The argument about whether alliances are effective and therefore inevitable is over; they are both. The potential benefits to be realised have increased substantially as markets have liberalised. Without the historic constraints on frequency and price, market share increases through network expansion have made alliances inevitable. A key, and as yet unresolved question, is how best to organise and govern a multi-carrier alliance involving multiple cultures and stakeholders and many potentially conflicting interests.
Arguably a neutral third party entity needs to be created to govern the alliance. Its prime role will be to induce the alliance partners to keep score of the benefits and costs and how they are distributed. This article suggests a set of mechanisms for helping a multi-carrier partnership approach its full potential while addressing the needs of its individual partners.
Worldwide market liberalisation means that market performance will increasingly matter more in international aviation than politics. Some tactical partnerships that made sense five years ago may not make sense anymore. As markets liberalise, each carrier's opportunity set changes and this may alter the relative value of potential partnerships. A carrier will probably participate in only one global strategic alliance, so it has strong incentives to be in the one where its own benefits are likely to be maximised. This will depend on its control of local markets; the geographic position of its hub or hubs in relation to those of potential partners; the existence of other partnerships operating in the same world region; and a host of other factors. With economics as the predominant force in airline markets, some shake-outs in existing alliances are likely. It is in every carrier's interest to gain entry into the best alliance from its point of view. Some will succeed; others may fail because they moved too late.
It is helpful to look at a multi-carrier alliance in somewhat abstract terms. Each partner has a single home country in which it operates one or more hubs. To a greater or lesser extent, these hubs provide each partner with a degree of control over local markets - to and from the hub and behind the hub within the home country. The bigger and richer the home market, and the more a partner controls the home market, the more valuable the airline is to an alliance.
A key to understanding the benefits of associating with a particular alliance is to define the foregone benefit to the company in relation to its next best alternative. In other words, the airline needs to understand the opportunity cost of not joining a particular alliance. Let's suppose a carrier has the opportunity to join alliance A. Is the airline better off in another alliance, X, or could it gain by going it alone? To make a well informed decision, the company needs to know which course has the greatest chance of maximising its benefits while taking account of the level of risk.
Defining this opportunity cost is of paramount importance in governing any alliance. The next best alternative is to establish the absolute minimum the partner can accept from an alliance: in accepting anything less, it would have been better taking an alternative course.
The maximum benefits to be realised from an alliance occur when the alliance acts like a single company. In other words, the alliance takes its combined assets and deploys them to their highest and best use, subject to whatever constraints it faces. For example, if it made more sense to expand the operations of one partner at the expense of another, then the single company would do so unless there was a constraint that prohibited it from taking that course of action. Of course, the nub of the problem is that all of the partners come to an alliance with a whole host of constraints that they and their partners must live with. These constraints and the problems they cause for each of the other partners constitute one potential source of friction within the alliance.
These issues are not abstract. Each partner comes to an alliance with stockholders whose interests must be represented, labour groups that have been given certain promises, commitments to airports, debtholders and other stakeholders, and a certain market position that should not be squandered. The actions that the alliance may want to take may be at the expense of a particular partner, and some of these actions may not be easily reversible. For example, one carrier may be asked to stop serving a particular city pair. Once it leaves the market, releases its slots and its station personnel, and stops selling in the local market, its presence is lost and its opportunity may not be easily recoverable (at least at an economic price).
Unfortunately the partnership cannot act to realise the level of benefits that would be achieved in a single company without hurting its partners at least some of the time. Therefore, if the alliance is to come at all close to its potential, it will have to find a way to compensate members for the sacrifices they make in the interest of the common good.
In so doing the following principles should be followed. First, no partner should be made worse off (after being compensated) by joining its chosen alliance; in other words it must be better off than if it had chosen its next best alternative. Second, if the alliance is to hold together, a formal way of compensation must be devised so that the alliance can overcome the very real individual interests of the partners.
Both of these points require the benefits of an alliance to be rigorously defined and tracked. Indeed, a carrier needs to have the information to select its best course in the first place. Once it has joined, it then needs to understand the benefits the partnership is enjoying so that it can make sure it gets its fair share.
It seems unlikely that a partner would trust the score-keeping in an alliance to one of the partners. It is more likely that each partner would want to participate actively in the process of defining the benefits and costs of alliance actions and then in dividing up the spoils. To do this, it may be appropriate to establish a separate alliance entity charged with being the neutral facilitator of the alliance.
This entity would include representatives from each of the partners and be charged with maximising the net benefits of the alliance and helping the partners reach agreement on the distribution of benefits. To make this easier, it would create and operate a formal 'score-keeping' system defined by the sum of the parts of the alliance - the constraints, endowments and opportunities of each of the partners - and the single objective of maximising joint benefits. The score-keeping system would also formalise the distribution of benefits.
The partners come to the alliance with different opportunities (size, wealth of national markets and relative dominance); endowments of assets (routes, brands, hubs, aircraft, slots, capabilities, cash flow and balance sheets); and constraints (labour agreements, national regulations, bilateral agreements and competitors).
Assuming everyone comes to the alliance in the spirit of goodwill, many of these differences can be overcome. But, once the honeymoon is over and the real work of the alliance begins, these differences will have the potential for doing mischief to the partnership.
To overcome potential differences, partners would be well advised to begin working on the 'score-keeping' system in the early stages of the relationship. Full participation among the partners should be mandatory. To begin building the system, the partners should try to develop a base case that assesses the expected benefits of their association by focusing first on revenues. Their alliance will allow the partners to codeshare at key hubs and thereby increase their share of defined city-pair markets. The expected change in share and the likely benefits to each partner (without any other actions) can be estimated using a model like the GRA Codeshare Evaluator. A key advantage of using a neutral, third party model is that all the partners will be placed on an equal footing with the model and will help construct the base and alternative cases from the bottom up. By the end of the process, the analytical methods and assumptions should be transparent to each of the partners, which will enhance their confidence in the results. No partner will have to depend on another to help define its benefits. This transparency will play an important role when the alliance goes about the business of taking actions to maximise joint benefits.
In the discussion which follows, we assume that every member of the alliance is new. However the same general effort would be required if a new member joined an existing partnership. For each 'case' built, partners work on estimating the origin-destination revenues, market shares and passengers per segment per partner.
In this earliest phase of the alliance, the partners should build up the following cases as the first step in implementing the 'score-keeping' system.
1 Historic Case: A pre-partnership case designed to calibrate the score keeping system, it should replicate the actual market shares and revenues of the partners before they joined the alliance. The accuracy of the historic case will give the partners the confidence to trust the projections of future actions.
3 Alliance Case: This is the case which accounts for the benefits of the codeshare alliance. It should anticipate the city-pair markets where the codeshares will be effective and any changes in schedule times to make codeshare connections. The model should estimate the changes in market share, revenues to the individual parties (assuming a standard Iata prorate), and the change in segment passengers (which may impact the capacity deployed).
The initial benefit to each partner of the alliance is the difference between Case 3 and Case 2, in other words the change in revenues and passengers on specific flight segments attributable to the alliance versus what would have happened (including anticipated competitive moves) in the absence of the alliance.
Inevitably, the partners will find that the benefits of the alliance are asymmetrically distributed. For example, a short-haul carrier may feed its partners a significant number of long-haul passengers, but realise only short- haul feed in return. The total revenue benefits will be distributed in favour of the long-haul carriers and the partners may want (or insist) that some adjustment be made. This can be a difficult issue early in the alliance and there is no 'right' answer. But, as was discussed previously, the formal 'score keeping' system can help lay out the facts.
As stated earlier, no partner should be made worse off than would have been the case with the next best alternative. Although it may not be possible to make an adjustment that makes every partner whole (relative to the next best alternative) on the first day of the alliance, the partners should begin work immediately to ensure that each of them reaches this goal as soon as practicable. In negotiations at the outset of the partnership, this principle should be a point of departure for adjusting the Alliance Case prorates.
When the negotiation over compensation prorates is complete, the partners will have finished the first phase 'score-keeping' system.
1 A great deal will have been accomplished: a rudimentary score-keeping system will have been developed to estimate and keep track of the benefits of the alliance.
2 In developing this system, the partners will have developed a mutually useful working relationship and way of guiding their decisions based on facts and common information which can be expanded upon. The information that is produced in the score-keeping system will form the basis of reports made by each of the representatives to his or her management. Since the process and data will be transparent, each firm will have the benefit of assessing the tradeoffs made during the alliance discussions; this should improve decision-making and help the alliance move more quickly.
3 Many of the natural barriers to close interaction that are common in alliances will have been avoided.
The facilitator will have played a crucial part in assembling the facts and organising them in a transparent way. Each partner will have equal access to the 'score-keeping' system and the methodological and data/information issues that attend the development of such a system will be on the table and available for all to see. Since the system was first calibrated to replicate the historical experience of each of the individual partners, there will be confidence in the answers it produces.
Each partner will continue to participate in the process going forward, and each partner will know that the minimum payoff target is at least as good, and hopefully much better, than its next best alternative. This should give the partners the confidence to go to the next step: taking the actions, subject to constraints, that replicate the behaviour of a single firm. We have already seen that this is the key to maximising joint benefits. The first phase will have set in motion an objective and transparent process for dividing up the spoils. The 'second phase' will be the subject of a follow up article in the October issue of Airline Business.
International strategic alliances among multiple parties are relatively new in the airline business. Alliances with the best chance to succeed in other industries have been ones among non-competing, complementary companies of approximately equal size. Alliances between weak and strong players, among weak players, and between large and small players have a much higher failure rate. The multi-party alliances being formed now in the airline industry may have one or more of these pairings embedded in them.
In other industries a common outcome is that the larger or stronger company buys the weaker one. However nationality clauses presently limit this option in the airline industry. The other common outcome is that the alliance breaks up, often with each party experiencing a large write-off.
Over time, in the airline business a carrier may not have many attractive options if it finds itself outside one of the three or four global alliances. Seen from this perspective, there are large incentives to make the alliances work.
The role of the facilitator and the neutral score-keeping system is to help the partners overcome the inherent weaknesses in airline alliances. The system also has the important virtue of helping the alliance reach its joint potential. Put another way, the global alliance that does the best job of fulfilling its potential will have important advantages over rival alliances, while creating greater wealth for its members.
Source: Airline Business
