BUSINESS TRAVEL DECISIONS - Cosy club class.

When the fledgling airline industry convened in Chicago just before the end of the Second World War, borders, protectionism and territorial control were the concepts uppermost in delegates’ minds. The rules for the age of international passenger flight were founded on a simple principle: I control my territory, you control yours.

These were natural enough sentiments after years of bitter warfare, but the legacy this kind of thinking bequeathed the airline industry has done international travel few favours. Where other industries have multinational companies more or less free to compete globally, the airline industry has been constrained by national boundaries. The system has encouraged flourishing national airlines, which was one of the chief aims of the industry’s founding delegates. However, with all the players limited to forging point-to-bi-lateral-point arrangements on the “I’ll let you fly to me if you let me fly to you” basis, the mathematics for a wider link up couldn’t be made to work.

British Airways, for example, has no trouble flying to Delhi, but on its own it will hit a brick wall when a traveller wants to continue on from Delhi to, say, New York. When airlines try to play at joining the dots, with the world’s major cities as their targets, they very quickly end up chewing the ends off their pencils in frustration.

In other sectors, a time-honoured way of acquiring market share in a new geographical territory is the M&A route. Buying a local operator gives you a base in a new place. But this is very difficult to achieve in the airline game. There has been cross-border investment by one airline in another, with Singapore Airlines being one of the most active in this respect. But there are plenty of barriers in the way of all-out mergers.

National governments regard airlines – probably incorrectly in today’s world – as strategic national assets. Michael Blunt, vice president of public relations at Oneworld, points out that BA and KLM’s recent merger talks failed because it became clear the merger would jeopardise a number of KLM’s authorised routes.

Bi-lateral route agreements are jealously guarded and, much like flight tickets, are issued to named parties and are not transferable. If the names change, the authority evaporates. Swiss Air and Sabina are currently making some headway in their effort to complete a cross border merger, but they still face major challenges.

All of this makes for an artificially disjointed global airline sector.

For business travellers, it means increased complexity and a general muddle when flying across multiple zones. Since the industry is acutely aware of the need to court business travellers, as the highest margin, highest profit customers, this is a state of affairs that the airlines have done their best to address.

Given the obstacles in the way of rationalisation through cross-border acquisitions and mergers, the only other way forward is for various players to get together in loose alliances. If A can fly to B, which can fly to C, which has routes to D, between them they have all points covered.

For the business traveller, as Blunt explains it, such an alliance brings at least three major benefits. First, given suitable agreements among the parties, a platform exists that allows the status accorded to A’s gold or silver club members to be recognised by the other parties to the alliance.

Second, a powerful marketing tool for each alliance is obviously to extend the much prized frequent-flyer miles schemes run by each member individually, across the group. For globe-trotting consultants and executives this massively increases the chances of racking up sufficient air miles to fly their families to exotic locations when the holiday season comes around. To many business travellers and their families, these trips, which are funded wholly or in large part by corporate air miles, are one of the most tangible compensations for nights spent away on business.

The third benefit covers a whole raft of issues that come under the twin headings of cost and convenience. Scheduling compatibilities, code sharing, baggage routing and the opening up of business lounges all come into play here.

However, as Blunt notes, alliances have to be particularly careful to ensure that in smoothing things for travellers, they are not crossing the line and slipping into anti-competitive practices.

It might be thought that deciding what is, and what is not, anti-competitive would be simple. Far from it. There is no detailed code of practice that airlines can consult to see if what they are proposing sails too close to the wind for the regulatory authorities. They either have to explicitly go to the authorities and discuss a proposed plan in detail, or they can implement it and see what happens. The main regulatory body, as far as European Airlines are concerned, is the European Union. A spokesperson for the EU’s competition office pointed out to Financial Director that the EU approaches every new twist and turn of the various major alliances’ burgeoning marketing initiatives individually. “It is difficult to make general statements about where the issues lie. If it was easy, the airlines could see for themselves when they are about to cross the line. We have to evaluate each instance of a new agreement on each route,” she said.

One recent example of the EU clashing with an alliance is the agreement between Austrian Airlines and the Star Alliance partners SAS and Lufthansa.

“This was about bringing Austrian Airlines into the Star Alliance. We sent what are called ‘Letters of Serious Doubt’ to the parties involved.

Our concern was that the agreements would eliminate competition on routes between Austria and Germany. This matter is still under review,” the spokesperson says.

The major point, from the EU’s perspective, is that far-reaching agreements between suppliers on code sharing, on frequent-flyer programmes and so on, raise issues that are not dissimilar in nature to the issues that would emerge from a full scale merger or acquisition. “We look to see if the deals could cause a dominant position to come into being on any route, which would mean that travellers would be faced with little or no choice of carriers. The likely result in such instances would be an unacceptable lack of competition and an inevitable increase in fares,” she says.

The EU’s interest in air travel is set out in its transport policy, where the primary fact is the steady increase in travel across Europe by European citizens. Loyola de Palacio, vice president of the European Commission, pointed out in a recent speech on EU transport policy that among all modes of transport, air flights had recorded the highest levels of increase over the past 20 years. Measuring traffic as number of passengers per kilometre, air travel has increased by a steady 7% since 1980, with traffic to European airports quintupling since 1970.

The Commission’s underlying concern is to forge policy that will allow for continued growth without jeopardising the safety of travellers, which means tackling the problem of congested skies. It also means trying to wean European airline operators away from their fixation with the hub and spoke system, whereby a number of principal city airports act as concentrators, or hub points. While the EU’s plans for this are somewhat foggy, it is very interested in ensuring that the airline industry does not worsen the situation by shrinking competition through alliance deals.

In his speech de Palacio called for “more realistic planning and scheduling of services by operators”. More importantly, he used the occasion to bemoan the EU’s “current inability to negotiate traffic rights with third countries on a common basis”. The EU is particularly aggrieved by the fact that the US, for example, has been able to operate a divide-and-rule policy in Europe, with spectacular benefit to its own airlines, by keeping negotiations on a country-specific basis. Dealing with each European country separately has allowed US airlines to achieve a rather good position as far as their combined share of trans-Atlantic routes is concerned.

The EU would like to be able to take over such negotiations and deal on a Europe-wide basis. De Palacio argued that “the creation of a Transatlantic Common Aviation Area would certainly contribute to the evolution of the role and scope of the airport network” – to the benefit of both business and tourist travellers in Europe. The EU is currently engaged in an action on this matter in the European Court of Human Rights.

As to the specifics, the Austrian Airlines, Lufthansa and SAS case shows how vigorous the EU authorities are in their scrutiny of deals. “Our main concerns are that, as they currently stand, the agreements between these parties would eliminate competition on a large number of routes between Austria and Germany, while raising similar concerns on the Austrian-Nordic aviation market,” the EU spokesperson said.

The aim of Austrian Airlines and the two Star Alliance members is to build a lasting structure that will create an integrated air-traffic system based on close cooperation of their commercial, marketing and day-to-day operations. The network arrangement includes passenger transport, maintenance, airport facilities and ground handling, plus co-ordinated fares and schedules for all flights. It embraces code sharing, reciprocal access to frequent-flyer miles and extends into data processing and a couple of bi-lateral traffic system deals with shared profits and losses.

What worries the Commission is that on almost all of the 33 direct routes between Austria and Germany, AuA and Lufthansa have a 100 percent joint market share, with not much by way of compelling alternative transport modes (rail and road). Another fundamental point is that once this latest development in the Star Alliance rolls out, the Commission reckons that the barriers to any competitor coming in on that route will be too stiff.

The frequency of flights by the Alliance partners, allied to the frequent-flyer miles pooling, will be a wall against competitors. This case still has to play out, but it shows what the Commission can do to block the onward march of alliances.

Yet the industry has moved decisively into a phase where alliances are the way forward. Blunt says: “Once one set of airline companies formed an alliance, everyone else had to respond, or concede competitive edge.”

There are two simple reasons why airlines have formed alliances. First, as we have seen, the way the industry is presently structured, no single airline can put together a truly global set of routes. Second, straightforward business economics dictate that even if the route authorisations could be obtained, it would be very difficult for one single airline to invest in the infrastructure required to cover every major destination.

Underlying everything is the conspicuous fact that more people now want to fly to more places, with greater ease and for lower prices. Of course, alliances take substantial amounts of management time to set up and maintain.

They also have the disadvantage of being “soft” agreements. However, they do allow one airline to leverage its alliance partners’ assets as if they were its own.

From the airlines’ perspective, Blunt notes, alliances are also attractive because they open the way to cost savings. “Individual airlines have been cost-cutting for years, so they tend to be hard pressed to find new ways of working smarter or more cost effectively. Alliances are good for business.

You can achieve economies of scale across an alliance that go beyond what any one airline could do on its own,” he says.

Blunt points out that a great deal can also be done in the area of joint purchasing, particularly with e-procurement. In the US, Oneworld uses the B2B exchange Freemarkets for a substantial part of its purchasing requirements. “We staged our first reverse auction (where suppliers bid to fulfil a buyer’s tender) for in-flight entertainment headsets recently.

All eight airlines had a common specification for their headsets and went for a joint purchasing pitch. This allowed us to make savings in excess of 50% on what each airline would have had to pay individually,” he says.

Is there more that alliances can do? Plenty, according to a spokesperson for the Star Alliance. “This is still a young concept. As far as we – and many of the analysts in this sector – are concerned, alliances have barely scratched the surface of what is possible,” he says.

Matthew Davis, director of consulting services Europe at American Express Corporate Services, agrees, but he argues that the alliances already have their winning formula, as far as the business traveller is concerned.

Air miles are a big deal for travellers, and by extending the traveller’s right to claim air miles to partnering airlines in the alliance, the airlines have ensured that they have a solid marketing strategy from the outset.

Hassle-free routing of baggage and access to business class lounges in participating airlines, together with limousines and all the rest of the hoopla are nice, but air miles top the lot.

Davis expects to see alliance partners looking for more and more anti-trust immunity deals as they seek to harden up their alliances while still staying on the right side of “market abuse” legislation. Already, round the world (RTW) tickets with some alliances can be up to 50% cheaper than the best offerings on the open market. “If you were just going to fly from London to New York and then on to Sydney, an RTW ticket can sometimes work out to be the cheapest way to do things, while also offering other destinations if the traveller wants to take some free time. There are loads of benefits for business travellers,” he says.

Alliances for long-haul services raise some interesting strategic issues for the budget short-haul airlines. Right now, the general feeling is that alliances are a game for the long-haul folk. A spokesperson for Easyjet, for example, said that all an alliance would mean for Easyjet would be additional costs. The whole point about a budget airline is to strip away the overheads associated with air miles, business lounges and all the rest of the add-ons that make an alliance attractive. Onward flights are the business traveller’s responsibility, but in exchange for shouldering that inconvenience, they get cheap tickets.

Alastair Munro, business sales manager at Go, makes a similar point.

“We set our prices at half what a bigger airline would charge for a flexible economy fare. That is our proposition for the business traveller and we improve this proposition by adding more scheduled flights, not by joining alliances. We do flights to 22 European destinations, and it is up to the traveller to plan their onward journeys,” he says.

Munro also makes the point that, while frequent-flyer miles are great for the traveller, they play havoc with corporate travel policies, since individual executives have an interest in choosing routes and airlines that maximise their air miles. “The bottom line is that big airlines are all about trying to make long-haul travel a perk. We are about making short-haul flights crisp, efficient and low cost. That is not an alliance issue,” he says.

So far so good, but as Amex’s Davis points out, time has a way of changing things. As the big alliances sign up short-haul local airlines as affiliates to act as feeder services, ferrying passengers to their long haul aircraft, and as low-cost lines such as Ryanair grow, the pressure to do deals will mount. One option would be for an alliance to exempt the short haul budget airline from the costs associated with alliance membership, in return for more access to potential onward traffic carried by the budget airline.

Just how this will develop remains to be seen.

THE MAJOR ALLIANCES

To date, there are five major groupings and plenty of smaller or local alliances. Oneworld includes BA, Aer Lingus, American Airlines, Cathy Pacific, Finnair, Iberia, Lan Chili and Qantas, plus some 20 affiliates.

The Star Alliance now includes United Airlines, BMI, Lufthansa, SAS, Singapore Airlines, Ansett, Air Canada, the Brazilian airline Varig, and Thai Airlines.

Skyteam, one of the newer groupings, was formed last year when Delta Airlines broke away and teamed up with Air France, Aero Mexico, Korean Airlines and others.

Wings has become the de facto name for a grouping comprising KLM and North West and affiliates, and then there is a European alliance, Plus Qualifier, led by Swiss Air, Lot, Sabina and other European lines.