Reaching New Heights Together: How Airlines Can Maximize the Value of Joint Ventures
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
EXECUTIVE INSIGHTS VOLUME XVI, ISSUE 4
Reaching New Heights Together: How Airlines Can Maximize
the Value of Joint Ventures
The ground-breaking partnership between Northwest Airlines We believe that deeper integration between JV partners of
and KLM Royal Dutch Airlines more than two decades ago all sizes is inevitable, and that "virtual mergers" will become
ushered in an era of increasing cooperation among global car- increasingly popular around the world. L.E.K. market forecasts
riers. Once focused on modest collaboration such as selective suggest that by 2023, 45% of all global long-haul traffic will
codesharing and reciprocal frequent flyer benefits, joint venture be part of a JV. With transatlantic markets largely mature, this
agreements today have in many cases become so tight as to substantial growth is likely to come from increased collaboration
be virtual mergers. Emboldened by the spread of Open Skies between developed and developing markets. In the case of Latin
agreements, which provide the foundation for airlines wish- America, L.E.K. projects that well over half of the traffic bound
ing to coordinate activities, a growing number of carriers are for North America will be linked to a joint business within 10
seeking the synergies of a merger even as they stop short of full years. How these partnerships are structured and managed
unification. More than 15 airlines now participate in immunized will determine their success. In this paper, we highlight the key
joint ventures. L.E.K. research suggests that such arrangements questions for airline executives and investors looking to capture
were responsible for an astonishing 30% of all global long-haul the maximum value from joint ventures.
traffic in 2013, up from only 9% a decade ago.
Building a Strong Foundation
In some cases, immunized JVs occur between large, global
airlines, such as the recent market-disrupting tie-ups between Airlines have long understood that trust is essential to their rela-
Qantas and Emirates, and Delta and Virgin Atlantic. In other tionship with customers. Building trust between erstwhile com-
cases, executives for flagship carriers pursue JVs with regional petitors does not come as naturally. The longevity and success
airlines to gain access to growth markets – a proposition that of JVs depends on airlines’ ability to construct equitable and
appeals to regional airlines because of the economies of scale flexible partnership arrangements. In most cases, these arrange-
offered by a global partner. Japanese carrier ANA’s recent ments will be founded on the principle of “metal neutrality,”
purchase of an equity stake in Myanmar Airlines and Delta’s which dictates that revenue or profit is shared proportionally no
innovative partnership with GOL are examples of such symbiotic matter which airline actually flies the passenger. Metal neutral-
relationships between big and small carriers. ity helps align incentives and build trust. But the preservation of
standalone value – that is to say, pre-deal financial performance
– is also key to establishing confidence from the onset
Reaching New Heights Together: How Airlines Can Maximize the Value of Joint Ventures was written by John Thomas, a Managing Director in L.E.K. Consulting’s
Boston office, and Brett Catlin, a Senior Consultant at L.E.K. Consulting. For more information, contact aviation@lek.com.
L.E.K. Consulting / Executive Insights INSIGHTS @ WORK TM
LEK.COMEXECUTIVE INSIGHTS
Figure 1
Understanding Airline Collaboration
Equity investment can occur throughout the
process, although vested interest typically yields
increased overall cooperation
Fully independent
Interline Codeshare Joint Venture Merger
(no collaboration)
(full collaboration)
Shared frequent flyer program, lounge access and
Airline has all the coordinated schedules may be enabled early on
decision making power Commonly achieved through an alliance, or be achieved later on in con- Allows for full
and does not share through alliances and junction with a joint venture; however, fare alignment integration between
information with other low-level partnerships and network optimization typically follows antitrust carriers.
airlines immunity (ATI) and is likely to be maximized following
a joint venture agreement.
Approximate percent of overall collaborative benefit realized:
0% 5% 65% 90% 100%
Source: L.E.K. experience and analysis
of negotiations. From this foundation, there are a host of Market Example: When Delta Air Lines and Virgin Atlantic
potential considerations regarding the structure, mechanism executed their JV agreement in late 2012, they elected
and governance for both parties to analyze and negotiate. to include all traffic between the United States, Canada
and Mexico to London and to explicitly exclude substantial
Virgin Atlantic leisure traffic destined for the Caribbean.
Determining the Right Structure
Determing the structure of joint ventures lays the groundwork • How will exclusivity be addressed? Will there be
for all subsequent negotiations. L.E.K.’s experience suggests carveouts to preserve existing relationships? Will multiple
that the most successful agreements focus on several key parties be permitted to operate on the same city-pairs?
questions:
Market Example: When Air France, KLM and Delta formed
a transatlantic JV, it included specific carveout provisions
• Which regions or routes will the partnership
to capture and jointly account for connecting traffic from
agreement cover? Will there be full metal neutrality
Los Angeles to Papeete and from Amsterdam to India.
for all of these routes? How will “behind” and “beyond”
As a result, Delta and KLM split operations to India, with
traffic be handled – that is, the connecting flights to and
Delta exclusively operating to Mumbai and KLM exclusive-
from the shared gateways?
ly operating to New Delhi. In contrast, the A++ JV
between Air Canada, Lufthansa and United fully covers
Page 2 L.E.K. Consulting / Executive Insights Volume XVI, Issue 4 INSIGHTS @ WORK TM
LEK.COMEXECUTIVE INSIGHTS
all traffic between North America and Europe, Africa, Market Example: The transatlantic JV between American
the Middle East and India. Airlines, British Airways and Iberia determined standalone
profitability by using the 2008-2009 period as the baseline
• Will service standards and selling practices be to the agreement, with a 15% allowance for codeshare
aligned across carriers? Will fare buckets and pricing traffic which transits behind or beyond the gateway
programs be integrated? airport.
Market Example: Following the close of a JV deal between • Will there be a parity-payment adjustment (that
ANA and Lufthansa, the two parties worked to simplify is, a payment from a poorer-performing partner
fare structures and to harmonize joint selling. The unifica- to a higher-performing partner to make that
tion resulted in ANA being able to competitively sell tickets partner whole) to address differences in baseline
to 190 European destinations, up from 120 destinations profitability? How will the financial mechanism to
prior to the agreement. protect standalone performance be structured?
• Which sources of revenue will be subject to the
Deciding on a Partnership Mechanism
agreement (e.g., ancillaries, loyalty revenue,
The most tenuous and time consuming portion of JV forma- cargo, etc.)?
tion often involves determining how revenue or profit will be
calculated and ultimately allocated. This is understandable:
Figure 2
Negotiating an equitable mechanism to calculate and allocate Seats Falling Under JV Agreements, by Region (2003-23F)*
the current and future performance of the joint business is criti- 50%
cal given the permanence of the agreement. With that in mind, 45.1%
45%
executives should ensure they thoroughly explore all options by
examining the following questions: 40%
4%
CAGR
35%
• Will the joint enterprise operate as a revenue-
Percentage of Seats
30.2%
30%
sharing or profit-sharing venture?
25%
Market Example: While the vast majority of JVs are 29%
20% CAGR
structured as revenue-sharing ventures, Delta has execut-
ed profit-sharing agreements for both of its transatlantic 15%
joint ventures. While challenging to negotiate and imple- 10% 8.8%
ment, Delta decided that profit sharing ultimately
5%
ensured an optimally aligned incentive structure.
0%
2003 2013 2023F
• How will standalone (i.e., baseline) profitability of
each party be determined? How many years prior to Transatlantic Transamerica Other
the agreement will be considered? Will adjustments be Transpacific E.U. to Asia
permitted to account for irregularities?
Note: *Includes routes at least 2,500 nm in length with at least 52 flights p.a.
Source: Diio Mi, L.E.K. analysis
L.E.K. Consulting / Executive Insights INSIGHTS @ WORK TM
LEK.COMEXECUTIVE INSIGHTS
Figure 3
Historical Mechanisms of JV Agreements
Year Partners Current Mechanism
2009 A++ (Air Canada, Lufthansa, United) Revenue
2009-10 Delta, Air France, KLM, Alitalia Profit
2010 American, British Airways, Iberia Revenue
2011 ANA, United Revenue
2011 American, JAL Revenue
2011 Delta, Virgin Australia Revenue
2012-13 ANA, Lufthansa, Austrian, Swiss Revenue
2013 Qantas, Emirates Revenue
2013 British Airways, Japan Airlines, Finnair Revenue
2013 Delta, Virgin Atlantic Profit
Source: American, Delta, KLM, Lufthansa and Virgin Atlantic press releases; Examiner; Bloomberg; Financial Review; Business Traveller; L.E.K. analysis
• For profit-sharing agreements, how will costs be Ensuring Good Governance
allocated to the JV? What is the mechanism to deal
with unilateral escalation in labor costs – for example, A good rule of thumb for establishing a strong governance
if one airline is contractually obligated to increase pay for structure is for executives to hope for the best, but plan for the
pilots and other flight staff at a certain date? worst; even the most amicable partnership can turn sour (and
expensive!) in the face of unforeseen circumstances. Strong
• Again for profit-sharing agreements, how will the governance can be established by addressing the following
inclusion of certain assets, such as the introduction representative questions:
of new aircraft or the purchase of slots, be account-
ed for in the agreement? • What is the length of the agreement? Will an ever-
green provision or termination penalties be included?
• Will a proportionality clause be enforced to regulate
capacity growth? How will any imbalance be addressed? Market Example: When Air France/KLM and Delta inked
What is the mechanism to reduce shared capacity? an integrated agreement in May 2009, they favored a
long-term, auto-renewing arrangement that can only
Market Example: Over the past three years, while Air be canceled with three-years’ notice after a period of
France, KLM and Delta have collectively withdrawn nearly 10 years.
3% of seats from the transatlantic market, the carriers
relative split has remained stable at 45% (DL) and 55% • Who owns pooled resources such as takeoff and
(AF/KL) – a strong indication that a proportionality cause landing slots at major airports and how are those
has been enforced as joint capacity was rationalized. resources managed by the JV?
Page 4 L.E.K. Consulting / Executive Insights Volume XVI, Issue 4 INSIGHTS @ WORK TM
LEK.COMEXECUTIVE INSIGHTS
• Under what conditions, if any, will be the partner- Looking Toward the Future
ship agreement be void (e.g., insolvency by one
party)? As the model matures, airlines may pursue further opportunities
to monetize the assets of the JV to the benefit of shareholders.
• How are approval and/or veto rights structured For instance, executives may choose to spin-off the JV portion
for major decisions? What is the protocol for resolving of their business in an IPO – a bold strategic move similar to the
disputes? loyalty program spinoffs undertaken by Air Canada, Aeromexico
and others over the past decade. Such a structure would enable
• What is the process for terminating the partnership? the asset to be independently valued, while providing investors
If liquidated damages or other remedies will be required, with the ability to invest in a specific region or route system.
how will they be calculated? How do you structure an
agreement that permits minimal disruption should that Whatever course they take, we expect immunized joint ventures
agreement fall apart? will continue to gain favor across the airline industry. Our
forecasts suggest that in 10 years nearly half of all long-haul
traffic will be carried by an airline participating in a JV. How
much value such partnerships bring to industry stakeholders will
depend in large part on how the questions raised in this paper
are addressed.
INSIGHTS @ WORK
TM
L.E.K. Consulting is a global management For further information contact: International
consulting firm that uses deep industry Boston New York Offices:
expertise and analytical rigor to help 75 State Street 1133 Sixth Avenue Bangkok
clients solve their most critical business 19th Floor 29th Floor Beijing
Boston, MA 02109 New York, NY 10036 Chennai
problems. Founded 30 years ago, L.E.K. Telephone: 617.951.9500 Telephone: 646.652.1900
London
employs more than 1,000 professionals in Facsimile: 617.951.9392 Facsimile: 212.582.8505
Melbourne
22 offices across Europe, the Americas and
Milan
Asia-Pacific. L.E.K. advises and supports Chicago San Francisco
One North Wacker Drive 100 Pine Street Mumbai
global companies that are leaders in their 39th Floor Suite 2000 Munich
industries – including the largest private Chicago, IL 60606 San Francisco, CA 94111 New Delhi
and public sector organizations, private Telephone: 312.913.6400 Telephone: 415.676.5500 Paris
Facsimile: 312.782.4583 Facsimile: 415.627.9071
equity firms and emerging entrepreneurial São Paulo
businesses. L.E.K. helps business leaders Seoul
Los Angeles
consistently make better decisions, deliver 1100 Glendon Avenue Shanghai
21st Floor Singapore
improved business performance and create
Los Angeles, CA 90024 Sydney
greater shareholder returns. Telephone: 310.209.9800 Tokyo
Facsimile: 310.209.9125
Wroclaw
L.E.K. Consulting is a registered trademark of L.E.K. Consulting LLC. All other products and brands mentioned in this document are properties of their respective
owners.
While L.E.K. advised the parties cited in a number of the examples, all data are sourced from publically available records.
© 2014 L.E.K. Consulting LLC
L.E.K. Consulting / Executive Insights INSIGHTS @ WORK TM
LEK.COMYou can also read
