Have you ever wondered why Airlines focus so much on alliances and codeshare networks especially in the last few years?
Would it seem more rational to keep profits in house rather than allowing them to go to other networks?
The answer is “it depends.”
We usually think of financially using leverage as a way to accomplish more with less of our own money and more of someone else’s money.
Hence, if you wanted to start a lawnmower business – You could take 100$ of your own money and use that as collateral to borrow an additional $100 and have enough to buy a 200$ lawnmower to start generating income in a way you couldn’t with the original 100$. (Obviously there would be a payment.) Leverage financially can be a powerful tool just like a lever or other tool allows us to use our existing strength ( $100 ) to produce much more. For instance most normal human beings wouldn’t consider pulling a nail out with their bare fingers. Instead we use the leverage provided by a hammer to increase the productivity of our limited strength to accomplish more.
In the airline world there’s more than one type of leverage just like in our personal lives there’s more than one type of leverage. We may have mechanical leverage in the form of tools in our garage or financial leverage in the form of our mortgage, auto loans or even educational loans.
The airlines use financial leverage in the form of debt or equity offerings that allow them to build financial and physical capital in order to accomplish more than they could without that leverage. Some airlines and businesses lean more towards debt based leverage and others lean towards equity based leverage. The cost can be different depending upon the economic environment. (Which is best based upon different circumstances is a conversation for another post!)
Often times Airlines may use different financial levers depending upon the stage they are in and what makes more sense.
So let’s get back to network carriers and their codeshare partners and how they are related to leverage. With the vast network provided by most of the major airlines today there’s a strong financial incentive to develop, strengthen and feed those networks. That’s the inherent strength in a network Carrier, they are able to take someone in a small city like Savannah Georgia and place them in Boise Idaho. Most of the non-network carriers simply cannot do this. A network carrier increases their strength as they grow the network profitably.
How do they grow their network? An option includes borrowing money to purchase more airplanes, hire employees and build the infrastructure to support and develop additional routes. This is expensive but there are advantages with this type of growth,
- the airline gets the advantage of branding that network and
- capturing the majority of the profits generated by the additional route.
So what happens when an airline has reached a point where it’s no longer comfortable issuing/keeping more equity or debt. Airlines can use partnerships with other carriers to leverage its existing network and the network and equipment of the other airline.
So as an example, we saw recently LATAM withdraw from the one world alliance and the move towards a Delta codeshare. While this may not affect American much since they didn’t have much traffic from that network it does remove the ability for American to leverage the wide-body and network Capital to supplement Americans South American network. We saw American relatively quickly announce additional frequency on many of the routes the LATAM was flying. These were aircraft that American could have used on other profitable routes, or aircraft they would now have to use their capital resources to purchase to make up for the loss of widebody flying to South America.
On the flipside this allowed Delta to leverage LATAMs widebody fleet to expand their network in South America without needing to buy additional capital. Granted this leverage was not cheap for Delta as they spent $1.9 billion (mostly financed by debt) to purchase a stake in LATAM.
There are pros and cons, Delta did gain leverage in South America which helps them keep their existing fleet on other routes which may be more profitable for those aircraft for now. This did come at the cost of $1.9 billion of debt but it will provide them important intelligence as they try to develop a larger network in South America.
On the flipside it’s not all negative for American. With the GOL partnership American will still have access to a large domestic network in South America to feed into Americans network. The catch is American will need to use aircraft it could have been using on other routes to make up for the loss of widebody leverage in their partner. Having said this the benefit for the employee groups at American are obvious as American takes on the majority of the international and widebody flying to South America. Opening up greater opportunity for job growth and progression for American’s employees as American will need to grow its capital to make up for the loss of the LATAM assets.
As a summary – effective network partnerships allow airlines to expand their reach without using existing capital that may be being used in more profitable ventures. It provides exposure to certain markets with limited risk, which allows them to virtually develop markets without the heavy use of capital, until they are more confident in the markets success. The synergy’s developed by a partnership are highly dependent on the right partnerships.
Similarly the right partnerships produce more opportunity for an airlines employees while the wrong partnership may not.
