Airline alliances (September 27th)

1.  Concepts.

Global alliances: it is a strategy that has traditionally involved various co-operative arrangements (such as codesharing, blocked space, co-operation in frequent flyer programmes, joint marketing, service and purchasing, and franchising) to strengthen or expand their market presence and to redefine or consolidate their position in an increasingly competitive environment (OECD, 2000). Currently, most important global alliances are: OneWorld, Star Alliance and Skyteam.

Scale economies: it occurs when unit costs go down as total production is increased. They involves mostly from the spreading of fixed cost over an increasing volume of output […] Economies of scale have been divided into “technological economies” (based on large scale production or large plants), “managerial economies” (improve division of labor) and “financial economies” (reductions in unit cost when purchases, sales and financial transactions are made on a large scale). (Kleymann and Seristö, 2004).

2.Question

Why are Airline alliances used to reach economies of scales?

Since the 90’s airlines alliances are increasingly common and they have been developed in different ways according to the needs of companies which are participating in the cooperative links and the scope of each alliance. Kleymann and Seritö (2004) said that airline alliances can be classified into 9 types where main alliances are: Cost sharing ventures (for purchasing equipment), asset pools (in maintenance areas), Codesharing, Marketing alliances and joint ventures.

However, the most important type of alliance is “global Alliance” because it is generally led by the biggest airlines in the world that definitively have great control on the airline industry. So, “Global Alliances”, such us OneWorld, Skyteam or Star Alliance, have most of the passenger, most of the flights and routes and most of the profits of the sector. But, which have the factors been driving the creation of alliances?

Firstly, is important to consider that airline sector has been very protected by governments in order to ensure participation of local airlines in some routes because “countries have always seen airlines as a key industry” (Daniels, 2004: p 512). So, government intervention was, according to Oneworld, one of the main determinants of alliances in the 90’s. Oneworld says that one reason for the emergence of alliances was that “More people want to fly to more places more easily and for greater value – but government restrictions and business economics make it impossible for any one airline to serve all these markets by itself”. So, having a shared code allows companies to access to countries where their flights were restricted.

 

Source: Star Alliance. three airplanes operated by Star Alliance Members airlines. [Online]. Available at: http://www.staralliance.com/en/about/

But, regulatory order is perhaps a less important reason than the possibility of reaching scale and scope economies. The OECD (2000), mentioned that “economies of scale and scope in the airline industry give rise to key observable features of airline competition. Airline networks tend to be organized into a hub-and-spoke structure. There are important economies of scope associated with the provision of services at a hub. Airlines foster demand-side economies of scope through loyalty programs (such as frequent flyer plans and travel agent incentive schemes). These economies of scale and scope give larger airline networks advantages over smaller networks and give rise to a strong tendency towards hub dominance”.  Economies of scale for alliances can be represented in each one of categories mentioned in the item 1 but, according to Oretti and Latrau (2007), the most common are:

• More efficiency from the acquisition of larger aircrafts.
•  Higher bargaining power in purchasing aircraft, spare parts, fuel, maintenance, catering or other services. 
• Specialization in relation to the learning and sharing of best work practices. 
•   Fixed costs (sales offices, airport ground and handling, maintenance), that can spread by the increase utilization, are shared by alliance’s parts and so it can reduce the overall costs for all partners. 
•   Joint procurement: negotiations with suppliers in order to get better prices by increase volumes. It is one of the most important categories because the alliance can take great advantages from the relationships with suppliers and consequently, it can reduce its cost or be more efficient. 
•  Labor cost reductions: labor force represents one of the biggest costs for an airline.

Last items show the reasons why airlines see alliances as the best way in a very competitive industry where the most important thing is to improve the efficiency and the frequencies of the flights and it can be reached working as a block.

3. Point of view

In my opinion, alliances are a reality and a need not only for airline industry but also for companies in many sectors where collaborative and cooperative strategies improve the performance of the economy. Currents market conditions require that companies implement strategies in order to satisfy the customers that every day look for something new. In this sense, sometimes alliances are a good option for companies that are unable to compete effectively.

However, in many cases alliances can have too power and therefore they can make decision that affect other small companies that are excluded, for example big alliances have power to pressure small companies to achieving unfair acquisitions or absorptions. For this reason, I consider that the creation of a regulatory order is very important. Governments and other institutions must ensure fair conditions in every sector because monopoly is banned for most of laws around the world. So, I think that governments should act as observers and regulators of all activities carried out by the airlines and alliances so as to preserve the conditions of free competition.

In conclusion, I agree with the position of the OECD about alliances and their regulation, that is; it’s very important to promote and protect in the airline industry and it includes careful review of proposals for mergers and alliances, careful use of remedies to offset anti-competitive effects and consideration of divestiture or separation in cases of dominance and careful control over predatory behaviour and other anti-competitive practices.

BIBLIGRAPHY

Latrau, K. and Oretti, M. (2007) Airlines choices for the future: from alliances to mergers. [Online] Available at: http://books.google.com/books?id=Isqt3GATUEoC&pg=PA117&lpg=PA117&dq=scales+economies+in+airline+alliances&source=bl&ots=cj2xN0BndQ&sig=GUNqxidtEDcdsGH5u7nJKy35dY8&hl=en&ei=9RWxTIC1OoOKlwecx8zmDw&sa=X&oi=book_result&ct=result&resnum=2&ved=0CBYQ6AEwAQ#v=onepage&q&f=false

Kleymann, B. and Seristö, H (2004). Managing strategic airline alliances. [Online]. Available at: http://books.google.com/books?id=kWNR-T7a8isC&printsec=frontcover&dq=airline+alliances&hl=en&ei=6-mwTO7LLIGBlAee_LzlDw&sa=X&oi=book_result&ct=result&resnum=1&ved=0CC8Q6AEwAA#v=onepage&q&f=false

OECD (2000). Airline mergers and alliances. [Online]. Available at: http://titania.sourceoecd.org/vl=6336608/cl=14/nw=1/rpsv/cgi-bin/fulltextew.pl?prpsv=/ij/oecdjournals/15607771/v2n2/s4/p122.idx

OneWorld. (2010) An introduction to oneworld:The alliance that revolves around you [Online] available at: http://www.oneworld.com/content/factsheet/W1_2010-08-02%20Introduction%20to%20oneworld.pdf