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Three lions go roaring on

Posted 28 April 2017 · Add Comment

The Middle East Three – or ME3, a common collective term for Qatar Airways, Etihad Airways, and Emirates – are on a roll, as Lufthansa Consulting's Guillaume Schmitt and Arvind Chandrasekhar report.


n the course of summer 2016, Qatar announced it would take a 10% stake in the LATAM Airlines Group, – the deal completed in January – acquire a 49% shareholding in Meridiana and raise its stake in IAG to 20%. Etihad confirmed it would invest further in Virgin Australia in order to maintain its 22% stake and strengthen its foothold in the Americas by entering into codeshare agreements with Air Canada and Avianca. Emirates, which announced a number of changes to capacity deployment across its network (including several new A380 routes), set up a new codeshare agreement with Copa Airlines, while expanding cooperation with codeshare partners Malaysian Airlines and WestJet.
As the share of global traffic carried by the ME3 continues to rise, it is instructive to see how each of these airlines has pursued breakneck growth.
The manner in which these airlines have expanded their global presence over the last decade is remarkable. There are two clear components: organic growth (from a collective 2.1 billion available seat kilometres (ASKs) and 80 destinations in 2005 to 10.9bn ASKs and 175 destinations in 2015); and inorganic growth, which encompasses a variety of partnership models within the global airline ecosystem.
The simplest of these inorganic options is interline or codeshare agreements, typically with small carriers serving a network of secondary cities or large carriers that can provide significant feed. More complex, however, is the wide swathe of ‘higher order’ relationships, such as joint ventures, strategic agreements and equity investments these airlines have undertaken to accelerate expansion.
As airlines around the world increasingly pursue such relationships, it is interesting to note how the ME3 have chosen to follow approaches distinct from each other and, in doing so, have begun to upend the traditional view of alliances and build cross-alliance bridges.
The partnership visualisation (shown in graphic form) puts into perspective the nature of the ME3’s engagement with other airlines and alliances. Each node represents an airline (where size reflects the ASKs it flies) and the connectors indicate a relationship between airlines weighted by the depth of the relationship.
In particular, it highlights the distinct approaches favoured by each ME3 airline: Emirates has been very selective in pursuing partnerships, while Etihad has built a dense network of partnerships that bridge alliances and Qatar has strongly embedded itself in the Oneworld ecosystem.
It should be noted that the image does not reflect a geographic network map; the relative position of an airline arises from the strengths of the different relationships it has built with other airlines.
Emirates, a pioneer of the aggressive international hub-and-spoke model built on the geographic advantages of the Middle East, has achieved growth largely through organic expansion. This is in keeping with its long-standing positioning vis-à-vis legacy carriers. Where necessary, codeshares or interline agreements have been established to ensure feed at vulnerable points in its network – the relationship with JetBlue in the US being a prime example.
The airline recently established two large strategic agreements, with Qantas (May 2013) and Malaysia Airlines (December 2015). These arose from situations where the partner faced severe financial and strategic pressure, and chose to align with Emirates to achieve broader access to lucrative markets in Europe and elsewhere by funnelling traffic through Dubai, while optimising capacity to more profitable ‘core’ markets – Southeast Asia for Malaysia Airlines, and Asia and the US for Qantas.
Interestingly, both are members of Oneworld, but saw more value in partnering with Emirates rather than with alliance members; Emirates’ strong connectivity through Dubai and the airline’s dominant market position clearly encourage opportunistic extra-alliance cooperation.
Etihad, being the last of the ME3 to launch, needed to rapidly build scale to emerge as a viable alternative in the congested Middle Eastern hub-and-spoke environment. Alongside ambitious organic growth, therefore, Etihad has relied heavily on inorganic growth – extensive codeshare agreements to build network scale complemented by strategic agreements (with Air France-KLM, for example) and equity investments in airlines around the world. In effect, this has allowed Etihad to build a global presence at significantly lower cost than an organic rollout.
The endgame was the establishment of the Etihad Airways Partners (‘EAP’) alliance in 2014, an independent Etihad-centric alliance of eight airlines collaborating on network and commercial deployment. EAP also ensures sharing of best practices and resources across the alliance, as evidenced by aircraft from Jet Airways and crew expertise from Alitalia being used to launch Air Serbia’s transatlantic service.
Remarkably, Etihad’s assertive partnership strategy seeks to extract synergies with prominent members of global alliances such as Alitalia, Air France-KLM (SkyTeam) and Airberlin (Oneworld). This, with Etihad’s extensive codeshares with Star Alliance members, allows the airline to create ‘bridges’ across alliances.
Qatar, from its relaunch in 1997, initially pushed for aggressive organic growth comparable to the Emirates’ hub-and-spoke model operations before shifting to broader cooperative structures.
It surprised the industry in 2013 by joining Oneworld, becoming the first ME3 carrier in a global alliance.
Qatar is now well embedded in the Oneworld ecosystem, with a majority of its equity or strategic partnership activities linked to alliance members. It has also signed a strategic agreement with Royal Air Maroc to broaden its access to central and west Africa.
Of more interest in recent times, however, have been the equity investments – mentioned earlier – in IAG and LATAM Airlines Group (20% and 10% stake, respectively), both of which are large Oneworld partners. This cements existing alliance relationships and offers room to explore further cooperation that could deliver financial, commercial and strategic value.
Although it is yet unclear exactly how Qatar will act on these investments, they are likely to generate significant value by increasing Qatar’s grasp on strategic positions (transatlantic routes and major European hubs with IAG, and the competitive South American market with LATAM). These are, of course, in addition to the basic financial benefits from stock appreciation.
However, the recent investment in Meridiana and a possible investment in Royal Air Maroc indicate a potential pivot to an Etihad-like model based on turning around a smaller airline with close operational and commercial synergies.
The nature of the ME3 airlines’ growth through partnerships provides several insights to the industry and some indication of how this may evolve further.
Scale and profitability are twin drivers for evolving cooperation models. The global ambitions of the ME3, particularly Etihad and Qatar as they play catch-up with Emirates, are causing them to increasingly penetrate the global ecosystem of relationships for inorganic growth. The objective has clearly been to achieve market access at a reasonable cost – an impulse that will continue as competition intensifies. Carriers around the world seek the opportunity for financial, commercial and strategic benefits from ME3 partnerships through joint value creation.
There is, prima facie, a case for mutual value addition by ME3 alliance membership. Qatar has seen a strong rise in traffic through Oneworld partners, and the addition of Qatar has allowed Oneworld an expanded footprint into areas of relative weakness, such as the Middle East, South Asia and Africa.
Etihad is generating strong revenue flows from, and to, EAP partners and drawing ever closer to SkyTeam.
There is, however, a possibility that alliance structures might prove to be restrictive for the ME3 in the light of their independent expansionary aspirations, as evidenced by occasional reports of tensions between Oneworld members Qatar and American Airlines.
Traditional alliances are not going away anytime soon, although emergent parallel alliances/partnerships will distort the ecosystem.
There are still strong commercial and operational incentives to alliance membership; the majority of the world’s most heavily trafficked routes remain the domains of key alliance members and their joint ventures (JVs).
While there may be some conflicts within alliances, the cost and complexity of exiting alliances will give airlines pause. Airlines not already in an alliance, though, may choose to keep their options open.
Extended ME3-centric alliances or partnerships, building on network scalability and commercial alignment, are likely to provide viable alternatives to existing alliances for some airlines and passengers. The ME3 have steadily built these alternate spheres of influence to capture increasing passenger flows.
Carriers are drifting towards engagement with the ME3 outside alliances, and will continue to pursue opportunistic, multi-pronged cooperation agreements. In many cases, a carrier’s decision to partner with an ME3 airline may arise from a ‘if you can’t beat them, join them’ position – Emirates’ strategic agreements being prime examples. In others, the ME3 airline might play the role of a white knight, as in the case of Etihad’s investments.
While there is a clear value for both parties in such agreements, the ME3 often engage from a position of strength, backed by strong network connectivity and financial resources.
In general, airlines will continue to seek profitable growth, even if that entails acting ‘outside’ traditional forms of cooperation such as alliances, in consort with the ME3.
Should margins come under pressure again in the coming years, there will be an even stronger incentive to pursue partnerships to sustain momentum. Carriers will enter multiple relationships to cover all commercial and strategic bases optimally.
The current trend of elevating partnerships from codeshares to JVs, strategic agreements and equity engagements, will continue apace across the industry, with the ME3 being equally opportunistic in taking advantage of market developments.
This will strain traditional alliance structures and relationships. Qantas scaled back long-standing relationships with British Airways at Singapore and Cathay Pacific at Hong Kong in favour of a partnership with Emirates through Dubai.
Carriers are, thus, clearly seeking a strategic and operational path that is likely to generate the most sustainable profit over and above, or in addition to, alliance considerations.
By offering deeper cooperation outside the alliances (within which most legacy airlines’ JVs still reside), the ME3 are creating parallel spheres of influence. Etihad, in particular, will continue to effectively ‘bridge’ members across alliances.
Equity investment further deepens the ME3’s impact on alliances, and will continue to grow as a vehicle for expansion.
While the ME3 are not the only active dealmakers, the scale and breadth of Qatar and Etihad’s investments increase their penetration into key alliance members and raise their ability to drive the targets’ commercial and strategic moves more substantially in order to support or strengthen an ME3-centric model.
An equity stake also allows an investor to capture additional value through appreciation in the target’s stock price or enterprise value – upside that would otherwise be ‘lost’ to the shareholders of the target. In general, these airlines will expect equity investments to deliver value across three dimensions: financial (growth in enterprise/stock value), commercial (access to valuable and/or growing markets through preferred partnerships) and strategic (greater synergies and mutual benefits).
Global competition – including equity investments by American and Chinese carriers – will spur further investment to lock in strategic assets across the industry, particularly those that provide a strong regional presence and feed. This will also encourage more distressed regional airlines, or their governments, to actively court ME3 capital and restructuring support.
For an industry constantly in flux, these are particularly exciting times. With profit margins soaring, global traffic rising and ever more capacity coming into the market, many airlines will seek partnerships for growth and sustainability. And the ME3, with their global ambitions, strong connectivity and financial strength, will undoubtedly have a significant role to play in the evolution of the industry.

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