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Themotivationaldriversofhorizontal integrationstrategies

UniversiteitvanAmsterdam SuzannedeBruijne(6266320) Version:Final MScBusinessStudiesInternational Management Supervisor:Drs.J.G.deWit 16September2012

Abstract.....................................................................................................................................................................43 Introduction...............................................................................................................................................................54 Chapter1.Externalgrowthandunderlyingtheories................................................................................................. 8

1.1 Transactioncosttheory(TCT).............................................................................................................. 10 1.2 Resourcebasedview(RBV)................................................................................................................. 11 1.3 IndustryPerspective(IP)...................................................................................................................... 12 1.4 InstitutionBasedview(IBV)................................................................................................................. 12 1.5 Socialnetworktheory(SNT),PathdependenceandResourcedependencytheory(RDT).................13 1.6 Howdothetheoriesrelatetothetopic?............................................................................................ 14
Chapter2.Defininghorizontalgrowthinthevaluechain....................................................................................... 15

2.1 Valuechain...........................................................................................................................................15 2.2 Horizontalintegration.......................................................................................................................... 17 2.3 Horizontalgrowthstrategies............................................................................................................... 18 2.4 Integrateorcooperate?....................................................................................................................... 19


3.1 Networksandairlineconsolidation..................................................................................................... 23
Chapter4.Consolidationinthecommercialairlineindustry................................................................................... 25

4.1 Whyconsolidate?.................................................................................................................................25 4.2 IndustrydevelopmentssincederegulationinEuropeandtheUS......................................................26 4.3 Alliancedevelopments......................................................................................................................... 30 4.4 Currentstateofconsolidation............................................................................................................. 34

Chapter5.Conceptualmodelandbusinesscases.................................................................................................... 37

5.1 IntroductionCase1.............................................................................................................................. 40 5.2 IntroductionCase2.............................................................................................................................. 46

Chapter6.Researchmethodology........................................................................................................................... 50

6.1 Datacollection&analysis.................................................................................................................... 51
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 2

7.1 Case1:Airberlinjoinsoneworldalliance............................................................................................. 52 7.2 Case2:SouthwestacquiresAirTran ..................................................................................................... 61

DiscussionandLimitations........................................................................................................................................73 Conclusion.................................................................................................................................................................76 References.................................................................................................................................................................77 AppendixI:OverviewUSM&A..................................................................................................................................83 AppendixIII:SummaryofEuropeanairlinescrossholding...................................................................................... 85 AppendixIV:Overviewoverlappingairports............................................................................................................. 86
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Industryconsolidationorhorizontalintegrationinthevaluechainhasbeenatrendintheairlineindustrysinceits deregulation. Indeed, mostof the national or legacy airlines flying today area product of one ormore mergers in the last decades. The need for consolidation in the airline industry is mainly attributed to the desire to offer a global and seamless service; many customers today (especially business passengers) demand a seamless service from anywhere to anywhere. Two types of strategies are used to achieve this goal: cooperative and integrative strategies. Although these two strategies share the same objective many different forms are being used within those strategies. The objective of this study is to find the motivational drivers behind these choices. The study is of qualitative nature and consists of two parts. The first part provides the theoretical background of the topic in order to create a conceptual model. The second part explains the differences in motivational drivers through the use of two business cases. This latter part tests the model of the first part. It appears that both strategies are motivated by drivers at the same levels (environmental, firm and relational) but the importance of the levels and the driving factors within those levels differ. In the first business case the alliance strategy seems to be chosen from a more defensive standpoint and out of necessity (competitive pressures and financial uncertainty), and the M&A strategy in the second case seems to be chosen from a more offensive point of view in order to increase marketpower.However,bothstrategiesaremotivatedbytheattractivenessoftheassetsinvolved,especiallythe route network and airports. An important drawback of this study is the extensiveness of the conceptual model, whichinturnlimitedgeneralizabilitybecauseonlyonecaseforeachstrategycouldbetested.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase

ThederegulationoftheairlineindustrystartedintheUSin1978.Sincethenmorethan200airlineshavemerged, allowing large efficiency gains in the industry. Indeed, most of the national or legacy airlines flying today are a product of one or more mergers in the last decades. This trend towards consolidation or horizontal value chain integration in the airline industry is not limited to the US; rather it is a global phenomenon as the European merger between British Airways and Iberia in 2010 shows. Whether this is a good or a bad development is questionable and opinions about this topic are divided. On the one hand, industry consolidation can increase efficiency and thus reduceprices for customers. On the other hand,industry consolidation decreases the number competitors and increases the chance of price collusion, which is generally undesirable because this decreases customer wealth. The need for consolidation in the commercial airline industry is mainly attributed to the desire to offer a global and seamless service and to gain market power. Many customers today (especially business passengers) demand a seamless service from anywhere to anywhere. However, no airline is able to provide this by its own at a competitive cost level. In order to meet customer demands as efficiently as possible, airlines look for partners to help them provide the network and service coverage required. Consolidation however, is not only limited to mergers and acquisitions. In many cases the government imposes restrictions on foreign ownership, which is one of the reasons why many airlines choose different forms of integration. Some airlines for example choosetopurchaseaminoritystakeinanotherairlineonlytogainaccesstonewmarketsbutsometimeswiththe longterm objective to acquire a majority stake by acquisition. Other airlines choose to become a member of one of the three globally branded alliances. Even within and between these strategic alliances other forms of collaboration and integration take place. To summarize, increased collaboration and integration amongst airlines has been a major trend in the commercial airline industry, and strategies range from full mergers to smallscale alliances(Evans,2001). However, when compared to other, previously regulated industries, a different picture arises. Over the last decades a wave of crossborder mergers and acquisitions has taken place in many major industries, such as financialmarkets,telecommunications,IT,andtheautomotiveindustry(Chan,2000).Theairlineindustrythough, still retains a certain nationalistic character that has been slowing down full international growth compared to these industries (Chan, 2000). In a presentation at Airneth in Brussels by the vice president of business development of Star Alliance (2011), it was estimated that the four major players in the global telecommunications industry possess 61% of the market; in the PC industry the major players have a market shareof59%.Accordingtothesameestimations,thefourmajorplayersintheglobalairlineindustrypossessonly 24% of the total market. This relatively low level of industry concentration seems to be directly related to the large variety of strategies that commercial airlines use to collaborate and integrate. This in turn is most probably duetorestrictionsonforeignownership.Buttheremightalsobeotherfactorsinfluencingthesestrategicchoices. Moreover, it would be interesting to see what the reasons are for choosing a certain strategy type over another. Therefore, the research objective is to find the answer to the question why an airline chooses a specific form of
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integrationorcollaboration,andwhatfactorscanexplainthesedifferences.Thus,thisstudyisofbothexplorative andexplanatorynature.Thisleadstothefollowingresearchquestionandsubquestions: Whattypesofexternalgrowthstrategieswithregardtohorizontalvaluechainintegrationcanbeidentifiedinthe airlineindustryandwhatdriverscanexplainthedifferencesbetweenthem? 1. Whatismeantbytheconceptsofhorizontalgrowthstrategiesandvaluechainintegration? 2. What types of horizontal growth strategies can be identified and why may a firm choose a certain strategyoracombination? 3. Whatistheinfluenceofnetworkeconomiesonindustryconsolidation,andhowhasitinfluencedthe commercialairlineindustry? 4. How has the commercial airline industry developed with regard to horizontal growth in the value chain? 5. Which horizontal growth strategies can be identified in the two airline business cases and what are thedriverfactorsbehindthatchoiceofstrategy? 6. Which factors have been of most importance for each case and what theoretical explanation relates mostlytothosefactors? Past research with regard to horizontal integration and cooperation (consolidation) has mainly focused on either integrative or cooperative strategies. Hoffman and SchaperRinkel (2001) were one of the first to develop a contextdependent framework that clarified the choice between the two strategies. Their framework however, is of generic nature and does not apply to one industry specifically. Which is why in this study their framework will be applied and extended to the commercial airline industry. When looking at past research about consolidationinthecommercialairlineindustry,muchresearchhasfocusedeitheronmergersandacquisitionsor on alliance formation and especially their outcome on consumer welfare or from the perspective of antitrust concerns. Other research presents an overview of consolidation developments since the deregulation. In this study I will take the outcome on consumer welfare and the matter of antitrust concerns for granted, and I will solely focus on the different forms of consolidation that are used by airlines (two business cases) and the motivationbehindthatchoice. Besides the wider context of market integration where general economic factors explain horizontal concentration in the value chain (consolidation), I will also specifically look at the consolidation in the airline industry where these general factors and industry/firm specific factors come together. First I will provide an extensive theoretical background that identifies these generic and industry specific factors based on relevant literature and desk research, these chapters also provide an explanation of the concepts used in this study.
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Starting off very broadly I will narrow it down to the specific case of the airline industry, where after I will test thesegenericandindustryspecificfactorsofconsolidationwithtwobusinesscases.ThetwocasesIwilluseinthis study are: Southwests acquisition of AirTran and Airberlin joining the Oneworld alliance. I will study these business cases using a combination of quantitative and qualitative data ranging from database analysis to secondary sources such as annual reports and newspaper articles. From these cases I will try to find an explanation for the differences between the types of consolidation. It would be interesting to see whether there are also new factors, besides the ones identified in the theoretical background, that explain differences in consolidationstrategies. The theoretical background is structured as follows. First, the concept of external growth and its underlying theories are presented. Second, the topic of integration in the value chain is explained. Next, I will discuss the different modes of horizontal integration and I will make a distinction between integrative and cooperative strategies. Moreover, I will present an existing framework that explains the choice between these different types of strategies. In thethird chapter I discuss an important characteristic that is of great influence on thechoiceofstrategyforairlines,namelynetworks.Havingstartedoffinamoregeneralsense,thisthirdchapter already starts to focus more specifically on the commercial airline industry. The fourth chapter will be totally devoted to the commercial airline industry itself, and current trends and developments will be presented with regard to the consolidation. After this sound theoretical background I will present a conceptual model that provides an overview of all the generic and industry specific factors that possibly come to play in the horizontal concentrationintheairlineindustry.Thesecondpartofthisstudyinvolvesthetestingofthisconceptualmodel.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase

In this first part of the study I will start off with a broad introduction to the general topic of horizontal growth through an extensive literature review, and I will slowly narrow this down to the specific case of the commercial airline industry. The objective of this literature review is to identify existing generic motivations that drive the choice between horizontal growth strategies and to identify those that are specific for the commercial airline industry. Moreover, I will also explain and clarify the concepts used in the research question. In this first chapter the concept of external growth and its underlying theories are presented in order to get a better understanding onwhyafirmwouldengageinconsolidationinthefirstplace. For a firm to capture the highest profits and maximize shareholder value it can either grow its revenues and/orminimizeitscosts.Toachievethis,afirmcanchoosetouseinternalorexternalgrowthstrategiesthatcan be used individually or in combination with each other. Internal growth strategies refer to (re)investments of firms in existing businesses to increase its own assets or output. External growth strategies on the other hand, provide firms with access to external resources that help to fill up the gaps of their existing businesses. External growth strategies vary from cooperative strategies such as marketing based alliances to mergers or full takeovers (acquisitions), and can increase firm size, market share and firm value. In this study I will distinguish between mergers, acquisitions and strategic alliances as external growth strategies, and I will elaborate more extensively on these concepts in chapter 3. External growth strategies are popular because they deliver results more quickly than internal growth strategies that are characterized by their slow pace. Especially in a world where economies become more interconnected through globalization, internal development becomes more complicated and external growth strategies offer quick solutions (Hoffman & SchaperRinkel, 2001).Figure 1 explains the concepts ofinternalandexternalgrowthforfirmsinaschematicoverview.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase

InthisstudyIwillfocusonexternalgrowthstrategiesbecausetheairlineindustryischaracterizedbyhigh fixed costs (which complicate internal growth) and hence also by the need for economies of scale, scope, and density which is mainly achieved through external growth (Vasigh et al., 2008). I will elaborate on this motivation in chapter 4. When growing through external strategies a firm can choose to expand either vertically or horizontally in the value chain. The value chain is a concept that can be interpreted in many ways. In this study I will use the concept value the way it was developed by Porter (1991). Porter (1991) explains the value chain as a set of activities for a firm operating in a specific industry. Products or services pass through all the different activitiesofthechainandcustomervaluecanbeobtainedineachactivity(Porter,1991).Whenthevaluechainis applied to an entire industry, Porter calls this the value system. In that case a firm can either move upwards or downwards the value chain (vertical integration) by integrating other firms that execute different activities than the focal firm. Or a firm can integrate another firm that either executes the same kind of activities or activities that differentiate the focal firms current products/services but on the same level in the value chain (horizontal integration). Both forms of external growth are driven by different motivations even though both have the final objective to increase profit. Figure 2 illustrates which activities create value for one firm throughout the total chain(Porter,1991).Notethatthisfigureonlyrepresentsonelinkinthevaluesystemorindustryvaluechain;the industrychainismadeupfrommanydifferentfirms,eachwiththeirownvaluechain,linkedtogethertoproduce acertainoutcome.Inchapter2Iwillexplaintheconceptofthevaluechainmorethoroughly.


In the next section I will discuss several theories that underpin a firms need to grow externally and explain how they affect either vertical or horizontal growth. First, both the transactioncost theory and resource based theory explain the firms existence, boundaries and interfirm linkages. Second, the firms position within a valuechaincanalsobeexplainedfromanindustryperspective.Third,institutionaltheorybrings inthedistinctive aspect of external growth on an international level. Fourth, resource dependency theory, social network theory and path dependency are three other theories that focus on contextual factors influencing the motivation for
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external growth strategies. Most of these theories are not mutually exclusive and can be used in combination witheachotherbecausetheyallexplaindifferentfactorsinfluencingthechoiceforexternalgrowthstrategies.



The main rationale behind the TCT in explaining the existence of firms and their external growth is to minimize transactions costs (Hennart, 1988). Transactions costs are those related to establishing and governing exchange relationshipsbetweenfirmsthataresubjecttoboundedrationalityandopportunism.Examplesofthesecostsare associated with: negotiating, writing contracts, contract breach and monitoring performance of the partner (Ireland et al., 2002). This theory recommends choosing a strategy that minimizes these transaction costs which mainlydependsonthethreatofopportunisticbehavior,therelativecostsofintegratingtheotherfirmversusthe expected synergies, and the level of asset specificity (Williamson, 1981). By investing in specialization (or asset specificity) transaction costs increase because with increased asset specificity comes more complex governance structures (Williamson, 1981). The choice of governance structure does not only influence transaction costs but also the incentives to engage in value creating activities (Dyer, 1997). Thus, due to differences between firms, different strategies are employed with regard to both the level of asset specificity and the choice of governance (Dyer,1997). Thistheoryhasbeeneffectiveinexplainingandpredictingverticalintegrationinthevaluechainbetween

suppliersandbuyersinmatureindustriessuchastheautomotiveindustryandalsoinexplainingtheuseofequity (mergers and acquisitions) as a governance mechanism (Eisenhardt & Schoonhoven, 1996). Vertical integration can increase a firms value added margins for a particular part of its value chain and economies can be gained from shared facilities and resources (Harrigan, 1985). More importantly, vertical integration (backwards and forwards) minimizes the risk of opportunism from buyers/suppliers and can act as a safeguard mechanism (Rindfleisch & Heide, 1997). However, as Ghosal and Moran (1995) note, this theory is most relevant to static efficiency and routine situations and does not explain many other strategic advantages besides transaction cost minimization. Both in horizontal as in vertical integration, internalization strategies such as mergers and acquisitions are preferred when transaction costs of an exchange are high because these strategies control transactions costs effectively (Das & Teng, 2000). Strategic alliances combine characteristics of both M&A and market exchanges; hence contracts are needed in combination with joint coordination (Das & Teng, 2000). Thus alliancesarepreferredwhenthetransactioncostsofanexchangeareintermediateandnothighenoughtojustify integration and thus canbeviewed as semiinternalization strategies (Das & Teng,2000).Or as Kogut (1988) puts it:TheanswerofwhyfirmschooseforcooperativestrategiesliesinthediseconomiesofM&Awhicharisedueto the costs of divesting or managing unrelated activities. Thus, a necessary condition for an alliance is that the production costs achieved through M&A is significantly higher than external sourcing for at least one of the partners (Kogut, 1988). An example of cooperative strategies that seemed to have failed due to transaction costs is that of the Dutch ProRail and NS. Before the deregulation of the Dutch railway system in 1995, the two companieswerepartofthesamesemistatedownedfirm:NederlandseSpoorwegen.After1995,ProRailbecame
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responsible for the railway network and infrastructure and NS for the trains, passengers and railway exploitation, and both firms work together on offering one service for the customer; travelling by train. However, this split of firms turned out not to be more efficient and both transaction and production costs have become higher than in caseofamergerofthetwofirms.Currently,NShasproposedtomergethetwocompaniesbacktogetherinorder toincreasecostefficienciesandservicequality(NOS,2012).



TheRBVexplainsthefirmasabundleofheterogeneousresources(tangibleandintangibleassetsandcapabilities) and thus stresses the internal aspects of the firm (Das & Teng, 2000). In contrast to TCT, which focuses on cost minimization, the RBV emphasizes value maximization of a firm through combining and using valuable resources (Das & Teng, 2000). According to Barney (1991) valuable firm resources are those that are scarce, inimitable, and nonsubstitutable. The knowledgebased extension from this view emphasizes that knowledge is a firms most important distinctive resource and its ultimate source of competitive advantage, and that knowledge asymmetries between firms provide the foundation of benefits that can be derived from firms working together (Hoffmann & SchaperRinkel, 2001). From an RBV perspective, a firms lack of resources or the desire to strengthen its own are the main motivations behind the need for external growth, and trading and accumulating resources are a strategic necessity (Das & Teng, 2000). The difference between these two motivations is that obtaining resources (fill up the gap) is more about creating competitive advantage in the present and that retaining resources (strengthening current resources) is more about protecting a future competitive advantage (Das & Teng, 2000). When efficient market exchange of resource is possible, firms are likely to rely on the spot market.However,efficientexchangesaremostofthetimeimpossiblebecauseresourcesarenotalwaysperfectly tradable as they are embedded within a particular context (Das & Teng, 2000). Thus, when additional resources cannot be purchased on the spot market or developed internally with acceptable cost or within acceptable time, external growth strategies come to play (Hoffman & SchaperRinkel, 2001). Both strategic alliances as M&A can servetheobjectivetoobtainand/orretainresources,butDasandTeng(2000)statethatthedistinctadvantageof strategic alliances is to have access to exactly those resources that are needed with a minimum waste of other resources. Moreover, the possible advantage of strategic alliances over M&A is that the firm only temporarily gives up its resources, which then remain available for future internal deployment. In other words, strategic alliancesarepreferredwhenthediscountedpresentvalueofthedeploymentofafirmsresourcesinthefutureis greater than the realized value of selling its resources in the present (Das & Teng, 2000). Thus, strategic alliances should only be used when the realized value of those resources contributed to the alliance is higher than their valuewhenrealizedthroughinternaldeploymentorM&A(Das&Teng,2000). The RBV perspective does not specifically make a distinction between the impact of horizontal and vertical growth strategies; the argument is that resource integration can be accomplished anyhow (Das & Teng, 2000). There is however a difference in the type of resources that are acquired by combining two or more firms (either in an alliance or through M&A). Highly similar resources provide the opportunity to gain economies of
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scale but allow firms to primarily exploit existing competitive advantages. These economies of scale are usually acquired through horizontal integration (Ireland et al., 2002). On the other hand, different but complementary resources can be used to gain economies of scope, create synergies and develop new resources and skills hence alsonewcompetitiveadvantages(Irelandetal.,2002).



From yet another perspective, one could say that a firm chooses a certain external growth strategy that fits best with its environment or more specifically with its industry, which is also known as the positioning school. Industry structure has an important influence on how the competitive game is played as well as the potential strategies available to the firm (Porter, 1980). Porter has been largely responsible for the success of this strategy school. Porter (1980) states that the intensity of competition is not a matter of luck; rather it is rooted in the underlying industry economics. The five forces (bargaining power of suppliers, bargaining power of customers, threat of new entrants, threat of substitutes and rivalry among existing firms) influence the attractiveness of an industry,andafirmshouldchooseapositionwithintheindustrywhereitcanbestcopewiththeseforces(Porter, 1980). Hence, a firm would choose a certain growth strategy that minimizes the competitive forces. One way to dosoisbysettingupentrybarriersthusmakingitlessattractiveforotherfirmstoentertheindustry.So,instead ofincreasingthenumberofcompetitorsinanindustrythatwouldmaximizesocialwelfare,Porter(1980)claimed thatfirmsshouldminimizethenumberofcompetitorsbyraisingentrybarriersinordertomaximizeprofits. From this school of thought, the argument of market power can be derived; to maximize profits a firm should minimize/eliminate competition. As mentioned before, a reduction of competition reduces social welfare and is therefore not stimulated by governments and other authorities. However, it is an underlying motivation of why firms would choose to use M&A rather than strategic alliances, especially in the case of horizontal integration. I will elaborate more extensively on the topic of horizontal integration in the next chapter. In industries of moderate concentration where collusion (through M&A) is difficult, Joint Ventures can be seen as a form of defensive investment by which firms protect themselves against strategic uncertainty (Kogut, 1988). When external strategies are used in a protective manner such as described, partners are chosen to improve ones competitive position instead of minimizing costs (TCT) or learning (RBV). This can happen through collusion orbytakingawaycompetitorspotentiallyvaluableallies(Kogut,1988).



In the case of external growth beyond national borders (international business) a firm should take into account the different institutional contexts. Institutions are the humanly devised constraints that structure human interaction,asNorth(1990,p.3)explainsit.Or:theregulative,normative,andcognitivestructuresandactivities that provide stability and meaning to social behavior (Scott, 1995, p. 33). In short, institutions provide the rules of the game, both in a societal and a business context. By providing the rules of the game, institutions have the objective to reduce uncertainty. A distinction can be made between formal and informal institutions. Formal
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institutions are relatively easily codified and are represented by laws, regulations and rules. Informal institutions on the other hand are more difficult to recognize and exist in norms, values and cultures. For this reason institutions directly influence the choice of strategy and moderate the impact of other determinants of strategy. Institutional theory complements the industrybased view and resourcebased view by emphasizing the importance of institutions rather than perceiving institutions as background factors (Peng et al., 2008). IBV does not make a distinction in application on horizontal or vertical growth; rather it emphasizes the importance of context in every (international) strategic decision. The IBV focuses on the dynamic interaction between institutionsandfirmsandconsidersstrategicchoicestobethecorrespondingoutcome(Peng,2002). With regard to crossborder acquisitions, Dikova et al. (2010) found that former experience with

completed deals increased the likelihood of actual transaction completion, but only in the case of less distant countries (institutionally). They also demonstrated that the size of the impact of formal and informal institutional differences on transaction completion is comparable to the effect of the transactionspecific features of cross borderacquisitions,whichemphasizesagaintheimportanceofinstitutionsinbusiness.



The following three theories all take into account the context of the firm, and the influence of that particular context on the choice of strategy. None of them make a clear distinction between vertical and horizontal integration,buttheydohelptoexplainwhyacertainstrategyischosen. SNT suggests that the firms strategic actions are affected by the social context in which they are embedded and the position of actors in this context (Gulati, 1998). This theory brings in a social argument to the choice of a certain strategy. SNT recognizes that key drivers, processes and outcomes of a firms strategy choice are defined and shaped by the firms embeddedness (Gulati, 1998). The embeddedness of a firm in a social network and the position within that network can explain the choices for specific external growth strategies. The firms social context includes both direct and indirect ties with network actors and it includes both inter and intraorganizational relationships (Ireland et al., 2002). Social embeddedness is closely related to path dependence,whichalsobringsinamoresocialviewofthefirm. Path dependence, or the historical context of the firm, explains that external strategic actions are influenced by exogenous factors outside the control of the firm. This suggests that chance and prior history may play a role in the choice of an external growth strategy. Also because strategic choices made in the past can influencenewexternalgrowthdecisions(Hite&Hesterly,2001). RDT differs from the RBV and TCT in the sense that it recognizes the influence of external factors on organizational behavior, and that managers can act to reduce external uncertainty and dependence (Hillman et al., 2009). Thus, if firm A is scarce in a particular resource but dependent, it will try to find another firm that can provide firm A with these resources. This theory brings in the arguments of mutual dependency and power
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asymmetry. RDT offers an externally focused perspective on why firms are active in specific external growth strategies. Mergers and acquisitions (M&A) occur between firms that depend on one another as a mechanism to reduce dependence and uncertainty. Moreover, the magnitude of the dependency predicts the likelihood of M&A. Other cooperative strategies (strategic alliances, Joint Ventures etc.) only provide partial absorption of the interdependencies but can also be explained by their mutual dependency (Hillman et al., 2009). For example, at intermediate levels of industry concentration firms experience high levels of competitive uncertainty and are likelytomitigatethiscompetitiveinterdependencebyenteringintoJointVenturesorothercooperativestrategies (Hillmanetal.,2009).AlthoughRDTexplainswhyafirmengagesinexternalgrowthstrategiesandtosomeextent also the choice of strategy, it does not explain how this differs between vertical and horizontal integration. Therefore, RDT offers an incomplete picture of the reason of existence of M&A and strategic alliances, which is whyitisoftenusedincombinationwithsocialnetworktheoryandpathdependencetheory.



The theories discussed and explained in this chapter all explain different types of motivations for a firm to grow externally and integrate in the value chain (either vertically or horizontally) and why then a certain strategy is preferred over another. I have presented four distinct main theories (TCT, RBV, IP and IBV) that are complementary rather than being mutually exclusive. Besides these three theories, I also presented three other complementarytheoriesthatallbringinamoresocialandcontextualviewofthefirmanditsstrategychoice.Itis important to note that all of these theories have their shortcomings and none of them paint a full a picture of a firms motivation; only when used together they provide a more comprehensive framework on the motivation of a firms strategic actions. Table 1 presents an overview of these seven motivations with a brief explanation of theirmainarguments.InthenextchapterIwillexplaintheconceptofindustryintegrationmoreextensivelyandI willzoominontheconceptofhorizontalintegrationinthevaluechain.
TransactionCostTheory ResourceBasedView Aimsatminimizingtransactioncostsdependingonopportunisticbehavior, relativeproductioncostsandsynergies,andlevelofassetspecificity. Aimsatmaximizingfirmvaluethroughtheoptimalcombinationof resources.Astrategicnecessitytotrade/accumulateresourcesinorderto fillupgapsorstrengthentheexistingresourcebase. Aimsatpositioningitselfasbestaspossibleinanindustrybyraisingbarriers tocompetitionandincreasingmarketpower. Formalandinformalinstitutionsintheenvironmentofthefirmcan influencethechoiceofstrategy. Aimsatreducinguncertaintyanddependencyandbringsinargumentsof mutualdependencyandpowerasymmetryonthechoiceofstrategy. Thefirmsactionsareinfluencedbyitssocialnetworkembeddednessand thepositionofthefirminthatcontext. Thefirmsactionsareinfluencedbyexternalfactorsoutsideitscontrol, addstheargumentofchanceandpriorhistory.

IndustryPerspective InstitutionalBasedView ResourceDependencyPerspective SocialNetworkTheory PathDependence

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


2.1 Valuechain

As mentioned in the previous chapter, when a firm chooses to grow through external growth strategies it can achieve this through either vertical or horizontal integration in the value chain. In the first chapter I briefly introduced the concept of a value chain as proposed by Porter (1991). When the value chain is applied to an entire industry it is often called the value system (Porter, 1991). The value chain is a very broad concept and can be applied to many different industries. Another term that overlaps with the concept of the value chain is the supply chain, which Mentzer et al. (2001) define as a set of at least three entities (individuals or organizations) directlyinvolvedintheupstreamanddownstreamflowsofproducts,services,financesand/orinformationfroma source to a customer. Compared to Porters (1991) concept of the value chain, the term supply chain does not include customer value. Thus a main difference between the terms is that in value chains the created customer value is what results in profits and in supply chains it is more about the profits that result along the chain from supplier to customer (Feller et al., 2006). Or in other words, value chains are more downstream focused and supply chains more upstream focused. However, what both terms have in common is that they both present a viewofanextendedfirmwithintegratedbusinessprocessesthatenabletheflowofproducts/servicesinacertain direction. Moreover, both terms overlay the same network of firms that work together to provide products/services(Felleretal.,2006).Anotherdistinctioncanbemadeforlogisticchainswhichcanbedefinedas a system of components including suppliers of materials, production facilities, distribution services and customers,whicharealllinkedthroughthefeedforwardflowofmaterialsandthefeedbackflowofinformation (Stevens, 1989). In the logistic chain the focus is on the logistic processes including feedforward flows (transportation, material handling and transformation), the feedback flow of information (information exchange regarding orders, deliveries, transportation etc.) and finally the management and control (purchasing, marketing, forecasting, inventory management, planning, sales and aftersales services) (Slats et al., 1995). The goal is to integrate these different logistic processes and actors involved to create advantages for each actor and to increaseefficiencythroughoutthetotalchain(Slatsetal.,1995).Notethatthelogisticchaindoesnotincludethe customer, as it is the case in the supply chain and value chain. As explained in the first chapter,in this study I will usethetermvaluechainfortheentireindustryinsteadofasinglefirmasPorteroriginallyintended.Eventhough the main focus of value chains is integrating downstream activities, I also include the integration of upstream activitiesinmyuseofthetermvaluechain. For a single firm to grow within the value chain it can either achieve this through vertical or horizontal integration, which is illustrated in figure 3. In the case of vertical integration a firm can either integrate upstream or downstream in the value chain using M&As and strategic alliances. Downstream/forward integration means thatafirmintegratesactivitiesthatareclosertotheendcustomer.Acommonexampleisthatofamanufacturer moving downstream by offering their products in wholly owned stores instead of selling through intermediary wholesalers/retailers.Upstream/backwardsintegrationmeansthatafirmintegratesactivitiesthatmovecloserto
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the source of the production. For example: a PC manufacturer that integrates its supplier of PC components. Horizontal integration on the other hand, means that a firm integrates another business on the same level of the value chain. This can either be a direct competitor which would increase its existing resource base and lead to economiesof scale,orthiscanbeanindirectcompetitorofferingproducts/servicesthatarenotexactlythesame but diversify the firms existing products/services (economies of scope). A common example of horizontal integration is a bookstore chain buying up another bookstore chain (economies of scale), or a bookstore buying up a store chain in DVDs and music (economies of scope). Another way for a firm to integrate horizontally is in a geographic sense; an airline can offer a wider variety of destinations (or in other words; a wider variety of products) by integrating with another airline. This does not applyto airlines only, itapplies to any firm that offers its customers transportation from A to B; they all want to offer a package of products that covers as many destinationsaspossible.

When discussing the topic of value chain integration one should also take into account the softer forms that do not necessarily increase firm size but take shape in close networks or value networks. Value networks are those networks where firms closely cooperate with interfirm relationships playing an important role in strategic performance (Peppard & Rylander, 2006). In that case, the focus of the value chain is on the end product/service and the chain is designed around the activities that are necessary to realize it and every firm occupies a position within that chain (Peppard & Rylander, 2006). With this value network concept, value is co created through a combination of all actors in the field. Thus, the focus of analysis lies on the value creating system itself where different economic actors work together to coproduce value (Peppard & Rylander, 2006). The crucial defining characteristic of value networks is the complementarity between the different firms. Firms in networks are independent but the relationship enjoyed by these firms are a necessity for their competitive position; hence a value network consists out of different autonomous economic actors that depend heavily on
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 16

each other with regard to their performance (Peppard & Rylander, 2006). This interdependence brings in a dynamicnature;anactionbyoneactorcaninfluenceothernetworkmembers(Peppard&Rylander,2006).



In this study I will focus on horizontal integration because general growth objectives in the commercial airline industryaremainlyachievedthroughhorizontalintegrationstrategies.Thesegrowthobjectivesareformulatedby Barla and Constantatos (2006) as follows: offering a global service, increasing service quality, exploiting economies of scale and scope, and gaining market power. In this section I will explain that these growth objectives in the airline industry are mainly achieved through horizontal integration. Horizontal integration in the value chain can lead to industry consolidation; M&A and alliances of horizontal nature decrease the number of competitors in an industry and increases the size and market share of those players integrating others. Although industry consolidation can possibly lead to a reduced number of competitors in an industry and a possible reduction in public welfare, not every collusive motivation is contrary to public welfare. In the case of strong network externalities, such as in telecommunications, joint research and development of standards can result in lower prices and improvedquality in thefinal market (Kogut, 1988).I will explain the topic of network economies anditsapplicationtothecommercialairlineindustryinchapter4. Industries that are highly concentrated (horizontally integrated) may be more sensitive to monopolistic and oligopolistic characteristics, while industries with multiple players may tend to be characterized by monopolistic competition (Vasigh et al., 2008). The global airline industry is an oligopolistic industry and one of the main characteristics of this type of industry structure is that the actions of the players will substantially affect the total market which in turn may influence the actions of competitors and hence create a complex interdependence between firms (Vasigh et al., 2008). Moreover, high entry barriers make that the number of competitors is relatively small. Oligopoly is usually viewed as undesirable, but the advantage is that a few large firms can often enjoy economies of scale and thereby produce at lower cost and sell at lower prices than an industry composed of smaller, more numerous firms (Vasigh et al., 2008). However, it might be the case that competitionisartificiallysuppressedandthatcustomersarenotbetterof(Vasigh etal.,2008).Sofromonepoint of view, industry consolidation can increase efficiency and thus reduces prices for customers, but it is not sure whether this efficiency eventually will be gained as M&A also bring organizational uncertainty (Vasigh et al., 2008). From the other point of view, industry consolidation decreases the number competitors and increases the chance of price collusion, which is generally undesirable because this decreases customer wealth (Vasigh et al., 2008). In short, a tradeoff should be made between the possible benefits and threats of industry consolidation. This is where regulators step in to approve of the horizontal integration. Strategic alliances might offer a possible solution because they allow for firms to cooperate with each other while staying independently, and depending on the type of alliance they are usually not included in concentration figures because they do not always involve equity. In the next chapter I will discuss each external growth strategy separately and explain why a firm would chooseoneoranothereventhoughtheyarenotmutuallyexclusive.
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 17

2.3 Horizontalgrowthstrategies

In this part I will explain the two types of external growth strategies that I mentioned before in the first chapter: M&A(mergersandacquisitions),andstrategicalliances.Theformerstrategyisoneofintegrationandthelatteris one of cooperation. Both strategies can have similar objectives; resource combinations and synergy exploitation (Delfmann et al., 2005). Because the two strategies can share the same set of objectives, they can be considered as strategic substitutes (Sawler, 2005). First I will explain what each strategy contains and then I will use the decisionmaking framework of Hoffmann and SchaperRinkel (2001) to explain the choice between strategies in a genericsense. Integration:Mergers&Acquisitions(M&A) Both mergers and acquisitions are characterized by hierarchybased decisionmaking, which differs from the consensusbased decisionmaking in cooperative strategies such as strategic alliances (Delfmann et al., 2005). Even though integrative strategies and cooperative strategies share some strategic objectives, some objectives can only be achieved through integrative strategies: increase revenues and market share, taking over inefficient management and capital investments, and satisfy the managements desire for a new challenge or prestige (Delfmann et al., 2005). Another difference between the two types of strategies is that integrative strategies actually take away competition; their competitive effects are larger than those of cooperative strategies, especially in the case of horizontal M&A (Delfmann et al., 2005). Moreover, M&As are of a more permanent nature than cooperative strategies (Sawler, 2005). The terms mergers and acquisitions are often used interchangeably defined by a process of combining two or more firms together to create synergy and increase value. However, there is a difference between the two terms. In mergers ownership shares between the companiesareequallydistributedandthetwofirmscontinueasonenewentitytogether,whereasinacquisitions one company takes over a majority of the shares of the other firm and continues alone (Investopedia, n.d.). In spite of the fact that many M&A fail and sometimes even destroy shareholder value, there is a continuing increase of global M&A activity. Apparently the benefits offset the potential threats of shareholder destruction (Mtetwa,2011). Cooperation:StrategicAlliances Collaborative strategies are hybrid forms of organization where firms decide to share resources while remaining independent. They can take many different forms such as; contractual agreements, minority equity investments, and equity joint ventures (Mayrhofer, 2004). Because of the numerous types of collaborative strategies, much confusion still exists around the concept. In this study I will use the term strategic alliances for the total range of collaborative strategies. I define strategic alliances as voluntary cooperative interfirm agreements to improve theircompetitivepositionandperformancebysharingresources(Irelandetal.,2002).Alliancesarecharacterized by mutual interdependence making each partner vulnerable to its partners actions (Ireland et al, 2002). Das and Teng (2000) distinguish between the following types of alliances: Joint Ventures (JVs), minority equity alliances, bilateral contractbased alliances, and unilateral contract based alliances. Bilateral contractbased alliances
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 18

requirepartnerstoputinresourcesandworktogetheronacontinuousbasissothattheyareintegratedinatight manner. Examples are: joint R&D, joint marketing, joint production and enhanced supplier partnership (Das &Teng, 2000). Unilateral contractbased alliances embody a welldefined transfer of property rights such as; licensing, distribution agreements and R&D contracts. Key is that each firm carries out its obligation independently of each other and the level of integration is relatively low (Das & Teng, 2000). Another distinction can be made between equity and nonequity alliances, where equity alliances come closer to actual integration throughM&A. Morespecifically,Iwillfocusonhorizontalalliances,whichcanalsobecalledquasihorizontalintegration (Anderson, 1995) or scale alliances (Dussauge et al., 2000). Scale alliances are those where the partners contribute similar resources pertaining to the same stage in the value chain and will produce significant economies of scale and can reduce excess capacity. Such alliances provide a way of avoiding or postponing mergersandacquisitions(Dussaugeetal.,2000).Horizontalalliancesbetweenpotentialcompetitorsaredifferent from vertical alliances in that they do not tap resources outside the focal industry. Moreover, strategic alliances with competitors are proven to be more difficult to manage which explains why firms usually only engage in few horizontal alliances (Hamel et al., 1989). As a result, as the number of horizontal alliances increases the pool of potential partners will decrease (Silverman & Baum, 2002). Thus, horizontal alliances keep rivals from forming similar alliances while having no beneficial effect on the resource base available to an industry (Silverman & Baum,2002).



Whether a firm chooses to integrate, cooperate or use a combination of the two is a complex decision and the choice is influenced by many internal and external factors. Hoffmann and SchaperRinkel (2001) developed a genericcontextdependentframeworktoclarifythechoicebetweenM&Aandstrategicalliances.Theydistinguish between environmental, transactional (relational), and company characteristics, and say that these three main factors are of influence on the relative favorability of either M&A or strategic alliances. The framework is based on the need for control and strategic flexibility which is what distinguishes the two strategies from each other; M&Ahavearelativelyhighlevelofcontrolandstrategicalliancesareusuallycharacterizedbyrelativelyhighlevel offlexibility.HoffmannandSchaperRinkel(2001)stressthatthereisnotoneruleforthechoicetoeitheracquire or ally and that their findings need to be put in the context of other influencing factors of the specific firm and industry. According to Hoffmann and SchaperRinkel (2001), a high need for strategic flexibility and a low need for control favor a web of contractual collaborations. On the contrary, acquisitions are the best choice in the case of low need for strategic flexibility and high need for control. Equity JVs are preferred if both the need for flexibility and control are high. A minority interest provides additional information and control rights and increases commitment of the patterns but reduces strategic flexibility. The decision matrix that Hoffmann and Schaper
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 19

Rinkel (2001) created is shown in figure 4. In their decisionmaking matrix it is also shown that the need for controlincreaseswhenhightransactionspecificinvestmentsarenecessary,whenthereisahighriskofbehavioral uncertainty(opportunism)andwhenthereisaweakappropriabilityregime.Buttheneedforcontroldecreasesin the case of high absorptive capacity. The need for strategic flexibility increases in the case of high strategic uncertainty (emerging markets and technologies), in the case of dispersed knowledge and because of limited resourceendowment.However,theneedforstrategicflexibilitydecreasesinthecaseofpersistenceofeconomic synergies.


Thus,HoffmanandSchaperRinkel(2001)showthatthereisatradeoffbetweentheneedforcontroland strategic flexibility and offer a schematic overview of a continuum of organizational modes along this tradeoff (figure 5). This gives a clear overview of the different types of interorganizational relationships along the level of flexibilityandlinkageintensity.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 20



Althoughnotexplicitlymentionedintheirframework,pathdependencywasrevealedintheirstudytobe of influence on company behavior; the preference of the firms or their decision makers becomes involved. This results from the firms past experience with different types of growth strategies; as long as a firms perception of new situation matches previous ones, a pattern of external growth that was successful in the past tends to dominate in future developments (Hoffmann & SchaperRinkel, 2001). This finding coincides with the path dependencytheoryexplainedinthefirstchapterofthisliteraturereview. Sawler (2005) extends this framework and also takes into account cost savings and profitability, which can differ between the strategic alliances and M&A and thereby takes a TCT perspective. He considers the tradeoff between integration costs and appropriation concerns which both raise transaction costs. More specifically, differences in costs savings arise from the ability of both strategies to realize economies of scale; mergers can achieve greater economies relative to a strategic alliance, but alliance can be useful to avoid dis economies. In horizontal transactions where the cost savings from the two strategies are almost the same, the competitive balance within the industry must also be taken into account. The conclusion is that when all other factors remain equal, a horizontal alliance where partners cooperate in production or development but market the resulting product independently is more profitable than a horizontal merger. This is because the alliance enables the partners to realize the savings arising from combining some of their operations while avoiding the problem of the merger paradox where market shareis transferred to nonmerging parties. Thus, from this point of view strategic alliances do not serve as a substitute for M&A, they rather are preferred because they can actuallybemoreprofitable.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


Asmentionedinchapter2,horizontalintegrationinindustrieswithstrongnetworkexternalitiesisnotnecessarily negative andcan actually lead to lower prices and improved quality.This is why in this chapter Iwill explain what network industries are and how network economies work. Many industries are characterized by their network, such as: transportation, communications, information, and railroad networks (Economides, 1996). Networks can reveal positive consumption externalities which means that the value of a good increases with the expected number of units sold (Economides, 1996). Or in other words: the utility of a good increases with the number of persons consuming the good in the same network (Katz & Shapiro, 1985). Moreover, network industries have a peculiar characteristic; the coexistence of incompatible products may be unstable and a single winning standard dominates the market due to the customers expectations of the ultimate size of the network (Besen & Farrell, 1994). Another feature of network industries is its path dependency. Both firms and customers make their decisions based on sizes of installed base and on expectations of growth over time, thus advantages such as a firstmover advantage can have long run effects for a firms success (Economides, 1996). In short, small differencesineitherperceptionorrealitycanbemagnifiedinaprocessinwhichsomefirmsmakeextremelylarge profits,andinwhichdominantmarketpositionsarehardtochange(Besen&Farrell,1994). The networks of these industries are composed by links that connect nodes with each other. Depending on the structure of the network, a multiple number of components are necessary to provide a particular service; network components are complementary to each other and provide a certain outcome in combination with each other (Economides, 1996). The combination of various components will not result in identical outcomes. Thus a network will provide substitutes made of complements (Economides, 1996). A distinction can be made between oneway and twoway networks. Twoway networks are those where the outcome of the composition differs, examples are railroads, road, and telecommunications networks. When there is a difference between the compositions but the outcome is the same, the network is called a oneway network, an example of these networks is broadcasting (Economides, 1996). A crucial relationship in both types of networks is the complementarity between the pieces of network (which is the main explanation for network externalities). Compatibilityhowever,iswhatmakescomplementarityactual(Economides,1996).Thedegreetowhichdifferent compositions are compatible determines the network boundaries of the customer (Garud & Kumaraswamy, 1993). Katz and Shapiro (1985) present two ways to ensure compatibility. One way is by jointly adopting a standard (given set of firms must act together to make their products compatible), and another way is through the construction of an adapter where one firm can make its products compatible with those of others. When network externalities are large, the compatibility choice of firms will be one of the most important dimensions of the market performance (Katz &Shapiro, 1985). On a horizontal level, which is the focus of this study, firms choices are either to make their products compatible with those of rivals (competing within a standard), or to make them incompatible (competition between standards) (Besen & Farrell, 1994). In the next paragraph I will

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


explainhowthisgeneralnetworktheoryisappliedtothecommercialairlineindustryandhowitaffectshorizontal integrationandthemodeofintegration.



Airlines cooperate to join up their networks because consumers want network scope and depth, and the economics of providing this are prohibitive for a single airline. Before applying the network theory to the commercial airline industry, I will first explain some concepts that are important for understanding network economies in the airline industry: economies of scale, scope and density. When airlines are being merged, economies of scale (reduction in costs per unit as production increases) allow airlines to spread their fixed costs over a greater network. Economies of scale are common in capitalintensive industries with high fixed costs (Vasigh et al., 2008). An airline will realize economies of scope when it expands its route network with new routes. Economies of scope exist when the firm achieves saving as it increases the variety of goods/services and aredefinedintermsofrelativetotalcostofproducingavarietyofgoodstogetherinonefirmversusseparatelyin more firms. Thus, multiple goods/services/projects/processes can be more costefficient when performed together rather than individually. Airlines achieve economies of scope by operating multiple additional programs or services such as frequent flyer plans (FFP), and also in a spatial manner because things such as personnel and maintenance are already in place at the point of origin and their costs can now be spread over more units of output. Network scope will be especially important for business passengers who require service to a wide range of destinations. Economies of scale and scope can both be achieved by connecting different networks. On the otherhand,economiesofdensityarenotachievedbyaddingnewroutes,ratherbyusingexistingprocessesmore intensively and effectively (consolidation of operations) and create a denser flow of passengers, which increases seat utilization. Economies of density in the airline industry can be achieved through the use of hubs, larger aircrafts, and by intensifying ground operations processes that in turn lead to cost reductions and higher flight frequency due to shorter connecting times (attracting more passengers). Connecting feeder traffic in a huband spoke system can improve the passenger flow density on a citypair, allowing airlines to operate larger, more efficient aircraft and to spread endpoint fixed costs over a larger number of passengers (Pearce & Doernhoefer, 2011). A combined network in an alliance relationship can bring improved traffic density to both spoke to hub, and hubtohub routes. Increased demand drives better utilization of capacity that in turn boosts profitability. However, for more distant forms of alliances such as codesharing, maximizing economies of density is limited. In the absence of a JV, alliance partners will operate separate services on a hubtohub route. This will divide traffic between the two separate operations, whereas under a JV, the airlines would operate as a single entity, allowing theuseoflargeraircraftandmaximizingtheefficiencygains(Pearce&Doernhoefer,2011). As mentioned in the previous section, networks are composed by links that connect nodes with each other. In the airline industry two types of route networks can be distinguished: hubandspoke network or point topoint network (Vasigh et al., 2008). Under the regulated system that existed in the USA before 1980, airlines faced constraints on both their fares and route structures. However, since the deregulation, which provided
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 23

airlines with more freedom of entry and exit, it also allowed for more rationalization of route structures (Brueckner, 2004). This led to an increase of hubandspoke networks; by concentrating traffic on the spoke routes in and out of hub airports, airlines could exploit economies of density or increasing returns at the route level by reducing the number of flights (Brueckner, 2004). With the use of hubandspoke networks, flights from many different cities come together on a single airport (hub) at approximately the same time and after letting passengers transfer to their connecting flights, all flights leave the hub for different city destinations. Burton and Hanlon (1994) describe that by creating larger networks increased concentration can result in greater market power and significant economies of density as a strong hubandspoke system protects its traffic from being divertedtoanotherairlineonitsway.Hubairlinesderivemarketpowernotonlyfromairportcapacityconstraints but also from passengers loyalty advantages that airlines with large presence in a given city derive from loyalty programs(Burton&Hanlon1994). When airlines consider M&A and/or strategic alliances, one of the first evaluations is the effect on network structure; the level of network complementarity/parallel or the level of dominance of the airlines involved (Shaw & Ivy, 1994). When airlines merge it immediately affects its network structure in terms of geographic coverage of cities and routes, overall connectivity and hubandspoke patterns (Shaw & Ivy, 1994). Parketal.(2001)studytwotypesofairline(alliances)basedontheirnetworkcharacteristics:complementaryand parallel alliances. Complementary alliances occur when two firms link up their existing network and build a new complementary network to feed traffic to each other (Park et al., 2001). A parallel alliance refers to two firms who, priortotheir alliance,are competitors on some routes of their network (Parket al., 2001). It is importantto make this distinction between networks because they can have different outcomes. Complementary networks of two different airlines can lead to double marginalization: each airline involved on the route (A> B>C) sets its own price and therefore two different profit margins. In case of an alliance or M&A between these two different airlines the double margins are eliminated which will in the end decrease the price for consumers (Horan, 2010). ThisdoesnothappenwhenthetwoairlinesintheallianceorM&Ahaveparallelnetworks.Thislatterargumentis also one of the main arguments for the US Department of Transportation to approve of (or grant Anti Trust Immunitywhichwillbediscussedinchapter4)alliancesbetweenairlines.Parketal.(2001)foundthatpartnersin a complementary alliance are likely to increase traffic output opposed to their rival firms who are likely to decrease both output and profit as a result. Moreover, complementary alliances are likely to decrease price and hence consumer welfare will increase. However, parallel alliances are likely to decrease total output and increase full price in a market where the alliance is formed. Hence, consumer welfare will decrease in the case of parallel alliances and the most important outcome for the firms involved is increased market power (Park et al., 2001). Thus, as explained in the previous section, network complementarity is also a crucial component in the airline industry as well to achieve positive network externalities and hence increase customer welfare, and also to increase revenues (output). This explains why route networks and hub airports play such an important role inthe partnerchoiceforM&Aand/oralliances.
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 24

In the second part of this study I will focus more specifically on the commercial airline industry itself. In order to understand and analyze the specific business cases that will be discussed later in this study, it is relevant to get a notion of their context and how the industry as a whole has developed with regard to consolidation. So having presented the literature on the topic of horizontal integration in the value chain in the previous chapters, in this part I will describe how this horizontal integration matter has influenced the commercial airline industry as a whole. In this chapter I will focus on the commercial airline industry in the US and Europe because these have beenthemostdominantpartsoftheglobalairlineindustry.Iwillstartbyexplainingwhythisparticularindustryis consolidating, and then I will describe how the industry in Europe and the US has changed in the last 20 years. Third,Iwillpresentthecurrentstateofconsolidationinthecommercialairlineindustry.



What are the underlying forces that drive the need in the airline industry to collaborate or consolidate from a theoreticalpointofview?Fanetal.(2001)identifiedfivemainforcesatmacrolevelthatareinfluencingthetrend towards consolidation. The first one is increased globalization in trade and air transport, which creates an increase in demand for more international travels. Secondly, increased intraregional interaction (or a sense of regional identity as the authors call it) as a counter part of globalization. Third, there are strong economic incentives for airlines to consolidate and operate at large, dense networks. Fourth, the airline industry is not yet totally liberalized because the granting of most international air traffic rights to specific airlines is based on the country of ownership of the airlines, and limited foreign ownership for major airlines. The final force of influence is antitrust concerns. As mentioned briefly in the five trends (Fan et al., 2001), on the cost side, economies of density have been known to be a major advantage of larger networks (Fan et al., 2001). On the revenue side, a stronger market position may translate into higher airfares and hence increased revenues. Even though this is an advantage for the firm it possibly hurts consumer welfare (Fan et al., 2001). Burton and Hanlon (1994) state that globalization is the main reason in business in general for firms to collaborate and explain why alliances are preferred over consolidation. They base their argument on Ohmeas globalization thesis that it is purely the scale of contemporary global industries and markets that requires interfirm collaborations (to share sunk costs and exploit economies of scale) as opposed to establishing large global enterprises. When applied to the airline industry,theopportunitieslieinreapingeconomiesofscoperatherthanscale;therearenoparticularadvantages in a large firm size per se, but advantages do exist on the marketing side (frequent flyer programs) and by exploiting hubandspoke systems (economies of traffic density as I explained in the previous chapter) (Burton & Hanlon, 1994). From a marketing perspective, airlines want to offer the best global network possible for their customers. Moreover, one of the most valuable marketing advantages in forming alliances is to arrange a mutual exchange of frequentflyerprograms, which inturn will increase loyalty of business travelersto certain airlines or alliances (Burton & Hanlon, 1994). Economies of density are achieved through the consolidation of operations (Vasigh et al., 2008). This concept is very much applicable to the commercial airline industry where firms have
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 25

found it to be more costeffective to consolidate operations at a single airportthatis used as a hub (Vasigh etal., 2008). Evans (2001) makes a distinction between external and internal drivers for consolidation. Internal drivers include: risk sharing, economies of scale, scope and learning, access to resources, and shaping competition. External drivers are: the information revolution (CRS systems), economic restructuring (deregulation), and global competition. Overall, all these different studies come up with similar motivations for the airline industry to consolidate. Firstly, consolidation is market driven and influenced by globalization and elimination of regulatory barriers. Second, on the costs side there are strong incentives to operate on dense networks and exploit economiesofscopeanddensity.Finally,onthemarketingside,astrongermarketpositionmayincreaserevenues andthemutualexchangeofloyaltyprogramswillincreasecustomerloyalty.



In this section I will present a brief overview of the industry developments with regard to consolidation since the liberalization of the commercial airline industry in Europe and the US. The following sections will go into more detailanddepthwithregardtobothM&Atransactionsandallianceformations.Thefirstcountrythatstartedwith deregulation of the airline industry was the US, later on other regions and countries replicated these ideas. In 1978 the US airline industry was deregulated. This triggered a structural change in the entire industry as it provided airlines with freedom on fares and route structures. In the EU, this deregulation occurred later and was moregradualthanintheUS.Oneofthefirststepstowardstransnationalconsolidationwastakenin1992;theUS andtheNetherlandsgovernmentsagreedtoanOpenSkiesbilateralairtreaty.TheUSgrantedNorthwestAirlines and KLM full antitrust immunity (ATI), thus allowing the two airlines to market, schedule, and price joint services to essentially operate as a single competitor. The last step in the EU was taken in 1997 when the Single Aviation Market came into full effect which removed borders and allowed for free competition between all EU licensed airlines. By the end of the 90s, the US domestic airline deregulation had been replicated inside Europe and distinctmarketsegmentshademergedinboththeUSandEurope(Chan,2000). Many US legacy airlines achieved substantial cost efficiencies through consolidation and through the adoption of the hubandspoke system, which allowed for a rationalization of the route structure (Brueckner, 2004).Byusingthistypeofnetwork,airlinescouldexploiteconomiesofdensitybecausetrafficisconcentratedon the spoke routes in and out of hub airports which reduce the costs per passenger and hence airfares (Brueckner, 2004).InEuropehowever,airlinesweremoreorlessalreadystructuredaroundhubairportswithaninternational feeder system, which used to be protected by regulatory authorities. But after deregulation these regulatory authorities were not in place anymore and new defensive strategies were necessary to protect their dominant position at their hub airports. Therefore, European airlines chose to use preemptive (keep competition away by restrictingforeignacquisitions)anddefensivestrategies(consolidatingitspositionofdominanceonhomeground resulting in one major, national airline) (Chan, 2000).Freedom of entry and exitalso gave rise to low cost carriers
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 26

(LCCs) that quickly appeared in Europe and opened up new markets, but they also entered the markets of establishedlegacyairlines.Inshort,despitesmalldifferencesintheevolutionoftheairlineindustryinboththeUS and EU, ultimately similar competitive dynamics took place (European Commission & US Department of Transportation,2010). Both markets are currently divided into prederegulation legacy airlines and postderegulation lowfare airlines. The larger European airlines have historically focused on intercontinental flights, which also remained after the deregulation of the industry. The US airlines needed to change their business models because pre regulation legacy airlines could not keep up with the new airlines that focused on building a strong domestic network (new domestic majors) and struggled with their adaptation to the new deregulated market (especially because these airlines were still organized around a linear system without international feeders) (European Commission & US Department of Transportation, 2010). This has caused several major US legacy carriers (PanAm and TWA) into liquidation or bankruptcy protection (Vasigh et al., 2008). As a result, the US airlines that exist today are offspring of the new major domestic airlines and hence relatively new to international operations compared to their European counterparts. Figure 6 shows the market share of the top 20 airlines since the deregulation of the industry. It shows that each step in this global liberalization process has contributed to the consolidation of the global industry, and that especially the last years have significantly contributed to this process.Thislatterdevelopmentwillbediscussedinthenextsection.Thisfigureisextractedfromareportofthe Deutsche Bank about airline consolidation, and should be interpreted as an estimation of the industry developmentbecausethedatabehindthesecalculationsarenotpublic. M&AintheUS As mentioned earlier in the previous sections, deregulation has led to a natural decrease of players in the US commercial airline industry because some airlines just could not keep up with the developments in the industry. Bankruptcy was the result of rising debts, higher aircraft costs, price wars and declining business traffic. By 1992, Midway, Pan Am, and Eastern had been liquidated and America West, Continental and TWA were in bankruptcy (Chan, 2000). However, many bankrupt airlines were able to continue flyingbecause the US established special laws regarding bankruptcy (Chapter 11) which put pressure on the other remaining airlines (Chan, 2000). Right after deregulation in the US in 1978 mergers rapidly increased; in the ten years after deregulation 51 airline mergers and acquisitions took place, which resulted into six major airlines (Dempsey, 1990). The mergers took place in the first years after deregulation in the US and generally followed two themes: merging to eliminate competitionathubsorspecificroutes,ormergingtoexpandgeographiccoverage(Shaw&Ivy,1994).

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase




Twenty years after the start of deregulation, the US airline industry consolidated into two market segments: the hubandspoke segments dominated by the established airlines (new major domestics), and the regional markets serviced by pointtopoint airlines lead by Southwest Airlines (Chan, 2000). Thus, the US airline industry already experienced a previous airline consolidation period in 80s and 90s (right after the liberalization of the market) and yet the market share of the top four airlines never seemed to get much higher than 60% (Linenberg et al., 2012). In Appendix I an overview is presented of all M&A in the US since its deregulation in 1978. From this overview it can be stated that by the 90s the industry had already consolidated into seven major players and some smaller airlines around it. In the last five years the merger of Delta and Northwest, and United and Continentalhasnarrowedthisdownevenfurther.Figure7presentsthemarketshare(domesticandinternational RPM) of the top four US airlines in the last decade. This shows that the recent waves of M&A in the US has significantly contributed to consolidation. Consolidation can be measured in two different ways: (1) the concentration ratio and (2) the HerfindahlHirschman Index (HHI). The concentration ratio is a measure of the total market share held by a certain number of firms in the industry. The most used concentration ratio is the fourfirm concentration ratio, where the output of the four largest firms in the industry is measured. When the fourfirmrationislessthan20%,themarketisassumedtofollowthedynamicsofaperfectlycompetitiveindustry (Vasigh et al., 2008). When the concentration ratio is higher than 80%, the market is highly concentrated and closer to a monopoly. The middle of this spectrum represents monopolistic competition (2050%) and oligopolies (5080%). The HHI is another way to measure consolidation in an industry, and is measured by squaring the
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 28

marketshareofeachoftheplayersandthenaddingthoseup.Thus,thehighertheindex,themoreconcentration and (within limits) the less open the market. By squaring the market share, firms with a large share receive more weight in the calculations than those with a smaller share. A market with a result of less than 1000 is considered tobecompetitive,andthosehigherthan1800areconsideredtobehighlyconcentrated(Vasighetal.,2008).The HHI is frequently used by the Department of Justice to determine if a proposed merger is acceptable for antitrust reasons. Today (2012) the major US players in the airline industry are the following: Southwest Airlines, Delta Air Lines, United Airlines, US Airways and American Airlines (the last two are currently considering a merger). The merger of Southwest and AirTran in 2011 is the first one that is a full LCC merger. From figure 7 it can be concluded that indeed the US commercial industry has become highly concentrated in the past few years (since 2010). When the merger between US airways and American Airlines will continue and approved of, the industry willbeevenmoreconcentrated.


M&AinEurope After the deregulation in Europe, airlines started using defensive strategies in order to protect their dominant position in their home market. This mainly included M&A by the dominant airlines with smaller players. This lockingin of locally based small and medium airlines was a strategy employed by many Western European legacy airlines (Chan, 2000). Air France for example, contracted TAT and Brit Air to operate services on its behalf (Chan, 2000). In the final stage of the European airline industry liberalization more crossborder acquisitions took place. BAs acquisition in 1992 of 49% in the German Delta Air is an example of such a case (Chan, 2000). The table below is based on the study of Nmeth and Niemeier (2012) and provides an overview of approved M&A by the
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 29

European Commission. This study however, only shows those M&A that were large enough to be approved of by the European Commission, the smaller ones are not included in their data. It shows that most M&A indeed took place between a dominant and a smaller airline, with the exception of Lufthansa/Swiss Air, Air France KLM and British Airways/Iberia (International Airlines Group). These last two groups plus Lufthansa (also including Austrian and Sabena) are currently the largest players in Europe. Do note that these firms operate a hubandspoke network and that pointtopoint low cost airlines such as Air Berlin, Ryan Air and Easyjet also play an important roleintheEuropeanairlineindustry.

Year Airlines 1995 1996 1997 1997 2002 2004 2005 2005 2008 2009 2009 2009 2010 SwissAir/Sabena BritishAirways/TAT BritishAirways/AirLibert KLM/AirUK SAS/SpanAir AirFrance/KLM Lufthansa/Eurowings Lufthansa/SwissAirways KLM/Martinair Lufthansa/AustrianAirlines Lufthansa/BritishMidlandAirways Lufthansa/SNBrusselsAirlines BritishAirways/Iberia Result 49.5%ownershipbySwissAir fullacquisitionbyBA 70%ownershipbyBritishAirways 55%ownershipbyKLM 74%ownershipbySAS fullacquisitionbyLufthansa fullacquisitionbyLufthansa fullacquisitionbyLufthansa 55%ownershipbyBritishAirways




After deregulation, European airlines started facing competition from US airlines that had been able to expand their international presence by leveraging their strong domestic networks. The European airlines were still prohibited to access the US domestic market and were initially in favor of restricting traffic rights to and from member states in order to protect their own competitive position. Later, they agreed to the first forms of cooperation; codesharing and marketing agreements, to cope with their changing competitive landscape (DOT and European Commission report, 2010).At that sametime, the US airlines sought for more costeffective access to European destinations and also for increased brand awareness, which resulted in a need for closer ties with other airlines. The network airline business model that arose after deregulation, in both the US and Europe, is based on a from anywhere to everywhere principle. No airline by itself though, is able to efficiently serve every requested destination. Thus, in order to meet customer demands, airlines seek partners that can help them provide better network coverage. As mentioned earlier in this chapter, one of the first steps in airline alliances was taken in 1992; the US en the Netherlands agreed to an Open Skies bilateral air treaty. The US granted Northwest Airlines and KLM full antitrust immunity (ATI). The partners of the alliance or JV that has been granted
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 30

ATI are allowed to essentially operate as one single airline. Under an ATI JV, the partners can split revenue or profits. These JVs are driven by the objective of metal neutrality; the airlines involved are indifferent to which aircraft carries a passenger. ATI is usually granted on the condition that a country is a signatory to an Open Skies agreement, but that does not guarantee the granting of antitrust immunity (Linenberg et al., 2012). The three globallybrandedalliances(StarAlliance,Skyteamandoneworld)receivedATIfortheirkeyEUandUSmembersto formsuchJVs. Currently, the larger airlines in both the EU and the US face competition from LCCs in their markets, and depend increasingly on revenues from longhaul international routes. To remain competitive these airlines face two challenges: expanding their global network and increasing their competitiveness regarding the cost side (European Commission & US Department of Transportation, 2010). To address the first challenge, airlines continuetobroadenanddeepentheirglobalnetworkintegrationwithalliancepartners(EuropeanCommission& US Department of Transportation, 2010). Alliances may give opportunities for its members to reduce costs by coordinating activities in multiple fields, which in turn may increase the competitiveness of its members (Park et al., 2001). Alliances also bring other benefits, but the differing degrees of cooperation give rise to different types and levels of benefits. The following benefits apply to a basic alliance membership (European Commission & US Department of Transportation, 2010). First, strategic/global alliances allow airlines to link their networks and sell tickets on the flights of their partners. Second, members in an alliance aim to provide value to customers by creating a comprehensive route network, better coordinated schedules, single online prices, single point check in,coordinatedservicestandards,andreciprocalfrequentflyerprograms.Third,throughawidernetwork,airlines can also benefit of improved brand recognition. Fourth, alliances can improve access to feeder traffic of alliance partners (especially for longhaul services) because airlines in an alliance tend to favor their alliance partners in the financial terms of their interlining and choose them for code sharing. With the increasing membership of alliances it may be difficult for others to secure feeder traffic at some airports andcan thereforeencourage them tojoinanalliance.Fifth,alliancepartnersarealsobetterabletoaddresstheneedsofcorporatecustomers,which mayleadtoasinglecontract.Finally,membersmayalsotogetherfinanceexpensiveprojectsbypoolingresources (especiallyITrelatedinvestments)orbenefitfromjointprocurementdecisions. Airline alliances are also motivated by regulatory barriers such as; limitations on foreign ownership and trafficrights(Parketal.,2001).Mostcountrieshavestrictcitizenshiprequirementsfortheownershipoftheirflag airlines. Besides national ownership restrictions, bilateral aviation agreements also include restrictions on

ownership. Beforeanairlinecanoperateinternationallytoanothercountry,thegovernmentsofthecountriesin
question must first negotiate about an agreement, which is known as a bilateral air services agreement. These bilateral agreements include clauses with regard to traffic rights, capacity, designation, and ownership. Today, international aviation is regulated by a complex web of over 3000 interlocking bilateral air services agreements. The US for example, has restricted ownership of its airlines to 25% of the voting equity since the 1930s. Moreover,twothirdoftheBoardmembersmustbeUScitizensandkeymanagementpositionsarerequiredtobe
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 31

held by US citizens (Linenberg et al., 2012). One of the main reasons of these restrictions is that airlines have historicallybeenviewedasanindustrythatiscriticaltoacountrysnationalsecurity;duringtimesofwar,aircrafts are conscripted by the military into service as troop transports. Thus, if foreign interests control a local airline, how can they be forced to cooperate during times of war? Another reason is that foreign ownership restrictions represent a form of protectionism for labor unions that see foreign competition as a threat to their earnings powerandjobsecurity(Linenbergetal.,2012). Ownership restriction together with high investment barriers for internal development, are usually seen as the reasons why airlines choose for strategic alliances over M&As. Barla and Constantatos (2006) however, show that strategic reasons may also enhance the desirability of strategic alliances over M&A and extend the findings of Sawler (2005) to the commercial airline industry specifically. They found that partial cooperation instead of M&A may be more profitable. The cost synergies necessary for alliances to be as profitable as acting alone are less important than the corresponding costs for M&A, which would make strategic alliances more attractive because they are of less threat to the competition (Barla & Constantatos, 2006). Another difference between alliances and M&A is that the latter strategy is always bilateral whereas an alliance can be multilateral. An alliance can be extended to more than two partners and thereby also disproportionally increase mutual networkbenefitsalongthesemultiplepartners. As described in the previous section reasons and benefits for entering into a cooperative agreement vary widely,whichalsocountsforthedetailsoftheparticularcooperation.Afirsttypeofdistinctionbetweenalliances can be made with regard to their networks: complementary and parallel alliances. In the previous chapter I already discussed the importance of route networks and hubs for airlines. A second type of distinction can be made with regard to the intensity of cooperation; tactical and strategic alliances (European Commission & US Department of Transportation, 2010). Tactical alliances are formed to address a specific deficiency in the airlines networks, they usually involve only two airlines and cover a limited number of routes with the only objective to provideconnectivitytoeachothersnetworks.Thesealliancesofteninvolveatleastoneindependentairlinethat is not a member of a larger strategic alliance. Examples are: Virgin Atlantic/Continental (code sharing), American/JetBlue (interline and frequent flyer program arrangement), AirFrance/FlyBe (code sharing). Many airlinesthatprovideinternationalservicesthough,prefertojoinoneofthethreebrandedstrategicalliances;Star Alliance, SkyTeam, or Oneworld. Membership does not keep them from also forming tactical alliances with non alliedairlinesandinsomecasesmembersofotherstrategicalliances(EuropeanCommission&USDepartmentof Transportation, 2010). Members of these strategic alliances coordinate on a global basis to create the largest possible worldwide network. (European Commission & US Department of Transportation, 2010). These types of alliances include basic/tactical types of alliances (code sharing, frequent flyer programs and lounge sharing), but some alliance members seek higher levels of cooperation within the alliance to enhance the benefits of the alliance.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


Table 3 is based on the DOT and European Commission report, 2010) and shows the level of integration among existing strategic alliance members. The most highly integrated members (which are also the founding members) of all three alliances have launched a mergerlike Joint Venture and typically involve full coordination of major airline functions on the affected routes (European Commission & US Department of Transportation, 2010).
Table3:Integrationamongalliancemembers StarAlliance 25(all Low Medium High

Oneworld 11(all members) 5 3

Skyteam 15(all members)

members) 9 3

5 3

The trend towards joining a strategic alliance may not necessarily represent consolidation because that highly depends on the level of integration within the alliance and whether this is of tactical or strategic nature. Moreover, in order to decide whether cooperation leads to less competition one also has to take into account networkcomplementarity.Figure8showsthespectrumofairlinecooperationforms.Airlinesthatparticipateina revenue or profit seeking (the latter also shares costs) JV with antitrust immunity from DOT engage in the highest form of integration. Their strategic goal is to become effectively indifferent to which plane carries a passenger, and hence is a close substitute of a merger because it usually involves full coordination of the major airlinefunctionsontheaffectedroutes(scheduling,pricing,revenuemanagement,marketingandsales).


According to the market research conducted by Linenberg et al. (2012) from the Deutsche Bank, the growth of airline ATI joint ventures coincided with the development of global airline alliances, and in most cases these JVs formed the basis of the alliance. Currently, airline alliances account for 59% of global capacity and representasignificantshare(>75%)ofthemajoraircorridors(figure9)

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 33





Asdescribedintheprevioussection,consolidationintheUSmostlytookplaceinthefirstyearsafterderegulation because new players entered the industry and old ones had to keep up with the quick developments. Early consolidation in the US appeared in a natural way through liquidations but also through mergers and acquisitions (Appendix I). Bttner and Burge (2008) report that the recent DeltaNorthwest merger will result in further consolidation of the US airline industry that is currently characterized by too many hubs. Further consolidation would offer better use of the capacities, avoid price wars, and cope with the high costs of fuel (Bttner&Burger,2008).Earlierinthischapter,figure7alreadypresentedtheincreasedmarketshareofthetop four US airlines in the last decade. Currently, they possess about 80% systemwide (domestic and international) market share based on Revenue Passenger Miles (RPM). The pie chart (figure 10) below shows the system wide (international and domestic) market share of US airlines in 2011 based on RPM, and illustrates that the top 4 airlines (United, Delta, American Airlines, and Southwest) together represent more than 75% of the US market (79% precisely). This coincides with the market share numbers presented by Linenberg et al. (2012) from the Deutsche Bank, and thus it can be concluded that indeed the US airline industry is already highly concentrated andwillbeevenmoreincaseoftheAmerican/USmergercontinues.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 34


2% 3% 2% 4% 8% 1% 1% United(plusContinental) 25% Delta AmericanAirlines Southwest(plusAirtran) USAirways 14% 23% 17% JetBlue Alaska SkyWest Frontier Hawaian AmericanEagle

In Europe, airlines have to deal withbothEU and national regulationsand policies. Moreover, because of the different nations involved, it is fairly difficult to obtain an overview of concentration ratios for all European airlines. From all the reports and statistics that I could find, there was not one that could give a clear picture of the European airline market share (including both flag and low fare airlines and within and outside Europe traffic). In the following section I will try to give a reflection of what the European airline industry currently looks like. One thing is for sure; the European airline industry is less concentrated than it is in the US, but how much exactly remains vague. This is probably because the EU countries still have to deal with nationality clauses that complicatecrossbordermergers. AreportbyBooz&Co(Ringbeck&Gross,2008)presentsa47%marketshare(2008)ofpassengerscarried by European flag carriers for the top three major European airlines (Air France KLM, British Airways and the Lufthansa Group). This number however, does not include low cost carriers nor does it include M&A activities in 2009 and 2010. Another report (Bttner & Burger, 2008) states that the top five airlines in Europe have a combinedmarketshareof31%.Thislastestimationthoughisnotclearonwhattypesofairlinesitincludesandon what type of ratio it is based. What does become clear from both concentration indications is that the ratio in EuropeissignificantlylowerthanintheUS. When looking at the total number of passengers carried by European airlines the picture is much more fragmented. Based on an estimated compilation of Europes largest airlines by passengers carried in 2011, I created a table that shows a different picture of the industry. This one also includes low cost carriers and shows
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 35

that the top four airlines represent only little over 50% of the European market. Important to note is that this tableagainisaroughestimationbecauseitisbasedonthenumberpassengerscarried.Whentakingintoaccount ASKs(kilometerperpassenger)airlinessolelyoperatingwithinEuropewilldropontheranking.
Table4:MarketshareEuropeanairlines(2011)basedonpassengerscarried Airline
Lufthansa Ryanair AirFranceKLM Easyjet IAG TurkishAirlines AirBerlin SASGroup Alitalia NorwegianAirShuttle Aeroflot Vueling PegasusAirlines WizzAir AustrianAirlines Note.Basedon:Wikipedia(n.d.).ListoflargestairlinesinEurope.

MarketShare Passengerscarried(millions)2011
18,51% 13,30% 13,19% 9,66% 9,00% 5,68% 5,53% 4,73% 4,35% 2,73% 2,45% 2,14% 1,97% 1,95% 1,96% 106,33 76,4 75,78 55,47 51,68 32,62 31,78 27,2 25 16,36 15,7 14,1 12,3 11,3 11,21 11,26

SwissInternationalAirlines 2,85%

Lookingatthe10largestEuropeanairlinesintermsoftotalseatssold,adistinctioncanbemadebetween intraEuropean flights and total flights to/from European. Table 5 is based on information from CAPA (CAPA AviationAnalysis,07/072012)andshowthatthetopfourairlinestogetherpossesslessthan60%ofthemarketin either situation. These figure though only include the ten largest airlines, hence results will probably be even more fragmented when the smaller ones are also included. Moreover, these figures consider (recently) merged airlines as separate entities. Thus, this final overview probably presents the best picture of the European airline industry.

Airline 1 Lufthansa 2 Ryanair 3 AirFrance

Totalseats sold 1.514.268,00 1.422.771,00 975.483,00 36

Totalseats Airline sold 1.762.254,00 1 Ryanair 1.553.202,00 2 Lufthansa 1.133.750,00 3 easyJet

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase

4 easyJet 5 BritishAirways 6 TurkishAirlines 7 SAS 8 airberlin 9 Iberia 10 1.018.845,00 4 AirFrance 848.611,00 5 SAS 845.200,00 6 TurkishAirlines 685.091,00 7 airberlin 654.941,00 8 BritishAirways 549.554,00 9 Iberia 822.572,00 656.435,00 631.740,00 597.555,00 551.338,00 452.686,00 436.946,00 8.061.794,00 59%

NorwegianAir KLMRoyalDutch 530.878,00 10 Airlines Shuttle Total 9.582.326,00 Total

Top4 57% Top4 Source:CAPACentreforAviation(2012,07/07).

Globally,thecommercialairlineindustryshowsevenfurtherfragmentation.InAppendixIIanoverviewis presented of the worlds largest airlines based on the capacity per week (ASKs) and this shows that the top four airlines (Delta, American, United and Emirates) together represent only 31% of the global market (CAPA Centre for Aviation, 04052012). To conclude, the US commercial airline industry is already highly concentrated (leaning towards a monopoly) and might even become more concentrated in the future (possible American/US Airways merger), the market shares and concentration ratios in Europe are rather vague but all the data found indicate a less concentrated industry than in the US (oligopoly). Unfortunately I have not been able to find the exact same dataforboththeUSandEuropewhichmakesitdifficulttocompareandpresentaclearpictureofthesituation.

In the previous four chapters I have defined and explained the topic of horizontal integration in the value chain. Moreover, I have described the theories that underpin a firms need to grow, and also explained what factors influence the choice for modes of integration and/or cooperation. Besides generic motivations, the industry specific factors have been discussed in the previous chapter. Based on the framework of Hoffmann and Schaper Rinkel(2001)thathasbeendiscussedinchapter2,Icreatedatablewithdrivingfactorsforairlinestochoosefora certain strategy and a corresponding conceptual model that explains the differences between the two strategies and their driving factors (table 6). These factors are sorted along three levels of analysis. The different factors included in this model have all been discussed in the previous theoretical chapters. Hoffman and SchaperRinkel (2001) made a distinction between environmental, firm specific and relational/transactional factors involved in the choice for either a cooperative or an integrative strategy. When applied to the commercial airline industry their generic drivers can be combined with some industry specific drivers. The drivers themselves are located in the second column of table 6, the column next to it explains in keywords to what each driver relates to (which factors are involved). When these drivers are applied to either strategic alliances or M&A, they will differ in their nature, or in other words; the factors involved for each type of external growth strategy will be different. This is
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 37

illustrated in the model shown on page 39 (figure 11). This conceptual model will be tested using two recent businesscasesthatrepresentonetypeofexternalgrowthstrategyeach.

Levelofanalysis Drivers Environmental Firm Relational Legalconstraints Degreeofstrategicuncertainty Marketingoutcome Outcomecompetitivestructure Financialposition Socialcapital/embeddedness Externalgrowthexperience Economicsynergies Requiredinvestments Levelofintegration

Factorsinvolved nationalownershiprestrictionsandbilateralagreements(trafficrights),bankruptcy protectionunderchapter11,antitrustlegislation industrydevelopments(globalization,profitability,newentrants,competitionetc.) meetcustomerdemands(largernetwork,frequentflights,goodconnections), mergedloyaltyprograms,brandrecognition increasemarketshare(improveposition)orkeepupwithcompetition(ensure position)byexpandingroutenetwork weakorstrongfinancialendowment(shareriskorstrengthenfinancialbase) smallorlargecurrentnetwork/socialembeddedness,humancapital(laborunions) historyofhorizontalgrowthstrategies achieveeconomiesofscaleandscopebycombining(complementary/parallel) routesandhubs Transactionspecificinvestmentsneededtocreateeconomicsynergies loworhighlevelofintegrationtocreateeconomiesofdensity levelofprotection,similarityoffirms sizeandcompetitivepositionofpartnerandfinancialposition

Degreeofbehavioraluncertainty Levelofinterdependence

In order to answer the research question of this study What types of horizontal growth strategies with regard to value chain integration can be identified in the airline industry and what factors can explain the differencesbetweenthem?thefollowinghypothesesaretested: H1A: Drivers at environmental, firm, and relational level play a role in the choice for an airline to form either a strategicallianceorM&A. H1B: There is a difference in importance between the drivers for each growth strategy (strategic alliance and M&A); environmental drivers will play a more important role for strategic alliances and firm specific drivers for M&A,relationaldriverswillplayanimportantroleforbothstrategies. H2A: An airline choosing for a strategic alliance is driven by the following environmental factors: strict legal constraintsandahighdegreeofstrategicuncertainty. H2B: An airline choosing for a strategic alliance is driven by the following firm specific factors: meet customer demands, increase/improve customer loyalty and brand recognition, ensure competitive position, weak financial endowment,largecurrentsocialnetwork,littleexternalgrowthexperience.
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 38

H2C:Anairlinechoosingforastrategicallianceisdrivenbythefollowingrelationalfactors:complementaryroutes and hubs to achieve economies of scale and scope, small required investments, low level of integration, high level ofinterdependency. H3A: An airline choosing for M&A is driven by the following environmental factors: no legal constraints, low degreeofstrategicuncertainty. H3B:AnairlinechoosingforM&Aisdrivenbythefollowingfirmspecificfactors:meetcustomerdemands,improve competitive position (increase market share), strong financial endowment, small current social network, previous M&Aexperience. H3C: An airline choosing for M&A is driven by the following relational factors: Complementary and parallel routes and hubs to achieve economies of scale and scope, large required investments, high level of integration to economiesofdensity,lowlevelofbehaviouraluncertaintyandalowlevelofinterdependency.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 39




5.1 IntroductionCase1

In this and the following paragraph I will briefly present the parties involved in the two business cases that are used to test this studys model. These are just introductions to the case and meant to give a broad picture of the firmsinvolved,theactualanalysiswillbepresentedintheResultschapter. The first case is that of airberlin joining the global alliance Oneworld. The second largest German airline, airberlin, joined the Oneworld alliance in March 2012. Airberlin will be one of the first lowfare airlines to join a
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 40

global alliance that has so far been dominated by legacy airlines. Airberlins move to become a full member of an alliance goes one large step further than the recent introduction of codesharing services between lowfare (LCC) and legacy airlines. If successful, it could further blur the boundaries between legacies and LCC. From another pointofview,italsoindicatesOneworldsneedtogrowafteracquiringlateapprovalandATIforthetransatlantic alliance and its recent rivalry with other global alliances for suitable partners. I chose to use this particular businesscaseformystudybecauseitisarecentexampleofanairlinejoiningoneofthebrandedglobalalliances. Moreover, it is a special case because it is one of the first LCC to become a full member of one of those global alliances(notasanaffiliatepartner). Airberlin Sinceitslaunchin1978,airberlinhasgrowntobecomeGermanyssecondlargestairline(nexttoLufthansa).With the acquisition of holiday airline LTU in 2011 it became sixth in Europe in terms of passengers boarded. Its fleet comprises 170 aircraft (average age of five years) and the group employs 9,200 staff. The airline has developed from its origins in the shorthaul leisure market to serving also business travellers with its Euro Shuttle service (providinghighfrequencyconnectionsbetweenEuropeskeydestinations)andtodayalsoofferslonghaulflights. Airberlin is not positioned as a standard LCC (like Ryan Air or Easyjet), rather it uses a hybrid model with characteristicsofbothLCC,holidaychartersandlegacyairlines.Moreover,itistryingtoservetwodifferenttypes ofpassengers:businesstravellersandleisureseekers. Thislatteraspectisreflectedinitsroutenetwork;Airberlin has an extensive German network but also serves many airports at destinations such as Greece, Spain and Portugal. Currently, the airline serves 162 destinations in 40 countries with bases in German cities such as Berlin (the new Brandenburg BBI airport intended to be opened from June 2012) and Dusseldorf, in leisure destinationssuchasPalmadeMallorca,andalsowithbasesinbothAustriaandSwitzerland.Theairlinesrelative success in the last years was mainly linked to LCC features; its network primarily focuses on pointtopoint services (Flottau, 2011). Airberlin has focused on Dusseldorf and Berlin as its most important bases with capacity in Berlin being a constraining factor. However, the new Berlin airport (BBI) opens up new opportunities where Airberlin plans to introduce hub structures, especially for NorthSouth traffic. At BBI it will have access to its own dedicated terminal area that will ensure easy connections. This will give Airberlin the opportunity to increase its fullyusedcapacityinBerlinfromTegelAirportofamaximumof6,000flightsaweek(AirberlinPLC,2012).BBIwas supposedtoopeninthesummerof2012butthishasbeenpostponed.TheclosureofBerlinTegelandSchonefeld (the other two airports) therefore was also postponed and scheduled flights at BBI had to be rescheduled at the old airports. Airberlins top 10 city pairs in 2010, before its oneworld membership, are shown in table 7. This showsthatmosttraffictookplacewithintheGermanregion.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 41

Toptencitypairs2010 HamburgMunich CologneBerlinTegel DusseldorfMunich MunichBerlinTegel StuttgartBerlinTegel CologneMunich BerlinTegelZurich DusseldorfBerlinTegel DusseldorfPalmadeMallorca DusseldorfVienna FrankfurtBerlinTegel Source:OAG2010 #Passengers 660.258 604.496 589.679 574.683 414.427 403.314 391.332 390.875 372.227 361.769 359.185

The chart below shows Airberlins current top 10 airports by ASKs and number of seats per week in the summer of 2012, after becoming an oneworld member. This shows that most passengers are still flown in the German/Austria/Switzerlandarea(withtheexceptionofholidaydestinationPalmadeMallorca).


Airberlin has grown both internally and through acquisitions. In 2004 Airberlin and NIKI created the first lowfareallianceinEurope,andin2010AirberlinincreaseditsshareinNIKIfrom24%to49.9%.NIKIsbaseairport is Vienna. NIKI remains a legally independent firm with its own management board. Since March 2012 NIKI has become an affiliate member of the oneworld alliance. In 2007 Airberlin acquired a 49% share in Belair Airlines. Belairs base airport is Zurich and the airline operates services to holiday destinations around the Mediterranean,
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 42

Egypt, the Canary Islands and major German cities. Since the end of 2011 Etihad Airways (Abu Dhabi) and Airberlinformastrategicpartnership.Throughthispartnership,EtihadbecameAirberlinslargestshareholderand gainedaccesstonewEuropeanroutes.Etihadincreaseditsformer3%staketojustover29%.Moreover,thedeal also included a codesharing agreement that gives Etihad access to Airberlins European shortdistance network and to Berlin. Besides Etihad, Airberlin also has codeshare agreements with its oneworld partners American Airlines,BA,Finnair,Iberia,JapanAirlines,RoyalJordanian,andS7Airlines.Moreoveritoperatescodeshareflights (outsideitsoneworldpartners)withBangkokAirways,HainanAirlines,PegasusAirlinesandMeridianafly. From table 8 it can be stated that Airberlin has not been able to achieve a positive result for the last two years. The firm has not been able to doso since 2007(BBC News, 2012). Eventhough revenues have increased in 2011, Airberlin has not been able to cope with uncertainties that have significantly put pressure on its costs. Airberlin blames the weather, strikes, rising fuel costs, the Arab spring and a new German airport tax for its poor performance (BBC News, 2012). Moreover, by the end of 2011 Etihad increased its stake in airberlin to 29% by paying EUR72.9 million for new shares and they provided airberlin with a longterm financial loan up to USD255 milliontohelptheairlineexpandtheirfleet(Parker,2011).
Keyfinancialfigures Revenu(millioneuros) includingticketsale EBITDAR(millioneuros) EBIT(millioneuros) Consolidatedloss(millioneuros) Earningspershare(euros) Totalassets(millioneuros) Employees Source:Airberlin,PLC(2011).AnnualReport2011. 2011 4227.3 3857.0 425.9 (247.0) (271.8) (3.2) 2264.0 9113 2010 3850.2 3531.7 619.9 (16.7) (106.3) (1.14) 2370.1 8900

From an operational point of view Airberlin has improved in the past two years (table 9). The CEO of AirberlinintroducedaprogramcalledShape&Sizethathastheobjectivetomaketheairlinemore(cost)efficient. TheresultsofthisprogramareespeciallyreflectedinitsincreasedRPKandloadfactor.
Keyoperatingfigures Aircraft Flights Passengers(thousands;"Pax") Destinations Availableseatkilometres(bn;RPK) Revenuepassengerkilometres(bn;RPK) Passengerloadfactor(percent;Pax/capacity) Source:Airberlin,PLC(2011).AnnualReport2011. 2011 170 270,498 35,300 162 62.16 52.14 78.21 2010 169 274,227 34,890 163 61.04 46.96 76.45

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


Oneworld Oneworld is one of the three global airline alliances (oneworld, Skyteam, Star alliance) and brings together 11 airlines and 20 affiliates. The alliance was established in 1998 by founding members American Airlines, British Airways, Cathay Pacific and Qantas. The alliance has grown since with Finnair and Iberia in 1999, LAN in 2000, JapanAirlinesandRoyalJordanianin2007andS7Airlinesin2010.Together,theoneworldmembersserveabout 800airportsin150countries,withmorethan8,750dailydepartures.Its11activemembersare:
Airline airberlin Oneworldaffiliates NIKI(Austrian) Hub(s)&majorbases Berlin,Dusseldorf,PalmadeMallorca, Vienna Dallas/FortWorth,ChicagoOHare,Los Angeles,Miami,NewYorkJFK&LaGuardia LondonHeathrow,LondonGatwick

American Airlines BritishAirways (IAG) Iberia(IAG)


BAcityflyer,Comair(SouthAfrican), SunAir(Turkish) IberiaRegional,AirNostrum,Iberia Express Dragonair


CathayPacific Airways Finnair JapanAirlines



Helsinki Tokyo(NaritaandHaneda),Osaka(Kansai andItami),Nagoya(ChubuandKomaki), Okinawa(Naha) SantiagodeChile,BuenosAires,Lima, Quito,Guayaquil Sidney


LANArgentina,LANEcuador,LAN Express,LANPeru QantasLink:Airlink,EasternAustralia Airlines,SunstateAirlines,Jetconnect


Royal Jordanian S7Airlines



Besides the benefits for all member of the oneworld alliance, oneworld member airlines have also expanded their working relationship beyond those general benefits. In 2010, American Airlines, British Airways and Iberia launched a Joint Venture across the North Atlantic. This took place relatively late because the UKUS bilateral air service agreement was still based on classic nationality clauses and capacity and route constraints. This was different from the bilateral EUUS Open Skies agreement that allowed the other global alliances to form JVsbasedonATI.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


In2011,AmericanAirlinesandJapanAirlineslaunchedasimilarventurebetweenAsiaandNorthAmerica. In 2012, American Airlines and Qantas followed that line of business across the South Pacific, when at the same time British Airways and Japan Airlines also sought for approval for a Joint Venture between Europe and Japan. BritishAirwaysandQantashavehadaJointVentureinplacefor15yearstheKangarooRoutebetweenEurope and Australia, which had been extended for five more years in 2010. In January 2011, British Airways and Iberia merged under the name of International Airlines Group. Both airlines continue to operate with their own brand names. Figure 13 shows how the oneworld alliance is integrated with these revenue sharing Joint Ventures betweenthemain/foundingmembers.

Table 10 presents the financial positions of all oneworld member airlines (including their affiliates) and thetotaloneworldresults,thetableisbasedontheoneworldfactsheetsandincludes2011financialfigures.From thetableitcanbestatedthatespeciallyAmericanAirlines,oneofitslargestmembers,issufferingfromnetlosses. Since the end of 2011, American Airlines filed for Chapter 11 bankruptcy protection, which has been granted and provides the airline the opportunity to continue normal operations while restructuring its debts, costs and other
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 45

obligations (The Guardian, 2009). On the other hand, the Asian airlines (Cathay and JAL) are the best performers in2011withthelargestnetprofitsoftheoneworldgroup.
Tot.Rev. (millions) OperatingProfit (millions) NetProfit (millions) $1.267,00 $130,00 $739,00

oneworld airberlin AmericanAirlines IAG(BAandIberia) CathayPacific Finnair JapanAirlines LAN Qantas RoyalJordanian S7Airlines

$105.514,00 $4.696,00 $4.976,00 $12,00 $21.762,00 $646,00

$23.979,00 $1.054,00 $1.979,00 $11.477,00 $1.806,00 $1.825,00 $2.990,00 $118,00 $117,00 $16.379,00 $2.266,00 $2.266,00 $5.718,00 $540,00 $15.955,00 $690,00 $966,00 $23,00 $1.312,00 $91,00 $321,00 $591,00 $14,00 $3,00




In September 2010 Southwest announced its plans to acquire its lowfare rival AirTran Airways in a $1.4 billion share purchase. The transaction is a full acquisition and plans are to rebrand AirTran Airways entirely under the Southwestbrand.SouthwestexpectedtoreceiveasingleoperatingcertificatefromtheUSFAAinthefirstquarter of 2012, and, according to its website, they indeed obtained it. However, actual plans for entire integration have not been shared yet. The deal significantly strengthens its presence in eastern and midwest US, the Caribbean and, most importantly, the deal comes with presence at the Atlanta hubairport. The LCC characteristics of both airlines are what make this case interesting. Especially because previous consolidation in the US airline industry has been dominated by legacy airlines. The question is whether Southwest will remain a full LCC or that it might slowly change into a network airline in order to sustain its current growth pattern. In the coming section I will briefly introduce both airlines. I will use data from the two airlines at the time of the acquisition in order to comparethemequally.Actualanalysisofthecasewilltakeplaceintheresultschapterofthisstudy. Southwest Southwest Airlines is a US domestic airline, one of the first lowcost airlines (LCC) in the world. The firm was founded in 1971 with services in Dallas, Houston and San Antonio. Many successors today such as Easyjet and RyanaircopieditssuccessfulLCCbusinessmodel.Theairlineprimarilyprovidespointtopointservicesin72cities around the US. It is headquartered in Dallas (Texas) and employs more than 34,000 people. At the end of 2010 Southwests fleet consisted out of 548 Boeing 737 aircrafts, flying more than 3400 flights a day. Currently, it tops the list of passengers carried by US airlines. Southwest serves many secondary or downtown airports. It also
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 46

offersnearinternationalflightstoMexicoincooperationwiththeMexicanairlineVolaris.Southwesthasapastof growth by full acquisitions. During the 1980s it acquired Morris Air and Muse Air. Moreover, it acquired ATA Airlinesoperatingcertificateandremainingassetsin2008thatgaveSouthwestaccesstoNewYorkLaGuardia. Southwests top 10 city pairs in 2010 pre acquisition are presented in table 11. At the time of the acquisition(yearend2010),ithadaUSdomesticmarketshareof21%anditsmainairportsbypassengerscarried includedLasVegas,ChicagoMidwayandPhoenixasisshowninfigure14
CityPair DALHOU BUROAK SANSMF OAKSAN LAXOAK LAXSFO SANSJC BURLAS SANSFO ONTSMF #Passengers 685.933 670.941 610.927 610.050 572.666 528.767 528.000 479.034 474.904 466.486



Source:SouthwestAirlinesCo.,2010.Onereport. Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 47

Also from a financial perspective Southwest has obtained a strong position in theUS domestic market. In contrasttomanyofitscompetitors,Southwesthasbeenabletoremainprofitableduringtheglobalfinancialcrisis of the past few years with just a small dip in its net income in 2009 (table 11). The main increase in operating expensesin2010camefromtherisingcostofjetfuel.Overall,Southwestisafinanciallystablefirmwithahealthy debt ratio. The table below shows Southwests main financial figures and it also includes postacquisition figures of 2011. This is reflected in significantly increased operating expenses and increased total assets. From an operational standpoint Southwest has also improved (table 12). Though its capacity remained relatively equal in 20092010,itespeciallysawanincreaseRPMandloadfactor,whichindicatesimprovedefficiency.
Financialfigures(inmillions) OperatingRevenues OperatingExpenses OperatingIncome OtherIncomenet Incomebeforetaxes Provisionforincometaxes NetIncome TotalAssets LongTermobligations $16.772,00 $2.050,00 $14.068,00 $3.498,00 $14.269,00 $3.325,00 $5.454,00 $15.463,00 $2.875,00 $6.237,00 $18.068,00 $3.107,00 $6.887,00 2007 $9.861,00 $9.070,00 $791,00 $267,00 $1.058,00 $413,00 $645,00 2008 $11.023,00 $10.574,00 $449,00 $171,00 $278,00 $100,00 $178,00 2009 $10.350,00 $10.088,00 $262,00 $98,00 $164,00 $65,00 $99,00 2010 $12.104,00 $11.116,00 $988,00 $243,00 $745,00 $286,00 $459,00 2011 $15.658,00 $14.965,00 $693,00 $370,00 $323,00 $145,00 $178,00

Stockholder'sequity $6.941,00 $4.953,00 Source:SouthwestAirlinesCo.(2011).AnnualReport2011.

Enplanedpassengers RPM ASM 2009 101.338.228,00 74.456.710,00 98.001.550,00 2010 114.213.010,00 78.046.967,00 98.437.092,00 79,3% Change 12,7% 4,8% 0,4% 3,3%

Loadfactor 76,0% Source:SouthwestAirlinesCo.(2010).AnnualReport2010.

AirTran AirTranisalowfareUSairlinethatisheadquarteredinOrlando(Florida)andhasastrongfocusontheEasterpart of the US with regard to its route network. The airline employed approximately 8,330 people in 2010. A majority of its flights either originate or terminate at it largest hub in Atlanta (Georgia) where it competes directly with legacy airline Delta. Besides Atlanta, AirTran also serves markets from its hubs in Baltimore, Milwaukee and Orlando. At the beginning of 2011 the airline operated 138 aircrafts of two different types: Boeing B717200 and BoeingB737700.AirTranoffersabout700scheduledflightsadaytoapproximately69destinationsintheUSand
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 48

the Caribbean. Table 13 presents AirTrans main airports in 2010 by daily operations and also the importance of the airport in its entire route system. Atlanta, Orlando and Baltimore together represent a significant share or AirTranstotaloperations.
Airport Dailyoperations Marketsserved Shareofsystemdailyflights Atlanta 360 55 49% Orlando 130 42 18% Baltimore/Washington 104 23 14% Milwaukee 87 20 12% FortMyers 49 13 7% Tampa 40 11 6% Boston 39 8 5% Indianapolis 37 8 5% FortLauderdale 34 9 5% NewYorkLaGuardia 34 6 5% Source:AirTranHolding(2010).AnnualReport2010.

Thefirmhaswitnessedadeclineinitsfinancialperformanceinthepastfewyears(table14).Itsoperating income in 2010 decreased by 27,6% compared to 2009 and it experienced some volatility in net income since 2006 with a negative net income in 2008. The decline in operating income in 2010 was largely due to an increase in jet fuel costs. Besides, its operating margins also declined from 7,6% to 4,9%, same for its profit margins. This decline in margins could indicate inefficient cost management and/poor decisionmaking. Moreover, the share of debtintotalassetshasconsistentlybeenaround50%,whichindicatesmuchdependenceandfinancialobligations tothirdparties.FromanoperationalstandpointAirTranhasimproveditspositionsignificantlyoverthepastyears (table15).ItsloadfactorhasimprovedsignificantlyduetoincreasedcapacityandhigherRPMs.
Financialfigures(inthousands) Operatingrevenues Operatingincome Netincome Totalassets 2006 $1.892.083,00 $40.294,00 $14.494,00 $1.616.159,00 2007 $2.309.983,00 $142.646,00 $50.545,00 $2.071.784,00 2008 $2.552.478,00 $75.821,00 $266.334,00 $2.085.262,00 $1.104.056,00 2009 $2.341.442,00 $177.010,00 $134.662,00 $2.284.172,00 $1.214.017,00 2010 $2.619.172,00 $128.191,00 $38.543,00 $2.179.348,00 $996.490,00

Longtermdebt $784.093,00 $1.037.246,00 Source:AirTranHolding(2010).AnnualReport2010.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 49

OperatingFigures Revenuepassengers Revenuepassengersmiles(RPM) Availableseatmiles(ASM) Passengerloadfactor Source:AirTranHolding(2010).AnnualReport2010. 2007 23.780.058,00 17.297.724,00 22.692.355,00 76,2% 2008 24.619.120,00 18.955.843,00 23.809.190,00 79,6% 2009 23.997.810,00 18.588.036,00 23.294.117,00 79,8% 2010

24.721.226,00 19.557.674,00 24.062.434,00 81,3%

It has already been mentioned in the introduction of this thesis that this study is of explorative and explanative nature; in the first place I am trying to deepen a general understanding of consolidation, and second, I am trying to find an explanation for the differences between these different forms of consolidation in the specific case of the commercial airline industry. In order to answer the research question of this study I will use a case study research design. The case study is most often used in explanatory and exploratory research (Saunders et al., 2007:139) to better understand complex social phenomena (Yin, 2003). Case studies are the preferred strategy when the researcher has little control over events and when the focus is on a contemporary phenomenon within areallifecontext(Yin,2003),whichisthecaseofthisparticularstudy. Yin (2003) distinguished four case study strategies, based on two dimensions: (1) single versus multiple cases, and (2) holistic versus embedded case. Single case designs are used where it represents a critical or a unique case (Saunders et al., 2007: 140). Multiple case designs incorporate more than one case, and can be used when there is a need to generalize the findings of the first case to the second case. Therefore Yin (2003) argues that multiple case studies may be preferable over a single case and that the choice for a single case study will need to have a strong justification. The second dimension of Yin (2003) refers to the unit of analysis. If the same case study involves more than one unit of analysis the design is called an embedded case study. If the case study only examines the global nature of an organization it is called a holistic design (Yin, 2003). With regard to this study, I will be using a multiple case design of holistic nature because I want to compare two different situations (cases)witheachothertogainabetterunderstandingofthespecificcontextinwhichconsolidationdecisionsare taken and to explain the drivers behind those decisions. Furthermore, Yin (2003) states that the selected cases in multiplecase studies should either predict similar results (literal replication) or predict contrasting results but for predictable reasons (a theoretical replication). The latter one is applicable to this thesis. An important part is the development of a rich theoretical framework, which states the conditions under which a particular phenomenon is likely to be found (Yin, 2003). This framework later becomes the mechanism for generalizing to new cases. The theoreticalframeworkinthisparticularstudyhasalreadybeenformulatedinthepreviouschapteronthebasisof therelevantliteratureanddeskresearch.
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 50

6.1 Datacollection&analysis

For case studies it is recommended to use multiple sources of evidence because it allows the researcher to address a broader range of issues (Yin, 2003). Moreover, it allows for triangulation, which in turn addresses the possibleproblemofconstructvalidity;multiplesourcesprovidemultiplemeasuresofthesamephenomenon(Yin, 2003).Thesourcesofevidenceusedinthisstudywillmainlybeofsecondarynature,namely:documentationand archival records. The downside of both these data types is that they have been produced for a specific purpose and audience, which should be taken into account when interpreting the usefulness of the data. Unfortunately, the broadness and global nature of this research topic makes it difficult to obtain primary data. Because in that case, primary data would have to be obtained from the organizations in question which are either physically unreachable (geographical distance) or difficult to get access to. For this reason I have chosen to answer the research questions as best as possible with secondary data. The exception is the (primary) data that I obtained directly from the OAG database. The advantage is that this combination of sources of evidence is of both qualitativeandquantitativenature.Bycombiningtheinformationofthedifferentsources(triangulation),Iwilltry to be as objective as possible because allof the sources provide a different perspective on the cases and because each source has a different relation to the firms involved. This will in turn improve the internal validity of the study. I will make use of secondary qualitative data such as: research reports, industry reports, newspaper articles, industry journals, existing interviews, annual reports, company statistics etc. From these sources I will select the information that applies to the variables in the model. First I will make a list of literal quotations from thesesourcesafterwhichIwillsummarizeandinterpretthemtogiveaclearpictureofthesituation.Theprimary quantitativedatathatIusedealswiththeroutenetworksoftheairlinesinquestion,andaresubtractedfromthe OAG database and MIDT database. The OAG database includes all routes and citypairs of registered airlines. It gives the opportunity to identify and analyze changes in route networks. Thus, the OAG can help to identify overlapping and complementary networks. To detect changes in route networks I compared the city pairs and benchmarked them withthe current summer schedules (2012) thatcan be found on the airlines websites. I used the Atlanta transfer data to see whether there is overlap between markets directly served by Southwest and those with a transfer at Atlanta by AirTran. This latter data contains passenger movements and is derived from the MIDT database. OAG only contains flight schedules and citypairs but does not include the number of passengers. Therefore, the two data sources are combined in this research. The data that I obtained from MIDT andOAGincludedthefollowing: 2010citypairsandcarriedpassengerforAirberlin,SouthwestandAirTran 2010transfersatAtlantaofAirTran 2010transfersatDusseldorfofAirberlin

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 51

The conceptual model and corresponding hypotheses that were presented in chapter 5 are tested with two business cases that were also already introduced in chapter 5. For each case I will systematically use secondary and primary (OAG and MIDT) data sources to see whether these factors indeed do apply to the case, and hence to test the hypotheses. Thus, I will sort the relevant information along the identified drivers and their correspondingfactors.

In the following two sections I will present the results that were found after analyzing all the (secondary) sources forthecases.ThefirstcaseisthatofAirberlinjoiningthegloballybrandedallianceoneworld,andthesecondcase is that of Southwest fully acquiring AirTran. The data is sorted along the three main levels of analysis (environmentallevel,firmlevelandrelationallevel)andthecorrespondingfactorswithinthoselevels.



Environmentallevel:legalconstraintsandstrategicuncertainty Legal constraints: Airberlin is a German airline and oneworld is a global alliance. Airberlin has to confirm to both German (national) and European legislation. This is especially important with regard to antitrust legislation and hence horizontal integration strategies. Dual confirmation complicates hard integration strategies such as M&A. Moreover,amorelogicalstepforAirberlinwouldbetoconsidera mergerstrategywithEtihad,butthiswouldbe impossible due to foreign ownership restrictions on traffic rights (bilateral agreements). Thus, due to these high legal constraints the only avenue for Airberlin to grow andto keepup withthe consolidation trend in Europe and therestoftheworld,istoeitherjoinaglobalalliancesuchasoneworldorgrowslowlythroughsmallerM&Athat donothavetopassEuropeanantitrustlegislation. Strategic uncertainty: Airberlin has to cope with competition on two different levels: on national level with LufthansaandonregionalEuropeanlevelwithotherlowfareairlinessuchasEasyJetandRyanAir.Lufthansaisa network airline (hubandspoke) that operates on a national, European and global level. In the past years it has mainly focused on growing in Asian and American markets (Lufthansa, n.d.). Although less growth comes from Europeanmarkets,still44.9%oftotaltrafficrevenuesin2010camefromEurope,whichindicatestheimportance of the European market for Lufthansa (Lufthansa, n.d.). Although Lufthansa is less well positioned in Berlin, it is verystronglyrepresentedinGermanysmaindestinationFrankfurtandMunichasitssecondaryinternationalhub. BecauseofAirberlinshybridbusinessmodelitisnotstronglypositionedasalowfareairlineandthatcomplicates competition with other European lowfare airlines that compete heavily on price. On a macro level, Airberlin has been faced with loss of revenue due to the political unrest in Egypt and Tunisia in 2011. Today, flights to these destinations are still being booked reluctantly. Before, Airberlin used to be European market leader in these markets(Airberlin,PLC,2011).Tomakeupfortheselossesithastoincreasecapacitytoexistingmarketsorenter new markets. Other macro economic factors that have brought along uncertainty are the recently introduced
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 52

German airtravel tax and the increasedcost of kerosene (Airberlin,PLC, 2011). The introducedaviation tax levies departures from German airports. This does not apply to cargo or transfer traffic and thus affects Airberlin more severely than its competitors (mainly Lufthansa). Besides political unrest in North Africa, new taxes and more expensive kerosene, Airberlin also serves markets in Europe that are currently experiencing a severe economic crisis. Especially the economic downturn in Spain (one of the most important markets for Airberlin) brings along uncertainties (Airberlin, PLC, 2012). According to IATA, 2012 remains a challenge for the global aviation industry. The outlook for global profits decreased by $0.5 billion to $3 billion. IATA also stresses the correlation between globalGDPandairlineprofitability(Airberlin,PLC,2012).OverallitcanbestatedthatAiberlinoperatesinahighly uncertainstrategicenvironment. To conclude the environmental factors involved in Airberlins decision to join the oneworld alliance it can be stated that legal constraints and strategic uncertainty played an important role. Firstly, Airberlin has to cope with strong competition on different levels. Second, the European and North African markets that it operates are either economically uncertain or politically uncertain. Some of Airberlins most important leisure markets such as SpainandGreecehavebeenheavilyaffectedbyaneconomicrecession.Third,othermacroeconomicfactorssuch asincreasedoilpricesandnewaviationtaxesbringalongevenmoreuncertainty.Finally,onalegallevelAirberlin hastodealwithnationalandEuropeanlegislation,whichcomplicatesgrowthstrategies.Moreover,tosurvivethe severe European competition and keep up with the global and European consolidation trend Airberlin probably has no other choice than to join one of the global alliances. This in turn might provide future possibilities for further integration. Thus, hypothesis 2A is confirmed; an airline choosing for a strategic alliance is driven by strict legalconstraintsandahighdegreeofstrategicuncertainty. Firm specific level: marketing outcome, competitive position, financial endowment, social embeddedness, and externalgrowthexperience Marketing outcome: Airberlins network will be extended through codeshare agreements with the other oneworldmemberairlines.ThenetworksofAirberlinanditsaffiliateNIKIwillbecoveredbyoneworldsmarketing alliance fares and sales product that includes participation in Business Flyer (the alliance offering for small & mediumenterprises).AirberlinalreadyoffersasimilarproductinGermanySwitzerlandandAustria(Airberlin,PLC, 2011). Moreover, members of Airberlins bonus program will also enjoy the benefits of oneworld frequent flyers when travelling with any other member airline. According to Airberlins CEO (Mr. Mehdorn) the oneworld global alliance was chosen as a strategy to please its customers by offering global lounges, more destinations and attractive frequent flyer programs (CAPA Centre for Aviation, 2012 20/03). Airberlin has strong brand recognition in the German region (Germany, Austria and Switzerland) that will be improved by joining a globally branded alliance. Thus, from a marketing perspective AIrberlin meets customer demands by offering more destinations through its member airlines, a more attractive frequent flyer loyalty program, and it will increase brand recognitionbyjoiningagloballybrandedalliance.
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 53

Competitiveposition:AccordingtoAirberlinsCEOjoiningoneworld willstrengthenAirberlinscompetitivenessby enabling it to offer passengers a global network served by partners that include some of the biggest in the world (Airberlin, PLC, 2011). Moreover, Airberlin strengthens oneworlds network by introducing Germany as a new home market to the alliance. Besides Germany, Airberlin will also give access to middle and Eastern European markets. More specifically, Airberlins (future) presence at Berlins new international airport (BBI) is an important asset for oneworld. As it is an international airport the other oneworld member can start flying there and it will become oneworlds gate to middle and Eastern Europe. Moreover, BBI can take away pressures from oneworld European transfer hubs such as London Heathrow, Madrid and Barcelona. London Heathrow is saturated and growth opportunities are limited, and opportunities for oneworld in Frankfurt are very small because that is Lufthansas home base. Thus, further oneworld presence in Berlin may be driven as much by opportunity as by necessity(CAPACentreforAviation,201220/03).BBIwassupposedtoopeninJune2012butthiswaspostponed. However, Airberlin already scheduled 68 city pairs with a total of 676 flights per week for September 2012 (OAG, 2012).Theserouteshadtobecancelledandwere,ifpossible,rescheduledfromBerlinTegel.AslongasBBIisnot inuseyet,oneworldcannotfullyenjoythebenefitsofhavingAirberlininitsnetwork. Airberlinsdecisiontojoinoneworldwillbecloselywatchedbyotherlowfareairlinesthathavealsobeen playing with the idea of codesharing or other network airline inventions that usually do not apply to ptp networks. Airberlins move to become a full member of a global alliance goes one step further than recent codeshare agreements between for example JetBlue (LCC) and Lufthansa (Flottau, 2011). Airberlins CEO explain the move in the following way: Our strategy was orientated along the question what we had to do to position ourselves as industry consolidation progresses. The decision to join oneworld was only the last mosaic stone; the firstandmostimportantonewasaroutenetworkthatwouldbeattractivetobusinesstravellers.AIrberlinhadto focus on metropolitan routes and a network that was linking as many business markets as possible (Flottau, 2011). Moreover, British Airways (oneworld member) has recently gone public with its intentions to grow IAG by addingmoreairlines,whichcouldposeafuturepossibilityforAirberlin. This oneworld membership has two sides: it strengthens Airberlins competitive position and that of

oneworld. Airberlin will not immediately capture market share, but oneworld in turn will gain market share by addingAirberlin.ButoneworldscompetitorsSkyteamandStarAllianceareexpandingaswellbyaddingmembers in key growth markets. Star Alliance has been the largest alliance in seat share and is gaining members in growth marketssuchasAfrica,ChinaandSouthEastAsia.SkyteamhasespeciallybeenexpandinginChina.Oneworldhas no mainland Chinese member but will also add Malaysia Airline. Moreover, Star Alliance will loose three memberstooneworld;bmi,TAPandTAM.Soallthreeallianceswillgrowinseatshare,andalthoughStarAlliance willremainthelargest,thegapbetweenSkyteamandoneworldwillnarrow(CAPAAviationAnalysis,201208/06). By adding Airberlin, oneworld will become the second largest global alliance present in Germany, after Star Alliance.AirberlintriplesoneworldsmarketsbeingservedinGermanyto25anddoubleitspresenceAustriatosix airports. Airberlins joining of oneworld will bring the largest change in Europe, where it is the 8th largest airline
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 54

(CAPA Aviation Analysis, 2012 08/06). For intraEuropean traffic airberlin is the 7th largest, ahead of British Airways. Oneworld capacity share will increase in Europe from 9.8% to 13.2%, right after Skyteam with 15.5% share (CAPA Aviation Analysis, 2012 08/06). To conclude this section, competitive advantages are mainly present for oneworld. It will also improve Airberlins competitive position but not as directly visible as for oneworld. For Airberlin, joining oneworld might be more a necessity in order to survive LCC competition and European consolidation. Another competitive advantage for Airberlin can be that its oneworld membership might speed up the process of becoming a full hubandspoke airline with hubs in Berlin and Dusseldorf. The complementary intercontinentalnetworksoftheothermembersprovidethisopportunity. Financial position: Airberlin has been successful in its strategic moves in the past few years by building markets share, changing its business model and moving into corporate markets, but this has not paid of financially yet (Flottau, 2011). In the past three years Airberlin has not been profitable and debt has been piling up. Over the first nine months in 2011 for example, the airline piled up more than $170 million in losses while increasing its debt obligations. In 2011 the loss before tax was EUR358.8 million after EUR150.7 in 2010. The net result for 2011wasEUR271.8afterareportedloss ofEUR92.7millionin2010(AirberlinAnnualReport,2011).Thesethree years (20092011) of losses have contributed to a total debt of approximately EUR813 million by the end of 2011 (AirberlinAnnualReport,2011).Theproportionofshareholdersequitycomparedtototalassetswas11.2%atthe end of 2011 compared to 21.3% in 2010, which indicates its major dependence on debt and financial instability. Etihad provided Airberlin with more financial freedom because it increased its stake to 29.21%. Moreover, Airberlin is listed on the Frankfurt stock exchange, and its performance in 2011 was disappointing with a decline of 32.6% compared with the closing price of the prior year (Airberlin Annual Report, 2011). Overall, Airberlin is in averyweakfinancialposition. Social embeddedness: Airberlins main strategic partner is Etihad Airways (Abu Dhabi), who is not a member of anyglobalalliance.EtihadincreaseditsshareinAirberlinalmostatthesametimeitbecameanoneworldmember. Etihad now has 29.21% stake and two seats on the board of directors. The two airlines have codeshare agreements on certain routes, Airberlin moved its service from Dubai to Abu Dhabi, shared frequent flyer programs, Airberlin will use Etihads pilot training program for its forthcoming Boeing 787 fleet and the two will combine their 787 orders to leverage synergies but also have standardization (CAPA Aviation Analysis, 2012 20/03). Thus, Airberlins relationship with Etihad goes much further than with the oneworld members. As mentioned before, due to restrictions on foreign ownership Etihad probably cannot further increase its stake in Airberlin. For Etihad, Airberlin is not its first oneworld partnership. Before, it established a codeshare agreement withAmericanAirlines,as wellasfrequentflyerandcodeshareagreementswithMalaysiaAirlines(CAPAAviation Analysis, 2012 20/03). For years Lufthansa has been trying to prevent Gulf airlines like Etihad to gain traffic rights inGermancities.ItaccusesGulfairlinesofmassivelybeingsupportedbystatefinancials.Thatargumentmaynow
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 55

be weaker. The oneworld members might also not be too excited about Etihads stake in Airberlin. Almost all of themviewsuchairlinesasbitterrivalsandaredoingtheirbesttokeepthemaway(Deckstein,2011). External growth experience: As mentioned in the introduction of this case Airberlin has grown both organically and through external growth strategies. The figure below shows Airberlins growth path since 2006. The takeover of DBA (2006) gave Airberlin access to a dense German domestic network for the first time, as well as the acquisition of LTU in 2007 (Flottau, 2011). TUIfly was integrated in Airberlins network in 2009, but not the entire firm. Only those parts that were most convenient to Airberlin were integrated and TUIfly acquired a minority stakeof7.9%inAirberlin(Flottau,2011).Overall,Airberlinhasexperiencewithfullacquisitions(DBA,LTU,Belair), mergers (NIKI), strategic partnerships (Etihad) and codeshare agreements. For an airline that is originally a LCC, it hasrelativelymuchexperiencewithexternalgrowthstrategies,bothintegrativeandcooperativestrategies.

From a firm level perspective it can be concluded that hypothesis 2B can be partly confirmed. The marketing outcome indeed plays a role for Airberlin; an extended route network, joint loyalty programs and global branding can help Airberlin to attract more customers and increase revenues. Ensuring its competitive positionseemstobeofgreatimportance,bothforAirberlinandoneworld.Airberlinhastocopewithcompetition on a national and regional level and cannot compete purely on price (as it is not a full LCC). Oneworld competes with the other two global alliances for the largest global coverage and for potential members that operate in growth markets. For both Airberlin and oneworld it seems that they have to keep up with competition and make these kinds of strategic moves out of necessity rather than to become the number one player in the market.
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 56

Furthermore,fromafinancialpositionAirberlinisweaklyendowedwhichexplainswhyitcannotgroworganically (by itself) or by integrative external strategies. Joining oneworld seems to provide Airberlin with the opportunity to leave behind its LCC characteristics and slowly turn into a full hubandspoke airline with hubs in Berlin and Dusseldorf. The final two factors of the hypothesis are not confirmed: large current social network and little external growth experience. Airberlin does not have many other partnering airlines, except for Etihad with whom it is strongly integrated. Moreover, Airberlin has relatively much external growth experience differing from acquisitionstocooperativestrategies.Thus,thefirstthreepartsofhypothesis2Bareconfirmedbutfinaltwonot. Relational level: economic synergies, required investments, level of integration, degree of behavioral uncertainty, levelofinterdependency Economic synergies; Economic synergies in this case can mainly be achieved through economies of scope. Scale economies can be achieved because Airberlin can benefit from shared reservation systems, loyalty programs and marketing campaigns. But most benefits would have to come from wider route coverage. The majority of routes of the oneworld members and Airberlin are complementary and do not overlap. However, some of the oneworld membersdonotconnecttoAirberlinatallandthusdonotprovideany(immediate)scopeeconomies.Asalready mentioned earlier, Airberlins membership will more than triple oneworlds served cities in Germany to 25, and double its coverage trough NIKI in Austria (Airberlin, 2012). 70 of Airberlins 162 destinations are new to the oneworld network, but most of those are primarily leisure destinations and not the corporate destinations that boostairlineyields.Tobenefitfromoneworldscoverage,Airberlinalreadyconcludedcodeshareagreementswith American Airlines, Finnair and S7 in 2011. Contracts with Iberia and British Airways will follow shortly (Airberlin, 2011). Stronger yields will come from the codeshare agreement with American Airlines that gives it wider access in its largest long haul market; the US (CAPA Aviation Analysis, 2012 20/03). From the OAG Airberlin data (2010 two way city pairs with more than 100 passengers carried) it can be concluded that Airberlin has significantly adjusted its route network compared to its current schedule (July 2012) that it presents on its website. Of its city pairs in 2010, approximately 41% has been eliminated from its summer schedule in 2012. From my analysis I was only able to identify the removed city pairs. Thus, the only development I can conclude is a severe network change in general. However, whether this is due to regular network changes (because Airberlin is a lowfare airline)orwhetherthisisduetoitsnewmembershiptooneworldisunclear.Besidescuttingroutes,Airberlinhas also added over 40 new routes in the period of August 2010 August 2011 of which at least 10 are from both BerlinTegelandDusseldorf(AnnaAero,2011). Airberlins new hub (BBI) can only be utilized if the other oneworld members serve it, and so far there has been some hesitation from that side because they prefer to serve Frankfurt instead of Berlin (CAPA Aviation Analysis, 2012 20/03). Frankfurt is one of the points in the world that is served by all oneworld members, and in most cases this is also their only German destination. Airberlin has a limited presence in Frankfurt; it does not rank in its top 10 served airports. Those that do serve Berlin are: British Airways, Finnair, Iberia and Royal
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 57

Jordanian. JAL is currently expanding its longhaul network by adding for example Helsinki. Berlin could also become part of JALs strategy but depends very much on Europes financial developments. The other airlines (Cathay, LAN and Malaysian) are less likely to fly to Berlin in the near future. S7 from Russia is nearby but suffers from financial distress and probably will not expand to Berlin in the near future either ( 20/03 Aviation Analysis, 2012). Thus, American Airlines is Airberlins most promising partner but they are currently under bankruptcy protection, which in turn could complicate their potentially fruitful relationship. Because the opening of BBI has been postponed and perhaps because Berlin is not the most preferred destination of the oneworld members, Airberlin has made a big push at Dusseldorf International Airport through growth in its transAtlantic network. The expansion of services to North America intensifies competition with Lufthansa that also operates from Dusseldorf but has little possibilities to develop it longhaul network there (CAPA Aviation Analysis, 2012 08/06). From MIDT it appeared that in 2010, Airberlin transferred 726,815 passengers at Dusseldorf, which was only 3% of its total passengers. According to the list below (changes in route network 20112012) based on OAG analyses from Anna Aero (an airline network news and analysis website), it can be observed that Airberlin is focussing its newroutes(nonseasonal)onbothBerlinTegel(futureBBI)andDusseldorf.
from Dsseldorf Dsseldorf Dsseldorf Berlin Berlin Berlin Berlin Berlin Berlin to AbuDhabi LasVegas Miami Phuket LosAngeles NewYork Gdansk Kaliningrad Budapest seasonal seasonal seasonal ? seasonal frequencyperweek 7 2 6 7 3 4 12 3 7

Friedrichshafen Ibiza Bazel Neurenberg Stuttgart Munster Malta Malta Moscow Catania

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


Munich Windhoek seasonal

Overall,economicsynergies(economies ofscaleandscope)forbothpartiesarenotimmediatelypresent andwhentrafficindeedconnectsitiscomplementaryandnotoverlapping.Muchdependsonthedevelopmentof BBI and oneworld members adjusting their German traffic to Berlin instead of Frankfurt. Moreover, those parties that could provide Airberlin with synergies (American Airlines and S7) are both currently in a financially weak position. It seems that oneworld chose Airberlin to secure itself of a position in the middle and Eastern European marketratherthanthebenefitsofeconomicsynergiesandconnectingtraffic.Airberlinitselfhaschangeditsroute network since 2010 but whether this is due to its oneworld membership remains unclear. However, the strategic move to Dusseldorf probably is due to its codeshare agreement with American Airlines. The potential intercontinental complementary network connectivity provides Airberlin with the opportunity to become a hub andspokeairlineinthefuture. Required investments: The CEO of Airberlin said the following about the costs for Airberlin to join oneworld: The costs will run in the lower twodigit millions, the long term, under normal circumstances, we are expecting clear annual additional returns to exceed this onetime cost (Airberlin, 2011). The main costs are that of establishing compatibility with the booking systems of the other member airlines. After joining oneworld, it will become difficult for Airberlin to maintain its low level of unit costs because of corresponding complexities (Flottau, 2011). Whenenteringanalliance,expertsarguethattheinitialphaseonlymeansadditionalexpenses(Deckstein,2011). Level of integration: Economies of traffic density can only be achieved through the use of larger aircrafts or more efficient connecting traffic in a hubandspoke system and neither one of them is the case for Airberlin. Airberlin will only enjoy the most basic alliance benefits; marketing benefits and codeshare agreements. With these types of more distant cooperation the scope for integrating service and maximizing economies of density is limited. In the absence of a JV, alliance partners will operate separate service on hubtohub routes. This will divide traffic between two operations, whereas under a JV the airlines operate as a single entity. As mentioned in the case introduction,oneworld indeed has these types of JVs and there might be futurepotential for Airberlin to become partofthem. Degree of behavioral uncertainty: The similarity between Airberlin and the other oneworld members is small becausemostofthemarelegacyairlinesthatoperateahubandspokenetwork.OnlytheRussianS7alsoisalow fare airline, but is much smaller in size than Airberlin. Thus, Airberlin mainly differs because of its hybrid business model and pointtopoint network. This increases behavioral uncertainty but also provides the opportunity to changetoanewerandclearerbusinessmodel.Behavioraluncertaintyalsorisesbecauseoftheloosecooperative arrangement that Airberlin has with the other members; the level of control from both sides (Airberlin and oneworld) is low. Moreover, Airberlins strategic partnership with Etihad poses extra uncertainty because other
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 59

members such as British Airways and Iberia do not favor this partnership. Moreover, as mentioned before, the possibility exists that this membership is just a first step in the process of being acquired or merged with another member airline. Overall the members of oneworld differ in many ways; geographical coverage, business model, financial stability and global and regional market share. Thus, the degree of behavioral uncertainty is relatively high. Level of interdependency: Airberlins oneworld membership has one important objective and is therefore of strategic importance; restoring sustainable profitability. This indicates Airberlins dependence ononeworld. Table 8 in the case introduction shows the financial results of the oneworld alliance and of each of its members (including Airberlin). In terms of revenues Airberlin belongs to the category of small members. The table also shows that four out of ten members booked a negative operating profit at the end of 2011 (including Airberlin). Thus, in financial terms Airberlin actually brings down the oneworld average. However, when looking at the positionofAirberlinfromanoperationalperspectiveintermsofpassengerscarriedanddailydeparturesitispart of the top four. Table 16 shows the operational figures of the oneworld alliance. Although Airberlin is relatively strong in terms of numbers of flights and passengers it lacks behind in terms of efficiency and capacity compared to the other members. Thus, Airberlin is dependent on oneworld in terms of future sustainable profitability, but oneworld needed a member like Airberlin in order to compete with the other two alliances. Because most of the larger (network) airlines are already allied, potential members have become scarce and the three global alliances arenowfightingforthebestpotentialmembers.Inthatsense,oneworldisalsodependentonAirberlin.
oneworld airberlin AmericanAirlines IAG(BAandIberia) CathayPacific Finnair JapanAirlines LAN Qantas RoyalJordanian S7Airlines dailydept's pax(millions) 8627 719 3400 1800 326 286 700 408 725 116 192 324,4 33,6 105,2 51,7 26,8 8 39,7 22,6 27,9 3 5,9 RPK(scheduled,millions) ASK(scheduled,millions) PLF(%) 734819,00 45244,00 201950,00 168617,00 96558,00 21498,00 62785,00 38423,00 78947,00 7805,00 12992,00 928952,00 58780,00 246617,00 213193,00 115748,00 29345,00 91635,00 48154,00 97523,00 10986,00 16971,00 79,1% 77,0% 81,9% 79,1% 83,4% 73,3% 68,5% 79,8% 81,0% 71,0% 76,6%


The following can be concluded with regard the final level of drivers (relational factors). In the case of Airberlin and oneworld there are no direct economic synergies visible. Except for some codeshare agreements that Airberlin has already agreed on with several other oneworld members. However, there is absolutely a potentialwiththenewBerlinairport.TheonlyconditionforreapingeconomicsynergiesfromBBIisthattheother
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members also start flying to Berlin. From the OAG data it appeared that Airberlin made lots of changes in its current schedule (summer 2012) compared to 2010 but whether this is due to its oneworld membership or because of regular seasonal route changes is not clear. Except for its increased capacity at Dusseldorf for transatlanticflightstoNorthAmerica.SoanimportantfactoristhatAirberlinsflightsneedtoconnectwiththose of the other members, otherwise no synergies can be gained. Overall, Airberlins routes are complementary to thoseoftheexistingoneworldroutenetworkanditalsoaddsnewdestinations,especiallyinGermanyandcentral Europe. The required investments are relatively low in comparison to other strategies. However, investments havetobemadewithregardtoIT,andalthoughtheexactcostsarenotmentioned,itwilltakeafewyearsbefore this will pay off. Moreover, this will depend very much on the macro economic development of Europe. So the investmentmightberelativelylowbutthereismuchuncertaintysurroundingit.Thelevelofintegrationisindeed low, and therefore no economies of traffic density can be reaped. But this low level of integration does give Airberlin the freedom to develop itself further with little obligations to others. However, there is potential for Airberlin to become further integrated with other members. But again; only if the BBI airport becomes a successful hub in Germany. The level of dependence on the side of Airberlin is high; its recovery to sustainable profitability depends highly on the potential synergies with oneworld. From the oneworld perspective the dependence is more on a strategic level (rivalry for members with the other alliances); access to Germany and middle and Eastern Europe through BBI. Thus, interdependence is indeed high; both parties need each other to improve performance. Overall hypothesis 2C cannot be confirmed fully in the case if Airberlin and oneworld. Firstly,thefutureobjectiveindeedistocaptureeconomiesofscaleandscopethroughcomplementaryroutesbut that is not immediately possible. Secondly, required investments are relatively low but are surrounded by uncertainty. The third factor can be fully confirmed; level of integration in the oneworld alliance is low which providesAirberlinwithsomefreedom.However,ontheotherhandAirberlinishighlyintegratedwithitsstrategic partner Etihad that provided them with shortterm strategic flexibility but might constrain them in the future when they might have to choose between partnership with oneworld and Etihad. Finally, the level of interdependenceishighandthuscanalsobefullyconfirmed.



Environmentallevel:legalconstraintsandstrategicuncertainty Legal constraints: The SouthwestAirTran acquisition is a transaction that took place within the US borders. Thus, the parties did not have todeal with differences in legislation and regulation between countries. Moreover, none of the parties were under bankruptcy protection. The US Department of Justice (DOJ) and the Department of Transportation (DOT) were the institutions involved in this acquisition, especially with regard to anti trust legislation. According to American Antitrust Institute (AAI) the transaction met with little antitrust enforcement resistance based on the DOJ public statements in recent airline mergers such as United/Continental and Delta/Northwest.
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


Strategicuncertainty:TheUSairlineindustryhasbeenveryvolatileinthelastdecade.AccordingtotheSouthwest 2011 annual report, total financial losses in the industry during the past decade exceeded $50 billion. This has been driven by events such as 9/11, the economic recession, and the global credit crisis. The US economy itself has been recovering slightly since the recession in 2009. Moreover, fuel costs have risen over 300% since 2000. ThisuncertainmacroenvironmenthasresultedinseveralUSairlinesceasingoperationsorreorganizationthrough bankruptcy. These reorganizing airlines could emerge from bankruptcy as more vigorous competition as they will havetoadjusttheircoststructures(Datamonitor,2011).AlthoughthegrowthoftheUSairlineindustryfluctuated in2009and2010,itisexpectedtogrowconsistentlyfrom2011.AccordingtotheFederalAviationAdministration (FAA) the number of passengers on US domestic flights will increase by 3.5% in 2011 and will continue to grow with more than 1 billion passengers on US airlines expected by 2021 (Datamonitor, 2011). Moreover, international traffic will grow more quickly than domestic US travel; 7.8% more international passenger traffic on USairlinesby2031isexpected(Datamonitor,2011). IntheyearsbeforetheSouthwest/Airtrantransactionanumberofairlinemergershadalreadyappeared: Delta/Northwest in 2008 and United/Continental in 2010. Moreover, US Airways and American Airlines are currentlyconsideringapossiblemerger.Thus,itcouldbesaidthatSouthwestisfollowingthisconsolidationtrend in the US airline industry. Or as it was stated by a marketing professor at Columbia Business School in a NY Times article: Merge or acquire to stay alive and competitive (Mouawad, 2010). In general, competition in the US airline industry is intense and unpredictable due to multiple players in the same markets and low entry barriers (Southwest Airlines Co., 2011). Airlines in general compete on: pricing and cost structure, routes and schedules, loyalty programs and customer service. Moreover, other forms of transportation also compete with airlines such as Southwest and Airtran (Southwest Airlines Co., 2011). From a rivalry perspective, Airtran stated in its 2010 annual report that competitors with greater liquidity or a broader network may set fares lower or increase flight frequencies, this in turn would prevent Airtran to remain profitable. Thus, from the Airtran standpoint there was probablynootherchoicethanteamingupwiththeirbiggestcompetitortostayalive. The low level of legal constraints coincides with hypothesis 3A where it was proposed that an airline choosing for the M&A strategy is driven by little legal constraints. However, it cannot be concluded that there is no strategic uncertainty. The airline industry by itself is characterized by uncertainty due to its dependence on macro economic events. Moreover, even though the US economy and theairline industry are recovering, there is still great competitive pressure and a consolidation trend. However, for a dominant and stable player on the US market such as Southwest there is relatively less uncertainty when compared with its target Airtran or any other LCC. Hence, the biggest competitive threat comes from other consolidated airlines. So, hypothesis 3 can only be partlyconfirmed. Firm specific level: marketing outcome, competitive position, financial endowment, social embeddedness, and externalgrowthexperience
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 62

Marketingoutcome:ThroughthisacquisitioncustomersfrombothsidescanbenefitofgreaterUSdomesticreach. Together the airlines will serve 100 million passengers with the potential of hundreds of new itineraries for customers of both airlines, and the combination of the two will have a stronger frequent flyer program (CAPA AviationAnalysis,201028/9).Whetheritwillresultinlowerpricesisunsure.AccordingtoFarecomparepriceswill go up in markets where both airlines competed head to head, and new Southwest markets will experience lower prices (temporarily until competitors leave the market) (Hunter, CNN, 2010). Whether Southwest will keep or modify current customer policies (such as reservations through its own website, free checked bags, free seating, singleclassof service)isnotsure(CAPAAviationAnalysis,201028/9).Airtranhasbuildupstrongbrandloyaltyin Atlanta and their passengers will probably experience most changes because they are used to seat selection and business class service. Thus, customer demands do not seem to be the most important driver of this transaction. Ratheritseemstobemoreofasideissue.Obviously,thisacquisitioncomeswithgreaterreachforcustomersand moreattractiveFFP,andhencewillmeetcustomerdemandsinthatsense.Whetherthesedemandsaremetwith regardtopricesandonboardserviceisquestionable. Competitive position: At the time of acquisition Southwest was the 5th largest US airline based on miles flown by paying passengers, and Airtran was number 8. And right after the United/Continental merger Southwest ranked 4thonthelist.Southwestincreaseditscapacityby2025%withtheAirtranacquisitionwithoutincreasingindustry capacity, and the combined SouthwestAirtran capacity share of the US domestic market will be 22.2%, just 0.2ppts more than its competitor Delta (Aviation Analysis, 28 September 2010). This increase in capacity will in turn positively affect its market share (Schlangenstein, 2010). Moreover, it contributes to the US consolidation trend and decreases the number of LCC competitors for Southwest (Hunter, 2010). Besides decreasing competition and increasing its own market share, the transaction also puts pressure on those airlines that have not tied up yet (Mouawad, 2010). The biggest competitive change will be with regard to its competitor Delta at SouthwestsnewlyacquiredAtlantahub.Figure16showsthemarketshareofallairlinesactiveatAtlantaandthe dominantpositionofDelta. Besides the hub in Atlanta, Southwest will also attack Delta at New York La Guardia where it will be offeringmoreservices,alongwithnewserviceandaterminalatNewYorkJFK(CAPAAviationAnalysis,201128/4). Southwestimmediatelyacquired27%oftheLGAATLmarket,26%oftheATLBOSmarketand22%oftheATLPHL market. This will directly strengthen Southwests competitive strength in these markets. Note that Southwest is replacing Airtran instead of entering new markets (Boyd Group International, 2010). Delta however, is a strong player with a stable dominant position at Atlanta and growth opportunities for Southwest at Atlanta are very limited. The analysis from the Boyd Group explains this situation in the following way. In the period 20092010 Airtrans market share at ATL (number of carried passengers) was 21.8%, right behind Delta who was clearly the dominant player with more than 60% market share. Table 17 shows the most important O&D markets for both DeltaandAirtran(20092010)anditcanbeconcludedthattheyarecompetingforthesameO&Dmarkets.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase



Source:CAPACentreforAviation(2011,28/04). Table17:Top10ATLO&Dmarkets(source:BoydGroupInternationalResearchReport)

Top10ATLO&Dmarkets Delta #Pax LGA LAX DCA BOS MCO FLL LAS DFW PHL SFO Airtran #Pax 78275 50150

190484 LGA 124740 FLL 121353 BWI 101108 MCO 95852 DCA 89632 MDW 84343 PHL 82172 BOS 78576 TPA 73020 LAS

49446 40770 38221 35990 33500 31145 30930 30716


However, the O&D markets at ATL are saturated and there is barely space for Southwest to grow in that aspect. Thus, for Southwest to be successful (and keep up with or defeat Delta) it must attain high levels of flow traffic(transferpassengers).In20092010Airtranreliedon67.3%shareofflowtraffic,Deltasshareofflowtraffic
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was 78.1%. In order to maintain or increase this share of flow traffic it will have to compete heavily with Delta who has transformed ATL into a hubbing machine and who even competes on price at most Airtran markets. Moreover, Delta has been aggressively competing on Airtrans secondary markets. Those secondary markets that are not served by Delta are the key to success for flow traffic for Southwest. Secondary markets that serve each other through ATL (such as SRQATLIND) with high yields are the true assets of Airtran that have been gained by Southwest. More importantly, Atlanta will be the first major hub that Southwest will be operating and this will pose great challenges. Though Southwest has some experience with the hubandspoke system at smaller hubs suchasBaltimore/Washington,AtlantaandDeltascompetitionwillnotbeeasyforSouthwest. Financialposition:ThetablebelowpresentsSouthwestsmainfinancialfiguresfrom20072011andisbasedonits AnnualReportof2011.ItshowsthatSouthwesthasbeenprofitableeveryyearsince2007withasmalldipduring the2009recession.Itsrevenueshavebeenincreasingcontinuouslyanditslongtermobligationsandstockholder equityhavealsobeenstableoverthepastyears.Jetfuelhasbeenseverelyaffectingitsincome;in2011and2010 this represented approximately 38% and 33% respectively (largest expense in 2011). These financial data also already show the results of the Airtran acquisition. For example, a 29.4% revenue increase in 2011 compared to 2010 is attributable to the inclusion of Airtran results. The same counts for the 34.6% increase in operating expensesfollowingtheacquisitionsandincreasedcapacity.
Financialfigures(inmillions) OperatingRevenues OperatingExpenses OperatingIncome OtherIncomenet Incomebeforetaxes Provisionforincometaxes NetIncome TotalAssets LongTermobligations Stockholder'sequity $16.772,00 $2.050,00 $6.941,00 $14.068,00 $3.498,00 $4.953,00 $14.269,00 $3.325,00 $5.454,00 $15.463,00 $2.875,00 $6.237,00 $18.068,00 $3.107,00 $6.887,00 2007 $9.861,00 $9.070,00 $791,00 $267,00 $1.058,00 $413,00 $645,00 2008 $11.023,00 $10.574,00 $449,00 $171,00 $278,00 $100,00 $178,00 2009 $10.350,00 $10.088,00 $262,00 $98,00 $164,00 $65,00 $99,00 2010 $12.104,00 $11.116,00 $988,00 $243,00 $745,00 $286,00 $459,00 2011 $15.658,00 $14.965,00 $693,00 $370,00 $323,00 $145,00 $178,00


Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


Socialembeddedness:Southwestisverymuchanairlineonitsown.Becauseitonlyservesdomesticmarketswith its own network there is not much need for partnerships such as alliances, codeshare partners or marketing agreements. Hence, its social embeddedness is very small. Another social aspect to take into account are the employees. The acquisition will bring labor issues because AirTran will ultimately be entirely integrated into Southwest. Southwests CEO said that seniority agreements need to be solved between employee units, and pay gaps must be identified. According to him every single workgroup at Southwest has a better pay and benefits package than AirTran (CAPA Aviation Analysis, 2010 28/9). In 2011 the different pilot unions and flight attendant unions of Southwest and AirTran cameto an agreement with regardto seniority lists. Also the other unions seem tohavecometoseniorityagreements(SouthwestAirlinesCo.,2011). External growth experience: Southwest has experience with this type of growth strategy; the AirTran acquisition represents the third one in three decades and according to its CEO it is absolutely the most ambitious one (Mouawad, 2010). Previously, Southwest successfully acquired Morris Air and Muse Air during the 1980s. In addition, it acquired ATA Airlines operating certificate and remaining assets in 2008, which gave Southwest access to New York La Guardia (CAPA Aviation Analysis, 2010 28/9). Thus, Southwest indeed has fullacquisition experience. To conclude the firmspecific factors that drive Southwests choice for this type of growth strategy I will briefly summarize the findings. With regard to marketing it could be stated that indeed customer demands play a roleinthesenseofimprovedcoveragebutimprovedcustomerexperienceorbrandrecognitionarenotapriority. Competitive outcome seems to play an important role in this transaction. After the acquisition the number of competitors will decrease and other airlines are even more pressured to also find a partner. Moreover, the acquisition directly increases Southwests capacity and market share. Furthermore, it becomes a direct competitor of Delta at the Atlanta hub where it will have to fight a tough battle to be able to grow at this newly acquired hub. So Southwests move is very much from a shaping point of view rather than defensive, with the direct objective to increase market shares and further improve its already dominant US domestic position. With regard to its financial position it can be stated firmly that Southwest is very much financially endowed and stable enough to take such risks. With its previous M&A experience Southwest will have less trouble to successfully takeoverAirTran,whichinturnreducesuncertainties.Thus,thefull3Bhypothesiscanbeconfirmed. Relational level: economic synergies, required investments, level of integration, degree of behavioral uncertainty, levelofinterdependence Economic synergies: Economies of scale and scope are in this case achieved with an increased aircraft fleet and extendedroutecoverage.Furthermore,costscanreduceinareassuchasIT,advertising,corporateoverhead,and aircraft financing. Those cost synergies can offset increased costs such as labor. Ultimately, the net synergy opportunitiesaredrivenbynetworkandimprovedrevenuepotential.Combinedtheairlinesoperate690aircrafts (including 88 717s of the Airtran fleet). By acquiring Airtran, Southwest added a new type of aircraft to its fleet,
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 66

whichnowconsistsofthreedifferenttypes.ThisindicatesthatitisleavingbehindanimportantLCCcharacteristic: oneaircrafttypethatisofgreatimportancetokeepthecostsdown(Ranson,2011).Furthermore,thetransaction would expand Southwestsnetwork by25% and also give its first nearinternational destinations in the Caribbean and Mexico. There are 37 destinations that are not served by Southwest and 37 that are not served by Airtran, which presents opportunities for new city pairs. This counts especially for the smaller and medium sized communities that are served by Airtran (CAPA Aviation Analysis, 2010 28/9). According to Southwests CEO the opportunities are threefold: Atlanta, small cities and international. According to Mouawad (2010) in a NY Times article, the combined networks present little overlap, they were only competing directly on 19 routes. Moreover, compared with Southwests other competitors, Airtran presents the smallest overlap (CAPA Aviation Analysis, 2011 28/4). However, the combination of the two airlines also has some overlap and will strengthen Southwests competitive position at for example New York La Guardia and Chicago Midway (CAPA Aviation Analysis, 2010) 28/9.Figure17givesanindicationofthegeographicalspreadofthetwoairlinescombined.Thefollowinganalysis about the overlap between city pairs contains both data from OAG and from an independent research report by BoydGroup.

BeforeIstartedanalyzingthe2010OAGdataofbothSouthwestandAirtranIcleanedupthedatasetsby deletingthosecitypairsthatcarriedlessthan100passengers.ForAirtrantheseroutesrepresentonly0.15%ofits
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 67

totalcarriedpassengers,whichcanbeperceivedasinsignificant.However,thesecitypairsdorepresent75%ofits total city pairs. This latter fact is more an indication of its (in)efficiency. The deleted Southwest routes represent only 0.01% of its total carried passengers, which can also be perceived as insignificant. However, these city pairs dorepresent35%ofitstotalcitypairs.Table19containsthekeyfiguresfromthedatasets.
TotalcitypairsSouthwest2010(>100pax) TotalcitypairsAirtran2010(>100pax) TotalcitypairswithtransferatATLAirtran2010(>100pax) Totaloverlapcitypairs2010(>100pax) 2137 1547 1297 385

Total Airtran ATL transfer overlap Southwest city pairs 2010 (>100 363(17%ofSouthwestscitypairs) pax) OverlapnotthroughATL TotaleliminatedcitypairsATLoverlap(summerschedule2012) 22 49

I compared the 2010 city pairs of Southwest with the 2010 AirTran transfers at Atlanta. Thus, I analyzed whether there are markets that AirTran serves through Atlanta which Southwest also serves (either directly or through another airport). One would expect that Southwest would adjust its city pairs to this type of overlap. In 2010 AirTran served a total of 19.748.704 passengers of which 15.8% were served through a transfer at Atlanta, which indicates the importance of the Atlanta hub for AirTran. Moreover, approximately 60% of its city pairs (>100 passengers) include a transfer at Atlanta. From the 363 overlapping routes in 2010, the two airlines together already deleted 49 in the summer schedule of 2012. Though it cannot be stated firmly, it could be said that Southwest is already adjusting its route network to the acquisition. Southwest is mainly deleting routes of AirTranwhereitalreadyhasadominantpositionoverAirTran(nonATLflights). Overallitappearedthatcomparedtothecitypairsof2010(>100passengers)Southwestdeletedonly6.8% of these in the summer schedule of 2012. Thus, not much has changed (with regard to deleted routes) since the acquisitionofAirTran.However,thisdoesnettellwhethernewrouteshavebeenaddedandwhetherthedeleted routes were indeed deleted because of the acquisition. However, from the 146 deleted routes, only 4 were overlappingroutes(withatransferatATL).OntheAirTransidemorerouteshadbeendeletedsince2010,namely 418intotal.Fromthese418citypairs49wereoverlappingroutes.Twooverlappingroutesweredeletedentirely; onbothSouthwestsandAirTransside. FromtheSouthwestOneReportof2010and2011theoverlappingairportscouldberetrieved.Southwest indicated in the 2011 report on which airports it is currently working (longterm project) to optimize the capacity
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of the two airlines. In Appendix IV the overview can be found with these airports. The table below shows the overlapping airports, the ones that Southwest has plans for to change and the ones that are currently changing (changes in summer schedule 2012 compared OAG data 2010). This shows that Southwest is already actively workingonoptimizingitsroutenetwork. According to the AAI, the 18 city pairs most affected (where the acquisition will eliminate one of the merging airlines) originate at Baltimore or Orlando. In 6 of these 18 city pairs, the acquisition would produce a monopoly and the change in concentration at the airports exceed the threshold specified in the DOJ/Federal Trade Commission Horizontal Merger Guidelines. From the Boyd Group analysis it appears that in 2010 Q1 there is an overlap on 26 routes from and to Orlando (MCO), but only on 11 routes the two airlines together own 70% or more market share (table 20) From the 2010 OAG data and 2012 summer schedule it appears that these 11 overlapping markets still exist, except for HOUMCO where AirTran has stopped service. The difference with the overlapping markets at Baltimore (BWI) is that this airport is a Southwest and AirTran hub where Southwest already has a dominant position. Out of 24 overlapping markets 13 will have a joint market share of more than 70%.NotethatSouthwestalreadyhadmorethan70%marketshareon4ofthoseroutes.Inthesummerschedule of2012theseoverlappingrouteswereallstillintact.
Table20:JointmarketshareatMCOandBWI Orlando



73,1% 93,0% 91,7% 92,7% 89,8% 75,3% 96,0% 89,1% 85,2% 78,5% 89,4% 92,5% 75,6%

93,0% BWIBOS 83,8% BWIMCO 85,9% BWIFLL 90,4% BWITPA 78,4% BWIRSW 95,0% BWIMSY 69,1% BWIMKE 87,6% BWIIND 84,8% BWIPBI 79,1% BWIJAX 69,9% BWIHOU BWIMDW BWISTL

Source:BoydGroupInternational(2010). Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


Requiredinvestments:Southwestexpectstheonetimecostsformergingthetwoairlinestobebetween$300and $500million,andannualsynergiestobeabout$400millionby2013(CAPAAviationAnalysis,201028/9).In2011, $80 million in net pretax synergies were already attributable to the acquisition (Southwest Airlines Co., 2011). The onetime costs include the cost of the deal, facilities transition, aircraft integration, labor integration (including training), technology and system integration along with marketing and other unanticipated costs. The proposed transaction (including the anticipated net synergies and excluding the onetime acquisition and integration costs) is expected to contribute to Southwests earnings per share in the first year after the transactionandevenmorethereafter(CAPAAviation Analysis,201028/9).Thus,thenetsynergiesseemtooffset theonetimetransactioncosts Level of integration: The ultimate goal of the acquisition is the full integration of AirTran in Southwest. An important step in this process is to obtain a Single Operating Certificate (SOC) from the Federal Administration Analysis. Southwest achieved this in March 2012. However, receiving approval does not mean that integration process of the AirTran fleet into the Southwest fleet (paint scheme and interior configuration) is complete. Furthermore,thetransitiontoasingleticketingsystemisalargeandcomplexprocessthatwilltakeseveralyears tocomplete.Thus,whenthetwoairlineswilltrulyoperateasoneisstillunclear. Economies of traffic density for ptp airlines such as Southwest are usually achieved by promoting low fares and by operating large aircrafts. AirTran however has a strong hubandspoke network built around its hub in Atlanta. Southwest on the other hand neither solely operates a pure ptp network. From the Boyd Group analysisitappearedthatintheperiod20092010SouthwestwasnotsolelyrelyingonO&D(ptp)traffic;attenof its top 19 airports flow passengers accounted for more than 1/3 of the traffic. For example, at Chicago Midway, 43.2% of passengers in 20092010 were not local passengers. Thus, it was already leaving some of its lowfare airline characteristics behind before the AirTran acquisition. Whether this hub experience will help Southwest to makeAtlantaasuccessfulhubremainsquestionablebecausethereamuchhigherlevelofflowtrafficisnecessary. Asmentionedbeforeinthisanalysis,forSouthwesttomakeAtlantaworkitshouldnotrelyonO&Dtraffic.Rather it should try to generate more flow traffic and more reliance on hubandspoke banking schedules will be critical inordertoachieveeconomiesofdensity. Behavioral uncertainty: As mentioned in the previous section, the two airlines mainly differ in their type of network; AirTran relies heavily on connecting traffic in Atlanta and Southwest still mainly operates a ptp network with little dependence on connecting traffic. According to Southwest CEO, only 15% of its passengers make transfers (CAPA Aviation Analysis). With regard to similarities, both airlines have placed emphasis on customer service, high quality lowcost operations, solid low fare brands and strong employee cultures (Southwest Annual Report 2011). However, there are small differences such as higher costs at Southwest, a varianceinserviceproductsanddifferencesinmarketstrategies,butaccordingtoBoydGroupthesewillnotbea threat to the success of the merger. Moreover, because of the full acquisition and integration of AirTran to the
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 70

Southwest family there will be relatively little behavioral uncertainty as the level of control will be high. These typesofuncertaintieshowever,canneverbetakenawayandcanalwaysinfluencethemergerprocess. Interdependence: With regard to relative size and competitive position Southwest clearly has the stronger position.Table21showsthatSouthwestisthedominantpartyintermsorganizationalsize(employeesandfleet), operating revenue, capacity, cash flow and expenditures. Important to note is that AirTran is a financially healthy airlinethatwasinitiallynotforsale,whichmoderatesthelevelofinterdependence(CAPAAviationAnalysis,2010). The question is whether AirTran would have survived by itself in the long run when it had to compete with Southwest.Thus,inthatsenseAirTranwasverymuchdependentontheactionsthatSouthwesttakes.


To conclude these relational drivers behind the choice for an acquisition, I will briefly summarize the findings of the final five driving factors. With regard to economic synergies and economies of scale and scope it can be concluded that especially scope economies (geographical scope) played an important role in the acquisition. Obviously economies of scale automatically come to play when costs can be divided over a larger operation,butitseemsthatSouthwestcarefullyselectedAirTranbecauseofits(mainly)complementarynetwork. TheacquisitionwillenhanceandimproveSouthwestscoverageintheUS.Althoughitisminimal,overlap(parallel city pairs) exists in certain markets. This latter aspect would enhance Southwests market power at some airports/city pairs in case it does not adjust operations. With regard to investments, large onetime costs are indeed needed to fully integrate the two airlines and to ultimately gain the calculated netsynergies. Uncertainty around financing such transactions always remains, especially in such economic turbulent times. The level of
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 71

integration is very high; AirTran will be fully converted to Southwest. This is necessary in order to obtain the network andcosts synergies. Economies of traffic density can only be achieved if Southwest increases its reliance on connecting flow traffic rather than O&D traffic. Thus, in order for Southwest to truly gain from traffic density it will have to leave behind one of the main LCC characteristics, namely its ptp network. In case that does not happen it could be stated that economies of traffic density have not been of great importance in the acquisition ofAirTran.Thefourthfactortoconsideristhatofbehaviouraluncertainty.Thetwoairlinesareverymuchalikein their objectives and value propositions. Although there are some smaller differences, these will not influence the merger in the sense of behavioural uncertainty. Finally, with regard to interdependence, Southwest is clearly the larger player and AirTran is the dependent player in this transaction. Thus, interdependence is low indeed. Overall, most of the hypothesis with regard to relational factors (H3C) is supported. With a small annotation that economies of traffic density in this case might not be of much importance due to the low fare (ptp) nature of Southwest. The first two overarching hypothesis (H1A+B) have not been discussed yet because the two cases answeredH2and3separately.Thefirstoverarchinghypothesis(H1A)statedthatallthreelevelsofanalysisplaya role in both cases (strategic alliance or M&A). This can be confirmed because for both cases there were always some factors at each level of analysis that contributed to the strategic choice, and none of the hypotheses were completely rejected. Hypothesis 1B can also be confirmed fully. Because the drivers at environmental level were fullyconfirmedincase1andonlypartlyincase2itcouldbestatedthatindeedenvironmentalfactorsplayamore important role for choosing strategic alliances. Moreover, the drivers at firm level were fully confirmed in case 2 but only partly in case 1. This could mean that firm level drivers are indeed more important when choosing for M&A. With regard to relational drivers it could be stated that these were not equally important for both cases because these were partly confirmed for case 1 and fully for case 2. An overview of the results is presented in table22.
Hypothesis Confirmed? Note 1A 1B 2A 2B 2C 3A 3B 3C Fully Fully Fully Partly Partly Partly Fully Fully Nolargecurrentsocialnetworkandmuchexternalgrowthexperience Nodirectcomplementarynetwork,uncertaintysurroundingthelevelofneededinvestments Uncertaineconomic(macro)environment Highlevelofintegrationdoesnotnecessarilyleadtoeconomiesoftrafficdensityduetolowfarenature (ptpnetwork)

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


Thetopicofthisstudyisvaluechainintegrationstrategiesonahorizontallevelandtheairlineindustryspecifically. The main research question is the following: What types of external growth strategies with regard to horizontal value chain integration can be identified in the airline industry and what drivers can explain the differences between them? The objective of the first (theoretical)part was to explain the topic and presentthe underpinning theories. From there the topic was narrowed down to the airline industry because that is a sector where this consolidation trend is currently taking place. The first part of the research question what types of horizontal growth strategies with regard to value chain integration can be identified in the airline industry? has been answered purely on the basis of this literature review. A clear distinction can be made between cooperative and integrative strategies. Within the airline industry many types of cooperative strategies exist that differ by their level of integration. I used the terms strategic alliances and M&A to cover the types of external growth strategies usedintheairlineindustry.TofindthedrivingfactorsthatexplainthechoiceforeitherstrategicalliancesorM&A I created a conceptual model based on Hoffman & SchaperRinkel (2011) and additional theory specific for the airline industry. This model includes both generic and industry specific driving factors along three levels of analysis (environmental, firm, relational). To answer the second part of the research question what drivers can explain the differences between these strategies? two business cases were used to test this conceptual model. One important drawback should be taken into account that influences the results of this entire study and especiallywhencomparingthetwocases:foreachstrategy(strategicalliancesandM&A)onlyonecasewasused to test the theory. The consequence is that the results cannot be generalized. Thus, the results only apply to the firms involved in the cases. Internal validity however is high because of data triangulation (different sources of both qualitative and quantitative nature). Future research should cover more cases, or focus on one type of strategywithmultiplecases.Eitherway,multiplecasesareneededtoprovidebettergeneralizability. The first two hypotheses have the objective to compare the two different strategies. The first hypothesis was confirmed; it appeared that all three levels of analysis are indeed taken into account by airlines that choose for a certain strategy (both strategic alliances and M&A). Although all three levels of analysis are taken into accountinbothcases,thereisadifferenceinimportancebetweenthem.InthisstudyImeasuredimportanceby lookingatwhetherthehypothesisarebeingfully orpartlyconfirmed(becausenoneofthemwerefullyrejected). Whether this is the right way for measuring importance is questionable but it was the only way available for me to make a distinction. Environmental drivers indeed seem to be of greater importance in the strategic alliance case (Airberlin joining oneworld), and firmlevel drivers for the M&A case (Southwest acquiring AirTran). An unexpectedoutcomeisthattherelationaldriversalsoseemtobeofgreaterimportancefortheM&Athanforthe strategic alliance case (I expected this one to be equally important). This outcome could be due to casespecific characteristics. In the case of Airberlin it might be that it had no other choice than joining a strategic alliance because of severe environmental and competitive pressures and a weak financial position, and relational factors could therefore have been of less importance. Furthermore, it can also be explained by the level of integration
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 73

withinthestrategicalliance;mayberelationalfactorsbecomeofgreaterimportancewhenthelevelofintegration increases. This is something to consider in future research on this topic. Within the M&A case it is not possible to tell whether firm or relationallevel drivers are of more importance. Thus, prioritizing the driving factors within the cases is not possible with the research design used in this study. Future research could focus on one type of strategyandtheorderofimportanceofthedrivingfactors. With regard to the strategic alliance case only the hypothesis with driving factors at environmental level is fully supported. At firm level only three out of five driving factors are supported. In contrary to the theory of Hoffman and SchaperRInkel (2011) Airberlin was not embedded in a large social network, and the airline had relatively much external growth experience with integrative strategies. As it was mentioned earlier, it is very well possible that Airberlin had no other choice than joining the globally branded oneworld alliance to safe itself from apossibledownwardsspiral.Inthatcase,joiningastrategicalliancecouldbeusedasadefensivemechanism.The relational hypothesis was also only partly confirmed. What came forward was that there are no direct economic synergiestogain,butthereisdefinitelypotentialforfuturesynergies.TheroleofthenewBerlinairport(BBI)and the complementary network that gives oneworld access to Germany and its surroundings play an important role in this potential. Thus, apparently in a strategic alliance the future potential of economic synergies might be of greaterimportancethanthedirectbenefits.InthecaseofAirberlinjoiningoneworldtwotheoriescanexplainthe most important results: Resource Based View (RBV) and Resource Dependency Theory (RDT). RBV explains the attractiveness of Airberlin for oneworld, even though these resources only have potential and will be of value on the long term. From the Airberlin perspective oneworld mainly comes with marketing related resources (FFP and larger network) that benefit the airline. The main theory that underlies Airberlins decision to join oneworld comes form uncertainty. RDT explains that firms join hands to reduce uncertainty and hence brings in an interdependency argument, which is the case for both Airberlin and oneworld; they need each other to survive competitiveandenvironmentaluncertainties. The M&A case presented a US based acquisition where Southwest acquired the smaller LCC AirTran. Hypothesis 3A (environmental drivers) was partly confirmed; indeed there was little legal uncertainty because of the domestic nature but strategic uncertainty was present. The nature of the airline industry probably explains this outcome. The airline industry in general is very sensitive to macrolevel uncertainties and especially macro economic uncertainty. Thus, strategic uncertainty will always be present in the airline industry and this will therefore probably not have a direct impact on the strategic choice. From a firmlevel perspective all hypothesized factors are confirmed. There indeed is a motivation to meet customer demands by offering the largest network possible, there is enough financial stability to perform such a strategy and experience with acquisitions made it easier for Southwest to choose for this type of strategy. The most striking outcome on this level of analysis was the motivation to shape competition. By acquiring AirTran Southwest directly increases its marketshareandcapacity,decreasesthenumberofcompetitorsandputspressureonthemtopartnerup.More importantly, through this acquisition Southwest directly attacks its competitor Delta at ATL. In order for
Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase 74

SouthwesttocompetewithDeltaatATLitwillhavetoleavebehinditsLCCcharacteristicsandstartorganizingits network around a hubandspoke system rather than pointtopoint. AirTran was already organized around hubs with multiple types of aircrafts and Southwest probably uses this acquisition to (slowly) change strategy and transform into a regular network airline. On the relational level all hypothesized factors were also confirmed. Behavioraluncertaintyislowbecausebothairlineshaveasomewhatsimilarbusinessmodelandinterdependence is also low. Although Southwest is clearly the larger party, AirTran was also a financially healthy airline with a strong customer base. Southwest can directly reap economies of scale and scope with AirTrans complementary network. Although, some overlap between the two route networks exists and not all of this overlap is being eliminated. This remaining overlap provides Southwest with increased market power, even though it is only a minor share of the total networks. To obtain the actual synergies large investments have to be made on Southwests side and the two airlines have to become highly integrated. For Southwest to achieve economies of density(throughhighintegration)itwilleitherhavetoflylargerairplanesororganizeflightsaroundthehuband spokesystem.Thus,oneofthemainresultsisthatinorderforSouthwesttoactuallyshapecompetitionandreap economic synergies it will have to leave behind its LCC characteristics. The market power argument (shaping competition) clearly came forward in this second case. Thus, the Industry Perspective where barriers of entry are used as a measure to increase market power applies here. The RBV also comes forward in this case; without AirTrans complementary network and strong brand Southwest would have never acquired it. Path Dependence also played a small role because Southwest has a past of acquisitions. The RBV is the theory that seems to be of importanceforbothstrategicalliancesandM&A. Limitationsandmanagerialimplications This study is marked by two main limitations: no generalizability and an ambitious model. The first limitation was already explained in the first section of this chapter. Due to limitations in time it was not possible to test the modelwithmorecases.Thesizeoftheconceptualmodelalsocontributedtothisproblem.Futureresearchcould focus on those factors that came forward as important in this study (downsize the model) and apply them to morecases.Oranotheroptionwouldbetofocus ononestrategyspecificallyandnotonthedifferencesbetween them. In that case the researcher can zoom in on just a few motivational drivers with multiple cases. Either way, more cases are needed to provide generalizability. To minimize the consequences of this problem I tried to maximize internal validity by presenting a highly detailed description of the cases using multiple types of sources. Moreover, the subjective nature of this study because of its qualitative research design brings in the problem of interpretation. This makes it difficult to come up with hard findings and conclusions. Future research should try tousemorequantitativedatatoreducethisproblem.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


Thisstudystartedoffbypresentingthecurrentconsolidation/horizontalintegrationtrendwithintheglobalairline industry; (crossborder) M&A are increasing and more and more types of cooperative strategies are being used. Allofthesehorizontalintegrationstrategiessharethesameobjective:worktogethertoachievethebestnetwork possible.Butifthesestrategiesallhavethesameobjectivewhydoairlinesusesomanydifferentformstoachieve this. The objective of this study was to find the motivational drivers behind these choices and the corresponding research questions was the following: what types of external growth strategies with regard to horizontal value chain integration can be identified in the airline industry and what drivers can explain the differences between them? The two business cases used in this study represented each one type of strategy: a cooperative strategy (strategic alliance) and the integrative strategy (M&A). It was found that three levels of motivational drivers motivate both types of strategies: environmental level, firm level and relational level. However, there is a difference in importance of these levels for each case and also the factors included in these levels of analysis differ. From the first case (strategic alliance Airberlin joining oneworld) it appeared that the environmental drivers played a more important role than firm and relational level drivers. Moreover, the uncertainty (strategic uncertainty, weak financial performance, competitive pressure) surrounding the choice of Airberlin to join a strategic alliance plays an important role. It seems that this choice was mainly made from defensive reasons with no direct positive synergies being gained but with possible potential for the future. In the second case (M&A Southwest acquiring AirTran) firm and relational level drivers seemed to be of greater importance. The main motivationaldriverofthiscasewastoshapecompetitionbydirectlyreducingthenumberofcompetitors,directly increasing market share and attacking competitor airlines at major airports. However, in order for Southwest to achieve positive economic synergies from this acquisition it will have to let go of its LCC business model and AirTran provides Southwest with this opportunities because they were already using multiple aircrafts and hub andspoke systems. Thus, overall Airberlin seems to have chosen for strategic alliances from a defensive point of viewoutofnecessityandSouthwestchoseanacquisitionstrategyfromamoreoffensivepointofviewtoincrease marketpower.However,bothstrategiesaremotivatedbytheattractivenessoftheassetsinvolved,especiallythe routenetworkandairports.

Themotivationaldriversofhorizontalintegrationstrategies Theairlinebusinesscase


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Year Airlines 1979 NorthCentralAirlines/SouthernAirways/HughesAirways 1980 PanAm/NationalAirlines 1980 RepublicAirlines/HughesAirwest 1982 ContinentalAirlines/TexasAirCorporation 1985 SouthwestAirlines/MuseAirlines 1986 NorthwestAirlines/RepublicAirlines 1986 TWA/OzarkAirLines 1986 DeltaAirLines/WesternAirlines 1986 AlaskaAirlines/HorizonAir 1987 ContinentalAirlines/PeopleExpress/NewYorkAir/FrontierAirlines 1987 AmericanAirlines/AirCal 1987 USAir/PacificSouthwestAirlines 1987 AlaskaAirlines/JetAmerica 1989 USAir/PiedmontAirlines 1990 AmericanAirlines/EasternAirLines;LatinRoutes 1991 AmericanAirlines/TWA;HeathrowRoutes 1991 DeltaAirLines/PanAmAirlines;ShuttleandAtlanticRoutes 1992 UnitedAirlines/PanAm;LatinandCarribeanRoutes 1993 SouthwestAirlines/MorrisAirlines 1997 AirTranAirways/Valujet 1999 AmericanAirlines/RenoAir 1999 DeltaAirLines/AtlanticSoutheastAirlines 1999 DeltaAirLines/Comair 2001 AmericanAirlines/TWA 2005 RepublicAirways/ShuttleAmerica 2005 Skywest/AtlanticSoutheastAirlines 2007 PinnacleAirlines/ColganAir 2008 SouthwestAirlines/ATAAirlines 2009 RepublicAirways/MidwestAirlines 2009 RepublicAirways/FrontierAirlines 2009 DeltaAirLines/NorthwestAirlines 2010 PinnacleAirlines/MesabaAirlines 2010 UnitedAirlines/ContinentalAirlines 2010 Skywest/AtlanticSoutheastAirlines/ExpressJetAirlines 2011 Southwest/AirTRanAirways 2012 USAirways/AMR/AmericanAirlines Result RepublicAirlines PanAm RepublicAirlines ContinentalAirlines SouthwestAirlines NorthwestAirlines TWA DeltaAirLines AlaskaAirlines/HorizonAir ContinentalAirlines AmericanAirlines USAir AlaskaAirlines USAir AmericanAirlines AmericanAirlines DeltaShuttle UnitedAirlines SouthwestAirlines AirTranAirways AmericanAirlines DeltaAirLines DeltaAirLines AmericanAirlines RepublicAirways Skywest/ASA PinnacleAirlines/ColganAir SouthwestAirlines RepublicAirways RepublicAirways DeltaAirLines PinnacleAirlines/MesabaAirlines UnitedAirlines Skywest/SureJet SouthwestAirlines


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th Source:Worldsbiggestairlinesrankings:Jul2011,CAPACentreforAviation,July5 2011 ( combined54821)

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