2

Lecture Outline

Evolving Network Strategies

Capacity Discipline and Profitability Recent Capacity Strategies of Western airlines Capacity Reduction Impact on Yields and Load Factors

Global Network Expansion: Emerging Carriers Rapid Growth of Competing Hubs

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

2 04 de marzo de 2016

3

The Evolution of Networks

Hub Operation 55 City Pairs

Network Operation 231 City Pairs

Point-to-Point 5 City Pairs

Pre-1980s Route vs. Route

1980s-1990s Hub vs. Hub

21st Century Network vs. Network

CO

MPE

TITI

ON

ST

RU

CTU

RE

www.airlines.org

4

US Airline Network Developments

US airlines have posted five profitable years 2010-2014 Dramatic improvements in unit costs and productivity since 2002 US bankruptcy laws allowed major labor cost reductions Recovery from financial crisis and record fuel prices in 2008-09

Profitability despite high fuel prices and slow recovery Industry consolidation – “Big 3” Legacy plus Southwest/AirTran Emphasis on profits and financial strength over market share

Unique network strategies Domestic “capacity discipline” International capacity expansion

5

US Airline Industry Profits 2000-2014

Source: US Bureau of Transportation Statistics

(35,000)

(30,000)

(25,000)

(20,000)

(15,000)

(10,000)

(5,000)

-

5,000

10,000

15,000

20,000

Milli

ons

Years

Oper Profit

Net Profit

http://tonto.eia.doe.gov/dnav/pet/pet_pnp_pct_dc_nus_pct_a.htm

6

US Airlines System RPM Shares (1Q 2014)

Source: US Bureau of Transportation Statistics

23.7%

20.5% 19.8%

11.8%

4.4% 3.3%

1.8% 1.8% 1.7% 1.7% 1.2% 1.1% 1.0% 1.0% 0.0%

5.0%

10.0%

15.0%

20.0%

25.0%Largest 4

carriers with 75%+ of RPMs

http://tonto.eia.doe.gov/dnav/pet/pet_pnp_pct_dc_nus_pct_a.htm

7

696 688 566 529 502 446

2213 2147 2068 2002 1737 1517

978 939 971 1003 1115 1223

4273 4324 4278 4254 4277 4300

8160 8099 7882 7787 7631 7485

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

2010 2011 2012 2013 2014 2015*

Turboprops Small RJs (50 seats or less)Large RJs (51 to 99 seats) Other Jets (100 seats or more)

8% Decrease in US Domestic Flights (thousands) from 2010 to 2015

* Forecast

Source: M. Halpin (2015)

8

Larger Aircraft – Percentage of US Domestic Flights Aircraft Type

9% 8% 7% 7% 7% 6%

27% 27% 26% 26% 23% 20%

12% 12% 12% 13% 15% 16%

52% 53% 54% 55% 56% 57%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012 2013 2014 2015*

Turboprops Small Regional Jets (50 seats or less)Large Regional Jets (51 to 99 seats) Other Jets (100 seats or more)

* Forecast


9

0 200 400 600 800 1000 1200

JetBlue

Alaska

United

Southwest

Delta

American

Average Stage Length of US Domestic Flights per Airline

2010 2015* * Forecast

+ 6 %

+ 10 %

+ 11 %

+ 8 %

+ 12 %

- 0 %

Average Stage Lengths Have Increased


10

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

YoY % Change GDP YoY % Change Domestic Seats

Domestic Seat Capacity Stagnant Despite Economic Growth

Source: M. Wittman, Data from BTS T-100 via Diio Mi, BEA

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US Domestic Capacity Discipline Has Led to Higher Yields and Load Factors

$0.12

$0.13

$0.14

$0.15

$0.16

$0.17

$0.18

65%

67%

69%

71%

73%

75%

77%

79%

81%

83%

85%

20002001200220032004200520062007200820092010201120122013

Yiel

d (U

SD/R

PM)

Aver

age

Load

Fact

or

LOAD FACTOR

YIELD

Source: MIT Airline Data Project

12

International v. Domestic Network Growth

Intercontinental 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 revenue international traffic helps to compensate for

higher cost structures of more mature carriers in the market

13

Total International ASMs for U.S. Airlines

70%

72%

74%

76%

78%

80%

82%

84%

86%

88%

90%

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

0

50

100

150

200

250

300

350

Load

Fac

tor

Year

Avai

labl

e Se

at M

iles (

billi

ons)

U.S. Airline ASMs U.S. Airline Load Factor


14

Shift to International Flying by US Airlines

0

10

20

30

40

50

60

American Continental Delta Northwest United US Airways

1995200020062013

Perc

ent o

f Sys

tem

ASM

Percent of Capacity in International Markets


15

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 started in May 2014 and Emirates in March 2014 Emirates added 2nd daily 777 flight in October 2015 Qatar begins service in March 2016

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Geographical Advantage to Access the Emerging Market Traffic Flows

14,800km

4,500 nm 86% World Population

63% World GDP

4,600km 36% World Population

16% World GDP

Source: Airbus

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The emergence of Gulf/Middle East carriers has caused a shift in global traffic flows across major connecting hubs

Global Traffic Flows are Shifting Toward Gulf/Middle East Carriers

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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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MERGER OR ACQUISITION

ANTITRUST IMMUNITY

LIMITED JOINT VENTURE

Integration Level 0%

CODE SHARE

100%

Prof

it O

ptim

izat

ion

/ C

ost I

mpr

ovem

ent

100%

Alliances and Strategic

Partnerships

Airline Partnerships Have Goals of Increased Revenues and/or Lower Costs

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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 002 JFK-IST

also listed as SQ* 6202 JFK-IST

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Global Airline Alliances 2014

Year of Formation 1997 2000 1999

Member Airlines 26 20 15

Annual Revenues $173 B $150 B $142 B

Annual Passengers 637 M 588 M 506 M

Destinations Served 1269 1,064 992

Daily Departures 18,000 15,000 14,000

Source: K. Al-Sayeh (2013) MIT Study

oneworld 15%

SkyTeam 19%

Star Alliance

26%

Unaffiliated 40%

ASK Share (YE May 2014)

22

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)

Aeroméxico Air France Delta Korean Air

Alitalia

Continental Northwest

KLM Aeroflot

Copa Airlines China Southern Air Europa Kenya Airlines

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

Vietnam Airlines Tarom

China Eastern China Airlines

American British Airways Qantas Cathay Pacific Canadian

Finnair Iberia

Aer Lingus LAN --Canadian-- Japan Airlines

Royal Jordanian Malev --Aer Lingus--

Mexicana S7 Airlines Lufthansa

United Air Canada SAS Thai Airways Varig

All Nippon Airways Air New Zealand Ansett Australia

Singapore Airlines Austrian bmi Mexicana

--Ansett Australia--

Asiana LOT Polish Spanair

US Airways Croatia Airlines Adria Airways Blue 1 --Mexicana--

Swiss South African Airways

Air China Shanghai Airlines --Varig--

TAP Portugal

Turkish Airlines Egyptair

Brussels Airlines Continental

TAM Linhas Aereas Aegean 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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Alliance capacity growth over the past decade

11% 12% 16% 17% 19%

24%

53%

48%

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

2005 2014

Flig

hts

oneworld SkyTeam Star Alliance Other

15% 16% 16%

19% 21%

26% 48%

40%

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

2005 2014A

SM

s (b

illion

s)

oneworld SkyTeam Star Alliance Other

• The three alliances collectively account for over 50% of all flights operated, and 60% of the generated global capacity in 2014

Source: Innovata Schedule Reference Service

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SkyTeam: Member Airlines

Africa Asia Australasia Europe Latin America Middle East North America

1 7 0 7 2 2 1

25

oneworld: Member Airlines

American Airlines Group (USA)

Air Berlin (Germany)

British Airways (UK) Cathay Pacific (Hong Kong)

Iberia (Spain) Finnair (Finland) Japan Airlines (Japan)

LAN (Chile)

Qantas (Australia) Malaysia Airlines (Malaysia)

Royal Jordanian (Jordan)

S7 Airlines (Russia)

Qatar Airways (Qatar)

TAM (Brazil) Sri Lankan Airlines


0 4 1 5 2 2 1

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Star Alliance: Member Airlines


3 7 1 10 2 1 2

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Top 40 Airlines and Alliance Affiliations: Largest Airlines by Passenger Traffic

(RPKs) Rank Airline

1 Delta Air Lines 2 United Airlines 3 American Airlines Group 4 Emirates Airline 5 Southwest Airlines 6 Lufthansa 7 Air France 8 British Airways 9 China Eastern Airlines

10 China Southern Airlines 11 Ryanair 12 Air China 13 Cathay Pacific 14 Singapore Airlines 15 Air Canada 16 KLM Royal Dutch Airlines 17 Qantas 18 Turkish Airlines 19 Qatar Airways 20 Korean Air

Rank Airline 21 easyJet 22 ANA 23 Thai Airways 24 LATAM 25 JetBlue Airways 26 Aeroflot 27 Iberia 28 Air Berlin 29 Etihad Airways 30 Japan Airlines 31 Saudia 32 Transaero Airlines 33 Virgin Atlantic Airways 34 Alaska Airlines 35 Malaysia Airlines 36 GOL 37 Alitalia 38 Swiss 39 Asiana Airlines 40 China Airlines

SkyTeam (10) Oneworld (10) Star Alliance (10) Unaffiliated Source: Airline Business, Annual Rankings 2012

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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 Globe Selected 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 • Newer generation widebody aircraft enable service to more

spokes from major global hubs

• Replacement alternatives for smaller narrow-body fleet?

Airline Network Strategies Dr. Peter Belobaba Presented...

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