Why airlines need investors in high places3 min read . Updated: 06 Nov 2014, 12:48 AM IST
The rising number of minority stakes confirms that these are a smart way to get around the constraints that have been stifling the industry's development
In almost every industry, the ebb and flow of consolidation is constant. Mergers or acquisitions might mean more growth for the companies involved, but for other companies, it represents a competitive threat. Rivals will start looking for their own merger and acquisition opportunities, and before you know it, the face of the industry has changed.
But consolidation of this sort can be a force for good. It brings growth (and associated economies of scale) and the chance to review business efficiency. Smarter, leaner businesses can invest in new products and can pass cost savings on to their customers. Everyone wins.
I did say almost every industry. In the past 50 years, airlines have been the one glaring exception to this generally positive practice.
As so often in business, this is down to the law of unintended consequences. After the Second World War, national governments worked to create a regulatory framework for the fledgling national airline industry. It was decided that air travel would be governed by a series of bilateral agreements between national governments, the capacity of the regulating market and other factors.
But what was good for a new industry finding its way in the 1940s and ’50s is not so useful now. The unintended consequence of the bilateral agreements is now a very real bar to the type of consolidation that has happened across ever major global industry, and which is necessary to ensure sustainability and commercial success.
The good thing about business, though, is that it always finds a way. Airlines, unable to merge or acquire in the traditional way, have found new strategies for working together. The first wave of innovation was the code share, which is where airlines join forces for marketing purposes, doubling their virtual networks. It allows a traveller to fly from Cochin to Abu Dhabi with one airline, then from Abu Dhabi to London with another, on tickets that were marketed and sold as one seamless product.
The success of code shares led to a global alliance, with airlines coming together in increasingly formal groups to market code share routes. They also offered shared facilities, such as airport lounges and frequent-flier benefits. Now, we are seeing a third wave of this cooperative development: minority equity investments.
Airlines are moving beyond the sales-centric focus of the alliances and looking at how to make the cost and business savings traditionally found in full-on mergers and acquisitions.
The model is gaining traction: a quick online search flags up around 50 minority investments in the airline sector, from long-established airlines such as Lufthansa (whose considerable investments help to reinforce its European dominance) and Qantas (which has invested in Jetstar Asia and Jetstar Japan), through to the newer carriers such as Virgin Group, which has holdings in AirAsia X.
It is a model that Etihad Airways has embraced. As a very new national carrier, just over a decade old, its industry-leading rates of organic growth are still not enough to catch up with the long-established legacy airlines and their alliances. We at the company are proud of what we have achieved in a short space of time, but we are still tiny compared with, say, Lufthansa—and even tinier compared with the might of Star Alliance.
So, Etihad too has chosen to use minority stakes as a way to spur growth and add value for consumers. These investments, such as our share in Jet Airways, now reach into strategic markets around the world.
Minority equity investments require a different mindset. The skin in the game brings a greater shared commitment to getting things done, but this takes management teams and workforces with the desire to find collaborative ways of working.
The key driver in everything becomes the customer offer. Airlines are scale businesses, and nowhere is this more true than in network choice. Customers want airlines that fly them to all destinations, so the bigger the network, the more destinations are available. When two airlines align to time stop-overs and connections more conveniently, the benefit to customers is significant. If, as an airline, you can manage all that while combining procurement actions and sharing the many significant capital costs, the business benefits can also be significant.
The rising number of minority stakes confirms that these are a smart way to get around the constraints that have been stifling the industry’s development. These are not constraints that are likely to change much in our lifetime, so minority investment looks set to grow.
Flying in formation doesn’t just look good at air shows; in the business world too, airlines’ abilities to synchronize is the key to success.
James Hogan is president and chief executive officer of Etihad Airways. He is a co-chair of the Indian Economic Summit 2014, which takes place on 4-6 November in New Delhi.