chapter  5
30 Pages

Allied and Profitable, or Miserably Entangled?

Airlines, like all firms, form alliances because they expect to accumulate financial

rewards by doing so. These rewards take the form of increased revenue, profit

maximisation and cost reduction. The value of any alliance lies in its ability to

produce such benefits – either by increasing dominance in existing markets or

opening up access to new ones. Recent research (Iatrou and Alamdari, 2005) has

shown that airline alliances have performed well at revenue enhancement level and

lived up to airlines’ expectations, whereas cost reduction efforts have been rather

limited, with correspondingly poor results. Revenues for Lufthansa, for example,

were up DM 250−270 million in 1997, thanks to its alliance with United Airlines,

SAS, Thai Airways, Air Canada and Varig (Doganis, 2001). For British Airways,

the alliance with USAir generated 68,000 extra passengers and US$100 million in

additional revenue (Doganis, 2001). Yet sooner rather than later, cost-savings will

have to be boosted to match the benefits from initial revenue gains. As the airline

industry matures in terms of markets and players, there is increasing evidence that

revenue gain is reaching its ceiling and thus current priorities focus on cost-savings

through efficiencies:

According to the principles of rudimentary economics, in network industries the

sheer size of the allied airlines will bring about economies of scale. This, together

with the spread of the combined networks, leads to economies of scope. Economies

of scale and scope, along with the way the respective networks are combined to

increase traffic and facilitate connections, will in turn produce economies of traffic

density. Clearly, to examine these parameters in isolation is misleading, since they are

closely interrelated and any increase in one or all of them will lead to an increase in

revenue and profit. However, for the sake of clarity they will be examined separately

here, with an attempt at a brief summary.