UK: Survival of the biggest.

UK: Survival of the biggest. - British Airways and American Airlines know that in today's market, consolidation is king and the alliance is queen - there is no room for minor players.

by Fiona Jebb.
Last Updated: 31 Aug 2010

British Airways and American Airlines know that in today's market, consolidation is king and the alliance is queen - there is no room for minor players.

As with the Great War, they thought it would all be over by Christmas.

'They' being British Airways (BA); 'it' being the regulatory approval necessary for BA's proposed alliance with American Airlines (AA); and the Christmas in question, December 1996. With a following wind, 'it' may now be over by Christmas 1998. In the meantime, of course, BA and AA have announced the five-airline oneworld marketing alliance - a grouping (with Canadian, Cathay Pacific and Qantas) and with no current regulatory implications, but one whose links could go deeper if BA/AA regulatory approval is granted.

Unlike the wartime politicians, BA/AA did have some grounds - some precedents - for expecting swift progress when they announced their alliance in June 1996. Theirs was the fourth such major tie-up to be published, and the most comparable - the Lufthansa/United Airlines partnership, which forms the basis of the Star Alliance - had taken only three months to get past the US Department of Transportation (DoT), the US regulatory body. As with the preceding KLM/Northwest and Delta/Swissair alliances, the EC competition authorities had not even raised their heads above the parapet when Lufthansa and United talked of commercial co-operation.

But the transatlantic route to America is by far the most significant in a business where the (generally pretty meagre) profits lie in long-haul premium flights. And London's principal airport has long been regarded as Fortress Heathrow, with BA holding 40% of all landing and take-off slots. Add into the mix the fact that an unregulated BA/AA alliance would hold 60% of the market between the UK and the US and that by the time BA and AA announced their plans, transport veteran Karel Van Miert had taken over as competition watchdog in Brussels, and maybe trouble was to be expected after all.

In the face of the onslaught the duo's reaction was twofold. First they marshalled their own arguments, and then they did everything they could to make sure that the three other alliances were subjected to scrutiny by Brussels' finest bureaucrats as well. Final resolutions from all possible regulators on all four alliances are still expected by the end of the year.

As Henry Schlee, a vice-president of Mercer Management Consulting, puts it: 'Airlines through alliances are embarking on a quasi-consolidation process that most other industries with similar characteristics started between 20 and 50 years ago.' The trend towards alliances and supergroupings (whose members can often number well into double digits when each stake, each code-sharing arrangement and each local deal is taken into account) is the result of decades-old legislation which prevents foreign ownership of national airlines: the maximum stake foreign investors may hold is 25% in the US and 49% in the EU. And all this is in pursuit of the business traveller who, usually not too worried about the bill, insists on a frequent, reasonably direct and seamless service - as well as air miles or an equivalent - as part of the airline's 'package'. For the service provider, the allure of the business traveller as opposed to, say, the student backpacker is glaringly obvious. 'You make four times as much per square metre for a business traveller,' says Chris Avery, aviation analyst for Banque Paribas.

The consolidation trend - which most expect to result in a handful of alliances dominating air traffic worldwide - leaves little room for weaker players to hide. Though such partnerships do not guarantee success, non-alignment is a cause for concern for as yet unpaired players. 'Alliances are like frequent-flyer programmes,' says Avery. 'Once most other people have got one, you have to have one yourself. And there's a very limited number of players left now.'

That said, there will still be some unallied niche players. Experts agree, for example, that low-cost airlines such EasyJet and Go! should be able to take a reasonably distanced view of the proceedings, offering as they do a point-to-point service while alliances are based on the idea of networked travel. They may even prosper from changing industry trends, suggests one observer, if consolidation sees alliance fares take off. The fate of an airline such as Richard Branson's Virgin Atlantic, however, which has been keen to capture business travellers but only offers point-to-point routes is rather more debatable, according to Schlee. Virgin has alliances with Continental and British Midland but these are relatively undeveloped. 'Virgin's strategic dilemma,' he says, 'is whether it can generate growth without trading over into becoming a network.' He believes that the airline's tentative steps into alliances betray uncertainty as to which path to take. For while in many ways, offering a point-to-point service from other European capitals to the US might be a more viable strategy, the problem here is either a lack of slots (Frankfurt), a lack of market (Amsterdam) or a lack of open skies (France). 'Virgin is at a crossroads,' elaborates Schlee, 'since it doesn't have the capacity to draw in the most attractive partners - what they would be looking for is a short-haul network.' Recognition of this problem has motivated Virgin's vociferous opposition to the BA/AA tie-up.

Yet even for those who are already spoken for, the benefits an alliance offers are uncertain. For smaller airlines, alliance membership is a face-saving way of being squeezed out of existence. 'Alliances allow nations to maintain the continued existence of their flag carrier without it going bankrupt,' explains Peter Martin, director-general of the Air Transport Users' Council. 'An alliance allows a national flag carrier to feed its major partners but it won't be flying independent long-haul flights. What you want to be is the long-haul carrier.' Greece's Olympic, Spain's Iberia, Portugal's TAP and Italy's Alitalia all risk being marginalised.

For the strongest players the crucial axis in at least three of the four tie-ups seems to be solidifying - BA/AA (assuming all goes well), United/Lufthansa and KLM/Northwest. With BA/AA, the problem is not so much one of two mice but of two elephants combining to form a colossus much feared by competitors.

And it is here that the thorny slots issue comes in. Slots (for obvious reasons, they come in pairs) are the right to take off or land at a certain time and once an airline has acquired them, it more or less owns them in perpetuity. Moreover, short of building new airports or terminals, increasing the number of slots is nigh on impossible.

So, while BA is, of course, clamouring that the EC recommendation that it relinquish 267 slots, chiefly at Heathrow, is iniquitous, its rivals are hollering that Van Miert's findings do not go far enough. Delta, for example, is still protesting that 800 slots is closer to the right figure while United is busily engaged in arguing that the BA/AA issue is completely different from the Star Alliance (where the Commission has recommended the ceding of 108 slots, chiefly from Frankfurt). The logic is summarised by United's vice-president for the Atlantic, Graham Atkinson, who claims that the Commission's ruling does not adequately reflect the twin argument that Germany's skies are already open and that, by virtue of its geography, London is a more logical European hub for American flights than Frankfurt.

Not that it is just a matter of the number of slots, for while there has been much discussion as to whether these may or may not be sold, failure to resolve this issue means there has been little discussion as to who will eventually benefit. United alone would like a further 200 or so slots a week, one indication of the extent to which demand is likely to outstrip supply. Crucially every beneficiary will need a decent number of slots if they are to be in a position to provide business travellers with a sufficiently frequent service. 'It will be farcical if we all only get two slots a day,' says Delta's press officer, Corrie Shanahan, 'we'll get hammered. Apart from low-fare leisure passengers, why would you go with someone flying only twice a day so that if you miss tonight's flight you have to wait for tomorrow?' David Holmes, BA's director of corporate resources, is trenchant about the issue ('we don't care which competitors get our slots') since he thinks the matter must be decided by the market, with pairs of slots going to the highest bidder; slots are currently thought to be changing hands for around $6 million (£3.6 million) a pair.

But Holmes and co are still battling on the basic numbers. 'The Commission's suggestion involves giving up 19 round-trips a day,' he explains, '16 of which would be at Heathrow. But American only has 14 daily trips to Heathrow as it is. Why if we get together should our combined operation be smaller than it is now? No merger approved by any competition authority anywhere in the world has ever ended up with a smaller entity ... And if on top of that if we are not compensated (for the slots) it would be confiscation ... absolutely outrageous.' As competitors gripe about the virtual monopoly that a BA/AA alliance would enjoy on several major routes, Holmes protests that Star's market share at Frankfurt is a hefty 57% of all German/US flights. Moreover, he adds, BA/AA's share at Heathrow will fall once the open-skies agreement, a US condition of approving the alliance, comes into operation. And so the backbiting goes on as it has for the last two years.

Going with the conventional wisdom, that BA and AA will find some accommodation with the regulatory bodies, their alliance looks likely to model itself fairly closely upon the existing tie-ups between major partners which consist in the main of code-sharing, joint pricing and marketing, co-scheduling and joint frequent-flyer programmes. BA/AA will, however, go one step further, with a formal profit-sharing arrangement (details of which are not being disclosed) on the transatlantic routes.

Few players so far have used their quasi-mergers to cut costs in the manner of more traditional corporate marriages. Mercer's Schlee says the emphasis has been far more on increasing revenues than on slashing outgoings, reckoning that the ratio of revenue growth to cost stripping activity has been in the region of 20:1. Kevin O'Toole, editor of Airline Business, agrees with the general drift but says that was always likely to be the case, citing Star as an example. 'Star seems to be working,' he says, 'but it's not achieving the traditional things that are normally achieved by a merger - cost or overhead reduction. They are looking for increases in scope. The thing about alliances is that you get immediate scope by having a marketing presence in every country in the world.' And figures bear this out: United reports that its membership of the Star Alliance boosted revenues by $170 million in 1997, most of which fed through to the bottom line. And one analyst estimates that the BA/AA tie-up should add £300 million to BA's operating profits after three years.

There are enormous opportunities, says Schlee, who argues that common branding and the co-ordinated purchasing which could follow is another obvious money-spinner. 'Yet,' he cautions, 'someone in the business told me that when they tried to co-ordinate their purchasing, it turned out that there were insuperable obstacles even to co-purchasing napkins. Until you have commonly branded products, it's not really worth the effort.'

The difficulty is that with so much brand equity tied up in national flag carriers, individual partners in any alliance are more than a little worried about diluting their existing claims to fame. Star has gone the furthest down this route by carrying all partners' names plus the Star signature on its planes, but John Patterson, director of alliances at BA, the master brand-builder, is dismissive of Star's efforts. 'They are bizarre aircraft,' he says, 'all divided up. We're delighted to say we think it's a brand nightmare.' Yet he will admit that it would be something of a branding disaster for, say, Air France to suddenly to rechristen itself 'Air Polyglot' and lose all the customer loyalty which it has built up with its passengers over the years.

Ah yes, Air France, Europe's third carrier (after BA and Lufthansa) so obviously absent from the roll call of alliance members (although it recently reached a code-sharing agreement with Delta) and still to negotiate its way through the open-skies quagmire. Delta's interest in Air France suggests that the fourth major alliance, Delta and the Qualiflyer Group (Swissair, Sabena, Austrian Airlines) may be less stable than its three counterparts.

Andrew Lobbenberg, Delta's European/Asian manager, hints at this. 'Our partnership with Swissair is very developed and it's going very well,' he says, 'but Air France is a very attractive partner and we are keen to develop it (the partnership) ... In Europe, Air France is the key to the jigsaw.' Others predict that since it is too small to compete alone, Qualiflyer's strategy may be to set itself up as an alliance to partner one of the other three major groupings.

Such a double whammy - the alliance of two existing alliances - would doubtless keep the red tape churning but then Mr Van Miert and his counterparts must have always suspected that they were in for a long haul. For them, it's very unlikely to be over by Christmas.



American Airlines 985

United Airlines 949

Delta Airlines 934

British Airways 754

Singapore Airlines Group 670

Northwest Airlines 597

US Airways Group* 494

Lufthansa 482

Continental Airlines 385

Southwest Airlines 318

*US Airways excludes gain on taxes and disposals.

Source: Flight International.

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