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FACING THE GLOBAL
AVIATION CRISIS
The Benefits and Challenges
of Airline Alliance Agreements
The economic downturn and volatile oil prices have driven a
dramatic collapse in airline profits . . .

                                                 Global Airline Net Profit
                                                       2004 - 2009
     $20


     $15                                                            $12.9


     $10


      $5

                                                         ($0.1)
      $0


      -$5                           ($4.1)
                ($4.6)

     -$10                                                                              ($9.0)
                                                                             ($10.4)

     -$15
                 2004                2005                2006       2007     2008E     2009F




            Source: ICAO (2004-2007), IATA (2008-2009)
                                                                                                1
… resulting in a large number of airline failures in 2008 – and
certainly more to come




                                                                  2
Airline mergers and acquisitions were accelerating even before
the economic downturn
                                                             RosAvia
                                         +                     +


                      +                      +


                                     +
         +
                                 /                                 +
     +                       +                       +


                                                 +       +
                  +




                                                                       3
In the current environment, joining an alliance has become almost
  a prerequisite for smaller, non-LCC airlines, to enable them to
  remain competitive – particularly in liberalized markets
  Alliance Advantages:
     Increased critical mass, enabling airline to remain competitive with “mega-carriers”
     Economies of scale and scope
     Enhanced network reach
     Increased flow traffic
     Leverage alliance partners’ resources – capacity, distribution networks, terminals, FFP’s, purchasing power
     “Presence” advantages – and potential yield premiums -- at key airports and on key routes




Note: Reflects airlines
approved for membership
and anticipated alliance
switching



                                                                                                                   4
Benefits of alliance membership can be considerable for a
prospective partner carrier

       SH&E was recently engaged by a mid-size European carrier to quantify the
       potential benefits to it of membership in two alliances under consideration

  Enplanements, Thousands              Revenue, USD $ Millions             Profits, USD $ Millions
600                             $270                                $100
                                                                                $90
                                           $262                      $90
500                   483       $260
         450                                                         $80                      $73
                                                                     $70
400                             $250
                                                                     $60

300                             $240                                 $50

                                                                     $40
                                                         $229
200                             $230
                                                                     $30

                                                                     $20
100                             $220
                                                                     $10

  0                             $210                                  $0
      Alliance 1   Alliance 2             Alliance 1   Alliance 2            Alliance 1    Alliance 2




                                                                                                        5
The three Global Alliances now account for more than 60% of
scheduled capacity worldwide – and dominate key markets such
as North America-Europe and North America-Asia
        Estimated Alliance Share of                                                           Global Alliance Share of
        Scheduled World ASK’s, 1996-2009                                                         ASK's by Market:
                                                                                          North America-Europe:       85%
 100%          SkyTeam                                                                    North America-Asia:         81%
               oneworld                                                                   Europe-Asia:                79%
  90%          Qualiflyer (Swissair)                                                      Intra-North America:        68%
               STAR                                                                       Intra-Asia:                 58%
  80%          Wings (NW/KL)                                                              Intra-Europe:               39%


  70%

  60%
                                           60% 60%                                                            59% 60%
                                                             56%      54% 55%                 53%     54%
                                           10%
                                                                                       53%
                                                    12%                                                                  16%
  50%                                                        11%       11%      11%                           20%
                                                                                       18%    18%     18%
                                   40% 17%
  40%                                               16%
                                                             16%       16%      15%                                      16%
  30%                             15%       4%       3%                                                       15%
                          25%                                                          14%    14%     15%
                  20% 4%           4%
  20%                                      19%      20%      20%                21%
                                                                       19%
                14%      15%      15%                                                                                    28%
                                                                                       21%    21%     21%     24%
  10%   6%
                                           10%       9%       9%       8%       8%
        6%       6%       6%       6%
  0%
        1996    1997     1998     1999     2000      2001    2002      2003     2004   2005   2006    2007     2008      2009E


                Based on published schedules for August of each year. Source: OAG                                                6
Antitrust immunity among alliance members is likely to increase,
making them even more powerful


   Recent and Pending U.S. Immunity Grants     Immunity enables carriers within
                                               the alliance to operate virtually
  Recent                                       as a single entity
                                                – Coordinated capacity planning,
                                                  scheduling, pricing, revenue
             AF / KL / DL / NW / AZ / OK          management and sales
                                                – Revenue sharing

                                               With U.S.-Europe air transport
             CO + 10 Star members plus         liberalization, immunity applications
             CO / AC / LH / UA joint venture   have been more favorably received
                       (Tentative)

                                               In spite of the liberalization and
  Pending                                      “carve-outs”, it is difficult for
                                               non-aligned carriers to compete in
                                               markets that are dominated by
             AA / BA / IB / AY / RJ            immunized alliances




                                                                                       7
The threat to smaller, stand-alone carriers remains considerable

 Advantages of M&A and Alliances:              Implications for Stand-Alone Carriers:
  Gain incremental traffic, revenue & profit        Traffic and revenue siphoned off
  Higher yield from increased market share,         Yield dilution
  service frequency, “S-Curve” benefits
  Greatly extend network reach – with little        Network remains circumscribed
  increase in assets and operating costs
  Circumvent difficulties in obtaining              Network expansion may continue to be
  international route authority                     blocked by restrictive bilaterals and
                                                    government route allocation policies
  Defend against organized aggression by            Increased vulnerability to strengthened
  other mega-carriers & alliance groups             competitors
  Scale and scope economies in distribution,        Sales remain limited to single carrier
  marketing & publicity programs                    distribution network and interlines
  More advantageous GDS listings to off-line        Inferior GDS listings to off-line destinations
  destinations
  Exploit scale economies in operations and         Comparatively higher costs of operations
  procurement                                       and procurement
  Greater access to capital markets                 Limited access to capital markets


                                                                                                     8
While alliance benefits are undeniable, planning, negotiating and
implementing entry into a global alliance can be time consuming
and the outcome is not guaranteed


 Evaluate and Plan                            Negotiate                                      Implement

Assess      Select     Identify      Make Case      Interim       Plan      FFP    Align      Product Marketing & IT Links
Alliance   Preferred   Alliance     for Entry to   Bilateral   Implemen-   Links Pricing &   Improve- Distribution   and
Options    Option(s)   Sponsor        Existing       Code-       tation             RM         ment      Links     Upgrades
                                      Alliance     Sharing
                                     Members          with
                                                   Alliance
                                                   Members

            Develop Alliance Plan           Formally Invited to Join Alliance            Airline Becomes Alliance Member


                       1+ Years                                                     12 – 18 Months


     Costs can be incurred as schedules are refined, revenue management practices
  aligned, and systems upgraded. Benefits may not be seen for an additional few years




                                                                                                                              9
As alliances have grown, they have become increasingly
selective about new partners – and are imposing stringent
requirements for entry
   As alliances have gotten larger, the likelihood of a prospective new member competing
   with existing members has grown

   There are fewer and fewer regions of the world that are not already covered by global
   alliances

   Existing alliance anchor carriers may prefer to serve a region themselves rather than
   acquire a new partner based in that region

   For the alliance, there can be diminishing returns and increased costs and complexity
   with each new member added

   New alliance members may lose some commercial independence, and in some cases be
   forced to sever existing bilateral code-share arrangements

   Members may be encouraged to give up their own FFP program, losing a valuable
   marketing tool

   Membership fees can be high

   Depending on the alliance, a new member may only receive “associate member” status,
   and have little decision-making authority within the alliance

   New members must adhere to strict policies regarding product quality, safety and security


                                                                                               10
Bilateral code-sharing with partners in different geographic
regions can be a viable alternative to Global Alliance membership,
providing many of the same benefits
         Even anchor members of Global alliances continue to pursue
             bilateral code-shares outside the alliance framework
                                                 Some Non-Aligned Carriers
        Recent Bilateral                         Have Been Able to Partner
    Code-Sharing Agreements                     Across Competitive Alliances




                                                                               11
Bilateral code-shares can also offer the first step towards possible
acceptance in one of the three main alliances

  STEP 1             STEP 2            STEP 3                     STEP 4      STEP 5

                          /
                              Airlines expand
                              Airlines expand
                               code-share to
                               code-share to
                               major aligned
                               major aligned
                                    airline
                                    airline



                                             /            Airlines expand
                                                           Airlines expand
                                                            relationship
                                                             relationship
                                                              to include
                                                               to include
                                                         synergies through
                                                         synergies through
                                                           FFP links, etc.
                                                            FFP links, etc.




                                                                       /

                                  Existing alliance
                                  Existing alliance
    Airlines form
    Airlines form                 member carrier
                                   member carrier
   bilateral code-
   bilateral code-              sponsors “adopted
                                sponsors “adopted                                      Airline becomes full
                                                                                        Airline becomes full
   shares based                 airline” for alliance
                                 airline” for alliance                                 or associate member
    shares based                                                                       or associate member
   on region and                    membership
                                     membership                                         of a Global Alliance
   on region and
       market
        market                                                                    /     of a Global Alliance




                                                                                                               12
Partnership agreements should be reviewed periodically to
determine if they continue to provide optimum benefits

    Code-sharing: scope of code-shares, regional exclusivity, audit of listings
    Route and schedule coordination
    Revenue sharing: SPA’s, code-share commissions
    Inventory allocation: Block space (hard, soft), free-sale
    Pricing, revenue management: joint fares, booking terms & conditions
    Product and service: Quality standards, audit provisions
    Marketing, advertising, branding
    Loyalty program linkages: Accrual and redemption policies, value of miles
    Cargo
    IT: Linkages, required upgrades
    Procurement


                                                                                  13
Most recent partnership trend: airlines have begun to use technology
to complement or bypass the need for actual code-sharing

         Carriers are using their own website distribution channels to
       jointly market potential connecting services with partner carriers



                +

                +

                +
 Linkages may be across traditional definitions of “network”, “point-to-point”,
  “low cost” and “legacy” carriers, but nonetheless make commercial sense

                                                                                  14
SH&E offers an array of services that help carriers identify,
develop, negotiate, implement and improve code-sharing and
alliance agreements


      Assistance in identifying and selecting prospective code-share or alliance
      partners

      Valuation of alliance opportunities
       – Utilizing SH&E’s proprietary NETWORKS route planning model

      Assistance in “selling” carrier to prospective alliance partners

      Negotiation assistance

      Implementation assistance

      Evaluation and optimization of existing partnership agreements




                                                                                   15
Thank you for your time!

                                                                     Mark Diamond
                                                                   mdiamond@sh-e.com
                                                                    +1-617-218-3546

                                                                           Arik De
                                                                        ade@sh-e.com
                                                                       +1-617-218-3561




                                sh-e.com                                                                                                        icfi.com

LONDON                    NEW YORK               BOSTON            WASHINGTON, DC                                                        ICF CORPORATE HEADQUARTERS
+44 20 7242 9333          +1 212 656 9200        +1 617 218 3500   +1 202 572 9400                                                            Fairfax, VA • +1 703 934 3000
london@sh-e.com           newyork@sh-e.com       boston@sh-e.com   washington@sh-e.com                                                                         info@icfi.com

LOS ANGELES               PORTLAND               CHICAGO                                                                                           ADDITIONAL ICF OFFICES
+1 310 471 9118           +1 503 265 3212        +1 503 265 3217                               Albany • Charleston, SC • Dallas, TX • Dayton, OH • Denver, CO • Houston, TX
losangeles@sh-e.com       cam@sh-e.com           cam@sh-e.com                                      Irvine, CA • Lexington, MA • Los Angeles, CA • Middletown, PA • Ogden, UT
                                                                                         Oklahoma City, OK • Research Triangle Park, NC • San Francisco, CA • Washington DC
© 2009 ICF International. All rights reserved.                                                                      London • Moscow • New Delhi • Rio De Janeiro • Toronto
                                                                                                                                                                        16

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The Benefits and Challenges of Airline Alliances: SH&E Webinar, 2009

  • 1. FACING THE GLOBAL AVIATION CRISIS The Benefits and Challenges of Airline Alliance Agreements
  • 2. The economic downturn and volatile oil prices have driven a dramatic collapse in airline profits . . . Global Airline Net Profit 2004 - 2009 $20 $15 $12.9 $10 $5 ($0.1) $0 -$5 ($4.1) ($4.6) -$10 ($9.0) ($10.4) -$15 2004 2005 2006 2007 2008E 2009F Source: ICAO (2004-2007), IATA (2008-2009) 1
  • 3. … resulting in a large number of airline failures in 2008 – and certainly more to come 2
  • 4. Airline mergers and acquisitions were accelerating even before the economic downturn RosAvia + + + + + + / + + + + + + + 3
  • 5. In the current environment, joining an alliance has become almost a prerequisite for smaller, non-LCC airlines, to enable them to remain competitive – particularly in liberalized markets Alliance Advantages: Increased critical mass, enabling airline to remain competitive with “mega-carriers” Economies of scale and scope Enhanced network reach Increased flow traffic Leverage alliance partners’ resources – capacity, distribution networks, terminals, FFP’s, purchasing power “Presence” advantages – and potential yield premiums -- at key airports and on key routes Note: Reflects airlines approved for membership and anticipated alliance switching 4
  • 6. Benefits of alliance membership can be considerable for a prospective partner carrier SH&E was recently engaged by a mid-size European carrier to quantify the potential benefits to it of membership in two alliances under consideration Enplanements, Thousands Revenue, USD $ Millions Profits, USD $ Millions 600 $270 $100 $90 $262 $90 500 483 $260 450 $80 $73 $70 400 $250 $60 300 $240 $50 $40 $229 200 $230 $30 $20 100 $220 $10 0 $210 $0 Alliance 1 Alliance 2 Alliance 1 Alliance 2 Alliance 1 Alliance 2 5
  • 7. The three Global Alliances now account for more than 60% of scheduled capacity worldwide – and dominate key markets such as North America-Europe and North America-Asia Estimated Alliance Share of Global Alliance Share of Scheduled World ASK’s, 1996-2009 ASK's by Market: North America-Europe: 85% 100% SkyTeam North America-Asia: 81% oneworld Europe-Asia: 79% 90% Qualiflyer (Swissair) Intra-North America: 68% STAR Intra-Asia: 58% 80% Wings (NW/KL) Intra-Europe: 39% 70% 60% 60% 60% 59% 60% 56% 54% 55% 53% 54% 10% 53% 12% 16% 50% 11% 11% 11% 20% 18% 18% 18% 40% 17% 40% 16% 16% 16% 15% 16% 30% 15% 4% 3% 15% 25% 14% 14% 15% 20% 4% 4% 20% 19% 20% 20% 21% 19% 14% 15% 15% 28% 21% 21% 21% 24% 10% 6% 10% 9% 9% 8% 8% 6% 6% 6% 6% 0% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E Based on published schedules for August of each year. Source: OAG 6
  • 8. Antitrust immunity among alliance members is likely to increase, making them even more powerful Recent and Pending U.S. Immunity Grants Immunity enables carriers within the alliance to operate virtually Recent as a single entity – Coordinated capacity planning, scheduling, pricing, revenue AF / KL / DL / NW / AZ / OK management and sales – Revenue sharing With U.S.-Europe air transport CO + 10 Star members plus liberalization, immunity applications CO / AC / LH / UA joint venture have been more favorably received (Tentative) In spite of the liberalization and Pending “carve-outs”, it is difficult for non-aligned carriers to compete in markets that are dominated by AA / BA / IB / AY / RJ immunized alliances 7
  • 9. The threat to smaller, stand-alone carriers remains considerable Advantages of M&A and Alliances: Implications for Stand-Alone Carriers: Gain incremental traffic, revenue & profit Traffic and revenue siphoned off Higher yield from increased market share, Yield dilution service frequency, “S-Curve” benefits Greatly extend network reach – with little Network remains circumscribed increase in assets and operating costs Circumvent difficulties in obtaining Network expansion may continue to be international route authority blocked by restrictive bilaterals and government route allocation policies Defend against organized aggression by Increased vulnerability to strengthened other mega-carriers & alliance groups competitors Scale and scope economies in distribution, Sales remain limited to single carrier marketing & publicity programs distribution network and interlines More advantageous GDS listings to off-line Inferior GDS listings to off-line destinations destinations Exploit scale economies in operations and Comparatively higher costs of operations procurement and procurement Greater access to capital markets Limited access to capital markets 8
  • 10. While alliance benefits are undeniable, planning, negotiating and implementing entry into a global alliance can be time consuming and the outcome is not guaranteed Evaluate and Plan Negotiate Implement Assess Select Identify Make Case Interim Plan FFP Align Product Marketing & IT Links Alliance Preferred Alliance for Entry to Bilateral Implemen- Links Pricing & Improve- Distribution and Options Option(s) Sponsor Existing Code- tation RM ment Links Upgrades Alliance Sharing Members with Alliance Members Develop Alliance Plan Formally Invited to Join Alliance Airline Becomes Alliance Member 1+ Years 12 – 18 Months Costs can be incurred as schedules are refined, revenue management practices aligned, and systems upgraded. Benefits may not be seen for an additional few years 9
  • 11. As alliances have grown, they have become increasingly selective about new partners – and are imposing stringent requirements for entry As alliances have gotten larger, the likelihood of a prospective new member competing with existing members has grown There are fewer and fewer regions of the world that are not already covered by global alliances Existing alliance anchor carriers may prefer to serve a region themselves rather than acquire a new partner based in that region For the alliance, there can be diminishing returns and increased costs and complexity with each new member added New alliance members may lose some commercial independence, and in some cases be forced to sever existing bilateral code-share arrangements Members may be encouraged to give up their own FFP program, losing a valuable marketing tool Membership fees can be high Depending on the alliance, a new member may only receive “associate member” status, and have little decision-making authority within the alliance New members must adhere to strict policies regarding product quality, safety and security 10
  • 12. Bilateral code-sharing with partners in different geographic regions can be a viable alternative to Global Alliance membership, providing many of the same benefits Even anchor members of Global alliances continue to pursue bilateral code-shares outside the alliance framework Some Non-Aligned Carriers Recent Bilateral Have Been Able to Partner Code-Sharing Agreements Across Competitive Alliances 11
  • 13. Bilateral code-shares can also offer the first step towards possible acceptance in one of the three main alliances STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 / Airlines expand Airlines expand code-share to code-share to major aligned major aligned airline airline / Airlines expand Airlines expand relationship relationship to include to include synergies through synergies through FFP links, etc. FFP links, etc. / Existing alliance Existing alliance Airlines form Airlines form member carrier member carrier bilateral code- bilateral code- sponsors “adopted sponsors “adopted Airline becomes full Airline becomes full shares based airline” for alliance airline” for alliance or associate member shares based or associate member on region and membership membership of a Global Alliance on region and market market / of a Global Alliance 12
  • 14. Partnership agreements should be reviewed periodically to determine if they continue to provide optimum benefits Code-sharing: scope of code-shares, regional exclusivity, audit of listings Route and schedule coordination Revenue sharing: SPA’s, code-share commissions Inventory allocation: Block space (hard, soft), free-sale Pricing, revenue management: joint fares, booking terms & conditions Product and service: Quality standards, audit provisions Marketing, advertising, branding Loyalty program linkages: Accrual and redemption policies, value of miles Cargo IT: Linkages, required upgrades Procurement 13
  • 15. Most recent partnership trend: airlines have begun to use technology to complement or bypass the need for actual code-sharing Carriers are using their own website distribution channels to jointly market potential connecting services with partner carriers + + + Linkages may be across traditional definitions of “network”, “point-to-point”, “low cost” and “legacy” carriers, but nonetheless make commercial sense 14
  • 16. SH&E offers an array of services that help carriers identify, develop, negotiate, implement and improve code-sharing and alliance agreements Assistance in identifying and selecting prospective code-share or alliance partners Valuation of alliance opportunities – Utilizing SH&E’s proprietary NETWORKS route planning model Assistance in “selling” carrier to prospective alliance partners Negotiation assistance Implementation assistance Evaluation and optimization of existing partnership agreements 15
  • 17. Thank you for your time! Mark Diamond mdiamond@sh-e.com +1-617-218-3546 Arik De ade@sh-e.com +1-617-218-3561 sh-e.com icfi.com LONDON NEW YORK BOSTON WASHINGTON, DC ICF CORPORATE HEADQUARTERS +44 20 7242 9333 +1 212 656 9200 +1 617 218 3500 +1 202 572 9400 Fairfax, VA • +1 703 934 3000 london@sh-e.com newyork@sh-e.com boston@sh-e.com washington@sh-e.com info@icfi.com LOS ANGELES PORTLAND CHICAGO ADDITIONAL ICF OFFICES +1 310 471 9118 +1 503 265 3212 +1 503 265 3217 Albany • Charleston, SC • Dallas, TX • Dayton, OH • Denver, CO • Houston, TX losangeles@sh-e.com cam@sh-e.com cam@sh-e.com Irvine, CA • Lexington, MA • Los Angeles, CA • Middletown, PA • Ogden, UT Oklahoma City, OK • Research Triangle Park, NC • San Francisco, CA • Washington DC © 2009 ICF International. All rights reserved. London • Moscow • New Delhi • Rio De Janeiro • Toronto 16