988). An example of cooperative strategies that seemed to have failed due to transaction costs is that of the Dutch ProRail and NS. Before the deregulation of the Dutch railway system in 1995, the two companies were part of the same semi‐stated owned firm: Nederlandse Spoorwegen. After 1995, ProRail became
The motivational drivers of horizontal integration strategies The airline business case 10
responsible for the railway network and infrastructure and NS for the trains, passengers and railway exploitation, and both firms work together on offering one service for the customer; travelling by train. However, this split of firms turned out not to be more efficient and both transaction and production costs have become higher than in case of a merger of the two firms. Currently, NS has proposed to merge the two companies back together in order to increase cost efficiencies and service quality (NOS, 2012).
Resource‐based view (RBV)
The RBV explains the firm as a bundle of heterogeneous resources (tangible and intangible assets and capabilities) and thus stresses the internal aspects of the firm (Das & Teng, 2000). In contrast to TCT, which focuses on cost minimization, the RBV emphasizes value maximization of a firm through combining and using valuable resources (Das & Teng, 2000). According to Barney (1991) valuable firm resources are those that are scarce, inimitable, and non‐substitutable. The knowledge‐based extension from this view emphasizes that knowledge is a firm’s most important distinctive resource and its ultimate source of competitive advantage, and that knowledge asymmetries between firms provide the foundation of benefits that can be derived from firms working together (Hoffmann & Schaper‐Rinkel, 2001). From an RBV perspective, a firm’s lack of resources or the desire to strengthen its own are the main motivations behind the need for external growth, and trading and accumulating resources are a strategic necessity (Das & Teng, 2000). The difference between these two motivations is that obtaining resources (fill up the gap) is more about creating competitive advantage in the present and that retaining resources (strengthening current resources) is more about protecting a future competitive advantage (Das & Teng, 2000). When efficient market exchange of resource is possible, firms are likely to rely on the spot market. However, efficient exchanges are most of the time impossible because resources are not always perfectly tradable as they are embedded within a particular context (Das & Teng, 2000). Thus, when additional resources cannot be purchased on the spot market or developed internally with acceptable cost or within acceptable time, external growth strategies come to play (Hoffman & Schaper‐Rinkel, 2001). Both strategic alliances as M&A can serve the objective to obtain and/or retain resources, but Das and Teng (2000) state that the distinct advantage of strategic alliances is to have access to exactly those resources that are needed with a minimum waste of other resources. Moreover, the possible advantage of strategic alliances over M&A is that the firm only temporarily gives up its resources, which then remain available for future internal deployment. In other words, strategic alliances are preferred when the discounted present value of the deployment of a firm’s resources in the future is greater than the realized value of selling its resources in the present (Das & Teng, 2000). Thus, strategic alliances should only be used when the realized value of those resources contributed to the alliance is higher than their value when realized through internal deployment or M&A (Das & Teng, 2000). The RBV perspective does not specifically make a distinction between the impact of horizontal and vertical growth strategies; the argument is that resource integration can be accomplished anyhow (Das & Teng, 2000). There is however a difference in the type of resources that are acquired by combining two or more firms (either in an alliance or through M&A). Highly similar resources provide the opportunity to gain economies of
The motivational drivers of horizontal integration strategies The airline business case 11
scale but allow firms to primarily exploit existing competitive advantages. These economies of scale are usually acquired through horizontal integration (Ireland et al., 2002). On the other hand, different but complementary resources can be used to gain economies of scope, create synergies and develop new resources and skills hence also new competitive advantages (Ireland et al., 2002).
Industry Perspective (IP)
From yet another perspective, one could say that a firm chooses a certain external growth strategy that fits best with its environment or more specifically with its industry, which is also known as the ‘positioning school’. Industry structure has an important influence on how the competitive game is played as well as the potential strategies available to the firm (Porter, 1980). Porter has been largely responsible for the success of this strategy school. Porter (1980) states that the intensity of competition is not a matter of luck; rather it is rooted in the underlying industry economics. The five forces (bargaining power of suppliers, bargaining power of customers, threat of new entrants, threat of substitutes and rivalry among existing firms) influence the attractiveness of an industry, and a firm should choose a position within the industry where it can best cope with these forces (Porter, 1980). Hence, a firm would choose a certain growth strategy that minimizes the competitive forces. One way to do so is by setting up entry barriers thus making it less attractive for other firms to enter the industry. So, instead of increasing the number of competitors in an industry that would maximize social welfare, Porter (1980) claimed that firms should minimize the number of competitors by raising entry barriers in order to maximize profits. From this school of thought, the argument of market power can be derived; to maximize profits a firm should minimize/eliminate competition. As mentioned before, a reduction of competition reduces social welfare and is therefore not stimulated by governments and other authorities. However, it is an underlying motivation of why firms would choose to use M&A rather than strategic alliances, especially in the case of horizontal integration. I will elaborate more extensively on the topic of horizontal integration in the next chapter. In industries of moderate concentration where collusion (through M&A) is difficult, Joint Ventures can be seen as a form of defensive investment by which firms protect themselves against strategic uncertainty (Kogut, 1988). When external strategies are used in a protective manner such as described, partners are chosen to improve one’s competitive position instead of minimizing costs (TCT) or learning (RBV). This can happen through collusion or by taking away competitors’ potentially valuable allies (Kogut, 1988).
Institution Based view (IBV)
In the case of external growth beyond national borders (international business) a firm should take into account the different institutional contexts. Institutions are “the humanly devised constraints that structure human interaction”, as North (1990, p.3) explains it. Or: the “regulative, normative, and cognitive structures and activities that provide stability and meaning to social behavior” (Scott, 1995, p. 33). In short, institutions provide the rules of the game, both in a societal and a business context. By providing the rules of the game, institutions have the objective to reduce uncertainty. A distinction can be made between formal and informal institutions. Formal
The motivational drivers of horizontal integration strategies The airline business case 12
institutions are relatively easily codified and are represented by laws, regulations and rules. Informal institutions on the other hand are more difficult to recognize and exist in norms, values and cultures. For this reason institutions directly influence the choice of strategy and moderate the impact of other determinants of strategy. Institutional theory complements the industry‐based view and resource‐based view by emphasizing the importance of institutions rather than perceiving institutions as background factors (Peng et al., 2008). IBV does not make a distinction in application on horizontal or vertical growth; rather it emphasizes the importance of context in every (international) strategic decision. The IBV focuses on the dynamic interaction between institutions and firms and considers strategic choices to be the corresponding outcome (Peng, 2002). With regard to cross‐border acquisitions, Dikova et al. (2010) found that former experience with
completed deals increased the likelihood of actual transaction completion, but only in the case of less distant countries (institutionally). They also demonstrated that the size of the impact of formal and informal institutional differences on transaction completion is comparable to the effect of the transaction‐specific features of cross‐ border acquisitions, which emphasizes again the importance of institutions in business.
Social network theory (SNT), Path dependence and Resource dependency theory (RDT)
The following three theories all take into account the context of the firm, and the influence of that particular context on the choice of strategy. None of them make a clear distinction between vertical and horizontal integration, but they do help to explain why a certain strategy is chosen. SNT suggests that the firm’s strategic actions are affected by the social context in which they are embedded and the position of actors in this context (Gulati, 1998). This theory brings in a social argument to the choice of a certain strategy. SNT recognizes that key drivers, processes and outcomes of a firm’s strategy choice are defined and shaped by the firm’s embeddedness (Gulati, 1998). The embeddedness of a firm in a social network and the position within that network can explain the choices for specific external growth strategies. The firm’s social context includes both direct and indirect ties with network actors and it includes both inter‐ and intra‐organizational relationships (Ireland et al., 2002). Social embeddedness is closely related to path dependence, which also brings in a more social view of the firm. Path dependence, or the historical context of the firm, explains that external strategic actions are influenced by exogenous factors outside the control of the firm. This suggests that chance and prior history may play a role in the choice of an external growth strategy. Also because strategic choices made in the past can influence new external growth decisions (Hite & Hesterly, 2001). RDT differs from the RBV and TCT in the sense that it recognizes the influence of external factors on organizational behavior, and that managers can act to reduce external uncertainty and dependence (Hillman et al., 2009). Thus, if firm A is scarce in a particular resource but dependent, it will try to find another firm that can provide firm A with these resources. This theory brings in the arguments of mutual dependency and power
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asymmetry. RDT offers an externally focused perspective on why firms are active in specific external growth strategies. Mergers and acquisitions (M&A) occur between firms that depend on one another as a mechanism to reduce dependence and uncertainty. Moreover, the magnitude of the dependency predicts the likelihood of M&A. Other cooperative strategies (strategic alliances, Joint Ventures etc.) only provide partial absorption of the interdependencies but can also be explained by their mutual dependency (Hillman et al., 2009). For example, at intermediate levels of industry concentration firms experience high levels of competitive uncertainty and are likely to mitigate this competitive interdependence by entering into Joint Ventures or other cooperative strategies (Hillman et al., 2009). Although RDT explains why a firm engages in external growth strategies and to some extent also the choice of strategy, it does not explain how this differs between vertical and horizontal integration. Therefore, RDT offers an incomplete picture of the reason of existence of M&A and strategic alliances, which is why it is often used in combination with social network theory and path dependence theory.
How do the theories relate to the topic?
The theories discussed and explained in this chapter all explain different types of motivations for a firm to grow externally and integrate in the value chain (either vertically or horizontally) and why then a certain strategy is preferred over another. I have presented four distinct main theories (TCT, RBV, IP and IBV) that are complementary rather than being mutually exclusive. Besides these three theories, I also presented three other complementary theories that all bring in a more social and contextual view of the firm and its strategy choice. It is important to note that all of these theories have their shortcomings and none of them paint a full a picture of a firm’s motivation; only when used together they provide a more comprehensive framework on the motivation of a firm’s strategic actions. Table 1 presents an overview of these seven motivations with a brief explanation of their main arguments. In the next chapter I will explain the concept of industry integration more extensively and I will zoom in on the concept of horizontal integration in the value chain.
Table 1: Main motivations behind industry integration and external growth strategies
Transaction Cost Theory Resource Based View Aims at minimizing transaction costs depending on opportunistic behavior, relative production costs and synergies, and level of asset specificity. Aims at maximizing firm value through the optimal combination of resources. A strategic necessity to trade/accumulate resources in order to fill up gaps or strengthen the existing resource base. Aims at positioning itself as best as possible in an industry by raising barriers to competition and increasing market power. Formal and informal institutions in the environment of the firm can influence the choice of strategy. Aims at reducing uncertainty and dependency and brings in arguments of mutual dependency and power asymmetry on the choice of strategy. The firm’s actions are influenced by its social network embeddedness and the position of the firm in that context. The firm’s actions are influenced by external factors outside its control, adds the argument of chance and prior history.
Industry Perspective Institutional Based View Resource Dependency Perspective Social Network Theory Path Dependence
The motivational drivers of horizontal integration strategies The airline business case
Chapter 2. Defining ‘horizontal growth in the value chain’
2.1 Value chain
As mentioned in the previous chapter, when a firm chooses to grow through external growth strategies it can achieve this through either vertical or horizontal integration in the value chain. In the first chapter I briefly introduced the concept of a value chain as proposed by Porter (1991). When the value chain is applied to an entire industry it is often called the value system (Porter, 1991). The value chain is a very broad concept and can be applied to many different industries. Another term that overlaps with the concept of the value chain is the supply chain, which Mentzer et al. (2001) define as “a set of at least three entities (individuals or organizations) directly involved in the upstream and downstream flows of products, services, finances and/or information from a source to a customer”. Compared to Porter’s (1991) concept of the value chain, the term supply chain does not include customer value. Thus a main difference between the terms is that in value chains the created customer value is what results in profits and in supply chains it is more about the profits that result along the chain from supplier to customer (Feller et al., 2006). Or in other words, value chains are more downstream focused and supply chains more upstream focused. However, what both terms have in common is that they both present a view of an extended firm with integrated business processes that enable the flow of products/services in a certain direction. Moreover, both terms overlay the same network of firms that work together to provide products/services (Feller et al., 2006). Another distinction can be made for logistic chains which can be defined as “a system of components including suppliers of materials, production facilities, distribution services and customers, which are all linked through the feed‐forward flow of materials and the feed‐back flow of information” (Stevens, 1989). In the logistic chain the focus is on the logistic processes including feed‐forward flows (transportation, material handling and transformation), the feedback flow of information (information exchange regarding orders, deliveries, transportation etc.) and finally the management and control (purchasing, marketing, forecasting, inventory management, planning, sales and after‐sales services) (Slats et al., 1995). The goal is to integrate these different logistic processes and actors involved to create advantages for each actor and to increase efficiency throughout the total chain (Slats et al., 1995). Note that the logistic chain does not include the customer, as it is the case in the supply chain and value chain. As explained in the first chapter, in this study I will use the term value chain for the entire industry instead of a single firm as Porter originally intended. Even though the main focus of value chains is integrating downstream activities, I also include the integration of upstream activities in my use of the term value chain. For a single firm to grow within the value chain it can either achieve this through vertical or horizontal integration, which is illustrated in figure 3. In the case of vertical integration a firm can either integrate upstream or downstream in the value chain using M&A’s and strategic alliances. Downstream/forward integration means that a firm integrates activities that are closer to the end‐customer. A common example is that of a manufacturer moving downstream by offering their products in wholly owned stores instead of selling through intermediary wholesalers/retailers. Upstream/backwards integration means that a firm integrates activities that move closer to
The motivational drivers of horizontal integration strategies The airline business case 15
the source of the production. For example: a PC manufacturer that integrates its supplier of PC components. Horizontal integration on the other hand, means that a firm integrates another business on the same level of the value chain. This can either be a direct competitor which would increase its existing resource base and lead to economies of scale, or this can be an indirect competitor offering products/services that are not exactly the same but diversify the firm’s existing products/services (economies of scope). A common example of horizontal integration is a bookstore chain buying up another bookstore chain (economies of scale), or a bookstore buying up a store chain in DVDs and music (economies of scope). Another way for a firm to integrate horizontally is in a geographic sense; an airline can offer a wider variety of destinations (or in other words; a wider variety of products) by integrating with another airline. This does not apply to airlines only, it applies to any firm that offers its customers transportation from A to B; they all want to offer a package of products that covers as many destinations as possible.
Figure 3: Integration in the value chain
When discussing the topic of value chain integration one should also take into account the softer forms that do not necessarily increase firm size but take shape in close networks or ‘value networks’. Value networks are those networks where firms closely cooperate with inter‐firm relationships playing an important role in strategic performance (Peppard & Rylander, 2006). In that case, the focus of the value chain is on the end product/service and the chain is designed around the activities that are necessary to realize it and every firm occupies a position within that chain (Peppard & Rylander, 2006). With this value network concept, value is co‐ created through a combination of all actors in the field. Thus, the focus of analysis lies on the value creating system itself where different economic actors work together to co‐produce value (Peppard & Rylander, 2006). The crucial defining characteristic of value networks is the complementarity between the different firms. Firms in networks are independent but the relationship enjoyed by these firms are a necessity for their competitive position; hence a value network consists out of different autonomous economic actors that depend heavily on
The motivational drivers of horizontal integration strategies The airline business case 16
each other with regard to their performance (Peppard & Rylander, 2006). This interdependence brings in a dynamic nature; an action by one actor can influence other network members (Peppard & Rylander, 2006).
In this study I will focus on horizontal integration because general growth objectives in the commercial airline industry are mainly achieved through horizontal integration strategies. These growth objectives are formulated by Barla and Constantatos (2006) as follows: offering a global service, increasing service quality, exploiting economies of scale and scope, and gaining market power. In this section I will explain that these growth objectives in the airline industry are mainly achieved through horizontal integration. Horizontal integration in the value chain can lead to industry consolidation; M&A and alliances of horizontal nature decrease the number of competitors in an industry and increases the size and market share of those players integrating others. Although industry consolidation can possibly lead to a reduced number of competitors in an industry and a possible reduction in public welfare, not every collusive motivation is contrary to public welfare. In the case of strong network externalities, such as in telecommunications, joint research and development of standards can result in lower prices and improved quality in the final market (Kogut, 1988). I will explain the topic of network economies and its application to the commercial airline industry in chapter 4. Industries that are highly concentrated (horizontally integrated) may be more sensitive to monopolistic and oligopolistic characteristics, while industries with multiple players may tend to be characterized by monopolistic competition (Vasigh et al., 2008). The global airline industry is an oligopolistic industry and one of the main characteristics of this type of industry structure is that the actions of the players will substantially affect the total market which in turn may influence the actions of competitors and hence create a complex interdependence between firms (Vasigh et al., 2008). Moreover, high entry barriers make that the number of competitors is relatively small. Oligopoly is usually viewed as undesirable, but the advantage is that a few large firms can often enjoy economies of scale and thereby produce at lower cost and sell at lower prices than an industry composed of smaller, more numerous firms (Vasigh et al., 2008). However, it might be the case that competition is artificially suppressed and that customers are not better of (Vasigh et al., 2008). So from one point of view, industry consolidation can increase efficiency and thus reduces prices for customers, but it is not sure whether this efficiency eventually will be gained as M&A also bring organizational uncertainty (Vasigh et al., 2008). From the other point of view, industry consolidation decreases the number competitors and increases the chance of price collusion, which is generally undesirable because this decreases customer wealth (Vasigh et al., 2008). In short, a tradeoff should be made between the possible benefits and threats of industry consolidation. This is where regulators step in to approve of the horizontal integration. Strategic alliances might offer a possible solution because they allow for firms to cooperate with each other while staying independently, and depending on the type of alliance they are usually not included in concentration figures because they do not always involve equity. In the next chapter I will discuss each external growth strategy separately and explain why a firm would choose one or another even though they are not mutually exclusive.
The motivational drivers of horizontal integration strategies The airline business case 17
2.3 Horizontal growth strategies
In this part I will explain the two types of external growth strategies that I mentioned before in the first chapter: M&A (mergers and acquisitions), and strategic alliances. The former strategy is one of integration and the latter is one of cooperation. Both strategies can have similar objectives; resource combinations and synergy exploitation (Delfmann et al., 2005). Because the two strategies can share the same set of objectives, they can be considered as strategic substitutes (Sawler, 2005). First I will explain what each strategy contains and then I will use the decision‐making framework of Hoffmann and Schaper‐Rinkel (2001) to explain the choice between strategies in a generic sense. Integration: Mergers & Acquisitions (M&A) Both mergers and acquisitions are characterized by hierarchy‐based decision‐making, which differs from the consensus‐based decision‐making in cooperative strategies such as strategic alliances (Delfmann et al., 2005). Even though integrative strategies and cooperative strategies share some strategic objectives, some objectives can only be achieved through integrative strategies: increase revenues and market share, taking over inefficient management and capital investments, and satisfy the management’s desire for a new challenge or prestige (Delfmann et al., 2005). Another difference between the two types of strategies is that integrative strategies actually take away competition; their competitive effects are larger than those of cooperative strategies, especially in the case of horizontal M&A (Delfmann et al., 2005). Moreover, M&A’s are of a more permanent nature than cooperative strategies (Sawler, 2005). The terms mergers and acquisitions are often used interchangeably defined by a process of combining two or more firms together to create synergy and increase value. However, there is a difference between the two terms. In mergers ownership shares between the companies are equally distributed and the two firms continue as one new entity together, whereas in acquisitions one company takes over a majority of the shares of the other firm and continues alone (Investopedia, n.d.). In spite of the fact that many M&A fail and sometimes even destroy shareholder value, there is a continuing increase of global M&A activity. Apparently the benefits offset the potential threats of shareholder destruction (Mtetwa, 2011). Cooperation: Strategic Alliances Collaborative strategies are hybrid forms of organization where firms decide to share resources while remaining independent. They can take many different forms such as; contractual agreements, minority equity investments, and equity joint ventures (Mayrhofer, 2004). Because of the numerous types of collaborative strategies, much confusion still exists around the concept. In this study I will use the term strategic alliances for the total range of collaborative strategies. I define strategic alliances as voluntary cooperative inter‐firm agreements to improve their competitive position and performance by sharing resources (Ireland et al., 2002). Alliances are characterized by mutual interdependence making each partner vulnerable to its partner’s actions (Ireland et al, 2002). Das and Teng (2000) distinguish between the following types of alliances: Joint Ventures (JVs), minority equity alliances, bilateral contract‐based alliances, and unilateral contract based alliances. Bilateral contract‐based alliances
The motivational drivers of horizontal integration strategies The airline business case 18
require partners to put in resources and work together on a continuous basis so that they are integrated in a tight manner. Examples are: joint R&D, joint marketing, joint production and enhanced supplier partnership (Das &Teng, 2000). Unilateral contract‐based alliances embody a well‐defined transfer of property rights such as; licensing, distribution agreements and R&D contracts. Key is that each firm carries out its obligation independently of each other and the level of integration is relatively low (Das & Teng, 2000). Another distinction can be made between equity and non‐equity alliances, where equity alliances come closer to actual integration through M&A. More specifically, I will focus on horizontal alliances, which can also be called quasi‐horizontal integration (Anderson, 1995) or scale alliances (Dussauge et al., 2000). Scale alliances are those where the partners contribute similar resources pertaining to the same stage in the value chain and will produce significant economies of scale and can reduce excess capacity. Such alliances provide a way of avoiding or postponing mergers and acquisitions (Dussauge et al., 2000). Horizontal alliances between potential competitors are different from vertical alliances in that they do not tap resources outside the focal industry. Moreover, strategic alliances with competitors are proven to be more difficult to manage which explains why firms usually only engage in few horizontal alliances (Hamel et al., 1989). As a result, as the number of horizontal alliances increases the pool of potential partners will decrease (Silverman & Baum, 2002). Thus, horizontal alliances keep rivals from forming similar alliances while having no beneficial effect on the resource base available to an industry (Silverman & Baum, 2002).
Integrate or cooperate?
Whether a firm chooses to integrate, cooperate or use a combination of the two is a complex decision and the choice is influenced by many internal and external factors. Hoffmann and Schaper‐Rinkel (2001) developed a generic context‐dependent framework to clarify the choice between M&A and strategic alliances. They distinguish between environmental, transactional (relational), and company characteristics, and say that these three main factors are of influence on the relative favorability of either M&A or strategic alliances. The framework is based on the need for control and strategic flexibility which is what distinguishes the two strategies from each other; M&A have a relatively high level of control and strategic alliances are usually characterized by relatively high level of flexibility. Hoffmann and Schaper‐Rinkel (2001) stress that there is not one rule for the choice to either acquire or ally and that their findings need to be put in the context of other influencing factors of the specific firm and industry. According to Hoffmann and Schaper‐Rinkel (2001), a high need for strategic flexibility and a low need for control favor a web of contractual collaborations. On the contrary, acquisitions are the best choice in the case of low need for strategic flexibility and high need for control. Equity JVs are preferred if both the need for flexibility and control are high. A minority interest provides additional information and control rights and increases commitment of the patterns but reduces strategic flexibility. The decision matrix that Hoffmann and Schaper‐
The motivational drivers of horizontal integration strategies The airline business case 19
Rinkel (2001) created is shown in figure 4. In their decision‐making matrix it is also shown that the need for control increases when high transaction specific investments are necessary, when there is a high risk of behavioral uncertainty (opportunism) and when there is a weak appropriability regime. But the need for control decreases in the case of high absorptive capacity. The need for strategic flexibility increases in the case of high strategic uncertainty (emerging markets and technologies), in the case of dispersed knowledge and because of limited resource endowment. However, the need for strategic flexibility decreases in the case of persistence of economic synergies.
Figure 4: Decision matrix on external growth strategies
Source: Hoffmann, W. H., & Schaper‐Rinkel, W. (2001).
Thus, Hoffman and Schaper‐Rinkel (2001) show that there is a tradeoff between the need for control and strategic flexibility and offer a schematic overview of a continuum of organizational modes along this tradeoff (figure 5). This gives a clear overview of the different types of inter‐organizational relationships along the level of flexibility and linkage intensity.
The motivational drivers of horizontal integration strategies The airline business case 20
Figure 5: Continuum of inter‐organizational relationships
Source: Hoffmann, W. H., & Schaper‐Rinkel, W. (2001).
Although not explicitly mentioned in their framework, path dependency was revealed in their study to be of influence on company behavior; the preference of the firms or their decision makers becomes involved. This results from the firm’s past experience with different types of growth strategies; as long as a firm’s perception of new situation matches previous ones, a pattern of external growth that was successful in the past tends to dominate in future developments (Hoffmann & Schaper‐Rinkel, 2001). This finding coincides with the path dependency theory explained in the first chapter of this literature review. Sawler (2005) extends this framework and also takes into account cost savings and profitability, which can differ between the strategic alliances and M&A and thereby takes a TCT perspective. He considers the tradeoff between integration costs and appropriation concerns which both raise transaction costs. More specifically, differences in costs savings arise from the ability of both strategies to realize economies of scale; mergers can achieve greater economies relative to a strategic alliance, but alliance can be useful to avoid dis‐ economies. In horizontal transactions where the cost savings from the two strategies are almost the same, the competitive balance within the industry must also be taken into account. The conclusion is that when all other factors remain equal, a horizontal alliance where partners cooperate in production or development but market the resulting product independently is more profitable than a horizontal merger. This is because the alliance enables the partners to realize the savings arising from combining some of their operations while avoiding the problem of the ‘merger paradox’ where market share is transferred to non‐merging parties. Thus, from this point of view strategic alliances do not serve as a substitute for M&A, they rather are preferred because they can actually be more profitable.
The motivational drivers of horizontal integration strategies The airline business case
Chapter 3. Network Economies
As mentioned in chapter 2, horizontal integration in industries with strong network externalities is not necessarily negative and can actually lead to lower prices and improved quality. This is why in this chapter I will explain what network industries are and how network economies work. Many industries are characterized by their network, such as: transportation, communications, information, and railroad networks (Economides, 1996). Networks can reveal positive consumption externalities which means that the value of a good increases with the expected number of units sold (Economides, 1996). Or in other words: the utility of a good increases with the number of persons consuming the good in the same network (Katz & Shapiro, 1985). Moreover, network industries have a peculiar characteristic; the coexistence of incompatible products may be unstable and a single winning standard dominates the market due to the customers’ expectations of the ultimate size of the network (Besen & Farrell, 1994). Another feature of network industries is its path dependency. Both firms and customers make their decisions based on sizes of installed base and on expectations of growth over time, thus advantages such as a first‐mover advantage can have long run effects for a firm’s success (Economides, 1996). In short, small differences in either perception or reality can be magnified in a process in which some firms make extremely large profits, and in which dominant market positions are hard to change (Besen & Farrell, 1994). The networks of these industries are composed by links that connect nodes with each other. Depending on the structure of the network, a multiple number of components are necessary to provide a particular service; network components are complementary to each other and provide a certain outcome in combination with each other (Economides, 1996). The combination of various components will not result in identical outcomes. Thus a network will provide substitutes made of complements (Economides, 1996). A distinction can be made between one‐way and two‐way networks. Two‐way networks are those where the outcome of the composition differs, examples are railroads, road, and telecommunications networks. When there is a difference between the compositions but the outcome is the same, the network is called a one‐way network, an example of these networks is broadcasting (Economides, 1996). A crucial relationship in both types of networks is the complementarity between the pieces of network (which is the main explanation for network externalities). Compatibility however, is what makes complementarity actual (Economides, 1996). The degree to which different compositions are compatible determines the network boundaries of the customer (Garud & Kumaraswamy, 1993). Katz and Shapiro (1985) present two ways to ensure compatibility. One way is by jointly adopting a standard (given set of firms must act together to make their products compatible), and another way is through the construction of an adapter where one firm can make its products compatible with those of others. When network externalities are large, the compatibility choice of firms will be one of the most important dimensions of the market performance (Katz &Shapiro, 1985). On a horizontal level, which is the focus of this study, firms’ choices are either to make their products compatible with those of rivals (competing within a standard), or to make them incompatible (competition between standards) (Besen & Farrell, 1994). In the next paragraph I will
The motivational drivers of horizontal integration strategies The airline business case
explain how this general network theory is applied to the commercial airline industry and how it affects horizontal integration and the mode of integration.
Networks and airline consolidation
Airlines cooperate to join up their networks because consumers want network scope and depth, and the economics of providing this are prohibitive for a single airline. Before applying the network theory to the commercial airline industry, I will first explain some concepts that are important for understanding network economies in the airline industry: economies of scale, scope and density. When airlines are being merged, economies of scale (reduction in costs per unit as production increases) allow airlines to spread their fixed costs over a greater network. Economies of scale are common in capital‐intensive industries with high fixed costs (Vasigh et al., 2008). An airline will realize economies of scope when it expands its route network with new routes. Economies of scope exist when the firm achieves saving as it increases the variety of goods/services and are defined in terms of relative total cost of producing a variety of goods together in one firm versus separately in more firms. Thus, multiple goods/services/projects/processes can be more cost‐efficient when performed together rather than individually. Airlines achieve economies of scope by operating multiple additional programs or services such as frequent flyer plans (FFP), and also in a spatial manner because things such as personnel and maintenance are already in place at the point of origin and their costs can now be spread over more units of output. Network scope will be especially important for business passengers who require service to a wide range of destinations. Economies of scale and scope can both be achieved by connecting different networks. On the other hand, economies of density are not achieved by adding new routes, rather by using existing processes more intensively and effectively (consolidation of operations) and create a denser flow of passengers, which increases seat utilization. Economies of density in the airline industry can be achieved through the use of hubs, larger aircrafts, and by intensifying ground operations processes that in turn lead to cost reductions and higher flight frequency due to shorter connecting times (attracting more passengers). Connecting feeder traffic in a hub‐and‐ spoke system can improve the passenger flow density on a city‐pair, allowing airlines to operate larger, more efficient aircraft and to spread end‐point fixed costs over a larger number of passengers (Pearce & Doernhoefer, 2011). A combined network in an alliance relationship can bring improved traffic density to both spoke to hub, and hub‐to‐hub routes. Increased demand drives better utilization of capacity that in turn boosts profitability. However, for more distant forms of alliances such as codesharing, maximizing economies of density is limited. In the absence of a JV, alliance partners will operate separate services on a hub‐to‐hub route. This will divide traffic between the two separate operations, whereas under a JV, the airlines would operate as a single entity, allowing the use of larger aircraft and maximizing the efficiency gains (Pearce & Doernhoefer, 2011). As mentioned in the previous section, networks are composed by links that connect nodes with each other. In the airline industry two types of route networks can be distinguished: hub‐and‐spoke network or point‐ to‐point network (Vasigh et al., 2008). Under the regulated system that existed in the USA before 1980, airlines faced constraints on both their fares and route structures. However, since the deregulation, which provided
The motivational drivers of horizontal integration strategies The airline business case 23
airlines with more freedom of entry and exit, it also allowed for more rationalization of route structures (Brueckner, 2004). This led to an increase of hub‐and‐spoke networks; by concentrating traffic on the spoke routes in and out of hub airports, airlines could exploit economies of density or increasing returns at the route level by reducing the number of flights (Brueckner, 2004). With the use of hub‐and‐spoke networks, flights from many different cities come together on a single airport (hub) at approximately the same time and after letting passengers transfer to their connecting flights, all flights leave the hub for different city destinations. Burton and Hanlon (1994) describe that by creating larger networks increased concentration can result in greater market power and significant economies of density as a strong hub‐and‐spoke system protects its traffic from being diverted to another airline on its way. Hub airlines derive market power not only from airport capacity constraints but also from passengers’ loyalty advantages that airlines with large presence in a given city derive from loyalty programs (Burton & Hanlon 1994). When airlines consider M&A and/or strategic alliances, one of the first evaluations is the effect on network structure; the level of network complementarity/parallel or the level of dominance of the airlines involved (Shaw & Ivy, 1994). When airlines merge it immediately affects its network structure in terms of geographic coverage of cities and routes, overall connectivity and hub‐and‐spoke patterns (Shaw & Ivy, 1994). Park et al. (2001) study two types of airline (alliances) based on their network characteristics: complementary and parallel alliances. Complementary alliances occur when two firms link up their existing network and build a new complementary network to feed traffic to each other (Park et al., 2001). A parallel alliance refers to two firms who, prior to their alliance, are competitors on some routes of their network (Park et al., 2001). It is important to make this distinction between networks because they can have different outcomes. Complementary networks of two different airlines can lead to double marginalization: each airline involved on the route (A ‐> B ‐>C) sets its own price and therefore two different profit margins. In case of an alliance or M&A between these two different airlines the double margins are eliminated which will in the end decrease the price for consumers (Horan, 2010). This does not happen when the two airlines in the alliance or M&A have parallel networks. This latter argument is also one of the main arguments for the US Department of Transportation to approve of (or grant Anti Trust Immunity which will be discussed in chapter 4) alliances between airlines. Park et al. (2001) found that partners in a complementary alliance are likely to increase traffic output opposed to their rival firms who are likely to decrease both output and profit as a result. Moreover, complementary alliances are likely to decrease price and hence consumer welfare will increase. However, parallel alliances are likely to decrease total output and increase full price in a market where the alliance is formed. Hence, consumer welfare will decrease in the case of parallel alliances and the most important outcome for the firms involved is increased market power (Park et al., 2001). Thus, as explained in the previous section, network complementarity is also a crucial component in the airline industry as well to achieve positive network externalities and hence increase customer welfare, and also to increase revenues (output). This explains why route networks and hub airports play such an important role in the partner choice for M&A and/or alliances.
The motivational drivers of horizontal integration strategies The airline business case 24
Chapter 4. Consolidation in the commercial airline industry
In the second part of this study I will focus more specifically on the commercial airline industry itself. In order to understand and analyze the specific business cases that will be discussed later in this study, it is relevant to get a notion of their context and how the industry as a whole has developed with regard to consolidation. So having presented the literature on the topic of horizontal integration in the value chain in the previous chapters, in this part I will describe how this horizontal integration matter has influenced the commercial airline industry as a whole. In this chapter I will focus on the commercial airline industry in the US and Europe because these have been the most dominant parts of the global airline industry. I will start by explaining why this particular industry is consolidating, and then I will describe how the industry in Europe and the US has changed in the last 20 years. Third, I will present the current state of consolidation in the commercial airline industry.
What are the underlying forces that drive the need in the airline industry to collaborate or consolidate from a theoretical point of view? Fan et al. (2001) identified five main forces at macro‐level that are influencing the trend towards consolidation. The first one is increased globalization in trade and air transport, which creates an increase in demand for more international travels. Secondly, increased intra‐regional interaction (or a sense of regional identity as the authors call it) as a counter part of globalization. Third, there are strong economic incentives for airlines to consolidate and operate at large, dense networks. Fourth, the airline industry is not yet totally liberalized because the granting of most international air traffic rights to specific airlines is based on the country of ownership of the airlines, and limited foreign ownership for major airlines. The final force of influence is anti‐trust concerns. As mentioned briefly in the five trends (Fan et al., 2001), on the cost side, economies of density have been known to be a major advantage of larger networks (Fan et al., 2001). On the revenue side, a stronger market position may translate into higher airfares and hence increased revenues. Even though this is an advantage for the firm it possibly hurts consumer welfare (Fan et al., 2001). Burton and Hanlon (1994) state that globalization is the main reason in business in general for firms to collaborate and explain why alliances are preferred over consolidation. They base their argument on Ohmea’s globalization thesis that it is purely the scale of contemporary global industries and markets that requires inter‐firm collaborations (to share sunk costs and exploit economies of scale) as opposed to establishing large global enterprises. When applied to the airline industry, the opportunities lie in reaping economies of scope rather than scale; there are no particular advantages in a large firm size per se, but advantages do exist on the marketing side (frequent flyer programs) and by exploiting hub‐and‐spoke systems (economies of traffic density as I explained in the previous chapter) (Burton & Hanlon, 1994). From a marketing perspective, airlines want to offer the best global network possible for their customers. Moreover, one of the most valuable marketing advantages in forming alliances is to arrange a mutual exchange of frequent‐flyer‐programs, which in turn will increase loyalty of business travelers to certain airlines or alliances (Burton & Hanlon, 1994). Economies of density are achieved through the consolidation of operations (Vasigh et al., 2008). This concept is very much applicable to the commercial airline industry where firms have
The motivational drivers of horizontal integration strategies The airline business case 25
found it to be more cost‐effective to consolidate operations at a single airport that is used as a hub (Vasigh et al., 2008). Evans (2001) makes a distinction between external and internal drivers for consolidation. Internal drivers include: risk sharing, economies of scale, scope and learning, access to resources, and shaping competition. External drivers are: the information revolution (CRS systems), economic restructuring (deregulation), and global competition. Overall, all these different studies come up with similar motivations for the airline industry to consolidate. Firstly, consolidation is market driven and influenced by globalization and elimination of regulatory barriers. Second, on the costs side there are strong incentives to operate on dense networks and exploit economies of scope and density. Finally, on the marketing side, a stronger market position may increase revenues and the mutual exchange of loyalty programs will increase customer loyalty.
Industry developments since deregulation in Europe and the US
In this section I will present a brief overview of the industry developments with regard to consolidation since the liberalization of the commercial airline industry in Europe and the US. The following sections will go into more detail and depth with regard to both M&A transactions and alliance formations. The first country that started with deregulation of the airline industry was the US, later on other regions and countries replicated these ideas. In 1978 the US airline industry was deregulated. This triggered a structural change in the entire industry as it provided airlines with freedom on fares and route structures. In the EU, this deregulation occurred later and was more gradual than in the US. One of the first steps towards transnational consolidation was taken in 1992; the US and the Netherlands governments agreed to an Open Skies bilateral air treaty. The US granted Northwest Airlines and KLM full antitrust immunity (ATI), thus allowing the two airlines to market, schedule, and price joint services to essentially operate as a single competitor. The last step in the EU was taken in 1997 when the Single Aviation Market came into full effect which removed borders and allowed for free competition between all EU licensed airlines. By the end of the ’90‐s, the US domestic airline deregulation had been replicated inside Europe and distinct market segments had emerged in both the US and Europe (Chan, 2000). Many US ‘legacy’ airlines achieved substantial cost efficiencies through consolidation and through the adoption of the hub‐and‐spoke system, which allowed for a rationalization of the route structure (Brueckner, 2004). By using this type of network, airlines could exploit economies of density because traffic is concentrated on the spoke routes in and out of hub airports which reduce the costs per passenger and hence airfares (Brueckner, 2004). In Europe however, airlines were more or less already structured around hub airports with an international feeder system, which used to be protected by regulatory authorities. But after deregulation these regulatory authorities were not in place anymore and new defensive strategies were necessary to protect their dominant position at their hub airports. Therefore, European airlines chose to use pre‐emptive (keep competition away by restricting foreign acquisitions) and defensive strategies (consolidating its position of dominance on home ground resulting in one major, national airline) (Chan, 2000). Freedom of entry and exit also gave rise to low cost carriers
The motivational drivers of horizontal integration strategies The airline business case 26
(LCCs) that quickly appeared in Europe and opened up new markets, but they also entered the markets of established legacy airlines. In short, despite small differences in the evolution of the airline industry in both the US and EU, ultimately similar competitive dynamics took place (European Commission & US Department of Transportation, 2010). Both markets are currently divided into pre‐deregulation legacy airlines and post‐deregulation low‐fare airlines. The larger European airlines have historically focused on intercontinental flights, which also remained after the deregulation of the industry. The US airlines needed to change their business models because pre‐ regulation legacy airlines could not keep up with the new airlines that focused on building a strong domestic network (new domestic majors) and struggled with their adaptation to the new deregulated market (especially because these airlines were still organized around a linear system without international feeders) (European Commission & US Department of Transportation, 2010). This has caused several major US legacy carriers (PanAm and TWA) into liquidation or bankruptcy protection (Vasigh et al., 2008). As a result, the US airlines that exist today are offspring of the new major domestic airlines and hence relatively new to international operations compared to their European counterparts. Figure 6 shows the market share of the top 20 airlines since the deregulation of the industry. It shows that each step in this global liberalization process has contributed to the consolidation of the global industry, and that especially the last years have significantly contributed to this process. This latter development will be discussed in the next section. This figure is extracted from a report of the Deutsche Bank about airline consolidation, and should be interpreted as an estimation of the industry development because the data behind these calculations are not public. M&A in the US As mentioned earlier in the previous sections, deregulation has led to a natural decrease of players in the US commercial airline industry because some airlines just could not keep up with the developments in the industry. Bankruptcy was the result of rising debts, higher aircraft costs, price wars and declining business traffic. By 1992, Midway, Pan Am, and Eastern had been liquidated and America West, Continental and TWA were in bankruptcy (Chan, 2000). However, many bankrupt airlines were able to continue flying ‐because the US established special laws regarding bankruptcy (Chapter 11) which put pressure on the other remaining airlines (Chan, 2000). Right after deregulation in the US in 1978 mergers rapidly increased; in the ten years after deregulation 51 airline mergers and acquisitions took place, which resulted into six major airlines (Dempsey, 1990). The mergers took place in the first years after deregulation in the US and generally followed two themes: merging to eliminate competition at hubs or specific routes, or merging to expand geographic coverage (Shaw & Ivy, 1994).
The motivational drivers of horizontal integration strategies The airline business case
Figure 6: Market share of top 20 global airlines: 1974‐2015E
Source: Linenberg et al. (2012).
Twenty years after the start of deregulation, the US airline industry consolidated into two market segments: the hub‐and‐spoke segments dominated by the established airlines (new major domestics), and the regional markets serviced by point‐to‐point airlines lead by Southwest Airlines (Chan, 2000). Thus, the US airline industry already experienced a previous airline consolidation period in ‘80’s and ‘90’s (right after the liberalization of the market) and yet the market share of the top four airlines never seemed to get much higher than 60% (Linenberg et al., 2012). In Appendix I an overview is presented of all M&A in the US since its deregulation in 1978. From this overview it can be stated that by the ‘90’s the industry had already consolidated into seven major players and some smaller airlines around it. In the last five years the merger of Delta and Northwest, and United and Continental has narrowed this down even further. Figure 7 presents the market share (domestic and international RPM) of the top four US airlines in the last decade. This shows that the recent waves of M&A in the US has significantly contributed to consolidation. Consolidation can be measured in two different ways: (1) the concentration ratio and (2) the Herfindahl‐Hirschman Index (HHI). The concentration ratio is a measure of the total market share held by a certain number of firms in the industry. The most used concentration ratio is the four‐firm concentration ratio, where the output of the four largest firms in the industry is measured. When the four‐firm ration is less than 20%, the market is assumed to follow the dynamics of a perfectly competitive industry (Vasigh et al., 2008). When the concentration ratio is higher than 80%, the market is highly concentrated and closer to a monopoly. The middle of this spectrum represents monopolistic competition (20‐50%) and oligopolies (50‐80%). The HHI is another way to measure consolidation in an industry, and is measured by squaring the
The motivational drivers of horizontal integration strategies The airline business case 28
market share of each of the players and then adding those up. Thus, the higher the index, the more concentration and (within limits) the less open the market. By squaring the market share, firms with a large share receive more weight in the calculations than those with a smaller share. A market with a result of less than 1000 is considered to be competitive, and those higher than 1800 are considered to be highly concentrated (Vasigh et al., 2008). The HHI is frequently used by the Department of Justice to determine if a proposed merger is acceptable for antitrust reasons. Today (2012) the major US players in the airline industry are the following: Southwest Airlines, Delta Air Lines, United Airlines, US Airways and American Airlines (the last two are currently considering a merger). The merger of Southwest and AirTran in 2011 is the first one that is a full LCC merger. From figure 7 it can be concluded that indeed the US commercial industry has become highly concentrated in the past few years (since 2010). When the merger between US airways and American Airlines will continue and approved of, the industry will be even more concentrated.
Figure 7: Share of top four US carriers ‐ based on system RPMs, 2000‐2012E
Source: Bureau of Transportation Statistics (BTS) and Deutsche Bank Airline Research
M&A in Europe After the deregulation in Europe, airlines started using defensive strategies in order to protect their dominant position in their home market. This mainly included M&A by the dominant airlines with smaller players. This locking‐in of locally based small and medium airlines was a strategy employed by many Western European legacy airlines (Chan, 2000). Air France for example, contracted TAT and Brit Air to operate services on its behalf (Chan, 2000). In the final stage of the European airline industry liberalization more cross‐border acquisitions took place. BA’s acquisition in 1992 of 49% in the German Delta Air is an example of such a case (Chan, 2000). The table below is based on the study of Németh and Niemeier (2012) and provides an overview of approved M&A by the
The motivational drivers of horizontal integration strategies The airline business case 29
European Commission. This study however, only shows those M&A that were large enough to be approved of by the European Commission, the smaller ones are not included in their data. It shows that most M&A indeed took place between a dominant and a smaller airline, with the exception of Lufthansa/Swiss Air, Air France KLM and British Airways/Iberia (International Airlines Group). These last two groups plus Lufthansa (also including Austrian and Sabena) are currently the largest players in Europe. Do note that these firms operate a hub‐and‐spoke network and that point‐to‐point low cost airlines such as Air Berlin, Ryan Air and Easyjet also play an important role in the European airline industry.
Table 2: Approved airline M&A in Europe by European Commission
Airline M&A approved by European Commission
Year Airlines 1995 1996 1997 1997 2002 2004 2005 2005 2008 2009 2009 2009 2010 Swiss Air/Sabena British Airways/TAT British Airways/Air Liberté KLM/Air UK SAS/SpanAir AirFrance/KLM Lufthansa/Eurowings Lufthansa/Swiss Airways KLM/Martinair Lufthansa/Austrian Airlines Lufthansa/British Midland Airways Lufthansa/SN Brussels Airlines British Airways/Iberia Result 49.5% ownership by Swiss Air full acquisition by BA 70% ownership by British Airways 55% ownership by KLM 74% ownership by SAS full acquisition by Lufthansa full acquisition by Lufthansa full acquisition by Lufthansa 55% ownership by British Airways
Source: Német & Niemeier (2012).
After deregulation, European airlines started facing competition from US airlines that had been able to expand their international presence by leveraging their strong domestic networks. The European airlines were still prohibited to access the US domestic market and were initially in favor of restricting traffic rights to and from member states in order to protect their own competitive position. Later, they agreed to the first forms of cooperation; codesharing and marketing agreements, to cope with their changing competitive landscape (DOT and European Commission report, 2010). At that same time, the US airlines sought for more cost‐effective access to European destinations and also for increased brand awareness, which resulted in a need for closer ties with other airlines. The network airline business model that arose after deregulation, in both the US and Europe, is based on a ‘from anywhere to everywhere’ principle. No airline by itself though, is able to efficiently serve every requested destination. Thus, in order to meet customer demands, airlines seek partners that can help them provide better network coverage. As mentioned earlier in this chapter, one of the first steps in airline alliances was taken in 1992; the US en the Netherlands agreed to an Open Skies bilateral air treaty. The US granted Northwest Airlines and KLM full antitrust immunity (ATI). The partners of the alliance or JV that has been granted
The motivational drivers of horizontal integration strategies The airline business case 30
ATI are allowed to essentially operate as one single airline. Under an ATI JV, the partners can split revenue or profits. These JVs are driven by the objective of metal neutrality; the airlines involved are indifferent to which aircraft carries a passenger. ATI is usually granted on the condition that a country is a signatory to an Open Skies agreement, but that does not guarantee the granting of antitrust immunity (Linenberg et al., 2012). The three globally branded alliances (Star Alliance, Skyteam and oneworld) received ATI for their key EU and US members to form such JV’s. Currently, the larger airlines in both the EU and the US face competition from LCCs in their markets, and depend increasingly on revenues from long‐haul international routes. To remain competitive these airlines face two challenges: expanding their global network and increasing their competitiveness regarding the cost side (European Commission & US Department of Transportation, 2010). To address the first challenge, airlines continue to broaden and deepen their global network integration with alliance partners (European Commission & US Department of Transportation, 2010). Alliances may give opportunities for its members to reduce costs by coordinating activities in multiple fields, which in turn may increase the competitiveness of its members (Park et al., 2001). Alliances also bring other benefits, but the differing degrees of cooperation give rise to different types and levels of benefits. The following benefits apply to a basic alliance membership (European Commission & US Department of Transportation, 2010). First, strategic/global alliances allow airlines to link their networks and sell tickets on the flights of their partners. Second, members in an alliance aim to provide value to customers by creating a comprehensive route network, better coordinated schedules, single on‐line prices, single point check‐ in, coordinated service standards, and reciprocal frequent flyer programs. Third, through a wider network, airlines can also benefit of improved brand recognition. Fourth, alliances can improve access to feeder traffic of alliance partners (especially for long‐haul services) because airlines in an alliance tend to favor their alliance partners in the financial terms of their interlining and choose them for code sharing. With the increasing membership of alliances it may be difficult for others to secure feeder traffic at some airports and can therefore encourage them to join an alliance. Fifth, alliance partners are also better able to address the needs of corporate customers, which may lead to a single contract. Finally, members may also together finance expensive projects by pooling resources (especially IT related investments) or benefit from joint procurement decisions. Airline alliances are also motivated by regulatory barriers such as; limitations on foreign ownership and traffic rights (Park et al., 2001). Most countries have strict citizenship requirements for the ownership of their ‘flag’ airlines. Besides national ownership restrictions, bilateral aviation agreements also include restrictions on
ownership. Before an airline can operate internationally to another country, the governments of the countries in
question must first negotiate about an agreement, which is known as a bilateral air services agreement. These bilateral agreements include clauses with regard to traffic rights, capacity, designation, and ownership. Today, international aviation is regulated by a complex web of over 3000 interlocking bilateral air services agreements. The US for example, has restricted ownership of its airlines to 25% of the voting equity since the 1930’s. Moreover, two‐third of the Board members must be US citizens and key management positions are required to be
The motivational drivers of horizontal integration strategies The airline business case 31
held by US citizens (Linenberg et al., 2012). One of the main reasons of these restrictions is that airlines have historically been viewed as an industry that is critical to a country’s national security; during times of war, aircrafts are ‘conscripted’ by the military into service as troop transports. Thus, if foreign interests control a local airline, how can they be forced to cooperate during times of war? Another reason is that foreign ownership restrictions represent a form of protectionism for labor unions that see foreign competition as a threat to their earnings power and job security (Linenberg et al., 2012). Ownership restriction together with high investment barriers for internal development, are usually seen as the reasons why airlines choose for strategic alliances over M&A’s. Barla and Constantatos (2006) however, show that strategic reasons may also enhance the desirability of strategic alliances over M&A and extend the findings of Sawler (2005) to the commercial airline industry specifically. They found that partial cooperation instead of M&A may be more profitable. The cost synergies necessary for alliances to be as profitable as acting alone are less important than the corresponding costs for M&A, which would make strategic alliances more attractive because they are of less threat to the competition (Barla & Constantatos, 2006). Another difference between alliances and M&A is that the latter strategy is always bilateral whereas an alliance can be multilateral. An alliance can be extended to more than two partners and thereby also disproportionally increase mutual network benefits along these multiple partners. As described in the previous section reasons and benefits for entering into a cooperative agreement vary widely, which also counts for the details of the particular cooperation. A first type of distinction between alliances can be made with regard to their networks: complementary and parallel alliances. In the previous chapter I already discussed the importance of route networks and hubs for airlines. A second type of distinction can be made with regard to the intensity of cooperation; tactical and strategic alliances (European Commission & US Department of Transportation, 2010). Tactical alliances are formed to address a specific deficiency in the airlines’ networks, they usually involve only two airlines and cover a limited number of routes with the only objective to provide connectivity to each other’s’ networks. These alliances often involve at least one independent airline that is not a member of a larger strategic alliance. Examples are: Virgin Atlantic/Continental (code sharing), American/JetBlue (interline and frequent flyer program arrangement), AirFrance/FlyBe (code sharing). Many airlines that provide international services though, prefer to join one of the three branded strategic alliances; Star Alliance, SkyTeam, or Oneworld. Membership does not keep them from also forming tactical alliances with non‐ allied airlines and in some cases members of other strategic alliances (European Commission & US Department of Transportation, 2010). Members of these strategic alliances coordinate on a global basis to create the largest possible worldwide network. (European Commission & US Department of Transportation, 2010). These types of alliances include basic/tactical types of alliances (code sharing, frequent flyer programs and lounge sharing), but some alliance members seek higher levels of cooperation within the alliance to enhance the benefits of the alliance.
The motivational drivers of horizontal integration strategies The airline business case
Table 3 is based on the DOT and European Commission report, 2010) and shows the level of integration among existing strategic alliance members. The most highly integrated members (which are also the founding members) of all three alliances have launched a merger‐like Joint Venture and typically involve full coordination of major airline functions on the affected routes (European Commission & US Department of Transportation, 2010).
Table 3: Integration among alliance members Star Alliance 25 (all Low Medium High
Oneworld 11 (all members) 5 3
Skyteam 15 (all members)
members) 9 3
The trend towards joining a strategic alliance may not necessarily represent consolidation because that highly depends on the level of integration within the alliance and whether this is of tactical or strategic nature. Moreover, in order to decide whether cooperation leads to less competition one also has to take into account network complementarity. Figure 8 shows the spectrum of airline cooperation forms. Airlines that participate in a revenue‐ or profit seeking (the latter also shares costs) JV with anti‐trust immunity from DOT engage in the highest form of integration. Their strategic goal is to become effectively indifferent to which plane carries a passenger, and hence is a close substitute of a merger because it usually involves full coordination of the major airline functions on the affected routes (scheduling, pricing, revenue management, marketing and sales).
Figure 8: Continuum of alliance integration
Note. Based on: European Commission & US Department of Transportation. (2010).
According to the market research conducted by Linenberg et al. (2012) from the Deutsche Bank, the growth of airline ATI joint ventures coincided with the development of global airline alliances, and in most cases these JVs formed the basis of the alliance. Currently, airline alliances account for 59% of global capacity and represent a significant share (>75%) of the major air corridors (figure 9)
The motivational drivers of horizontal integration strategies The airline business case 33
Figure 9: Alliances market share: June‐January 2012
Source: Linenberg et al. (2012).
Current state of consolidation
As described in the previous section, consolidation in the US mostly took place in the first years after deregulation because new players entered the industry and old ones had to keep up with the quick developments. Early consolidation in the US appeared in a ‘natural’ way through liquidations but also through mergers and acquisitions (Appendix I). Büttner and Burge (2008) report that the recent Delta‐Northwest merger will result in further consolidation of the US airline industry that is currently characterized by too many hubs. Further consolidation would offer better use of the capacities, avoid price wars, and cope with the high costs of fuel (Büttner & Burger, 2008). Earlier in this chapter, figure 7 already presented the increased market share of the top four US airlines in the last decade. Currently, they possess about 80% system‐wide (domestic and international) market share based on Revenue Passenger Miles (RPM). The pie chart (figure 10) below shows the system wide (international and domestic) market share of US airlines in 2011 based on RPM, and illustrates that the top 4 airlines (United, Delta, American Airlines, and Southwest) together represent more than 75% of the US market (79% precisely). This coincides with the market share numbers presented by Linenberg et al. (2012) from the Deutsche Bank, and thus it can be concluded that indeed the US airline industry is already highly concentrated and will be even more in case of the American/US merger continues.
The motivational drivers of horizontal integration strategies The airline business case 34
Figure 10: US Airlines system wide Market Share (2011) based on Revenue Passenger Miles
RPM system wide 2011
2% 3% 2% 4% 8% 1% 1% United (plus Continental) 25% Delta American Airlines Southwest (plus Airtran) US Airways 14% 23% 17% Jet Blue Alaska Sky West Frontier Hawaian American Eagle
Note. Based on: Rita (n.d.). Airline market shares January 2011‐February2012.
In Europe, airlines have to deal with both EU and national regulations and policies. Moreover, because of the different nations involved, it is fairly difficult to obtain an overview of concentration ratios for all European airlines. From all the reports and statistics that I could find, there was not one that could give a clear picture of the European airline market share (including both flag‐ and low fare airlines and within and outside Europe traffic). In the following section I will try to give a reflection of what the European airline industry currently looks like. One thing is for sure; the European airline industry is less concentrated than it is in the US, but how much exactly remains vague. This is probably because the EU countries still have to deal with nationality clauses that complicate cross‐border mergers. A report by Booz&Co (Ringbeck & Gross, 2008) presents a 47% market share (2008) of passengers carried by European flag carriers for the top three major European airlines (Air France KLM, British Airways and the Lufthansa Group). This number however, does not include low cost carriers nor does it include M&A activities in 2009 and 2010. Another report (Büttner & Burger, 2008) states that the top five airlines in Europe have a combined market share of 31%. This last estimation though is not clear on what types of airlines it includes and on what type of ratio it is based. What does become clear from both concentration indications is that the ratio in Europe is significantly lower than in the US. When looking at the total number of passengers carried by European airlines the picture is much more fragmented. Based on an estimated compilation of Europe’s largest airlines by passengers carried in 2011, I created a table that shows a different picture of the industry. This one also includes low cost carriers and shows
The motivational drivers of horizontal integration strategies The airline business case 35
that the top four airlines represent only little over 50% of the European market. Important to note is that this table again is a rough estimation because it is based on the number passengers carried. When taking into account ASK’s (kilometer per passenger) airlines solely operating within Europe will drop on the ranking.
Table 4: Market share European airlines (2011) based on passengers carried Airline
Lufthansa Ryanair Air France KLM Easyjet IAG Turkish Airlines Air Berlin SAS Group Alitalia Norwegian Air Shuttle Aeroflot Vueling Pegasus Airlines Wizz Air Austrian Airlines Note. Based on: Wikipedia (n.d.). List of largest airlines in Europe.
Market Share Passengers carried (millions) 2011
18,51% 13,30% 13,19% 9,66% 9,00% 5,68% 5,53% 4,73% 4,35% 2,73% 2,45% 2,14% 1,97% 1,95% 1,96% 106,33 76,4 75,78 55,47 51,68 32,62 31,78 27,2 25 16,36 15,7 14,1 12,3 11,3 11,21 11,26
Swiss International Airlines 2,85%
Looking at the 10 largest European airlines in terms of total seats sold, a distinction can be made between intra‐European flights and total flights to/from European. Table 5 is based on information from CAPA (CAPA Aviation Analysis, 07/07 2012) and show that the top four airlines together possess less than 60% of the market in either situation. These figure though only include the ten largest airlines, hence results will probably be even more fragmented when the smaller ones are also included. Moreover, these figures consider (recently) merged airlines as separate entities. Thus, this final overview probably presents the best picture of the European airline industry.
Table 5: Top 10 European airlines
Total European flights
Airline 1 Lufthansa 2 Ryanair 3 Air France
Total seats sold 1.514.268,00 1.422.771,00 975.483,00 36
Total seats Airline sold 1.762.254,00 1 Ryanair 1.553.202,00 2 Lufthansa 1.133.750,00 3 easyJet
The motivational drivers of horizontal integration strategies The airline business case
4 easyJet 5 British Airways 6 Turkish Airlines 7 SAS 8 airberlin 9 Iberia 10 1.018.845,00 4 Air France 848.611,00 5 SAS 845.200,00 6 Turkish Airlines 685.091,00 7 airberlin 654.941,00 8 British Airways 549.554,00 9 Iberia 822.572,00 656.435,00 631.740,00 597.555,00 551.338,00 452.686,00 436.946,00 8.061.794,00 59%
Norwegian Air KLM Royal Dutch 530.878,00 10 Airlines Shuttle Total 9.582.326,00 Total
Top 4 57% Top 4 Source: CAPA Centre for Aviation (2012, 07/07).
Globally, the commercial airline industry shows even further fragmentation. In Appendix II an overview is presented of the world’s largest airlines based on the capacity per week (ASK’s) and this shows that the top four airlines (Delta, American, United and Emirates) together represent only 31% of the global market (CAPA Centre for Aviation, 04‐05‐2012). To conclude, the US commercial airline industry is already highly concentrated (leaning towards a monopoly) and might even become more concentrated in the future (possible American/US Airways merger), the market shares and concentration ratios in Europe are rather vague but all the data found indicate a less concentrated industry than in the US (oligopoly). Unfortunately I have not been able to find the exact same data for both the US and Europe which makes it difficult to compare and present a clear picture of the situation.
Chapter 5. Conceptual model and business cases
In the previous four chapters I have defined and explained the topic of horizontal integration in the value chain. Moreover, I have described the theories that underpin a firm’s need to grow, and also explained what factors influence the choice for modes of integration and/or cooperation. Besides generic motivations, the industry specific factors have been discussed in the previous chapter. Based on the framework of Hoffmann and Schaper‐ Rinkel (2001) that has been discussed in chapter 2, I created a table with driving factors for airlines to choose for a certain strategy and a corresponding conceptual model that explains the differences between the two strategies and their driving factors (table 6). These factors are sorted along three levels of analysis. The different factors included in this model have all been discussed in the previous theoretical chapters. Hoffman and Schaper‐Rinkel (2001) made a distinction between environmental, firm specific and relational/transactional factors involved in the choice for either a cooperative or an integrative strategy. When applied to the commercial airline industry their generic drivers can be combined with some industry specific drivers. The drivers themselves are located in the second column of table 6, the column next to it explains in keywords to what each driver relates to (which factors are involved). When these drivers are applied to either strategic alliances or M&A, they will differ in their nature, or in other words; the factors involved for each type of external growth strategy will be different. This is
The motivational drivers of horizontal integration strategies The airline business case 37
illustrated in the model shown on page 39 (figure 11). This conceptual model will be tested using two recent business cases that represent one type of external growth strategy each.
Table 6: Driving factors for airlines to choose a type of horizontal growth strategy
Level of analysis Drivers Environmental Firm Relational Legal constraints Degree of strategic uncertainty Marketing outcome Outcome competitive structure Financial position Social capital/embeddedness External growth experience Economic synergies Required investments Level of integration
Horizontal growth strategy choice for airlines
Factors involved national ownership restrictions and bilateral agreements (traffic rights), bankruptcy protection under chapter 11, antitrust legislation industry developments (globalization, profitability, new entrants, competition etc.) meet customer demands (larger network, frequent flights, good connections), merged loyalty programs, brand recognition increase market share (improve position) or keep up with competition (ensure position) by expanding route network weak or strong financial endowment (share risk or strengthen financial base) small or large current network/social embeddedness, human capital (labor unions) history of horizontal growth strategies achieve economies of scale and scope by combining (complementary/parallel) routes and hubs Transaction specific investments needed to create economic synergies low or high level of integration to create economies of density level of protection, similarity of firms size and competitive position of partner and financial position
Degree of behavioral uncertainty Level of interdependence
In order to answer the research question of this study ‐ What types of horizontal growth strategies with regard to value chain integration can be identified in the airline industry and what factors can explain the differences between them? – the following hypotheses are tested: H1A: Drivers at environmental, firm, and relational level play a role in the choice for an airline to form either a strategic alliance or M&A. H1B: There is a difference in importance between the drivers for each growth strategy (strategic alliance and M&A); environmental drivers will play a more important role for strategic alliances and firm specific drivers for M&A, relational drivers will play an important role for both strategies. H2A: An airline choosing for a strategic alliance is driven by the following environmental factors: strict legal constraints and a high degree of strategic uncertainty. H2B: An airline choosing for a strategic alliance is driven by the following firm specific factors: meet customer demands, increase/improve customer loyalty and brand recognition, ensure competitive position, weak financial endowment, large current social network, little external growth experience.
The motivational drivers of horizontal integration strategies The airline business case 38
H2C: An airline choosing for a strategic alliance is driven by the following relational factors: complementary routes and hubs to achieve economies of scale and scope, small required investments, low level of integration, high level of interdependency. H3A: An airline choosing for M&A is driven by the following environmental factors: no legal constraints, low degree of strategic uncertainty. H3B: An airline choosing for M&A is driven by the following firm specific factors: meet customer demands, improve competitive position (increase market share), strong financial endowment, small current social network, previous M&A experience. H3C: An airline choosing for M&A is driven by the following relational factors: Complementary and parallel routes and hubs to achieve economies of scale and scope, large required investments, high level of integration to economies of density, low level of behavioural uncertainty and a low level of interdependency.
The motivational drivers of horizontal integration strategies The airline business case 39
Figure 11: Conceptual model
5.1 Introduction Case 1
In this and the following paragraph I will briefly present the parties involved in the two business cases that are used to test this study’s model. These are just introductions to the case and meant to give a broad picture of the firms involved, the actual analysis will be presented in the Results chapter. The first case is that of airberlin joining the global alliance Oneworld. The second largest German airline, airberlin, joined the Oneworld alliance in March 2012. Airberlin will be one of the first low‐fare airlines to join a
The motivational drivers of horizontal integration strategies The airline business case 40
global alliance that has so far been dominated by legacy airlines. Airberlin’s move to become a full member of an alliance goes one large step further than the recent introduction of code‐sharing services between low‐fare (LCC) and legacy airlines. If successful, it could further blur the boundaries between legacies and LCC. From another point of view, it also indicates Oneworld’s need to grow after acquiring late approval and ATI for the transatlantic alliance and its recent rivalry with other global alliances for suitable partners. I chose to use this particular business case for my study because it is a recent example of an airline joining one of the branded global alliances. Moreover, it is a special case because it is one of the first LCC to become a full member of one of those global alliances (not as an affiliate partner). Airberlin Since its launch in 1978, airberlin has grown to become Germany’s second largest airline (next to Lufthansa). With the acquisition of holiday airline LTU in 2011 it became sixth in Europe in terms of passengers boarded. Its fleet comprises 170 aircraft (average age of five years) and the group employs 9,200 staff. The airline has developed from its origins in the short‐haul leisure market to serving also business travellers with its Euro Shuttle service (providing high‐frequency connections between Europe’s key destinations) and today also offers long‐haul flights. Airberlin is not positioned as a standard LCC (like Ryan Air or Easyjet), rather it uses a hybrid model with characteristics of both LCC, holiday charters and legacy airlines. Moreover, it is trying to serve two different types of passengers: business travellers and leisure seekers. This latter aspect is reflected in its route network; Airberlin has an extensive German network but also serves many airports at destinations such as Greece, Spain and Portugal. Currently, the airline serves 162 destinations in 40 countries with bases in German cities such as Berlin (the new Brandenburg – BBI ‐ airport intended to be opened from June 2012) and Dusseldorf, in leisure destinations such as Palma de Mallorca, and also with bases in both Austria and Switzerland. The airline’s relative success in the last years was mainly linked to LCC features; its network primarily focuses on point‐to‐point services (Flottau, 2011). Airberlin has focused on Dusseldorf and Berlin as its most important bases with capacity in Berlin being a constraining factor. However, the new Berlin airport (BBI) opens up new opportunities where Airberlin plans to introduce hub structures, especially for North‐South traffic. At BBI it will have access to its own dedicated terminal area that will ensure easy connections. This will give Airberlin the opportunity to increase its fully used capacity in Berlin from Tegel Airport of a maximum of 6,000 flights a week (Airberlin PLC, 2012). BBI was supposed to open in the summer of 2012 but this has been postponed. The closure of Berlin Tegel and Schonefeld (the other two airports) therefore was also postponed and scheduled flights at BBI had to be rescheduled at the old airports. Airberlin’s top 10 city pairs in 2010, before its oneworld membership, are shown in table 7. This shows that most traffic took place within the German region.
The motivational drivers of horizontal integration strategies The airline business case 41
Table 7: Airberlin top 10 city pairs 2010
Top ten city pairs 2010 Hamburg ‐ Munich Cologne ‐ Berlin Tegel Dusseldorf ‐ Munich Munich ‐ Berlin Tegel Stuttgart ‐ Berlin Tegel Cologne ‐ Munich Berlin Tegel ‐ Zurich Dusseldorf ‐ Berlin Tegel Dusseldorf ‐ Palma de Mallorca Dusseldorf ‐ Vienna Frankfurt ‐ Berlin Tegel Source: OAG 2010 # Passengers 660.258 604.496 589.679 574.683 414.427 403.314 391.332 390.875 372.227 361.769 359.185
The chart below shows Airberlin’s current top 10 airports by ASKs and number of seats per week in the summer of 2012, after becoming an oneworld member. This shows that most passengers are still flown in the German/Austria/Switzerland area (with the exception of holiday destination Palma de Mallorca).
Figure 12: Airberlin top 10 bases by ASK per week, June 2012 (source: CAPA & Innovata)
Source: CAPA Centre for Aviation (2012, 08/06).
Airberlin has grown both internally and through acquisitions. In 2004 Airberlin and NIKI created the first low‐fare alliance in Europe, and in 2010 Airberlin increased its share in NIKI from 24% to 49.9%. NIKI’s base airport is Vienna. NIKI remains a legally independent firm with its own management board. Since March 2012 NIKI has become an affiliate member of the oneworld alliance. In 2007 Airberlin acquired a 49% share in Belair Airlines. Belair’s base airport is Zurich and the airline operates services to holiday destinations around the Mediterranean,
The motivational drivers of horizontal integration strategies The airline business case 42
Egypt, the Canary Islands and major German cities. Since the end of 2011 Etihad Airways (Abu Dhabi) and Airberlin form a strategic partnership. Through this partnership, Etihad became Airberlin’s largest shareholder and gained access to new European routes. Etihad increased its former 3% stake to just over 29%. Moreover, the deal also included a codesharing agreement that gives Etihad access to Airberlin’s European short‐distance network and to Berlin. Besides Etihad, Airberlin also has codeshare agreements with its oneworld partners American Airlines, BA, Finnair, Iberia, Japan Airlines, Royal Jordanian, and S7 Airlines. Moreover it operates codeshare flights (outside its oneworld partners) with Bangkok Airways, Hainan Airlines, Pegasus Airlines and Meridiana fly. From table 8 it can be stated that Airberlin has not been able to achieve a positive result for the last two years. The firm has not been able to do so since 2007 (BBC News, 2012). Even though revenues have increased in 2011, Airberlin has not been able to cope with uncertainties that have significantly put pressure on its costs. Airberlin blames the weather, strikes, rising fuel costs, the Arab spring and a new German airport tax for its poor performance (BBC News, 2012). Moreover, by the end of 2011 Etihad increased its stake in airberlin to 29% by paying EUR72.9 million for new shares and they provided airberlin with a long‐term financial loan up to USD255 million to help the airline expand their fleet (Parker, 2011).
Table 8: Key financial figures Airberlin 2010‐2011
Key financial figures Revenu (million euros) including ticket sale EBITDAR (million euros) EBIT (million euros) Consolidated loss (million euros) Earnings per share(euros) Total assets (million euros) Employees Source: Airberlin, PLC (2011). Annual Report 2011. 2011 4227.3 3857.0 425.9 (247.0) (271.8) (3.2) 2264.0 9113 2010 3850.2 3531.7 619.9 (16.7) (106.3) (1.14) 2370.1 8900
From an operational point of view Airberlin has improved in the past two years (table 9). The CEO of Airberlin introduced a program called Shape & Size that has the objective to make the airline more (cost) efficient. The results of this program are especially reflected in its increased RPK and load factor.
Table 9: Airberlin key operating figures 2010 ‐2011
Key operating figures Aircraft Flights Passengers (thousands; "Pax") Destinations Available seat kilometres (bn; RPK) Revenue passenger kilometres (bn; RPK) Passenger load factor (per cent; Pax/capacity) Source: Airberlin, PLC (2011). Annual Report 2011. 2011 170 270,498 35,300 162 62.16 52.14 78.21 2010 169 274,227 34,890 163 61.04 46.96 76.45
The motivational drivers of horizontal integration strategies The airline business case
Oneworld Oneworld is one of the three global airline alliances (oneworld, Skyteam, Star alliance) and brings together 11 airlines and 20 affiliates. The alliance was established in 1998 by founding members American Airlines, British Airways, Cathay Pacific and Qantas. The alliance has grown since with Finnair and Iberia in 1999, LAN in 2000, Japan Airlines and Royal Jordanian in 2007 and S7 Airlines in 2010. Together, the oneworld members serve about 800 airports in 150 countries, with more than 8,750 daily departures. Its 11 active members are:
Airline airberlin Oneworld affiliates NIKI (Austrian) Hub(s)& major bases Berlin, Dusseldorf, Palma de Mallorca, Vienna Dallas/Fort Worth, Chicago O’Hare, Los Angeles, Miami, New York JFK & La Guardia London Heathrow, London Gatwick
American Airlines British Airways (IAG) Iberia (IAG)
American Eagle, American Connection
BA city flyer, Comair (South African), Sun‐Air (Turkish) Iberia Regional, Air Nostrum, Iberia Express Dragonair
Cathay Pacific Airways Finnair Japan Airlines
‐ JAL Express, J‐Air, Japan Transocean Air
Helsinki Tokyo (Narita and Haneda), Osaka (Kansai and Itami), Nagoya (Chubu and Komaki), Okinawa (Naha) Santiago de Chile, Buenos Aires, Lima, Quito, Guayaquil Sidney
LAN Argentina, LAN Ecuador, LAN Express, LAN Peru QantasLink: Airlink, Eastern Australia Airlines, Sunstate Airlines, Jetconnect
Royal Jordanian S7 Airlines
Besides the benefits for all member of the oneworld alliance, oneworld member airlines have also expanded their working relationship beyond those ‘general’ benefits. In 2010, American Airlines, British Airways and Iberia launched a Joint Venture across the North Atlantic. This took place relatively late because the UK‐US bilateral air service agreement was still based on classic nationality clauses and capacity and route constraints. This was different from the bilateral EU‐US Open Skies agreement that allowed the other global alliances to form JVs based on ATI.
The motivational drivers of horizontal integration strategies The airline business case
In 2011, American Airlines and Japan Airlines launched a similar venture between Asia and North America. In 2012, American Airlines and Qantas followed that line of business across the South Pacific, when at the same time British Airways and Japan Airlines also sought for approval for a Joint Venture between Europe and Japan. British Airways and Qantas have had a Joint Venture in place for 15 years – the Kangaroo Route – between Europe and Australia, which had been extended for five more years in 2010. In January 2011, British Airways and Iberia merged under the name of International Airlines Group. Both airlines continue to operate with their own brand names. Figure 13 shows how the oneworld alliance is integrated with these revenue sharing Joint Ventures between the main/founding members.
Figure 13: oneworld members’ level of integration
Note. Based on oneworld factsheets
Table 10 presents the financial positions of all oneworld member airlines (including their affiliates) and the total oneworld results, the table is based on the oneworld factsheets and includes 2011 financial figures. From the table it can be stated that especially American Airlines, one of its largest members, is suffering from net losses. Since the end of 2011, American Airlines filed for Chapter 11 bankruptcy protection, which has been granted and provides the airline the opportunity to continue normal operations while restructuring its debts, costs and other
The motivational drivers of horizontal integration strategies The airline business case 45
obligations (The Guardian, 2009). On the other hand, the Asian airlines (Cathay and JAL) are the best performers in 2011 with the largest net profits of the oneworld group.
Table 10: oneworld financial figures
Tot. Rev. (millions) Operating Profit (millions) Net Profit (millions) $ 1.267,00 $ ‐130,00 $ 739,00
oneworld airberlin American Airlines IAG (BA and Iberia) Cathay Pacific Finnair Japan Airlines LAN Qantas Royal Jordanian S7 Airlines
$ 105.514,00 $ 4.696,00 $ 4.976,00 $ ‐12,00 $ 21.762,00 $ 646,00
$ 23.979,00 $ ‐1.054,00 $ ‐1.979,00 $ 11.477,00 $ 1.806,00 $ 1.825,00 $ 2.990,00 $ ‐118,00 $ ‐117,00 $ 16.379,00 $ 2.266,00 $ 2.266,00 $ 5.718,00 $ 540,00 $ 15.955,00 $ 690,00 $ 966,00 $ 23,00 $ 1.312,00 $ ‐91,00 $ 321,00 $ 591,00 $ 14,00 $ 3,00
Source: oneworld (n.d.). Oneworld at a glance.
Introduction Case 2
In September 2010 Southwest announced its plans to acquire its low‐fare rival AirTran Airways in a $1.4 billion share purchase. The transaction is a full acquisition and plans are to rebrand AirTran Airways entirely under the Southwest brand. Southwest expected to receive a single operating certificate from the US FAA in the first quarter of 2012, and, according to its website, they indeed obtained it. However, actual plans for entire integration have not been shared yet. The deal significantly strengthens its presence in eastern and mid‐west US, the Caribbean and, most importantly, the deal comes with presence at the Atlanta hub‐airport. The LCC characteristics of both airlines are what make this case interesting. Especially because previous consolidation in the US airline industry has been dominated by legacy airlines. The question is whether Southwest will remain a full LCC or that it might slowly change into a network airline in order to sustain its current growth pattern. In the coming section I will briefly introduce both airlines. I will use data from the two airlines at the time of the acquisition in order to compare them equally. Actual analysis of the case will take place in the results chapter of this study. Southwest Southwest Airlines is a US domestic airline, one of the first low‐cost airlines (LCC) in the world. The firm was founded in 1971 with services in Dallas, Houston and San Antonio. Many successors today such as Easyjet and Ryanair copied its successful LCC business model. The airline primarily provides point‐to‐point services in 72 cities around the US. It is headquartered in Dallas (Texas) and employs more than 34,000 people. At the end of 2010 Southwest’s fleet consisted out of 548 Boeing 737 aircrafts, flying more than 3400 flights a day. Currently, it tops the list of passengers carried by US airlines. Southwest serves many secondary or downtown airports. It also
The motivational drivers of horizontal integration strategies The airline business case 46
offers near‐international flights to Mexico in cooperation with the Mexican airline Volaris. Southwest has a past of growth by full acquisitions. During the 1980’s it acquired Morris Air and Muse Air. Moreover, it acquired ATA Airlines’ operating certificate and remaining assets in 2008 that gave Southwest access to New York La Guardia. Southwest’s top 10 city pairs in 2010 – pre acquisition‐ are presented in table 11. At the time of the acquisition (year end 2010), it had a US domestic market share of 21% and its main airports by passengers carried included Las Vegas, Chicago Midway and Phoenix as is shown in figure 14
Table 10: Southwest top 10 city pairs 2010
City Pair DAL‐HOU BUR‐OAK SAN‐SMF OAK‐SAN LAX‐OAK LAX‐SFO SAN‐SJC BUR‐LAS SAN‐SFO ONT‐SMF # Passengers 685.933 670.941 610.927 610.050 572.666 528.767 528.000 479.034 474.904 466.486
Source: OAG 2010
Figure 14: Southwest top 10 airports 2010
Source: Southwest Airlines Co., 2010. Onereport. The motivational drivers of horizontal integration strategies The airline business case 47
Also from a financial perspective Southwest has obtained a strong position in the US domestic market. In contrast to many of its competitors, Southwest has been able to remain profitable during the global financial crisis of the past few years with just a small dip in its net income in 2009 (table 11). The main increase in operating expenses in 2010 came from the rising cost of jet fuel. Overall, Southwest is a financially stable firm with a healthy debt ratio. The table below shows Southwest’s main financial figures and it also includes post‐acquisition figures of 2011. This is reflected in significantly increased operating expenses and increased total assets. From an operational standpoint Southwest has also improved (table 12). Though its capacity remained relatively equal in 2009‐2010, it especially saw an increase RPM and load factor, which indicates improved efficiency.
Table 11: Southwest financial figures 2007‐2011
Financial figures (in millions) Operating Revenues Operating Expenses Operating Income Other Income net Income before taxes Provision for income taxes Net Income Total Assets Long‐Term obligations $ 16.772,00 $ 2.050,00 $ 14.068,00 $ 3.498,00 $ 14.269,00 $ 3.325,00 $ 5.454,00 $ 15.463,00 $ 2.875,00 $ 6.237,00 $ 18.068,00 $ 3.107,00 $ 6.887,00 2007 $ 9.861,00 $ 9.070,00 $ 791,00 $ 267,00 $ 1.058,00 $ 413,00 $ 645,00 2008 $ 11.023,00 $ 10.574,00 $ 449,00 $ ‐171,00 $ 278,00 $ 100,00 $ 178,00 2009 $ 10.350,00 $ 10.088,00 $ 262,00 $ ‐98,00 $ 164,00 $ 65,00 $ 99,00 2010 $ 12.104,00 $ 11.116,00 $ 988,00 $ ‐243,00 $ 745,00 $ 286,00 $ 459,00 2011 $ 15.658,00 $ 14.965,00 $ 693,00 $ ‐370,00 $ 323,00 $ 145,00 $ 178,00
Stockholder's equity $ 6.941,00 $ 4.953,00 Source: Southwest Airlines Co. (2011). Annual Report 2011.
Table 12: Southwest key operational figures
Enplaned passengers RPM ASM 2009 101.338.228,00 74.456.710,00 98.001.550,00 2010 114.213.010,00 78.046.967,00 98.437.092,00 79,3% Change 12,7% 4,8% 0,4% 3,3%
Load factor 76,0% Source: Southwest Airlines Co. (2010). Annual Report 2010.
AirTran AirTran is a low fare US airline that is headquartered in Orlando (Florida) and has a strong focus on the Easter part of the US with regard to its route network. The airline employed approximately 8,330 people in 2010. A majority of its flights either originate or terminate at it largest hub in Atlanta (Georgia) where it competes directly with legacy airline Delta. Besides Atlanta, AirTran also serves markets from its hubs in Baltimore, Milwaukee and Orlando. At the beginning of 2011 the airline operated 138 aircrafts of two different types: Boeing B717‐200 and Boeing B737‐700. AirTran offers about 700 scheduled flights a day to approximately 69 destinations in the US and
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the Caribbean. Table 13 presents AirTran’s main airports in 2010 by daily operations and also the importance of the airport in its entire route system. Atlanta, Orlando and Baltimore together represent a significant share or AirTran’s total operations.
Table 13: AirTran’s main airports in 2009‐2010
Airport Daily operations Markets served Share of system daily flights Atlanta 360 55 49% Orlando 130 42 18% Baltimore/Washington 104 23 14% Milwaukee 87 20 12% Fort Myers 49 13 7% Tampa 40 11 6% Boston 39 8 5% Indianapolis 37 8 5% Fort Lauderdale 34 9 5% New York La Guardia 34 6 5% Source: AirTran Holding (2010). Annual Report 2010.
The firm has witnessed a decline in its financial performance in the past few years (table 14). Its operating income in 2010 decreased by 27,6% compared to 2009 and it experienced some volatility in net income since 2006 with a negative net income in 2008. The decline in operating income in 2010 was largely due to an increase in jet fuel costs. Besides, its operating margins also declined from 7,6% to 4,9%, same for its profit margins. This decline in margins could indicate inefficient cost management and/poor decision‐making. Moreover, the share of debt in total assets has consistently been around 50%, which indicates much dependence and financial obligations to third parties. From an operational standpoint AirTran has improved its position significantly over the past years (table 15). Its load factor has improved significantly due to increased capacity and higher RPMs.
Table 14: Key financial figures AirTran 2006‐2010
Financial figures (in thousands) Operating revenues Operating income Net income Total assets 2006 $1.892.083,00 $40.294,00 $14.494,00 $1.616.159,00 2007 $2.309.983,00 $142.646,00 $50.545,00 $2.071.784,00 2008 $2.552.478,00 $‐75.821,00 $‐266.334,00 $2.085.262,00 $1.104.056,00 2009 $2.341.442,00 $177.010,00 $134.662,00 $2.284.172,00 $1.214.017,00 2010 $2.619.172,00 $128.191,00 $38.543,00 $2.179.348,00 $996.490,00
Long‐term debt $784.093,00 $1.037.246,00 Source: AirTran Holding (2010). Annual Report 2010.
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Table 15: Key operating figures AirTran 2007‐2010
Operating Figures Revenue passengers Revenue passengers miles (RPM) Available seat miles (ASM) Passenger load factor Source: AirTran Holding (2010). Annual Report 2010. 2007 23.780.058,00 17.297.724,00 22.692.355,00 76,2% 2008 24.619.120,00 18.955.843,00 23.809.190,00 79,6% 2009 23.997.810,00 18.588.036,00 23.294.117,00 79,8% 2010
24.721.226,00 19.557.674,00 24.062.434,00 81,3%
Chapter 6. Research methodology
It has already been mentioned in the introduction of this thesis that this study is of explorative and explanative nature; in the first place I am trying to deepen a general understanding of consolidation, and second, I am trying to find an explanation for the differences between these different forms of consolidation in the specific case of the commercial airline industry. In order to answer the research question of this study I will use a case study research design. The case study is most often used in explanatory and exploratory research (Saunders et al., 2007:139) to better understand complex social phenomena (Yin, 2003). Case studies are the preferred strategy when the researcher has little control over events and when the focus is on a contemporary phenomenon within a real‐life context (Yin, 2003), which is the case of this particular study. Yin (2003) distinguished four case study strategies, based on two dimensions: (1) single versus multiple cases, and (2) holistic versus embedded case. Single case designs are used where it represents a critical or a unique case (Saunders et al., 2007: 140). Multiple case designs incorporate more than one case, and can be used when there is a need to generalize the findings of the first case to the second case. Therefore Yin (2003) argues that multiple case studies may be preferable over a single case and that the choice for a single case study will need to have a strong justification. The second dimension of Yin (2003) refers to the unit of analysis. If the same case study involves more than one unit of analysis the design is called an embedded case study. If the case study only examines the global nature of an organization it is called a holistic design (Yin, 2003). With regard to this study, I will be using a multiple case design of holistic nature because I want to compare two different situations (cases) with each other to gain a better understanding of the specific context in which consolidation decisions are taken and to explain the drivers behind those decisions. Furthermore, Yin (2003) states that the selected cases in multiple‐case studies should either predict similar results (literal replication) or predict contrasting results but for predictable reasons (a theoretical replication). The latter one is applicable to this thesis. An important part is the development of a rich theoretical framework, which states the conditions under which a particular phenomenon is likely to be found (Yin, 2003). This framework later becomes the mechanism for generalizing to new cases. The theoretical framework in this particular study has already been formulated in the previous chapter on the basis of the relevant literature and desk research.
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6.1 Data collection & analysis
For case studies it is recommended to use multiple sources of evidence because it allows the researcher to address a broader range of issues (Yin, 2003). Moreover, it allows for triangulation, which in turn addresses the possible problem of construct validity; multiple sources provide multiple measures of the same phenomenon (Yin, 2003). The sources of evidence used in this study will mainly be of secondary nature, namely: documentation and archival records. The downside of both these data types is that they have been produced for a specific purpose and audience, which should be taken into account when interpreting the usefulness of the data. Unfortunately, the broadness and global nature of this research topic makes it difficult to obtain primary data. Because in that case, primary data would have to be obtained from the organizations in question which are either physically unreachable (geographical distance) or difficult to get access to. For this reason I have chosen to answer the research questions as best as possible with secondary data. The exception is the (primary) data that I obtained directly from the OAG database. The advantage is that this combination of sources of evidence is of both qualitative and quantitative nature. By combining the information of the different sources (triangulation), I will try to be as objective as possible because all of the sources provide a different perspective on the cases and because each source has a different relation to the firms involved. This will in turn improve the internal validity of the study. I will make use of secondary qualitative data such as: research reports, industry reports, newspaper articles, industry journals, existing interviews, annual reports, company statistics etc. From these sources I will select the information that applies to the variables in the model. First I will make a list of literal quotations from these sources after which I will summarize and interpret them to give a clear picture of the situation. The primary quantitative data that I use deals with the route networks of the airlines in question, and are subtracted from the OAG database and MIDT database. The OAG database includes all routes and city‐pairs of registered airlines. It gives the opportunity to identify and analyze changes in route networks. Thus, the OAG can help to identify overlapping and complementary networks. To detect changes in route networks I compared the city pairs and benchmarked them with the current summer schedules (2012) that can be found on the airlines’ websites. I used the Atlanta transfer data to see whether there is overlap between markets directly served by Southwest and those with a transfer at Atlanta by AirTran. This latter data contains passenger movements and is derived from the MIDT database. OAG only contains flight schedules and city‐pairs but does not include the number of passengers. Therefore, the two data sources are combined in this research. The data that I obtained from MIDT and OAG included the following: ‐ ‐ ‐ 2010 city pairs and carried passenger for Airberlin, Southwest and AirTran 2010 transfers at Atlanta of AirTran 2010 transfers at Dusseldorf of Airberlin
2012 scheduled Airberlin city pairs from BBI
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The conceptual model and corresponding hypotheses that were presented in chapter 5 are tested with two business cases that were also already introduced in chapter 5. For each case I will systematically use secondary and primary (OAG and MIDT) data sources to see whether these factors indeed do apply to the case, and hence to test the hypotheses. Thus, I will sort the relevant information along the identified drivers and their corresponding factors.
Chapter 7. Results
In the following two sections I will present the results that were found after analyzing all the (secondary) sources for the cases. The first case is that of Airberlin joining the globally branded alliance oneworld, and the second case is that of Southwest fully acquiring AirTran. The data is sorted along the three main levels of analysis (environmental level, firm level and relational level) and the corresponding factors within those levels.
Case 1: Airberlin joins oneworld alliance
Environmental level: legal constraints and strategic uncertainty Legal constraints: Airberlin is a German airline and oneworld is a global alliance. Airberlin has to confirm to both German (national) and European legislation. This is especially important with regard to antitrust legislation and hence horizontal integration strategies. Dual confirmation complicates ‘hard’ integration strategies such as M&A. Moreover, a more logical step for Airberlin would be to consider a merger strategy with Etihad, but this would be impossible due to foreign ownership restrictions on traffic rights (bilateral agreements). Thus, due to these high legal constraints the only avenue for Airberlin to grow and to keep up with the consolidation trend in Europe and the rest of the world, is to either join a global alliance such as oneworld or grow slowly through smaller M&A that do not have to pass European antitrust legislation. Strategic uncertainty: Airberlin has to cope with competition on two different levels: on national level with Lufthansa and on regional European level with other low‐fare airlines such as Easy Jet and Ryan Air. Lufthansa is a network airline (hub‐and‐spoke) that operates on a national, European and global level. In the past years it has mainly focused on growing in Asian and American markets (Lufthansa, n.d.). Although less growth comes from European markets, still 44.9% of total traffic revenues in 2010 came from Europe, which indicates the importance of the European market for Lufthansa (Lufthansa, n.d.). Although Lufthansa is less well positioned in Berlin, it is very strongly represented in Germany’s main destination Frankfurt and Munich as its secondary international hub. Because of Airberlin’s hybrid business model it is not strongly positioned as a low‐fare airline and that complicates competition with other European low‐fare airlines that compete heavily on price. On a macro level, Airberlin has been faced with loss of revenue due to the political unrest in Egypt and Tunisia in 2011. Today, flights to these destinations are still being booked reluctantly. Before, Airberlin used to be European market leader in these markets (Airberlin, PLC, 2011). To make up for these losses it has to increase capacity to existing markets or enter new markets. Other macro economic factors that have brought along uncertainty are the recently introduced
The motivational drivers of horizontal integration strategies The airline business case 52
German air travel tax and the increased cost of kerosene (Airberlin, PLC, 2011). The introduced aviation tax levies departures from German airports. This does not apply to cargo or transfer traffic and thus affects Airberlin more severely than its competitors (mainly Lufthansa). Besides political unrest in North Africa, new taxes and more expensive kerosene, Airberlin also serves markets in Europe that are currently experiencing a severe economic crisis. Especially the economic downturn in Spain (one of the most important markets for Airberlin) brings along uncertainties (Airberlin, PLC, 2012). According to IATA, 2012 remains a challenge for the global aviation industry. The outlook for global profits decreased by $0.5 billion to $3 billion. IATA also stresses the correlation between global GDP and airline profitability (Airberlin, PLC, 2012). Overall it can be stated that Aiberlin operates in a highly uncertain strategic environment. To conclude the environmental factors involved in Airberlin’s decision to join the oneworld alliance it can be stated that legal constraints and strategic uncertainty played an important role. Firstly, Airberlin has to cope with strong competition on different levels. Second, the European and North African markets that it operates are either economically uncertain or politically uncertain. Some of Airberlin’s most important leisure markets such as Spain and Greece have been heavily affected by an economic recession. Third, other macro economic factors such as increased oil prices and new aviation taxes bring along even more uncertainty. Finally, on a legal level Airberlin has to deal with national and European legislation, which complicates growth strategies. Moreover, to survive the severe European competition and keep up with the global and European consolidation trend Airberlin probably has no other choice than to join one of the global alliances. This in turn might provide future possibilities for further integration. Thus, hypothesis 2A is confirmed; an airline choosing for a strategic alliance is driven by strict legal constraints and a high degree of strategic uncertainty. Firm specific level: marketing outcome, competitive position, financial endowment, social embeddedness, and external growth experience Marketing outcome: Airberlin’s network will be extended through codeshare agreements with the other oneworld member airlines. The networks of Airberlin and its affiliate NIKI will be covered by oneworld’s marketing alliance fares and sales product that includes participation in Business Flyer (the alliance offering for small & medium enterprises). Airberlin already offers a similar product in Germany Switzerland and Austria (Airberlin, PLC, 2011). Moreover, members of Airberlin’s bonus program will also enjoy the benefits of oneworld frequent flyers when travelling with any other member airline. According to Airberlin’s CEO (Mr. Mehdorn) the oneworld global alliance was chosen as a strategy to please its customers by offering global lounges, more destinations and attractive frequent flyer programs (CAPA Centre for Aviation, 2012 20/03). Airberlin has strong brand recognition in the German region (Germany, Austria and Switzerland) that will be improved by joining a globally branded alliance. Thus, from a marketing perspective AIrberlin meets customer demands by offering more destinations through its member airlines, a more attractive frequent flyer loyalty program, and it will increase brand recognition by joining a globally branded alliance.
The motivational drivers of horizontal integration strategies The airline business case 53
Competitive position: According to Airberlin’s CEO joining oneworld will strengthen Airberlin’s competitiveness by enabling it to offer passengers a global network served by partners that include some of the biggest in the world (Airberlin, PLC, 2011). Moreover, Airberlin strengthens oneworld’s network by introducing Germany as a new home market to the alliance. Besides Germany, Airberlin will also give access to middle‐ and Eastern European markets. More specifically, Airberlin’s (future) presence at Berlin’s new international airport (BBI) is an important asset for oneworld. As it is an international airport the other oneworld member can start flying there and it will become oneworld’s gate to middle‐ and Eastern Europe. Moreover, BBI can take away pressures from oneworld European transfer hubs such as London Heathrow, Madrid and Barcelona. London Heathrow is saturated and growth opportunities are limited, and opportunities for oneworld in Frankfurt are very small because that is Lufthansa’s home base. Thus, further oneworld presence in Berlin may be driven as much by opportunity as by necessity (CAPA Centre for Aviation, 2012 20/03). BBI was supposed to open in June 2012 but this was postponed. However, Airberlin already scheduled 68 city pairs with a total of 676 flights per week for September 2012 (OAG, 2012). These routes had to be cancelled and were, if possible, rescheduled from Berlin Tegel. As long as BBI is not in use yet, oneworld cannot fully enjoy the benefits of having Airberlin in its network. Airberlin’s decision to join oneworld will be closely watched by other low fare airlines that have also been playing with the idea of codesharing or other network airline ‘ inventions’ that usually do not apply to p‐t‐p networks. Airberlin’s move to become a full member of a global alliance goes one step further than recent codeshare agreements between for example JetBlue (LCC) and Lufthansa (Flottau, 2011). Airberlin’s CEO explain the move in the following way: “Our strategy was orientated along the question what we had to do to position ourselves as industry consolidation progresses. The decision to join oneworld was only the last mosaic stone; the first and most important one was a route network that would be attractive to business travellers. AIrberlin had to focus on metropolitan routes and a network that was linking as many business markets as possible” (Flottau, 2011). Moreover, British Airways (oneworld member) has recently gone public with its intentions to grow IAG by adding more airlines, which could pose a future possibility for Airberlin. This oneworld membership has two sides: it strengthens Airberlin’s competitive position and that of
oneworld. Airberlin will not immediately capture market share, but oneworld in turn will gain market share by adding Airberlin. But oneworld’s competitors Skyteam and Star Alliance are expanding as well by adding members in key growth markets. Star Alliance has been the largest alliance in seat share and is gaining members in growth markets such as Africa, China and South‐East Asia. Skyteam has especially been expanding in China. Oneworld has no ‘mainland’ Chinese member but will also add Malaysia Airline. Moreover, Star Alliance will loose three members to oneworld; bmi, TAP and TAM. So all three alliances will grow in seat share, and although Star Alliance will remain the largest, the gap between Skyteam and oneworld will narrow (CAPA Aviation Analysis, 2012 08/06). By adding Airberlin, oneworld will become the second largest global alliance present in Germany, after Star Alliance. Airberlin triples oneworld’s markets being served in Germany to 25 and double its presence Austria to six airports. Airberlin’s joining of oneworld will bring the largest change in Europe, where it is the 8th largest airline
The motivational drivers of horizontal integration strategies The airline business case 54
(CAPA Aviation Analysis, 2012 08/06). For intra‐European traffic airberlin is the 7th largest, ahead of British Airways. Oneworld capacity share will increase in Europe from 9.8% to 13.2%, right after Skyteam with 15.5% share (CAPA Aviation Analysis, 2012 08/06). To conclude this section, competitive advantages are mainly present for oneworld. It will also improve Airberlin’s competitive position but not as directly visible as for oneworld. For Airberlin, joining oneworld might be more a necessity in order to survive LCC competition and European consolidation. Another competitive advantage for Airberlin can be that its oneworld membership might speed up the process of becoming a full hub‐and‐spoke airline with hubs in Berlin and Dusseldorf. The complementary intercontinental networks of the other members provide this opportunity. Financial position: Airberlin has been successful in its strategic moves in the past few years by building markets share, changing its business model and moving into corporate markets, but this has not paid of financially yet (Flottau, 2011). In the past three years Airberlin has not been profitable and debt has been piling up. Over the first nine months in 2011 for example, the airline piled up more than $170 million in losses while increasing its debt obligations. In 2011 the loss before tax was EUR‐358.8 million after EUR‐150.7 in 2010. The net result for 2011 was EUR‐271.8 after a reported loss of EUR92.7 million in 2010 (Airberlin Annual Report, 2011). These three years (2009‐2011) of losses have contributed to a total debt of approximately EUR813 million by the end of 2011 (Airberlin Annual Report, 2011). The proportion of shareholder’s equity compared to total assets was 11.2% at the end of 2011 compared to 21.3% in 2010, which indicates its major dependence on debt and financial instability. Etihad provided Airberlin with more financial freedom because it increased its stake to 29.21%. Moreover, Airberlin is listed on the Frankfurt stock exchange, and its performance in 2011 was disappointing with a decline of 32.6% compared with the closing price of the prior year (Airberlin Annual Report, 2011). Overall, Airberlin is in a very weak financial position. Social embeddedness: Airberlin’s main strategic partner is Etihad Airways (Abu Dhabi), who is not a member of any global alliance. Etihad increased its share in Airberlin almost at the same time it became an oneworld member. Etihad now has 29.21% stake and two seats on the board of directors. The two airlines have codeshare agreements on certain routes, Airberlin moved its service from Dubai to Abu Dhabi, shared frequent flyer programs, Airberlin will use Etihad’s pilot training program for its forthcoming Boeing 787 fleet and the two will combine their 787 orders to leverage synergies but also have standardization (CAPA Aviation Analysis, 2012 20/03). Thus, Airberlin’s relationship with Etihad goes much further than with the oneworld members. As mentioned before, due to restrictions on foreign ownership Etihad probably cannot further increase its stake in Airberlin. For Etihad, Airberlin is not its first oneworld partnership. Before, it established a codeshare agreement with American Airlines, as well as frequent flyer and codeshare agreements with Malaysia Airlines (CAPA Aviation Analysis, 2012 20/03). For years Lufthansa has been trying to prevent Gulf airlines like Etihad to gain traffic rights in German cities. It accuses Gulf airlines of massively being supported by state financials. That argument may now
The motivational drivers of horizontal integration strategies The airline business case 55
be weaker. The oneworld members might also not be too excited about Etihad’s stake in Airberlin. Almost all of them view such airlines as bitter rivals and are doing their best to keep them away (Deckstein, 2011). External growth experience: As mentioned in the introduction of this case Airberlin has grown both organically and through external growth strategies. The figure below shows Airberlin’s growth path since 2006. The takeover of DBA (2006) gave Airberlin access to a dense German domestic network for the first time, as well as the acquisition of LTU in 2007 (Flottau, 2011). TUIfly was integrated in Airberlin’s network in 2009, but not the entire firm. Only those parts that were most convenient to Airberlin were integrated and TUIfly acquired a minority stake of 7.9% in Airberlin (Flottau, 2011). Overall, Airberlin has experience with full acquisitions (DBA, LTU, Belair), mergers (NIKI), strategic partnerships (Etihad) and codeshare agreements. For an airline that is originally a LCC, it has relatively much experience with external growth strategies, both integrative and cooperative strategies.
Figure 15: Airberlin’s growth path
Source: Airberlin (n.d.). Factsheet Airberlin (2012).
From a firm level perspective it can be concluded that hypothesis 2B can be partly confirmed. The marketing outcome indeed plays a role for Airberlin; an extended route network, joint loyalty programs and global branding can help Airberlin to attract more customers and increase revenues. Ensuring its competitive position seems to be of great importance, both for Airberlin and oneworld. Airberlin has to cope with competition on a national and regional level and cannot compete purely on price (as it is not a full LCC). Oneworld competes with the other two global alliances for the largest global coverage and for potential members that operate in growth markets. For both Airberlin and oneworld it seems that they have to keep up with competition and make these kinds of strategic moves out of necessity rather than to become the number one player in the market.
The motivational drivers of horizontal integration strategies The airline business case 56
Furthermore, from a financial position Airberlin is weakly endowed which explains why it cannot grow organically (by itself) or by integrative external strategies. Joining oneworld seems to provide Airberlin with the opportunity to leave behind its LCC characteristics and slowly turn into a full hub‐and‐spoke airline with hubs in Berlin and Dusseldorf. The final two factors of the hypothesis are not confirmed: large current social network and little external growth experience. Airberlin does not have many other partnering airlines, except for Etihad with whom it is strongly integrated. Moreover, Airberlin has relatively much external growth experience differing from acquisitions to cooperative strategies. Thus, the first three parts of hypothesis 2B are confirmed but final two not. Relational level: economic synergies, required investments, level of integration, degree of behavioral uncertainty, level of interdependency Economic synergies; Economic synergies in this case can mainly be achieved through economies of scope. Scale economies can be achieved because Airberlin can benefit from shared reservation systems, loyalty programs and marketing campaigns. But most benefits would have to come from wider route coverage. The majority of routes of the oneworld members and Airberlin are complementary and do not overlap. However, some of the oneworld members do not connect to Airberlin at all and thus do not provide any (immediate) scope economies. As already mentioned earlier, Airberlin’s membership will more than triple oneworld’s served cities in Germany to 25, and double its coverage trough NIKI in Austria (Airberlin, 2012). 70 of Airberlin’s 162 destinations are new to the oneworld network, but most of those are primarily leisure destinations and not the corporate destinations that boost airline yields. To benefit from oneworld’s coverage, Airberlin already concluded codeshare agreements with American Airlines, Finnair and S7 in 2011. Contracts with Iberia and British Airways will follow shortly (Airberlin, 2011). Stronger yields will come from the codeshare agreement with American Airlines that gives it wider access in its largest long haul market; the US (CAPA Aviation Analysis, 2012 20/03). From the OAG Airberlin data (2010 two way city pairs with more than 100 passengers carried) it can be concluded that Airberlin has significantly adjusted its route network compared to its current schedule (July 2012) that it presents on its website. Of its city pairs in 2010, approximately 41% has been eliminated from its summer schedule in 2012. From my analysis I was only able to identify the removed city pairs. Thus, the only development I can conclude is a severe network change in general. However, whether this is due to regular network changes (because Airberlin is a low‐fare airline) or whether this is due to its new membership to oneworld is unclear. Besides cutting routes, Airberlin has also added over 40 new routes in the period of August 2010 – August 2011 of which at least 10 are from both Berlin Tegel and Dusseldorf (Anna Aero, 2011). Airberlin’s new hub (BBI) can only be utilized if the other oneworld members serve it, and so far there has been some hesitation from that side because they prefer to serve Frankfurt instead of Berlin (CAPA Aviation Analysis, 2012 20/03). Frankfurt is one of the points in the world that is served by all oneworld members, and in most cases this is also their only German destination. Airberlin has a limited presence in Frankfurt; it does not rank in its top 10 served airports. Those that do serve Berlin are: British Airways, Finnair, Iberia and Royal
The motivational drivers of horizontal integration strategies The airline business case 57
Jordanian. JAL is currently expanding its long‐haul network by adding for example Helsinki. Berlin could also become part of JAL’s strategy but depends very much on Europe’s financial developments. The other airlines (Cathay, LAN and Malaysian) are less likely to fly to Berlin in the near future. S7 from Russia is nearby but suffers from financial distress and probably will not expand to Berlin in the near future either ( 20/03 Aviation Analysis, 2012). Thus, American Airlines is Airberlin’s most promising partner but they are currently under bankruptcy protection, which in turn could complicate their potentially fruitful relationship. Because the opening of BBI has been postponed and perhaps because Berlin is not the most preferred destination of the oneworld members, Airberlin has made a big push at Dusseldorf International Airport through growth in its trans‐Atlantic network. The expansion of services to North America intensifies competition with Lufthansa that also operates from Dusseldorf but has little possibilities to develop it long‐haul network there (CAPA Aviation Analysis, 2012 08/06). From MIDT it appeared that in 2010, Airberlin transferred 726,815 passengers at Dusseldorf, which was only 3% of its total passengers. According to the list below (changes in route network 2011‐2012) based on OAG analyses from Anna Aero (an airline network news and analysis website), it can be observed that Airberlin is focussing its new routes (non‐seasonal) on both Berlin Tegel (future BBI) and Dusseldorf.
from Düsseldorf Düsseldorf Düsseldorf Berlin Berlin Berlin Berlin Berlin Berlin to Abu Dhabi Las Vegas Miami Phuket Los Angeles New York Gdansk Kaliningrad Budapest seasonal seasonal seasonal ? seasonal frequency per week 7 2 6 7 3 4 12 3 7
Friedrichshafen Ibiza Bazel Neurenberg Stuttgart Munster Malta Malta Moscow Catania
The motivational drivers of horizontal integration strategies The airline business case
Munich Windhoek seasonal
Overall, economic synergies (economies of scale and scope) for both parties are not immediately present and when traffic indeed connects it is complementary and not overlapping. Much depends on the development of BBI and oneworld members adjusting their German traffic to Berlin instead of Frankfurt. Moreover, those parties that could provide Airberlin with synergies (American Airlines and S7) are both currently in a financially weak position. It seems that oneworld chose Airberlin to secure itself of a position in the middle and Eastern European market rather than the benefits of economic synergies and connecting traffic. Airberlin itself has changed its route network since 2010 but whether this is due to its oneworld membership remains unclear. However, the strategic move to Dusseldorf probably is due to its codeshare agreement with American Airlines. The potential intercontinental complementary network connectivity provides Airberlin with the opportunity to become a hub‐ and‐spoke airline in the future. Required investments: The CEO of Airberlin said the following about the costs for Airberlin to join oneworld: “The costs will run in the lower two‐digit millions, the long term, under normal circumstances, we are expecting clear annual additional returns to exceed this one‐time cost” (Airberlin, 2011). The main costs are that of establishing compatibility with the booking systems of the other member airlines. After joining oneworld, it will become difficult for Airberlin to maintain its low level of unit costs because of corresponding complexities (Flottau, 2011). When entering an alliance, experts argue that the initial phase only means additional expenses (Deckstein, 2011). Level of integration: Economies of traffic density can only be achieved through the use of larger aircrafts or more efficient connecting traffic in a hub‐and‐spoke system and neither one of them is the case for Airberlin. Airberlin will only enjoy the most basic alliance benefits; marketing benefits and codeshare agreements. With these types of more distant cooperation the scope for integrating service and maximizing economies of density is limited. In the absence of a JV, alliance partners will operate separate service on hub‐to‐hub routes. This will divide traffic between two operations, whereas under a JV the airlines operate as a single entity. As mentioned in the case introduction, oneworld indeed has these types of JVs and there might be future potential for Airberlin to become part of them. Degree of behavioral uncertainty: The similarity between Airberlin and the other oneworld members is small because most of them are legacy airlines that operate a hub‐and‐spoke network. Only the Russian S7 also is a low fare airline, but is much smaller in size than Airberlin. Thus, Airberlin mainly differs because of its hybrid business model and point‐to‐point network. This increases behavioral uncertainty but also provides the opportunity to change to a newer and clearer business model. Behavioral uncertainty also rises because of the loose cooperative arrangement that Airberlin has with the other members; the level of control from both sides (Airberlin and oneworld) is low. Moreover, Airberlin’s strategic partnership with Etihad poses extra uncertainty because other
The motivational drivers of horizontal integration strategies The airline business case 59
members such as British Airways and Iberia do not favor this partnership. Moreover, as mentioned before, the possibility exists that this membership is just a first step in the process of being acquired or merged with another member airline. Overall the members of oneworld differ in many ways; geographical coverage, business model, financial stability and global and regional market share. Thus, the degree of behavioral uncertainty is relatively high. Level of interdependency: Airberlin’s oneworld membership has one important objective and is therefore of strategic importance; restoring sustainable profitability. This indicates Airberlin’s dependence on oneworld. Table 8 in the case introduction shows the financial results of the oneworld alliance and of each of its members (including Airberlin). In terms of revenues Airberlin belongs to the category of small members. The table also shows that four out of ten members booked a negative operating profit at the end of 2011 (including Airberlin). Thus, in financial terms Airberlin actually brings down the ‘oneworld average’. However, when looking at the position of Airberlin from an operational perspective in terms of passengers carried and daily departures it is part of the top four. Table 16 shows the operational figures of the oneworld alliance. Although Airberlin is relatively strong in terms of numbers of flights and passengers it lacks behind in terms of efficiency and capacity compared to the other members. Thus, Airberlin is dependent on oneworld in terms of future sustainable profitability, but oneworld needed a member like Airberlin in order to compete with the other two alliances. Because most of the larger (network) airlines are already allied, potential members have become scarce and the three global alliances are now ‘fighting’ for the best potential members. In that sense, oneworld is also dependent on Airberlin.
Table 16: Operational figures oneworld alliance (Oneworld factsheet, 2012)
oneworld airberlin American Airlines IAG (BA and Iberia) Cathay Pacific Finnair Japan Airlines LAN Qantas Royal Jordanian S7 Airlines daily dept's pax (millions) 8627 719 3400 1800 326 286 700 408 725 116 192 324,4 33,6 105,2 51,7 26,8 8 39,7 22,6 27,9 3 5,9 RPK (scheduled, millions) ASK (scheduled, millions) PLF (%) 734819,00 45244,00 201950,00 168617,00 96558,00 21498,00 62785,00 38423,00 78947,00 7805,00 12992,00 928952,00 58780,00 246617,00 213193,00 115748,00 29345,00 91635,00 48154,00 97523,00 10986,00 16971,00 79,1% 77,0% 81,9% 79,1% 83,4% 73,3% 68,5% 79,8% 81,0% 71,0% 76,6%
Source: Oneworld (n.d.). Oneworld at a glance.
The following can be concluded with regard the final level of drivers (relational factors). In the case of Airberlin and oneworld there are no direct economic synergies visible. Except for some codeshare agreements that Airberlin has already agreed on with several other oneworld members. However, there is absolutely a potential with the new Berlin airport. The only condition for reaping economic synergies from BBI is that the other
The motivational drivers of horizontal integration strategies The airline business case 60
members also start flying to Berlin. From the OAG data it appeared that Airberlin made lots of changes in its current schedule (summer 2012) compared to 2010 but whether this is due to its oneworld membership or because of regular seasonal route changes is not clear. Except for its increased capacity at Dusseldorf for transatlantic flights to North America. So an important factor is that Airberlin’s flights need to connect with those of the other members, otherwise no synergies can be gained. Overall, Airberlin’s routes are complementary to those of the existing oneworld route network and it also adds new destinations, especially in Germany and central Europe. The required investments are relatively low in comparison to other strategies. However, investments have to be made with regard to IT, and although the exact costs are not mentioned, it will take a few years before this will pay off. Moreover, this will depend very much on the macro economic development of Europe. So the investment might be relatively low but there is much uncertainty surrounding it. The level of integration is indeed low, and therefore no economies of traffic density can be reaped. But this low level of integration does give Airberlin the freedom to develop itself further with little obligations to others. However, there is potential for Airberlin to become further integrated with other members. But again; only if the BBI airport becomes a successful hub in Germany. The level of dependence on the side of Airberlin is high; its recovery to sustainable profitability depends highly on the potential synergies with oneworld. From the oneworld perspective the dependence is more on a strategic level (rivalry for members with the other alliances); access to Germany and middle – and Eastern Europe through BBI. Thus, interdependence is indeed high; both parties need each other to improve performance. Overall hypothesis 2C cannot be confirmed fully in the case if Airberlin and oneworld. Firstly, the future objective indeed is to capture economies of scale and scope through complementary routes but that is not immediately possible. Secondly, required investments are relatively low but are surrounded by uncertainty. The third factor can be fully confirmed; level of integration in the oneworld alliance is low which provides Airberlin with some freedom. However, on the other hand Airberlin is highly integrated with its strategic partner Etihad that provided them with short‐term strategic flexibility but might constrain them in the future when they might have to choose between partnership with oneworld and Etihad. Finally, the level of interdependence is high and thus can also be fully confirmed.
Case 2: Southwest acquires AirTran
Environmental level: legal constraints and strategic uncertainty Legal constraints: The Southwest‐AirTran acquisition is a transaction that took place within the US borders. Thus, the parties did not have to deal with differences in legislation and regulation between countries. Moreover, none of the parties were under bankruptcy protection. The US Department of Justice (DOJ) and the Department of Transportation (DOT) were the institutions involved in this acquisition, especially with regard to anti trust legislation. According to American Antitrust Institute (AAI) the transaction met with little antitrust enforcement resistance based on the DOJ public statements in recent airline mergers such as United/Continental and Delta/Northwest.
The motivational drivers of horizontal integration strategies The airline business case
Strategic uncertainty: The US airline industry has been very volatile in the last decade. According to the Southwest 2011 annual report, total financial losses in the industry during the past decade exceeded $50 billion. This has been driven by events such as 9/11, the economic recession, and the global credit crisis. The US economy itself has been recovering slightly since the recession in 2009. Moreover, fuel costs have risen over 300% since 2000. This uncertain macro environment has resulted in several US airlines ceasing operations or reorganization through bankruptcy. These reorganizing airlines could emerge from bankruptcy as more vigorous competition as they will have to adjust their cost structures (Datamonitor, 2011). Although the growth of the US airline industry fluctuated in 2009 and 2010, it is expected to grow consistently from 2011. According to the Federal Aviation Administration (FAA) the number of passengers on US domestic flights will increase by 3.5% in 2011 and will continue to grow with more than 1 billion passengers on US airlines expected by 2021 (Datamonitor, 2011). Moreover, international traffic will grow more quickly than domestic US travel; 7.8% more international passenger traffic on US airlines by 2031 is expected (Datamonitor, 2011). In the years before the Southwest/Airtran transaction a number of airline mergers had already appeared: Delta/Northwest in 2008 and United/Continental in 2010. Moreover, US Airways and American Airlines are currently considering a possible merger. Thus, it could be said that Southwest is following this consolidation trend in the US airline industry. Or as it was stated by a marketing professor at Columbia Business School in a NY Times article: “Merge or acquire to stay alive and competitive” (Mouawad, 2010). In general, competition in the US airline industry is intense and unpredictable due to multiple players in the same markets and low entry barriers (Southwest Airlines Co., 2011). Airlines in general compete on: pricing and cost structure, routes and schedules, loyalty programs and customer service. Moreover, other forms of transportation also compete with airlines such as Southwest and Airtran (Southwest Airlines Co., 2011). From a rivalry perspective, Airtran stated in its 2010 annual report that competitors with greater liquidity or a broader network may set fares lower or increase flight frequencies, this in turn would prevent Airtran to remain profitable. Thus, from the Airtran standpoint there was probably no other choice than teaming up with their biggest competitor to stay alive. The low level of legal constraints coincides with hypothesis 3A where it was proposed that an airline choosing for the M&A strategy is driven by little legal constraints. However, it cannot be concluded that there is no strategic uncertainty. The airline industry by itself is characterized by uncertainty due to its dependence on macro economic events. Moreover, even though the US economy and the airline industry are recovering, there is still great competitive pressure and a consolidation trend. However, for a dominant and stable player on the US market such as Southwest there is relatively less uncertainty when compared with its target Airtran or any other LCC. Hence, the biggest competitive threat comes from other consolidated airlines. So, hypothesis 3 can only be partly confirmed. Firm specific level: marketing outcome, competitive position, financial endowment, social embeddedness, and external growth experience
The motivational drivers of horizontal integration strategies The airline business case 62
Marketing outcome: Through this acquisition customers from both sides can benefit of greater US domestic reach. Together the airlines will serve 100 million passengers with the potential of hundreds of new itineraries for customers of both airlines, and the combination of the two will have a stronger frequent flyer program (CAPA Aviation Analysis, 2010 28/9). Whether it will result in lower prices is unsure. According to Farecompare prices will go up in markets where both airlines competed head to head, and new Southwest markets will experience lower prices (temporarily until competitors leave the market) (Hunter, CNN, 2010). Whether Southwest will keep or modify current customer policies (such as reservations through its own website, free checked bags, free seating, single class of service) is not sure (CAPA Aviation Analysis, 2010 28/9). Airtran has build up strong brand loyalty in Atlanta and their passengers will probably experience most changes because they are used to seat selection and business class service. Thus, customer demands do not seem to be the most important driver of this transaction. Rather it seems to be more of a side issue. Obviously, this acquisition comes with greater reach for customers and more attractive FFP, and hence will meet customer demands in that sense. Whether these demands are met with regard to prices and on‐board service is questionable. Competitive position: At the time of acquisition Southwest was the 5th largest US airline based on miles flown by paying passengers, and Airtran was number 8. And right after the United/Continental merger Southwest ranked 4th on the list. Southwest increased its capacity by 20‐25% with the Airtran acquisition without increasing industry capacity, and the combined Southwest‐Airtran capacity share of the US domestic market will be 22.2%, just 0.2ppts more than its competitor Delta (Aviation Analysis, 28 September 2010). This increase in capacity will in turn positively affect its market share (Schlangenstein, 2010). Moreover, it contributes to the US consolidation trend and decreases the number of LCC competitors for Southwest (Hunter, 2010). Besides decreasing competition and increasing its own market share, the transaction also puts pressure on those airlines that have not tied up yet (Mouawad, 2010). The biggest competitive change will be with regard to its competitor Delta at Southwest’s newly acquired Atlanta hub. Figure 16 shows the market share of all airlines active at Atlanta and the dominant position of Delta. Besides the hub in Atlanta, Southwest will also attack Delta at New York La Guardia where it will be offering more services, along with new service and a terminal at New York JFK (CAPA Aviation Analysis, 2011 28/4). Southwest immediately acquired 27% of the LGA‐ATL market, 26% of the ATL‐BOS market and 22% of the ATL‐PHL market. This will directly strengthen Southwest’s competitive strength in these markets. Note that Southwest is replacing Airtran instead of entering new markets (Boyd Group International, 2010). Delta however, is a strong player with a stable dominant position at Atlanta and growth opportunities for Southwest at Atlanta are very limited. The analysis from the Boyd Group explains this situation in the following way. In the period 2009‐2010 Airtran’s market share at ATL (number of carried passengers) was 21.8%, right behind Delta who was clearly the dominant player with more than 60% market share. Table 17 shows the most important O&D markets for both Delta and Airtran (2009‐2010) and it can be concluded that they are competing for the same O&D markets.
The motivational drivers of horizontal integration strategies The airline business case
Figure 16: ATL capacity (seats per week) by airline 25‐Apr‐2011 to 01‐May‐2011
Source: CAPA Centre for Aviation (2011, 28/04). Table 17: Top 10 ATL O&D markets (source: Boyd Group International Research Report)
Top 10 ATL O&D markets Delta # Pax LGA LAX DCA BOS MCO FLL LAS DFW PHL SFO Airtran # Pax 78275 50150
190484 LGA 124740 FLL 121353 BWI 101108 MCO 95852 DCA 89632 MDW 84343 PHL 82172 BOS 78576 TPA 73020 LAS
49446 40770 38221 35990 33500 31145 30930 30716
Source: Boyd Group International (2010).
However, the O&D markets at ATL are saturated and there is barely space for Southwest to grow in that aspect. Thus, for Southwest to be successful (and keep up with or defeat Delta) it must attain high levels of flow traffic (transfer passengers). In 2009‐2010 Airtran relied on 67.3% share of flow traffic, Delta’s share of flow traffic
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was 78.1%. In order to maintain or increase this share of flow traffic it will have to compete heavily with Delta who has transformed ATL into a ‘hubbing machine’ and who even competes on price at most Airtran markets. Moreover, Delta has been aggressively competing on Airtran’s secondary markets. Those secondary markets that are not served by Delta are the key to success for flow traffic for Southwest. Secondary markets that serve each other through ATL (such as SRQ‐ATL‐IND) with high yields are the true assets of Airtran that have been gained by Southwest. More importantly, Atlanta will be the first major hub that Southwest will be operating and this will pose great challenges. Though Southwest has some experience with the hub‐and‐spoke system at smaller hubs such as Baltimore/Washington, Atlanta and Delta’s competition will not be easy for Southwest. Financial position: The table below presents Southwest’s main financial figures from 2007‐2011 and is based on its Annual Report of 2011. It shows that Southwest has been profitable every year since 2007 with a small dip during the 2009 recession. Its revenues have been increasing continuously and its long‐term obligations and stockholder’ equity have also been stable over the past years. Jet fuel has been severely affecting its income; in 2011 and 2010 this represented approximately 38% and 33% respectively (largest expense in 2011). These financial data also already show the results of the Airtran acquisition. For example, a 29.4% revenue increase in 2011 compared to 2010 is attributable to the inclusion of Airtran results. The same counts for the 34.6% increase in operating expenses following the acquisitions and increased capacity.
Table 18: Financial figures Southwest 2007‐2011
Financial figures (in millions) Operating Revenues Operating Expenses Operating Income Other Income net Income before taxes Provision for income taxes Net Income Total Assets Long‐Term obligations Stockholder's equity $ 16.772,00 $ 2.050,00 $ 6.941,00 $ 14.068,00 $ 3.498,00 $ 4.953,00 $ 14.269,00 $ 3.325,00 $ 5.454,00 $ 15.463,00 $ 2.875,00 $ 6.237,00 $ 18.068,00 $ 3.107,00 $ 6.887,00 2007 $ 9.861,00 $ 9.070,00 $ 791,00 $ 267,00 $ 1.058,00 $ 413,00 $ 645,00 2008 $ 11.023,00 $ 10.574,00 $ 449,00 $ ‐171,00 $ 278,00 $ 100,00 $ 178,00 2009 $ 10.350,00 $ 10.088,00 $ 262,00 $ ‐98,00 $ 164,00 $ 65,00 $ 99,00 2010 $ 12.104,00 $ 11.116,00 $ 988,00 $ ‐243,00 $ 745,00 $ 286,00 $ 459,00 2011 $ 15.658,00 $ 14.965,00 $ 693,00 $ ‐370,00 $ 323,00 $ 145,00 $ 178,00
Source: Southwest Airlines Co. (2011). Annual Report 2011.
The motivational drivers of horizontal integration strategies The airline business case
Social embeddedness: Southwest is very much an airline on its own. Because it only serves domestic markets with its own network there is not much need for partnerships such as alliances, codeshare partners or marketing agreements. Hence, its social embeddedness is very small. Another social aspect to take into account are the employees. The acquisition will bring labor issues because AirTran will ultimately be entirely integrated into Southwest. Southwest’s CEO said that seniority agreements need to be solved between employee units, and pay gaps must be identified. According to him every single workgroup at Southwest has a better pay and benefits package than AirTran (CAPA Aviation Analysis, 2010 28/9). In 2011 the different pilot unions and flight attendant unions of Southwest and AirTran came to an agreement with regard to seniority lists. Also the other unions seem to have come to seniority agreements (Southwest Airlines Co., 2011). External growth experience: Southwest has experience with this type of growth strategy; the AirTran acquisition represents the third one in three decades and according to its CEO it is absolutely the most ambitious one (Mouawad, 2010). Previously, Southwest successfully acquired Morris Air and Muse Air during the 1980’s. In addition, it acquired ATA Airlines’ operating certificate and remaining assets in 2008, which gave Southwest access to New York La Guardia (CAPA Aviation Analysis, 2010 28/9). Thus, Southwest indeed has full‐acquisition experience. To conclude the firm‐specific factors that drive Southwest’s choice for this type of growth strategy I will briefly summarize the findings. With regard to marketing it could be stated that indeed customer demands play a role in the sense of improved coverage but improved customer experience or brand recognition are not a priority. Competitive outcome seems to play an important role in this transaction. After the acquisition the number of competitors will decrease and other airlines are even more pressured to also find a partner. Moreover, the acquisition directly increases Southwest’s capacity and market share. Furthermore, it becomes a direct competitor of Delta at the Atlanta hub where it will have to fight a tough battle to be able to grow at this newly acquired hub. So Southwest’s move is very much from a shaping point of view rather than defensive, with the direct objective to increase market shares and further improve its already dominant US domestic position. With regard to its financial position it can be stated firmly that Southwest is very much financially endowed and stable enough to take such risks. With its previous M&A experience Southwest will have less trouble to successfully takeover AirTran, which in turn reduces uncertainties. Thus, the full 3B hypothesis can be confirmed. Relational level: economic synergies, required investments, level of integration, degree of behavioral uncertainty, level of interdependence Economic synergies: Economies of scale and scope are in this case achieved with an increased aircraft fleet and extended route coverage. Furthermore, costs can reduce in areas such as IT, advertising, corporate overhead, and aircraft financing. Those cost synergies can offset increased costs such as labor. Ultimately, the net synergy opportunities are driven by network and improved revenue potential. Combined the airlines operate 690 aircrafts (including 88 717’s of the Airtran fleet). By acquiring Airtran, Southwest added a new type of aircraft to its fleet,
The motivational drivers of horizontal integration strategies The airline business case 66
which now consists of three different types. This indicates that it is leaving behind an important LCC characteristic: one aircraft type that is of great importance to keep the costs down (Ranson, 2011). Furthermore, the transaction would expand Southwest’s network by 25% and also give its first near‐international destinations in the Caribbean and Mexico. There are 37 destinations that are not served by Southwest and 37 that are not served by Airtran, which presents opportunities for new city pairs. This counts especially for the smaller and medium sized communities that are served by Airtran (CAPA Aviation Analysis, 2010 28/9). According to Southwest’s CEO the opportunities are threefold: Atlanta, small cities and international. According to Mouawad (2010) in a NY Times article, the combined networks present little overlap, they were only competing directly on 19 routes. Moreover, compared with Southwest’s other competitors, Airtran presents the smallest overlap (CAPA Aviation Analysis, 2011 28/4). However, the combination of the two airlines also has some overlap and will strengthen Southwest’s competitive position at for example New York La Guardia and Chicago Midway (CAPA Aviation Analysis, 2010) 28/9. Figure 17 gives an indication of the geographical spread of the two airlines combined. The following analysis about the overlap between city pairs contains both data from OAG and from an independent research report by Boyd Group.
Figure 17: Geographical spread
Source: Southwest (n.d.). AirTran acquisition factsheet.
Before I started analyzing the 2010 OAG data of both Southwest and Airtran I cleaned up the data sets by deleting those city pairs that carried less than 100 passengers. For Airtran these routes represent only 0.15% of its
The motivational drivers of horizontal integration strategies The airline business case 67
total carried passengers, which can be perceived as insignificant. However, these city pairs do represent 75% of its total city pairs. This latter fact is more an indication of its (in)efficiency. The deleted Southwest routes represent only 0.01% of its total carried passengers, which can also be perceived as insignificant. However, these city pairs do represent 35% of its total city pairs. Table 19 contains the key figures from the data sets.
Table 19: Key figures OAG data sets 2010
Total city pairs Southwest 2010 (>100 pax) Total city pairs Airtran 2010 (>100 pax) Total city pairs with transfer at ATL Airtran 2010 (>100 pax) Total overlap city pairs 2010 (>100 pax) 2137 1547 1297 385
Total Airtran ATL transfer overlap Southwest city pairs 2010 (>100 363 (17% of Southwest’s city pairs) pax) Overlap not through ATL Total eliminated city pairs ATL overlap (summer schedule 2012) 22 49
I compared the 2010 city pairs of Southwest with the 2010 AirTran transfers at Atlanta. Thus, I analyzed whether there are markets that AirTran serves through Atlanta which Southwest also serves (either directly or through another airport). One would expect that Southwest would adjust its city pairs to this type of overlap. In 2010 AirTran served a total of 19.748.704 passengers of which 15.8% were served through a transfer at Atlanta, which indicates the importance of the Atlanta hub for AirTran. Moreover, approximately 60% of its city pairs (>100 passengers) include a transfer at Atlanta. From the 363 overlapping routes in 2010, the two airlines together already deleted 49 in the summer schedule of 2012. Though it cannot be stated firmly, it could be said that Southwest is already adjusting its route network to the acquisition. Southwest is mainly deleting routes of AirTran where it already has a dominant position over AirTran (non‐ATL flights). Overall it appeared that compared to the city pairs of 2010 (>100 passengers) Southwest deleted only 6.8% of these in the summer schedule of 2012. Thus, not much has changed (with regard to deleted routes) since the acquisition of AirTran. However, this does net tell whether new routes have been added and whether the deleted routes were indeed deleted because of the acquisition. However, from the 146 deleted routes, only 4 were overlapping routes (with a transfer at ATL). On the AirTran side more routes had been deleted since 2010, namely 418 in total. From these 418 city pairs 49 were overlapping routes. Two overlapping routes were deleted entirely; on both Southwest’s and AirTran’s side. From the Southwest One Report of 2010 and 2011 the overlapping airports could be retrieved. Southwest indicated in the 2011 report on which airports it is currently working (long‐term project) to optimize the capacity
The motivational drivers of horizontal integration strategies The airline business case 68
of the two airlines. In Appendix IV the overview can be found with these airports. The table below shows the overlapping airports, the ones that Southwest has plans for to change and the ones that are currently changing (changes in summer schedule 2012 compared OAG data 2010). This shows that Southwest is already actively working on optimizing its route network. According to the AAI, the 18 city pairs most affected (where the acquisition will eliminate one of the merging airlines) originate at Baltimore or Orlando. In 6 of these 18 city pairs, the acquisition would produce a monopoly and the change in concentration at the airports exceed the threshold specified in the DOJ/Federal Trade Commission Horizontal Merger Guidelines. From the Boyd Group analysis it appears that in 2010 Q1 there is an overlap on 26 routes from and to Orlando (MCO), but only on 11 routes the two airlines together own 70% or more market share (table 20) From the 2010 OAG data and 2012 summer schedule it appears that these 11 overlapping markets still exist, except for HOU‐MCO where AirTran has stopped service. The difference with the overlapping markets at Baltimore (BWI) is that this airport is a Southwest and AirTran hub where Southwest already has a dominant position. Out of 24 overlapping markets 13 will have a joint market share of more than 70%. Note that Southwest already had more than 70% market share on 4 of those routes. In the summer schedule of 2012 these overlapping routes were all still in tact.
Table 20: Joint market share at MCO and BWI Orlando
BWI‐MCO CMH‐MCO HOU‐MCO IND‐MCO MCI‐MCO MCO‐MDW MCO‐MKE MCO‐MSY MCO‐PIT MCO‐RDU MCO‐STL
73,1% 93,0% 91,7% 92,7% 89,8% 75,3% 96,0% 89,1% 85,2% 78,5% 89,4% 92,5% 75,6%
93,0% BWI‐BOS 83,8% BWI‐MCO 85,9% BWI‐FLL 90,4% BWI‐TPA 78,4% BWI‐RSW 95,0% BWI‐MSY 69,1% BWI‐MKE 87,6% BWI‐IND 84,8% BWI‐PBI 79,1% BWI‐JAX 69,9% BWI‐HOU BWI‐MDW BWI‐STL
Source: Boyd Group International (2010). The motivational drivers of horizontal integration strategies The airline business case
Required investments: Southwest expects the one‐time costs for merging the two airlines to be between $300 and $500 million, and annual synergies to be about $400 million by 2013 (CAPA Aviation Analysis, 2010 28/9). In 2011, $80 million in net pre‐tax synergies were already attributable to the acquisition (Southwest Airlines Co., 2011). The one‐time costs include the cost of the deal, facilities transition, aircraft integration, labor integration (including training), technology and system integration along with marketing and other unanticipated costs. The proposed transaction (including the anticipated net synergies and excluding the one‐time acquisition and integration costs) is expected to contribute to Southwest’s earnings per share in the first year after the transaction and even more thereafter (CAPA Aviation Analysis, 2010 28/9). Thus, the net synergies seem to offset the one‐time transaction costs Level of integration: The ultimate goal of the acquisition is the full integration of AirTran in Southwest. An important step in this process is to obtain a Single Operating Certificate (SOC) from the Federal Administration Analysis. Southwest achieved this in March 2012. However, receiving approval does not mean that integration process of the AirTran fleet into the Southwest fleet (paint scheme and interior configuration) is complete. Furthermore, the transition to a single ticketing system is a large and complex process that will take several years to complete. Thus, when the two airlines will truly operate as one is still unclear. Economies of traffic density for p‐t‐p airlines such as Southwest are usually achieved by promoting low fares and by operating large aircrafts. AirTran however has a strong hub‐and‐spoke network built around its hub in Atlanta. Southwest on the other hand neither solely operates a pure p‐t‐p network. From the Boyd Group analysis it appeared that in the period 2009‐2010 Southwest was not solely relying on O&D (p‐t‐p) traffic; at ten of its top 19 airports flow passengers accounted for more than 1/3 of the traffic. For example, at Chicago Midway, 43.2% of passengers in 2009‐2010 were not local passengers. Thus, it was already leaving some of its low‐fare airline characteristics behind before the AirTran acquisition. Whether this hub experience will help Southwest to make Atlanta a successful hub remains questionable because there a much higher level of flow traffic is necessary. As mentioned before in this analysis, for Southwest to make Atlanta work it should not rely on O&D traffic. Rather it should try to generate more flow traffic and more reliance on hub‐and‐spoke banking schedules will be critical in order to achieve economies of density. Behavioral uncertainty: As mentioned in the previous section, the two airlines mainly differ in their type of network; AirTran relies heavily on connecting traffic in Atlanta and Southwest still mainly operates a p‐t‐p network with little dependence on connecting traffic. According to Southwest CEO, only 15% of its passengers make transfers (CAPA Aviation Analysis). With regard to similarities, both airlines have placed emphasis on customer service, high quality low‐cost operations, solid low fare brands and strong employee cultures (Southwest Annual Report 2011). However, there are small differences such as higher costs at Southwest, a variance in service products and differences in market strategies, but according to Boyd Group these will not be a threat to the success of the merger. Moreover, because of the full acquisition and integration of AirTran to the
The motivational drivers of horizontal integration strategies The airline business case 70
Southwest ‘family’ there will be relatively little behavioral uncertainty as the level of control will be high. These types of uncertainties however, can never be taken away and can always influence the merger process. Interdependence: With regard to relative size and competitive position Southwest clearly has the stronger position. Table 21 shows that Southwest is the dominant party in terms organizational size (employees and fleet), operating revenue, capacity, cash flow and expenditures. Important to note is that AirTran is a financially healthy airline that was initially not for sale, which moderates the level of interdependence (CAPA Aviation Analysis, 2010). The question is whether AirTran would have survived by itself in the long run when it had to compete with Southwest. Thus, in that sense AirTran was very much dependent on the actions that Southwest takes.
Table 21: Key comparable figures
Source: Southwest Airlines Co. (2010). Onereport 2010.
To conclude these relational drivers behind the choice for an acquisition, I will briefly summarize the findings of the final five driving factors. With regard to economic synergies and economies of scale and scope it can be concluded that especially scope economies (geographical scope) played an important role in the acquisition. Obviously economies of scale automatically come to play when costs can be divided over a larger operation, but it seems that Southwest carefully selected AirTran because of its (mainly) complementary network. The acquisition will enhance and improve Southwest’s coverage in the US. Although it is minimal, overlap (parallel city pairs) exists in certain markets. This latter aspect would enhance Southwest’s market power at some airports/city pairs in case it does not adjust operations. With regard to investments, large one‐time costs are indeed needed to fully integrate the two airlines and to ultimately gain the calculated net‐synergies. Uncertainty around financing such transactions always remains, especially in such economic turbulent times. The level of
The motivational drivers of horizontal integration strategies The airline business case 71
integration is very high; AirTran will be fully converted to Southwest. This is necessary in order to obtain the network and costs synergies. Economies of traffic density can only be achieved if Southwest increases its reliance on connecting ‘flow’ traffic rather than O&D traffic. Thus, in order for Southwest to truly gain from traffic density it will have to leave behind one of the main LCC characteristics, namely its p‐t‐p network. In case that does not happen it could be stated that economies of traffic density have not been of great importance in the acquisition of AirTran. The fourth factor to consider is that of behavioural uncertainty. The two airlines are very much alike in their objectives and value propositions. Although there are some smaller differences, these will not influence the merger in the sense of behavioural uncertainty. Finally, with regard to interdependence, Southwest is clearly the larger player and AirTran is the dependent player in this transaction. Thus, interdependence is low indeed. Overall, most of the hypothesis with regard to relational factors (H3C) is supported. With a small annotation that economies of traffic density in this case might not be of much importance due to the low fare (p‐t‐p) nature of Southwest. The first two overarching hypothesis (H1A+B) have not been discussed yet because the two cases answered H2 and 3 separately. The first overarching hypothesis (H1A) stated that all three levels of analysis play a role in both cases (strategic alliance or M&A). This can be confirmed because for both cases there were always some factors at each level of analysis that contributed to the strategic choice, and none of the hypotheses were completely rejected. Hypothesis 1B can also be confirmed fully. Because the drivers at environmental level were fully confirmed in case 1 and only partly in case 2 it could be stated that indeed environmental factors play a more important role for choosing strategic alliances. Moreover, the drivers at firm level were fully confirmed in case 2 but only partly in case 1. This could mean that firm level drivers are indeed more important when choosing for M&A. With regard to relational drivers it could be stated that these were not equally important for both cases because these were partly confirmed for case 1 and fully for case 2. An overview of the results is presented in table 22.
Table 22: Results
Hypothesis Confirmed? Note 1A 1B 2A 2B 2C 3A 3B 3C Fully Fully Fully Partly Partly Partly Fully Fully No large current social network and much external growth experience No direct complementary network, uncertainty surrounding the level of needed investments Uncertain economic (macro) environment High level of integration does not necessarily lead to economies of traffic density due to low fare nature (p‐t‐p network)
The motivational drivers of horizontal integration strategies The airline business case
Discussion and Limitations
The topic of this study is value chain integration strategies on a horizontal level and the airline industry specifically. The main research question is the following: What types of external growth strategies with regard to horizontal value chain integration can be identified in the airline industry and what drivers can explain the differences between them? The objective of the first (theoretical) part was to explain the topic and present the underpinning theories. From there the topic was narrowed down to the airline industry because that is a sector where this consolidation trend is currently taking place. The first part of the research question – what types of horizontal growth strategies with regard to value chain integration can be identified in the airline industry? – has been answered purely on the basis of this literature review. A clear distinction can be made between cooperative and integrative strategies. Within the airline industry many types of cooperative strategies exist that differ by their level of integration. I used the terms strategic alliances and M&A to cover the types of external growth strategies used in the airline industry. To find the driving factors that explain the choice for either strategic alliances or M&A I created a conceptual model based on Hoffman & Schaper‐Rinkel (2011) and additional theory specific for the airline industry. This model includes both generic and industry specific driving factors along three levels of analysis (environmental, firm, relational). To answer the second part of the research question – what drivers can explain the differences between these strategies? – two business cases were used to test this conceptual model. One important drawback should be taken into account that influences the results of this entire study and especially when comparing the two cases: for each strategy (strategic alliances and M&A) only one case was used to test the theory. The consequence is that the results cannot be generalized. Thus, the results only apply to the firms involved in the cases. Internal validity however is high because of data triangulation (different sources of both qualitative and quantitative nature). Future research should cover more cases, or focus on one type of strategy with multiple cases. Either way, multiple cases are needed to provide better generalizability. The first two hypotheses have the objective to compare the two different strategies. The first hypothesis was confirmed; it appeared that all three levels of analysis are indeed taken into account by airlines that choose for a certain strategy (both strategic alliances and M&A). Although all three levels of analysis are taken into account in both cases, there is a difference in importance between them. In this study I measured ‘importance’ by looking at whether the hypothesis are being fully or partly confirmed (because none of them were fully rejected). Whether this is the right way for measuring ‘importance’ is questionable but it was the only way available for me to make a distinction. Environmental drivers indeed seem to be of greater importance in the strategic alliance case (Airberlin joining oneworld), and firm‐level drivers for the M&A case (Southwest acquiring AirTran). An unexpected outcome is that the relational drivers also seem to be of greater importance for the M&A than for the strategic alliance case (I expected this one to be equally important). This outcome could be due to case‐specific characteristics. In the case of Airberlin it might be that it had no other choice than joining a strategic alliance because of severe environmental and competitive pressures and a weak financial position, and relational factors could therefore have been of less importance. Furthermore, it can also be explained by the level of integration
The motivational drivers of horizontal integration strategies The airline business case 73
within the strategic alliance; maybe relational factors become of greater importance when the level of integration increases. This is something to consider in future research on this topic. Within the M&A case it is not possible to tell whether firm‐ or relational‐level drivers are of more importance. Thus, prioritizing the driving factors within the cases is not possible with the research design used in this study. Future research could focus on one type of strategy and the order of importance of the driving factors. With regard to the strategic alliance case only the hypothesis with driving factors at environmental level is fully supported. At firm level only three out of five driving factors are supported. In contrary to the theory of Hoffman and Schaper‐RInkel (2011) Airberlin was not embedded in a large social network, and the airline had relatively much external growth experience with integrative strategies. As it was mentioned earlier, it is very well possible that Airberlin had no other choice than joining the globally branded oneworld alliance to safe itself from a possible downwards spiral. In that case, joining a strategic alliance could be used as a defensive mechanism. The relational hypothesis was also only partly confirmed. What came forward was that there are no direct economic synergies to gain, but there is definitely potential for future synergies. The role of the new Berlin airport (BBI) and the complementary network that gives oneworld access to Germany and its surroundings play an important role in this potential. Thus, apparently in a strategic alliance the future potential of economic synergies might be of greater importance than the direct benefits. In the case of Airberlin joining oneworld two theories can explain the most important results: Resource Based View (RBV) and Resource Dependency Theory (RDT). RBV explains the attractiveness of Airberlin for oneworld, even though these resources only have potential and will be of value on the long term. From the Airberlin perspective oneworld mainly comes with marketing related resources (FFP and larger network) that benefit the airline. The main theory that underlies Airberlin’s decision to join oneworld comes form uncertainty. RDT explains that firms join hands to reduce uncertainty and hence brings in an interdependency argument, which is the case for both Airberlin and oneworld; they need each other to survive competitive and environmental uncertainties. The M&A case presented a US based acquisition where Southwest acquired the smaller LCC AirTran. Hypothesis 3A (environmental drivers) was partly confirmed; indeed there was little legal uncertainty because of the domestic nature but strategic uncertainty was present. The nature of the airline industry probably explains this outcome. The airline industry in general is very sensitive to macro‐level uncertainties and especially macro‐ economic uncertainty. Thus, strategic uncertainty will always be present in the airline industry and this will therefore probably not have a direct impact on the strategic choice. From a firm‐level perspective all hypothesized factors are confirmed. There indeed is a motivation to meet customer demands by offering the largest network possible, there is enough financial stability to perform such a strategy and experience with acquisitions made it ‘easier’ for Southwest to choose for this type of strategy. The most striking outcome on this level of analysis was the motivation to shape competition. By acquiring AirTran Southwest directly increases its market share and capacity, decreases the number of competitors and puts pressure on them to partner up. More importantly, through this acquisition Southwest directly attacks its competitor Delta at ATL. In order for
The motivational drivers of horizontal integration strategies The airline business case 74
Southwest to compete with Delta at ATL it will have to leave behind its LCC characteristics and start organizing its network around a hub‐and‐spoke system rather than point‐to‐point. AirTran was already organized around hubs with multiple types of aircrafts and Southwest probably uses this acquisition to (slowly) change strategy and transform into a ‘regular’ network airline. On the relational level all hypothesized factors were also confirmed. Behavioral uncertainty is low because both airlines have a somewhat similar business model and interdependence is also low. Although Southwest is clearly the larger party, AirTran was also a financially healthy airline with a strong customer base. Southwest can directly reap economies of scale and scope with AirTran’s complementary network. Although, some overlap between the two route networks exists and not all of this overlap is being eliminated. This remaining overlap provides Southwest with increased market power, even though it is only a minor share of the total networks. To obtain the actual synergies large investments have to be made on Southwest’s side and the two airlines have to become highly integrated. For Southwest to achieve economies of density (through high integration) it will either have to fly larger airplanes or organize flights around the hub‐and‐ spoke system. Thus, one of the main results is that in order for Southwest to actually shape competition and reap economic synergies it will have to leave behind its LCC characteristics. The market power argument (shaping competition) clearly came forward in this second case. Thus, the Industry Perspective where barriers of entry are used as a measure to increase market power applies here. The RBV also comes forward in this case; without AirTran’s complementary network and strong brand Southwest would have never acquired it. Path Dependence also played a small role because Southwest has a past of acquisitions. The RBV is the theory that seems to be of importance for both strategic alliances and M&A. Limitations and managerial implications This study is marked by two main limitations: no generalizability and an ambitious model. The first limitation was already explained in the first section of this chapter. Due to limitations in time it was not possible to test the model with more cases. The size of the conceptual model also contributed to this problem. Future research could focus on those factors that came forward as important in this study (downsize the model) and apply them to more cases. Or another option would be to focus on one strategy specifically and not on the differences between them. In that case the researcher can zoom in on just a few motivational drivers with multiple cases. Either way, more cases are needed to provide generalizability. To minimize the consequences of this problem I tried to maximize internal validity by presenting a highly detailed description of the cases using multiple types of sources. Moreover, the subjective nature of this study because of its qualitative research design brings in the problem of interpretation. This makes it difficult to come up with ‘hard’ findings and conclusions. Future research should try to use more quantitative data to reduce this problem.
The motivational drivers of horizontal integration strategies The airline business case
This study started off by presenting the current consolidation/horizontal integration trend within the global airline industry; (cross‐border) M&A are increasing and more and more types of cooperative strategies are being used. All of these horizontal integration strategies share the same objective: work together to achieve the best network possible. But if these strategies all have the same objective why do airlines use so many different forms to achieve this. The objective of this study was to find the motivational drivers behind these choices and the corresponding research questions was the following: what types of external growth strategies with regard to horizontal value chain integration can be identified in the airline industry and what drivers can explain the differences between them? The two business cases used in this study represented each one type of strategy: a cooperative strategy (strategic alliance) and the integrative strategy (M&A). It was found that three levels of motivational drivers motivate both types of strategies: environmental level, firm level and relational level. However, there is a difference in importance of these levels for each case and also the factors included in these levels of analysis differ. From the first case (strategic alliance – Airberlin joining oneworld) it appeared that the environmental drivers played a more important role than firm‐ and relational level drivers. Moreover, the uncertainty (strategic uncertainty, weak financial performance, competitive pressure) surrounding the choice of Airberlin to join a strategic alliance plays an important role. It seems that this choice was mainly made from defensive reasons with no direct positive synergies being gained but with possible potential for the future. In the second case (M&A – Southwest acquiring AirTran) firm‐ and relational level drivers seemed to be of greater importance. The main motivational driver of this case was to shape competition by directly reducing the number of competitors, directly increasing market share and attacking competitor airlines at major airports. However, in order for Southwest to achieve positive economic synergies from this acquisition it will have to let go of its LCC business model and AirTran provides Southwest with this opportunities because they were already using multiple aircrafts and hub‐ and‐spoke systems. Thus, overall Airberlin seems to have chosen for strategic alliances from a defensive point of view out of necessity and Southwest chose an acquisition strategy from a more offensive point of view to increase market power. However, both strategies are motivated by the attractiveness of the assets involved, especially the route network and airports.
The motivational drivers of horizontal integration strategies The airline business case
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Appendix I: Overview US M&A
US M&A since deregulation (1978)
Year Airlines 1979 North Central Airlines/Southern Airways/Hughes Airways 1980 Pan Am/National Airlines 1980 Republic Airlines/Hughes Airwest 1982 Continental Airlines/ Texas Air Corporation 1985 Southwest Airlines/Muse Airlines 1986 Northwest Airlines/Republic Airlines 1986 TWA/Ozark Air Lines 1986 Delta Air Lines/Western Airlines 1986 Alaska Airlines/Horizon Air 1987 Continental Airlines/People Express/New York Air/Frontier Airlines 1987 American Airlines/AirCal 1987 US Air/Pacific Southwest Airlines 1987 Alaska Airlines/Jet America 1989 US Air/Piedmont Airlines 1990 American Airlines/Eastern Air Lines; Latin Routes 1991 American Airlines/TWA; Heathrow Routes 1991 Delta Air Lines/Pan Am Airlines; Shuttle and Atlantic Routes 1992 United Airlines/Pan Am; Latin and Carribean Routes 1993 Southwest Airlines/Morris Airlines 1997 AirTran Airways/Valujet 1999 American Airlines/Reno Air 1999 Delta Air Lines/Atlantic Southeast Airlines 1999 Delta Air Lines/Comair 2001 American Airlines/TWA 2005 Republic Airways/Shuttle America 2005 Skywest/Atlantic Southeast Airlines 2007 Pinnacle Airlines/Colgan Air 2008 Southwest Airlines/ATA Airlines 2009 Republic Airways/Midwest Airlines 2009 Republic Airways/Frontier Airlines 2009 Delta Air Lines/Northwest Airlines 2010 Pinnacle Airlines/Mesaba Airlines 2010 United Airlines/Continental Airlines 2010 Skywest/Atlantic Southeast Airlines/Express Jet Airlines 2011 Southwest/AirTRan Airways 2012 US Airways/AMR/American Airlines Result Republic Airlines Pan Am Republic Airlines Continental Airlines Southwest Airlines Northwest Airlines TWA Delta Air Lines Alaska Airlines/Horizon Air Continental Airlines American Airlines US Air Alaska Airlines US Air American Airlines American Airlines Delta Shuttle United Airlines Southwest Airlines AirTran Airways American Airlines Delta Air Lines Delta Air Lines American Airlines Republic Airways Skywest/ASA Pinnacle Airlines/Colgan Air Southwest Airlines Republic Airways Republic Airways Delta Air Lines Pinnacle Airlines/Mesaba Airlines United Airlines Skywest/SureJet Southwest Airlines ‐
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Appendix II: Global top 25 airlines
th Source: World’s biggest airlines rankings: Jul‐2011, CAPA Centre for Aviation, July 5 2011 (http://www.centreforaviation.com/analysis/worlds‐biggest‐airlines‐rankings‐jul‐2011‐delta‐bigger‐than‐united‐and‐continental‐ combined‐54821)
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Appendix III: Summary of European airlines’ cross‐holding
Source: Linenberg et al. (2012).
The motivational drivers of horizontal integration strategies The airline business case
Appendix IV: Overview overlapping airports
Overlapping airports Atlanta Austin Baltimore/Washington Boston Buffalo Chicago Midway Columbus Dallas Love Field Denver Detroit Fort Lauderdale Fort Meyers Houston Indianapolis Jacksonville Kansas City Las Vegas Los Angeles Milwaukee Minneapolis New Orleans New York La Guardia Orange County Orlando Philadelphia Phoenix Pittsburgh Change progress x x x x x x x x x x x x x x x in Eliminated routes summer 2012 x x x x x x x x x x
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Raleigh/Durham San Antonio San Fransisco Seattle St. Louis Tampa West Palm Beach x x x x
Source: Southwest One Report 2011 & Southwest summer schedule 2012
The motivational drivers of horizontal integration strategies The airline business case