Please note! This essay has been submitted by a student.
Research on aviation circulated by the World Bank and the International Air Transport Association (IATA) demonstrates the significance of commercial aviation and highlight its continual growth over the last two decades with traffic volume growing from 1.3 billion passengers and 18 million scheduled departures in 1995 to the high record level of 3.2 billion passengers and 32 million departures in 2014. This growing demand for air services can be associated with an increase in global GDP and ease of personal mobility.
As such, air carriers’ capacity has been increasing in line with consumer demand for travel, with the number of operating aircrafts increasing 31% in the ten years to 2015 and their importance as major employers becoming ever more present. As the volume of passengers, aircraft and employees increase so does competition in the aviation industry, with focus on the European market, where airlines such as TAP Portugal are required to look for cooperation and consolidation strategies to stay profitable and maintain product appeal to attract new and keep existing consumers.
The airline business is characterized by it sensitivity and susceptibility to economic, political and natural events, posing challenges and threats to carriers, especially medium sized airlines that are not equipped with the resources to overcome such barriers. Thus, with greater competition in Europe, airlines need to increasingly focus on strategies to foster their competitive core competencies.
The liberalization of European airspace has opened up unparalleled freedoms to airlines which has led to an increase in competition. In recent years, the European aviation sector has experienced changes on both the demand and supply side. In contrast to many other industries such as telecommunications, the driving forces of change do not depend primarily on technological factors, but rather on developments in the legal, institutional and cultural spheres of airlines and the market itself.
“International air transportation has, until recently, been one of the most regulated of industries”. The Chicago Convention of 1944 laid down a basis upon which a system of international bilateral agreements (ASAs) was founded. This was a compromise that attempted to reconcile the very liberal, free market ideals of the US and the more restrictive and limited views of countries such as Australia, that wanted a single global carrier. The convention established national sovereignty over airspace and a framework within which countries could essentially trade these rights (freedom of the skies) between themselves. This resulted in a mass of bilateral agreements between states that stipulated which airlines could fly between them, the passenger capacity, the price of fares, and often how revenues were to be shared.
In the past 30 years, the structure of the global aviation market has been through dramatic changes. The US removed most economic regulation from its domestic market quite suddenly in 1978, however, the liberalization of the European market only started to take form years later in the 1980’s and was only officially announced in the 1990’s. Although deregulation in the US occurred rather rapidly, the European aviation sector was liberalized through three successive packages adopted at a European level covering air carrier licensing, market access, and fares.
The decades of restrictions that had limited the airline industry in Europe and prevented private cross boarder investment were removed, allowing European airlines to create a similar free market environment to that present in the U.S., which experienced the freedom of deregulation years before. This development of a more coordinated and free market in Europe has created significant economic benefits to both passengers and carriers, however, it has also led to greater competition and threats to medium sized airlines, the likes of TAP Portugal, Olympic Air, Austrian Airlines and Aer Lingus among others, who are frequently finding themselves on the verge of going bankrupt or being acquired by larger and more powerful airline groups.
As per Franken et al “according to the objectives of deregulation, competition should increase as a result of the deregulating process”, lowering the barriers to entry and enhancing airlines’ ability to compete for passengers and resulting in lower prices. The opening up of the European airspace pushed airlines to look toward cooperative arrangements between them via alliances and joint ventures to enable higher efficiency and greater value for consumers. It also allowed carriers to develop and structure their networks through the implementation of hub-and-spoke networks, whereby carriers are able to connect small markets with their hub airports and expand their services to new destinations.
With the continuous developments, traditional Full-Service Carriers (FSC) like TAP Portugal have been faced with a new type of competitor, the Low-Cost Carrier (LCC) such as EasyJet and Ryanair, where the competitive advantage of the two lay in their ability to strip down costs and offer low fares to consumers. They achieve this by offering point-to-point connections, operating out of secondary airports with lower landing and handling fees along with being less busy, resulting in faster turnaround times and higher utilization rates. Their fleet consists of generally one or two types of aircraft with simple, basic services.
Ryanair and EasyJet pioneered the LCC model in Europe and generated significant growth for the aviation industry after 1999, which according to Hammermesh (2006) can be attributed to changes in travellers’ demands and surge in globalization, whereby there has been a surge in the mobility of people and cargo, and thus an increase of business travellers. Furthermore, leisure tourism has shifted toward shorter, cheaper holidays, also freeing the glamour of flying and thus allowing the lower services provided by LCC to be accepted by many travellers.
Sustainable competitive advantage hangs on an organization’s ability to remain flexible in its development of core competencies. If a firm does something particularly well, it should exploit it and build the business in a manner that will highlight this expertise, focusing on different sets of activities from their competitors and delivering them in a way that creates unique value. According to Porter (1980), firms can target different spectrums of the market by adopting either a low-cost or differentiation strategy, whereby the former attempts to keep costs to a minimum and offer basic quality, less desirable characteristics to provide lower prices compared to its rivals, and the latter aims to provide particular features with high quality services, ultimately raising costs and prices.
In order to minimize costs and maximize efficiency, LLCs reduce overhead, provide no frill services and often use secondary airports that have cheaper landing and handling fees. The organizational management is simplified by the lack of hub-and- spoke networks, and maintaining point-to-point networks, direct or online booking, and ticketless operations. With the significant reduction in costs and fares, the LCCs have set wider point-to-point journeys, which many are not served by the FSCs, and with this, have managed to attract some price conscious customers.
In contrast to LCCs, differentiation strategy is used by established FSCs and naturally bears heavier overhead costs, higher operating costs due to extra services provided which is essential to the hub-and-spoke network and premium priced products and services. Differentiation is generally offered through more personal space and comfort on-board, inflight entertainment as well as complementary food and drinks, frequent flyer programs, airport lounges and the use of more expensive primary city airports. The combination of these benefits raises the cost per seat for consumers aboard traditional carriers.
Increased competition and globalization of consumers has augmented the need for collaboration between firms, as no organization has all the necessary resources to gain and sustain a competitive advantage. The case is present across airlines in Europe, looking toward consolidation and strategic alliances as a means of sharing risk and reducing costs, which led to a shift in competitive paradigm from “firm versus firm” to group versus group”. Across the airline industry we can experience a number of consolidation strategies used to address such challenges.
According to Parkhe Airline Alliances is a “relatively enduring inter-firm cooperative arrangements, involving cross-border flows and linkages that utilize resources and/or governance structures from autonomous organizations headquartered in two or more countries, for the joint accomplishment of individual goals linked to the corporate mission of each sponsoring firm”. In other words, airline alliances are formal agreements between various airlines that allow the sharing of services and networks while maintaining separate identities.
Since the 1990s, global airline alliances have become a popular strategy among carriers as they seek to expand their network reach and attract more passengers to gain a competitive advantage over rivals. They have evolved into being a crucial and common feature of airline operations in the 21st century, and include services such as sourcing, production, and branding. According to Park (1997), there are two types of alliances among airlines.
These can be either complementary or parallel; with the main differentiating factor being complementary alliances have no overlapping routes, whereas parallel alliances do. There are numerous strategies within airline alliances, the most common being code sharing, block spacing, shareholdings, franchising, and joint marketing. In addition to these agreements, there are also the global airline alliance groupings (GAAPs), which incorporate various airlines into one partnership: the three main ones being Star Alliance, One World, and SkTeam.
Youssef (1992) claims that there are essentially two expansive reasons why airlines form alliances. Firstly, alliances lead to an improvement in technical economic efficiency in terms of scale, networks, and services; and secondly, airlines, like any other form of business, are driven to increase their market share and to be better positioned for competition.
A Joint venture is an agreement where two independent firms decide to create among them, a new legal entity with its own social capital. This new firm is assigned the necessary resources to operate by the parent companies, and in return, gets to receive the revenues generated by its activity, while still being subject to the parent companies’ strategies. Airlines around the world have been looking for ways to join forces via joint ventures (JV), to ensure long-term sustainability and benefits. Many JVs select specific markets to target such as Delta/Air France/KLM, allowing Delta for instance to promote almost 250 daily flights to nearly 500 destinations on its homepage, a feature it could not do without leveraging the networks of its JV partners.
These partners often share the costs and revenues, and have transparent partnerships allowing travellers to be aware of their arrangements. Due to this close relationship, airlines are able to assemble pricing, scheduling, and marketing as a single entity. It is often argued that JVs allow for the same benefits provided by M&A, without bearing the high costs. JVs has become particularly attractive in the airline industry as carriers have historically struggled with profitability, economic trends and the price of fuel.
Alliances are no longer the only arrangements between airlines to share flight codes and cross-sell their tickets, instead, airlines are directing towards mergers in order to evade national rules governing foreign ownership of domestic carriers. “Mergers and acquisitions (M&A) have become a dominant mode of growth, allowing firms to instantly increase their market share, acquire new competencies or penetrate new countries”.
One of the key outcomes resulting from airline liberalization is that it has become possible for airlines to grow much faster by merging and acquiring stakes in each other. According to Merkert & Morrell “consolidation in the form of mergers and acquisitions (M&A) is often seen as a very effective way of surviving in the competitive environments of many aviation markets”. For instance, the CEO of the merger of British Airways and Iberia sees M&A as a “game-changer” for the industry, and after their merger, already had a number of further airlines on target (including TAP Portugal).
In a general sense, airlines use these consolidation and expansion strategies for a number of reasons. Firstly, their home markets may be experiencing slow growth or stagnation and growth in foreign markets is limited by Air Service Agreements. Secondly, the objective may be to gain access to slots in key strategic airports, or thirdly it might be to increase synergies and to extend their route network.
Merket and Morrell (2012) claim synergies and efficiency are a result of network and fleet rationalization through the elimination of overlapping services and better utilization of assets. The other major cost saving aspect of M&A is usually through labor, as the merged airline will be able to reduce staff costs and increase employee productivity. As mentioned previously, economies of scale may be achieved, through utilizing larger aircrafts and improved traffic feed, as M&A lead to higher frequency flights, resulting in an increase of market share.
TAP Portugal is Portugal’s national carrier and has been operating since 1945. In March 2005, as well as celebrating its 60th anniversary, TAP became the 16th member of Star Alliance, which ended its previous code-sharing agreement with Delta Air Lines and began a new partnership with United Airlines, as part of their membership through the alliance. Prior to joining Star Alliance in 2005, the airline had significant intercontinental coverage but due to the bilateral ASA configuration and the specific large-scale movements of Portuguese nationals to former colonies, TAP focused mostly on routes to Brazil and Angola.
According to Button et al., “Normally carriers like TAP are either alliance members to gain the advantages of scope, density, and market coverage that this brings, or have a range of code-share agreements on a route basis with other carriers”. Once it joined Star Alliance, it adopted code-share agreements with various airlines like BMI, Finnair, Iberia, and Olympic. TAP’s focus on niche intercontinental markets like Brazil and parts of Africa allowed it to avoid substantial competition and adopt an almost monopolistic status on these routes.
However, it was only when TAP joined Star Alliance in 2005 that its operations took form and expanded into the 225 destinations worldwide and 11.3 million passengers per year. With access to more destinations through the alliance’s members, TAP managed to collect traffic through their own European routes and through partners’ routes, and transfer them to Africa and the South Atlantic (TAP’s niche markets) through the Lisbon Hub, resulting in greater traffic and aircraft load factors.
The constant change taking place in the aviation industry as a result of the deregulation that took place in the US in the 70s and later in Europe in the 90s has led to airlines turning towards strategic alliances and mergers and acquisitions in order to survive in the oligopolistic environment that is taking over the industry. The success of TAP Portugal will surely depend on factors such as Low-cost carriers and the strategic partnerships between major players.
TAP has a series of strategies it can choose to pursue to fight the increasing consolidation among carriers in Europe. Should it continue to be a member of one the three major global alliances? Should it allow bigger players to merge or acquire their operations? Or should it adopt a stand-alone strategy such as the LCCs in order to maintain independent decision- makings and strong branding?