Will Alliances Evolve or Will Etihad's Model Prevail?

Airline alliances, including the Star Alliance, oneworld, and SkyTeam, have generated substantial benefits for their members. Those benefits, however, have primarily been on the marketing side of the business, as code-shares and connecting traffic increase revenues for alliance members, particularly when flying into partner hubs for traffic feed. Alliances have also taken the first steps at joint purchasing. To date, however, those purchases have focused primarily on disposable items -- such as napkins or blankets for use inside the cabin, but not focused on larger items, such as aircraft, engines, and maintenance. Equity alliances, such as Etihad’s investments in a number of airlines, have already seen aircraft transition between one member and another (Jet to Etihad) and appears ready to move more aggressively into joint purchasing and leveraging of purchasing power. IAG, which owns British Airways and Iberia, has already negotiated orders for the A350 on behalf of both airlines, and is likely achieving significant volume-based discounts. The problem for a global alliance, such as Star, oneworld or SkyTeam, is the broad range of fleet types operated. With each alliance, there will be operators of Airbus and Boeing narrow-bodies and Airbus and Boeing wide-bodies. An example of that is the oneworld alliance, whose fleet is shown below: But what would happen if the alliance decided to take things to the next level, and make fleet decisions together? Imagine an aircraft procurement with 15 airlines aggregating fleet needs and negotiating with Airbus and Boeing over massive orders or 300-400, rather than 40-50 aircraft? That type of negotiating leverage would significantly impact pricing. One order could potentially “make or break” a program. Is there a reason the carriers can’t get together, combine fleet needs, and negotiate as a block, with the subtle differences in BFE taken care of by each carrier? With respect to buyer furnished equipment (BFE) and interiors, standards should exist among alliance members that are acceptable to all of the operators. There are currently a myriad of interior options available to an airline, with only minor differences, yet these small differences impact costs by a lot. At one point there were more than 100 different galley carts available for the Boeing 747. Do we really need more than 2 or 3 different designs, as they serve the same function and are quite similar? Northwest and KLM collaborated on a World Business Class in their alliance, offering the same seats and comfort level to ensure that business traveler expectations were met in their alliance. But that was just two carriers collaborating, and not 15 as we see in current alliances. Airlines need initial provisioning when they order aircraft, and this means maintaining separate spares inventories, typically at hubs and major destinations. But with 15 carriers operating larger fleets, statistical analysis tells us that too many spares are currently purchased, and that with pooling, an optimal arrangement can be made. Shouldn’t BA handle all the oneworld spares at LHR, American at JFK, and have spares replenished as they are used? There are operational savings that are not being taken advantage of. Clearly commonly fleet types drive huge economies of scale. The savings would be significant. Maintenance is another area in which economic synergies should occur. While each carrier may have its own maintenance facilities and wish to maintain them (as in some countries it isn’t easy to reduce staff levels), opportunities exist to specialize in certain types of repairs and leverage the volume of the entire alliance to enhance the efficiency of operations. In the oneworld example, American could specialize in 777s while BA could specialize in the A320 family. Engine power by the hour contracts would be negotiated with better rates for a fleet of 400 than a fleet of 25. MRO contracts for component repair and overhaul would be significant better with the guarantee of more volume. We believe the answer is self-evident. Etihad, and its equity alliance partners, are moving in that direction, and will be leveraging the combined purchasing power of its carriers in purchasing for key operational components, including aircraft and maintenance. By combining purchasing power, the alliance can take advantage of volume discounts, economies of scale, and pooling of spares inventories. Those benefits sink directly to the bottom line, but require agreement on standards, vendors, and joint negotiations. That’s much easier to do as an equity shareholder than as a member of a loose federation. Moreover, the industry is familiar with standards - the FAA, EASA and JAA all honor each other's certifications. Maintenance undertaken by Japan Airlines will be to the same standards as American or BA. Of course, equity doesn’t guarantee an alliance will succeed. Delta, Singapore, and Swissair once had 5% equity cross-holding stakes in the Qualiflyer alliance, which disintegrated as the carriers moved in different directions. This may yet happen to some members of the Etihad alliance. Pundits have long predicted the “virtual airline” in which marketing and operational aspects would be separated, with the latter being optimized by third parties. Should alliances delve more deeply into operational issues, an element of that strategy could come into play. But getting airlines to agree on anything is like herding cats, and more likely to happen in an equity sharing arrangement than via a marketing confederation. It will be interesting, now that Etihad has invested in perennially bankrupt Alitalia, to see the degree to which operational synergies can be added to the marketing synergies created by the alliance. Italy's unions have to swallow a lot of humble pie for this to work. If the alliance proves successful, and helps lower the costs through economies of scale, we could see a new direction for the three alliances in the future. The OEMs will not be happy.

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