Airline Network StrategiesDr. Peter Belobaba

Network, Fleet and Schedule

Strategic Planning

Module 17 :   13  March 2014

Istanbul Technical University

Air Transportation Management 

M.Sc. Program 

2

Lecture Outline

Review: Evolving Network Strategies

US Airline Network Developments Impacts of Recent US Mergers International vs. Domestic Network Growth

Global Network Expansion: Emerging Carriers Rapid Growth of Competing Hubs

Airline Cooperation and Consolidation Alliances and Code-sharing Joint Ventures Mergers and Acquisitions

2 24 de febrero de 2014

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Review: Evolving Network Strategies

From linear – to hub construction – to hub-to-hub flying

From national dominance – to a regional footprint –to a global focus

Domestic networks supporting international growth International expansion contributes to improved on board

revenue for the domestic operation

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The Evolution of Networks

Hub Operation55 City Pairs

Network Operation231 City Pairs

Point-to-Point5 City Pairs

Pre-DeregulationRoute vs. Route

1980s-1990sHub vs. Hub

21st CenturyNetwork vs. Network

CO

MP

ET

ITIO

NS

TR

UC

TU

RE

www.airlines.org

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US Airline Network Developments

Industry consolidation through mergers US Airways and America West in 2005 [US Airways] Delta and Northwest in 2008 [Delta] United and Continental in 2010 [United] Southwest and AirTran in 2012 [Southwest] American and US Airways in 2014 [American]

International vs. Domestic Network Growth Domestic Capacity Cuts and Shifts to Regional Partners International Network Expansion

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US Carrier System RPM Traffic Share 12 Months 2012

Source: Aviation Daily, 1/21/2013

22.6%21.3%

15.9%

12.9%

7.8%

4.2% 3.8%3.1% 2.6%

1.5% 1.5% 1.3% 0.8%

0%

5%

10%

15%

20%

25%80.5%

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Impacts of Mergers on Flight Volumes

US Airways and Delta Airlines effectively absorbed flight volumes of America West and Northwest, respectively, with little to no change in total mainline flight volumes

18,119 16,860

60,836

37,540 33,970

0

20,000

40,000

60,000

80,000

2000 2005 2010

US Airways Total Flight Volume

America West US Airways

44,657 42,414

75,097

58,750 61,559

0

20,000

40,000

60,000

80,000

2000 2005 2010

Delta Airlines Total Flight Volume

Northwest Airlines Delta Airlines

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Drop in US Domestic Capacity –Shift to Regional Partners

US

Do

mes

tic

AS

Ms

in B

illio

ns

Source: ATA

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International v. Domestic Network Growth

Inter-continental growth has proven successful in conjunction with alliance partners Presence of low cost carriers make domestic profitability difficult Low cost carrier operations primarily focus on largest origin and

destination markets which makes profitable flying more difficult

Important to diversify route portfolio between international and domestic flying Domestic networks sized primarily to feed international flights can

benefit from carrying international connecting passengers Higher yield international traffic helps to compensate for higher

cost structures of more mature carriers in the market

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Domestic Departures from U.S. Airports

Drop of 1.3 million departures/year since 2007.

0

2

4

6

8

10

12

2007 2008 2009 2010 2011 2012

Mill

ion

s o

f D

epar

ture

s

Core 30 Non-Core 30

Source: Diio Mi Schedule Data

57.3%

42.7%

60.7%

39.3%

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Total US Domestic Capacity IndexFlights Down 14%; ASMs Down 8% Since 2007

0.80

0.85

0.90

0.95

1.00

1.05

2004 2005 2006 2007 2008 2009 2010 2011 2012

FLIGHTS

SEATS

ASMS

‐11%

‐ 8%

‐14%

Source: Diio Mi Schedule Data

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Capacity Shift from U.S. Domestic to International Routes

Source: Airlines for America

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Diversification of the Route Portfolio Critical to Improved Profitability

Percen

t of System ASM

Percent of Capacity in International Markets

0

10

20

30

40

50

60

1995 2000 2009 2011

American Delta United US Airways

Source: MIT Airline Data Project

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US Airline International Service IndexLarger Aircraft and Longer Flights Since 2004

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

1.20

1.25

1.30

2004 2005 2006 2007 2008 2009 2010 2011 2012

FLIGHTS

SEATS

ASMS

Source: Diio Mi Schedule Data

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Global Network Expansion:Emerging Global Carriers

Continued rapid growth of these airlines will affect global traffic flows Emirates (Dubai), Etihad (Abu Dhabi), Qatar (Doha) and Turkish

(Istanbul) building large hubs that depend on connecting traffic Future success is highly dependent on negotiating new bilateral

rights to further expand their hub networks

Implications for airports Emerging carriers looking for new spoke cities to feed their

connecting global hubs with 6th freedom international traffic Operations involve long-haul, wide-body (and A380) aircraft and

full-service products (premium classes, lounges) Competition among airports to attract these new services – at

BOS, Turkish will start May 2014 and Emirates in March 2014

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Geographical Advantage toAccess the Emerging Market Traffic Flows

8,000 nm

4,500 nm86% World Population

63% World GDP

2,500 nm36% World Population

16% World GDPSource: Airbus

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Flights from Emerging Carrier hubs have more than doubled since 2004

Flights to all regions have increased rapidly over the past 8 years

Nearly 50% of flights are destined to Europe

0

50000

100000

150000

200000

250000

2004 2005 2006 2007 2008 2009 2010 2011 2012

Africa Asia Australia Europe Latin America North America

Source: Karim Al-Sayeh, Innovata SRS, accessed through Diio Mi

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Competition with European Hubs

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Airline Cooperation and Consolidation

Regulatory hurdles block the type of cross-border consolidation that has occurred in other industries. International flight operations still regulated by bilateral

agreements Limits on foreign ownership of airlines in many countries Influence of political and union forces against such consolidation Anti-trust laws can constrain mergers and cooperation even

within same country

Many forms of cooperation possible: Code-sharing agreements between two airlines Membership in global airline alliances Joint ventures to share both revenues and costs Mergers and acquisitions

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The Synergies of Airline Cooperation are Determined by the Level of Integration

Economical Benefit/Complexity

Special Prorate Agreement (SPA)

(Free sale) Codesharing

Merger/ M&A

Depth of integration

100%

no cooperation

Interline Agreements

Sales Incentive Agreement

Blocked Seat Agreements (Codeshare)

1

23

4

5

6

8

Alliances

JV

Bilateral Joint Ventures (Revenue)

Bilateral Joint Ventures (Profit)7

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Code-Sharing

Under a “code-share” arrangement, partner airline places its own code on an alliance flight: Partner markets and sells its own tickets for the flight Flight is actually operated by another alliance airline Flight is listed twice (or more) in airline schedules and computer

reservations systems (CRS)

Code sharing increases consumers’ perceptions of network coverage in CRS displays:EXAMPLE:

TK 012 JFK-ISTalso listed as US* 5003 JFK-IST

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Airline Alliances and Network Coverage

“Strategic alliances” between two airlines take the economic logic of hub networks one step further: Partner airlines can expand their network coverage without

increasing their own flights and operating costs Leads to further consolidation of loads, as two or more airlines

now contribute passengers to a single “alliance flight” Marketing power of larger networks is reinforced--more

destinations, seamless connections, frequent flyer benefits Additional cost savings are possible in alliance airlines due to

combined flights, airport check-in and club operations, integrated purchasing and information systems

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HubsAirline I

HubsAirline II

NetworkAirline II

NetworkAirline I

AircraftAirline I

AircraftAirline II

AircraftAirline II

& Airline I

International Alliance Networks

International alliances link their networks through hub-to-hub flights

Global Strategic Alliance -- Strongly connected domestic networks linked together through high-density flights between international hubs

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0

5

10

15

20

25

30

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012(Feb)

AeroméxicoAir FranceDeltaKorean Air

Alitalia

ContinentalNorthwest

KLM

Aeroflot

Copa AirlinesChina SouthernAir EuropaKenya Airlines

--Continental----Copa Airlines----Northwest--

Vietnam AirlinesTarom

China Eastern China Airlines

AmericanBritish AirwaysQantasCathay PacificCanadian

FinnairIberia

Aer LingusLAN--Canadian-- Japan Airlines

Royal JordanianMalev--Aer Lingus--

MexicanaS7 AirlinesLufthansa

United Air CanadaSASThai AirwaysVarig

All Nippon AirwaysAir New ZealandAnsett Australia

Singapore AirlinesAustrian bmiMexicana

--Ansett Australia--

AsianaLOT PolishSpanair

US AirwaysCroatia AirlinesAdria AirwaysBlue 1--Mexicana--

SwissSouth African Airways

Air ChinaShanghai Airlines--Varig--

TAP Portugal

Turkish AirlinesEgyptair

Brussels AirlinesContinental

TAM Linhas AereasAegean Airlines--Shanghai Airlines--

--Continental--

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15

12

Ethiopian Airlines

Growth of Global Alliances

Source: Tugores, T. (2011) MIT SM Thesis

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Global Airline Alliances

Year of Formation 1997 2000 1999

Member Airlines 27 15 12

Annual Revenues $174 B $112 B $92 B

World RPK Share 30% 19% 19%

Destinations Served 1135 832 712

Countries Served 181 169 145

Source: Tugores, T. (2011) MIT SM Thesis

Star Alliance, 25.2%

SkyTeam, 15.7%

oneworld, 13.7%

Others, 45.4%

Available Seat Kilometres 

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Advantages of Airline Alliances

Airlines can strengthen networks and market position against competing alliances: Expand network coverage with little risk or increased operating

costs, and no new capital required (aircraft or facilities) Access to new O-D markets and incremental revenues Increased market shares in existing markets due to greater

presence, meaning increased traffic, revenues, and profit

For consumers, a “seamless” travel experience: World-wide service with single check-in, consistent passenger

service standards, club rooms and FFP benefits

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Disadvantages of Airline Alliances

Potential for disagreements among airline partners: Can be difficult and costly to completely standardize customer

service standards and procedures Cost savings might not be as great as anticipated Conflicting network and revenue sharing objectives Possible for one partner to actually lose revenue as dominant

airline exerts market and RM strengths Alliance relationships are not permanent, as airlines switch

partners and alliances

For consumers, confusion about code-sharing, operating carriers and potentially anti-competitive impacts.

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Consolidation Activity Around the GlobeSelected M&A and/or Cross-Border Investment: 2005-Present

USA Non-USA

Republic/Shuttle America Air France/KLM

US Airways/America West Copa/AeroRepública

SkyWest/Atlantic Southeast Lufthansa/Swiss

Pinnacle/Colgan Air China/Cathay Pacific*

Lufthansa/JetBlue* Cathay Pacific/Dragonair

Delta/Northwest Lufthansa/Brussels*/BMI/Austrian

Republic/Midwest/Frontier Avianca/TACA

United/Continental British Airways/Iberia

Pinnacle/Mesaba LAN/TAM

SkyWest-ASA/ExpressJet LAN/Aires

Southwest/AirTran TAM/TRIP*

Source: ATA and Deutsche Bank Global Research * Strategic investment but not full ownership or control

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Different Models of M&A Integration

Examples

Characteristics

Advantages

Disadvantages

One Brand Co-Brand Multi-Brand

Full integration

One management

One brand

Maximum of synergies

Fast decision processes

Loss of a potentially well known brand

Very high integration

Integrated management

Two brands

Higher synergies

Maintain (national) brands

Higher complexity

High integration

Management teams

Multi-brand

Profit center orientation

Maintain (national) brands

Flexibility in growth

Higher complexity

Source: Lufthansa Presentation to MIT (2010)

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Factors Affecting Future Networks

Network Structure• No evidence of shift away from large hub and spoke networks• Even LCCs have been developing “focus cities” for connections

Industry Consolidation• Recent (and future) mergers could eliminate smaller hubs• Alliances and joint ventures reinforce largest international hubs

Availability of New Aircraft Options• 787 delivery delays, A350 still years away• Replacement alternatives for smaller narrow-body fleet?