Airline partnerships Matchmaking for success in Africa By Stephan Heinz, Senior Analyst - Seabury Group, London Africa Wings magazine Aug-Oct 2015 Do alliances and partnerships hold the key to helping African airlines overcome some of the unique challenges posed by their operating environment? Are African carriers keeping up with industry players, who are tailoring alliance strategies to meet their needs? Talk of alliances and partnerships has never been stronger in African aviation circles. Rhetoric around the need for further cross-border cooperation to drive intra-african connectivity is plentiful, and the importance for African airlines to enter into relationships with their regional counterparts is continuously being emphasised. Closer cooperation between African carriers is viewed by many as a mechanism to overcome some of the challenges of growing sustainably profitable airlines on the continent. Persistent government protectionism, lagging deregulation, structurally high costs and generally thin demand on long sectors are some of these challenges. Three of the five past AFRAA Annual General Assemblies have been themed around partnerships and cooperation, but how can African airlines act on this sentiment and deliver the benefits of closer collaboration? AFRAA AGA Theme 2 nd Adapting to Survive and Prosper 3 rd Harnessing Growth Opportunities Together th Business Together in the Era of Growing Opportunities 5 th Challenging times Africa's strategic alignment 6 th Winning Together through Innovation and Collaboration The alliance spectrum African airlines should be active in examining the types of partnership structures that exist and develop a strategy that fits their needs best. Airlines are constantly developing innovative ways to drive partnership benefits, beyond merely entering a global alliance, and African airlines should be no exception. The partnership options available are diverse and in some cases complex, involving increasingly integrated structures which require careful consideration and up-front due diligence. The types of alliances that exist today are many and varied and can be reflected on a spectrum of increasing economic benefit and complexity and depth of integration. Interline agreements reflect the lowest form of integration with cooperation only extending to allowing passengers to connect, with their baggage, between partner flights. Progression from interlines includes codeshare structures which are deeper commercial agreements that allow airlines to sell their code on partner airline metal and provide passengers with benefits including earning frequent flyer miles. Global alliances provide a structure for a network of codeshares between members as well as providing members with synergies on the cost side such as joint procurement or savings in shared facilities. Joint ventures reflect a more advanced form of partnership, in that revenues or profit are shared between partners on specific markets. Equity partnerships and management contracts may include a number of elements of other partnership structures, with the additional control through an equity investment or management contract. Finally, the ultimate form of partnership is a merger, which may include the integration of one entity into another, often merging workforces, balance sheets and brands.
Economic benefit / complexity Figure 1: Airline partnership continuum High Merger JV Merger / M&A Equity partnerships / management contracts Multilateral joint ventures Bilateral joint ventures (profit) Bilateral joint ventures (revenue) Global alliance Alliances Blocked seat agreements (codeshare) Sales incentive agreement Low Interline agreements No cooperation Special prorate agreement (SPA) Depth of integration / QSI value High The extent to which African airlines have progressed along the alliance continuum is varied. Large African carriers (South African Airways, Kenya Airways, Ethiopian Airlines and Egyptair) with expansive networks have entered into the global alliances, providing alliance members with attractive market access to Africa. For smaller carriers, the focus has been more on establishing a network of cherry-picked codeshares to strengthen their regional footholds. Recent developments have also seen a growing number of equity partnerships and management contracts (Ethiopian Airlines-Asky, Precision Air-Kenya Airways, etc.) as small airlines seek commercial, technical and management expertise from more established carriers either from within or outside Africa. Alliances and codeshares While there are a wide variety of airline partnerships that exist outside the three global airline alliances (Star Alliance, oneworld and SkyTeam), the evolution of these three alliances over the past two decades is some measure of the increased appetite among airlines to enter into global partnerships. The number of airlines participating in one of the three global alliances has increased significantly since the inception of Star Alliance in 1997, followed by oneworld in 1999 and SkyTeam in 2000 (Figure 2). In recent years, the growth in membership has come mainly from airlines in developing markets in Asia and South America, while consolidation in Europe and North America has left fewer eligible new alliance members. Africa still has a vast number of relatively small carriers but only a few carriers have the scale to add value in a global alliance. Other than South African Airways, Kenya Airways, Ethiopian Airlines and Egyptair, there are only a limited number of additional carriers that may be attractive to a global alliance.
Figure 2: Alliance membership growth Number of airlines 5 5 13 20 21 21 23 26 27 30 36 2 38 3 0 3 3 7 55 58 62 AFRAA alliance members Oceania M. East N. America S. America Asia Europe 1997 1998 1999 2000 2001 2002 2003 200 2005 2006 2007 2008 2009 2010 2011 2012 2013 201 Source: Alliance websites Note: Tracks the joining dates of current members only Outside alliances, there is an increased prominence in airlines establishing a network of bilateral codeshares, as a viable alternative to alliance membership. This has been driven particularly by the carriers such as Etihad Airways and may be a growth strategy appropriate for smaller African carriers, who lack the critical mass and network coverage to add value in an alliance. However, limited progress has been made by African carriers in establishing partnerships particularly with other African carriers. The majority of new partnerships established outside any alliance over the past 10 years have developed with Asian carriers, and can be mostly attributed to two or three dominant carriers. (Figure 3 and Figure ). Figure 3: AFRAA member airlines codeshares 2001 (excluding alliance-based codeshares) Source: Diio Mi, codeshare summary Note: Lines link two partner airlines hub countries and do not indicate codeshare routes (i.e. SAA-Etihad codeshare, line connects SA with UAE)
Figure : AFRAA member airlines codeshares 2015 (excluding alliance-based codeshares) Source: Diio Mi, codeshare summary; Airline websites Note: Lines link two partner airlines hub countries and do not indicate codeshare routes (i.e. SAA-Etihad codeshare, line connects SA with UAE) Over the past five years, partnerships formed by AFRAA carriers have increased, although this has been driven largely by the four major carriers within their respective alliances. Partnerships are predominantly between African and non-african carriers with the proportion of partnerships between African carriers remaining limited. Partnerships formed by African carriers outside any alliance have shown uncertain growth, and even a decline between 2005 and 2010. While 2015 has shown an incease in these partnerships, growth is slow and the proportion of intra-african parternships is still low. Figure 5: African carriers partnership evolution Source: Diio Mi, codeshare summary As the regulatory landscape continues to evolve, opportunities for further intra-african cooperation will emerge. To date, the limited implementation of the Yamoussoukro declaration has hindered the intra-african network growth of African carriers and limited the options for cross-border cooperation, including the development of codeshares.
Joint ventures The natural progression for alliances, beyond the network of codeshares they facilitate, and where the regulatory framework allows, is a deeper commercial agreement such as a joint venture, in which revenue and sometimes costs are shared. This is particularly true for large African carriers who will seek to expand the benefits of partnerships, beyond pure codeshares formed within their respective alliances. While joint ventures themselves are not new, the breadth and depth of these immunised unions is still developing. There are a wide variety of joint venture structures, and how suitable each of these is in a particular case will depend on the market s size, regulation and the size and complexity of the involved partners. Figure 6 represents the type of structures that can exist, from simple revenue sharing, to various mechanisms of cost sharing. Figure 6: Joint venture structures Revenue Costs Revenue only: Basic model, liable to swings, but easy to implement and audit Revenue share: FFP, ancillary, cargo + Fixed costs: Head office overheads + Semi-fixed costs: Terminals, aircraft, marketing + Route variable costs: Handling, overflying, crew, tactical marketing + Load variable costs: Fuel, catering, selling Rarely included, open to abuse Involves major business decisions, adds complexity Increases impact of route decisions; closer link to business decisions More work to establish, requires greater monitoring Unlike pure codeshare agreements, the revenue and cost sharing implications of a joint venture mean they should be entered into carefully, and only after sufficient due diligence. Some of the key factors for evaluation include the baseline calculation for revenue and/or cost sharing, clear definitions of revenue and/or cost items to be included and excluded from the agreements, the treatment of fuel surcharges, the structure of prorate calculations, the geographic scope of the agreement and the governance structure and regulatory implications. While it is clear joint ventures are starting to grow beyond the transatlantic market where they emerged, there are still very few markets and only a handful of airlines involved in such arrangements in other regions. Given the myriad of partnership opportunities that exist, joint ventures may not always make sense, nor may the regulatory environment be liberal enough in other regions to support such close cooperation. The prospect for intra-african joint ventures may still be limited as long as regulatory barriers persist, constraining the implementation of a truly open-sky. To date, notable examples of joint ventures with African carriers include KLM-Kenya Airways (based on an equity partnership as well), and the recently formed Qatar Airways-Royal Air Maroc partnership. While for African carriers the concept may still be new, it is something that might make sense in the future, particularly as larger carriers seek to grow, competition in the region strengthens and regulation potentially loosens.
The age of equity stakes and management contracts Other than pure commercial arrangements, the number of partnerships tied to either an equity stake and / or a management contract among African airlines is on the rise. This is a promising development on a continent where government protectionism typically supersedes the need to run airlines as efficient commercial entities. Recently, more national and private African airline start-ups are leveraging expertise, both technical and commercial, from more established carriers often based on an equity stake or management contract with a foreign carrier. Nevertheless, while increased cooperation between airlines might still be evolving, attempts at government cooperation in building shared airlines is not new. The challenges that airlines face in Africa including the structurally high cost environment, limited infrastructure and a lack of specialist skilled workers has meant that in the past governments have joined forces and pooled resources to establish shared airlines. The most notable examples were Air Afrique, involving 12 founder countries and Alliance Air, founded by stakes from three countries. Both carriers ceased to exist, and while they were examples of cross-border cooperation, they also reflected the difficulties with managing multiple government interests under a single entity and brand. More recent, and potentially more sustainable developments in cross-border cooperation, have been built around models which allow national airlines to keep their individual identity, but with management and expertise from partner airlines (Figure 7). Figure 7: Major equity, management contracts and commercial and/or technical partnerships involving AFRAA carriers While there are notable examples of intra-african equity partnerships and expertise-sharing relating predominantly to Ethiopian Airline s efforts in Togo (Asky Airlines) and Malawi (Malawian Airlines), the majority of partnerships involve relationships with carriers outside Africa who have an interest in expanding their market access across the continent. In general, these partnerships are based on a developing carrier providing access to niche markets as well as local knowledge in those markets in exchange for investment and management as well technical and / or commercial expertise
from a more established carrier. The blueprint below illustrates the structure of how such a partnership could work. Figure 8: Blueprint partnership structure Money Network revenue Invested capital Return on investment Established carrier Expertise Management Technical and operational Commercial Market access Intercontinental markets Regional niche markets Developing carrier The way forward for AFRAA carriers Considering the restrictive regulatory environment in which African airlines operate, the extent to which mergers, equity stakes, joint ventures and other deep forms of partnership can be implemented may still be limited. Nevertheless, African governments and airlines seem to be increasingly aware of the important role which partnerships play in mitigating some of the challenges inherent in the African operating environment such as high costs and sparse demand. The former can be addressed through joint purchasing and scale economies which certain partnerships afford while the latter can be overcome as carriers build connectivity and feed to partner airline hubs, improving load factors and viability of long, sparse sectors. Combined with the potential to draw on management as well as technical and operational expertise, partnerships can deliver sustained relief to many of the difficulties which carriers in Africa face today. For small African carriers, benefits can come from carefully selected partnerships with more developed carriers in their region and can stem from pure codeshare agreements. Larger carriers should focus on using partnerships with smaller carriers to allow growth into niche regional markets as well as expanding their international partnerships, in some cases leveraging their alliance membership status. For these carriers, deeper commercial agreements with other large players such as joint ventures should also be explored, particularly in larger markets. There is no one-size-fits partnership solution. Growing a presence in new markets through partnerships, without the associated high investment in operating own metal, will always be an attractive growth strategy. Whichever route an airline chooses, the decision should be based on sound commercial insights, an acute awareness of the regulatory complications and a deep understanding of the overall impact on the carriers networks. The complexities of such decisions should not be underestimated and where possible, airlines should base decisions on robust analysis from industry-leading tools and specific expertise if necessary.