Cross-border consolidation may be slow to materialise in the airline industry but it is only a matter of time. And as the industry does become truly global, it is hubbing strategies that will hold the key to success, writes Chris Tarry of Commerzbank.
In theory the life cycle of the airline industry should be little different from any other market. As it matures the business should tend to consolidate around fewer successful players and see others exit. That is the theory. In reality the process has been rather more complex, not least due to lingering national boundaries. But that does not necessarily mean that the fundamentals fail to apply either to airline companies or their networks.
It is true that even within a single country, the path to consolidation is not all smooth sailing. Look at the US industry's current upheavals in reaching its final consolidated form. Theoretically Europe too is a single market and cross border acquisition is already possible today, especially if there is no impairment of the route rights of the acquired. However, if British Airways and KLM had gone ahead with their merger it was clear that the only ongoing long haul service that the combined airline could have flown out of the Netherlands would have been across the Atlantic. This, it appears, was a step too far given the emotion still associated with the idea of the national flag carrier.
There have been numerous such false dawns on the road to European cross-border consolidation, and it will still take some time. How long is too risky to predict but it is a question of when, rather than if, it will happen
Even before reaching the stage of a merger or perhaps more accurately the acquisition of one airline by another, significant benefits can be obtained by a coming closer. Increased reach and feed are the fundamental factors for success. In this respect it becomes a necessary condition for a successful alliance to show how it will bring together market and network. In other words for one airline it should extend the reach and for the other it should raise traffic feed.
Naturally it is generally true that point-to-point traffic will produce the best fare levels. Yet there are exceptions to this rule. It is not hard to find examples of direct services on which mainline airlines cannot or should not expect to compete, due the extent of segmentation and/or the level of competition. At the same time, transfer traffic can be highly profitable in its own right for a network carrier and can produce a high marginal contribution.
So what ensures the best quality transfer traffic? The answer at least in the theoretical world is quite straightforward and includes network, connections and airport.
In reality, for most travellers the market place is still the travel agent's computer reservation screen. That old statistic that 80% of bookings are made from the top of the first screen page still largely holds true. Or to put that another way, an airline needs to maximise its real and virtual display of network breadth.
Increasingly, competition is not so much between airlines - perhaps even less so as the seat product becomes more of a commodity - but between the networks that they and their partners can offer. The central question is how to lock travellers (and corporate travel buyers)into their system.
Global hubbing
Therefore, over time it seems inevitable that a US style of hub-and-spoke operation will be replicated on a global basis. This will result in short- and medium-haul traffic being fed into long-haul services in one world region and being fed out into the partner's network at the other. Each is a giant vacuum cleaner sucking up feed at one end of the long-haul route and blowing it out at the other.
Of course a combination of market growth and aircraft with the right economics may make increased direct long-haul services viable from more and smaller cities in the future but in most cases today the more compelling economics are to flow the passengers over a hub.
A recent study from the US Department of Transportation only confirmed what most analysts had already calculated, that the fastest growing element of alliance traffic is the so-called behind and beyond traffic. By definition the most important transatlantic link for alliances is between their hubs. Better opportunities might possibly arise from "capacity co-ordination" on point-to-point routes but it would have to get past the regulators first.
As the intra-hub services develop, so the competitive landscape changes and the opportunities for passengers increase. In recent years BA has offered the only direct Europe-Denver service. This will change with the coming summer schedule with a joint Lufthansa/United flight from Frankfurt to Denver which will clearly take feed traffic from mainland European. Furthermore United will be able to exploit the behind and beyond opportunity this service will offer at both ends of the route.
Travellers seeking broader choice can already see their options rise as the airlines form alliances. And they appear to like such choice. What airlines need to do is to offer yet more choice and that means developing a multi-hub strategy.
So far in Europe it is the Star Alliance that has the only effective multi-hub approach and it will become even more powerful with regulatory change - not least if the proposed creation of a Transatlantic Common Aviation Area or similar gains momentum. Although in other areas of the airline business less can be more, this is clearly not the case for hubs - the more the better.
However in Europe there are only a limited number of opportunities. That perhaps leads on to some interesting discussions yet to come about the changing nature of the airline value chain. But the basic challenge remains straightforward: how to love and lock-in the maximum number of profitable travellers and flow them through whatever hubs you have.
Source: Airline Business
